UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2004September 30, 2005

OR

For the transition period from            to            

Commission file number 1-5517

SCIENTIFIC-ATLANTA, INC.

(Exact name of Registrant as specified in its charter)

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.

Yes  x    No  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yesþ    No¨    No  x

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act).

Yesþx    No¨

As of January 28,September 30, 2005, Scientific-Atlanta, Inc. had outstanding 152,061,822153,561,509 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)

SEE ACCOMPANYING NOTES

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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(IN THOUSANDS, EXCEPT SHARE DATA)

(UNAUDITED)

SEE ACCOMPANYING NOTES

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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

SEE ACCOMPANYING NOTES

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SCIENTIFIC ATLANTA,SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(IN THOUSANDS)

(UNAUDITED)

⁽¹⁾Assumed weighted-average of 30 and 35 percent tax rate in fiscal years 2006 and 2005, respectively.

SEE ACCOMPANYING NOTES

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NOTES:

(Amounts in thousands, except share and per share data)

During the third quarter of fiscal year 2004,2005, we identified certain cash equivalentsbegan classifying all auction rate securities and short-term investments which were misclassified.variable rate demand obligations as Short-term investments. We have reclassified $12,904$103,540 and $27,514$157,076 from Cash and cash equivalents to Short-term investments at JanuaryOctober 1, 2004 and July 2, 2004, respectively, related to these securities and June 27, 2003, respectively.obligations. The Consolidated StatementsStatement of Cash Flows for the sixthree months ended January 2,October 1, 2004 has been restatedreclassified to reflect these adjustments.

Scientific-Atlanta’s fiscal year ends on the Friday closest to June 30 of each year. Fiscal year 2005, which ends on July 1, 2005, will include fifty-two weeks. The second quarter ofDuring fiscal year 2005, we also identified certain purchases and 2004 each included thirteen weeks. The sixproceeds from the sale of investments in cash equivalents which had been improperly classified as purchases and proceeds from the sale of short-term investments in the Consolidated Statement of Cash Flows for the three months ended December 31, 2004 included twenty-six weeks whileOctober 1, 2004. Accordingly, we reduced purchases by $304,786 and proceeds from the sixsale of short-term investments by $251,250 in the Consolidated Statement of Cash Flows for the three months ended January 2,October 1, 2004 included twenty-seven weeks.for the reclassifications discussed above. The reclassification of certain purchases and proceeds from the sale of investments in cash equivalents had no impact on net cash used in investing activities in the three months ended October 1, 2004.

Basic and diluted earnings per share are computed as follows:

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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:

As previously discussed in our Form 10-K for fiscal year 2005, pro forma compensation expense for fiscal year 2005 was adjusted from previously reported amounts to correct for an error in the attribution of compensation expense in the period. The adjustment resulted in an increase in basic and diluted pro forma earnings per share of $0.01 for the three months ended October 1, 2004.

We have historically recognized pro forma stock compensation expense over the explicit vesting period even though there were provisions for acceleration or continued vesting upon retirement under our stock option plans. Under the guidance of SFAS No. 123R, which we adopted in the first quarter of fiscal year 2006, we will recognize stock compensation expense over the period through the date that the employee first becomes eligible to retire and is no longer required to perform service to vest in the award for grants made after the adoption of SFAS No. 123R. After the adoption of SFAS No. 123R, we will continue to recognize stock compensation costs over the explicit vesting period for awards granted prior to the adoption of SFAS No. 123R.

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Pro forma stock compensation expense and related earnings per share, if we had recognized compensation expense over the period through the date that the employee had first become eligible to retire, would be as follows:

The following table shows a comparison of selected line items of the accompanying financial statements for the quarter ended September 30, 2005 as reported with the effect of adopting SFAS No. 123R on July 2, 2005 and on a pro forma basis if the company had continued to account for stock option compensation as previously required by SFAS No. 123 and APB Opinion No. 25:

SFAS No. 123R requires that the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash flow, rather than as an operating cash flow as required under prior guidance. Excess tax benefits of $1,653 were included in cash provided by financing activities for the quarter ended September 30, 2005.

