UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended April 2,December 31, 2004
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 1-5517
SCIENTIFIC-ATLANTA, INC.
(Exact name of Registrant as specified in its charter)
Georgia | 58-0612397 | |
(State or other jurisdiction of
| (I.R.S. Employer
|
5030 Sugarloaf Parkway Lawrenceville, Georgia | 30042-5447 | |
(Address of principal executive offices) | (Zip Code) |
770-236-5000
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesxþ No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).
Yesxþ No¨
As of April 30, 2004,January 28, 2005, Scientific-Atlanta, Inc. had outstanding 153,164,380152,061,822 shares of common stock.
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PART I –- FINANCIAL INFORMATION
SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||||||||||||||||||
SALES | $ | 436,969 | $ | 382,630 | $ | 1,249,171 | $ | 1,046,193 | $ | 441,672 | $ | 416,566 | $ | 894,346 | $ | 812,202 | ||||||||||||||||
COSTS AND EXPENSES | ||||||||||||||||||||||||||||||||
Cost of sales | 275,533 | 252,024 | 783,115 | 691,493 | 277,951 | 259,204 | 564,826 | 507,582 | ||||||||||||||||||||||||
Sales and administrative | 51,829 | 46,508 | 147,839 | 141,541 | 47,893 | 47,973 | 96,654 | 96,010 | ||||||||||||||||||||||||
Research and development | 38,896 | 35,728 | 110,234 | 112,351 | 37,881 | 36,015 | 76,222 | 71,338 | ||||||||||||||||||||||||
Restructuring | 51 | 3,555 | 1,364 | 14,790 | (8 | ) | 598 | (12 | ) | 1,313 | ||||||||||||||||||||||
Interest expense | 191 | — | 630 | 710 | 174 | 204 | 331 | 439 | ||||||||||||||||||||||||
Interest income | (4,235 | ) | (4,695 | ) | (12,275 | ) | (16,377 | ) | (6,765 | ) | (4,188 | ) | (12,539 | ) | (8,040 | ) | ||||||||||||||||
Other (income) expense, net | (4,638 | ) | 8,874 | (5,945 | ) | 21,379 | 1,020 | (2,208 | ) | 855 | (1,307 | ) | ||||||||||||||||||||
Total costs and expenses | 357,627 | 341,994 | 1,024,962 | 965,887 | 358,146 | 337,598 | 726,337 | 667,335 | ||||||||||||||||||||||||
EARNINGS BEFORE INCOME TAXES | 79,342 | 40,636 | 224,209 | 80,306 | 83,526 | 78,968 | 168,009 | 144,867 | ||||||||||||||||||||||||
PROVISION FOR (BENEFIT FROM) INCOME TAXES | ||||||||||||||||||||||||||||||||
Current | 27,718 | 3,645 | 70,310 | 30,848 | 23,925 | 24,219 | 56,632 | 42,592 | ||||||||||||||||||||||||
Deferred | (2,329 | ) | 10,171 | 6,145 | (3,524 | ) | 908 | 3,618 | (3,194 | ) | 8,474 | |||||||||||||||||||||
NET EARNINGS | $ | 53,953 | $ | 26,820 | $ | 147,754 | $ | 52,982 | $ | 58,693 | $ | 51,131 | $ | 114,571 | $ | 93,801 | ||||||||||||||||
EARNINGS PER COMMON SHARE | ||||||||||||||||||||||||||||||||
BASIC | $ | 0.35 | $ | 0.18 | $ | 0.97 | $ | 0.34 | $ | 0.39 | $ | 0.34 | $ | 0.75 | $ | 0.62 | ||||||||||||||||
DILUTED | $ | 0.35 | $ | 0.18 | $ | 0.96 | $ | 0.34 | $ | 0.38 | $ | 0.33 | $ | 0.74 | $ | 0.61 | ||||||||||||||||
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING | ||||||||||||||||||||||||||||||||
BASIC | 152,569 | 151,771 | 151,802 | 153,760 | 152,395 | 151,874 | 152,913 | 151,418 | ||||||||||||||||||||||||
DILUTED | 155,305 | 152,167 | 154,537 | 154,211 | 154,510 | 154,510 | 154,973 | 154,153 | ||||||||||||||||||||||||
DIVIDENDS PER SHARE PAID | $ | 0.01 | $ | 0.01 | $ | 0.03 | $ | 0.03 | $ | 0.01 | $ | 0.01 | $ | 0.02 | $ | 0.02 | ||||||||||||||||
SEE ACCOMPANYING NOTES
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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
April 2, 2004 | June 27, 2003 | December 31, 2004 | July 2, 2004 | |||||||||
ASSETS | ||||||||||||
CURRENT ASSETS | ||||||||||||
Cash and cash equivalents | $ | 443,948 | $ | 359,780 | $ | 339,585 | $ | 442,182 | ||||
Short-term investments | 751,505 | 588,775 | 976,040 | 855,434 | ||||||||
Receivables, less allowance for doubtful accounts of $3,260 at April 2 and $3,260 at June 27 | 224,621 | 184,585 | ||||||||||
Receivables, less allowance for doubtful accounts of $2,514 at December 31 and $3,102 at July 2 | 228,723 | 219,172 | ||||||||||
Inventories | 125,789 | 127,054 | 125,742 | 129,930 | ||||||||
Income tax receivables | 682 | 18,903 | ||||||||||
Deferred income taxes | 30,892 | 41,874 | 24,646 | 23,657 | ||||||||
Other current assets | 20,182 | 21,548 | 16,927 | 18,434 | ||||||||
TOTAL CURRENT ASSETS | 1,596,937 | 1,323,616 | 1,712,345 | 1,707,712 | ||||||||
PROPERTY, PLANT AND EQUIPMENT, at cost | ||||||||||||
Land and improvements | 22,248 | 22,139 | 23,882 | 21,223 | ||||||||
Building and improvements | 82,948 | 83,624 | ||||||||||
Buildings and improvements | 116,130 | 83,713 | ||||||||||
Machinery and equipment | 220,601 | 219,647 | 234,642 | 212,392 | ||||||||
325,797 | 325,410 | 374,654 | 317,328 | |||||||||
Less – Accumulated depreciation and amortization | 140,547 | 127,726 | ||||||||||
Less - Accumulated depreciation and amortization | 152,269 | 132,744 | ||||||||||
185,250 | 197,684 | |||||||||||
222,385 | 184,584 | |||||||||||
GOODWILL | 240,244 | 235,248 | 236,786 | 235,209 | ||||||||
INTANGIBLE ASSETS | 41,773 | 51,028 | 31,951 | 37,636 | ||||||||
NON-CURRENT MARKETABLE SECURITIES | 2,028 | 8,367 | ||||||||||
DEFERRED INCOME TAXES | 38,923 | 38,200 | 38,184 | 30,867 | ||||||||
OTHER ASSETS | 70,316 | 64,486 | 79,920 | 73,619 | ||||||||
TOTAL ASSETS | $ | 2,175,471 | $ | 1,918,629 | $ | 2,321,571 | $ | 2,269,627 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||||
CURRENT LIABILITIES | ||||||||||||
Current maturities of long-term debt | $ | 1,416 | $ | 1,455 | $ | 1,393 | $ | 1,265 | ||||
Accounts payable | 159,398 | 143,379 | 138,134 | 171,589 | ||||||||
Accrued liabilities | 87,453 | 100,876 | 84,543 | 101,132 | ||||||||
Deferred revenue | 17,972 | 15,626 | 15,132 | 18,053 | ||||||||
Income taxes currently payable | 31,733 | 12,273 | 13,673 | 13,663 | ||||||||
TOTAL CURRENT LIABILITIES | 297,972 | 273,609 | 252,875 | 305,702 | ||||||||
LONG-TERM DEBT, LESS CURRENT MATURITIES | 7,877 | 8,567 | 7,772 | 7,698 | ||||||||
NON-CURRENT DEFERRED REVENUE | 7,010 | 6,507 | 8,648 | 7,885 | ||||||||
OTHER LIABILITIES | 146,217 | 148,705 | 158,626 | 144,985 | ||||||||
STOCKHOLDERS’ EQUITY | ||||||||||||
Preferred stock, authorized 50,000,000 shares; no shares issued | — | — | — | — | ||||||||
Common stock, $0.50 par value, authorized 350,000,000 shares; issued 164,992,376 shares at April 2 and June 27 | 82,496 | 82,496 | ||||||||||
Common stock, $0.50 par value, authorized 350,000,000 shares; issued 164,992,376 shares at December 31 and July 2 | 82,496 | 82,496 | ||||||||||
Additional paid-in capital | 558,248 | 520,503 | 563,308 | 561,636 | ||||||||
Retained earnings | 1,234,020 | 1,127,441 | 1,410,302 | 1,300,691 | ||||||||
Accumulated other comprehensive income, net of taxes of $20,120 at April 2 and $13,169 at June 27 | 32,827 | 21,486 | ||||||||||
Accumulated other comprehensive income, net of taxes of $29,153 at December 31 and $19,506 at July 2 | 58,311 | 39,516 | ||||||||||
1,907,591 | 1,751,926 | 2,114,417 | 1,984,339 | |||||||||
Less –Treasury stock, at cost (12,056,542 shares at April 2 and 15,550,442 shares at June 27) | 191,196 | 270,685 | ||||||||||
Less - Treasury stock, at cost (12,997,424 shares at December 31 and 11,614,954 shares at July 2) | 220,767 | 180,982 | ||||||||||
1,716,395 | 1,481,241 | 1,893,650 | 1,803,357 | |||||||||
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 2,175,471 | $ | 1,918,629 | $ | 2,321,571 | $ | 2,269,627 | ||||
SEE ACCOMPANYING NOTES
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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended | Six Months Ended | |||||||||||||||
April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | |||||||||||||
NET CASH PROVIDED BY OPERATING ACTIVITIES | $ | 204,778 | $ | 300,082 | $ | 130,083 | $ | 122,279 | ||||||||
INVESTING ACTIVITIES: | ||||||||||||||||
Purchases of short-term investments, net | (159,592 | ) | (193,705 | ) | ||||||||||||
Purchases of short-term investments | (1,158,249 | ) | (919,190 | ) | ||||||||||||
Proceeds from sales of short-term investments | 1,032,814 | 871,150 | ||||||||||||||
Purchases of property, plant, and equipment | (19,733 | ) | (19,518 | ) | (58,071 | ) | (11,605 | ) | ||||||||
Purchase of shares of PowerTV | — | (4,580 | ) | |||||||||||||
Proceeds from the sales of investments | 16,573 | 2,880 | ||||||||||||||
Proceeds from the settlement of a collar on a warrant to purchase shares of common stock | — | 20,821 | ||||||||||||||
Payment of purchase price adjustment on businesses sold to ViaSat, Inc. | (9,000 | ) | — | |||||||||||||
Acquisition of certain assets of Arris Group | — | (30,000 | ) | |||||||||||||
Acquisition of certain assets of ChanneLogics, Inc. | — | (1,600 | ) | |||||||||||||
Proceeds from the sale of an investment in a marketable security | — | 13,583 | ||||||||||||||
Payment of purchase price adjustment on business sold to ViaSat, Inc. | — | (9,000 | ) | |||||||||||||
Other | 361 | 69 | 157 | 334 | ||||||||||||
Net cash used in investing activities | (171,391 | ) | (225,633 | ) | (183,349 | ) | (54,728 | ) | ||||||||
FINANCING ACTIVITIES: | ||||||||||||||||
Issuance of common stock pursuant to employee stock option and stock purchase plans | 56,226 | 2,294 | ||||||||||||||
Treasury shares acquired | — | (104,472 | ) | |||||||||||||
Purchases of common stock | (50,703 | ) | — | |||||||||||||
Issuance of common stock from treasury | 5,049 | 41,359 | ||||||||||||||
Dividends paid | (4,560 | ) | (4,579 | ) | (3,052 | ) | (3,032 | ) | ||||||||
Principal payments on debt, net | (885 | ) | (1,388 | ) | ||||||||||||
Principal payments on debt | (625 | ) | (575 | ) | ||||||||||||
Net cash provided by (used in) financing activities | 50,781 | (108,145 | ) | (49,331 | ) | 37,752 | ||||||||||
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 84,168 | (33,696 | ) | (102,597 | ) | 105,303 | ||||||||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD | 359,780 | 376,429 | 442,182 | 332,266 | ||||||||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD | $ | 443,948 | $ | 342,733 | $ | 339,585 | $ | 437,569 | ||||||||
SUPPLEMENTAL CASH FLOW DISCLOSURES | ||||||||||||||||
Cash paid during the period: | ||||||||||||||||
Interest | $ | 584 | $ | 653 | $ | 296 | $ | 408 | ||||||||
Income taxes paid (refunded), net | $ | 38,162 | $ | (17,081 | ) | |||||||||||
Income taxes paid, net | $ | 37,147 | $ | 15,523 | ||||||||||||
SEE ACCOMPANYING NOTES
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SCIENTIFIC-ATLANTA,SCIENTIFIC ATLANTA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
Three Months Ended | Nine Months Ended | |||||||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | |||||||||||
NET EARNINGS | $ | 53,953 | $ | 26,820 | $ | 147,754 | $ | 52,982 | ||||||
OTHER COMPREHENSIVE INCOME, NET OF TAX(1) | ||||||||||||||
Unrealized holding gains (losses) on short-term investments | (174 | ) | — | 59 | — | |||||||||
Unrealized holding gains (losses) on marketable securities, net(2) | (972 | ) | 1,003 | (512 | ) | 841 | ||||||||
Foreign currency translation adjustments | (6,430 | ) | 4,068 | 11,917 | 10,880 | |||||||||
Changes in fair value of derivatives | (165 | ) | 217 | (123 | ) | 1,101 | ||||||||
COMPREHENSIVE INCOME | $ | 46,212 | $ | 32,108 | $ | 159,095 | $ | 65,804 | ||||||
Three Months Ended | Six Months Ended | ||||||||||||||
December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | ||||||||||||
NET EARNINGS | $ | 58,693 | $ | 51,131 | $ | 114,571 | $ | 93,801 | |||||||
OTHER COMPREHENSIVE INCOME, NET OF TAX(1) | |||||||||||||||
Net foreign currency translation adjustments | 18,229 | 14,466 | 19,221 | 18,348 | |||||||||||
Net unrealized holding gains (losses) on short-term investments | (1,007 | ) | (328 | ) | (803 | ) | 233 | ||||||||
Net unrealized holding gains (losses) on available-for-sale marketable securities, net of reclassification adjustments of $0 and $876 in the three and six months ended December 31, 2004 and January 2, 2004, respectively. | (3 | ) | 759 | — | 459 | ||||||||||
Net change in fair value of derivatives | 110 | 153 | 377 | 42 | |||||||||||
COMPREHENSIVE INCOME | $ | 76,022 | $ | 66,181 | $ | 133,366 | $ | 112,883 | |||||||
(1) | Assumed tax rate of 34 percent and 38 percent |
$-0- and $4,170 in the three and nine months ended March 28, 2003, respectively. Unrealized gains and losses included in accumulated other comprehensive income are reclassified to the income statement when the related marketable securities are sold.
