UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

ARRIS GROUP, INC.

A Delaware Corporation
IRS Employer Identification No. 58-2588724
SEC File Number 000-31254

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

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

As of April 30, 2006, 106,920,664 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

 

 

ARRIS GROUP, INC.
FORM 10-Q
For the Three Months Ended March 31, 2006

INDEX

		Page
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005			2
b) Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005			3
c) Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005			4
d) Notes to the Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3. Quantitative and Qualitative Disclosures on Market Risk			21
Item 4. Controls and Procedures			22
Part II. Other Information
Item 1A Risk Factors			22
Item 6. Exhibits			26
Signatures			27
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. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ARRIS GROUP, INC.

		March 31,				December 31,
		2006				2005
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	129,559			$	75,286
Short-term investments, at fair value			36,250				54,250
Total cash, cash equivalents and short-term investments			165,809				129,536
Restricted cash			6,092				6,073
Accounts receivable (net of allowances for doubtful accounts of $3,692 in 2006 and $3,729 in 2005)			91,360				83,540
Other receivables			4,138				286
Inventories, net			99,673				113,909
Prepaid assets			4,094				10,945
Other current assets			3,251				4,331
Total current assets			374,417				348,620
Property, plant and equipment (net of accumulated depreciation of $71,761 in 2006 and $69,309 in 2005)			24,327				25,557
Goodwill			150,569				150,569
Intangibles (net of accumulated amortization of $106,418 in 2006 and $106,200 in 2005)			702				920
Investments			3,358				3,321
Other assets			388				416
		$	553,761			$	529,403
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	41,478			$	35,920
Accrued compensation, benefits and related taxes			9,503				20,424
Accrued warranty			8,020				8,479
Other accrued liabilities			22,151				20,633
Total current liabilities			81,152				85,456
Accrued pension			12,943				12,636
Other long-term liabilities			5,618				5,594
Total liabilities			99,713				103,686
Stockholders’ equity:
Preferred stock, par value $1.00 per share, 5.0 million shares authorized; none issued and outstanding			—				—
Common stock, par value $0.01 per share, 320.0 million shares authorized; 106.7 million and 105.6 million shares issued and outstanding in 2006 and 2005, respectively			1,081				1,069
Capital in excess of par value			740,954				732,405
Accumulated deficit			(284,831	)			(305,555	)
Unrealized gain on marketable securities			1,114				1,077
Unfunded pension losses			(4,618	)			(4,618	)
Unrealized gain on derivatives			532				1,523
Cumulative translation adjustments			(184	)			(184	)
Total stockholders’ equity			454,048				425,717
		$	553,761			$	529,403

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

(unaudited) (in thousands, except per share data and percentages)

		Three Months Ended
		March 31,
		2006				2005
Net sales		$	208,344			$	135,924
Cost of sales			151,837				99,133
Gross margin			56,507				36,791
Gross margin %.			27.1	%			27.1	%
Operating expenses:
Selling, general, and administrative expenses			21,278				16,519
Research and development expenses			15,074				14,801
Restructuring and impairment charges			328				198
Amortization of intangibles			218				557
Total operating expenses			36,898				32,075
Operating income			19,609				4,716
Other expense (income):
Interest expense			10				1,018
Loss on investments			—				75
Loss (gain) on foreign currency			(317	)			935
Interest income			(1,520	)			(609	)
Other expense (income), net			106				51
Income from continuing operations before income taxes			21,330				3,246
Income tax expense (benefit)			628				(152	)
Net income from continuing operations			20,702				3,398
Income from discontinued operations			21				10
Net income		$	20,723			$	3,408
Net income per common share:
Basic:
Income from continuing operations		$	0.20			$	0.04
Income from discontinued operations			—				—
Net income		$	0.20			$	0.04
Diluted:
Income from continuing operations		$	0.19			$	0.04
Income from discontinued operations			—				—
Net income		$	0.19			$	0.04
Weighted average common shares:
Basic			106,227				87,851
Diluted			109,345				90,497

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

(unaudited) (in thousands)

		Three Months Ended
		March 31,
		2006				2005
Operating activities:
Net income		$	20,723			$	3,408
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation			2,618				2,727
Amortization of intangibles			218				557
Stock compensation expense			2,248				553
Excess tax benefits from stock-based compensation plans			(169	)			—
Amortization of deferred finance fees			—				153
Provision for doubtful accounts			(265	)			(153	)
Gain related to Adelphia receivables			(475	)			—
Loss on disposal of fixed assets			2				(12	)
Loss on investments			—				75
Impairment of long-lived assets			—				291
Gain on discontinued product lines			(21	)			(10	)
Changes in operating assets and liabilities, net of effect of acquisitions and dispositions:
Accounts receivable			(7,555	)			(8,124	)
Other receivables			(3,852	)			20
Inventory			14,236				16,387
Accounts payable and accrued liabilities			(3,666	)			(8,833	)
Other, net			7,280				(133	)
Net cash provided by (used in) operating activities			31,322				6,906
Investing activities:
Purchases of property, plant and equipment			(1,389	)			(1,924	)
Cash proceeds from sale of property, plant and equipment			—				40
Purchases of short-term investments			—				(5,000	)
Disposals of short-term investments			18,000				1,600
Purchases of equity investments			—				(259	)
Net cash provided by (used in) investing activities			16,611				(5,543	)
Financing activities:
Excess tax benefits from stock-based compensation plans			169				—
Proceeds from issuance of stock			6,171				111
Net cash provided by (used in) financing activities			6,340				111
Net increase (decrease) in cash and cash equivalents			54,273				1,474
Cash and cash equivalents at beginning of period			75,286				25,072
Cash and cash equivalents at end of period		$	129,559			$	26,546

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

(unaudited)

Note 1. Organization and Basis of Presentation

ARRIS Group, Inc. (together with its consolidated subsidiaries, except as the context otherwise indicates, “ARRIS” or the “Company”), is an international communications technology company, headquartered in Suwanee, Georgia. ARRIS operates in one business segment, Communications, providing a range of customers with network and system products and services, primarily hybrid fiber-coax networks and systems, for the communications industry. ARRIS is a leading developer, manufacturer and supplier of telephony, data, video, construction, rebuild and maintenance equipment for the broadband communications industry. The Company provides its customers with products and services that enable reliable, high-speed, two-way broadband transmission of video, telephony, and data.

The consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) that are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements for the periods shown. Additionally, certain prior period amounts have been reclassified to conform to the 2006 financial statement presentation. Interim results of operations are not necessarily indicative of results to be expected from a twelve-month period. These financial statements should be read in conjunction with the Company’s most recently audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the United States Securities and Exchange Commission (“SEC”).