Our 2003 Long-Term Incentive Plan (LTIP Plan), which is shareholder-approved, permits the grant of stock options to employees that are time-based and performance-based for up to 8,000,000 shares of common stock. The Non-Employee Directors Stock Option Plan, which is also shareholder approved, permits the grant of stock options that are time-based to non-employee members of our Board of Directors for up to 1,800,000 shares. Upon option exercise, we generally issue shares from treasury shares.

Time-based Options

Option awards are granted with an exercise price equal to the market price of our stock at the date of grant; those option awards generally vest on a graded schedule over 4 years and have 10-year contractual terms. Employees and directors who are eligible to retire, as defined by the plans, and who do retire, continue to vest in their unvested options after retirement under the terms of the plans. In the event of a change of control of Scientific-Atlanta, all options held on the date of the change of control will become immediately exercisable in full, irrespective of the amount of time that has elapsed from the date of the grant. Dividends are not paid on unexercised options.

The fair value of each option grantaward is estimated on the date of grant using the Black-Scholes option pricing model which resultedthat uses the weighted-average assumptions noted in a weighted averagethe following table. Expected volatilities are based on the historical volatility of our stock. We believe that historical volatility is the best indicator of future volatility. We also use historical data to estimate the term options are expected to be outstanding and forfeitures of options granted. Separate groups of

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employees that have similar historical exercise behavior are considered separately for valuation purposes. The risk-free rate for periods within the expected life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair value of $14.21 and $19.09 per option grants with graded vesting is estimated separately for each vesting date. Compensation cost related to these grants inis amortized on a straight-line basis over the second quartervesting period of fiscal yearsthe option from the grant date to the final vesting date using the average fair value.

A summary of activity for time-based options as of September 30, 2005, and changes during the quarter then ended is as follows:

The weighted-average grant-date fair value of options granted during the fiscal quarters ended September 30, 2005 and October 1, 2004 respectively,was $18.16 and $15.28 and $19.84 per option for grants in the six months ended December 31 and January 2, 2004,$16.98, respectively. The following weighted-average assumptions were used intotal intrinsic value of options exercised during the pricing model for grants in the threequarters ended September 30, 2005 and six months ended December 31,October 1, 2004 was $11,416 and January 2, 2004:$1,099, respectively.

Time-based options outstanding at September 30, 2005 include options granted in prior years under the LTIP Plan and other stock option plans whose terms and fair value assumptions are similar to those described above.

We periodically compare our assumptions used in the pricing model forAs of September 30, 2005, there was $60,069 of total unrecognized compensation cost related to nonvested time-based stock options. This cost is expected to be recognized over a weighted-average period of 1.4 years.

Performance-based Options

Performance-based stock option grants with historical trends. Duringare made to selected executives and other key employees. Vesting of performance-based options granted in the secondfirst quarter of fiscal year 2005, we determined that2006 is contingent upon achieving compound annual percentage growth in net revenues. Stock options are granted at the expected termmarket price of our stock option grants was 4.7at the date of grant; contingently vest over a period of 3 to 10 years, rather than 5.0 yearsdepending on the achievement of the performance goal; and we have adjusted our assumptions accordingly.contractual lives of 10 years. In the event of a change of control of Scientific-Atlanta, all options held on the date of the change of control will become immediately exercisable in full, irrespective of the achievement of the performance goal. Dividends are not paid on unexercised options.

7The fair value of each performance-based option grant was estimated on the date of grant using the same option valuation model used for time-based options described above and assumes that performance goals will be achieved. If such goals are not met within 10 years from the date of grant, no compensation cost will be recognized; any recognized compensation cost will be reversed; and the options will be forfeited. The inputs for expected volatility, expected dividends, and risk-free rate used in estimating those options’ fair value are shown in the table below. No such options were granted during the three months ended October 1, 2004.

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A summary of the activity for performance-based options as of September 30, 2005 and changes during the quarter then ended is as follows:

The weighted-average grant-date fair value of options granted during the quarter ended September 30, 2005 was $21.68. We expect these options will fully vest. We expense the related compensation cost on a straight-line basis from the date of grant through the expected date of achievement of the performance target. No options were granted during the quarter ended October 1, 2004. There were no options exercised during the quarters ended September 30, 2005 and October 1, 2004. As of September 30, 2005, there was $17,783 of total unrecognized compensation cost related to performance-based options. This cost is expected to be recognized over a weighted-average period of 1.5 years.