SEE ACCOMPANYING NOTES
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NOTES:
NOTES:
(Amounts in thousands, except share and per share data)
A. | The accompanying condensed consolidated financial statements include the accounts of Scientific-Atlanta, Inc. (Scientific-Atlanta) and all subsidiaries after elimination of all material intercompany accounts and transactions. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. These condensed financial statements should be read in conjunction with the consolidated financial statements and related notes contained in our fiscal year |
During fiscal year 2004, we identified certain cash equivalents and short-term investments which were misclassified. We have reclassified $12,904 and $27,514 from Cash and cash equivalents to Short-term investments at January 2, 2004 and June 27, 2003, respectively. The Consolidated Statements of Cash Flows for the six months ended January 2, 2004 has been restated to reflect these adjustments.
Scientific-Atlanta’s fiscal year ends on the Friday closest to June 30 of each year. Fiscal year 2004,2005, which ends on July 2, 2004, includes fifty three1, 2005, will include fifty-two weeks. The thirdsecond quarter of fiscal year 20042005 and 20032004 each included thirteen weeks. The ninesix months ended AprilDecember 31, 2004 included twenty-six weeks while the six months ended January 2, 2004 included forty weeks while the nine months ended March 28, 2003 included thirty ninetwenty-seven weeks.
B. | Basic earnings per share were computed based on the weighted average number of shares of common stock outstanding. Diluted earnings per share were computed based on the weighted average number of outstanding common shares and potentially dilutive shares. |
Basic and diluted earnings per share are computed as follows (amounts in thousands, except per share data):follows:
In Thousands | Per Share | In Thousands | Per Share | |||||||||||||||
Quarter ended April 2, 2004
| Net Earnings | Shares | ||||||||||||||||
Net Earnings | Shares | Per Share | ||||||||||||||||
Quarter Ended December 31, 2004 | ||||||||||||||||||
Basic earnings per common share | $ | 53,953 | 152,569 | $ | 0.35 | $ | 58,693 | 152,395 | $ | 0.39 | ||||||||
Effect of dilutive stock options | — | 2,736 | — | — | 2,115 | (0.01 | ) | |||||||||||
Diluted earnings per common share | $ | 53,953 | 155,305 | $ | 0.35 | $ | 58,693 | 154,510 | $ | 0.38 | ||||||||
In Thousands | Per Share | |||||||||||||||||
Quarter ended March 28, 2003
| Net Earnings | Shares | ||||||||||||||||
Quarter Ended January 2, 2004 | ||||||||||||||||||
Basic earnings per common share | $ | 26,820 | 151,771 | $ | 0.18 | $ | 51,131 | 151,874 | $ | 0.34 | ||||||||
Effect of dilutive stock options | — | 396 | — | — | 2,636 | (0.01 | ) | |||||||||||
Diluted earnings per common share | $ | 26,820 | 152,167 | $ | 0.18 | $ | 51,131 | 154,510 | $ | 0.33 | ||||||||
In Thousands | Per Share | |||||||||||||||||
Nine months ended April 2, 2004
| Net Earnings | Shares | ||||||||||||||||
Six Months Ended December 31, 2004 | ||||||||||||||||||
Basic earnings per common share | $ | 147,754 | 151,802 | $ | 0.97 | $ | 114,571 | 152,913 | $ | 0.75 | ||||||||
Effect of dilutive stock options | — | 2,735 | (0.01 | ) | — | 2,060 | (0.01 | ) | ||||||||||
Diluted earnings per common share | $ | 147,754 | 154,537 | $ | 0.96 | $ | 114,571 | 154,973 | $ | 0.74 | ||||||||
In Thousands | Per Share | |||||||||||||||||
Nine months ended March 28, 2003
| Net Earnings | Shares | ||||||||||||||||
Six Months Ended January 2, 2004 | ||||||||||||||||||
Basic earnings per common share | $ | 52,982 | 153,760 | $ | 0.34 | $ | 93,801 | 151,418 | $ | 0.62 | ||||||||
Effect of dilutive stock options | — | 451 | — | — | 2,735 | (0.01 | ) | |||||||||||
Diluted earnings per common share | $ | 52,982 | 154,211 | $ | 0.34 | $ | 93,801 | 154,153 | $ | 0.61 | ||||||||
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The following information pertains to options to purchase shares of common stock which were not included in the computation of diluted earnings per common share because the option’s exercise price was greater than the average market price of the common shares:
April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | |||||||||
Number of options outstanding | 11,816,147 | 15,827,704 | 11,804,216 | 8,825,177 | ||||||||
Weighted average exercise price | $ | 47.74 | $ | 39.97 | $ | 47.39 | $ | 52.72 |
C. | We have elected to account for option plans under Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to |
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||||||||||
Net earnings as reported | $ | 53,953 | $ | 26,820 | $ | 147,754 | $ | 52,982 | $ | 58,693 | $ | 51,131 | $ | 114,571 | $ | 93,801 | ||||||||
Deduct: Pro forma compensation expense, net of tax | 8,903 | 15,708 | 29,690 | 50,766 | 7,719 | 9,310 | 15,546 | 20,787 | ||||||||||||||||
Pro forma net earnings | $ | 45,050 | $ | 11,112 | $ | 118,064 | $ | 2,216 | $ | 50,974 | $ | 41,821 | $ | 99,025 | $ | 73,014 | ||||||||
Earnings per share: | ||||||||||||||||||||||||
Basic | ||||||||||||||||||||||||
As reported | $ | 0.35 | $ | 0.18 | $ | 0.97 | $ | 0.34 | $ | 0.39 | $ | 0.34 | $ | 0.75 | $ | 0.62 | ||||||||
Pro forma | $ | 0.30 | $ | 0.07 | $ | 0.78 | $ | 0.01 | $ | 0.33 | $ | 0.28 | $ | 0.65 | $ | 0.48 | ||||||||
Diluted | ||||||||||||||||||||||||
As reported | $ | 0.35 | $ | 0.18 | $ | 0.96 | $ | 0.34 | $ | 0.38 | $ | 0.33 | $ | 0.74 | $ | 0.61 | ||||||||
Pro forma | $ | 0.29 | $ | 0.07 | $ | 0.76 | $ | 0.01 | $ | 0.33 | $ | 0.27 | $ | 0.63 | $ | 0.47 | ||||||||
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model which resulted in a weighted-averageweighted average fair value of $21.29$14.21 and $8.05$19.09 per option for grants in the thirdsecond quarter of fiscal years 2005 and 2004, respectively, and 2003,$15.28 and $21.22 and $8.05$19.84 per option for grants in the ninesix months ended AprilDecember 31 and January 2, 2004, and March 28, 2003, respectively. The following weighted-average assumptions were used in the pricing model for grants in the three and ninesix months ended April 2,December 31, 2004 and March 28, 2003:January 2, 2004:
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||||||||||||||||||
Risk free interest rate | 4.07 | % | 2.77 | % | 4.08 | % | 2.78 | % | 3.22 | % | 4.33 | % | 3.38 | % | 4.33 | % | ||||||||||||||||
Expected term | 5 years | 5 years | 5 years | 5 years | 4.7 years | 5.0 years | 4.8 years | 5.0 years | ||||||||||||||||||||||||
Volatility | 75.25 | % | 79.02 | % | 75.37 | % | 79.03 | % | 60 | % | 76 | % | 65 | % | 76 | % | ||||||||||||||||
Expected annual dividends | $ | 0.04 | $ | 0.04 | $ | 0.04 | $ | 0.04 | $ | 0.04 | $ | 0.04 | $ | 0.04 | $ | 0.04 |
We periodically compare our assumptions used in the pricing model for stock option grants with historical trends. During the second quarter of fiscal year 2005, we determined that the expected term of our stock option grants was 4.7 years rather than 5.0 years and we have adjusted our assumptions accordingly.
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D. | Inventories consist of the following: |
April 2, 2004 | June 27, 2003 | December 31, 2004 | July 2, 2004 | |||||||||
Raw materials and work-in-process | $ | 92,292 | $ | 82,890 | $ | 82,558 | $ | 99,872 | ||||
Finished goods | 33,497 | 44,164 | 43,184 | 30,058 | ||||||||
Total inventory | $ | 125,789 | $ | 127,054 | $ | 125,742 | $ | 129,930 | ||||
E. | During the |
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F. | Other |
In addition to the gain on the sale of a marketable security, otherOther income of $5,945$2,208 for the ninethree months ended AprilJanuary 2, 2004 included a gain of $6,755 from the sale of shares of Kabelnetz NRW Limited (Kabelnetz), which had been received as part of the termination settlement with German cable operator ish GmbH & Co. KG (ish) in the second quarter of fiscal year 2003, foreign exchange gains, gains from the increase in the cash surrender value of life insurance and gains from various other items, none of which was individually significant. We also recorded a loss of $6,147 from the settlement of purchase price adjustments, which included a cash payment of $9,000, related to the sale of the satellite networks business to ViaSat. In connection with this transaction, we utilizedViaSat, Inc. (ViaSat), of which $2,853 of liabilities which had been previously established related to indemnifications to ViaSat, primarily for warranty. reserved for.
In addition to the gainsgain from the salessale of marketable securities discussedshares of Kabelnetz and the loss from the settlement of purchase price adjustments with ViaSat described above, other income of $1,307 for the ninesix months ended AprilJanuary 2, 2004 included a gain of $1,907 from the sale of anothera marketable security, charges of $1,831 from other-than-temporary declines in the value of investments in privately-held companies, foreign exchange losses and losses from various other items, none of which was individually significant.