Note 2. Impact of Recently Issued Accounting Standards

In June 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including, in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 was effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have an effect on the unaudited consolidated financial statements. The Company will continue to apply the requirements of SFAS No. 154 to any future accounting changes and error corrections.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets – An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The standard requires that nonmonetary asset exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. Productive assets must be accounted for at fair value, rather than at carryover basis, unless neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or the transactions lack commercial substance. SFAS No. 153 states that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 was effective on January 1, 2006. The adoption of SFAS No. 153 did not have an effect on the Company’s unaudited consolidated financial statements.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs – An Amendment of ARB No. 43, Chapter 4. SFAS No. 151 requires that abnormal amounts of idle facility expense, freight, handling costs, and waste material be recognized as current period expense. Further, the standard requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 was effective on January 1, 2006. The adoption of SFAS No. 151 did not have an effect on the Company’s unaudited consolidated financial statements.

Note 3. Stock-Based Compensation

The Company elected to early adopt the fair value recognition provisions of SFAS No. 123R on July 1, 2005, using the modified prospective approach. Prior to the adoption date, ARRIS used the intrinsic value method for valuing its awards of stock options and restricted stock and recorded the related compensation expense, if any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. With the exception of some stock options subject to variable accounting, no other stock-based employee or director compensation cost for stock options was reflected in net income (loss) prior to July 1, 2005, as all options granted had exercise prices equal to the market value of the underlying common stock on the date of grant. The Company records equity compensation expense related to its restricted stock awards and director stock units.

The following table compares the three months ended March 31, 2006 and 2005 had the Company applied the provisions of SFAS No. 123R in the first quarter of 2005:

		Three Months Ended March 31,
		2006				2005
		(in thousands, except per share data)
		(unaudited)
Net income, as reported		$	20,723			$	3,408
Add: Stock-based compensation included in reported net income, net of taxes			2,248				553
Deduct: Total stock-based compensation expense determined under fair value based methods for all awards, net of taxes			(2,248	)			(2,693	)
Net income, pro forma		$	20,723			$	1,268
Net income per common share:
Basic – as reported		$	0.20			$	0.04
Basic – pro forma		$	0.20			$	0.01
Diluted – as reported		$	0.19			$	0.04
Diluted – pro forma		$	0.19			$	0.01

Note 4. Pension Benefits

Components of Net Periodic Pension Benefit Cost

		Three Months Ended March 31,
		2006				2005
		(in thousands)
		(unaudited)
Service cost		$	130			$	151
Interest cost			369				379
Expected return on plan assets			(281	)			(255	)
Amortization of prior service cost			119				119
Amortization of net (gain) loss			2				17
Net periodic pension cost		$	339			$	411

Employer Contributions

No minimum funding contributions are required in 2006 under the Company’s defined benefit plan. However, the Company made voluntary contributions to the plan of approximately $16 thousand during each three month period ended March 31, 2006 and 2005.

Note 5. Guarantees

Warranty

ARRIS provides warranties of various lengths to customers based on the specific product and the terms of individual agreements. The Company provides for the estimated cost of product warranties based on historical trends, the embedded base of product in the field, failure rates, and repair costs at the time revenue is recognized. Expenses related to product defects and unusual product warranty problems are recorded in the period that the problem is identified. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its suppliers, the estimated warranty obligation could be affected by changes in ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product failures outside of ARRIS’ baseline experience. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions (which could be material) would be recorded against the warranty liability. ARRIS evaluates its warranty obligations on an individual product basis.

The Company offers extended warranties and support service agreements on certain products. Revenue from these agreements is deferred at the time of the sale and recognized on a straight-line basis over the contract period. Costs of services performed under these types of contracts are charged to expense as incurred, which approximates the timing of the revenue stream.

Information regarding the changes in ARRIS’ aggregate product warranty liabilities for the three months ending March 31, 2006 was as follows (in thousands):

Balance at December 31, 2005		$	8,479
Accruals related to warranties (including changes in estimates)			584
Settlements made (in cash or in kind)			(1,043	)
Balance at March 31, 2006 (unaudited)		$	8,020

Note 6. Restructuring and Impairment Charges

During the first quarter of 2004, ARRIS consolidated two facilities in Georgia, giving the Company the ability to house many of its core technology, marketing, and corporate headquarters functions in a single building. This consolidation resulted in a restructuring charge of $6.2 million in the first quarter of 2004 related to lease commitments and the write-off of leasehold improvements and other fixed assets. As of March 31, 2006, approximately $3.0 million related to the lease commitments remained in the restructuring accrual to be paid. ARRIS expects the remaining payments to be made by the second quarter of 2009 (end of lease).

		(in millions)
Balance as of December 31, 2005		$	3.1
First quarter payments			(0.3	)
Adjustments to accrual			0.2
Balance as of March 31, 2006 (unaudited)		$	3.0

In the third quarter of 2001, the Company announced a restructuring plan to outsource the functions of most of its manufacturing facilities. This decision to reorganize was due in part to the ongoing weakness in industry spending patterns. Also during the third quarter of 2001, the Company reserved for lease commitments related to an excess facility in Atlanta. As a result of market conditions at that time, ARRIS had downsized and the facility was vacant. As of March 31, 2006, the remaining $0.4 million balance in the restructuring reserve related to lease terminations and other shutdown costs. The remaining costs are expected to be expended by the end of 2006 (end of lease).

		(in millions)
Balance as of December 31, 2005		$	0.4
First quarter 2006 payments			(0.1	)
First quarter 2006 adjustments to accrual			0.1
Balance as of March 31, 2006 (unaudited)		$	0.4

Note 7. Inventories

The components of inventory are as follows, net of reserves (in thousands):

		March 31,				December 31,
		2006				2005
		(unaudited)
Raw material		$	1,329			$	788
Finished goods			98,344				113,121
Total net inventories		$	99,673			$	113,909

Note 8. Property, Plant and Equipment

Property, plant and equipment, at cost, consisted of the following (in thousands):

		March 31,				December 31,
		2006				2005
		(unaudited)
Land		$	1,822			$	1,822
Building and leasehold improvements			11,113				11,126
Machinery and equipment			83,153				81,918
			96,088				94,866
Less: Accumulated depreciation			(71,761	)			(69,309	)
Total property, plant and equipment, net		$	24,327			$	25,557

Note 9. Goodwill and Intangible Assets

The Company’s goodwill and indefinite lived intangible assets are reviewed annually for impairment or more frequently if impairment indicators arise. The annual valuation is performed during the fourth quarter of each year and is based upon management’s analysis including an independent valuation. Separable intangible assets that are not deemed to have an indefinite life are amortized over their useful lives. Each of the Company’s intangible assets has an amortization period of three years.

The carrying amount of goodwill at both March 31, 2006 and December 31, 2005 was $150.6 million.