Performance-based options outstanding at September 30, 2005 include options granted in prior years under another shareholder-approved equity incentive plan whose terms and fair value assumptions are similar to those described above. However, options granted under this plan fully vest six years from the date of grant regardless of whether the performance target is achieved. Accordingly, compensation expense for these grants will be recorded regardless of whether the performance target is achieved, provided the requisite service is provided by the employee. We record compensation expense for these grants using the greater of straight-line amortization over six years or the estimated date of achievement of the performance target.

Cash received from option exercises for the quarters ended September 30, 2005 and October 1, 2004, was $12,982 and $1,569, respectively. The actual tax benefit realized for the tax deductions from option exercises totaled $4,171 and $429 for the quarters ended September 30, 2005 and October 1, 2004, respectively.

Other income10 of $2,208 for the three months ended January 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, Inc. (ViaSat), of which $2,853 had been previously reserved for.36

In addition to the gain from the sale of shares of Kabelnetz and the loss from the settlement of purchase price adjustments with ViaSat described above, other income of $1,307 for the six months ended January 2, 2004 included a gain of $1,907 from the sale of a 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.

During the first quarter of fiscal year 2005,2006, we made a contribution of $3,594$5,701 to the defined benefit pension plan. We believe no additional contributions will be made to the defined benefit pension plan in fiscal year 2005.2006.

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We also have unfunded defined benefit retirement plans for certain key officers and non-employee directors. Pension expense for these plans consists of the following:

In addition to providing pension benefits, we have contributory plans that provide certain health care and life insurance benefits to retired employees. The components of postretirement benefit expense consist of the following:

During the six months ended December 31, 2004, severance costs of $23 were paid under the restructuring plan.

The following reconciles the beginning restructuring liability at July 2, 2004, which consisted of an accrual for contractual obligations under a canceled lease, to the restructuring liability at December 31, 2004:

Since the initiation of these restructurings, we have incurred expenses of $5,898 from the write-off of fixed assets, $6,519 from contractual obligations under canceled leases, $27,517 from severance and $6,989 from other miscellaneous costs.

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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 December 31, 2004September 30, 2005 consisted of $15,562$14,298 in Accrued liabilities and $26,004$27,403 in Other liabilities in the Consolidated Statements of Financial Position.

The following reconciles the beginning warranty liability at July 2, 20041, 2005 to the warranty liability at December 31, 2004:September 30, 2005:

Other adjustments include changes in failure rates and costs to repair and adjustments for products whose warranty has expired.

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.

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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 monthsquarter of fiscal year 2005.2006.

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Adelphia Communications Corporation (Adelphia), a 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, 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, weWe have entered into a tolling agreement for any potential claims by the Adelphia estate where the statute of limitation has not yet run.

During fiscal year 2002, we wrote off accounts receivable of $89,652 from Adelphia resulting from its filing for bankruptcy in fiscal year 2002. We are unable to predict the portion, if any, of this amount we might recover.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment,” which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value effective for public companies for interim or annual periods beginning after June 15, 2005. Scientific-Atlanta will adoptadopted SFAS No. 123R in the first quarter of fiscal year 2006, 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 SFAS No. 123R’s fair value method could have a significant impact on our result of operations. 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 future. 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 sharediscussed further in Note C to our consolidated financial statements.C. SFAS No. 123R also requires the benefits of tax deductions in excess of recognized compensation cost to be reported as a financing cash flow, rather than as an operating cash flow as required under current literature.prior guidance. This requirement will reducereduced net operating cash flows and increaseincreased net financing cash flows in periods after adoption. While we cannot estimate what those amounts will be inbeginning with the future (because they depend on, among other things, when employees exercise stock options),quarter ended September 30, 2005 in the amount of operating 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.$1,653.

The FASB also recently issued FSPFASB Staff Position (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 (the Act),” 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 period 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 the 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. 109 due to the lack of clarification of certain provisions within the Act and the timing of the enactment. 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 $60,000,$77,000, with the respective tax benefitcost ranging from $0 to $3,000.$500. We expect to be in a position to finalize our assessment by DecemberMarch 31, 2005.2006.

