ARRIS GROUP, INC.

10-K 1 g93897e10vk.htm ARRIS GROUP, INC. ARRIS GROUP, INC.

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2004

ARRIS GROUP, INC.

A Delaware Corporation

IRS Employer Identification No. 58-2588724

SEC File Number 000-31254

3871 Lakefield Drive

Suwanee, GA 30024

(770) 622-8400

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

None

Securities registered pursuant to section 12(g) of the Act:

Common stock, $0.01 par value

Preferred Stock Purchase Rights

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

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

ARRIS Group, Inc. is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

The aggregate market value of ARRIS Group’s Common Stock held by non-affiliates as of June 30, 2004 was approximately $515.1 million (computed on the basis of the last reported sales price per share of such stock of $5.94 on the Nasdaq National Market System). For these purposes, directors, officers and 10% shareholders have been assumed to be affiliates. As of February 28, 2005, 87,717,872 shares of the registrant’s Common Stock were outstanding.

Portions of ARRIS Group’s Proxy Statement for its 2005 Annual Meeting of Stockholders are incorporated by reference into Part III.

TABLE OF CONTENTS


		Page

	PART I
ITEM 1.	Business		1
ITEM 2.	Properties		15
ITEM 3.	Legal Proceedings		16
ITEM 4.	Submission of Matters to a Vote of Security Holders		16
ITEM 4A.	Executive Officers and Board Committees		16
	PART II
ITEM 5.	Market for Registrant’s Common Equity and Related Stockholder Matters		18
ITEM 6.	Selected Consolidated Historical Financial Data		18
ITEM 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
ITEM 7A.	Quantitative and Qualitative Disclosures About Market Risk		54
ITEM 8.	Consolidated Financial Statements and Supplementary Data		55
ITEM 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure		55
ITEM 9A.	Controls and Procedures		55
	PART III
ITEM 10.	Directors and Executive Officers of the Registrant		96
ITEM 11.	Executive Compensation		96
ITEM 12.	Security Ownership of Certain Beneficial Owners and Management		96
ITEM 13.	Certain Relationships and Related Transactions		96
ITEM 14.	Principal Accountant Fees and Services		96
	PART IV
ITEM 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K		97
ITEM 15(a).	Index to Consolidated Financial Statements and Financial Statement Schedules		97
	Signatures		101
EX-23 CONSENT OF ERNST & YOUNG LLP
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

PART I


Item 1.	*Business*

As used in this Annual Report, “we,” “our,” “us,” “the Company,” and “ARRIS” refer to Arris Group, Inc. and our consolidated subsidiaries, including Arris International, Inc. (formerly ANTEC Corporation) and Arris Interactive L.L.C., unless the context otherwise requires.

General

Our principal executive offices are located at 3871 Lakefield Drive, Suwanee, Georgia 30024, and our telephone number is (770) 622-8400. We also maintain a website at www.arrisi.com. On our website we provide links to copies of the annual, quarterly and current reports that we file with the Securities and Exchange Commission, any amendments to those reports, and all press releases. Copies of our codes of ethics and the charters of our board committees also are available on our website. We will provide copies of these documents in electronic or paper form upon request to Investor Relations, free of charge.

Glossary of Terms

Below are commonly used acronyms in our industry and their defined terminology:


Acronym		Terminology

CAM		Cable Access Module
CBR		Constant Bit Rate
CMTS		Cable Modem Termination System
CPE		Customer Premises Equipment
DBS		Digital Broadcast Satellite
DMTS		Digital Multimedia Termination System
DOCSIS		Data Over Cable Service Interface Specification
DSG		DOCSIS Set-Top Gateway
E-MTA		Embedded Multimedia Terminal Adapters
HDT		Host Digital Terminal
HFC		Hybrid Fiber-Coaxial
ILEC		Incumbent Local Exchange Carrier
IP		Internet Protocol
MSO		Multiple Systems Operator
NGNA		Next Generation Network Architecture
NIU		Network Interface Units
RF		Radio Frequency
VoIP		Voice over Internet Protocol
VPN		Virtual Private Network

Industry Overview

We develop and supply equipment and technology for cable system operators and other broadband service providers that allow them to deliver a full range of integrated voice, video and data services to their subscribers. Further, we are a leading supplier of infrastructure products used by cable system operators in the build-out and maintenance of hybrid fiber-coaxial, or HFC, networks.

We provide our products and equipment principally to the cable television market and, more specifically, to operators of multiple cable systems, or MSOs, on a worldwide basis. In recent years, the technology used in cable systems has evolved significantly. Historically, cable systems offered only one-way analog video service.

Due to technological advancements and large investments in infrastructure upgrades, these systems have evolved to become two-way broadband systems featuring high-speed, high-volume, interactive services. MSOs have aggressively upgraded their networks to cost-effectively support and deliver enhanced video, voice and data services. As a result, cable operators have been able to use broadband systems to increase their revenues by offering enhanced interactive subscriber services, such as high-speed data, telephony, digital video and video on demand, and to effectively compete against other broadband communications technologies, such as digital subscriber line, local multiport distribution service, direct broadcast satellite, fiber to the home, and fixed wireless. Delivery of enhanced services also has helped MSOs offset slowing basic video subscriber growth, reduce their subscriber churn and compete against alternative video providers; in particular, digital broadcast satellite, or DBS.

A key factor supporting the growth of broadband systems is the powerful growth of the Internet. Rapid growth in the number of Internet users, their desire for ever higher internet access speeds, and more high-volume interactive services has created demand. Another key factor supporting the growth of broadband systems is the evolution of video services being offered to consumers. Video on demand and high definition television are two key video services expanding the use of MSOs’ broadband systems. The increase in volume and complexity of the signals transmitted through the network and emerging competitive pressures from telephone companies with digital subscriber line and fiber to the premises offerings are pushing cable operators to deploy new technologies as they evolve. Further, cable operators are looking for products and technology that are flexible, cost effective, easily deployable and scalable to meet future demand and mix of services. Because the technologies are evolving and the signals are growing in complexity and volume, cable operators need equipment that provides the necessary technical capacity at a reasonable cost at the time of initial deployment and the flexibility to accommodate expansion and technological advances.

Capital spending by MSOs on their networks has shifted over the past several years. Cable operators have largely completed the upgrades and re-builds required to support advanced services and are now in the process of enabling those services. As a result, spending has shifted away from HFC plant equipment and materials to head-end and customer premises equipment that enable high speed data, telephony, and digital video services. According to Kagan (2003 report), the industry experienced a decline in overall capital expenditures during this transition period, dropping from an estimated $18.5 billion in 2001, to $14.2 billion in 2004. However, during this same period spending on telephony, high speed data, and digital video all grew substantially and is expected to continue to grow for the foreseeable future. Also, maintenance and extension spending has grown steadily, and is expected to continue growing because of the installed base of the more sophisticated equipment required to support the advanced services.

One of the fastest growing services is cable telephony. The data below is Yankee Group’s estimates for the U.S. market, and illustrates the expected growth in subscribers for this service. We expect that the international market for cable telephony should experience similar growth.

Cable telephony allows cable operators to offer their customers local and long distance residential telephone service. It is presently offered to cable operators using two distinct technologies: constant bit rate, or CBR, technology and Internet Protocol, or IP, technology. CBR technology utilizes the switched-circuit technology currently used in traditional phone networks. This is a proven carrier-class telephony solution that enables operators to directly compete with incumbent telephone carriers with voice services and class-features, which include caller ID, call-waiting and three-party conferencing. At the end of 2004, our Cornerstone® CBR cable telephone products served over 4.7 million subscriber lines deployed by 56 operators in 102 cities in thirteen countries. IP technology, also known as Voice over IP, or VoIP, permits cable operators to provide toll-quality cable telephony at costs below those associated with CBR technology. In 2004, deployment of VoIP technology began in earnest. We expect that the growth in VoIP will begin to slow deployment of data-only cable modems because the customer premises devices that support VoIP also offer high speed data access. We are a leading supplier of both headend and customer premises equipment for VoIP services over cable.

Data and VoIP services are governed by a set of technical standards promulgated by CableLabs® in North America and tComLabs in Europe, two industry standard-setting bodies. While the standards set by these two bodies necessarily differ in a few details in order to accommodate the differences in HFC network architectures between North America and Europe, they have a great deal in common. The primary data standard specification for cable operators in North America is entitled DOCSIS®. Release 2.0 of this specification is the current governing standard for data services in North America. The Euro-DOCSIS standard Release 2.0 is the same for Europe. DOCSIS 2.0 builds upon the capabilities of DOCSIS 1.1 and adds additional throughput in the upstream portion of the cable plant — from the consumer out to the Internet. In addition to the DOCSIS standards that govern data transmission, CableLabs has defined the

PacketCable® standard for VoIP. This standard defines the interfaces between network elements such as cable modem termination systems, or CMTS, multi-media terminal adapters, or MTA, gateways and call management servers to provide high quality IP telephony service over the HFC network.

To date, MSOs have offered digital television signals to subscribers using proprietary technologies offered by a limited set of vendors, led by Scientific-Atlanta and Motorola, principally. The technologies that have enabled high-speed data and VoIP across the cable plant are, with modification, also applicable to video. MSOs are beginning to investigate Video over IP as an alternative and are engaging the vendor community, including ARRIS, in discussions. The advantage to the operator is to migrate to one common backbone/ technology for all services, and to eliminate proprietary video technology. We are actively developing products to compete in the emerging Video over IP market.

Our Principal Products

A broadband cable system consists of three principal components:


	•	Headend. The headend is a central point in the cable system where signals are received via satellite and other sources. Interfaces that connect the Internet and public switched telephony networks are located in the headend. The headend facility organizes, processes and retransmits those signals through the distribution network to subscribers.

	•	Distribution Network. The distribution network consists of fiber optic and coaxial cables and associated optical and electronic equipment that allocates the combined signals from the headend and transmits them throughout the cable system to nodes.

	•	Subscriber Premises. Cable drops extend from nodes to subscribers’ homes and connect to a subscriber’s television set, converter box, telephony network interface device or computer modem.

We provide cable system operators with a comprehensive product offering. We divide our product offerings into two categories:


Broadband:		• CBR telephony products, including HDTs in the headend and NIUs at the subscriber premises

		• VoIP telephony products, including CMTS

		• High-speed data products, including CMTS

		• Operational support systems

		• System integration services

Supplies & CPE:		• Infrastructure products for fiber optic or coaxial networks built under or above ground, including cable and strand, vaults, conduit, drop materials, tools, connectors, and test equipment

		• Subscriber cable modems and E-MTAs


	Voice over IP and Data Products

Headend — The heart of a Voice over IP headend is a cable modem termination system, or CMTS. A CMTS, along with a call agent, a gateway, and provisioning systems provide the ability to integrate the public-switched telephone network and high-speed data services over an HFC network. The CMTS provides the software and hardware to allow the IP traffic from the Internet or that used in VoIP telephony to be converted for use on HFC networks. It is also responsible for initializing and monitoring all cable modems connected to the HFC network. We provide two products that are used in the cable operator’s headend to provide VoIP and

high-speed data services to residential or business subscribers. These are the Cadant® C4 CMTS, and the Cadant C3 CMTS:


	•	The Cadant C4 CMTS is a high density, chassis-based product that provides flexible built-in redundancy to ensure carrier-grade performance. It is PacketCable 1.0, DOCSIS 2.0 and Euro-DOCSIS 2.0 qualified. Each chassis supports up to 32 downstream channels and 192 upstream channels. Three C4 chassis can be installed in a single seven foot tall cabinet, making it one of the highest density scalable headend products currently available. It can provide high-speed data and VoIP services in headends that service thousands to hundreds of thousands of subscribers. The C4 is deployed by cable operators in North America, Europe, Latin America, and Asia.

	•	The Cadant C3 CMTS is a rack mounted, single downstream-based product that provides high performance packet handling in an extremely compact package. It is DOCSIS 2.0 and Euro-DOCSIS 2.0 qualified. Each unit supports one downstream channel and up to 6 upstream channels with a selectable choice of modulation schemes. The C3 supports markets worldwide with DOCSIS, Euro-DOCSIS and Japanese DOCSIS parameters that are selectable via software. The C3 is in wide use in North America, Europe, and Asia.

Subscriber Premises — Subscriber premises equipment includes DOCSIS 2.0 certified cable modems for high-speed data applications as well as Euro-DOCSIS certified versions and PacketCable Certified E-MTAs for VoIP applications in both DOCSIS and Euro-DOCSIS networks. The PacketCable solution builds on DOCSIS 1.1 and its quality of service enhancements to support lifeline telephony deployed over HFC networks. Our Touchstone^tm product line provides carrier-grade performance to enable operators to provide all data, telephony and video services on the same network using common equipment. The Touchstone product line consists of the Touchstone 450 series of cable modems, the Touchstone 402 series of telephony modems for indoor applications and the Touchstone Telephony Port 30x for outdoor deployments.


	•	The Touchstone CM450A Cable Modem is DOCSIS 2.0 certified, which gives operators the potential to offer much higher upstream data rates. DOCSIS 2.0 is backward compatible with DOCSIS 1.0 and 1.1 headend systems. The Touchstone 450B Cable Modem provides the same features as the CM450A but is Euro-DOCSIS certified. The Touchstone 450C Cable Modem provides the same features as the CM450A but is compatible with Japanese standards. ARRIS also manufactures cable modems that have been homologated in other countries, including Chile, Argentina, Israel, Australia, Hong Kong, and Korea.

	•	The Touchstone TM402A is a PacketCable and DOCSIS 2.0 indoor E-MTA that supports enhanced services of high-speed data and up to two lines of IP telephony in a single unit. The TM402A’s innovative, compact design provides for easy installation. This product is also available in a Euro-DOCSIS version, the Touchstone TM402B, as well as one designed specifically for the unique frequency plan of Japanese cable systems, the Touchstone TM402C. The Touchstone TM402P is a PacketCable and DOCSIS 2.0 certified E-MTA that provides all of the features of the TM402A with the added benefit of an innovative, integrated lithium-ion battery back-up system enabling the service provider to guarantee service in the event of a power outage. This allows them to compete directly with the incumbent local exchange carrier, or ILEC. This is also available in a Euro-DOCSIS version, the Touchstone Telephony Modem 402Q. This line was the first product on the market to incorporate lithium-ion battery technology. The resulting product, the Touchstone TM402P, provides extended battery back-up time over older lead-acid battery designs.

	•	The Touchstone Telephony Port 302A/ 304A are rugged, environmentally-hardened outdoor E-MTAs that provides high-speed data access and two (TP302A) or four (TP304A) lines of carrier-grade VoIP for service providers wishing to maintain the demarcation point on the outside of the residence. This allows them to more closely parallel the deployment model used by ILECs, which makes service and maintenance easier over the long term.

	•	We expect to introduce the Touchstone Telephony Port 402A/ 404A in 2005. This is the next generation of the outdoor E-MTA line with DOCSIS 2.0 compatibility.


	Constant Bit Rate Products

Headend — We market our headend equipment under the brand name of Cornerstone Voice^tm. Cornerstone Voice products for the headend include host digital terminals, or HDTs. An HDT is the device that provides the interfaces, controls and communication channels between public-switched networks and the HFC network. Because the Cornerstone Voice system is easy to implement, economical and scalable, network operators can offer telephony at low initial penetration levels and expand as customer demand increases. We design this equipment to meet the strict performance and reliability specifications, and demanding environmental requirements expected of a lifeline, carrier-class residential telephone service. This reliability and robust design enables our customers to compete with the incumbent local telephone company with an equivalent, and often superior, service offering.

Subscriber Premises — The key equipment at subscriber premises is an NIU. We market our NIUs under the brand name Cornerstone Voice Port®. The Cornerstone Voice Port^tm is the most widely deployed CBR NIU. Voice Port units operate in conjunction with the Cornerstone HDT to provide cable telephony while also maintaining a subscriber’s existing video services. Operators who are also deploying high-speed data services, such as our Cornerstone, Cadant and Touchstone brands, may deploy cable modems inside the home or work premises and multiplex the data service signals onto the same HFC network as the Cornerstone Voice application. This combination of solutions provides subscribers with voice and high-speed data functionality from the same operator. The Voice Port portfolio includes a two-line single-family residence Voice Port NIU, a two-line indoor Voice Port NIU with an integrated backup battery, a four-line Voice Port NIU, and a twenty-four-line modular Voice Port NIU for multiple dwelling unit applications.