During the first quarter 2005, a decrease in expected future cash flows related to the Atoga product line indicated that the long-lived assets associated with those products may be impaired. As a result, the Company analyzed the fair value of those assets, using the expected cash flow approach, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The resulting analysis indicated that the remaining intangibles of $0.2 million were fully impaired and were written off in the first quarter 2005. There were no additional assets deemed to be impaired in 2005 or in the first quarter of 2006.

The gross carrying amount and accumulated amortization of the Company’s intangible assets, other than goodwill, as of March 31, 2006 and December 31, 2005 are as follows (in thousands ) :

		March 31, 2006 (unaudited)												December 31, 2005
		Gross				Accumulated				Net Book				Gross				Accumulated				Net Book
		Amount				Amortization				Value				Amount				Amortization				Value
Existing technology acquired:
Arris Interactive L.L.C.		$	51,500			$	(51,500	)		$	—			$	51,500			$	(51,500	)		$	—
Cadant, Inc.			53,000				(53,000	)			—				53,000				(53,000	)			—
Com21			1,929				(1,688	)			241				1,929				(1,527	)			402
cXm Broadband			691				(230	)			461				691				(173	)			518
Total		$	107,120			$	(106,418	)		$	702			$	107,120			$	(106,200	)		$	920

Amortization expense recorded on the intangible assets listed in the above table for the three months ended March 31, 2006 and 2005 was $0.2 million and $0.6 million, respectively. The estimated remaining amortization expense for the next five fiscal years is as follows (in thousands):

2006		$	414
2007		$	230
2008		$	58
2009		$	—
2010		$	—

Note 10. Long-Term Obligations

As of both March 31, 2006 and December 31, 2005, the Company had approximately $6.1 million outstanding under letters of credit, which are cash collateralized and classified as restricted cash on the Consolidated Balance Sheets.

As of March 31, 2006, the Company had approximately $18.6 million of other long-term liabilities, which included $12.9 million related to its accrued pension, $3.3 million related to its deferred compensation obligations, and deferred rental expense of $2.2 million related to landlord funded leasehold improvements. As of December 31, 2005, the Company had approximately $18.2 million of other long-term liabilities, which included $12.6 million related to its accrued pension, $3.2 million related to its deferred compensation obligations, $2.3 million related to deferred rental expense for landlord funded leasehold improvements, and $0.1 million related to security deposits received.

The Company has not paid cash dividends on its common stock since its inception. In 2002, to implement its shareholder rights plan, the Company’s Board of Directors declared a dividend consisting of one right for each share of its common stock outstanding. Each right represents the right to purchase one one-thousandth of a share of its Series A Participating Preferred Stock and becomes exercisable only if a person or group acquires beneficial ownership of 15% or more of its common stock or announces a tender or exchange offer for 15% or more of its common stock or under other similar circumstances.

Note 11. Comprehensive Income

Total comprehensive income represents the net change in stockholders’ equity during a period from sources other than transactions with stockholders. For ARRIS, the components of total comprehensive income include the unrealized gain (loss) on marketable securities, unrealized gain (loss) on derivative instruments qualifying for hedge accounting, and foreign currency translation adjustments. The components of comprehensive income for the three months ended March 31, 2006 and 2005 are as follows (in thousands):

		Three Months Ended March 31,
		(unaudited)
		2006				2005
Net income		$	20,723			$	3,408
Changes in the following equity accounts. Unrealized gain (loss) on marketable securities			37				36
Unrealized gain (loss) on derivative instruments			(991	)			—
Translation adjustment			—				(1	)
Comprehensive income		$	19,769			$	3,443

Note 12. Sales Information

The Company’s four largest customers (including their affiliates, as applicable) are Comcast, Cox Communications, Liberty Media International and Time-Warner Cable. Over the past year, certain customers’ beneficial ownership may have changed as a result of mergers and acquisitions. Therefore, the revenue for ARRIS’ customers for prior periods has been adjusted to include the affiliates under common control. A summary of sales to these customers for the three month periods ended March 31, 2006 and 2005 are set forth below (in thousands):

		Three Months Ended
		March 31,
		(unaudited)
		2006				2005
Comcast		$	72,507			$	25,390
% of sales			34.8	%			18.7	%
Cox Communications		$	25,790			$	28,786
% of sales			12.4	%			21.2	%
Liberty Media International		$	22,542			$	25,165
% of sales			10.8	%			18.5	%
Time–Warner Cable		$	22,935			$	18,338
% of sales			11.0	%			13.5	%

No other customer provided more than 10% of total sales for the three months ended March 31, 2006 or 2005.

The Company operates globally and offers products and services that are sold to cable system operators and telecommunications providers. The Company’s products and services are focused in two product categories: Broadband and Supplies & Customer Premises Equipment (“CPE”). Consolidated revenue by principal product and service for the three months ended March 31, 2006 and 2005 were as follows (in thousands):

		Three Months Ended
		March 31,
		(unaudited)
		2006				2005
Broadband		$	85,390			$	69,652
Supplies and CPE			122,954				66,272
Total sales		$	208,344			$	135,924

ARRIS sells its products primarily in North America. The Company’s 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, the Netherlands, Poland, Portugal, Spain, and Switzerland. The Latin American market primarily

includes Argentina, Brazil, Chile, and Puerto Rico. Sales to international customers were approximately $50.9 million, or 24.4% of total sales, for the three months ended March 31, 2006. International sales during the same period in 2005 were $36.0 million, or 26.0% of total sales.

As of March 31, 2006, ARRIS held approximately $2.6 million of assets in Ireland (related to its Com21 facility), comprised of $1.7 million of cash and $0.9 million of fixed assets. As of December 31, 2005, ARRIS held approximately $2.2 million of assets in Ireland, comprised of $1.3 million of cash and $0.9 million of fixed assets.

Note 13. Earnings Per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations for the periods indicated (in thousands except per share data):

		Three Months Ended
		March 31,
		(unaudited)
		2006				2005
Basic:
Income from continuing operations		$	20,702			$	3,398
Income from discontinued operations			21				10
Net income		$	20,723			$	3,408
Weighted average shares outstanding.			106,227				87,851
Basic earnings per share		$	0.20			$	0.04
Diluted:
Income from continuing operations		$	20,702			$	3,398
Income from discontinued operations			21				10
Net income		$	20,723			$	3,408
Weighted average shares outstanding.			106,227				87,851
Net effect of dilutive equity awards			3,118				2,646
Total			109,345				90,497
Diluted earnings per share		$	0.19			$	0.04

Item 2. 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. To achieve this goal, we have implemented a long-term business strategy that 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; and
	•		Maintain and improve an already strong capital structure and expense structure.