11In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections,” which requires retrospective application to prior periods’ financial statements of changes in accounting principle. This Statement also requires that a change in depreciation or amortization method for long-lived, non-financial assets be accounted for as a change in accounting estimate effected by a change in accounting principle. In addition, this Statement requires that any error, other than an immaterial error, in the financial statements of a prior period be reported as a prior period

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adjustment by restating the prior period financial statements. SFAS No. 154 will be effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. At this time, we cannot determine if the adoption of this Statement will have a material impact on future results of operations.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Sales for the three months ended December 31, 2004September 30, 2005 were $441.7$490.0 million, an increase of 68 percent over the comparable period of the prior year. The year-over-year increase was driven by higher sales volume of Explorer^®Explorer® digital set-tops including certain models which provide digital video recording and / or high-definition functionality.WebSTAR™ cable modems. Sales of transmission products also increased 8 percent. Gross marginsmargin of 37.137.5 percent were 0.7was 0.9 percentage points lowerhigher than the prior year. Operating expenses increased $1.2$15.1 million due primarily to the expensing of compensation related to stock options and incremental hiring of engineers related to new set-top designs. The increase in research and development expense was offset in part by lower restructuring costs in the second quarter of fiscal year 2005 as compared to the prior year. Net earnings for the three months ended December 31, 2004September 30, 2005 of $58.7$60.7 million were $7.6$4.9 million higher than the prior year driven primarily by the higher sales volume, improved gross margin and lower effective tax ratehigher interest income in the secondfirst quarter of fiscal year 20052006 as compared to the prior year.

During These increases were partially offset by 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 wererecording of compensation expense related to change during the third quarter of fiscal year 2005, we may include, as a 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 outcome of these settlement agreements.stock options.

FINANCIAL CONDITION AND LIQUIDITY

Scientific-Atlanta had stockholders’ equity of $1.9$2.1 billion and cash on hand was $339.6and cash equivalents were $496.7 million at December 31, 2004.September 30, 2005. We also had $1.1 billion of short-term investments at September 30, 2005. Cash provided by operating activities for the six monthsquarter ended December 31, 2004September 30, 2005 of $130.1$27.5 million included net earnings of $114.6$60.7 million and depreciation and amortizationan increase of $40.4 million. During the six months ended December 31, 2004, we received $22.7$16.1 million ofin income tax refunds and related interest from a federal income tax settlement for certain fiscal years prior to 2003.taxes payable. These receipts were offset by increases in accounts receivable and inventory of $9.2$30.5 million and $14.8 million, respectively, and a reduction in accrued liabilities of $18.8$19.5 million. The increase in accounts receivable relates primarily to the timing of payments from customersshipments and acceptance of product in the first six monthsquarter of fiscal year 20052006 as compared to July 2, 2004.the preceding quarter. The increase in inventory relates to the production of products for new markets and a shift in product mix due to the variety of models and additional features on these models we are currently offering. Accrued expenses decreased primarily due to the payment of fiscal year 20042005 incentives on performance-based plans.

During the six monthsquarter ended December 31, 2004,September 30, 2005, we increased our short-term investments by $120.6$6.1 million and acquired property, plant and equipment for $58.1 million, including$9.6 million. In addition, we acquired the outstanding interest in the Scientific-Atlanta Shanghai Limited joint venture from the other shareholders for a cash payment of $36.0 million for the purchase of buildings we had previously leased at our office site in Lawrenceville, Georgia. We also purchased 1,836,600 shares of our common stock 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.$4.3 million.

The current ratio of Scientific-Atlanta was 6.7:6.0:1 at December 31, 2004,September 30, 2005, up from 5.6:5.4:1 at July 2, 2004.1, 2005. At December 31, 2004,September 30, 2005, we had debt of $9.2$7.2 million, primarily mortgages on facilities we assumed in connection with the acquisition of BarcoNet NV during fiscal year 2002. We believe that funds generated from operations, existing cash balances and our available senior credit facility will be sufficient to support operations.

