Form 10-Q

10-Q 1 d10q.htm FORM 10-Q Form 10-Q

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 December 31, 2004

¨	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 incorporation or organization)		(I.R.S. Employer Identification Number)

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.

Yes þ No ¨

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

Yes þ No ¨

As of January 28, 2005, Scientific-Atlanta, Inc. had outstanding 152,061,822 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						Six Months Ended
	December 31, 2004			January 2, 2004			December 31, 2004			January 2, 2004
SALES	$	441,672		$	416,566		$	894,346		$	812,202
COSTS AND EXPENSES
Cost of sales		277,951			259,204			564,826			507,582
Sales and administrative		47,893			47,973			96,654			96,010
Research and development		37,881			36,015			76,222			71,338
Restructuring		(8	)		598			(12	)		1,313
Interest expense		174			204			331			439
Interest income		(6,765	)		(4,188	)		(12,539	)		(8,040	)
Other (income) expense, net		1,020			(2,208	)		855			(1,307	)

Total costs and expenses		358,146			337,598			726,337			667,335

EARNINGS BEFORE INCOME TAXES		83,526			78,968			168,009			144,867
PROVISION FOR (BENEFIT FROM) INCOME TAXES
Current		23,925			24,219			56,632			42,592
Deferred		908			3,618			(3,194	)		8,474

NET EARNINGS	$	58,693		$	51,131		$	114,571		$	93,801

EARNINGS PER COMMON SHARE
BASIC	$	0.39		$	0.34		$	0.75		$	0.62

DILUTED	$	0.38		$	0.33		$	0.74		$	0.61

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
BASIC		152,395			151,874			152,913			151,418

DILUTED		154,510			154,510			154,973			154,153

DIVIDENDS PER SHARE PAID	$	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)


	December 31, 2004		July 2, 2004
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	339,585	$	442,182
Short-term investments		976,040		855,434
Receivables, less allowance for doubtful accounts of $2,514 at December 31 and $3,102 at July 2		228,723		219,172
Inventories		125,742		129,930
Income tax receivables		682		18,903
Deferred income taxes		24,646		23,657
Other current assets		16,927		18,434

TOTAL CURRENT ASSETS		1,712,345		1,707,712

PROPERTY, PLANT AND EQUIPMENT, at cost
Land and improvements		23,882		21,223
Buildings and improvements		116,130		83,713
Machinery and equipment		234,642		212,392

		374,654		317,328
Less - Accumulated depreciation and amortization		152,269		132,744

		222,385		184,584
GOODWILL		236,786		235,209

INTANGIBLE ASSETS		31,951		37,636

DEFERRED INCOME TAXES		38,184		30,867

OTHER ASSETS		79,920		73,619

TOTAL ASSETS	$	2,321,571	$	2,269,627

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt	$	1,393	$	1,265
Accounts payable		138,134		171,589
Accrued liabilities		84,543		101,132
Deferred revenue		15,132		18,053
Income taxes currently payable		13,673		13,663

TOTAL CURRENT LIABILITIES		252,875		305,702

LONG-TERM DEBT, LESS CURRENT MATURITIES		7,772		7,698

NON-CURRENT DEFERRED REVENUE		8,648		7,885

OTHER LIABILITIES		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 December 31 and July 2		82,496		82,496
Additional paid-in capital		563,308		561,636
Retained earnings		1,410,302		1,300,691
Accumulated other comprehensive income, net of taxes of $29,153 at December 31 and $19,506 at July 2		58,311		39,516

		2,114,417		1,984,339
Less - Treasury stock, at cost (12,997,424 shares at December 31 and 11,614,954 shares at July 2)		220,767		180,982

		1,893,650		1,803,357

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	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)


	Six Months Ended
	December 31, 2004			January 2, 2004
NET CASH PROVIDED BY OPERATING ACTIVITIES	$	130,083		$	122,279

INVESTING ACTIVITIES:
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		(58,071	)		(11,605	)
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		157			334

Net cash used in investing activities		(183,349	)		(54,728	)

FINANCING ACTIVITIES:
Purchases of common stock		(50,703	)		—
Issuance of common stock from treasury		5,049			41,359
Dividends paid		(3,052	)		(3,032	)
Principal payments on debt		(625	)		(575	)

Net cash provided by (used in) financing activities		(49,331	)		37,752

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		(102,597	)		105,303

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		442,182			332,266

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	339,585		$	437,569

SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid during the period:
Interest	$	296		$	408

Income taxes paid, net	$	37,147		$	15,523

SEE ACCOMPANYING NOTES

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SCIENTIFIC ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(IN THOUSANDS)

(UNAUDITED)


	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 for fiscal year 2005 and 2004, respectively.