Other expense for the quarter ended March 28, 2003 of $8,874 included $6,830 of losses from other-than-temporary declines in the market value of investments in privately-held companies and marketable securities. Other expense for the nine months ended March 28, 2003 of $21,379 included losses of $17,872 from other-than-temporary declines in the market value of investments in privately-held companies and marketable securities and $3,317 from the decline in the market value of short-term investments. These losses were partially offset by a net gain of $2,491 from the settlement of a collar on a warrant to purchase common stock of a public company and the related warrant. There were no other significant items in other (income) expense for the three or nine months ended March 28, 2003.
G. |
Three Months Ended | Nine Months Ended | |||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | |||||||
$(63) | $ | (982 | ) | $ | 675 | $ | 998 |
We have a defined benefit pension plan covering substantially all of our domestic |
Three Months Ended | Nine Months Ended | Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||
April 2, 2004 | March 28, 2003 | April 2, 2004 | March 28, 2003 | December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||||||||||||||||||
Service cost | $ | 2,282 | $ | 2,066 | $ | 6,846 | $ | 6,198 | $ | 1,914 | $ | 1,757 | $ | 3,828 | $ | 3,514 | ||||||||||||||||
Interest cost | 2,151 | 2,154 | 6,451 | 6,462 | 1,379 | 1,397 | 2,758 | 2,794 | ||||||||||||||||||||||||
Expected return on plan assets | (1,627 | ) | (1,710 | ) | (4,880 | ) | (5,129 | ) | (1,691 | ) | (1,627 | ) | (3,382 | ) | (3,254 | ) | ||||||||||||||||
Amortization of transition net asset | (12 | ) | (12 | ) | (35 | ) | (36 | ) | (12 | ) | (12 | ) | (24 | ) | (24 | ) | ||||||||||||||||
Amortization of prior service cost | 7 | 7 | 14 | 14 | ||||||||||||||||||||||||||||
Amortization of net actuarial loss | 293 | 222 | 878 | 666 | 46 | — | 92 | — | ||||||||||||||||||||||||
Amortization of prior service cost | 64 | 72 | 192 | 216 | ||||||||||||||||||||||||||||
Pension expense | $ | 3,151 | $ | 2,792 | $ | 9,452 | $ | 8,377 | $ | 1,643 | $ | 1,522 | $ | 3,286 | $ | 3,044 | ||||||||||||||||
During fiscal year 2004, we made a contribution of $16,326 to the defined benefit pension plan and expect to make a contribution of approximately $3,600 in the first quarter of fiscal year 2005.2005, we made a contribution of $3,594 to the defined benefit pension plan. We believe no additional contributions will be made to the defined benefit pension plan in fiscal year 2005.
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In addition, we acquiredWe also have unfunded defined benefit retirement plans for certain key officers and non-employee directors. Pension expense for these plans consists of the software, technology and other assets of ChanneLogics, Inc. (ChanneLogics) for $1,600 of cash. The acquired assets were recorded at their estimated fair value at the date of acquisition. The purchase price of ChanneLogics has been allocated to the assets acquired including $539 of goodwill and $550 of other identifiable intangible assets (primarily existing technology, which are being amortized over varying periods of up to five years).following:
Three Months Ended | Six Months Ended | |||||||||||
December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||
Service cost | $ | 341 | $ | 379 | $ | 682 | $ | 758 | ||||
Interest cost | 532 | 566 | 1,064 | 1,132 | ||||||||
Amortization of prior service cost | 47 | 47 | 94 | 94 | ||||||||
Amortization of net actuarial loss | 428 | 243 | 856 | 486 | ||||||||
Pension expense | $ | 1,348 | $ | 1,235 | $ | 2,696 | $ | 2,470 | ||||
In July 2002,addition to providing pension benefits, we acquired a portionhave contributory plans that provide certain health care and life insurance benefits to retired employees. The components of postretirement benefit expense consist of the shares held by the minority shareholders of PowerTV, Inc., a majority-owned subsidiary, for $4,580 of cash. The entire purchase price was recorded as goodwill.following:
Three Months Ended | Six Months Ended | |||||||||||
December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||
Service cost | $ | 13 | $ | 12 | $ | 26 | $ | 24 | ||||
Interest cost | 169 | 183 | 338 | 366 | ||||||||
Amortization of prior service cost | 11 | 11 | 22 | 22 | ||||||||
Amortization of net actuarial loss | 65 | 51 | 130 | 102 | ||||||||
Postretirement expense | $ | 258 | $ | 257 | $ | 516 | $ | 514 | ||||
In August 2002, we announced a restructuring of our worldwide operations to align our costs with reduced sales levels. The restructuring included a reduction of our workforce by 400 positions, or approximately 6 percent of our total workforce, and was substantially completed by December 27, 2002. The positions eliminated were from manufacturing, engineering, marketing, sales, service and administrative functions. The restructuring also included the consolidation of certain office and manufacturing facilities. In addition, during the third quarter of fiscal year 2003, we reduced our workforce by approximately 120 positions, primarily in sales and other functions within the transmission |
During the ninesix months ended April 2,December 31, 2004, severance costs of $1,321$23 were paid to 40 employees whose positions had been eliminated under the restructuring plan.
The following reconciles the beginning restructuring liability at June 27, 2003July 2, 2004, which consisted of an accrual for contractual obligations under a canceled lease, to the restructuring liability at April 2,December 31, 2004:
Contractual Obligations Under Canceled Leases | Severance | Other | Total | Contractual Obligations Under a Canceled Lease | Severance | Total | ||||||||||||||||||||||
Balance at June 27, 2003 | $ | 3,309 | $ | 223 | $ | — | $ | 3,532 | ||||||||||||||||||||
Balance at July 2, 2004 | $ | 1,324 | $ | — | $ | 1,324 | ||||||||||||||||||||||
Restructuring provision | 17 | 1,098 | 249 | 1,364 | — | 23 | 23 | |||||||||||||||||||||
Charges to the reserve | (1,548 | ) | (1,321 | ) | (249 | ) | (3,118 | ) | (723 | ) | (23 | ) | (746 | ) | ||||||||||||||
Adjustments | (35 | ) | — | (35 | ) | |||||||||||||||||||||||
Balance at April 2, 2004 | $ | 1,778 | $ | — | $ | — | $ | 1,778 | ||||||||||||||||||||
Balance at December 31, 2004 | $ | 566 | $ | — | $ | 566 | ||||||||||||||||||||||
Since the initiation of these restructurings, we have incurred expenses of $5,857$5,898 from the write-off of fixed assets, $6,625$6,519 from contractual obligations under canceled leases, $27,473$27,517 from severance and $7,019$6,989 from other miscellaneous costs.
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The following is a summary of depreciation and amortization expense: |
Three Months Ended | Six Months Ended | |||||||||||
December 31, 2004 | January 2, 2004 | December 31, 2004 | January 2, 2004 | |||||||||
Depreciation expense | $ | 11,467 | $ | 11,057 | $ | 23,073 | $ | 22,332 | ||||
Amortization expense: | ||||||||||||
Intangible assets | 3,729 | 3,732 | 7,578 | 7,419 | ||||||||
Capitalized software | 3,298 | 1,685 | 5,593 | 3,988 | ||||||||
Premiums on short-term investments | 1,931 | 2,022 | 4,206 | 4,032 | ||||||||
Total | $ | 20,425 | $ | 18,496 | $ | 40,450 | $ | 37,771 | ||||
J. | We offer warranties of various lengths to our customers depending on the specific product and the terms of the agreements with the customer. Our standard warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer. We record an estimate for warranty-related costs based on our |
We offer extended warranties on certain products. Revenue from these extended warranty agreements is deferred at the time of the sale and recognized in future periods according to the terms of the warranty agreement. The warranty liability at April 2,December 31, 2004 consisted of $13,400$15,562 in Accrued liabilities and $22,100$26,004 in Other liabilities in the Consolidated Statements of Financial Position.
The following reconciles the beginning warranty liability at June 27, 2003July 2, 2004 to the warranty liability at April 2,December 31, 2004:
Accrued warranty at June 27, 2003 | $ | 36,001 | ||||||
Accrued warranty at July 2, 2004 | $ | 36,233 | ||||||
Reductions for payments | (14,929 | ) | (10,607 | ) | ||||
Additions for warranties issued during the period | 15,579 | 11,680 | ||||||
Other adjustments | (1,151 | ) | 4,260 | |||||
Accrued warranty at April 2, 2004 | $ | 35,500 | ||||||
Accrued warranty at December 31, 2004 | $ | 41,566 | ||||||
Other adjustments include changes in failure rates and costs to repair and adjustments for products whose warranty has expired.
K. | U.S. income taxes, net of applicable credits, have been provided on the undistributed earnings of foreign subsidiaries, except in those instances where the earnings are expected to be indefinitely reinvested. Scientific-Atlanta currently intends to indefinitely reinvest approximately $37,000 of undistributed earnings of a foreign subsidiary; however, this amount may be adjusted based on changes in business, economic or other conditions. At December 31, 2004, approximately $18,000 of such undistributed earnings had been indefinitely reinvested. |
The effective tax rate for the three months ended December 31, 2004 was 30 percent of pre-tax earnings, down from 35 percent in the prior year, due primarily to various discrete items in the quarter, the most significant of which was the reversal of valuation allowances on certain deferred tax assets. During the quarter ended December 31, 2004, we determined that valuation allowances on deferred tax assets related to net operating loss carryforwards generated by certain operations in Europe were no longer needed due to the recent and projected profitability of these operations. In addition, the rate was favorably impacted by the legislative, retroactive reinstatement, on October 4, 2004, of the research tax credit to June 30, 2004.
We believe that our effective tax rate will be approximately 33 percent of pre-tax earnings for fiscal year 2005.
L. |
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In the second quarter of fiscal year 2004, we identified transactions which had resulted in charges to paid in capital in excess of credits from treasury stock transactions and reclassified $31,131 from paid in capital to retained earnings. This reclassification of $31,131 included $10,507 and $20,624 related to treasury stock transactions in fiscal years 2004 and 2003, respectively. During the third quarter of fiscal year 2004, we charged an additional $5,487 to retained earnings related to treasury stock transactions during the quarter.
We perform annual goodwill impairment tests to identify potential impairment by comparing the fair value of the reporting unit with its net book value, including goodwill. We test for impairment at the |
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In addition to our annual impairment test, Scientific-Atlanta continually evaluates whether events and circumstances have occurred that indicate that the remaining balance of goodwill may not be recoverable. The results of our assessments did not result in any determination of an impairment of goodwill during the first six months of fiscal year 2005.
M. | We operate in one reportable segment, the Broadband segment, which consists of our subscriber and transmission operating segments. We have combined these operating segments into a single reportable segment under the aggregation criteria of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Operating segments may be aggregated into a single operating segment if the segments have similar economic characteristics, and if the segments are similar in 1) the nature of products and services; 2) the nature of production processes; 3) the type or class of customer for their products and services; 4) the methods used to distribute their products or provide their services; and 5) the nature of the regulatory environment. We believe our subscriber and transmission operating segments meet all of these criteria and that aggregation is consistent with the objective and basic principles of SFAS No. 131. |
N. | The following disclosure related to |
Adelphia Communications Corporation (Adelphia), a significant customer of Scientific-Atlanta, filed for bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code in June 2002. In the third quarter of fiscal year 2002, during the 90 days prior to such filing by Adelphia, we received payments from Adelphia for goods sold and delivered of approximately $67,000. We$67,000, and we are unable to predict the portion, if any, of this amount which might be the subject of avoidance claims by the Chapter 11 estate of Adelphia in connection with its bankruptcy proceeding. During fiscal year 2004, we entered into a tolling agreement for any potential claims by the Adelphia estate where the statute of limitation has not yet run.
O. | The Financial Accounting Standards Board (FASB) recently issued FASB Staff Position (FSP) No. |
FSPIn December 2004, the FASB issued SFAS No. 106-1 provides guidance related123R, “Share-Based Payment,” which requires all companies to the accountingmeasure compensation cost for and disclosure of,all share-based payments, including the deferral of recognition of, a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that isemployee stock options, at least actuarially equivalent to Medicare Part D provided under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the ACT). FSP No. 106-1 isfair value effective for public companies for interim or annual financial statements of fiscal years ending after December 7, 2003. We are currently evaluating the impact of the ACT and have elected to defer the recognition of the impact of the new Medicare provisions under a provision of FSP No. 106-1. We are unable to predict at this time the impact of the ACT and the provisions of FSP No. 106-1 on our results of operations or financial position.