RESULTS OF OPERATIONS

Sales for the quarter ended December 31, 2004September 30, 2005 were $441.7$490.0 million, up 6$37.4 million or 8 percent or $25.1 million over the prior year. International sales for the secondfirst quarter of fiscal year 20052006 were $116.1$134.5 million, up 2737 percent over the prior year. Year-over-year international sales were upincreased in all regions except the Asia / Pacific region.

Sales of subscriber products for the quarter ended December 31, 2004, increased 118 percent from the priorlast year’s secondfirst quarter to $327.6$360.8 million. InThe year-over-year increase was due to an increase in the secondnumber of digital set-tops sold to 1.1 million units, up from 1.0 million digital set-tops shipped during the first quarter of fiscal year 2005, we sold 911last year. In addition, an increase in the mix of higher-end digital set-top products and an increase in sales of WebSTAR cable modems to 957 thousand units contributed to the growth in sales. The impact related to the increase in volumes was partially offset by lower selling prices for all of our set-top and cable modem products. Of the 1.1 million Explorer digital set-tops as compared to 958 thousand in the prior year. During the second quarter of fiscal year 2005, we also sold 460 thousand WebSTAR^™ cable modems, up from 226 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.

During the quarter ended December 31, 2004, we sold 449465 thousand units were set-tops with digital video recording capability (DVRs), including 256244 thousand units of our standard-definition model and 193221 thousand units of our high-definition DVR model. We also sold 111141 thousand high-definition set-tops without DVR capability. Together with the high-definition DVRs

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mentioned previously, we sold 304362 thousand high-definition set-tops in the quarter, an increase of more than 20050 percent compared tofrom the same241 thousand units shipped during the first quarter of last year.

Sales for the six months ended December 31, 2004of transmission products were $894.3 million, up 10 percent from $812.2$129.4 million in the first six monthsquarter of the prior year. Sales of subscriber products were $660.7 million,fiscal year 2006, an increase of 16 percent from the prior year. We sold approximately 1.9 million digital set-tops during the six months ended December 31, 2004, which was relatively flat compared to the first six months of the prior fiscal year. Of the approximately 1.9 million digital set-tops sold, more than 845 thousand of the digital set-tops included digital video recording capability. This is an increase from approximately 438 thousand shipped during the six months of last year. Sales of transmission products were $233.7 million, a decline of 38 percent compared to the first six monthsprior year. During the quarter we recognized $19.2 million of last year. International sales forrelated to SBC Communications Inc.’s acceptance of the first six months of fiscal year 2005 totaled $214.2 million, up 24 percent comparedSuper Hub Office, Video Hub Office, and Video Operations Center related to the first six months last year. The increase from the prior year was due primarily to an increase in shipments to customers in all regions except the Asia / Pacific region.their Project Lightspeed initiative.

Gross margin in the secondfirst quarter of fiscal year 2005 was 37.137.5 percent of sales, a declinean increase of 0.70.9 percentage points from last year. The major sources of the secondimprovement in gross margin included year-to-year product cost improvements related to cost reductions through product design, procurement, and improvements in manufacturing efficiencies. In addition, benefits related to an 8 percent increase in sales compared to the first quarter of last year. Lower selling prices inyear, also contributed to the quarter ended December 31, 2004 as compared to last yeargross margin improvement. These favorable

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items were partially offset by material and conversion cost reductions. The combinedthe impact of the decline in the average selling price of our digital set-tops increasedof approximately 13 percent in the secondfirst quarter of fiscal year 20052006 as compared to the secondfirst 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 second 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.fiscal year 2005. Although the price of individual models of digital set-tops may decline in the 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 manufacturing.

Gross margins were 36.8 percent of sales for the six months of fiscal year 2005, 0.7 percentage points lower than the prior year. The decline from last year was related primarily to lower selling prices of digital set-tops across most set-top models in addition to the negative impact of shipping a greater number of Explorer 8000 digital set-tops that currently have a lower gross margin than the company average. Lower material and conversion costs coupled with the leverage of a 10 percent increase in sales compared to the first 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 relative to the first six months of last year.