     Below is a summary of some key year to date highlights:

	•		The VoIP market continued to grow in first quarter 2006 as MSOs continued their rollout of telephony to their customers. We leveraged our existing market position and product offerings to increase sales of both E-MTAs and CMTS product.
	•		In the first quarter 2006, we shipped 1.1 million E-MTAs which compares to 0.3 million and 0.6 million in the first quarter and fourth quarter of 2005, respectively. We anticipate robust unit shipments in the second quarter of 2006.
	•		In the first quarter 2006, we shipped 4,359 CMTS downstreams, which compares to 1,719 and 3,496 in the first quarter and fourth quarter of 2005, respectively.
	•		As anticipated, sales of our CBR product declined sequentially and year over year, as customers migrate to VoIP. We expect this trend to continue through 2006.
	•		As expected, we experienced a decline in consolidated gross margins in the first quarter 2006 as compared to the fourth quarter of 2005. We sold proportionately more E-MTAs that have margins lower than the company average. We also entered into several long term (with terms of 12 to 18 month) agreements with large customers in which we anticipate shipping our 500-series products, which carry a lower average unit cost than our 400-series products. However, our 500-series products had not yet been certified by these customers. To secure these long term agreements, we elected to ship the more costly 400-series products until such time as the 500-series products became certified. As of this date, all but a few of these customers has certified the 500-series products. We anticipate a vast majority of customers will certify the product by the end of the second quarter of 2006. A customer has requested that we provide a variant of the 500-series product with the 400-series battery so that they can maintain a single battery type in their inventory. We are in the process of designing this variant which we anticipate will become available in the third quarter of 2006. The net effect of these decisions was to reduce our margins in the first quarter of 2006. As we transition to shipping more 500-series products in the second and third quarters we expect our margins to improve.
	•		We invested $15.1 million in research and development in the first quarter 2006. Key products we expect to launch later this year include: our Keystone D5 Digital Multimedia Termination System, a wireless E-MTA gateway, a multiline E-MTA, a T1/E1 MTA, and our FlexPath wideband products including a wideband modem.
	•		In April 2006, we announced that we entered into a joint development, licensing and supply agreement with UTStarcom that will enable the fourth leg of the quadruple play for cable MSOs worldwide. The joint solution will allow customers with Wi-Fi enabled handsets to seamlessly roam between their cellular and Wi-Fi connections, or a service commonly referred to as fixed mobile convergence, or FMC. As part of this agreement, we expect to invest up to $5.0 million in license fees over three years to acquire certain technologies. In the second quarter of 2006, we anticipate recognizing expense of approximately $2.5 million related to this agreement; the remaining license fees are expected to be expensed in 2007 and 2008.

•

During first quarter 2006, we generated $31.3 million of cash from operating activities. Improvements were realized in both inventory and accounts receivable management. Total cash, cash equivalents, and short-term investments increased approximately $36.3 million during the first quarter 2006.

Significant Customers

The Company’s four largest customers (including their affiliates, as applicable) are Comcast, Cox Communications, Liberty Media International and Time-Warner Cable. Over the past year, certain customers’ beneficial ownership may have changed as a result of mergers and acquisitions. Therefore the revenue for ARRIS’ customers for prior periods has been adjusted to include the affiliates under common control. A summary of sales to these customers for the three month periods ended March 31, 2006 and 2005 are set forth below (in thousands):

		Three Months Ended
		March 31,
		(unaudited)
		2006				2005
Comcast		$	72,507			$	25,390
% of sales			34.8	%			18.7	%
Cox Communications		$	25,790			$	28,786
% of sales			12.4	%			21.2	%
Liberty Media International		$	22,542			$	25,165
% of sales			10.8	%			18.5	%
Time–Warner Cable		$	22,935			$	18,338
% of sales			11.0	%			13.5	%

No other customer provided more than 10% of total sales for the three months ended March 31, 2006 or 2005.

Comparison of Operations for the Three Months Ended March 31, 2006 and 2005

Net Sales

The table below sets forth our net sales for the three months ended March 31, 2006 and 2005, for each of our product categories (in millions):

		Net Sales
		For the Three Months
		Ended March 31,								Increase - 2006 vs. 2005
		2006				2005				$				%
Product Category:
Broadband		$	85.4			$	69.6			$	15.7				22.5	%
Supplies & CPE			122.9				66.3				56.7				85.6	%
Total sales		$	208.3			$	135.9			$	72.4				53.3	%

The table below sets forth our domestic and international sales for the three months ended March 31, 2006 and 2005 (in millions):

		Net Sales
		For the Three Months
		Ended March 31,								Increase - 2006 vs. 2005
		2006				2005				$				%
Domestic sales		$	157.4			$	99.9			$	57.5				57.6	%
International sales			50.9				36.0				14.9				41.4	%
Total sales		$	208.3			$	135.9			$	72.4				53.3	%

Broadband Net Sales 2006 vs. 2005

During the first quarter of 2006, sales of our Broadband products increased by approximately 22.5% as compared to the first quarter of 2005. This increase in Broadband revenue resulted from several components:

	•		Sales of our CMTS product increased in the first quarter 2006 as compared to the same quarter in 2005, as we recorded higher level of sales to many customers, most notably Comcast.
	•		The increase in CMTS revenue was partially offset by an anticipated decrease in sales of our CBR voice products in the first three months of 2006 as compared with the same period in 2005. We believe that ultimately the sales of these products will continue to decline through 2006 as customers change to VoIP.

Supplies & CPE Net Sales 2006 vs. 2005

Supplies & CPE product revenue increased by approximately 85.6% in the first quarter of 2006, as compared to the first quarter of 2005:

•

Increased sales of our E-MTA product provided the majority of the increase as operators ramped up deployment of VoIP. In the first quarter of 2006, we sold 1.1 million E-MTAs in comparison to approximately 334 thousand in the first quarter of 2005.

Gross Margin

The table below sets forth our gross margin for the three months ended March 31, 2006 and 2005, for each of our product categories (in millions):

		Gross Margin $
		For the Three Months Ended
		March 31,								Increase — 2006 vs. 2005
		2006				2005				$				%
Product Category:
Broadband		$	38.9			$	26.1			$	12.8				49.0	%
Supplies & CPE			17.6				10.7				6.9				64.5	%
Total		$	56.5			$	36.8			$	19.7				53.5	%

The table below sets forth our gross margin percentages for the three months ended March 31, 2006 and 2005, for each of our product categories:

		For the Three Months Ended								Percentage Point
		March 31,								Increase (Decrease)
		2006				2005				2006 vs. 2005
Product Category:
Broadband			45.6	%			37.4	%			8.2
Supplies & CPE			14.3	%			16.2	%			(1.9	)
Total			27.1	%			27.1	%			—

Broadband Gross Margin 2006 vs. 2005

The increase in Broadband gross margin dollars and percentages relates primarily to the following factors:

•

Gross margin dollars were impacted by the quarter-over-quarter increase in Broadband revenue and the improvement in gross margin percent.

•

In the first half of 2005, our next generation DOCSIS 2.0 CMTS was in the process of being cost reduced. The initial margin percentages for this product were lower than historical margins due to higher initial product costs. The cost reduction programs successfully improved our margin on our CMTS products year over year.