	Operational Support Systems

Operational support systems, or OSS, are a group of networked software suites that enable operators to automate many of the functions required to install, provision, manage and grow a subscriber base while managing, maintaining and upgrading the network for the multiple services offered. Without OSS automation, operators cannot manage subscriber growth and network operations effectively.

We are partnering with leading suppliers in the industry to provide operators with the ability to automatically provision headend and subscriber premises equipment to reflect subscribers’ parameters, provide key data for third-party billing software, and complete maintenance operations. We are an authorized value added reseller of C-Cor’s MetaServ^tm, which provides automated provisioning software for control of the call management server, gateways, CMTS and cable modems. MetaServ works with various billing and middleware software programs. We have strategic relationships with other equipment vendors to integrate existing Cornerstone software for CMTS and cable modem OSS functions. Operators are able to perform OSS functions across Cornerstone Voice and Cornerstone Data employing the Cadant CMTS and Touchstone product lines using a common OSS solution. The Cadant G2 IMS software supports configuration performance and fault management of the Cadant C4 CMTS through easy to use graphical user interfaces. A single Cadant G2 IM Server can support up to 100 Cadant C4 CMTS chassis and 20 simultaneous client applications.


	System Integration Services

We are a full service system integrator for converged services over HFC networks. We historically have been a pioneer in the voice and data over HFC business and have the experience and infrastructure in place to help operators launch these services. System integration offers the service provider a fully integrated solution that has been tested for end-to-end interoperability, performance, capacity, scalability, and reliability prior to ever being installed at the customer facility. We offer the operators coordination of the project management for the suppliers and solution assurance services for the long-term, including upgrade support, system audits, and configuration management. Our systems integration service enables operators to rapidly deploy new services on their networks with the assurance that all of the components of the network will interoperate seamlessly.


	Cable Plant Infrastructure Products

We offer a variety of products that are used by MSOs to build and maintain their cable plants. Our products are complemented by our extensive channel-to-market infrastructure, which is focused on providing efficient delivery of products from stocking or drop-ship locations.

We believe the strength of our products is our broad selection of trusted name-brand products and strategic proprietary lines and our experience in distribution. Our name-brand products are manufactured to our specifications by manufacturing partners. These products include taps, line passives, house passives and premises installation equipment marketed under our Regal brand name; MONARCH^tm aerial and underground plant construction products and enclosures; Digicon premium F-connectors; and FiberTel fiber optic connectivity devices and accessories. Through our product selection, we are able to address substantially all broadband infrastructure applications, including fiber optics, outside plant construction, drop and premises installation, and signal acquisition and distribution.

We also resell products from hundreds of strategic supplier-partners, which include widely recognized brands to small specialty manufacturers. Through our strategic supplier-partners, we also supply ancillary products like tools and safety equipment, testing devices and specialty electronics.

Our customers benefit from inventory management and logistics capabilities and services. These services range from just-in-time delivery, product “kitting,” specialized electronic interfaces, and customized reporting, to more complex and comprehensive supply chain management solutions. These services complement our products offerings with advanced channel-to-market and logistics capabilities, extensive product bundling opportunities, and an ability to deliver carrier-grade infrastructure solutions in the passive transmission portions of the network. The depth and breadth of our inventory and service capabilities enable us to provide our customers with single supplier flexibility.

Sales and Marketing

We are positioned to serve customers worldwide with both a sales force organization and supporting sales engineering team. The sales organization is divided to allocate resources to the top MSOs worldwide while others are committed to addressing the general supplies requirements that are common across all customers. We maintain sales offices in Georgia, Colorado, Pennsylvania, Ireland, Chile, Japan, Hong Kong, Spain, and the Netherlands. Additionally, we have partnership agreements in a variety of countries and regions with value-added resellers, or VARs, which extend our sales presence in markets without established sales offices.

We also maintain an inside sales group that is responsible for regular phone contact, prompt order entry, timely and accurate delivery and effective sales administration for the many changes frequently required in any substantial rebuild or upgrade activity. In addition, the sales structure includes sales engineers and technicians that can assist customers in system design and specification and can promptly be on site to resolve any problems as they arise during a project.

Our marketing and product management teams focus on each of the various product categories and work with our engineers and various technology partners on new products and product enhancements. These teams are responsible for inventory levels and pricing, delivery requirements, analyzing market demand and product positioning and advertising.

We are committed to providing superior levels of customer service by incorporating innovative customer-centric strategies and processes supported by business systems designed to deliver differentiating product support and value-added services. We have implemented advanced customer relationship management programs to bring additional value to our customers and provide significant value to our operations management. Through these information systems, we can provide our customers with product information ranging from operational manuals to the latest in order processing information. Through on-going development and refinement, these programs will help to improve our productivity and enable us to further improve our customer-focused services.

Customers

The majority of our sales are to cable system operators worldwide. We also sell products to traditional telephone companies, local exchange carriers, competitive local exchange carriers, and other businesses. Our broadband products can be deployed not only by cable system operators, but also by traditional telephone companies, electric utilities and others. As the U.S. cable industry continued a trend toward consolidation, the six largest MSOs controlled over 85% of the U.S. cable market (according to Dataxis in Q3 2004), thereby making our sales to those MSOs critical to our success.

Our sales are substantially dependent upon a system operator’s selection of our equipment, demand for increased broadband services by subscribers, and general capital expenditure levels by system operators.

Our three largest customers are Comcast, Cox Communications, and Liberty Media International (including its affiliates). Our sales to these customers for 2004, 2003, and 2002 were:


		Years Ended December 31,

		2004			2003			2002

		(in millions)
Comcast		$	108.2		$	136.6		$	250.2
	% of sales		22.1	%		31.5	%		38.4	%
Cox Communications		$	106.3		$	104.3		$	106.7
	% of sales		21.7	%		24.0	%		16.4	%
Liberty Media International and affiliates		$	81.7		$	46.9		$	67.4
	% of sales		16.7	%		10.8	%		10.3	%

No other customer provided more than 10% of total sales for the years ended December 31, 2004, 2003, or 2002.

Although with some of our customers we have general purchase agreements, the vast majority of our sales, to both those that have agreements and to our remaining customers, result from purchase orders or other short-term commitments. A summary of the key terms of the general purchase agreements with Comcast, Cox Communications and Liberty Media International is as follows:


	Comcast. We have non-exclusive agreements with Comcast to supply C4 CMTS units and parts and to sell cable television supplies for two-year terms expiring in March 2005. We are currently in negotiations with Comcast to renew or extend the contract; however, Comcast is expected to continue to buy on a purchase order basis in the interim. Commercial terms include a requirement to supply product based on Comcast forecasts (updated quarterly), most favorable pricing as compared to similarly-situated companies, and specific delivery lead times with penalties for late delivery and warranty terms ranging from one to five years depending on the product. Included in one of these purchase agreements is a service level agreement structured to provide Comcast service assurance by providing credits for any delinquent response to service needs with special escalation guidelines for the C4 CMTS. To date, no penalties have been incurred. Comcast is not obligated to make any purchases.

	Cox Communications. We have an exclusive agreement with Cox Communications to supply Cornerstone Voice and Touchstone Telephony products and services at favorable pricing based on volume commitments. The agreement has a five-year term ending on July 31, 2007. Commercial terms include payment and delivery terms, a five-year warranty, penalties for delivery shortfall and delinquent performance guarantees. To date, no penalties have been incurred. Cox Communications is not obligated to make any minimum purchase commitments. In January 2005, we entered into a letter of intent with Cox Communications in which Cox committed to purchase Cornerstone Voice Ports and agreed to purchase Touchstone E-MTAs exclusively from ARRIS for period of eighteen months in exchange for more favorable pricing.

	Liberty Media International. We have a non-exclusive agreement with Liberty Media International to supply our entire line of products for a three-year term expiring in April 2007. Commercial terms include a requirement to supply product based on Liberty’s forecasts (updated quarterly), most favorable

pricing as compared to similarly-situated companies, and specific delivery lead times with penalties for late delivery and warranty term of two years.

Because of their financial circumstances and other issues, our future sales to Adelphia and Cabovisao, historically two of our larger customers, are uncertain. Sales to these two customers for 2004, 2003, and 2002 are set forth below:


		Years Ended December 31,

		2004			2003			2002

		(in millions)
Adelphia Communications		$	14.8		$	14.1		$	25.9
	% of sales		3.0	%		3.2	%		4.0	%
Cabovisao		$	2.7		$	0.7		$	39.1
	% of sales		0.5	%		0.2	%		6.0	%

Sales to Adelphia decreased during the second quarter of 2002 as a result of Adelphia’s financial troubles, which ultimately resulted in a bankruptcy filing in June 2002. As a result, in June 2002, we established a bad debt reserve of $20.2 million in connection with our accounts receivable from Adelphia. In the third quarter of 2002, we sold a portion of our Adelphia accounts receivable to an unrelated third party, resulting in a net gain of approximately $4.3 million. Sales in 2003 to Adelphia decreased from 2002 as a result of their bankruptcy. The company has taken initial steps to restructure itself through its bankruptcy proceedings, including obtaining debtor in possession financing. We have extended commercially reasonable credit terms to Adelphia subsequently, and they have consistently paid us within those terms. At the end of 2004, Adelphia owed us approximately $0.9 million. We are uncertain whether Adelphia will be successful with its financial restructuring or what impact, if any, this may have on our future relationship with them.

Cabovisao, a Portugal-based MSO, accounted for approximately 6% of our total sales in 2002. As of November 18, 2003, Cabovisao owed us approximately $20.6 million in accounts receivable, all of which was past due. Cabovisao and its parent company, Csii, are in the process of restructuring their financing. On June 30, 2003, Csii filed for court-supervised restructuring and recapitalization in Canada. In 2003 and 2002, we reserved $8.7 million and $3.6 million, respectively, for our Cabovisao receivable. On November 18, 2003 we sold our accounts receivable due from Cabovisao to an unrelated party for $10.1 million, and as a result, recorded a gain with respect to our reserves for doubtful accounts of $1.5 million in the fourth quarter of 2003. Csii is continuing its restructuring efforts. We have and will continue to sell product to Cabovisao on “cash with order” terms. We are uncertain what effect these developments will have on our future relationship with them.

Research and Development

We are committed to the development of new technology and rapid innovation in the evolving broadband market. New products are developed in our research and development laboratories in Suwanee, Georgia, Cork, Ireland, and Lisle, Illinois. We form strategic alliances with world-class producers and suppliers of complementary technology to provide “best-in-class” solutions focused on “time-to-market.”

Research and development expenses in 2004, 2003, and 2002 were approximately $63.4 million, $62.9 million, and $72.5 million respectively. These costs include allocated common costs associated with information technologies and facilities. The decrease in 2003 is attributable to the closure of our development center in Andover, Massachusetts and other cost containment actions described elsewhere.

We believe that our future success depends on rapid adoption and implementation of broadband local access industry specifications, as well as rapid innovation and introduction of technologies that provide service and performance differentiation. To that end, we believe that the Cadant C4 CMTS product line continues to lead the industry in areas such as fault tolerance, wire-speed throughput and routing, and density. The Cadant C3 is designed for small to mid-size operators who are looking for a CMTS that delivers superior RF performance while only occupying one rack unit of space for delivering high-speed data services, including VPN services. The Touchstone^tm product line offers a wide-range of DOCSIS, Euro-DOCSIS and

PacketCable certified products, including Touchstone Cable Modems, Touchstone Telephony Modems and Touchstone Telephony Ports. These products are continuously being enhanced to include innovations that improve the subscriber’s experience and help to control operations expense.

In 2004 we announced the D5 DMTS. The D5 is a next generation headend system providing high speed data and video services over cable. Driven by the requirement to compete with direct broadcast satellite and telephone companies, the cable operators are moving to an all-services-on-demand network architecture known as next generation network architecture, or NGNA. Initially driven by Comcast, Time Warner, and Cox Communications, the development of the standards for this new architecture has been transferred to CableLabs. Its innovative design makes the D5 an excellent fit for the cable operators’ NGNA.

The following trends impact our current product development activities:


	•	Continued development and acceptance of open standards for delivering voice, video and data;

	•	widespread deployment of VoIP;

	•	continued increase in peer-to-peer services are accelerating demand for new services requiring intensive, high-touch processing and sophisticated management techniques;

	•	innovations in video encode/decode technology are making possible very low bit rate, high quality video streaming; and

	•	continued silicon integration and chip fabrication technology innovations are making possible very low cost, multi-functional broadband consumer devices, integrating not only telephony but wireless and video decompression and digital rights management functionality.

As a result, our product development activities are directed, primarily, in the following areas:


	•	Rapid development and delivery of Cadant C4 and C3 CMTS features, including DOCSIS 2.0 and 3.0, DSG and PacketCable Multimedia support, Layer 3 routing enhancements, packet inspection and filtering features, security enhancements, and increased downstream/ upstream density;

	•	expanding the range of next-generation, Lithium-Ion-based, Touchstone Telephony Modem E-MTAs to include formats to meet country and MSO specific performance and powering requirements;

	•	product cost reductions; and

	•	development of network and client technologies to address the emerging worldwide market opportunities in next generation video and multimedia delivery (video over IP and PacketCable multimedia), as embodied in the NGNA.

Intellectual Property

We have an aggressive program for protecting our intellectual property. The program consists of maintaining our portfolio of 59 issued patents (both U.S. and foreign) and pursuing patent protection on new inventions (currently more than 125 U.S. patent applications and U.S. provisional patent applications are pending plus 15 pending foreign applications). In our effort to pursue new patents, we have created a process whereby employees may submit ideas of inventions for review by management. The review process evaluates each submission for novelty, detectability, and commercial value, and patent applications are filed on the inventions that meet the criteria. ARRIS has 55 registered or pending trademarks.

Our patents and patent applications generally are in the areas of telecommunications hardware and software, and related technologies. Our recent research and development has led to a number of patent applications in technology related to DOCSIS. Our January 2002 purchase of the assets of Cadant resulted in the acquisition of 19 U.S. patent applications, seven Patent Convention Treaty (PCT) applications, five trademark applications, one U.S. registered trademark and five registered copyrights. The Cadant patents are in the area of cable modem termination systems. Our March 2003 purchase of the assets of Atoga Systems resulted in the acquisition of five U.S. patent applications, which also have been filed as PCT applications. Our Atoga patents are in the area of network traffic flow. In August of 2003, we acquired various assets of Com21,

Inc. Included in those assets were 16 issued U.S. patents plus 18 U.S. patent applications. The Com21 patents cover a wide range of technologies, including wide area networks, fiber and cable systems, ATM networks and cable modem termination systems.

For technology that is not owned by us, we have a program for obtaining appropriate licenses with the industry leaders to ensure that the strongest possible patents support the licensed technology. In addition, we have formed strategic relationships with leading technology companies that will provide us with early access to technology and will help keep us at the forefront of our industry. The key technologies not owned by us include:


	Components for Our CMTS Product Line

Broadcom provides several DOCSIS components in our cable modem termination system, or CMTS, product line.


	Components for Our Customer Premises Equipment Products

Texas Instruments provides components used in some of our customer premises equipment, or CPE, products (that is, embedded VoIP media terminal adapters, E-MTA, cable modems). Our agreements with Texas Instruments include technology licensing and component purchases. Several of our competitors have similar agreements with Texas Instruments for these components.

In addition, we purchase software for operating network and security systems or sub-systems, and a variety of routing protocols from different suppliers under standard commercial terms, including source code buy-out arrangements.

Although alternate supply and technology arrangements similar to the above are available or could be arranged, an interruption with any of the above companies could have a material impact on our business.

We have a program for protecting and developing trademarks. The program consists of procedures for the use of current trademarks and for the development of new trademarks. This program is designed to ensure that our employees properly use those trademarks and any new trademarks that will develop strong brand loyalty and name recognition. This is intended to protect our trademarks from dilution or cancellation.