SEE ACCOMPANYING NOTES

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NOTES:

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

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 2004 Annual Report on Form 10-K. The financial information presented in the accompanying statements reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the periods indicated. All such adjustments, except as described in the next paragraph, are of a normal recurring nature.

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 2005, which ends on July 1, 2005, will include fifty-two weeks. The second quarter of fiscal year 2005 and 2004 each included thirteen weeks. The six months ended December 31, 2004 included twenty-six weeks while the six months ended January 2, 2004 included twenty-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:


	In Thousands			Per Share Amount
	Net Earnings		Shares	Per Share Amount
Quarter Ended December 31, 2004
Basic earnings per common share	$	58,693	152,395	$	0.39
Effect of dilutive stock options		—	2,115		(0.01	)

Diluted earnings per common share	$	58,693	154,510	$	0.38

Quarter Ended January 2, 2004
Basic earnings per common share	$	51,131	151,874	$	0.34
Effect of dilutive stock options		—	2,636		(0.01	)

Diluted earnings per common share	$	51,131	154,510	$	0.33

Six Months Ended December 31, 2004
Basic earnings per common share	$	114,571	152,913	$	0.75
Effect of dilutive stock options		—	2,060		(0.01	)

Diluted earnings per common share	$	114,571	154,973	$	0.74

Six Months Ended January 2, 2004
Basic earnings per common share	$	93,801	151,418	$	0.62
Effect of dilutive stock options		—	2,735		(0.01	)

Diluted earnings per common share	$	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:


	December 31, 2004		January 2, 2004
Number of options outstanding		11,804,216		8,825,177
Weighted average exercise price	$	47.39	$	52.72

We have elected to account for option plans under Accounting Principles Board (APB) Opinion No. 25 “Accounting for Stock Issued to Employees”, which generally requires compensation costs for fixed awards to be recognized only when the option price differs from the market price at the grant date. Statement of Financial Accounting Standards (SFAS) No. 123 “Accounting for Stock-Based Compensation” and No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure” allow a company to follow APB Opinion No. 25 with the following additional disclosure that shows what our net earnings and earnings per share would have been using the fair value compensation model under SFAS No. 123:


	Three Months Ended				Six Months Ended
	December 31, 2004		January 2, 2004		December 31, 2004		January 2, 2004
Net earnings as reported	$	58,693	$	51,131	$	114,571	$	93,801
Deduct: Pro forma compensation expense, net of tax		7,719		9,310		15,546		20,787

Pro forma net earnings	$	50,974	$	41,821	$	99,025	$	73,014

Earnings per share:
Basic
As reported	$	0.39	$	0.34	$	0.75	$	0.62

Pro forma	$	0.33	$	0.28	$	0.65	$	0.48

Diluted
As reported	$	0.38	$	0.33	$	0.74	$	0.61

Pro forma	$	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 average fair value of $14.21 and $19.09 per option for grants in the second quarter of fiscal years 2005 and 2004, respectively, and $15.28 and $19.84 per option for grants in the six months ended December 31 and January 2, 2004, respectively. The following weighted-average assumptions were used in the pricing model for grants in the three and six months ended December 31, 2004 and January 2, 2004:


	Three Months Ended						Six Months Ended
	December 31, 2004			January 2, 2004			December 31, 2004			January 2, 2004
Risk free interest rate		3.22	%		4.33	%		3.38	%		4.33	%
Expected term		4.7 years			5.0 years			4.8 years			5.0 years
Volatility		60	%		76	%		65	%		76	%
Expected annual dividends	$	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:


	December 31, 2004		July 2, 2004
Raw materials and work-in-process	$	82,558	$	99,872
Finished goods		43,184		30,058

Total inventory	$	125,742	$	129,930

During the three and six months ended December 31, 2004, we purchased 1,836,600 shares of our common stock at an aggregate cost of $50,703 pursuant to a program announced in February 2003 to buy back up to 10,000,000 shares. At December 31, 2004, there were 7,604,700 shares available that may yet be purchased under this plan. No shares were purchased during the three or six months ended January 2, 2004.

Other expense of $1,020 and $855 for the three and six months ended December 31, 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 increase 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 $2,208 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.

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.

G.	We have a defined benefit pension plan covering substantially all of our domestic employees. Pension expense for this plan consists of the following:


	Three Months Ended						Six Months Ended
	December 31, 2004			January 2, 2004			December 31, 2004			January 2, 2004
Service cost	$	1,914		$	1,757		$	3,828		$	3,514
Interest cost		1,379			1,397			2,758			2,794
Expected return on plan assets		(1,691	)		(1,627	)		(3,382	)		(3,254	)
Amortization of transition net asset		(12	)		(12	)		(24	)		(24	)
Amortization of prior service cost		7			7			14			14
Amortization of net actuarial loss		46			—			92			—

Pension expense	$	1,643		$	1,522		$	3,286		$	3,044

During the first quarter of fiscal year 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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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:


	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 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:


	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 sector, and reduced our workforce by an additional 30 positions in the fourth quarter of fiscal year 2003.