•

Sales of our CBR product declined year over year. CBR products, on average, have lower margins than CMTS products, resulting in a favorable product mix.

Supplies & CPE Gross Margin 2006 vs. 2005

The Supplies & CPE category gross margin dollars increased while percentages decreased:

•

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

•

We implemented price reductions related to our E-MTA products at the beginning of 2006. The reductions were primarily implemented in conjunction with agreements entered into with customers that should provide us with better market share and visibility. The reductions were implemented as we were in the process of introducing a cost reduced version of the product. Until the product is fully introduced, we will record lower gross margins than in prior quarters. We believe that the introduction of the new version coupled with ongoing cost reduction efforts will lead to improved margins in the future. As a result, we believe that our Supplies & CPE margins will continue to improve in 2006, but the improvement is dependent upon the impact of, among other factors, achievement of planned cost reductions, product mix, and price pressures.

Operating Expenses

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

		Operating Expenses
		For the Three Months Ended
		March 31,								Increase (Decrease) — 2006 vs. 2005
		2006				2005				$				%
SG&A		$	21.3			$	16.5			$	4.8				29.1	%
R&D			15.1				14.8				0.3				2.0	%
Restructuring & impairment			0.3				0.2				0.1				50.0	%
Amortization of intangibles			0.2				0.6				(0.4	)			66.7	%
Total		$	36.9			$	32.1			$	4.8				15.0	%

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

The year over year increase in SG&A expense includes:

	•		Equity compensation expense associated with introduction of SFAS No. 123R.
	•		Higher variable compensation related to an increase in commissions, bonuses, slightly higher staffing level, taxes and other fringe benefits.
	•		Partially offsetting these increases was a reduction in bad debt expense, in particular, a $0.5 million gain related to our reserves associated with Adelphia.

Research & Development Expenses

We continue to aggressively invest in research and development. Our primary focus is on products that allow MSOs to capture new revenues, in particular, high-speed data, VoIP, and Video over IP; however, we also continue to place emphasis on reducing product costs and test equipment costs.

R&D expense for the three months ended March 31, 2006, was essentially flat as compared to the same period in 2005.

Restructuring and Impairment Charges

On a quarterly basis, we review our existing restructuring accruals and make adjustments if necessary. As a result of these evaluations, we recorded an increase to a restructuring accrual of $0.3 million during the first quarter of

2006 related to changes in estimates associated with real estate leases. This adjustment was required due to a change to the initial estimates used. See Note 6 of Notes to the Consolidated Financial Statements.

During the first quarter 2005, indications of impairment related to the long-lived assets associated with our Atoga products arose. As a result, we analyzed the fair value of those assets in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The resulting analysis indicated that the remaining intangibles of $0.2 million were fully impaired and were written off during the first quarter of 2005. See Note 9 of Notes to the Consolidated Financial Statements.

Amortization of Intangibles

Intangibles amortization expense for the three months ended March 31, 2006 and 2005 was $0.2 million and $0.6 million, respectively. Our intangible expense represents the amortization of existing technology acquired as a result of the Com21 acquisition in the third quarter 2003 and the cXm Broadband acquisition in the second quarter 2005. See Note 9 of Notes to Consolidated Financial Statements.

Operating Expense Outlook for Second Quarter 2006

We anticipate that operating expenses in the second quarter of 2006 will be in the range of $39.0 million to $42.0 million, up from the first quarter. Several factors are expected to contribute to this increase:

	•		As described elsewhere, we anticipate recording an expense of $2.5 million related to license fees we will pay to UTStarcom, associated with our joint development work on Fixed Mobile Convergence.
	•		We anticipate higher prototype expenses in the second quarter 2006.
	•		We anticipate higher variable compensation expense related to commissions and bonuses.
	•		We anticipate higher compensation costs related to merit increases implemented April 1, 2006, coupled with some increase in staffing.

Other Expense (Income):

Interest Expense

Interest expense for the first quarter 2006 and 2005 was $0.0 million and $1.0 million, respectively. Interest expense reflects the amortization of deferred finance fees and the interest paid on the convertible subordinated notes (“Notes”). Prior to the final redemption of the Notes during the second quarter 2005, the balance of our outstanding Notes was $75.0 million. This resulted in higher interest expense during the first quarter 2005 as compared to the first quarter 2006.

Loss (Gain) in Foreign Currency

During the first quarter 2006, we recorded a foreign currency gain of approximately $0.3 million. During the first quarter 2005, we recorded a foreign currency loss of approximately $0.9 million. The gains and losses are primarily driven by the fluctuation of the value of the euro, as compared to the U.S. dollar, as we had several European customers whose receivables and collections are denominated in euros. We have 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.

Interest Income

Interest income during the first quarter of 2006 and 2005 was $1.5 million and $0.6 million, respectively. The income reflects interest earned on cash, cash equivalents and short term investments, which increased year over year by approximately $58.0 million, thus resulting in higher interest income.

Other Expense (Income)

Other expense (income) for the three months ended March 31, 2006 and 2005 was $0.1 million in each period.

Financial Liquidity and Capital Resources

Overview

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

		Three Months Ended March 31,
		2006				2005
		(in millions, except DSO and turns)
Key Working Capital Items
Cash provided by operating activities		$	31.3			$	6.9
Cash, cash equivalents, and short-term investments		$	165.8			$	107.9
Accounts receivable, net		$	91.4			$	63.9
Days Sales Outstanding (“DSOs”)			38				40
Inventory		$	99.7			$	76.2
Inventory turns			5.7				4.7

Inventory & Accounts Receivable

We place a strong emphasis on working capital management, particularly with respect to accounts receivable and inventory. We use turns to evaluate inventory management and days sales outstanding, or DSOs, to evaluate accounts receivable management. As the table above indicates, we have improved our performance, particularly as evidenced by the first quarter 2006 inventory turns of 5.7 and DSOs of 38 days.

Looking forward, we do not anticipate a significant reduction in DSOs. It is possible that DSOs may increase, particularly if the international content of our business increases as international customers typically have longer payment terms.

Summary of Current Liquidity Position and Potential for Future Capital Raising

We believe our current liquidity position, including approximately $165.8 million of cash, cash equivalents, and short-term investments on hand as of March 31, 2006, 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.

Commitments

Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005. There has been no material change to our contractual obligations during the first quarter of 2006.