Product Sourcing and Distribution

Our product sourcing strategy centers on the use of contract manufacturers to subcontract production. Our largest contract manufacturers are Solectron, Mitsumi, Plexus Services Corporation, Flextronics, and ASUSTeK Computer Inc., located in the United States, Japan, the United States, Singapore, and Taiwan, respectively. The facilities owned and operated by these contract manufacturers for the production of our products are located in the United States, Mexico, the Philippines, Taiwan, and China.

We have standard agreements with each of these companies. We provide these vendors with a 6-month or 12-month rolling, non-binding forecast, and we typically have a minimum of 60 days of purchase orders placed with them for product. Purchase orders for delivery within 60 days are generally not cancelable. Purchase orders with delivery past 60 days generally may be cancelled with penalties in accordance with each vendor’s terms. Each contract manufacturer provides us with an 18-month warranty.

We distribute a substantial number of products that are not designed or trademarked by us in order to provide our customers with a comprehensive product offering. For instance, we distribute hardware and installation products. These products are distributed through regional warehouses in North Carolina, California, Japan, and the Netherlands and through drop shipments from our contract manufacturers located throughout the world.

Backlog

Our backlog consists of unfilled customer orders believed to be firm and long-term contracts that have not been completed. With respect to long-term contracts, we include in our backlog only amounts representing

orders currently released for production or, in specific instances, the amount we expect to be released in the succeeding 12 months. The amount contained in backlog for any contract or order may not be the total amount of the contract or order. The amount of our backlog at any given time does not reflect expected revenues for any fiscal period. Our backlog at December 31, 2004 was approximately $75.6 million, at December 31, 2003 was approximately $53.0 million and at December 31, 2002 was approximately $43.8 million.

We believe that substantially all of the backlog existing at December 31, 2004 will be shipped in 2005.

International Opportunities

We sell our products primarily in North America. Our international revenue is generated from Asia Pacific, Europe, Latin America and Canada. The Asia Pacific market primarily includes China, Hong Kong, Japan, Korea, Singapore, and Taiwan. The European market primarily includes Austria, Belgium, France, Germany, Netherlands, Poland, Portugal, Spain, and Switzerland. The Latin American market primarily includes Argentina, Chile, Brazil, and Puerto Rico. Sales to international customers were approximately 25.2%, 18.9% and 22.7% of total sales for 2004, 2003 and 2002, respectively.

We believe that international opportunities exist and continue to strategically invest in worldwide marketing efforts, which have yielded some promising results in several regions. We currently maintain international sales offices in Chile, Hong Kong, Ireland, Japan, Spain and the Netherlands.

Competition

All aspects of our business are highly competitive. The broadband communications industry itself is dynamic, requiring companies to react quickly and capitalize on change. We must retain skilled and experienced personnel as well as deploy substantial resources to meet the changing demands of the industry. We compete with national, regional and local manufacturers, distributors and wholesalers including some companies larger than we are. Our major competitors include:


	•	Big Band Networks;

	•	Cisco Systems, Inc.;

	•	Motorola, Inc.;

	•	Scientific-Atlanta, Inc.;

	•	Tellabs, Inc.; and

	•	TVC Communications, Inc.

Various manufacturers who are suppliers to us, also sell directly, as well as through distributors, into the cable marketplace. In addition, because of the convergence of the cable, telecommunications and computer industries and rapid technological development, new competitors may enter the cable market.

Since the introduction in 1996 of our Cornerstone® Voice product line, our customers have deployed over 4.5 million lines, giving us approximately two-thirds of the overall CBR cable telephony market. We continue to sell this product to our established customer base and attempt to add new, usually smaller, accounts. This product will approach the end of its life over the next few years.

One of the principal growth markets for ARRIS is cable modem termination systems, or CMTS, which are the headend product for data and VoIP services. The largest provider of CMTS products is Cisco, which took an early lead in the initial deployment of data-only CMTS products. Cisco is expected to defend its position via both upgrades to existing products and the introduction of new products. At present, Cisco continues to be a major competitor in data-only CMTS markets. Cisco had not previously developed a carrier-grade telephony CMTS product but has recently begun to market that capability. Motorola and Big Band Networks have been emphasizing routing and carrier-grade performance for their CMTS. During 2004, we believe ARRIS has garnered additional market share in the newer generation CMTS products that enable

both data and carrier grade telephony deployments. Consolidation in the CMTS market occurred in 2004. Most recently, Terayon has announced that it will exit the CMTS business. Earlier in 2004, ADC Telecommunications sold its CMTS product line to Big Band Networks.

The customer premises business consists of cable modems and voice over IP enabled modems (E-MTAs). In the cable modem and E-MTA business, the dynamics are very different. Cable modem sales are primarily driven by price and supply chain issues while E-MTAs are focused primarily on performance. Motorola is the market leader in cable modems. This position provides them with volume advantages in manufacturing, distribution and marketing expense. Motorola also was successful in gaining an early leader status in E-MTA sales at MSOs that were the first to deploy VoIP. However, as this market accelerates, ARRIS has been gaining share with several of these customers. We compete on product performance and our telephony experience and integration capabilities. Terayon has had some success in the cable modem business, especially in international markets. Scientific-Atlanta also has had some success in the cable modem market. ARRIS is a relatively small competitor in the cable modem market, but has a larger share of the E-MTA market. Both Scientific-Atlanta and Terayon also have E-MTA products and compete in this market. At present the E-MTA market is small but will grow as VoIP deployments accelerate.

In the supplies distribution business we compete with national distributors, like TVC Communications, Inc., and with several local and regional distributors. Product breadth, price, availability and service are the principal competitive advantages in the supply business.

Some of our competitors, notably Cisco, Motorola and Scientific-Atlanta, are larger companies with greater financial resources and product breadth than us. This may enable them to bundle products or be able to market and price products more aggressively than we can.

Our products are marketed with emphasis on quality and are competitively priced. Product reliability and performance, superior and responsive technical and administrative support, and breadth of product offerings are key criteria for competition. Technological innovations and speed to market are additional competitive factors.

Employees

As of February 28, 2005, we had 728 full-time employees. We believe that we have maintained a strong relationship with our employees. Our future success depends, in part, on our ability to attract and retain key executive, marketing, engineering and sales personnel. Competition for qualified personnel in the cable industry is intense, and the loss of certain key personnel could have a material adverse effect on us. We have entered into employment contracts with our key executive officers and have confidentiality agreements with substantially all of our employees. We also have long term incentive programs that are intended to provide substantial incentives for our key employees to remain with us.

Background and History

ARRIS is the successor to ANTEC Corporation. From its inception until its initial public offering in 1993, ANTEC was primarily a distributor of cable television equipment and was owned and operated by Anixter, Inc. Subsequently ANTEC completed several important strategic transactions and formed joint ventures designed to expand significantly its product offerings. In 2001, ANTEC formed a new holding company, ARRIS, and acquired Nortel Networks’ interest in Arris Interactive L.L.C., which previously had been a joint venture between ANTEC and Nortel Networks.

A synopsis of ARRIS’ evolution:


	• 1969 —	Anixter entered the cable industry.

	• 1987 —	Anixter acquired TeleWire Supply.

	• 1988 —	Anixter and AT&T developed the first analog video laser transmitter for the cable industry (Laser Link I).


	• 1991 —	ANTEC was established.

	• 1993 —	ANTEC’s initial public offering.

	• 1994 —	ANTEC completed the acquisition of the following companies, which significantly expanded its product development and manufacturing capabilities:


	•	Electronic System Products, Inc., or ESP, an engineering consulting firm with core capabilities in digital design, RF design and application specific integrated circuit development for the broadband communications industry.

	•	Power Guard, Inc., a manufacturer of power supplies and high security enclosures for broadband communications networks.

	•	Keptel, Inc., a designer, manufacturer and marketer of outside plant telecommunications and transmission equipment for both residential and commercial use, primarily by telephone companies.


	• 1995 —	ANTEC and Nortel Networks formed Arris Interactive L.L.C., focused on the development, manufacture and sale of products that enable the provision of a broad range of telephone and data services over HFC architectures; ANTEC initially owned 25% and Nortel Networks owned 75% of the Arris Interactive L.L.C. joint venture.

	• 1997 —	ANTEC acquired TSX Corporation, which provided electronic manufacturing capabilities and expanded the Company’s product lines to include amplifiers and line extenders and enhanced laser transmitters and receivers and optical node product lines.

	• 1998 —	ANTEC introduced the industry’s first 1550 nm narrowcast transmitter and dense wavelength division multiplexing, or DWDM, optical transmission system.

	• 1999 —	The Broadband Technology Division of Nortel Networks, which is known as LANcity, was combined with Arris Interactive L.L.C., resulting in an increase in Nortel Networks’ interest in the joint venture to 81.25% while ANTEC’s interest was reduced to 18.75%.


		ANTEC introduced the industry’s first 18-band block converter and combined that with the DWDM allowing 144 bands on a single fiber.


	• 2001 —	ARRIS acquired all of Nortel Networks’ ownership interest in Arris Interactive L.L.C. in exchange for approximately 49% of the common stock of a newly formed holding company, ARRIS, and a Class B membership interest in Arris Interactive L.L.C.


		ARRIS sold substantially all of its power product lines. During 2000, sales in those product lines were approximately $18.0 million, and during 2001 (through the date of the sale), sales were approximately $8.1 million. ARRIS continued as an authorized distributor and representative for these power product lines.


	• 2002 —	ARRIS acquired substantially all of the assets of Cadant, Inc., a privately held designer and manufacturer of next-generation cable modem termination systems.


		ARRIS sold its Keptel product line. During 2001, sales in this product line to telecommunications companies were approximately $44.8 million, and during 2002 (through the date of the sale), sales were approximately $7.5 million.

		ARRIS sold its Actives product line. During 2001, sales in this product line were approximately $68.2 million, and during 2002 (through the date of the sale), sales were approximately $58.8 million.

		ARRIS closed its office in Andover, Massachusetts, which was primarily a product development and repair facility.


		Nortel Networks sold 15 million shares of ARRIS through a public offering reducing their position to 22 million shares

		ARRIS redeemed, for cash and stock, $91.1 million of its convertible notes due May 2003.


	• 2003 —	ARRIS acquired certain assets of Atoga Systems, a Fremont, California-based developer of optical transport systems for metropolitan area networks.


		ARRIS completed the redemption of its convertible notes due May 2003.

		ARRIS raised $125 million through a private placement of convertible notes due 2008.

		ARRIS retired, at a discount, the Class B membership interest due to Nortel Networks for $88.4 million.

		ARRIS repurchased and retired 8 million shares from Nortel Networks for an aggregate purchase price of $30 million (taking into account the return of $2 million forgiven on the Class B membership interest), reducing Nortel’s position to 14 million shares.

		ARRIS sold ESP, its engineering services product line.

		ARRIS purchased certain assets of Com21 (including the stock of its Irish subsidiary), a designer and manufacturer of next generation cable modem termination systems.

		Nortel Networks sold 9 million shares of ARRIS through a public offering reducing their position to 5 million shares.

		ARRIS terminated its asset-based revolving bank credit facility.


	• 2004 —	ARRIS redeemed on March 8, 2004 $50 million of its convertible notes due 2008. In connection with the redemption, ARRIS made a make-whole interest payment that included the issuance of approximately 467 thousand common shares.


		ARRIS closed its Fremont, CA office.


Item 2.	*Properties*

We currently conduct our operations from 13 different locations; two of which we own, while the remaining 11 are leased. These facilities consist of sales and administrative offices and warehouses totaling approximately 470,000 square feet. Our long-term leases expire at various dates through 2023. We believe that our current properties are adequate for our operations. A summary of our principal leased properties that are currently in use is as follows:


Location	Description	Area (sq. ft.)		Lease Expiration

Ontario, California	Warehouse		57,269	January 31, 2009
Suwanee, Georgia	Office space		131,775	April 14, 2012
Englewood, Colorado	Office space		32,880	March 30, 2006
Lisle, Illinois	Office space		56,008	November 1, 2013
Philadelphia, Pennsylvania	Office space		1,007	January 31, 2008
Ireland	Office space		13,575	June 30, 2023
The Netherlands	Office space		3,660	September 15, 2009
Spain	Office space		1,916	June 1, 2007
Japan	Office space		2,833	January 14, 2006
Chile	Office space		645	December 31, 2005
Hong Kong	Office space		165	March 21, 2005

We own the following properties:


Location	Description		Area (sq. ft.)

Cary, North Carolina		Warehouse		151,500
Chicago, Illinois		Warehouse/Office space		18,000


Item 3.	*Legal Proceedings*

Metal Press Litigation. ARRIS was a defendant in a case entitled Metal Press S.A. de C.V. v. ARRIS International, Inc. f/k/a/ Antec Corporation, No. 1:01-CV-2435-CAP (N.D. Ga., Atlanta Div., filed September 13, 2001). In general, Metal Press alleged that ARRIS breached a purported oral requirements contract for certain products and requested damages of as much as $7.0 million. A jury trial was held, and a verdict was entered in ARRIS’ favor upon conclusion of the trial. The plaintiff filed a motion for a new trial and that motion was denied. The plaintiff did not file a notice of appeal, and the time for appeal recently expired.


Item 4.	*Submission of Matters to a Vote of Security Holders*

During the fourth quarter of 2004, no matters were submitted to a vote of our company’s security holders.


Item 4A.	*Executive Officers and Board Committees*

EXECUTIVE OFFICERS OF THE COMPANY

The following table sets forth the name, age as of March 30, 2005, and position of our executive officers.


Name	Age		Position

Robert J. Stanzione		57	Chief Executive Officer, Chairman of the Board
Lawrence A. Margolis		57	Executive Vice President, Strategic Planning, Administration, Chief Counsel, and Secretary
David B. Potts		47	Executive Vice President, Chief Financial Officer and Chief Information Officer
Ronald M. Coppock		50	President, ARRIS Worldwide Sales
Bryant K. Isaacs		45	President, New Business Ventures
James D. Lakin		61	President, Broadband
Robert Puccini		43	President, TeleWire Supply
Marc S. Geraci		52	Vice President, Treasurer
Debbie L. Marry		45	Vice President, Controller

Robert J. Stanzione has been Chief Executive Officer since January 1, 2000. From 1998 through 1999, Mr. Stanzione was President and Chief Operating Officer of ARRIS. Mr. Stanzione has been a director of ARRIS since 1998 and has been the Chairman of the Board of Directors since May 2003. From 1995 to 1997, he was President and Chief Executive Officer of Arris Interactive L.L.C. From 1969 to 1995, he held various positions with AT&T Corporation. Mr. Stanzione also serves as a director of the Georgia CF Foundation.

Lawrence A. Margolis has been Executive Vice President, Strategic Planning, Administration, and Chief Counsel since March 2004 and has served as the Secretary of ARRIS since 1992. Mr. Margolis was the Chief Financial Officer from 1992 to March 2004. Prior to joining ARRIS, Mr. Margolis was Vice President, General Counsel and Secretary of Anixter, Inc., a global communications products distribution company, from 1986 to 1992 and General Counsel and Secretary of Anixter from 1984 to 1986. Prior to 1984, he was a partner at the law firm of Schiff Hardin & Waite.

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

held various executive management positions with Nortel Networks including Vice President and Chief Financial Officer of Bell Northern Research in Ottawa and Vice President of Mergers and Acquisitions in Toronto. Prior to Nortel Networks, Mr. Potts was with Touche Ross in Toronto. Mr. Potts is a member of the Institute of Chartered Accountants in Canada.

Ronald M. Coppock has been President of ARRIS Worldwide Sales since November 2003. Prior to his current role, Mr. Coppock was President of International since January 1997 and was formerly Vice President International Sales and Marketing for TSX Corporation. Mr. Coppock has been in the cable television and satellite communications industry for over 20 years, having held senior management positions with Scientific-Atlanta, Pioneer Communications and Oak Communications. Mr. Coppock is an active member of the American Marketing Association, Kappa Alpha Order, Cystic Fibrosis Foundation Board, and the Auburn University Alumni Action Committee.

Bryant K. Isaacs has been President of ARRIS New Business Ventures since December 2002. Prior to the sale of the Actives product line, Mr. Isaacs was President of ARRIS Network Technologies since September 2000. Prior to joining ARRIS, he was Founder and General Manager of Lucent Technologies’ Wireless Communications Networking Division in Atlanta from 1997 to 2000. From 1995 through 1997, Mr. Isaacs held the position of Vice President of Digital Network Systems for General Instrument Corporation where he was responsible for developing international business strategies and products for digital video broadcasting systems.