SFAS No. 132 requires additional disclosures about assets, obligations, cash flows and net periodic benefit cost of defined benefit plans and other postretirement benefit plans. The provisions of this Statement are effective for fiscal years ending after December 15, 2003 and for interim periods beginning after December 15, 2003. We adopted the interim period disclosure provisions of SFAS No. 132, which are reflected in Note H, in the third quarter of fiscal year 2004.
Interpretation No. 46 addresses the consolidation by a reporting entity of variable interest entities with certain characteristics. This Interpretation was effective in January 2003 for variable interest entities created after January 31, 2003 and in the first fiscal year or interim period beginning after June 15, 2003. The FASB has issued FSPs which have deferred the effective date for applying the provisions of Interpretation2005. Scientific-Atlanta will adopt SFAS No. 46 for interests in certain variable interest entities or potential variable interest entities created before February 1, 2003 until the end of the first interim period ending after March 15, 2004. These FSPs also require certain disclosures about variable interest entities and potential variable interest entities. During the quarter ended April 2, 2004, we completed our evaluation of entities in which we hold equity investments and determined that they were not variable interest entities as defined in Interpretation No. 46.
EITF No. 00-21 provides guidance on determining units of accounting in a revenue arrangement with multiple deliverables and the allocation of the consideration received from the arrangement. EITF No. 00-21, which was effective for revenue
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arrangements entered into in the first annual or interim period after June 15, 2003, was adopted123R in the first quarter of fiscal year 2004. The2006 using a modified version of prospective application.
As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognize no compensation cost for employee stock options. Accordingly, the adoption of EITFSFAS No. 00-21 did not123R’s fair value method could have a significant impact on the recognitionour result of revenue or resultoperations. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the deferralfuture. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in Note C to our consolidated financial statements. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a significantfinancing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of revenueoperating cash flows recognized in prior periods for such excess tax deductions were $1,241 and $1,670 for the three and six months ended December 31, 2004, respectively, and $557 and $11,078 for the three and six months ended January 2, 2004, respectively.
The FASB also recently issued FSP No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004,” and FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (the Act). Under the guidance in FSP No. FAS 109-1, the deduction will be treated as a “special deduction” as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the first three quartersperiod in which the deduction is claimed on our income tax return. FSP No. FAS 109-2 allows enterprises time beyond the financial reporting period of fiscal year 2004.
In EITF Issuethe enactment of the Act to evaluate the effects of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 03-5, the EITF concluded that, in an arrangement that includes software that is more than incidental109 due to the products or services aslack of clarification of certain provisions within the Act and the timing of the enactment. As such, we are not yet in a whole,position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the software and software-related elements are includedU.S. Based on our analysis to date, however, it is reasonably possible that we may repatriate some amount ranging from $0 to $60,000, with the respective tax benefit ranging from $0 to $3,000. We expect to be in the scope of Statement of Position (SOP) 97-2, “Software Revenue Recognition.” EITF Issue No. 03-5, which was adopted in the second quarter of fiscal year 2004, was effective for arrangements entered into in the first annual or interim reporting period after August 13, 2003. The adoption of EITF Issue No. 03-5 did not have a significant impact on the recognition of revenue or result in the deferral of a significant amount of revenue in the second or third quarters of fiscal year 2004.position to finalize our assessment by December 31, 2005.
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MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Sales for the three months ended April 2,December 31, 2004 were $437.0$441.7 million, an increase of 146 percent over the comparable quarterperiod of the prior year. The year-over-year increase was driven by higher sales volume of Explorer® digital set-tops, including certain models which provide digital video recording and / or high-definition functionality. Gross margins of 36.937.1 percent improved 2.8were 0.7 percentage points overlower than the prior year due primarily to the higher sales volume, material cost reductions and improved efficiencies in manufacturing.year. Operating expenses increased $5.0$1.2 million due primarily to increasesincremental hiring of engineers related to new set-top designs. The increase in the cost of employee benefitsresearch and higher incentive accruals. These increases weredevelopment expense was offset in part by lower restructuring costs in the thirdsecond quarter of fiscal year 20042005 as compared to the prior year. Net earnings for the three months ended April 2,December 31, 2004 of $54.0$58.7 million were $27.1$7.6 million higher than the prior year due todriven primarily by the higher sales volume and improved gross marginslower effective tax rate in the second quarter of fiscal year 2005 as compared to the prior year.
During the second quarter, we engaged in substantive discussions with Gemstar – TV Guide International, Inc. (Gemstar) regarding a possible settlement and cross-licensing agreement. No agreement has been reached at this time. If circumstances were to change during the third quarter of fiscal year 20042005, we may include, as compareda result of any settlement, an additional expense or charge in our results of operations for the third quarter of fiscal year 2005. At this time, we can not assess the probability of a settlement and there can be no assurance as to the prior year.outcome of these settlement agreements.
FINANCIAL CONDITION AND LIQUIDITY
WeScientific-Atlanta had stockholders’ equity of $1,716.4 million,$1.9 billion and cash on hand was $443.9$339.6 million at April 2, 2004. Cash increased $84.2 million during the first nine months of fiscal yearDecember 31, 2004. Cash provided by operating activities for the ninesix months ended April 2,December 31, 2004 of $204.8$130.1 million included net earnings of $147.8$114.6 million and depreciation and amortization of $50.4$40.4 million. During the six months ended December 31, 2004, we received $22.7 million of income tax refunds and increases inrelated interest from a federal income taxes payable of $36.7 million and in accounts payable and accrued liabilities of $15.7 million.tax settlement for certain fiscal years prior to 2003. These receipts were offset partially by increases in accounts receivable of $40.8$9.2 million and gainsa reduction in accrued liabilities of $18.8 million. The increase in accounts receivable relates primarily to the timing of payments from customers in the first six months of fiscal year 2005 as compared to July 2, 2004. Accrued expenses decreased primarily due to the payment of fiscal year 2004 incentives on the sale of marketable securities and investments in privately-held companies of $11.4 million.performance-based plans.
During the ninesix months ended April 2,December 31, 2004, we increased our short-term investments by $159.6$120.6 million and acquired machineryproperty, plant and equipment for $19.7$58.1 million, received proceedsincluding a cash payment of $16.6$36.0 million fromfor the salepurchase of marketable securities and investmentsbuildings we had previously leased at our office site in privately-held companies, and made a $9.0 million payment to settle purchase price adjustments related to the sale of the satellite networks businesses to ViaSat.Lawrenceville, Georgia. We also received $56.2 million from the issuancepurchased 1,836,600 shares of our common stock under our employee stock option and other benefit plans.at an aggregate cost of $50.7 million pursuant to a program announced in February 2003 to buy back up to 10,000,000 shares.
The current ratio of Scientific-Atlanta was 5.4:6.7:1 at April 2,December 31, 2004, up from 4.8:5.6:1 at June 27, 2003.July 2, 2004. At April 2,December 31, 2004, we had debt of $9.3$9.2 million, primarily mortgages on facilities we assumed in connection with the acquisition of BarcoNet NV (BarcoNet) during fiscal year 2002.
We believe that funds generated from operations, and existing cash balances and our available senior credit facility will be sufficient to support operations and fund capital expenditures. We are currently negotiating a multi-year senior credit facility to replace the $150 million senior credit facility which expired in May 2004. We expect to complete the negotiation of the new facility by the end of fiscal year 2004.operations.
RESULTS OF OPERATIONS
Sales for the quarter ended December 31, 2004 were $441.7 million, up 6 percent or $25.1 million over the prior year. International sales for the second quarter of fiscal year 2005 were $116.1 million, up 27 percent over the prior year. Year-over-year international sales were up in all regions except the Asia / Pacific region.
Sales of subscriber products for the quarter ended April 2,December 31, 2004, increased 1811 percent from the prior year’s thirdsecond quarter to $318.5$327.6 million. In the thirdsecond quarter of fiscal year 2004,2005, we sold 997911 thousand Explorer digital set-tops as compared to 929958 thousand in the prior year. The 997 thousand digital set-tops sold included 306 thousand dual-tuner Explorer 8000 DVR (digital video recorder) set-tops, an increase from 106 thousand soldDuring the third quarter of the prior year and also included 32 thousand high-definition Explorer 8000HD set-tops. We sold a total of 198 thousand HD set-tops, including the Explorer 8000HD set-tops, during the thirdsecond quarter of fiscal year 2004, up from 54 thousand HD set-tops in the comparable period of the prior year. During the third quarter of fiscal year 2004,2005, we also sold 399460 thousand WebSTAR™ cable modems, up from 171226 thousand in the prior year. Sales of transmission products during the second quarter of fiscal year 2005 totaled $114.1 million, a decline of 5 percent from the prior year.
Since there is considerable cross-over between satellite products and certain transmission products as a result of the BarcoNet acquisition, and because sales of our satellite products have been consistently less than five percent of company totals, we have included satellite products together with transmission products.
Sales of transmission products duringDuring the quarter ended April 2,December 31, 2004, totaled $118.7 million, an increasewe sold 449 thousand set-tops with digital video recording capability (DVRs), including 256 thousand units of 5 percent overour standard-definition model and 193 thousand units of our high-definition DVR model. We also sold 111 thousand high-definition set-tops without DVR capability. Together with the comparable period of the prior year. Increased sales to customers in North America and the favorable impact of Euro-based operations as the Euro strengthened against the U.S. dollar were partially offset by a decline in sales to customers in the Asia-Pacific and Latin America regions.high-definition DVRs
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International salesmentioned previously, we sold 304 thousand high-definition set-tops in the third quarter, of fiscal year 2004 were $82.3 million, an increase of 7more than 200 percent fromcompared to the thirdsame quarter of last year. The increase in international sales was due primarily to an increase in shipments to customers in Europe and Canada and the favorable impact of Euro-based operations discussed above, which were partially offset by a decline in shipments to customers in the Asia- Pacific region.
Sales for the ninesix months ended April 2,December 31, 2004 were $1,249.2$894.3 million, up 1910 percent from $1,046.2$812.2 million in the first ninesix months of the prior year. Sales of subscriber products were $890.6$660.7 million, an increase of 2816 percent from the prior year. We sold approximately 2.91.9 million digital set-tops during the ninesix months ended April 2,December 31, 2004, which was relatively flat compared to approximately 2.3 million during the first ninesix months of the prior fiscal year. Included inOf the approximately 2.91.9 million digital set-tops shipped weresold, more than 744845 thousand Explorer 8000 DVRof the digital set-tops included digital video recording capability. This is an increase from approximately 228438 thousand shipped during the ninesix months ended March 28, 2003. We sold a total of 359 thousand HD set-tops, including the Explorer 8000HD set-tops, during the nine months ended April 2, 2004, up from 139 thousand HD set-tops in the comparable period of the prior year. During the nine months ended April 2, 2004, we also sold 916 thousand WebSTAR cable modems, up from 461 thousand in the comparable period of the priorlast year. Sales of transmission products were $358.8$233.7 million, up slightly froma decline of 3 percent compared to the first ninesix months of last year. International sales for the first six months of fiscal year 2005 totaled $254.6$214.2 million, an increase of 3up 24 percent fromcompared to the first six months last year. The increase from the prior year was due primarily to an increase in shipments to customers in both Europe and Canada andall regions except the favorable impact of Euro-based operations discussed above, partially offset by a decline in sales to customersAsia / Pacific region.
Gross margin in the Asia-Pacific and Latin America regions.
Also during the first nine months of the prior fiscal year, we reached an agreement with German cable operator ish related to work orders which had been suspended or cancelled during the fourthsecond quarter of fiscal year 2002 and our exposure in accounts receivable and inventory related to ish. We received a cash payment of $22.0 million, notes denominated at $19.0 million which we sold for $11.5 million, and preferred equity in a newly formed entity, Kabelnetz. In connection with this transaction, we recorded sales of $4.4 million and charged $10.9 million to cost2005 was 37.1 percent of sales, for in-process inventory retaineda decline of 0.7 percentage points from the second quarter of last year. Lower selling prices in the quarter ended December 31, 2004 as compared to last year were partially offset by ish. Duringmaterial and conversion cost reductions. The combined average selling price of our digital set-tops increased approximately 13 percent in the first nine monthssecond quarter of fiscal year 2004, we2005 compared to the second quarter of 2004. The increase in the combined average selling price of digital set-tops is attributable to the increase in the shipments of Explorer 8000 set-tops to more than 448 thousand units, up more than 72 percent from 260 thousand units sold in the sharessecond quarter of last year. Explorer 8000 digital set-tops, which have digital video recording capability, currently have an average selling price higher than other set-tops, and gross margins lower than the company average. Although the price of individual models of digital set-tops may decline in Kabelnetzthe future, the average selling price of digital set-tops will vary based on the mix of models sold during the period. We continue to focus on cost reductions through product design, procurement and recognized a gain of $6.8 million from the transaction.manufacturing.