Cash Flow

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

		For the Three Months Ended
		March 31,
		2006				2005
Cash provided by operating activities		$	31.3			$	6.9
Cash provided by investing activities		$	16.6			$	(5.6	)
Cash provided by financing activities		$	6.4			$	0.1
Net increase in cash		$	54.3			$	1.5

Operating Activities:

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

		For the Three Months Ended
		March 31,
		2006				2005
Net income after non-cash adjustments		$	24.9			$	7.6
(Increase)/Decrease in accounts receivable			(7.6	)			(8.1	)
(Increase)/Decrease in inventory			14.2				16.4
All other — net			(0.2	)			(8.9	)
Cash provided by operating activities		$	31.3			$	6.9

	•		Our inventory levels decreased in the first quarter of 2006 as we had fewer E-MTAs on hand as compared to the end of 2005. Our customers modestly reduced their purchases in the fourth quarter of 2005 leaving us with a higher than expected level of inventory at year end. This corrected itself in the first quarter of 2006. Our first quarter 2006 inventory turns were 5.7, as compared to our first quarter 2005 turns of 4.7.
	•		Our accounts receivable level increased in both periods reflecting higher sales. We continue to enjoy strong DSO performance. Our first quarter 2006 DSO was 38 days as compared to our first quarter 2005 DSO of 40 days.

Investing Activities:

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

		For the Three Months Ended
		March 31,
		2006				2005
Capital expenditures		$	(1.4	)		$	(1.9	)
Purchases of short-term investments			—				(5.0	)
Disposals of short-term investments			18.0				1.6
Other			—				(0.3	)
Cash provided by (used in) investing activities		$	16.6			$	(5.6	)

     Capital Expenditures —

Capital expenditures are mainly for test equipment and computing equipment. We anticipate investing approximately $12.0 million in fiscal year 2006.

     Purchases/Disposals of Short-Term Investments —

This represents purchases and disposals of auction rate securities held as short-term investments.

     Other —

This represents cash investments we made in 2005 in cXm Broadband, a private company.

Financing Activities:

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

		For the Three Months Ended
		March 31,
		2006				2005
Excess tax benefits from stock-based compensation plans		$	0.1			$	—
Proceeds from issuance of stock			6.2				0.1
Cash provided by financing activities		$	6.3			$	0.1

Cash provided from financing activities for both quarters presented is primarily related to the exercise of stock options by employees.

Interest Rates

As of March 31, 2006, we did not have any floating rate indebtedness or outstanding interest rate swap agreements.

Foreign Currency

A significant portion of our products are manufactured or assembled in Mexico, Taiwan, China, the Philippines, 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. We use a hedging strategy and enter into forward or currency option contracts based on a percentage of expected foreign currency receipts. The percentage can vary, based on the predictability of cash receipts. We routinely review our accounts receivable in foreign currency and periodically initiate forward or option contracts when appropriate.

As of March 31, 2006, we had 20.5 million euros of option contracts outstanding that expire in 2006. During the first quarter of 2006, we recognized a net gain of $0.4 million related to option contracts.

Financial Instruments

In the ordinary course of business, we, from time to time, will enter into financing arrangements, such as letters of credit, with customers. 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 March 31, 2006 and December 31, 2005, we had approximately $6.1 million outstanding at the end of each period under letters of credit that were cash collateralized. The cash collateral is reported as 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 that 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. These

investments had been below their cost basis for a period greater than six months, and consequently, impairment charges had been recorded. As of both March 31, 2006 and December 31, 2005, the carrying value of these investments was $0.

In addition, we held a number of non-marketable equity securities totaling approximately $32 thousand at March 31, 2006 and December 31, 2005, which were 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.

We offered a deferred compensation arrangement, which allowed certain employees to defer a portion of their earnings and defer the related income taxes. As of December 31, 2004, the plan was frozen and no further contributions are allowed. The deferred earnings are invested in a “rabbi trust,” 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). At both March 31, 2006 and December 31, 2005, ARRIS had an accumulated unrealized gain related to the rabbi trust of approximately $1.1 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 $1.4 million in the first quarter 2006 as compared to $1.9 million in the first quarter 2005. ARRIS had no significant commitments for capital expenditures at March 31, 2006. Management expects to invest approximately $12.0 million in capital expenditures for the fiscal year 2006.

Adoption of SFAS No. 123R, Share-Based Payment

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123R, Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, supercedes Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement of Cash Flows. SFAS 123R is effective for public companies for interim or annual periods beginning after June 15, 2005. As revised, this statement requires all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. We chose to early adopt SFAS 123R on July 1, 2005 using the modified prospective method. Prior to the adoption date, ARRIS used the intrinsic value method for valuing its awards of stock options and restricted stock and recorded the related compensation expense, if any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations.

Prior to the adoption of SFAS No. 123R, ARRIS used the Black-Scholes option valuation model to estimate the fair value of an option on the date of grant for pro forma purposes. Upon adoption of SFAS No. 123R, ARRIS elected to continue to use the Black-Scholes model; however, it engaged an independent third party to assist the Company in determining the Black-Scholes weighted average inputs utilized in the valuation of options granted subsequent to July 1, 2005. Prior to the adoption of SFAS No. 123R, the Company estimated the expected volatility exclusively on historical stock prices of ARRIS common stock over a period of time. Under SFAS No. 123R, the volatility factors are based upon a combination of historical volatility over a period of time and estimates of implied volatility based on traded option contracts on ARRIS common stock. The change in estimating volatility was made because the Company felt that the inclusion of the implied volatility factor was a more accurate estimate of the stock’s future performance. The expected term of the awards granted are based upon a weighted average life of exercise activity of the grantee population. The risk-free interest rate is based upon the U.S. treasury strip yield at the grant date, using a remaining term equal to the expected life. The expected dividend yield is 0%, as the Company has not paid cash dividends on its common stock since its inception. In calculating the stock compensation expense, ARRIS applies an estimated post-vesting forfeiture rate based upon historical rates.

In May 2005, the ARRIS Board of Directors approved the acceleration of outstanding options with exercise prices equal to $9.06 and above. All of these options were “out-of-the-money” at the time of acceleration, as the closing stock price on May 5, 2005 was $7.67. The acceleration covered options to purchase approximately 1.4 million shares of common stock, but did not involve any options held by directors or executive officers. The purpose of the acceleration was to reduce the expense that would be associated with these options in accordance with the

provisions of SFAS No. 123R, Share-Based Payment, once adopted. The acceleration resulted in incremental stock-based employee compensation of approximately $5.7 million in the pro forma expense for the second quarter 2005.

As of March 31, 2006, there was approximately $10.2 million of total unrecognized compensation cost related to unvested share-based awards granted under the Company’s incentive plans. This compensation cost is expected to be recognized over a weighted-average period of 2.1 years.

Critical Accounting Estimates

The accounting and financial reporting policies of the Company are in conformity with U.S. generally accepted accounting principles. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management has discussed the development and selection of the Company’s critical accounting estimates with the audit committee of the Company’s Board of Directors and the audit committee has reviewed the Company’s related disclosures. Our critical accounting policies and estimates are disclosed extensively in our Form 10-K for the year ended December 31, 2005, as filed with the SEC. Our critical accounting estimates have not changed in any material respect nor have we adopted any new critical policies during the three months ended March 31, 2006.