James D. Lakin has been President of ARRIS Broadband since the acquisition of Arris Interactive L.L.C. in August 2001. From October 2000 through August 2001, he was President and Chief Operating Officer of Arris Interactive L.L.C. From November 1995 until October 2000, Mr. Lakin was Chief Marketing Officer of Arris Interactive L.L.C. Prior to 1995, he held various executive positions with Compression Labs, Inc. and its successor General Instrument Corporation.

Robert Puccini has been President of ARRIS TeleWire Supply since 1999. Prior to his appointment to President, Mr. Puccini served as Chief Financial Officer of TeleWire for two years and has served as Vice President, Project Management for ARRIS’ AT&T account. Mr. Puccini brings 20 years of experience in the cable television industry to ARRIS TeleWire Supply. He has held various accounting and controller positions within the former Anixter and ANTEC Corporations. Mr. Puccini is a CPA.

Marc S. Geraci has been Vice President, Treasurer of ARRIS since January 2003 and has been with ARRIS and the former ANTEC Corporation since 1994. He began with ARRIS as Controller for the International Sales Group and in 1997 was named Chief Financial Officer of that group. Prior to joining ARRIS, he was a broker/ dealer on the Pacific Stock Exchange in San Francisco for eleven years and, prior to that, in public accounting in Chicago for four years. Mr. Geraci is a CPA.

Debbie L. Marry has been Vice President, Controller of ARRIS since May 2004 and was formerly Director of Financial Planning and Analysis, Controller of ARRIS Broadband from May 2000 to May 2004. Prior to joining ARRIS, she held various accounting and controller positions at a start-up company and within Motorola, Inc. Mrs. Marry began her career in public accounting at Price Waterhouse in Chicago. Mrs. Marry is a CPA.

Board Committees

Our Board of Directors has three committees: Audit, Compensation, and Nominating and Corporate Governance. The charters for all three committees are located on our website at www.arrisi.com. The Board believes that each of its members, with the exception of Mr. Stanzione, is independent, as defined by the SEC and Nasdaq rules. Additionally, the Board has identified Matthew Kearney and John Petty as the Audit Committee financial experts, as defined by the SEC.

PART II


Item 5.	*Market for Registrant’s Common Equity and Related Stockholder Matters*

ARRIS’ common stock is traded on the Nasdaq National Market System under the symbol “ARRS.” The following table reports the high and low trading prices per share of the Company’s common stock as listed on the Nasdaq National Market System:


	High		Low

2003
First Quarter	$	5.73	$	3.23
Second Quarter		6.70		3.63
Third Quarter		6.59		4.10
Fourth Quarter		7.58		4.85
2004
First Quarter	$	11.40	$	7.28
Second Quarter		9.92		4.42
Third Quarter		6.04		3.73
Fourth Quarter		7.23		4.34

We have not paid cash dividends on our common stock since our inception. On October 3, 2002, to implement our shareholder rights plan, our board of directors declared a dividend consisting of one right for each share of our common stock outstanding at the close of business on October 25, 2002. Each right represents the right to purchase one one-thousandth of a share of our Series A Participating Preferred Stock and becomes exercisable only if a person or group acquires beneficial ownership of 15% or more of our common stock or announces a tender or exchange offer for 15% or more of our common stock or under other similar circumstances.

As of February 28, 2005, there were approximately 459 record holders of our common stock. This number excludes shareholders holding stock under nominee or street name accounts with brokers or banks.


Item 6.	*Selected Consolidated Historical Financial Data*

The selected consolidated financial data as of December 31, 2004 and 2003 and for each of the three years in the period ended December 31, 2004 set forth below are derived from the accompanying audited consolidated financial statements of ARRIS, and should be read in conjunction with such statements and related notes thereto. The selected consolidated financial data as of December 31, 2002, 2001 and 2000 and for the years ended December 31, 2001 and 2000 is derived from audited consolidated financial statements that have not been included in this filing. The historical consolidated financial information is not necessarily indicative of the results of future operations and should be read in conjunction with ARRIS’ historical consolidated financial statements and the related notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this document. See Note 21 of the

Notes to the Consolidated Financial Statements for a summary of our quarterly consolidated financial information.


			Years Ended December 31,

			2004			2003			2002			2001			2000

			(in thousands, except per share data)
Consolidated Operating Data:
	Net sales		$	490,041		$	433,986		$	651,883		$	628,323		$	749,972
	Cost of sales(1)			343,864			307,726			425,231			479,663			624,720

	Gross margin			146,177			126,260			226,652			148,660			125,252
	Selling, general, administrative and development expenses(2)			131,912			151,980			200,574			129,743			86,721
	Impairment of goodwill(3)			—			—			70,209			—			—
	Amortization of goodwill			—			—			—			3,256			3,300
	Amortization of intangibles			28,690			35,249			34,494			7,012			—
	In-process R&D write-off(4)			—			—			—			18,800			—
	Restructuring and other(5)			7,648			891			7,113			11,602			—

	Operating income (loss)			(22,073	)		(61,860	)		(85,738	)		(21,753	)		35,231
	Interest expense			5,006			10,443			8,383			11,068			12,184
	Membership interest			—			2,418			10,409			4,110			—
	Loss (gain) on debt retirement(6)			4,406			(26,164	)		7,302			1,853			—
	Other expense (income), net			(2,403	)		(2,329	)		(5,513	)		8,120			(1,271	)
	Loss on investments and notes receivable(7)			1,320			1,436			14,894			767			773

	Income (loss) from continuing operations before income taxes			(30,402	)		(47,664	)		(121,213	)		(47,671	)		23,545
	Income tax expense (benefit)(8)			108			—			(6,800	)		35,588			9,622

	Net income (loss) from continuing operations			(30,510	)		(47,664	)		(114,413	)		(83,259	)		13,923
	Discontinued Operations:
		Income (loss) from discontinued operations (including a net gain on disposals of $2.1 million and $0.4 million and a net loss of $4.0 million for the years ended December 31, 2004, 2003 and 2002, respectively)(1)(2)(5)(9)		2,114			351			(18,794	)		(92,441	)		11,409
		Income tax expense (benefit)		—			—			—			(7,969	)		4,663

	Income (loss) from discontinued operations			2,114			351			(18,794	)		(84,472	)		6,746

	Net income (loss) before cumulative effect of accounting change			(28,396	)		(47,313	)		(133,207	)		(167,731	)		20,669
Cumulative effect of accounting change(10)				—			—			57,960			—			—

	Net income (loss)		$	(28,396	)	$	(47,313	)	$	(191,167	)	$	(167,731	)	$	20,669


			Years Ended December 31,

			2004			2003			2002			2001			2000

			(in thousands, except per share data)
Net income (loss) per common share:
Basic:
		Income (loss) from continuing operations	$	(0.36	)	$	(0.62	)	$	(1.40	)	$	(1.55	)	$	0.37
		Income (loss) from discontinued operations		0.02			—			(0.23	)		(1.58	)		0.18
		Cumulative effect of accounting change		—			—			(0.71	)		—			—

		Net income (loss)	$	(0.33	)	$	(0.62	)	$	(2.33	)	$	(3.13	)	$	0.54

Diluted:
	Income (loss) from continuing operations		$	(0.36	)	$	(0.62	)	$	(1.40	)	$	(1.55	)	$	0.35
	Income (loss) from discontinued operations			0.02			—			(0.23	)		(1.58	)		0.17
	Cumulative effect of accounting change			—			—			(0.71	)		—			—

		Net income (loss)	$	(0.33	)	$	(0.62	)	$	(2.33	)	$	(3.13	)	$	0.52

Selected Balance Sheet Data:
	Total assets		$	450,678		$	451,859		$	563,412		$	752,115		$	731,495
	Long-term obligations		$	91,781		$	138,052		$	11,500		$	115,000		$	204,000


(1)	Cost of Sales and Discontinued Operations:


	During 2004, we recorded a gain of approximately $0.9 million related to the recovery of amounts due from a customer in Argentina, of which approximately $0.3 million related to and is classified in discontinued operations, and $0.6 million is reflected in cost of goods sold.

	During 2004, 2003, 2002, and 2001, we recorded severance costs related to reductions in force of $0.1 million, $0.4 million, $1.5 million, and $47 thousand, respectively, which was reflected in cost of sales.

	During 2002, we wrote off the remaining $2.1 million of power inventories that had not been transferred to the buyer. This charge is reflected in cost of goods sold.

	During 2001, we recorded pre-tax restructuring and impairment charges of approximately $66.2 million. Of this total charge, approximately $50.1 million is classified in discontinued operations, $8.5 million is reflected in cost of goods sold, and $7.6 million is reflected in restructuring. Of the $50.1 million classified in discontinued operations, approximately $25.1 million related to the write-down of inventories, $14.8 million related to the impairment of fixed assets, $4.5 million related to lease termination and other shutdown expenses, and $5.7 million related to severance and associated personnel costs. The remaining $16.1 million related to continuing operations, of which approximately $8.5 million related to the write-down of inventories and certain purchase order and warranty obligations and was charged to cost of goods sold, and approximately $7.6 million related to the impairment of goodwill and lease termination expenses and was reflected in restructuring. Due to unforeseen delays in exiting the facility after the shutdown, the Company increased its reserve by approximately $2.4 million (charged to discontinued operations) and $4.8 million ($4.4 million charged to discontinued operations and $0.4 million charged to continuing operations) during 2002 and 2003, respectively.

	During 2001, we recorded a write-off of $4.4 million related to unrecoverable inventory amounts due from a customer in Argentina (due to the economic disturbances in that region), of which approximately $1.6 million relates to and is classified in discontinued operations, and $2.8 million is reflected in cost of goods sold.

	During 2000, we recorded an additional $3.5 million pre-tax charge to cost of sales related to the discontinuance of certain products in 1999 as a result of additional inventory write-downs.


(2)	SGA&D and Discontinued Operations:


	During 2004, 2003, 2002, and 2001, we recorded severance costs related to reductions in force of $0.4 million, $2.5 million, $3.9 million, and $1.4 million, respectively, which was reflected in selling, general, administrative and development expenses.

	During 2003, we recorded a charge of approximately $2.2 million related to the write-off of customer-relations software.

	During 2003 and 2002, we reserved $8.7 million and $3.6 million, respectively, for our Cabovisao receivable. Cabovisao is a Portugal-based customer who owed us approximately $20.6 million in accounts receivable at the end of the third quarter 2003, of which all was past due. Cabovisao and its parent company, Csii, have filed for court-supervised restructuring and recapitalization in Canada and are in the process of restructuring their financing. During the fourth quarter of 2003, we sold our accounts receivable to an unrelated third party for approximately $10.1 million, resulting in a gain of approximately $1.5 million.

	During 2003, we sold our engineering consulting services product line, known as ESP, to an unrelated third party. The transaction resulted in a loss of approximately $1.4 million.

	During 2003, we recorded a total of approximately $3.0 million related to potential patent litigation damages. The litigation involves our connector product, which is included in our Supplies & CPE product category. The litigation was ultimately settled in February 2004.

	During the first half of 2002, we established a reserve of $20.2 million in connection with our Adelphia receivables of which approximately $1.3 million relates to and is classified in discontinued operations, and approximately $18.9 million is reflected in selling, general, administrative and development expenses. Adelphia filed for bankruptcy in June 2002. During the third quarter of 2002, we sold a portion of our Adelphia accounts receivables to an unrelated third party, resulting in a net gain of approximately $4.3 million. Of this total gain, approximately $0.3 million relates to and is classified in discontinued operations, and $4.0 million is reflected in selling, general and administrative and development expense.

	In 2000, we recorded a pre-tax gain of $2.1 million as a result of the curtailment of our defined benefit pension plan.


(3)	Impairment of Goodwill


	During the fourth quarter of 2002, based upon management’s analysis including an independent valuation, we recorded a goodwill impairment charge of $70.2 million with respect to our Supplies & CPE product line.


(4)	In-process R&D write-off


	During 2001, we recorded a pre-tax write-off of in-process research and development of $18.8 million in connection with the Arris Interactive L.L.C. acquisition.


(5)	Restructuring and Impairment Charges and Discontinued Operations


	During 2004, we consolidated two facilities in Georgia, giving us the ability to house many of our core technology, marketing, and corporate headquarter functions in a single building. This consolidation resulted in a total restructuring charge of $6.4 million.

	During 2004, we closed our office in Fremont, CA. This resulted in a restructuring charge of approximately $0.3 million.

	During 2002, a restructuring charge of approximately $7.1 million was recorded in connection with the closure of our development and repair facility in Andover, Massachusetts, related to severance, lease termination, and other costs associated with closing the facility.

	During 2001, we closed a research and development facility in Raleigh, North Carolina and recorded a $4.0 million charge related to severance and other costs associated with closing that facility.

During 2001, we recorded pre-tax restructuring and impairment charges of approximately $66.2 million. Of this total charge, approximately $50.1 million is classified in discontinued operations, $8.5 million is reflected in cost of goods sold, and $7.6 million is reflected in restructuring. Of the $50.1 million classified in discontinued operations, approximately $25.1 million related to the write-down of inventories, $14.8 million related to the impairment of fixed assets, $4.5 million related to lease termination and other shutdown expenses, and $5.7 million related to severance and associated personnel costs. The remaining $16.1 million related to continuing operations, of which approximately $8.5 million related to the write-down of inventories and certain purchase order and warranty obligations and was charged to cost of goods sold, and approximately $7.6 million related to the impairment of goodwill and lease termination expenses and was reflected in restructuring. Due to unforeseen delays in exiting the facility after the shutdown, the Company increased its reserve by approximately $2.4 million (charges to discontinued operations) and $4.8 million ($4.4 million charged to discontinued operations and $0.4 million charged to continuing operations) during 2002 and 2003, respectively. During 2004, the Company adjusted its reserves due to a change in estimates which resulted in income of $0.9 million (income of $1.8 million charged to discontinued operations and expense of $0.9 million charged to continuing operations).


(6)	Loss (Gain) on Debt Retirement


	During 2004, we called $50.0 million of the Notes due 2008 for redemption, and holders of the called notes elected to convert their notes into an aggregate of 10.0 million shares of common stock, rather than have the notes redeemed. Under the indenture’s terms for redemptions prior to March 18, 2006, we made a make-whole interest payment of approximately 0.5 million common shares, resulting in a charge of $4.4 million.

	During the fourth quarter 2003, we chose to cancel our credit facility, which was due to expire in August 2004. As a result, we wrote off approximately $2.3 million of unamortized finance fees related to the facility upon cancellation.

	During the first quarter 2003, ARRIS redeemed the entire Class B membership interest in Arris Interactive L.L.C. held by Nortel Networks for approximately $88.4 million. This discounted redemption resulted in a gain of approximately $28.5 million

	During 2002, we recorded a loss of $9.3 million associated with the 4¹/2% notes due 2003 exchanges, in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 84, Induced Conversions of Convertible Debt. This loss was partially offset with a gain of approximately $2.0 million related to cash repurchases of the 4¹/2% notes due 2003 in accordance with SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.

	During 2001, we recorded pre-tax charges of $1.9 million on the extinguishment of debt in accordance with EITF 96-19, Debtor’s Accounting for a Modification or Exchange of Debt Instruments. The amount reflected unamortized deferred finance fees related to a loan agreement, which was replaced in connection with the Arris Interactive L.L.C. acquisition. In 2003, this loss was reclassified to loss from continuing operations as a result of the gain on cash repurchases recognized in the fourth quarter of 2003 in accordance with SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.


(7)	Loss on Investments and Notes Receivable

We held certain investments in the common stock of publicly traded companies, some of which were classified as trading securities and some are classified as available for sale. In addition, we hold a number of non-marketable equity securities, which are also classified as available for sale. Changes in the market value of the trading securities and gains or losses on related sales of these securities are recognized in income. Changes in the market value of the available for sale securities are recorded in other comprehensive income. However, the available for sale securities are subject to a periodic impairment review and any “other than temporary” impairments are recognized through income.