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:


	Contractual Obligations Under a Canceled Lease			Severance			Total
Balance at July 2, 2004	$	1,324		$	—		$	1,324
Restructuring provision		—			23			23
Charges to the reserve		(723	)		(23	)		(746	)
Adjustments		(35	)		—			(35	)

Balance at December 31, 2004	$	566		$	—		$	566

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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I.	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

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. In addition, 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. Expenses related to unusual product warranty problems and product defects are recorded in the period the problem is identified.

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, 2004 consisted of $15,562 in Accrued liabilities and $26,004 in Other liabilities in the Consolidated Statements of Financial Position.

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


Accrued warranty at July 2, 2004	$	36,233
Reductions for payments		(10,607	)
Additions for warranties issued during the period		11,680
Other adjustments		4,260

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.

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.

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.

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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.

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 contingencies was included in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended July 2, 2004 and continues to be relevant.

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, we entered into a tolling agreement for any potential claims by the Adelphia estate where the statute of limitation has not yet run.

The Financial Accounting Standards Board (FASB) recently issued FASB Staff Position (FSP) No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” FSP No. 106-2 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. FSP No. 106-2 is effective for interim or annual financial statements of fiscal years beginning after June 15, 2004. We have elected to defer the recognition of the impact of the new Medicare provisions under a provision of FSP No. 106-2 until fiscal year 2006. The effect of the subsidy is to reduce the plan’s accumulated postretirement benefit obligation by approximately $1,132 and the net periodic postretirement benefit cost by approximately $148 for fiscal year 2005.

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 adopt 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 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 financing 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 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.

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 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, with the respective tax benefit ranging from $0 to $3,000. We expect to be in a 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 December 31, 2004 were $441.7 million, an increase of 6 percent over the comparable period 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 37.1 percent were 0.7 percentage points lower than the prior year. Operating expenses increased $1.2 million due primarily to 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, 2004 of $58.7 million were $7.6 million higher than the prior year driven primarily by the higher sales volume and lower 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 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.

FINANCIAL CONDITION AND LIQUIDITY

Scientific-Atlanta had stockholders’ equity of $1.9 billion and cash on hand was $339.6 million at December 31, 2004. Cash provided by operating activities for the six months ended December 31, 2004 of $130.1 million included net earnings of $114.6 million and depreciation and amortization of $40.4 million. During the six months ended December 31, 2004, we received $22.7 million of income tax refunds and related interest from a federal income tax settlement for certain fiscal years prior to 2003. These receipts were offset by increases in accounts receivable of $9.2 million and a 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 performance-based plans.

During the six months ended December 31, 2004, we increased our short-term investments by $120.6 million and acquired property, plant and equipment for $58.1 million, including 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.

The current ratio of Scientific-Atlanta was 6.7:1 at December 31, 2004, up from 5.6:1 at July 2, 2004. At December 31, 2004, we had debt of $9.2 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, 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 December 31, 2004, increased 11 percent from the prior year’s second quarter to $327.6 million. In the second quarter of fiscal year 2005, we sold 911 thousand 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 449 thousand set-tops with digital video recording capability (DVRs), including 256 thousand units of our 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 high-definition DVRs

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mentioned previously, we sold 304 thousand high-definition set-tops in the quarter, an increase of more than 200 percent compared to the same quarter last year.

Sales for the six months ended December 31, 2004 were $894.3 million, up 10 percent from $812.2 million in the first six months of the prior year. Sales of subscriber products were $660.7 million, 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 3 percent compared to the first six months of last year. International sales for the first six months of fiscal year 2005 totaled $214.2 million, up 24 percent compared 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.

Gross margin in the second quarter of fiscal year 2005 was 37.1 percent of sales, a 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 material and conversion cost reductions. The combined average selling price of our digital set-tops increased approximately 13 percent in the second quarter of fiscal year 2005 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 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. 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 months ended December 31, 2004 were $37.9 million and $76.2 million, respectively, up approximately six percent over the comparable periods of the prior year. The primary driver of the year-to-year increases was incremental hiring 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.

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.

Interest income of $6.7 million and $12.5 million in the three and six months ended December 31, 2004, respectively, increased over the comparable periods of the prior year due primarily to higher average cash and short-term investment balances and higher yields in these periods of fiscal year 2005 as compared to the prior year.

Other expense of $1.0 million and $0.9 million for the three and six months ended December 31, 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 increase 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 million in the three and six months ended December 31, 2004, respectively, up over the comparable periods of the prior year. The year-over-year improvements were due to higher sales volume in these periods of fiscal year 2005 as compared to the prior year.

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 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.