Gross margin was 36.9margins were 36.8 percent of sales for the threesix months ended April 2, 2004, 2.8of fiscal year 2005, 0.7 percentage points higher than the comparable quarter of the prior year. The increase in gross margin percent relative to last year was primarily the result of the increase in sales volume, material cost reductions achieved through the re-design of products, increased effectiveness of procurement, and improved efficiencies in manufacturing. These improvements more than offset the negative impact of declines in the average selling prices of products and the shift to a higher mix of Explorer 8000 digital set-top shipments, which have a gross margin lower than the company average. A continued shift to a higher mix of Explorer 8000 set-tops might negatively impact our gross margin as a percent of sales. In addition, gross margin on transmission products in the three months ended April 2, 2004 improved over the prior year due primarily to favorable product mix, reductions in material costs and the consolidation of certain product lines we acquired when we purchased BarcoNet into our Juarez, Mexico factory.
Gross margin was 37.3 percent of sales for the nine months ended April 2, 2004, 3.4 percentage points higher than the prior year. The leverage associated with a 19 percent increasedecline from last year was related primarily to lower selling prices of digital set-tops across most set-top models in sales, coupled with the continued benefits of cost reductions through product redesign, the increased effectiveness of procurement, and improved manufacturing efficiencies, more than offsetaddition to the negative impact of declines in the average selling prices of products and the shift toshipping a greater mixnumber of Explorer 8000 digital set-tops whichthat currently have a lower gross margin than the company average. In addition,Lower material and conversion costs coupled with the gross marginleverage of transmission products improved during the first nine months of this yeara 10 percent increase in sales compared to the prior year. This improvement was related primarily to an increase infirst six months of last year partially offset the negative impact of the lower selling prices and higher mix of Explorer 8000 digital set-top shipments of higher margin transmission satellite and headend products in the current fiscal year as comparedrelative to the prior fiscal year, combined with material costs savings gained through the efficienciesfirst six months of procurement and other costs savings obtained from the various restructuring actions taken over the last twenty-one months. During the nine months ended March 27, 2003, the ish settlement discussed above negatively impacted gross margins by $6.5 million, or 0.8 percentage point.year.
SalesResearch and administrativedevelopment expenses of $51.8 million and $147.8 million infor the three and ninesix months ended April 2,December 31, 2004 increased $5.3were $37.9 million and $6.3$76.2 million, respectively, up approximately six percent over the comparable periods of the prior year. The year-over-yearprimary driver of the year-to-year increases were primarily due to higher incentive accruals on performance-based plans related to our improved profitability and higher payroll taxes and health care costs. These increases were partially offset by lower professional fees and reductions in amortization expense of intangible assets in fiscal year 2004 as compared to fiscal year 2003.
Research and development expenses for the quarter ended April 2, 2004 were $39.0 million, up $3.2 million over the prior year. Research and development expenses for the nine months ended April 2, 2004 were $110.2 million, down slightly from the prior year. For the quarter and nine months ended April 2, 2004, research and development expenses increased year-over-year due towas incremental hiring of engineers related to new set-top designs, higher incentive accruals on performance-based plans related to our improved profitability and higher payroll taxes and health care costs. These year-over-year increases were
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offset partially by the higher capitalization of software development costs in the three and nine months ended April 2, 2004 as compared to the comparable periods of the prior year and the benefits realized from previously announced restructurings. During the three and nine months ended April 2, 2004, we capitalized $4.2 million and $14.0 million, respectively, of software development costs, compared to $3.1 million and $5.2 million in the three and nine months ended March 27, 2003. The year-over-year increases in the capitalization of software development costs were driven primarily by increased development costs related to the Explorer 8300 Multi-Room™ DVR product, product enhancements for customers and products for expansion into new markets, such as a version of the Explorer interactive digital set-top for the Japanese market.designs. Research and development efforts continue to focus on advanced models of digital set-tops, network software enhancements and upgrades, data products, satellite products and transmission products.
Sales and administrative expenses of $47.9 million and $96.7 million in the three and six months ended December 31, 2004, respectively, were flat compared to the comparable periods of the prior year.
In August 2002, we announced a restructuring of our worldwide operations to align our costs with reduced sales levels. The restructuring included a reduction of our workforce by 400 positions, or approximately 6 percent of our total workforce, and was substantially completed by December 27, 2002. The positions eliminated were from manufacturing, engineering, marketing, sales, service and administrative functions. The restructuring also included the consolidation of certain office and manufacturing facilities. In addition, during the third quarter of fiscal year 2003, we reduced our workforce by approximately 120 positions, primarily in sales and other functions within the transmission businesses,sector, and reduced our workforce by an additional 30 positions in the fourth quarter of fiscal year 2003. WeDuring the three and six months ended January 2, 2004, we recorded restructuring charges of $0.1$0.6 million and $1.4$1.3 million, respectively, primarily for severance, during the quarter and nine months ended April 2, 2004, respectively.severance. We do not anticipate recording any significant additional restructuring charges in the fourth quarter ofduring fiscal year 2004.2005.
Interest income of $4.2$6.7 million and $12.3$12.5 million in the three and ninesix months ended April 2,December 31, 2004, declined $0.5 million and $4.1 million, respectively, fromincreased over the comparable periods of the prior year. These declines wereyear due primarily to lowerhigher average interest ratescash and short-term investment balances and higher yields in these periods of fiscal year 20042005 as compared to the prior year.
Other incomeexpense of $1.0 million and $0.9 million for the quarterthree and six months ended April 2,December 31, 2004, of $4.6 millionrespectively, included a gain of $2.2 millionlosses on short-term investments and from the saleother-than-temporary decline in the fair value of an investment in a marketable securityprivately-held company, gains from the increase in the cash surrender value of life insurance, partnership income, foreign exchange losses, and various other items, which resulted in additional income, none of which was individually significant.
In addition to the gain on the sale of a marketable security, otherOther income of $5.9$2.2 million for the ninethree months ended AprilJanuary 2, 2004 included a gain of $6.8 million from the sale of shares of Kabelnetz, NRW Limited (Kabelnetz), which had been received as part of the termination settlement with German cable operator ish GmbH & Co. KG (ish) in the
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second quarter of fiscal year 2003, foreign exchange gains, gains from the increase in the cash surrender value of life insurance and gains from various other items, none of which was individually significant. We also recorded a loss of $6.1 million from the settlement of purchase price adjustments, which included a cash payment of $9.0 million, related to the sale of the satellite networks business to ViaSat. In connection with this transaction, we utilizedViaSat, of which $2.9 million of liabilities which had been previously established related to indemnifications to ViaSat, primarily for warranty. reserved for.
In addition to the gainsgain from the salessale of marketable securities discussedshares of Kabelnetz and the loss from the settlement of purchase price adjustments with ViaSat described above, other income of $1.3 million for the ninesix months ended AprilJanuary 2, 2004 included a gain of $1.9 million from the sale of anothera marketable security, charges of $1.8 million from other-than-temporary declines in the value of investments in privately-held companies, foreign exchange losses and losses from various other items, none of which was individually significant.
Other expense for the quarter ended March 28, 2003 of $8.9Earnings before income taxes were $83.5 million included $6.8and $168.0 million of losses from other-than-temporary declines in the market value of investments in privately-held companiesthree and marketable securities. Other expense for the ninesix months ended March 28, 2003December 31, 2004, respectively, up over the comparable periods of $21.4 million included lossesthe prior year. The year-over-year improvements were due to higher sales volume in these periods of $17.9 million from other-than-temporary declines infiscal year 2005 as compared to the market value of investments in privately-held companies and marketable securities and $3.3 million from the decline in the market value of short-term investments. These losses were partially offset by a net gain of $2.5 million from the settlement of a collar on a warrant to purchase common stock of a public company and the related warrant. There were no other significant items in other (income) expense for the three or nine months ended March 28, 2003.prior year.
The effective tax rate for the three and nine months ended April 2,December 31, 2004 was 32 and 3430 percent of pre-tax earnings, respectively. Followingdown from 35 percent in the completionprior year, due primarily to various discrete items in the quarter, the most significant of which was the reversal of valuation allowances on certain deferred tax assets. During the quarter ended December 31, 2004, we determined that valuation allowances on deferred tax assets related to net operating loss carryforwards generated by certain operations in Europe were no longer needed due to the recent and projected profitability of these operations. In addition, the rate was favorably impacted by the legislative, retroactive reinstatement, on October 4, 2004, of the fiscal year 2003research tax credit to June 30, 2004.
The effective tax rate for the six months ended December 31, 2004 was 32 percent of pre-tax earnings, down from 35 percent in the prior year. In addition to the items discussed above, the effective rate for the six months ended December 31, 2004 was also favorably impacted by revisions to the estimates of foreign net operating loss carryforwards and additional refunds of income tax returns, we reducedtaxes and related interest from the IRS. We believe that our effective tax rate will be approximately 33 percent of pre-tax earnings for fiscal year 2005.
U.S. income taxes, net of applicable credits, have been provided on the undistributed earnings of foreign subsidiaries, except in those instances where the earnings are expected to be indefinitely reinvested. Scientific-Atlanta currently intends to indefinitely reinvest approximately $37.0 million of undistributed earnings of a foreign subsidiary; however, this amount may be adjusted based on changes in business, economic or other conditions. At December 31, 2004, approximately $18.0 million of such undistributed earnings had been indefinitely reinvested.
On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividend received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations and, as of today, uncertainty remains as to how to interpret numerous provisions in the third quarterAct. As such, we are not yet in a position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the U.S. Based on our analysis to date, however, it is reasonably possible that we may repatriate some amount ranging from $0 to $60 million, with the respective tax benefit ranging from $0 to $3 million. We expect to be in a position to finalize our assessment by December 31, 2005.
The Act also creates a deduction for income from qualified domestic production activities which will be phased in from 2005 through 2010, effective for our fiscal years 2006 through 2011. In return, the Act also provides for a two-year phase-out of the existing extra-territorial income exclusion (ETI) for foreign sales that was viewed to be inconsistent with international trade protocols by the European Union. We expect the phase out of ETI to result in an immaterial increase in the effective tax rate for fiscal year 2004years 2005, 2006 and 2007. The new deduction for domestic production activities is subject to 32 percent from 35 percentcertain limitations and interpretations and, as such, we are not yet in a position to reflect our revised estimates ofdetermine the potential impact on the effective tax rate of research and development credits and export incentivesfuture years.
Under the guidance in fiscal year 2004. We expectFSP No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the effective rate for fiscal yearTax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004,” the deduction will be approximately 34 percenttreated as a “special deduction” as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of pre-taxthis deduction will be reported in the period in which the deduction is claimed on our income unchanged from the prior year.tax return.
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Critical Accounting Policies
Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for fiscal year 20032004 includes a summary of the significant accounting policies or methods used in the preparation of our consolidated financial statements. Some of those significant accounting policies or methods require us to make estimates and assumptions that affect the amounts reported by us. We believe the following items require the most significant judgments and often involve complex estimates.
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General
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. We base our estimates and judgments on historical experience and various other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant estimates and assumptions relate to revenue recognition, the adequacy of receivable, inventory and inventorytax reserves, deferred tax allowances, asset impairments and accrued liabilities and other liabilities, principally relating to warranty provisions and the pension benefit liability.
Revenue Recognition
Our principal sources of revenues are from sales of digital interactive subscriber systems, broadband transmission networks and content distribution networks. We recognize revenue when (1) there is persuasive evidence of an agreement with the customer, (2) product is shipped and title has passed, (3) the amount due from the customer is fixed and determinable, (4) collectibility is reasonably assured, and (5) we have no significant future performance obligation. At the time of the transaction, we assess whether the amount due from the customer is fixed and determinable and collection of the resulting receivable is reasonably assured. We assess whether the amount due from the customer is fixed and determinable based on the terms of the agreement with the customer, including, but not limited to, the payment terms associated with the transaction. We assess collection based on a number of factors, including past transaction history with the customer and credit-worthiness of the customer. If we determine that collection of an amount due is not reasonably assured, we defer recognition of revenue until collection becomes reasonably assured.