	We offer a deferred compensation arrangement, which allows certain employees to defer a portion of their earnings and defer the related income taxes. These deferred earnings are invested in a “rabbi trust”, and are accounted for in accordance with Emerging Issues Task Force Issue No. 97-14, Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested. The investment in the rabbi trust is classified as an investment on our balance sheet.

	During the five-year periods of 2004, 2003, 2002, 2001, and 2000, we recognized total losses of $1.3 million, $1.4 million, $14.9 million, $0.8 million, and $0.8 million, respectively, on our investments discussed above.


(8)	Income Tax Expense (Benefit)


	During 2002, we recognized a $6.8 million income tax benefit as a result of a change in tax legislation, allowing us to carry back losses for five years versus the previous limit of two years.

	During 2001, as a result of the restructuring and impairment charges during that period, a valuation allowance of approximately $38.1 million against deferred tax assets was recorded in accordance with SFAS No. 109, Accounting for Income Taxes.


(9)	Income (Loss) from Discontinued Operations


	In addition to the comments within items 1, 2, and 5 above, the following items also impacted discontinued operations:


	—	During 2001, a one-time warranty expense relating to a specific product was recorded, resulting in a pre-tax charge of $4.7 million for the expected replacement cost of this product of which all relates to and is classified in discontinued operations. We do not anticipate any further warranty expenses to be incurred in connection with this product.

	—	During 2002, a loss of $6.2 million was recorded in connection with the sale of the Keptel product line. Additionally, during 2002, a gain of $2.2 million was recorded in connection with the sale of the Actives product line. The net loss of $4.0 million relates to and is classified in discontinued operations.

	—	In 2003, 2002, and 2001, we recorded severance costs related to reductions in force of $0.2 million, $1.3 million, and $4.6 million, respectively, which was reflected in discontinued operations.


(10)	Cumulative Effect of an Accounting Change

During 2002, we recognized a loss of approximately $58.0 million due to the cumulative effect of an accounting change. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, and upon management’s analysis of our intangibles including an independent valuation, we recorded a reduction in the value of our goodwill of approximately $58.0 million primarily related to our Keptel product line.


Item 7.	*Management’s Discussion and Analysis of Financial Condition and Results of Operations*

Overview

Our long-term goal is to continue to increase our leading position as a worldwide provider of broadband access products and services. Our primary market and focus is cable providers or MSOs; however, we regularly evaluate alternative outlets for our products and services — for example, the telecommunications market, including U.S. regional telephone companies, local exchange companies, competitive local exchange carriers, as well as international post, telephone and telegraph, or PT&Ts, and governmental agencies.

Industry Conditions

Our performance is largely dependent on capital spending for constructing, rebuilding, maintaining and upgrading broadband communications systems necessary for the provision of new voice, data, and video services. The cable market has evolved and changed significantly over the past few years. Key developments that have or may impact us include:


	Increase in Spending by MSOs on New Revenue-Generating Services

While reducing overall capital expenditures, MSOs have increased their expenditures on equipment, which allows them to create new revenue-generating opportunities, including high-speed data, telephony and digital video. We anticipate future increases in expenditures by the MSOs on new technologies, which allow them to capitalize on these opportunities.


	Cable Operator Demand of Open Standards for Equipment and Services Related to High-Speed Data, Telephony and, Digital Video

Each of the key new revenue-generating services (high-speed data, telephony and digital video) was originally made available to the MSOs by various companies using proprietary products; however, next generation products are being developed and deployed in compliance with open standards established by the cable industry:


	•	High-speed data was offered, most significantly by ARRIS (LANcity), Motorola and Terayon, using proprietary cable modem termination systems and cable modems. In the United States, the MSOs created CableLabs to create an open standard architecture for high-speed data. This architecture was introduced in 1999 and remains the industry standard. ARRIS and its competitors responded to the creation of this standard, and, as a result, ARRIS has not sold proprietary high-speed data products since 2000. Similar open standards exist in Europe.

	•	Telephony was first offered, most significantly by ARRIS, Motorola, ADC and Tellabs, using proprietary constant bit rate, or CBR, headend and network interface units. ARRIS continues to sell significant volumes of CBR equipment. The MSOs, through CableLabs, have created an open architecture for VoIP telephony. We anticipate that the majority of new telephony deployments will use this open architecture. ARRIS and its competitors have responded to the creation of this new standard.

	•	Digital Video was first offered, most significantly by Motorola, Scientific-Atlanta and Pace, using proprietary set-top boxes. In 2005 certain MSOs, in particular Comcast, Time Warner and Cox Communications, began the development of standards, known as Next Generation Network Architecture, which, among other things, will drive an open standards architecture for IP Video. We are actively participating in the development of these standards and plan to develop and market products to enable them.

We expect that MSOs will continue to create and demand open interfaces for all services in the future.


	Consolidation of Our Customer Base

Consolidation of our customers has, and may in the future, affect their purchases of our products. In the fourth quarter of 2002, Comcast completed its purchase of AT&T Broadband. Historically, AT&T Broadband had been our largest customer. AT&T Broadband, with the deployment of telephony as part of its core strategy, had been using our CBR products in many of its major markets. Comcast announced that, as its initial priority after its acquisition of AT&T Broadband, it would emphasize video and high-speed data operations and focus on improving the profitability of its telephony operations at the expense of subscriber growth. Comcast’s current strategy remains consistent with its initial strategy. As a result, we experienced a significant decline in sales of our CBR telephony product to Comcast in the fourth quarter of 2002 and 2003, which continued into 2004.

In 2004, Liberty Media increased its holdings in international properties making them one of the largest MSOs in the world. As a result, we entered into a global Master Purchase agreement with Liberty and its affiliates for all ARRIS products.

In 2004, Adelphia Communications announced, that as part of its bankruptcy proceedings, it planned to sell its cable properties. It is unclear who will ultimately purchase each property. It is possible that the sale of properties may have an impact on our future sales.

It also is possible that other customer consolidations may occur that could have an impact on future sales of our products.


	Decline in Spending by the MSOs on “Two-Way Plant Upgrades”

A significant portion of the MSOs have completed, or are nearing completion of, their “two-way” plant upgrade programs. We, as well as our competitors (in particular, Scientific-Atlanta, Motorola and TVC), have sold significant amounts of equipment to the MSOs over the past five years in support of their upgrade programs. These sales were predominately of our Supplies & CPE products as well as our former Transmission, Optical and Outside Plant products. We anticipate a further decline in revenues associated with these upgrades.

Our Strategy

In response to and in anticipation of the factors described above, we have implemented a long-term business strategy, which includes the following key elements:


	•	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

	•	Continually rationalize our product portfolio

	•	Maintain and improve an already strong capital structure and expense structure

Below is a summary of some of the key actions we have taken in support of these strategies.


	*Acquisitions*

In January 2002, we purchased substantially all the assets and assumed certain liabilities of Cadant, Inc., a manufacturer of cable modem termination systems that had developed a leading design in the industry for enabling voice over IP telephony and high-speed data. In March 2003, we purchased certain assets of Atoga Systems, a developer of optical transport systems for metropolitan area networks. In August 2003, we purchased certain cable modem termination system-related assets of Com21, including the stock of its Irish subsidiary. These acquisitions were made to better position us to provide products and services to our customers that support their growing needs in the areas of high speed data, telephony and video. We are actively exploring future acquisition opportunities. Below is a more detailed description of each of these acquisitions:


	Acquisition of Assets of Cadant, Inc.

On January 8, 2002, we acquired substantially all of the assets of Cadant, Inc., a privately held designer and manufacturer of next-generation cable modem termination systems. Under the terms of the transaction, we issued 5.25 million shares of our common stock and assumed approximately $14.9 million in liabilities in exchange for the assets. We issued 2.0 million options to purchase our common stock and 250,000 shares of

restricted stock to Cadant employees. We also agreed to issue up to 2.0 million additional shares of our common stock based upon the achievement of future sales targets through 2003 for the cable modem termination systems product. These sales targets were not achieved and no additional shares of our common stock will be issued.


	Acquisition of Certain Assets of Atoga Systems

On March 21, 2003, we purchased certain assets of Atoga Systems, a Fremont, California-based developer of optical transport systems for metropolitan area networks. Under the terms of the agreement, we obtained certain inventory, fixed assets, and intellectual property in consideration for approximately $0.4 million of cash and the assumption of certain lease obligations. Further, we retained approximately 28 employees and issued a total of 500,000 shares of restricted stock to those employees.


	Acquisition of Certain Assets of Com21

On August 13, 2003, we acquired certain cable modem termination system-related assets of Com21, including the stock of its Irish subsidiary. Under the terms of the agreement, ARRIS obtained accounts receivable, inventory, fixed assets, other current prepaid assets, and existing technology in exchange for approximately $2.4 million of cash, of which $2.2 million has been paid, and the assumption of approximately $0.6 million in liabilities. The Company has retained $0.2 million of the cash consideration for any liabilities ARRIS may be required to pay resulting from Com21 activity prior to the acquisition date. The Company also incurred approximately $0.2 million of legal and professional fees associated with the transaction. ARRIS retained approximately 50 Com21 employees.

Alliances and Cooperations

In order to enhance our offering to MSOs, in particular, in relation to their move into VoIP, we have entered into several formal and informal alliance and cooperations with various other companies. These relationships include such things as:


	•	Resale agreements with respect to complementary products, for example, with C-Cor for their operational support systems software and with Ellacoya for their peer-to-peer flow control. Resale of these products produces a profit for the Company and enables us to better serve our customers with more integrated solutions.

	•	Interoperability testing with a wide variety of key components for other manufacturers, including call management servers, media gateways, central office switches, and cable modems. Such testing enables us to assure our customers of complete compatibility between our products and products produced by these other manufacturers.

Investment in R&D

We have made significant investments through our research and development efforts in new products and expansion of our existing products. Our primary focus has been on products and services that will enable MSOs to build and operate high availability, fault-tolerant networks, which allow them to generate greater revenue by offering high-speed data, telephony and digital video. This “success-based” capital expenditure is becoming an increasing portion of the cable operators’ total capital spending. In 2004, we spent approximately $63.4 million on research and development, or 12.9% of revenue. We expect to continue to spend similar levels on research and development in the future.

Two new product offerings, both internally developed, contributed substantial revenues in 2004: the Touchstone^tm TM402 Embedded Multimedia Terminal Adapters (E-MTA) and the double-density DOCSIS 2.0 Cable Access Module (CAM) for our Cadant® C4^tm CMTS.

The TM402 development utilized state of the art components coupled with our world class cable telephony know-how to develop a family of E-MTAs. The family encompasses three basic types of E-MTA, each with regional variants:


	•	TM402A/ B/ C — A low cost, non-battery unit principally targeted at the international market where power is not a requirement for primary line services and for second line applications in the U.S.

	•	TM402G/ H — A unit functionally the same as the TM402A/ B/ C but with one low cost unit lithium ion battery which provides up to 8 hours of back-up power. The TM402G/ H meets the economic needs of certain customers while providing modest protection from power outages.

	•	TM402P/ Q — Our flagship unit capable of up to 20 hours of back-up power for primary line services in the U.S.

The E-MTA must interoperate with several other network elements such as the call management server, the CMTS, and the Media Gateway. Each element of the network is marketed by a variety of companies with varying degrees of capability and functionality. In order for us to provide our customers with trouble free E-MTA operation, much of our development is centered on ensuring the interoperability of our E-MTA with the different network elements that our customers identify as the components that they utilize in their networks. Our laboratories are equipped with call management servers and Media Gateways from various manufacturers. In addition to our own C3 and C4 CMTS, we routinely interoperate with CMTS’ from other vendors.

We also are mindful of the need to continuously enhance and optimize the cost of our products. To that end, we currently are engaged in the development of the next generation of E-MTAs, which we expect to ship later in 2005.

Our CMTS developments included the release of the DOCSIS 2.0 double density Cable Access Module (CAM). This module interfaces between the customers’ metro access network ethernet and the hybrid fiber-coax RF plant. The new, double density module provides two downstream channels and twelve upstream channels on a single card. This is twice the downstream capacity and one and a half times the upstream of its predecessor module.

We also began to aggressively invest in our first video product in support of the Next Generation Network Architecture, the Keystone^tm D5 Digital Multimedia Termination System (DMTS). This new product leverages the work we have done in the development of our CMTS products but significantly improves the cost per downstream. This is important to our vision of “Everything IP, Everywhere” and to competitively enter the video edge QAM market. As more and more information is delivered via Internet Protocol (IP) there is an ever increasing demand for bandwidth. The interconnection of the wide area backbone IP network with the hybrid fiber coax plant is a point of high capital expenditure. In order to enable cable operators to effectively compete against telephone companies, with their VDSL and fiber to the curb offerings, we believe we must produce more cost effective edge solutions. The Keystone D5 is such a product. With much of the video traffic moving to IPTV over the next five years, we believe that a demand for large amounts of downstream bandwidth will occur. The D5 is capable of routing both high speed data and video traffic so it provides a converged device at the edge of the network consolidating the functions of several different devices to serve the different purposes.

Product Line Rationalizations

During 2002, upon evaluation and review of our product portfolio, we concluded that two product lines, Keptel and Actives, were not core to our long-term goals; thus, we sold these product lines. Both of these product lines were components of the Company, and the results of these operations for all periods have been reclassified to discontinued operations. In 2003 we also sold Electronic System Products, an engineering

services product line, also not seen as core to our goals. Below is a more detailed description of each of these dispositions:


	Sale of Keptel Product Line

On April 24, 2002, we sold our Keptel telecommunications product line to an unrelated third party for net proceeds of $30.0 million. The transaction included a distribution agreement whereby we continued to distribute certain Keptel products to cable operators. Prior to the sale of the Keptel product line, the related products were manufactured by Keptel and were subsequently sold either directly by Keptel’s sales force to non-cable operators or through TeleWire, ARRIS’ distribution arm. Although a few Keptel products are still distributed by TeleWire in accordance with the distribution agreement from the new owner, they are no longer manufactured by the Company. As of December 31, 2004, approximately $33 thousand related to outside fees associated with the disposal remained in an accrual to be paid. The remaining payments are expected to be made in 2005.


	Sale of Actives Product Line

On November 21, 2002, we sold our Actives product line to Scientific-Atlanta for net proceeds of $31.8 million. As of December 31, 2004, approximately $0.2 million, primarily related to vendor liabilities, remained in an accrual to be paid. The remaining payments are expected to be made in 2005.


	Sale of Electronic System Products (“ESP”) Product Line

On August 18, 2003, ARRIS sold its engineering consulting services product line, known as ESP, to an unrelated third party. The agreement involved the transfer of net assets of approximately $1.3 million, which included accounts receivable, fixed assets, an investment, and other assets attributable to the product line. Further, the transaction provided for the transfer of approximately 30 employees. Additionally, the Company incurred approximately $0.1 million of related closure costs, primarily legal and professional fees associated with the closing. ARRIS recognized a loss on the sale of approximately $1.4 million during 2003.

Management of Operating Expenses

During the past three years we have aggressively and proactively managed our operating expenses, including the implementation of cost reduction actions. These actions were taken for several reasons, all with the intent to lower the breakeven point of our business:


	•	in conjunction with our acquisitions and product line divestitures we were left with duplicative and/or unnecessary costs that required rationalization

	•	as the “two-way” upgrades slowed and the general spending levels in the industry decreased, it was necessary to reduce our cost structure as we experienced lower revenues

	•	as a result of the Comcast purchase of AT&T Broadband we experienced a sharp decline in revenues in late 2002 and into 2003, as a result, it was necessary to reduce our cost structure

Our actions have included the consolidation of facilities in Georgia, closure of development facilities, general reductions in force, and curtailment of certain employee benefits and bonuses. We continue to regularly examine other actions that may need to be taken to reduce the cost structure of the business and improve profitability.

Debt Reduction and Refinancing Actions

We have taken steps over the past three years to restructure and reduce our debt:


	Notes due 2003

In 1998, the Company issued $115.0 million of 4¹/2% convertible subordinated notes due May 15, 2003. The notes were convertible, at the option of the holders, at any time prior to maturity, into the Company’s

common stock at a conversion price of $24.00 per share. In 2002, ARRIS exchanged 1,593,789 shares of its common stock for approximately $15.4 million of the notes. Additionally, the Company redeemed $23.9 million and $75.7 million of the notes during 2003 and 2002, respectively, using cash. As of May 15, 2003, all of the notes were redeemed.