Research and development expenses for the three and six monthsquarter ended December 31, 2004September 30, 2005 were $37.9$44.3 million, and $76.2up $5.9 million respectively, up approximately six percent over the comparable periodsprior year. The primary drivers of the year-to-year increase were the incremental hiring related to new set-top and advanced encoder designs and the expensing of $1.8 million of compensation related to stock options.

Sales and administrative expenses of $57.1 million in the quarter ended September 30, 2005 increased $8.3 million over the prior year. The primary driver of the year-to-year increasesyear-over-year increase was incremental hiringthe expensing of $6.5 million of compensation related to new set-top 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.stock options.

Sales and administrative expensesRestructuring charges of $47.9$0.9 million, and $96.7 million in the three and six months ended December 31, 2004, respectively, were flat comparedprimarily for severance, relates 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, primarilyfacilities in sales and other functions within the transmission sector, and reduced our workforce by an additional 30 positions in the fourth quarter of fiscal year 2003. During the three and six months ended January 2, 2004, we recorded restructuring charges of $0.6 million and $1.3 million, respectively, primarily for severance.Europe. We do not anticipate recording significant restructuring charges duringin fiscal year 2005.2006.

Interest income of $6.7 million and $12.5$10.6 million in the three and six months ended December 31, 2004, respectively, increased over the comparable periodsfirst quarter of fiscal year 2006 was $4.9 million higher than the prior yearyear. The year-over-year increase was due primarily to higher average cash and short-term investment balances and higher yields in these periodsthe first quarter of fiscal year 20052006 as compared to the prior year. In addition, the average tax equivalent yield was 3.2 percent, up from 2.0 percent in the prior year

Other expense of $1.0 million and $0.9 millionincome for the threequarters ended September 30, 2005 and six months ended December 31,October 1, 2004 respectively, included losses on short-term investments and from the other-than-temporary decline in the fair value of an investment in a privately-held company, gains from the increasechanges in the cash surrender value of life insurance, partnership income, foreign exchange losses and various other items, none of which was individually significant.

Other income of $2.2 million for the three months ended January 2, 2004 included a gain of $6.8 million from the sale of shares of Kabelnetz, which had been received as part of the termination settlement with German cable operator 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, of which $2.9 had been previously reserved for.

In addition to the gain from the sale of shares of Kabelnetz and the loss from the settlement of purchase price adjustments with ViaSat described above, other income of $1.3 million for the six months ended January 2, 2004 included a gain of $1.9 million from the sale of a 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.

Earnings before income taxes were $83.5 million and $168.0$91.8 million in the three and six monthsquarter ended December 31, 2004, respectively,September 30, 2005, up over the comparable periods of$7.3 million from the prior year. The year-over-year improvements wereimprovement was due to higher sales volume, improved gross margin and higher interest income in these periodsthe first quarter of fiscal year 20052006 as compared to the prior year. These increases were partially offset by the recording of compensation expense related to stock options.

The effective tax rate for the three months ended December 31, 2004first quarter of fiscal year 2006 was 3033.8 percent of pre-tax earnings, down from 35compared to 33.9 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.

year. The effective tax rate for the six months ended December 31, 2004 was 32fiscal year 2006 is expected to be approximately 34 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 taxes 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.income.

On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004 (the “Act”).2004. 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 Act. 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$77 million, with the respective tax benefitcost ranging from $0 to $3$0.5 million. We expect to be in a position to finalize our assessment by DecemberMarch 31, 2005.2006.

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 years 2005, 2006 and 2007. The new deduction for domestic production activities is subject to certain limitations and interpretations and, as such, we are not yet in a position to determine the potential impact on the effective tax rate of future years.fiscal year 2006.

Under the guidance in 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,” 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 period in which the deduction is claimed on our income tax return.

14Effective July 2, 2005, we adopted SFAS No. 123R’s, “Share-Based Payment,” fair value method using its modified prospective transition method. Under this transition method, compensation cost recognized after adoption includes: a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 2, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based

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Compensation,” and b) compensation cost for all share-based payments granted subsequent to July 2, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. Prior to July 2, 2005 as permitted by SFAS No. 123, we accounted for share-based payments to employees using Accounting Principles Board (APB) Opinion No. 25’s, “Accounting for Stock Issued to Employees”, intrinsic value method and, as such, recognized no compensation cost for employee stock options. Results for prior periods have not been restated.