The standard terms and conditions under which we ship allow a customer the right to return product for refund only if the product does not conform to product specifications; the non-conforming product is identified by the customer; and the customer rejects the non-conforming product and notifies us within ten days of receipt. If an agreement contains a non-standard right of return, we defer recognizing revenue until the conditions of the agreement are met. From time to time, our agreements include acceptance clauses. If an agreement includes an acceptance clause, revenue is recorded at the timedeferred until acceptance is deemed to have occurred.
Certain agreements also include multiple deliverables or elements for products and/or services. We recognize revenue from these agreements based on the relative fair value of the products and services. The determination of the fair value of the elements, which is based on a variety of factors, including the amount we charge other customers for the products or services, price lists or other relevant information, requires judgment by management. If an undelivered element is essential to the functionality of the delivered element or required under the terms of the contract to be delivered concurrently, we defer the revenue on the delivered element until that undelivered element is delivered.
We adopted EITF No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”Deliverables,” for agreements entered into in the first quarter of fiscal year 2004. Agreements with multiple deliverables are reviewed and the deliverables are separated into units of accounting under the provisions of EITF No. 00-21. The total consideration received is allocated over the relative fair value of the units of accounting. As indicated above, the determination of fair value requires judgment by management. Revenue is recognized as the elements are delivered, assuming all the other conditions for recognition of revenue discussed in the preceding paragraphs have been met.
For certain products where software is more than an incidental component of the hardware, we recognize software license revenue under SOP No. 97-2, “Software Revenue Recognition,” as amended by SOP No. 98-9, “Software Revenue Recognition, with Respect to Certain Transactions.” Software revenue recognition rules are very complex. Although we follow very specific and detailed guidelines in measuring revenue, the application of those guidelines requires judgment, including whether the software is more than an incidental component of the hardware and whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence of fair value exists for any undelivered elements.
Allowance for Doubtful Accounts
Management judgments and estimates are made in connection with establishing the allowance for doubtful accounts. Specifically, we analyze the aging of accounts receivable balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. Significant changes in customer concentration or payment terms, deterioration of customer credit-worthiness, as in the case of the bankruptcy of Adelphia, or weakening in economic trends could have a significant impact on the collectibility of receivables and our operating results. Generally, we do not require collateral or other security to support accounts receivable.
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Inventory Reserves
We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements for the next twelve months. In addition, our industry is characterized by rapid technological change, frequent introductions of new product developmentproducts and rapid product obsolescence that could result in an increase in the amount of obsolete inventory on hand. Recently, the rate at which we introduce new products has accelerated, which also may result in an increase in the amount of obsolete inventory on hand. Any significant, unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and operating results.
Non-Current Marketable SecuritiesIncome Taxes
Non-current marketable securities consistWe recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of investmentsassets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and the implementation of tax planning strategies. If we are unable to generate sufficient future taxable income in common stock, primarily technology companies, and warrants of publicly traded companies and are stated at market value. We have market risks associated with the volatilitycertain tax jurisdictions, or if there is a material change in the value ofactual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to increase the valuation allowance against our non-current marketable securities. All investmentsdeferred tax assets, resulting in common stockan increase in the effective tax rate and an adverse impact on operating results.
Management judgments and estimates are classified as “available for sale” under the provisions of SFAS No. 115,made in connection with establishing and thus, changesadjusting valuation allowances on deferred tax assets, estimated tax payments and tax reserves. Changes in these estimates could have a significant impact on our operating results.
Goodwill Impairment
We perform annual goodwill impairment tests to identify potential impairment by comparing the fair value of these securities are not included in our Consolidated Statementsthe reporting unit with its net book value, including goodwill. We test for impairment at the operating segment level (subscriber and transmission). Estimates of Earnings until realized. Unrealized holding gains and losses are included, net of taxes, in accumulated other comprehensive income. Realized gains and losses and declines in value judged to be other-than-temporary are included in Other (income) expense. We periodically evaluate the carrying value of our investments in common stock to determine if declines in fair value are other-than-temporary. This evaluation requires judgmentdetermined using discounted cash flows and market comparisons. We perform internal valuation analyses and consider other market information that is publicly available. These analyses use significant estimates and assumptions, including projected future cash flows (including timing), discount rates reflecting the risk inherent in future cash flows, determination of appropriate comparables and the determination of whether a premium or discount should be applied to comparables. These estimates and assumptions are reviewed and updated annually based on several factors including the market price of the security generally over the preceding six months, analysts’ reportsactual results and future projections. Changes in these estimates and assumptions may result in a determination that goodwill is impaired and could have a significant impact on the security, the performance of the stock market index of the security and the overall economic environment. Unrealized gains and losses on warrants are included in Other (income) expense.our operating results.
Investments in Privately-Held CompaniesSegments
InvestmentsWe operate in privately-held companies consist primarilyone reportable segment, the Broadband segment, which consists of securitiesour subscriber and transmission operating segments. We have combined these operating segments into a single reportable segment under the aggregation criteria of emerging technology companiesSFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.” Operating segments may be aggregated into a single operating segment if the segments have similar economic characteristics, and if the segments are similar in 1) the nature of products and services; 2) the nature of production processes; 3) the type or class of customer for which readily determinable fair values are not available. These investments are carried at costtheir products and are evaluated periodicallyservices; 4) the methods used to determine if declines in fair value are other-than-temporary. This evaluation requires judgmentdistribute their products or provide their services; and is based on several factors including recent private offerings by5) the company, the performancenature of the stock market indexregulatory environment. We believe our subscriber and transmission operating segments meet all of similar publicly traded securitiesthese criteria and that aggregation is consistent with the overall economic environment. Declines in value judged to be other-than-temporary are included in Other (income) expense. Investments in privately-held companiesobjective and basic principles of $7.8 million and $8.6 million were included in Other assets in the Consolidated Statements of Financial Position at April 2, 2004 and June 27, 2003, respectively.SFAS No. 131.
Warranty Costs
We offer warranties of various lengths to our customers depending on the specific product and the terms of the agreements with the customer. Our standard warranties require us to repair or replace defective product returned to us during the warranty period at no cost to the customer. We record an estimate for warranty-related costs based on our actual historical and/or projected failure rates and repair costs at the time of sale. We repair products in our manufacturing facilities and also outsource warranty repairs. Historical and/or projected failure rates and repair costs are reviewed and the estimated warranty liability is adjusted, if required, quarterly. Expenses related to unusual product warranty problems and product defects are recorded in the period the problem is identified. A significant increase in product failure rates, in the costs to repair our products or in the amount of warranty repairs outsourced could have a significant impact on our operating results. For certain purchased products, such as cable modems and hard drives, included in our set-tops, we provide the same warranty coverage to our customers as the supplier of the products provides to us. Failure of the supplier to honor its warranty commitment to us could also have a significant impact on our operating results. The warranty liability was $35.5$41.6 million and $36.0$36.2 million at AprilDecember 31, 2004 and July 2, 2004, and June 27, 2003, respectively.
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Pension Assumptions
The pension benefit liability and the related effects on our operating results are calculated using actuarial models. We use March 31 as a measurement date for all actuarial calculations of asset and liability values and significant actuarial assumptions. Two critical assumptions, discount rate and expected return on assets, are important elements of plan expense and / and/or liability measurement. We evaluatere-evaluate these assumptions annually. Other assumptions involve demographic factors such as retirement, mortality, rate of compensation increase and turnover. These assumptions are also evaluatedre-evaluated annually and are updated to reflect our experience. The discount rate is required to represent the market rate for high-quality fixed income investments. We reduced our discount rate from 7.50 percent at June 28, 2002 to 6.50 percent at June 27, 2003 to reflect market interest conditions. To determine the expected long-term rate of return on pension plan assets, we consider the historical and expected returns on the plan assets, as
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well as the current and expected allocation of the plan assets. We assumed that long-term returns on
At March 31, 2004, we reduced the discount rate used to calculate the pension benefit liability and expense from 6.50 percent to 6.00 to reflect the lower market interest conditions. This change in our pension plan assets would be 8.00 percent in fiscal year 2004 and 10.00 percent in fiscal year 2003. The changes in these assumptions will increaseincreased our pension expense by approximately $1.9$0.3 million in fiscal year 2004.2005 over the preceding year. The expected long-term rate of return on pension assets was 8.00 percent, unchanged from the preceding year.
Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. The actual results could have a significant impact on our operating results.
Goodwill ImpairmentAllowance for Doubtful Accounts
We perform annual goodwill impairment tests to identify potential impairment by comparingManagement judgments and estimates are made in connection with establishing the fair valueallowance for doubtful accounts. Specifically, we analyze the aging of accounts receivable balances, historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in our customer payment terms. Significant changes in customer concentration or payment terms, deterioration of customer credit-worthiness, as in the case of the reporting unit with its net book value, including goodwill. We test for impairment at the component level (subscriber and transmission businesses). Estimatesbankruptcy of fair value are determined using discounted cash flows and market comparisons. We perform internal valuation analyses and consider other market information that is publicly available. These analyses use significant estimates and assumptions, including projected future cash flows (including timing), discount rates reflecting the risk inherentAdelphia, or weakening in future cash flows, determination of appropriate comparables and the determination of whether a premium or discount should be applied to comparables. These estimates and assumptions are reviewed and updated annually based on actual results and future projections. Changes in these estimates and assumptions may result in a determination that goodwill is impaired andeconomic trends could have a significant impact on the collectibility of receivables and our operating results. Generally, we do not require collateral or other security to support accounts receivable.
Non-Current Marketable Securities
Non-current marketable securities consist of investments in common stock, primarily stock of technology companies, and warrants of publicly traded companies and are stated at market value. We have market risks associated with the volatility in the value of our non-current marketable securities. All investments in common stock are classified as “available-for-sale” under the provisions of SFAS No. 115, and thus, changes in the fair value of these securities are not included in our Consolidated Statements of Earnings until realized. Unrealized holding gains and losses are included, net of taxes, in Accumulated other comprehensive income. Realized gains and losses and declines in value judged to be other-than-temporary are included in Other (income) expense. We periodically evaluate the carrying value of our investments in common stock to determine if declines in fair value are other-than-temporary. This evaluation requires judgment and is based on several factors, including the market price of the security generally over the preceding six months, analysts’ reports on the security, the performance of the stock market index of the security and the overall economic environment. Unrealized gains and losses on warrants are included in Other (income) expense.
Investments in Privately-Held Companies
Investments in privately-held companies consist primarily of securities of emerging technology companies for which readily determinable fair values are not available. These investments are carried at cost and are evaluated periodically to determine if declines in fair value are other-than-temporary. This evaluation requires judgment and is based on several factors, including recent private offerings by the company, the performance of the stock market index of similar publicly traded securities and the overall economic environment. Declines in value judged to be other-than-temporary are included in Other (income) expense. Investments in privately-held companies of $5.8 million and $6.5 million were included in Other assets in the Consolidated Statements of Financial Position at December 31, 2004 and July 2, 2004, respectively.
Stock-Based Compensation
We have adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”Compensation,” but elected to continue to account for stock-based compensation using the intrinsic method prescribed in APB Opinion No. 25, “Accounting for Stock Issued to Employees”Employees,” and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our stock at the date of grant over the amount an employee must pay to acquire the stock.
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Pro forma stock-based compensation expense, net of tax, was $29.7$15.5 million and $50.8$20.8 million for the ninesix months ended AprilDecember 31, 2004 and January 2, 2004, and March 28, 2003, respectively. These amounts are significant and fluctuate significantly due to the relatively high and increasing volatility of our stock price. In addition, the amount of stock-compensation expense is impacted by our amortization of the compensation expense over a relatively short vesting period of three years and an increase in the number of options granted as we have shifted more ofgranted. We periodically review all assumptions used in our compensation to options from restricted stock.stock option pricing model.
New Accounting Pronouncements
TheDuring fiscal year 2004, the FASB recently issued FASB Staff Position (FSP)FSP No. 106-1106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,2003.” SFAS No. 132 (revised 2003) “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” Interpretation No. 46 “Consolidation of Variable Interest Entities” and EITF No. 00-21 “Accounting for Revenue Arrangements with Multiple Deliverables” and ratified the consensus reached by the EITF on Issue 03-5, “Applicability of AICPA Statement 97-2, Software Revenue Recognition, to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.”