	Notes due 2008

On March 18, 2003, we issued $125.0 million of 4¹/2% convertible subordinated notes due March 15, 2008. These notes are convertible at the option of the holder into our common stock at $5.00 per share, subject to adjustment. We are entitled to redeem the notes at any time, subject to our making a “make whole” payment if we call them for redemption prior to March 15, 2006. In addition, we are required to repurchase the notes in the event of a “change in control.” On March 8, 2004, we called $50.0 million of the notes for redemption, and holders of the called notes elected to convert their notes into an aggregate of 10.0 million shares of common stock, rather than have the notes redeemed. In connection with the exchange, we made a make-whole interest payment of approximately 0.5 million common shares, resulting in a charge of $4.4 million.


	Nortel Class B Membership Interest

We used $88.4 million of the proceeds of the notes issued in 2003 to retire the membership interest of $116.9 million, representing a $28.5 million discount. We also used the proceeds to repurchase and retire 8 million shares for $30.0 million (including $2 million for the reduction in the forgiveness of the return on the membership interest described elsewhere). On the date of the repurchase, the closing fair market value of the shares was approximately $32 million (closing stock price of $4.01).


	Credit Facility

On August 3, 2001 ARRIS entered into an asset-based credit facility. We last used the facility in the fourth quarter of 2001. On several occasions during 2002 and 2003, we modified the facility in order to allow us to, among other things: use existing cash reserves and proceeds of asset sales to purchase or redeem our outstanding notes due 2003, complete our acquisitions, complete our product line dispositions, repurchase shares from Nortel, and reduce the size of the facility. The facility was due to expire on August 3, 2004. During the fourth quarter of 2003, we examined our need for a bank facility and the cost to maintain it. We concluded that the cost benefit of renewing the facility did not warrant the expenditure of funds to do so, as we did not believe it would be likely that we would require access to funds from the facility in the foreseeable future. As a result, during 2003, we terminated the facility and wrote-off approximately $2.3 million of unamortized finance fees related to the facility upon cancellation.

The implementation of these actions has changed our business and as a result our historical results of operations will not be as indicative of future results of operations as they otherwise might suggest.

Results of Operations


	Overview

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

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


	Key Operating Data (as a percentage of net sales)


	Years Ended December 31,

	2004			2003			2002

Net sales		100.0	%		100.0	%		100.0	%
Cost of sales		70.2			70.9			65.2

Gross margin		29.8			29.1			34.8
Operating expenses:
Selling, general, and administrative expenses		14.1			19.1			15.9
Provision for doubtful accounts		(0.1	)		1.5			3.8
Research and development expenses		12.9			14.5			11.1
Restructuring and impairment charges		1.6			0.2			1.1
Impairment of goodwill		—			—			10.8
Amortization of intangibles		5.9			8.1			5.3

Operating income (loss)		(4.5	)		(14.3	)		(13.2	)
Other (income) expense:
Interest expense		1.0			2.4			1.3
Membership interest		—			0.6			1.6
Loss (gain) on debt retirement		0.9			(6.0	)		1.1
Loss (gain) on investments		0.3			0.3			2.3
Loss (gain) on foreign currency		(0.3	)		(0.5	)		(0.9	)
Other expense (income), net		(0.2	)		—			—

Income (loss) from continuing operations before income taxes		(6.2	)		(11.0	)		(18.6	)
Income tax expense (benefit)		—			—			(1.0	)

Net income (loss) from continuing operations		(6.2	)		(11.0	)		(17.6	)
Gain (loss) from discontinued operations		0.4			0.1			(2.9	)

Net income before cumulative effect of accounting change		(5.8	)		(10.9	)		(20.4	)
Cumulative effect of an accounting change		—			—			8.9

Net income (loss)		(5.8	)		(10.9	)		(29.3	)

Comparison of Operations for the Three Years Ended December 31, 2004


	Net Sales

The table below sets forth our net sales for the three years ended December 31, 2004, 2003, and 2002, for each of our product categories described in Item 1 of this Form 10-K (in millions):


			Net Sales						Increase (Decrease) Between Periods

			For the Years Ended December 31,						2004 vs. 2003				2003 vs. 2002

			2004		2003		2002		$		%		$			%

Product Category:
	Broadband		$	300.2	$	289.6	$	448.9	$	10.6		3.7	$	(159.3	)		(35.5	)
	Supplies & CPE			189.8		144.4		203.0		45.4		31.4		(58.6	)		(28.9	)

		Total sales	$	490.0	$	434.0	$	651.9	$	56.0		12.9	$	(217.9	)		(33.4	)

The table below sets forth our domestic and international sales for the three years ended December 31, 2004, 2003, and 2002 (in millions):


				Net Sales						Increase (Decrease) Between Periods

				For the Years Ended December 31,						2004 vs. 2003				2003 vs. 2002

				2004		2003		2002		$		%		$			%

Domestic				$	366.4	$	351.9	$	503.7	$	14.5		4.1	$	(151.8	)		(30.1	)
International:
	Asia Pacific				48.0		36.8		51.4		11.2		30.4		(14.6	)		(28.4	)
	Europe				46.2		27.2		67.9		19.0		69.9		(40.7	)		(59.9	)
	Latin America				18.2		8.0		20.4		10.2		127.5		(12.4	)		(60.8	)
	Canada				11.2		10.1		8.5		1.1		10.9		1.6			18.8

		Total International			123.6		82.1		148.2		41.5		50.5		(66.1	)		(44.6	)

			Total	$	490.0	$	434.0	$	651.9	$	56.0		12.9	$	(217.9	)		(33.4	)


	Broadband Net Sales 2004 vs. 2003

During 2004, sales of our Broadband products increased by $10.6 million or 3.7% as compared to 2003. This increase reflects:


	•	Sales of our CMTS product increased year over year. A significant portion of this increase is attributable to an increase in sales to Liberty Media International (including its affiliates).

	•	As anticipated, sales of our CBR voice products in 2004 declined from 2003. However, we continued to have steady sales of CBR product to Cox Communications and Jupiter. We believe that ultimately the sales of these products will decline as Cox Communications and Jupiter complete their initial rollout of telephony and transition to VoIP. We are uncertain about the rate and timing of this decline.


	Supplies & CPE Net Sales 2004 vs. 2003

Supplies & CPE product revenue increased by approximately 31.4% in 2004 as compared to 2003. This increase reflects:


	•	Included in the Supplies & CPE product category is DOCSIS cable modems and E-MTAs. Sales of these products increased significantly in 2004. A significant portion of the increase is attributable to the ramp in sales of our E-MTAs, as operators begin to deploy VoIP.

	•	Supplies & CPE product revenue internationally increased by $23.5 million in 2004 as compared to 2003, primarily due to an increase in sales of cable modems and E-MTAs to our international customers.

	•	Domestically, sales of our Supplies & CPE products increased by $21.9 million. A substantial portion of this increase is related to sales of E-MTAs, most notably to Time Warner.

	•	The market for E-MTAs developed significantly in 2004 as operators began to deploy to VoIP. As this market developed we achieved significant market success worldwide. We anticipate robust sales of this product family in 2005.


	Broadband Net Sales 2003 vs. 2002

During 2003, sales of our Broadband products declined by 35.5% as compared to 2002. This decrease reflects:


	•	Sales to Comcast for CBR telephony products declined by approximately $163.7 million year-over-year. AT&T Broadband had been our largest customer of CBR telephony products. In the fourth quarter 2002, Comcast completed its purchase of AT&T Broadband. Comcast had announced that its

initial priority after its acquisition of AT&T Broadband would be to emphasize video and high-speed data operations and focus on improving the profitability of its telephony operations rather than subscriber growth. As a result, our sales of CBR products to Comcast decreased significantly in 2003 and continued into 2004. This decline was partially offset by an increase in C4 sales to Comcast.

• In 2003, we began to achieve market traction for our new generation CMTS products. These new products included the C4, acquired as part of our Cadant acquisition, and the C3, acquired as part of our Com21 acquisition. In 2003, we had approximately $100 million of sales of these products. We believe we exited 2003 with a significant market share for these next generation CMTS products. Comcast was our most sizable customer; however, we shipped C3 and C4 products to 42 customers in 2003. We continued to achieve market success with the C3 and C4; however, with significant competition from, in particular Motorola, Cisco, Terayon, and ADC.

• We continued to have robust sales of our CBR product, particularly to Cox Communications and Jupiter. Both companies expanded their footprint of HDTs in 2003, a leading indicator of future voiceport volume.

• Broadband product revenue internationally declined by $69.4 million during 2003 as compared to 2002. A significant portion of this decline is attributable to the reduced purchases by Cabovisao as a result of its financing difficulties; Cabovisao accounted for approximately $39.0 million of the decrease in Broadband international revenue in 2003. Further, both Jupiter in Japan and VTR in Chile slowed their purchases of our CBR telephony equipment.


	Supplies & CPE Net Sales 2003 vs. 2002

Supplies & CPE product revenues decreased by approximately 28.9% in 2003 as compared to 2002. This decrease reflects:


	•	Sales of power supplies related to CBR products declined as a direct result of the significant decrease in Comcast’s purchases of telephony products, as described above. Consolidated power supply revenue for 2003 was $0.2 million, as compared to revenue of $14.4 million in 2002.

	•	Revenues were significantly impacted by the decline in shipments to Adelphia, which filed for bankruptcy during the second quarter of 2002. The bankruptcy filing by Adelphia and the resulting reduced sales to Adelphia accounted for approximately $6.5 million of the overall decrease in Supplies & CPE product revenue year-over-year.

	•	A general slowdown in MSOs infrastructure spending as a result of the tightened credit market and the decline in spending by some customers on “two-way” upgrades, contributed to the remaining decrease in Supplies & CPE revenue year-over-year.

	•	Included in the Supplies & CPE product category is DOCSIS cable modems and E-MTAs. Sales of these products increased modestly in 2003.


	Gross Margin

The table below sets forth our gross margin for the three years ended December 31, 2004, 2003, and 2002, for each of our product categories (in millions):


			Gross Margin $
									Increase (Decrease) Between Periods

			For the Years Ended
			December 31,						2004 vs. 2003				2003 vs. 2002

			2004		2003		2002		$		%		$			%

Product Category:
	Broadband		$	120.7	$	110.1	$	190.4	$	10.6		9.6	$	(80.3	)		(42.2	)
	Supplies & CPE			25.5		16.2		36.3		9.3		57.4		(20.1	)		(55.4	)

		Total	$	146.2	$	126.3	$	226.7	$	19.9		15.8	$	(100.4	)		(44.3	)

The table below sets forth our gross margin percentages for the three years ended December 31, 2004, 2003, and 2002, for each of our product categories:


			Gross Margin %

			For the Years Ended						Percentage Point Increase
			December 31,						(Decrease) Between Periods

			2004		2003		2002		2004 vs. 2003		2003 vs. 2002

Product Category:
	Broadband			40.2		38.0		42.4		2.2		(4.4	)
	Supplies & CPE			13.4		11.2		17.9		2.2		(6.7	)
		Total		29.8		29.1		34.8		0.7		(5.7	)


	Broadband Gross Margin 2004 vs. 2003

The increase in Broadband gross margin dollars and percentages in 2004 as compared to 2003 was related to the following factors:


	•	Gross margin dollars were impacted by year-over-year increases in revenues.

	•	Product cost reduction programs were implemented in the second half of 2003, which helped contribute to an increase in margins.

	•	In 2004, we recorded $2.7 million of inventory reserves versus $5.6 million in 2003.

	•	In the third and fourth quarters of 2004, our broadband gross margin percentages were 41.5% and 34.6%, respectively, reduced from the first half of 2004. The decrease is the result of costs associated with the introduction of our DOCSIS 2.0 CMTS, including higher initial product costs as we launch the product and a change in product mix, more specifically, lower sales of our higher margin CBR products. We believe that our broadband margins will improve in 2005 from the fourth quarter levels but the improvement is dependant upon the impact of, among other factors, achievement of planned cost reductions, product mix, and price reductions granted to customers, in particular for our CBR products. In early 2005, we announced that we had entered into a letter of intent with Cox, our largest CBR customer, in which we agreed to provide them with price reductions in return for volume commitments.


	Supplies & CPE Gross Margin 2004 vs. 2003

The increase in Supplies & CPE gross margin dollars and percentages in 2004 as compared to 2003 was related to the following factors:


	•	The increase in revenues year-over-year significantly impacted gross margin dollars. This was predominantly related to our increase in sales of E-MTAs.

	•	In 2004, we recorded $2.9 million of inventory reserves versus $6.4 million in 2003.

	•	In the third and fourth quarter of 2004, our Supplies & CPE gross margin percentages were 10.6% and 13.4%, respectively. We believe that our Supplies & CPE margins will improve in 2005 from the second half 2004 levels, but the improvement is dependant upon the impact of, amongst other factors, achievement of planned cost reductions, product mix, and price reductions granted to customers.


	Broadband Gross Margin 2003 vs. 2002

The reduction in Broadband gross margin dollars and percentages in 2003 as compared to 2002 was related to the following factors:


	•	Gross margin dollars were significantly impacted by year-over-year declines in revenues.

	•	The reduced sales volume contributed to lower margin percentages, as there was a lower base to cover our fixed costs.


	•	A shift within the Broadband product mix resulted in lower margins; specifically, we sold less CBR equipment in 2003 as compared to 2002.

	•	In 2003, we recorded $5.6 million of inventory reserves versus $2.1 million in 2002.

	•	Negatively impacting gross margin was $0.4 million and $0.7 million of employee severance for 2003 and 2002, respectively.

In the third and fourth quarters of 2003, we implemented product cost reductions, which helped contribute to an increase in margins. Gross margin for our Broadband product improved to 43.3% in the fourth quarter 2003, due to mix and the impact of the cost reductions.


	Supplies & CPE Gross Margin 2003 vs. 2002

The reduction in Supplies & CPE gross margin dollars and percentages in 2003 as compared to 2002 was related to the following factors:


	•	The decrease in revenues year over year significantly impacted gross margin dollars.

	•	Product mix, specifically, reduced sales of higher margin power supplies in the CBR market, increased sales of lower margin cable modems, and relatively reduced sales of other proprietary products negatively impacted margin.

	•	Increased competition in a declining revenue environment caused price erosion, which also negatively impacted gross margins.

	•	Negatively impacting gross margin was $0.8 million of employee severance for 2002.

	•	Inventory reserves, impacted by the general downturn in the industry, the Comcast acquisition of AT&T Broadband and the related change in purchase patterns, and the decision to divest the powering product line. In 2003, we recorded $6.4 million of inventory reserves versus $10.8 million in 2002.


	Operating Expenses

The table below provides detail regarding our operating expenses (in millions):


		Operating Expenses							Increase (Decrease) Between Periods

		For the Years Ended December 31,							2004 vs. 2003						2003 vs. 2002

		2004			2003		2002		$			%			$			%

SG&A		$	69.1		$	82.7	$	103.4	$	(13.6	)		(16.4	)	$	(20.7	)		(20.0	)
Provision for doubtful accounts			(0.5	)		6.4		24.7		(6.9	)		(107.8	)		(18.3	)		(74.1	)
R&D			63.4			62.9		72.5		0.5			0.8			(9.6	)		(13.2	)
Restructuring & impairment			7.6			0.9		7.1		6.7			744.4			(6.2	)		(87.3	)
Impairment of goodwill			—			—		70.2		—			0.0			(70.2	)		(100.0	)
Amortization of intangibles			28.7			35.2		34.5		(6.5	)		(18.5	)		0.7			2.0

	Total	$	168.3		$	188.1	$	312.4	$	(19.8	)		(10.5	)	$	(124.3	)		(39.8	)


	Selling, General, and Administrative, or SG&A, Expenses and Provision for Doubtful Accounts


	2004 vs. 2003

Several factors contributed to the reduction year over year:


	•	Legal fees and settlement costs decreased significantly in 2004. In 2003, we incurred approximately $5.0 million of settlement/legal expenses associated with patent litigation that ultimately was settled.

	•	In 2003, we recorded $2.2 million associated with the write-off of customer relations software.