Forward-Looking Statements

We make numerous forward-looking statements throughout this report, including statements with respect to expected changes in sales levels of different products, product development plans, expense levels, acquisitions and liquidity. Frequently these statements are introduced with words such as “may,” “expect,” “likely,” “will,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “plan,” “continue,” “could be,” or “predict.” Actual results may differ materially from those suggest by the forward-looking statements that we make for a number of reasons including those described in Part II, Item 1A, “Risk Factors” of this Report.

Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to various market risks, including interest rates and foreign currency rates. The following discussion of our risk-management activities includes “forward-looking statements” that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements.

We have an investment portfolio of auction rate securities that are classified as “available-for-sale” securities. Although these securities have maturity dates of 15 to 30 years, they have characteristics of short-term investments as the interest rates reset every 28 or 35 days and we have the potential to liquidate them in an auction process. Due to the short duration of these investments, a movement in market interest rates would not have a material impact on our operating results.

A significant portion of our products are manufactured or assembled in China, Mexico, the Philippines, Taiwan, and other countries outside the United States. 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. Changes in the monetary exchange rates may adversely affect our results of operations and financial condition. To manage the volatility relating to these typical business exposures, we may enter into various derivative transactions, when appropriate. We do not hold or issue derivative instruments for trading or other speculative purposes. The euro and the yen are the predominant currencies of those customers who are billed in their local currency. Taking into account the effects of foreign currency fluctuations of the euro and the yen versus the dollar, a hypothetical 10% weakening of the U.S. dollar (as of March 31, 2006) would provide a gain on foreign currency of approximately $0.7 million. Conversely, a hypothetical 10% strengthening of the U.S. dollar would provide a loss on foreign currency of

approximately $0.7 million. As of March 31, 2006, we had no material contracts, other than accounts receivable, denominated in foreign currencies.

We regularly review our accounts receivable in foreign currency and enter into derivative contracts when appropriate. As of March 31, 2006, we had 20.5 million euros in option collars outstanding.

Item 4. CONTROLS AND PROCEDURES

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

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

PART II. OTHER INFORMATION

Item 1A. Risk Factors

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

Our performance has been largely dependent on customers’ capital spending for constructing, rebuilding, maintaining or upgrading broadband communications systems. Capital spending in the telecommunications industry is cyclical. A variety of factors will affect the amount of capital spending, and therefore, our sales and profits, including:

	•		general economic conditions;
	•		availability and cost of capital;
	•		other demands and opportunities for capital;
	•		regulations;
	•		demands for network services;
	•		competition and technology;
	•		real or perceived trends or uncertainties in these factors; and
	•		acceptance of new services offered by our customers.

Developments in the industry and in the capital markets over the past several years reduced access to funding for our customers in the past and caused delays in the timing and scale of deployments of our equipment, as well as the postponement or cancellation of certain projects by our customers. In addition, we and other vendors received notification from several customers that they were canceling projects or scaling back projects or delaying orders to allow them to reduce inventory levels which were in excess of their then current deployment requirements.

Further, several of our customers have accumulated significant levels of debt. In particular, Adelphia has been operating in bankruptcy since the first half of 2002 and Cabovisao’s Canadian parent, Csii, has been operating under bankruptcy protection since the middle of 2003. Even if the financial health of those companies and other customers improves, we cannot assure you that these customers will be in a position to purchase new equipment at levels we have seen in the past. In addition, the bankruptcy filing of Adelphia in June 2002 has further heightened concerns in the financial markets about the domestic cable industry. The concern, coupled with the current uncertainty and volatile capital markets, has affected the market values of domestic cable operators and may further restrict their access to capital.

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

The markets for broadband communication systems are extremely competitive and dynamic, requiring the companies that compete in these markets to react quickly and capitalize on change. This will require us to retain skilled and experienced personnel as well as deploy substantial resources toward meeting the ever-changing demands of the industry. We compete with national and international manufacturers, distributors and wholesalers including many companies larger than ARRIS. Our major competitors include:

	•		Big Band Networks;
	•		Cisco Systems, Inc.;
	•		Motorola, Inc.; and
	•		TVC Communications, Inc.

Cisco Systems, Inc. acquired Scientific-Atlanta, Inc. in February 2006. We are uncertain what impact this may have on our future results, if any.

The rapid technological changes occurring in the broadband markets may lead to the entry of new competitors, including those with substantially greater resources than ours. Because the markets in which we compete are characterized by rapid growth and, in some cases, low barriers to entry, smaller niche market companies and start-up ventures also may become principal competitors in the future. Actions by existing competitors and the entry of new competitors may have an adverse effect on our sales and profitability. The broadband communications industry is further characterized by rapid technological change. In the future, technological advances could lead to the obsolescence of some of our current products, which could have a material adverse effect on our business.

Further, many of our larger competitors are in a better position to withstand any significant reduction in capital spending by customers in these markets. They often have broader product lines and market focus and therefore will not be as susceptible to downturns in a particular market. In addition, several of our competitors have been in operation longer than we have been, and therefore they have more long-standing and established relationships with domestic and foreign broadband service users. We may not be able to compete successfully in the future, and competition may harm our business.

Our business has primarily come from several key customers. The loss of one of these customers or a significant reduction in services to one of these customers would have a material adverse effect on our business.

Our four largest customers (including their affiliates, as applicable) are Comcast, Cox Communications, Liberty Media International, and Time-Warner Cable. For the three months ended March 31, 2006, sales to Comcast accounted for approximately 34.8%, sales to Cox Communications accounted for approximately 12.4% of our total revenues, sales to Liberty Media International accounted for approximately 10.8%, and sales to Time-Warner Cable accounted for approximately 11.0%. The loss of any of these customers, or one of our other large customers, or a significant reduction in the products or services provided to any of them would have a material adverse impact on our business.

The broadband products that we develop and sell are subject to technological change and a trend towards open standards, which may impact our future sales and margins.

The broadband products we sell are subject to continuous technological evolution. Further, the cable industry has and will continue to demand a move towards open standards. The move towards open standards is expected to increase the number of MSOs who will offer new services, in particular, telephony. This trend also is expected to increase the number of competitors and drive capital costs per subscriber deployed down. These factors may adversely impact both our future revenues and margins.

We have anti-takeover defenses that could delay or prevent an acquisition of our company.

On October 3, 2002, our Board of Directors approved the adoption of a shareholder rights plan (commonly known as a “poison pill”). This plan is not intended to prevent a takeover, but is intended to protect and maximize the

value of shareholders’ interests. This plan could make it more difficult for a third party to acquire us or may delay that process.

Products currently under development may fail to realize anticipated benefits.