As a result of adopting SFAS No. 123R on July 2, 2005, the company’s income before income taxes and net income for the quarter ended September 30, 2005, were $9.7 million and $6.4 million lower, respectively, than if it had continued to account for share-based compensation under APB Opinion No. 25. Stock option compensation expense of $1.4 million, $1.8 million and $6.5 million was included in cost of sales, research and development, and sales and administrative expense, respectively. Basic and diluted earnings per share for the quarter ended September 30, 2005 would have been $0.44 and $0.43, respectively, if the company had not adopted SFAS No. 123R, compared to reported basic and diluted earnings per share of $0.40 and $0.39, respectively.

Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Form 10-K for fiscal year 20042005 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.

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. Historically, actual results have not differed materially from our estimates. The most significant estimates and assumptions relate to revenue recognition, stock compensation, the adequacy of receivable, inventory and tax reserves, deferred tax allowances, asset impairments and accrued liabilities and other liabilities, principally relating to warranty provisions, and the pension benefit liability.liability and settlement liabilities.

Revenue Recognition

Our principal sources of revenues are from sales of digital interactive subscriber systems which include digital set-tops and cable modems, 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 deferred until acceptance is deemed to have occurred.

Certain agreements also includeAgreements with multiple deliverables or elements for products and/or services.are reviewed and the deliverables are separated into units of accounting under the provisions of Emerging Issues Task Force (EITF) No. 00-21. 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,” for agreements entered into in In some cases, 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.

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For certain products where software is more than an incidental component of the hardware, we recognize software license revenue under SOPStatement of Position (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.

15Stock-Based Compensation

Effective July 2, 2005, we adopted SFAS No. 123R’s fair value method using its modified prospective transition method. Under this transition method, compensation cost recognized after adoption includes: a) compensation cost for all share-based payments granted prior to, but not yet vested as of 36

As a result of adopting SFAS No. 123R on July 2, 2005, the company’s income before income taxes and net income for the quarter ended September 30, 2005, were $9.7 million and $6.4 million lower, respectively, than if it had continued to account for share-based compensation under APB Opinion No. 25. Basic and diluted earnings per share for the quarter ended September 30, 2005 would have been $0.44 and $0.43, respectively, if the company had not adopted SFAS No. 123R, compared to reported basic and diluted earnings per share of $0.40 and $0.39, respectively.

Management judgments and assumptions related to volatility, the expected term and the forfeiture rate are made in connection with the calculation of stock compensation expense. We periodically review all assumptions used in our stock option pricing model. Changes in these assumptions could have a significant impact on the amount of stock compensation expense.

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 products 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.

Income Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets 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 certain tax jurisdictions, or if there is a material change in the actual 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 deferred tax assets, resulting in an increase in the effective tax rate and an adverse impact on operating results.

Management judgments and estimates are made in connection with establishing and adjusting 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.

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Goodwill Impairment

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 operating segment level (subscriber and transmission). Estimates 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 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 actual 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 our operating results.

Segments

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.

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 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 generally 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 $41.6$41.7 million and $36.2$45.0 million at December 31, 2004September 30, 2005 and July 2, 2004,1, 2005, respectively. A rollforward of the warranty liability from July 1, 2005 to September 30, 2005 is included in Note H to the Consolidated Financial Statements in this Form 10-Q.

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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/or liability measurement. We re-evaluate these assumptions annually. Other assumptions involve demographic factors such as retirement, mortality, rate of compensation increase and turnover. These assumptions are also re-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. In selecting the discount rate, we also consider the timing of expected future cash flows. 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 well as the current and expected allocation of the plan assets.

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 percent to reflect the lower market interest conditions. This change in our assumptions increased our pension expense by approximately $0.3 million in fiscal year 2005 over the preceding year. At March 31, 2005, we reduced the discount rate to 5.75 percent to reflect the lower market interest conditions. This change in our assumptions will increase our pension expense by $0.2 million in fiscal year 2006 over fiscal year 2005. The expected long-term rate of return on pension assets was 8.00 percent unchanged from the preceding year.in fiscal years 2005, 2004 and 2003.

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.

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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.

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