	•	In 2003, we incurred $1.4 million of costs associated with the disposal of ESP.


	•	The impact of previously implemented cost reduction programs led to lower operating expenses, offset by higher employee incentive accruals.

	•	Reserves for doubtful accounts decreased year over year primarily as a result of lower year over year requirements for Cabovisao of $4.9 million, net of a gain of $1.5 million from the sale of the receivable to a third party.

	•	Included in the SG&A expenses for 2004 and 2003 are severance costs of $0.4 million and $1.1 million, respectively.


	2003 vs. 2002

Several factors contributed to the reduction year over year:


	•	The elimination of Nortel Networks’ agency fee accounted for approximately $11.7 million of the year-over-year decrease. The agreement with Nortel Networks for international agency fees terminated in December 2002.

	•	As we have highlighted elsewhere, we implemented several actions to reduce both SG&A and R&D costs. These actions include reductions in force, curtailment of certain employee benefits and reductions in bonuses.

	•	Included in the SG&A expenses for 2003 and 2002 are severance costs of $1.1 million and $2.9 million, respectively.

	•	In 2002, we incurred net charges of approximately $14.9 million related to the allowance for doubtful accounts for Adelphia (who entered in bankruptcy). In 2003, we recorded net charges of $4.9 million related to the allowance for doubtful accounts for Cabovisao (who also entered into bankruptcy).


	Research & Development 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 Telecom costs.


	2004 vs. 2003

R&D expenses increased $0.5 million year over year, or less than one percent. Our primary focus in research & development expenditures in 2004 and 2003 was on products that allow MSOs to garner new revenues, in particular, high-speed data, VoIP, and Video over IP. Major development efforts in 2004 and 2003 included work on the following: CMTS (C4, C3, D5), CPE (DOCSIS modems & E-MTAs), Atoga product suite, product cost reductions, and new initiatives (including VoIP).


	2003 vs. 2002

The decrease in R&D expense year over year encompasses several factors:


	•	The closure in November 2002 of our Andover, Massachusetts location, which was primarily a product development and repair facility. Following the purchase of Cadant, we were able to reduce duplicative effort and close this facility.

	•	As we have highlighted elsewhere, we implemented several actions to reduce both R&D and SG&A costs. These actions include reductions in force, curtailment of certain employee benefits and reductions in bonuses.

	•	Included in the R&D expenses for 2003 and 2002 are severance costs of $1.3 million and $1.0 million, respectively.

	•	Partially offsetting these decreases was the addition of expense related to the acquisition of Atoga in March 2003 and Com21 in August 2003.

Major development efforts in 2003 included work on the following: CMTS (C4, C3), CPE (DOCSIS modems & E-MTAs), Atoga product suite, sustaining effort on CBR products, and product cost reductions.


	Restructuring and Impairment Charges

During 2004, we consolidated two facilities in Georgia, giving us the ability to house many of our core technology, marketing, and corporate headquarter functions in a single building. This consolidation resulted in a restructuring charge of $6.2 million. Also during 2004, we adjusted our reserves related to previously closed facilities. This adjustment was due to a change in estimates and resulted in a restructuring charge of approximately $1.1 million. Lastly, our office in Fremont, California was closed at the end of 2004. This resulted in a restructuring charge of $0.3 million, of which $0.2 million related to severance charges and $0.1 million related to lease commitments.

During 2003, ARRIS evaluated the restructuring accruals related to previously closed facilities. Upon final review, we recorded additional restructuring charges of $0.9 million during the year ended December 31, 2003 as a result of a change to the initial estimates used.

On October 30, 2002, we announced the closure of our office in Andover, Massachusetts. We decided to close the office in order to reduce operating costs through consolidations of our facilities. The closure affected approximately 75 employees and was completed during the second quarter of 2003. In connection with this facility closure, we recorded a charge of approximately $7.1 million in the fourth quarter of 2002. Included in this restructuring charge was approximately $2.1 million related to remaining lease payments, $2.7 million of fixed asset write-offs, $2.1 million of severance, and $0.2 million of other costs associated with these actions.


	Impairment of Goodwill

We adopted SFAS No. 142, Goodwill and Other Intangible Assets, on January 1, 2002. Under the transitional provisions of SFAS No. 142, we recorded a goodwill impairment loss of approximately $58.0 million. The impairment loss has been recorded as a cumulative effect of a change in accounting principle on the accompanying Consolidated Statements of Operations for the year ended December 31, 2002.

On an annual basis, our goodwill is reviewed based upon management’s analysis and includes an independent valuation. During the fourth quarter of 2002, an impairment charge of $70.2 million was recorded with respect to our Supplies & CPE product category, primarily due to a decline in current purchasing by Adelphia, as well as the continuing decline in the industry in general. The valuation was determined using a combination of the income and market approaches on an invested capital basis, which is the market value of equity plus interest-bearing debt. Independent valuations based upon management’s analysis were performed in the fourth quarters of 2004 and 2003, and no further impairment was indicated.


	Amortization of Intangibles

Our intangibles amortization expense represents amortization of existing technology acquired as a result of the Arris Interactive L.L.C. acquisition in 2001, the Cadant, Inc. acquisition in 2002, and the Atoga and Com21 acquisitions in 2003. As of August 2004, the intangibles with respect to the Arris Interactive L.L.C. acquisition were fully amortized, and as of January 2005, the intangibles associated with Cadant, Inc. were fully amortized.


	Other Expense (Income)

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


		Other Expense (Income)									Increase (Decrease) Between Periods

		For the Years Ended December 31,									2004 vs. 2003			2003 vs. 2002

		2004			2003			2002

Interest expense		$	5.0		$	10.4		$	8.4		$	(5.4	)	$	2.0
Membership interest			—			2.4			10.4			(2.4	)		(8.0	)
Loss (gain) on debt retirement			4.4			(26.2	)		7.3			30.6			(33.5	)
Loss on investments and notes receivable			1.3			1.4			14.9			(0.1	)		(13.5	)
Gain on foreign currency			(1.3	)		(2.4	)		(5.7	)		1.1			3.3
Other expense (income)			(1.1	)		0.2			0.2			(1.3	)		—

	Total expense (income)	$	8.3		$	(14.2	)	$	35.5		$	(22.5	)	$	(49.7	)


	Interest Expense

Interest expense reflects the amortization of deferred finance fees, and the interest paid on our convertible subordinated notes and capital leases.


	Membership Interest Expense

In conjunction with the acquisition of Arris Interactive L.L.C. in August 2001, we issued to Nortel Networks a subordinated redeemable Class B membership interest in Arris Interactive L.L.C. with a face amount of $100.0 million. This membership interest earned a return of 10% per annum, compounded annually. During the first quarter 2003, we redeemed the entire Class B membership interest in Arris Interactive L.L.C. held by Nortel Networks, at a discount, at which point the membership interest ceased.


	Loss (Gain) on Debt Retirement

During 2004, we called $50.0 million of the notes due 2008 for redemption, and holders of the called notes elected to convert their notes into an aggregate of 10.0 million shares of common stock, rather than have the notes redeemed. Under the indenture’s terms for redemptions prior to March 18, 2006, we made a make-whole interest payment of approximately 0.5 million common shares, resulting in a charge of $4.4 million during the first quarter of 2004.

The net gain on debt retirement of $26.2 million in 2003 consists of two transactions:


	•	During the first quarter 2003, we redeemed the entire Class B membership interest in Arris Interactive L.L.C. held by Nortel Networks for approximately $88.4 million. This discounted redemption resulted in a gain of approximately $28.5 million during the first quarter of 2003.

	•	During the fourth quarter 2003, we chose to cancel our credit facility, which was due to expire in August 2004. As a result, we wrote off approximately $2.3 million of unamortized finance fees related to the facility upon cancellation.

The net loss on debt retirement of $7.3 million in 2002 consists of two transactions:


	•	During the second quarter 2002, we exchanged 1,593,789 shares of our common stock for approximately $15.4 million of the notes due 2003. The exchanges were recorded in accordance with SFAS No. 84, Induced Conversions of Convertible Debt, which requires the recognition of an expense equal to the fair value of additional shares of common stock issued in excess of the number of shares that would have been issued upon conversion under the original terms of the notes. As a result, in connection with these exchanges, we recorded a non-cash loss of approximately $8.7 million, based upon a weighted average common stock value of $9.10 (as compared with a common stock value of

$24.00 per share in the original conversion ratio for the notes). In connection with the exchanges, we also incurred associated fees of $0.6 million, resulting in an overall net loss of $9.3 million.

• During 2002, we redeemed $75.7 million of outstanding notes due 2003. The notes were redeemed at a discount, resulting in a gain on the debt retirement of $2.0 million which was recorded in accordance with SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.


	Loss on Investments and Notes Receivable

We hold certain investments in the common stock of publicly-traded companies, a number of non-marketable equity securities, and an investment in a rabbi trust associated with our deferred compensation plan. For further discussion on the classification and the accounting treatment of these investments, see the Investments section within Financial Liquidity and Capital Resources contained herein. During the years ended December 31, 2004, 2003, and 2002, we recorded net losses related to these investments of $1.2 million, $1.4 million, and $14.9 million, respectively.

During 2004, we recorded a charge of $0.1 million in relation to a short-term note receivable that we deemed to be fully impaired. The note, which was due from an unrelated private company, became due in October 2004, and the company was unable to repay the note.


	Gain in Foreign Currency

During 2004, 2003 and 2002, we recorded foreign currency gains related to our international customers whose receivables and collections are denominated in their local currency. Beginning in 2002, we implemented a hedging strategy to mitigate the monetary exchange fluctuations from the time of invoice to the time of payment, and have occasionally entered into forward contracts based on a percentage of expected foreign currency receipts.


	Income Tax Expense

In 2004, we recorded income tax expense of $0.1 million related to foreign income taxes. As we are in a cumulative loss position for tax purposes, we did not incur income tax expense (benefit) during 2003. In 2002, we recognized a tax benefit of $6.8 million due to a change in the tax laws allowing NOL carry-backs for five years, which allowed the Company to record a tax benefit. In 2005, we anticipate some income tax expense for foreign taxes and Alternative Minimum Tax in the United States.


	Discontinued Operations

We have adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, with respect to our Actives and Keptel product line disposals. As a result, these two product lines have been accounted for as discontinued operations and historical results have been reclassified accordingly. Revenues from the discontinued operations were $66.3 million and $113.0 million for the years ended December 31, 2002 and 2001, respectively. The income (loss) from discontinued operations, net of taxes, for the years ending December 31, 2002 and 2001 was $(18.8) million and $(84.5) million, respectively. During 2002, we recorded a net loss on disposals of $4.0 million.

During 2003, we reduced our accruals for vendor liabilities, warranty issues, and other estimated costs related to disposals by $4.8 million. This adjustment was the result of settling certain vendor liabilities for amounts less than originally anticipated and changes to our original estimated disposal costs. Also during 2003, we increased our accrual by $4.4 million for restructuring liabilities associated with the discontinued operations of the Company’s manufacturing facilities as a result of changes in estimates. The net result of the above transactions in 2003 was a gain of $0.4 million in discontinued operations.

During 2004, we recorded income from discontinued operations of approximately $1.8 million with respect to the Actives and Keptel product lines as a result of changes in estimates related to real estate, vendor liabilities, and other accruals. Additionally, we recognized a partial recovery of $0.9 million with respect to

inventory previously written off associated with an Argentinean customer, of which approximately $0.3 million related to the discontinued operations of Actives and Keptel. The net result of the above transactions in 2004 was a gain of $2.1 million in discontinued operations.


	Cumulative Effect of an Accounting Change — Goodwill

Financial Liquidity and Capital Resources


	Overview

As highlighted earlier, one of our key strategies is to maintain and improve our capital structure. The key metrics we focus on are summarized in the table below:


	Liquidity & Capital Resources Data


		Year Ended December 31,

		2004			2003			2002

		(in millions, except DSO and Turns)
Key Working Capital Items
Cash provided by operating activities		$	21.5		$	14.9		$	117.4
Cash, cash equivalents, and short-term investments		$	103.1		$	84.9		$	98.4
Accounts Receivable, net		$	55.7		$	56.3		$	81.0
	– Days Sales Outstanding (Full Year)		42			58			55
Inventory		$	92.6		$	78.6		$	104.2
	– Turns (Full Year)		4.0			3.4			3.5
Key Debt Items
	Convertible Notes due 2003	$	—		$	—		$	23.9
	Convertible Notes due 2008	$	75.0		$	125.0		$	—
	Nortel Class B Membership Interest	$	—		$	—		$	114.5
Capital Expenditures		$	10.2		$	5.9		$	7.9
Shares Owned by Nortel			3.2			5.0			22.0
% Owned by Nortel			3.6	%		6.6	%		26.7	%

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

	•	2008 Notes — implement a plan to retire the notes; the first step was taken by means of a partial redemption ($50 million) in March 2004

	•	2003 Notes — implement a plan to retire the notes; which was ultimately accomplished in 2002 and 2003 through a combination of cash redemptions ($99.6 million) and a share exchange offer ($15.4 million)

	•	Nortel Class B Membership Interest in Arris Interactive L.L.C. — implement a plan to retire the debt; which was ultimately accomplished in 2003 at a significant discount

	•	Growth — implement a plan to ensure that we have adequate capital resources, or access thereto, to execute acquisitions


	•	Overhang — implement a plan to reduce the overhang on our stock caused by Nortel Networks holdings; at the end of 2004 Nortel’s holdings were down to 3.2 million shares (or approximately 3.6% of the shares outstanding)

Below is a description of key actions taken and an explanation as to their potential impact:


	Asset-Based Credit Facility

In August 2001, in parallel with the acquisition of Arris Interactive L.L.C., we entered into an asset-based credit facility with customary terms and covenants. The facility was necessary to close the acquisition and to provide appropriate working capital for the business. We were borrowers under this facility until October 2001. After that time we generated sufficient funds from the disposal of non-core product lines and from operating activities to pay off the facility. In December 2003, we chose to terminate the facility. The facility was to expire on August 3, 2004. In the fourth quarter of 2003 we reviewed the need to renew or replace the facility and concluded that the cost benefit of renewing was not sufficient. This was driven in part by our cash reserves, our perspective on future cash flows, and our belief that a commercially reasonable facility would be available to us in the future, given our asset base, if we required it.


	Inventory & Accounts Receivable Programs

We have generated significant liquidity through reductions in our inventory and accounts receivable levels. From 2002 to 2004, we reduced them by approximately $11.6 million and $25.3 million, respectively. Reductions in sales volumes, divestiture of non-core product lines and overall improvement in the management of these assets has contributed to the reductions. We use turns to evaluate inventory management and days sales outstanding, or DSOs, to evaluate accounts receivable management. From the table above, you will note improvements, particularly as evidenced by the 2004 turns of 4.0 and DSOs of 42 days.

Looking forward, we do not anticipate a further reduction in DSOs. It is possible that DSOs may increase, particularly if the international component of our business increases as customers internationally typically have longer payment terms. Inventory turns may modestly improve in the future.


	Divestiture of Product Lines

We sold our Keptel, Power, Actives, and ESP product lines over the past three years. In each case, the product line was operating at a loss when we sold it. As a result, our cash flow from operations was improved. More significantly, the proceeds we generated from the divestitures provided us with flexibility for our acquisition of the assets of Cadant, Atoga, and Com21 and the retirement of the 2003 Notes. We received $30.0 million from Keptel, $11.2 million from Power, and $31.8 million in proceeds from Actives.


	2003 Notes Exchange Offer

As one step in our program to retire the 2003 Notes, through a registered exchange offer in 2002 we exchanged approximately 1.6 million of our shares for $15.4 million of the notes. The balance of the notes was redeemed for cash.


	2008 Notes & Nortel Debt/ Shares

In June 2002, we entered into an option agreement with Nortel Networks pursuant to which we were entitled to retire the Class B membership interest in Arris Interactive L.L.C. held by Nortel Networks at a substantial discount and repurchase up to 16.0 million shares. The agreement had an expiration date of June 30, 2003. In addition, we obtained from Nortel Networks an agreement to forgive approximately $5.9 million of the return on the membership interest if we redeemed it prior to March 31, 2003. In the first quarter of 2003, we had substantially completed the retirement of the notes due 2003, and had sufficient funds to retire the balance and maintain sufficient liquidity for our business. We investigated options to raise capital to take advantage of the agreement with Nortel Networks and in March 2003, we raised $125.0 million through the private placement of convertible notes. The terms were at market and are described elsewhere.