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 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 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 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.

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.

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Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in Form 10-K for fiscal year 2004 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. The most significant estimates and assumptions relate to revenue recognition, 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.

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 deferred 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,” 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.

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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 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.

Goodwill Impairment

Segments

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 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 million and $36.2 million at December 31, 2004 and July 2, 2004, 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/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. 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 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. 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.

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

We have adopted the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based 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,” 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 $15.5 million and $20.8 million for the six months ended December 31, 2004 and January 2, 2004, respectively. These amounts are significant and fluctuate significantly due to the relatively high 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 the number of options granted. We periodically review all assumptions used in our stock option pricing model.

New Accounting Pronouncements

During fiscal year 2004, the FASB issued FSP No. 106-2, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003.” FSP No. 106-2 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. FSP No. 106-2 is effective for interim or annual financial statements of fiscal years beginning after June 15, 2004. We have elected to defer the recognition of the impact of the new Medicare provisions under a provision of FSP No. 106-2 until fiscal year 2006. The effect of the subsidy is to reduce the plan’s accumulated postretirement benefit obligation by approximately $1.1 million and the net periodic postretirement benefit cost by approximately $0.1 million for fiscal year 2005.

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 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 financing 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 operating 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 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 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.

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 Lawrenceville, Georgia. The initial occupancy term was seven years and expired in July 2004. Lease payments were equal to the interest on the $36.0 million financed at a fixed rate of 6.51 percent per annum. We purchased the buildings financed under this long-term operating lease arrangement for $36.0 million at the expiration of the lease in July 2004.

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The lease qualified as an operating lease under SFAS No. 13, “Accounting for Leases,” as amended. The lessor was 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 had no ownership interest in the lessor or the financial institution. We evaluated the provisions of Interpretation No. 46, “Consolidation of Variable Interest Entities,” and concluded that these provisions did 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-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, and Explorer are registered trademarks of Scientific-Atlanta, Inc. WebSTAR is a trademark of Scientific-Atlanta, Inc.

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

(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 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.

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.

Hedging instruments, which were designated as cash flow or fair value hedges, at December 31, 2004 were as follows:


	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 December 31, 2004, we had unrealized gains of $23, net of tax of $13, related to cash flow hedges, which were included in Accumulated other comprehensive income. Scientific-Atlanta has no foreign exchange derivative exposure beyond the second quarter of fiscal year 2006.

Unrealized gains and losses on foreign exchange forward contracts which are accounted for as fair value hedges are recognized in Other (income) expense. During the six months ended December 31, 2004 and January 2, 2004, we recorded losses of $667 and gains of $423, respectively, related to these contracts. These contracts hedged our exposure on Euro- and Sterling-based receivables.

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” 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 Accumulated other comprehensive income. We recorded after-tax, unrealized holding gains of $459 in the first six months of fiscal year 2004. No such gains or losses were recorded in the first six months of 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 $2,444 on the sale of non-current marketable securities in the six months of fiscal year 2004. No such gains or losses were recorded in the first six months of fiscal year 2005. We recorded no losses in the first six months of fiscal year 2005 or 2004 from the other-than-temporary decline in the market value of marketable securities.

Scientific-Atlanta holds warrants to purchase common stock that are recorded at fair value. The warrants, which are included in Other 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 six months of fiscal years 2005 and 2004, we recorded unrealized gains of $12 and unrealized losses of $35, respectively, related to the changes in the fair value of warrants in Other (income) expense.

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 $692 and $1,831 in the first six months of fiscal year 2005 and 2004, respectively, from other-than-temporary declines in the fair value of our investments in privately-held companies. Investments in privately-held companies of $5,772 and $6,464 were included in Other assets in the Consolidated Statements of Financial Position at December 31, 2004 and July 2, 2004, respectively.

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ITEM 4.

CONTROLS AND PROCEDURES

(a) Disclosure Controls and Procedures. Scientific-Atlanta’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of Scientific-Atlanta’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act), as of the end of the period 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, the 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) under the Exchange Act) during the second quarter of fiscal year 2005 that have materially affected, or are 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.

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 disclosed, we are involved in several lawsuits, including 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.”

Regardless 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 complex technical issues and inherent uncertainties in litigation. During the second quarter of fiscal year 2005, 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 to change during the third quarter of fiscal year 2005, Scientific-Atlanta may include, as a result of any settlement, an additional expense or charge in its results of operations for the third quarter of fiscal year 2005. At this time, we cannot assess the probability of a settlement and there can be no assurance as to the outcome of these settlement negotiations.

Item 2.

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

During the three months ended December 31, 2004, the 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 December 31, 2004, there were 7,604,700 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

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.


	SCIENTIFIC-ATLANTA, INC. (Registrant)

Date: February 4, 2005	By:	/s/ Julian W. Eidson
		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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