Rapidly changing technologies, evolving industry standards, frequent new product introductions and relatively short product life cycles characterize the markets for our products. The technology applications that we are currently developing may not ultimately be successful. Even if the products in development are successfully brought to market, they may not be widely used or we may not be able to successfully exploit these technology applications. To compete successfully, we must quickly design, develop, manufacture and sell new or enhanced products that provide increasingly higher levels of performance and reliability. However, we may not be able to successfully develop or introduce these products if our products:

	•		are not cost-effective;
	•		are not brought to market in a timely manner;
	•		fail to achieve market acceptance; or
	•		fail to meet industry certification standards.

Furthermore, our competitors may develop similar or alternative new technology applications that, if successful, could have a material adverse effect on us. Our strategic alliances are based on business relationships that have not been the subject of written agreements expressly providing for the alliance to continue for a significant period of time. The loss of a strategic partner could have a material adverse effect on the progress of new products under development with that partner.

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

The telecommunications industry has experienced the consolidation of many industry participants, and this trend may continue. For instance, in November 2005, Cox Communications announced a definitive agreement to sell some of its cable television systems to Cebridge Connections and, in April 2005, Adelphia announced that its assets were going to be acquired by Comcast and Time Warner. When consolidations occur, it is possible that the acquirer will not continue using the same suppliers, thereby possibly resulting in an immediate or future elimination of sales opportunities for us or our competitors, depending upon who had the business initially. Consolidations also could result in delays in purchasing decisions by the merged businesses. The purchasing decisions of the merged companies could have a material adverse effect on our business.

Mergers among the supplier base also have increased, and this trend may continue. For example, in the fourth quarter of 2005, Cisco Systems, Inc. and Scientific-Atlanta, Inc. announced that Cisco would acquire Scientific-Atlanta. The acquisition was completed in February of 2006. Larger combined companies with pooled capital resources may be able to provide solution alternatives with which we would be put at a disadvantage to compete. The larger breadth of product offerings by these consolidated suppliers could result in customers electing to trim their supplier base for the advantages of one-stop shopping solutions for all of their product needs. Consolidation of the supplier base could have a material adverse effect on our business.

Acquisitions can involve significant risks.

We routinely consider acquisitions of, or investments in, other businesses. There are a number of risks attendant to any acquisition, including the possibility that we will overvalue the assets to be purchased, that we will not be able to successfully integrate the acquired business or assets, and that we will not be able to produce the expected level of profitability from the acquired business or assets. In addition, we might incur substantial indebtedness in order to finance an acquisition, which could require substantial payments in the future, and we might issue common stock or other securities to pay for an acquisition, in which event the acquisition may ultimately prove to be dilutive to our current stockholders. As a result, the impact of any acquisition on our future performance may not be as favorable as expected and actually may be adverse.

Our success depends in large part on our ability to attract and retain qualified personnel in all facets of our operations.

Competition for qualified personnel is intense, and we may not be successful in attracting and retaining key executives, marketing, engineering, technical support and sales personnel, which could impact our ability to maintain and grow our operations. Our future success will depend, to a significant extent, on the ability of our management to operate effectively. In the past, competitors and others have attempted to recruit our employees and in the future, their attempts may continue. The loss of services of any key personnel, the inability to attract and retain qualified personnel in the future or delays in hiring required personnel, particularly engineers and other technical professionals, could negatively affect our business.

We are substantially dependent on contract manufacturers, and an inability to obtain adequate and timely delivery of supplies could adversely affect our business.

Many components, subassemblies and modules necessary for the manufacture or integration of our products are obtained from a sole supplier or a limited group of suppliers. Our reliance on sole or limited suppliers, particularly foreign suppliers, and our reliance on subcontractors involves several risks including a potential inability to obtain an adequate supply of required components, subassemblies or modules and reduced control over pricing, quality and timely delivery of components, subassemblies or modules. Historically, we have not generally maintained long-term agreements with any of our suppliers or subcontractors. An inability to obtain adequate deliveries or any other circumstance that would require us to seek alternative sources of supply could affect our ability to ship products on a timely basis. Any inability to reliably ship our products on time could damage relationships with current and prospective customers and harm our business.

Our international operations may be adversely affected by any decline in the demand for broadband systems designs and equipment in international markets.

Sales of broadband communications equipment into international markets are an important part of our business. The entire line of our products is marketed and made available to existing and potential international customers. In addition, United States broadband system designs and equipment are increasingly being employed in international markets, where market penetration is relatively lower than in the United States. While international operations are expected to comprise an integral part of our future business, international markets may no longer continue to develop at the current rate, or at all. We may fail to receive additional contracts to supply equipment in these markets.

Our international operations may be adversely affected by changes in the foreign laws in the countries in which our manufacturers and assemblers have plants.

A significant portion of our products are manufactured or assembled in China, Ireland, Mexico, the Philippines, and other countries outside of the United States. The governments of the foreign countries in which our products are manufactured may pass laws that impair our operations, such as laws that impose exorbitant tax obligations or nationalize these manufacturing facilities.

We face risks relating to currency fluctuations and currency exchange.

We may encounter difficulties in converting our earnings from international operations to U.S. dollars for use in the United States. These obstacles may include problems moving funds out of the countries in which the funds were earned and difficulties in collecting accounts receivable in foreign countries where the usual accounts receivable payment cycle is longer.

We are exposed to various market risk factors such as fluctuating interest rates and changes in foreign currency rates. These risk factors can impact our results of operations, cash flows and financial position. We manage these risks through regular operating and financing activities and periodically use derivative financial instruments such as foreign exchange forward contracts. There can be no assurance that our risk management strategies will be effective.

Our profitability has been, and may continue to be, volatile, which could adversely affect the price of our stock.

We have experienced several years with significant operating losses. Although we have been profitable in the past, we may not be profitable or meet the level of expectations of the investment community in the future, which could have a material adverse impact on our stock price. In addition, our operating results may be adversely affected by the timing of sales or a shift in our product mix.

We may face higher costs associated with protecting our intellectual property.

Our future success depends in part upon our proprietary technology, product development, technological expertise and distribution channels. We cannot predict whether we can protect our technology or whether competitors can develop similar technology independently. We have received and may continue to receive from third parties, including some of our competitors, notices claiming that we have infringed upon third-party patents or other proprietary rights. Any of these claims, whether with or without merit, could result in costly litigation, divert the time, attention and resources of our management, delay our product shipments, or require us to enter into royalty or licensing agreements. If a claim of product infringement against us is successful and we fail to obtain a license or develop non-infringing technology, our business and operating results could be adversely affected.

Item 6. EXHIBITS

Exhibit No.		Description of Exhibit
31.1		Section 302 Certification of Chief Executive Officer, filed herewith
31.2		Section 302 Certification of Chief Financial Officer, filed herewith
32.1		Section 906 Certification of Chief Executive Officer, filed herewith
32.2		Section 906 Certification of Chief Financial Officer, filed herewith

SIGNATURES

Pursuant to the requirements the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: May 9, 2006