We used $88.4 million of the proceeds of the notes issuance to retire the membership interest of $116.9 million, representing a $28.5 million discount. We also used the funds to repurchase and retire 8.0 million shares for $30.0 million (including $2.0 million for the reduction in the forgiveness of the return on the membership interest described elsewhere). On the date of the repurchase, the closing fair market value of the shares was approximately $32.0 million (based on a closing stock price of $4.01).


	Redemption of the 2008 Notes

In February 2004, our stock price had risen to the levels required under the indenture where we were entitled to redeem, in full or in part, the notes due 2008. On February 4, 2004, we gave notice of a partial redemption of $50.0 million (with a “make whole” payment described elsewhere to be paid in stock). On that day our stock closed at $9.36 per share. By March 8, 2004, all redeemed note holders chose to convert their notes into stock, resulting in the issuance of 10.0 million shares of ARRIS common stock. It is possible that we will redeem additional notes in the future.


	Expense Management

We have taken significant steps to reduce our cost structure including the closure of factories, the divestiture of product lines, the consolidation of office facilities, general reductions in force and the curtailment of certain employee benefits. This has improved our cash from operations.


	Summary of Current Liquidity Position and Potential for Future Capital Raising

We believe our current liquidity position, where we had approximately $103.1 million of cash, cash equivalents, and short-term investments on hand as of December 31, 2004, together with the prospects for continued generation of cash from operations are adequate for our short- and medium-term business needs. However, a key part of our overall long-term strategy may be implemented through additional acquisitions. Either in order to be prepared to make acquisitions generally or in connection with particular acquisitions, it is possible that we will raise capital through private, or public, share or debt offerings. We believe we have the ability to access the capital markets upon commercially reasonable terms.


	Contractual Obligations

Following is a summary of our contractual obligations as of December 31, 2004:


	Payments due by period

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

	(in millions)
Long-term debt	$	—		$	—		$	75.0	$	—	$	75.0
Operating leases(1)		7.7			11.4			7.8		10.2		37.1
Sublease income		(1.0	)		(0.8	)		—		—		(1.8	)
Purchase obligations(2)		53.1			—			—		—		53.1

Total contractual obligations(3)	$	59.8		$	10.6		$	82.8	$	10.2	$	163.4


(1)	Includes leases which are reflected in restructuring accruals on the consolidated balance sheets.

(2)	Represents obligations under agreements with non-cancelable terms to purchase goods or services. The agreements are enforceable and legally binding, and specify terms, including quantities to be purchased and the timing of the purchase.

(3)	In January 2005, ARRIS entered into two separate and unrelated agreements with certain vendors for future purchase commitments over the next three years in the aggregate amount of $4.5 million. These amounts are not included in the table above as they were entered into subsequent to December 31, 2004.


	Cash Flow

It should be noted that auction rate securities, which were previously classified as cash equivalents, have been reclassified as available-for-sale short-term investments for all periods presented. As a result of this reclassification, the cash flow used in investing activities in 2003 increased by $10.0 million as compared to the investing cash use previously reported. The reported cash flows in 2002 remained as reported as we did not hold any auction rate securities until 2003. Below is a table setting forth the key lines of our Consolidated Statements of Cash Flows (in millions):


		2004			2003			2002

Cash provided by operating activities		$	21.5		$	14.9		$	117.4
Cash provided by (used in) investing		$	(77.6	)	$	(17.3	)	$	51.2
Cash provided by (used in) financing		$	6.2		$	(21.1	)	$	(75.5	)
	Net increase (decrease) in cash	$	(49.8	)	$	(23.5	)	$	93.1


	Operating Activities:

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


		2004			2003			2002

Net income (loss) after non-cash adjustments		$	17.5		$	(4.8	)	$	48.6
(Increase)/ Decrease in accounts receivable			1.2			17.0			30.7
(Increase)/ Decrease in inventory			(14.1	)		26.2			53.4
All other — net			16.9			(23.5	)		(15.3	)

	Cash provided by operating activities	$	21.5		$	14.9		$	117.4


	•	As described above, our net loss improved significantly year over year, resulting in an improvement in cash from operating activities.

	•	Our inventory increased in 2004, as expected, primarily to accommodate a change in contract manufacturers in the fourth quarter of 2004 and to build a pipeline of E-MTAs. In 2003 and 2002, we generated significant cash flow from the reductions in inventory in 2003 and 2002. This was facilitated by the sale of non-core product lines and a strong management focus on reducing inventory levels that had been built up prior to the decline in the industry in 2000. Our inventory turns for 2004 were 4.0 as compared to 2003 turns of 3.4.

	•	We generated cash flow from reductions in accounts receivable in 2003. This was facilitated by the reduction in our overall sales volume (due in part to the sale of non-core product lines) and a strong management focus on collections. Our 2004 DSO was 42 days as compared to the 2003 DSO of 58 days.

	•	While we believe we may be able to further improve our working capital position, future cash flow from operating activities will be more dependent on net income after adjustment for non-cash items.


	Investing Activities:

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


		2004			2003			2002

Capital expenditures		$	(10.2	)	$	(5.9	)	$	(7.9	)
Acquisitions/other			—			(3.2	)		(0.9	)
Purchases of short-term investments			(107.8	)		(10.0	)		—
Disposals of short-term investments			39.8			—			—
Proceeds from sale of investments			0.6			—			—
Proceeds from sale of product lines			—			1.8			60.0

	Cash provided by (used in) investing activities	$	(77.6	)	$	(17.3	)	$	51.2

Capital Expenditures — Capital expenditures are mainly for test equipment, laboratory equipment, and computing equipment. We anticipate investing approximately $15.0 million in 2005.

Acquisitions/ Other — This represents cash investments we have made in our various acquisitions including Com21, Atoga, Cadant and various small strategic investments.

Purchases and Disposals of Short-Term Investments — This represents purchases and disposals of auction rate securities held as short-term investments.

Proceeds from Sale of Investments — This represents the cash proceeds we received from the liquidation of excess assets from our deferred compensation plan.

Proceeds from Sale of Product Lines — This represents the cash proceeds we received from the sale of our Actives and Keptel product lines.


	Financing Activities:

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


		2004			2003			2002

Retirement of 2003 notes		$	—		$	(23.9	)	$	(73.7	)
Payments on notes payable			(1.2	)		(0.7	)		—
Payments on capital leases			—			(2.1	)		(0.9	)
Redemption of preferred membership interest			—			(88.4	)		—
Borrowing under 2008 notes			—			125.0			—
Borrowing under notes payable			—			1.6			—
Sale of common stock			7.4			1.2			1.0
Repurchase of common stock and stock units			—			(28.0	)		(0.1	)
Deferred financing fees paid			—			(5.8	)		(1.8	)

	Cash provided by (used in) financing activities	$	6.2		$	(21.1	)	$	(75.5	)

As can be seen from the above table, we have substantially refinanced our capital structure over the past three years. We have eliminated our bank debt, 2003 Notes and Class B Membership Interest. We did so using cash from operating activities, sale of non-core product lines and the issuance of $125.0 million through our 2008 notes offering.

In 2004, we converted $50.0 million of our 4¹/2% convertible subordinated notes due 2008 in exchange for common stock. In connection with the redemption, we made a make-whole interest payment that included the issuance of approximately 467 thousand common shares valued at approximately $4.4 million which is reflected as a loss on debt retirement in the first quarter of 2004. Additionally, we wrote off approximately $1.6 million of deferred finance fees related to the notes in the first quarter of 2004.


	Interest Rates

As of December 31, 2004, we did not have any floating rate indebtedness. At December 31, 2004, we did not have any outstanding interest rate swap agreements.


	Foreign Currency

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

We have certain international customers who are billed in their local currency. Beginning in 2002, we implemented a hedging strategy and entered into forward contracts based on a percentage of expected foreign currency receipts. The percentage can vary, based on the predictability of cash receipts. We continuously review our accounts receivable in foreign currency and purchase forward contracts when appropriate. As of December 31, 2004, we had no forward contracts outstanding.


	Financial Instruments

In the ordinary course of business, we, from time to time, will enter into financing arrangements with customers. These financial instruments include letters of credit, commitments to extend credit and guarantees of debt. These agreements could include the granting of extended payment terms that result in longer collection periods for accounts receivable and slower cash inflows from operations and/or could result in the deferral of revenue. As of December 31, 2004 and 2003, we had approximately $4.0 million and $6.1 million, respectively, outstanding under letters of credit which were cash collateralized. The cash collateral is held in the form of restricted cash.


	Short-Term Investments

We hold short-term investments consisting of debt securities classified as available-for-sale, which are stated at estimated fair value. These debt securities include U.S. treasury notes, state and municipal bonds, asset-backed securities, auction rate securities, corporate bonds, commercial paper, and certificates of deposit. These investments are on deposit with a major financial institution.


	Investments

We held certain investments in the common stock of publicly-traded companies, which were classified as trading securities. The remaining shares of common stock were sold during 2003 and the investment was $0 at December 31, 2004 and 2003. Changes in the market value of these securities and gains or losses on related sales of these securities were recognized in income and resulted in a gain of $0.1 million in 2003 and a loss of approximately $0.6 million in 2002.

We hold certain investments in the common stock of publicly-traded companies which are classified as available for sale. Changes in the market value of these securities are typically recorded in other comprehensive income. These securities are also subject to a periodic impairment review, which requires significant judgment. Because these investments had been below their cost basis for a period greater than six months, impairment charges of $1.4 million were recorded during the year ended December 31, 2004. In 2003 and 2002, unrealized losses of $0.4 million and $3.5 million, respectively, were considered “other than temporary” and recognized through income in those years. As of December 31, 2004 and 2003, the carrying value of these investments was $0 and $1.4 million, respectively.

In addition, we hold a number of non-marketable equity securities totaling approximately $0.8 million at December 31, 2004, which are classified as available for sale. The non-marketable equity securities are subject to a periodic impairment review, which requires significant judgment as there are no open-market valuations.

During the year ended December 31, 2004, we recorded a charge of approximately $0.1 million in relation to non-marketable equity securities deemed to be impaired based on various factors. During the years ended December 31, 2003 and 2002, we recorded impairment charges of $1.1 million and $10.0 million, respectively, related to our non-marketable equity securities. The impairment loss in 2003 is in relation to an investment in a start-up company, which raised a new round of financing at a substantial discount in early July 2003. The impairment charges in 2002 related to: 1) a $3.0 million impairment for an investment in a technology start-up, as its assets were sold to another company, 2) a $1.0 million impairment for an investment in a technology start-up company, as it was unable to raise further financing and filed for bankruptcy during the second quarter, and 3) additional impairment charges of $6.0 million in the fourth quarter of 2002 relating to other non-marketable equity securities deemed to be impaired based on various factors.

During the third quarter of 2004, we recorded a charge of $0.1 million in relation to a short-term note receivable that it deemed to be fully impaired. The note, which was due from an unrelated private company, became due in October 2004, and the company has been unable to repay the note.

As of December 31, 2004, ARRIS held a non-marketable equity security of $0.6 million (included in the total of $0.8 million described above) and a short-term note receivable of $0.5 million from a private company. Late in 2004, the investee was unsuccessful in attempts to raise additional funds to finance its business. On January 31, 2005, we foreclosed on the note receivable. This was a joint proceeding with the other major note holder of the private company. A new L.L.C. was formed with the other major note holder, of which ARRIS holds a 25% interest. In March 2005, ARRIS and the other note holder have agreed in principle to ARRIS’ acquisition of the other note holder’s interest in the L.L.C. This transaction is expected to close in the second quarter of 2005. The product line will be integrated into ARRIS at that time.

We offer a deferred compensation arrangement, which allows certain employees to defer a portion of their earnings and defer the related income taxes. These deferred earnings are invested in a “rabbi trust,” and are accounted for in accordance with Emerging Issues Task Force Issue No. 97-14, Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested. A rabbi trust is a funding vehicle used to protect deferred compensation benefits from various events (but not from bankruptcy or insolvency). The investment in the rabbi trust is classified as an investment on our balance sheet. During the fourth quarter of 2004, we withdrew the excess of the deferred compensation assets over the plan’s liabilities. A portion of the assets were liquidated, and resulted in a realized gain of approximately $0.3 million. In 2002, we recognized a loss of approximately $0.8 million in connection with realized losses on the related investments. At December 31, 2004, ARRIS had an accumulated unrealized gain related to the rabbi trust of approximately $0.7 million included in other comprehensive income.


	Capital Expenditures

Capital expenditures are made at a level designed to support the strategic and operating needs of the business. ARRIS’ capital expenditures were $10.2 million in 2004 as compared to $5.9 million in 2003 and $7.9 million in 2002. ARRIS had no significant commitments for capital expenditures at December 31, 2004. Management expects to invest approximately $15.0 million in capital expenditures for the year 2005.


	Net Operating Loss Carryforwards

As of December 31, 2004, ARRIS had net operating loss, or NOL, carryforwards for domestic and foreign income tax purposes of approximately $151.8 million and $29.6 million, respectively. The federal NOLs expires through 2024. Foreign NOLs related to our Irish subsidiary in the amount of $22.7 million have an indefinite life and can only be used to offset Irish income; the remaining foreign NOLs expire in 2005. The tax benefit associated with the NOLs is offset by a full valuation allowance, established in 2001 in accordance with the provisions of SFAS No. 109, Accounting for Income Taxes. We continually review the adequacy of the valuation allowance and recognize the benefits only as reassessment indicates that it is more likely than not that the benefits will be realized.

The availability of tax benefits of NOL carryforwards to reduce ARRIS’ federal and state income tax liability is subject to various limitations under the Internal Revenue Code. The availability of tax benefits of

NOL carryforwards to reduce ARRIS’ foreign income tax liability is subject to the various tax provisions of the respective countries.


	Defined Benefit Pension Plans

We sponsor two non-contributory defined benefit pension plans that cover our U.S. employees. As of January 1, 2000 we froze the defined pension plan benefits. The U.S. pension plan benefit formulas generally provide for payments to retired employees based upon their length of service and compensation as defined in the plans. The plans are accounted for in accordance with SFAS No. 87, Employers’ Accounting for Pensions, which requires that amounts recognized in the financial statements be determined on an actuarial basis. Disc


		initial priority after its acquisition of AT&T Broadband would be to emphasize video and high-speed data operations and focus on improving the profitability of its telephony operations rather than subscriber growth. As a result, our sales of CBR products to Comcast decreased significantly in 2003 and continued into 2004. This decline was partially offset by an increase in C4 sales to Comcast.

	•	In 2003, we began to achieve market traction for our new generation CMTS products. These new products included the C4, acquired as part of our Cadant acquisition, and the C3, acquired as part of our Com21 acquisition. In 2003, we had approximately $100 million of sales of these products. We believe we exited 2003 with a significant market share for these next generation CMTS products. Comcast was our most sizable customer; however, we shipped C3 and C4 products to 42 customers in 2003. We continued to achieve market success with the C3 and C4; however, with significant competition from, in particular Motorola, Cisco, Terayon, and ADC.

	•	We continued to have robust sales of our CBR product, particularly to Cox Communications and Jupiter. Both companies expanded their footprint of HDTs in 2003, a leading indicator of future voiceport volume.

	•	Broadband product revenue internationally declined by $69.4 million during 2003 as compared to 2002. A significant portion of this decline is attributable to the reduced purchases by Cabovisao as a result of its financing difficulties; Cabovisao accounted for approximately $39.0 million of the decrease in Broadband international revenue in 2003. Further, both Jupiter in Japan and VTR in Chile slowed their purchases of our CBR telephony equipment.


		$24.00 per share in the original conversion ratio for the notes). In connection with the exchanges, we also incurred associated fees of $0.6 million, resulting in an overall net loss of $9.3 million.

	•	During 2002, we redeemed $75.7 million of outstanding notes due 2003. The notes were redeemed at a discount, resulting in a gain on the debt retirement of $2.0 million which was recorded in accordance with SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.