FSP No. 106-1106-2 provides guidance related to the accounting for and disclosure of, including the deferral of recognition of, a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D provided under the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the ACT).2003. FSP No. 106-1106-2 is effective for interim or annual financial statements of fiscal years endingbeginning after December 7, 2003.June 15, 2004. We are currently evaluating the impact of the ACT and have elected to defer the recognition of the impact of the new Medicare provisions under a provision of FSP No. 106-1. We are unable to predict at this time the impact106-2 until fiscal year 2006. The effect of the ACTsubsidy is to reduce the plan’s accumulated postretirement benefit obligation by approximately $1.1 million and the provisions of FSP No. 106-1 on our results of operations or financial position.net periodic postretirement benefit cost by approximately $0.1 million for fiscal year 2005.
In December 2004, the FASB issued SFAS No. 132123R, “Share-Based Payment,” which requires additional disclosures about assets, obligations, cash flows and net periodic benefitall companies to measure compensation cost of defined benefit plans and other postretirement benefit plans. The provisions of this Statement arefor all share-based payments, including employee stock options, at fair value effective for fiscal years ending after December 15, 2003 andpublic companies for interim periods beginning after December 15, 2003. We adopted the interim period disclosure provisions of SFAS No. 132, which are reflected in Note H, in the third quarter of fiscal year 2004.
Interpretation No. 46 addresses the consolidation by a reporting entity of variable interest entities with certain characteristics. This Interpretation was effective in January 2003 for variable interest entities created after January 31, 2003 and in the first fiscal year or interim periodannual periods beginning after June 15, 2003. The FASB has issued FSPs which have deferred the effective date for applying the provisions of Interpretation2005. Scientific-Atlanta will adopt SFAS No. 46 for interests in certain variable interest entities or potential variable interest entities created before February 1, 2003 until the end of the first interim period ending after March 15, 2004. These FSPs also require certain disclosures about variable interest entities and potential variable interest entities. During the quarter ended April 2, 2004, we completed our evaluation of entities in which we hold equity investments and determined that they were not variable interest entities as defined in Interpretation No. 46.
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EITF No. 00-21 provides guidance on determining units of accounting in a revenue arrangement with multiple deliverables and the allocation of the consideration received from the arrangement. EITF No. 00-21, which was effective for revenue arrangements entered into in the first annual or interim period after June 15, 2003, was adopted123R in the first quarter of fiscal year 2004. The2006 using a modified version of prospective application.
As permitted by SFAS No. 123, we currently account for share-based payments to employees using APB Opinion No. 25’s intrinsic value method and, as such, recognize no compensation cost for employee stock options. Accordingly, the adoption of EITFSFAS No. 00-21 did not123R’s fair value method could have a significant impact on the recognitionour result of revenue or resultoperations. The impact of adoption of SFAS No. 123R cannot be predicted at this time because it will depend on levels of share-based payments granted in the deferralfuture. However, had we adopted SFAS No. 123R in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net income and earnings per share in Note C to our consolidated financial statements. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a significantfinancing cash flow, rather than as an operating cash flow as required under current literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be in the future (because they depend on, among other things, when employees exercise stock options), the amount of revenueoperating cash flows recognized in prior periods for such excess tax deductions were $1.2 million and $1.7 million for the three and six months ended December 31, 2004, respectively, and $0.6 million and $11.1 million for the three and six months ended January 2, 2004, respectively.
The FASB also recently issued FSP No. FAS 109-1, “Application of FASB Statement No. 109, Accounting for Income Taxes, to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004,” and FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (the Act). Under the guidance in FSP No. FAS 109-1, the deduction will be treated as a “special deduction” as described in SFAS No. 109. As such, the special deduction has no effect on deferred tax assets and liabilities existing at the enactment date. Rather, the impact of this deduction will be reported in the first three quartersperiod in which the deduction is claimed on our income tax return. FSP No. FAS 109-2 allows enterprises time beyond the financial reporting period of fiscal year 2004.
In EITF Issuethe enactment of the Act to evaluate the effects of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 03-5, the EITF concluded that, in an arrangement that includes software that is more than incidental109 due to the products or services aslack of clarification of certain provisions within the Act and the timing of the enactment. As such, we are not yet in a whole,position to decide on whether, and to what extent, we might repatriate foreign earnings that have not yet been remitted to the software and software-related elements are includedU.S. Based on our analysis to date, however, it is reasonably possible that we may repatriate some amount ranging from $0 to $60 million, with the respective tax benefit ranging from $0 to $3 million. We expect to be in the scope of SOP 97-2, “Software Revenue Recognition.” EITF Issue No. 03-5, which was adopted in the second quarter of fiscal year 2004, was effective for arrangements entered into in the first annual or interim reporting period after August 13, 2003. The adoption of EITF Issue No. 03-5 did not have a significant impact on the recognition of revenue or result in the deferral of a significant amount of revenue in the second and third quarters of fiscal year 2004.position to finalize our assessment by December 31, 2005.
Off-Balance Sheet Financing Arrangements
In July 1997, we entered into a long-term operating lease arrangement, which provided $36.0 million to finance the construction of the initial phase of our consolidated office site in Gwinnett County, Georgia, which was completed in the third quarter of fiscal year 1999.Lawrenceville, Georgia. The initial occupancy term iswas seven years and expiresexpired in July 2004. Three five-year extensions of the lease term are available to Scientific-Atlanta. Lease payments were equal to the interest on the $36.0 million financed at a fixed rate of 6.51 percent per annum. A final lease payment of $36.0 million is due at the termination of the lease. We can also purchasepurchased the buildings financed withunder this long-term operating lease arrangement at any time for $36.0 million. We are planning to makemillion at the finalexpiration of the lease payment of $36.0 million and purchase the building in July 2004.
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The lease qualifiesqualified as an operating lease under Statement of Financial Accounting StandardsSFAS No. 13, “Accounting for Leases,” as amended. The lessor iswas a non-bank, general-purpose corporation owned by a financial institution that has engaged in many types of transactions with parties other than Scientific-Atlanta and activities other than lease transactions. Scientific-Atlanta hashad no ownership interest in the lessor or the financial institution. We have evaluated the provisions of Interpretation No. 46, “Consolidation of Variable Interest Entities”Entities,” and have concluded that these provisions dodid not apply to this arrangement. Accordingly, the assets, liabilities, results of operations and cash flows of the lessor have not been included in the consolidated financial statements of Scientific-Atlanta.
After the completion of the initial phase of our consolidated office site, all facility expansions were financed with existing cash balances and cash generated from operations.
Scientific-Atlanta has no other off-balance sheet financing arrangements.
* * * * * * * * * * * * * * * * * * * * * * * * * * * *
Any statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations that are not statements about historical facts are forward-looking statements. Such forward-looking statements are based upon current expectations but involve risks and uncertainties. Investors are referred to the Cautionary Statements contained in Exhibit 99.1 to this Form 10-Q for a description of the various risks and uncertainties that could cause Scientific-Atlanta’s actual results and experience to differ materially from the anticipated results or other expectations expressed in Scientific-Atlanta’s forward- lookingforward-looking statements. Such Exhibit 99.1 is hereby incorporated by reference into Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Scientific-Atlanta, the Scientific-Atlanta logo, Explorer and PowerTVExplorer are registered trademarks of Scientific-Atlanta, Inc. Multi-Room and WebSTAR are trademarksis a trademark of Scientific-Atlanta, Inc.
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ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS |
ITEM 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
(Amounts(Amounts in thousands)
We are exposed to market risks from changes in foreign exchange rates and have a process to monitor and manage these risks. Scientific-Atlanta enters into foreign exchange forward contracts to hedge certain forecasted transactions, firm commitments and assets denominated in currencies other than the U.S. dollar. These contracts, which qualify as cash flow or fair value hedges, are designated as hedging instruments at inception, are for periods consistent with the exposure being hedged and generally have maturities of one year or less. Contracts are recorded at fair value. Changes in the fair value of derivatives are recorded in other comprehensive income until the underlying transaction affects earnings.earnings for cash flow hedges and in Other (income) expense for fair value hedges.
The effectiveness of the hedge is based on a high correlation between the changes in its value and the value of the underlying hedged item. Any ineffectiveness is recorded through earnings.
In the fourth quarter of fiscal year 2002, ish GmbH & Co. KG (ish), a customer in Germany, suspended or canceled a number of orders issued to the Cable upgrade Consortium, of which we were a member and through which we furnished our products and services. A significant portion of these orders was denominated in Euros, and we had forward contracts to sell approximately 33,220 Euros at June 28, 2002, which were designated as cash flow hedges. During fiscal year 2003, we reached a settlement with ish. As a result of the settlement, we no longer needed the forward contracts. We settled the portion of these contracts related to ish and recorded charges of $3,106 for ineffectiveness in Other (income) expense in the first nine months of fiscal year 2003.
Our foreign exchange forward contracts do not significantly subject our results of operations to risk due to exchange rate fluctuations because gains and losses on these contracts generally offset losses and gains on the exposure being hedged.
Firmly committed purchase exposure and related hedgingHedging instruments, which were designated as cash flow or fair value hedges, at April 2,December 31, 2004 were as follows:
Canadian Dollars | British Sterling | Euros | ||||||
Firmly committed purchase (sale) contracts | 12,488 | (1,098 | ) | (230 | ) | |||
Notional amount of forward contracts | 12,200 | (1,100 | ) | (210 | ) | |||
Average contract amount (Foreign currency/United States dollar) | 1.33 | 0.68 | 0.80 |
Euros | Canadian Dollars | UK Pounds | ||||||
Notional amount of forward buy (sales) contracts | (4,921 | ) | 7,250 | (7,859 | ) | |||
Average contract amount (Foreign currency/United States dollar) | 0.78 | 1.30 | 0.51 |
At April 2,December 31, 2004, we had unrealized lossesgains of $48,$23, net of tax benefits of $29,$13, related to the Canadian dollar foreign exchange forward contracts,cash flow hedges, which were included in accumulatedAccumulated other comprehensive income. Scientific-Atlanta has no foreign exchange derivative exposure beyond the second quarter of fiscal year 2006.
Unrealized gains and losses on the British sterling and Euro foreign exchange forward contracts which have not been designatedare accounted for as fair value hedges under the provisions of SFAS No. 133, are recognized in Other (income) expense. During the ninesix months ended AprilDecember 31, 2004 and January 2, 2004, and March 27, 2003, we recorded losses of $667 and gains of $110 and losses of $172,$423, respectively, related to these contracts. These contracts hedgehedged our exposure on sterling-basedEuro- and Euro-basedSterling-based receivables.
Scientific-Atlanta has no derivative exposure beyond the third quarter of fiscal year 2005.
We have market risks associated with the volatility in the value of our non-current marketable securities, which consist of investments in common stock, primarily technology companies, and warrants of publicly traded companies and are stated at market value. Non-current marketable securities are included in Other assets in the Consolidated Statements of Financial Position. All investments in common stock are classified as “available for sale”“available-for-sale” under the provisions of SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and thus, changes in the fair value of these securities are not included in our Consolidated Statements of Earnings until realized. Unrealized holding gains and losses are included, net of taxes, in accumulatedAccumulated other comprehensive income. We hadrecorded after-tax, unrealized holding gains of $1,028, net$459 in the first six months of taxfiscal year 2004. No such gains or losses were recorded in the first six months of $630, at April 2, 2004.fiscal year 2005. Realized gains and losses and declines in value judged to be other-than-temporary are included in Other (income) expense. We recorded realized gains of $4,496$2,444 on the sale of non-current marketable securities in the first ninesix months of fiscal year 2004. No such gains or losses were recorded in the first ninesix months of fiscal year 2003.2005. We recorded no losses of $6,875 in the first ninesix months of fiscal year 20032005 or 2004 from the other-than-temporary decline in the market value of marketable securities. No such losses were recorded in the first nine months of fiscal year 2004.
Scientific-Atlanta holds warrants to purchase common stock that are recorded at fair value. The warrants, which are included in Non-current marketable securitiesOther assets in the Consolidated Statements of Financial Position, were valued using the Black-Scholes pricing model. Fluctuations in the volatility of the market price of the common stock for which we hold a warrant, risk-free rate of return and expiration date of the warrant impact the valuation. During the first ninesix months of fiscal yearyears 2005 and 2004, we recorded unrealized gains of $12 and unrealized losses of $236$35, respectively, related to the declinechanges in the fair value of warrants in Other (income) expense. During the first nine months of fiscal year 2003, we recorded unrealized losses of $748 related to the decline in the fair value of the warrants and a realized gain of $2,491 from the settlement of a collar and related warrant in Other (income) expense.
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We also have market risks associated with the volatility of our investments in privately-held companies, which consist primarily of securities of emerging technology companies. These investments are carried at cost and are evaluated periodically to determine if declines in fair value are other-than-temporary. Declines in value judged to be other-than-temporary are included in Other (income) expense. We recorded losses of $1,831$692 and $10,996$1,831 in the first ninesix months of fiscal yearsyear 2005 and 2004, and 2003, respectively, from other-than-temporary declines in the fair value of our investments in privately-held companies. We also recorded gains of $6,860 in Other (income) expense from the sale of certain investmentsInvestments in privately-held companies during the nine months ended April 2, 2004. No such gains or lossesof $5,772 and $6,464 were recordedincluded in Other assets in the nine months ended March 27, 2003.Consolidated Statements of Financial Position at December 31, 2004 and July 2, 2004, respectively.
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ITEM 4. | CONTROLS AND PROCEDURES |
ITEM 4.CONTROLS AND PROCEDURES
We have carried out an evaluation, under the supervision(a) Disclosure Controls and Procedures. Scientific-Atlanta’s management, with the participation of our management, including our Chairman of the Board, President andits Chief Executive Officer James F. McDonald, and our Senior Vice President, Chief Financial Officer, and Treasurer, Julian W. Eidson, ofhas evaluated the effectiveness of the design and operation of Scientific-Atlanta’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) ofunder the Securities Exchange Act of 1934, as amended)amended (Exchange Act), as of the end of the fiscal quarterperiod covered by this report. Based on such evaluation, Scientific-Atlanta’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Scientific-Atlanta’sthe Company’s disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by Scientific-Atlanta in the reports that it files or submits under the Exchange Act.
(b) Internal Control Over Financial Reporting. There have not been any changes in Scientific-Atlanta’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) ofunder the Exchange Act) that occurred during the thirdsecond quarter of fiscal year 20042005 that hashave materially affected, or isare reasonably likely to materially affect, Scientific-Atlanta’s internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. | Legal Proceedings. |
Item 1. Legal Proceedings.Adelphia and Charter Matters
As previously disclosed, Adelphia Communications Corporation (Adelphia) is one of Scientific-Atlanta’s customers. Adelphia and several members of its former management are the subjects of civil and/or criminal charges brought by the SEC and the Justice Department; two of whom were found guilty of criminal charges. One aspect of the charges concerns Adelphia’s marketing support agreement with Scientific-Atlanta in 2000 and 2001, as well as Adelphia’s marketing support agreement with another vendor, and the manner in which Adelphia accounted for such arrangements.
The SEC and Justice Department have also brought charges against former officers of Charter Communications, another of Scientific-Atlanta’s customers. One aspect of those charges concerns an advertising agreement between Scientific-Atlanta and Charter in 2000, as well as Charter’s advertising agreement with another vendor, and the manner in which Charter accounted for such arrangements. Four former Charter officers pled guilty to certain charges; one of whom has pled guilty to charges related to the advertising agreement.
The SEC and the Justice Department have subpoenaed records of Scientific-Atlanta and have interviewed Scientific-Atlanta personnel with respect to the Adelphia and Charter agreements. Scientific-Atlanta has received notice from the SEC and the Justice Department that they are examining the conduct of Scientific-Atlanta and certain of its officers and employees with respect to these agreements. Scientific-Atlanta is cooperating and providing information in connection with these investigations. There can be no assurance as to the outcome of these investigations or the effects of any allegations against Scientific-Atlanta. In addition, any settlements and legal expenses may adversely affect our results of operations.
Gemstar-Related Legal Proceedings
As previously reporteddisclosed, we are involved in our Form 10-K for fiscal year 2003 and our Form 10-Q for first quarter of fiscal year 2004, we have filed several lawsuits, as plaintiff againstincluding multi-district patent and antitrust proceedings, Scientific-Atlanta patents proceedings, and International Trade Commission and related proceedings, with Gemstar-TV Guide International, Inc. and affiliated and/or related companies. Gemstar-TV Guide International, Inc. and/or its affiliated entities are referred to hereafter as “Gemstar.”
InRegardless of merit, these Gemstar legal proceedings are time-consuming and result in costly litigation, and there can be no assurance that we will prevail in these legal proceedings given the Multi-District Proceedings, which we filedcomplex technical issues and inherent uncertainties in December 1998 alleging that Gemstar has violated federal antitrust laws and has misused certain patents and seeking damages and an injunction, the U.S. District Court in Atlanta issued an order on March 26, 2004 granting our motion for summary judgment of non-infringement of Gemstar’s U.S. Patent No. 5,915,068 as to our Explorer and 8600X product lines. The court then issued an order on March 30, 2004 granting our motion for summary judgment of non-infringement of Gemstar’s U.S. Patent No. 4,908,713 as to the 8600X product line. Gemstar previously stipulated that the Explorer product line does not infringe the ‘713 patent. In March 2004, in connection with the antitrust action, the court also granted Gemstar’s motions for partial summary judgment in connection with two of our antitrust claims.
In connection with the Scientific-Atlanta Patents Proceedings, which we filed in April 1999 alleging that Gemstar and StarSight infringe certain of our patents and seeking damages and injunctive relief, the U.S. District Court in Atlanta issued in April 2004 an order adopting in its entirety the September 23, 2003 Report and Recommendation construing the claims of the Scientific-Atlanta patents-in-suit against Gemstar.
In connection with the Personalized Media Communications Proceeding (PMC), which was filed by PMC in the United States District Court for the Northern District of Georgia in March 2002 alleging patent infringement and seeking an injunction and unspecified monetary damages, the U.S. District Court in Atlanta held a Markman Hearing in February 2004 to construe the claims of the seven PMC patents at issue in the case.
Class Action-Related Legal Proceedings
As previously reported in our Form 10-K for fiscal year 2003 and our Form 10-Q for second quarter of fiscal year 2004, Paul Thompson, a shareholder, filed a putative shareholder’s derivative action purportedly on behalf of Scientific-Atlanta in the Superior Court of Gwinnett County, Georgia, against certain directors and officers of Scientific-Atlanta in April 2002, which was not served on us or the other defendants. The complaint was dismissed in June 2003, then re-filed in November 2003, and subsequently served on Scientific-Atlanta. This action is based upon substantially the same facts alleged in the securities class action litigation filed in July 2001 alleging violations of the federal securities laws by us and certain of our officers. This plaintiff shareholder is seeking to recover damages in an unspecified amount. Scientific-Atlanta filed a motion to dismiss on March 18, 2004.
Adelphia Matters
As previously reported in the Form 10-Q forlitigation. During the second quarter of fiscal year 2004, we2005, Scientific-Atlanta engaged in substantive discussions with Gemstar regarding a possible settlement and cross-licensing agreement. No agreement has been reached at this time. If circumstances were addedto change during the third quarter of fiscal year 2005, Scientific-Atlanta may include, as a co-defendantresult of any settlement, an additional expense or charge in January 2004 in a previously-filed purported securities action in the United States District Courtits results of operations for the Southern Districtthird quarter of New York (MDL No. 03-MD-1529 (LMM)). The suit is an individual action brought by W.R. Huff Asset Management Co., LLC, reportedly on behalffiscal year 2005. At this time, we cannot assess the probability of a settlement and there can be no assurance as an investment advisor and attorney-in-fact for certain unnamed purchasers of debt securities issued by Adelphia Communications Corporation and Arahova Communications Inc. The complaint alleges that certain of Adelphia’s underwriters, banks, auditors, law firms, and vendors are liable to plaintiff for various alleged securities laws violations by Adelphia and certain of Adelphia’s former management. It alleges that certain commercial transactions between Adelphia and Scientific-Atlanta relating to Adelphia’s purchase of digital set-top boxes and a marketing support arrangement and the related accounting treatment by Adelphia resulted in violations of the anti-fraud provisions of the federal securities laws with respect to the purchasersoutcome of Adelphia’s securities in whose interest the plaintiff purports to act. The complaint does not allege any impropriety as to our financial statements or statements made to our investors. The plaintiff is seeking to recover damages from us in an unspecified amount. In the Huff suit, Scientific-Atlanta filed a motion to dismiss on March 8, 2004.these settlement negotiations.
We were also added as a co-defendant in December 2003 in another previously-filed purported securities action in the United States District Court for the Southern District of New York (MDL No. 03-MD-1529 (LMM)). This suit is an individual action brought by Joseph and Evelyn Stocke who allege that they are purchasers of the common stock of Adelphia Communications Corporation. This complaint is based on the same commercial transactions between Adelphia and Scientific-
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Atlanta that are at issue in the Huff action described in the second quarter fiscal year 2004 Form 10-Q and similarly names as defendants certain of Adelphia’s former officers and directors, underwriters, banks, auditors, and vendors. Plaintiffs have asserted a claim against Scientific-Atlanta for “aiding and abetting” the common law fraud of Adelphia and its former management. The complaint does not allege any impropriety as to our financial statements or statements made to our investors. The plaintiffs are seeking to recover damages from us in an unspecified amount. Scientific-Atlanta filed a motion to dismiss on April 12, 2004. Scientific-Atlanta intends to vigorously defend the claim.
Item 2. Changes in Securities and Use of Proceeds.
Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. |
During the first ninethree months of fiscal yearended December 31, 2004, nothe following purchases of our common stock were made by or on behalf of Scientific-Atlanta.
Period | (a) Total Number of Shares Purchased | (b) Average Price Paid per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | (d) Maximum Number of Shares that can be Purchased Under the Plans or Programs | |||||
October 2, 2004 - October 29, 2004 | 797,900 | $ | 27.20 | 797,900 | 8,643,400 | ||||
October 30, 2004 - November 26, 2004 | 1,038,700 | $ | 27.92 | 1,038,700 | 7,604,700 | ||||
November 27, 2004 - December 31, 2004 | 0 | N/A | 0 | 7,604,700 |
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In February 2003, we announced a program to buy back up to 10,000,000 shares of our common stock. Purchases of our common stock during the second quarter of fiscal year 2005 were made under this plan. As of April 2,December 31, 2004, there were 9,441,0007,604,700 shares available that may yet be purchased under the February 2003 stock repurchase plan. This plan has no termination date and we may make additional purchases under this plan. We have no other programs to purchase our common stock.
Item 4. | Submission of Matters to a Vote of Security Holders |
Item 6. Exhibits and Reports on Form 8-K.
The following information is furnished with respect to matters submitted to a vote of security holders through the solicitation of proxies:
(a) | The matters described below were submitted to a vote of security holders at the Annual Meeting of Shareholders held on November 3, 2004. |
(b) | Election of directors: |
Votes for | Withhold Authority | |||
James I. Cash, Jr. | 131,829,742 | 2,970,902 | ||
James F. McDonald | 131,196,858 | 3,603,786 | ||
Terence F. McGuirk | 132,203,399 | 2,597,245 |
Marion H. Antonini, David W. Dorman, William E. Kassling, Mylle H. Mangum, David J. McLaughlin, James V. Napier and Sam Nunn continue as directors.
(c) | Ratification of the selection by the Audit Committee of Ernst & Young LLP as the Company’s independent registered public accounting firm for the fiscal year ending July 1, 2005: |
For | Against | Abstain | ||
132,566,289 | 1,484,478 | 749,877 |
Item 6. | Exhibits. |
Exhibit No. | Description | |
31.1 | Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. | |
31.2 | Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act. | |
32.1 | Certifications of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act. | |
32.2 | Certifications of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act. | |
99.1 | Cautionary Statements |
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SIGNATURES
Pursuant to the requirements of 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.
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SCIENTIFIC-ATLANTA, INC. (Registrant) | ||||||||
Date: February 4, 2005 | By: | /s/ Julian W. Eidson | ||||||
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Julian W. Eidson Senior Vice President, Chief Financial Officer and Treasurer | ||||||||
(Principal Financial Officer and duly | ||||||||
authorized signatory of the Registrant) |
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