Form 10-Q for Quarter Period Ended April 1,2005

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PYHi6b5HjeCRq6ex0sEEurwRL2NIJKj1CkOjXmlIQQ90BAgTssMIgABtx200AIZJ r/uEaGSlNSrsyPSHZRXG5w== 0001193125-05-102486.txt : 20050510 0001193125-05-102486.hdr.sgml : 20050510 20050510142036 ACCESSION NUMBER: 0001193125-05-102486 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050401 FILED AS OF DATE: 20050510 DATE AS OF CHANGE: 20050510 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCIENTIFIC ATLANTA INC CENTRAL INDEX KEY: 0000087777 STANDARD INDUSTRIAL CLASSIFICATION: RADIO & TV BROADCASTING & COMMUNICATIONS EQUIPMENT [3663] IRS NUMBER: 580612397 STATE OF INCORPORATION: GA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-05517 FILM NUMBER: 05815670 BUSINESS ADDRESS: STREET 1: 5030 SUGARLOAF PARKWAY CITY: LAWRENCEVILLE STATE: GA ZIP: 30044 BUSINESS PHONE: 7709035000 MAIL ADDRESS: STREET 1: 5030 SUGARLOAF PARKWAY CITY: LAWRENCEVILLE STATE: GA ZIP: 30044 FORMER COMPANY: FORMER CONFORMED NAME: SCIENTIFIC ASSOCIATES INC DATE OF NAME CHANGE: 19671024 10-Q 1 d10q.htm FORM 10-Q FOR QUARTER PERIOD ENDED APRIL 1,2005 Form 10-Q for Quarter Period Ended April 1,2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 1, 2005

¨	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 x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yes x No ¨

As of April 29, 2005, Scientific-Atlanta, Inc. had outstanding 152,388,563 shares of common stock.

PART I - FINANCIAL INFORMATION

SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)


	Three Months Ended						Nine Months Ended
	April 1, 2005			April 2, 2004			April 1, 2005			April 2, 2004
SALES	$	489,507		$	436,969		$	1,383,853		$	1,249,171

COSTS AND EXPENSES
Cost of sales		308,854			275,533			873,680			783,115
Sales and administrative		51,594			51,829			148,248			147,839
Research and development		42,797			38,896			119,019			110,234
Restructuring		(272	)		51			(284	)		1,364
Interest expense		197			191			528			630
Interest income		(8,003	)		(4,235	)		(20,542	)		(12,275	)
Other (income) expense, net		1,202			(4,638	)		2,057			(5,945	)

Total costs and expenses		396,369			357,627			1,122,706			1,024,962

EARNINGS BEFORE INCOME TAXES		93,138			79,342			261,147			224,209

PROVISION FOR (BENEFIT FROM) INCOME TAXES
Current		30,984			27,718			87,616			70,310
Deferred		415			(2,329	)		(2,779	)		6,145

NET EARNINGS	$	61,739		$	53,953		$	176,310		$	147,754

EARNINGS PER COMMON SHARE
BASIC	$	0.41		$	0.35		$	1.15		$	0.97

DILUTED	$	0.40		$	0.35		$	1.14		$	0.96

WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING
BASIC		152,146			152,569			152,657			151,802

DILUTED		154,261			155,305			154,736			154,537

DIVIDENDS PER SHARE PAID	$	0.01		$	0.01		$	0.03		$	0.03

SEE ACCOMPANYING NOTES

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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL POSITION

(IN THOUSANDS, EXCEPT SHARE DATA)

(UNAUDITED)


	April 1, 2005		July 2, 2004
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	404,008	$	285,106
Short-term investments		1,048,842		1,012,510
Receivables, less allowance for doubtful accounts of $2,235 at April 1 and $3,102 at July 2		203,861		219,172
Inventories		112,544		129,930
Income tax receivables		—		18,903
Deferred income taxes		27,371		23,657
Other current assets		18,734		18,434

TOTAL CURRENT ASSETS		1,815,360		1,707,712

PROPERTY, PLANT AND EQUIPMENT, at cost
Land and improvements		23,771		21,223
Buildings and improvements		111,074		83,713
Machinery and equipment		226,679		212,392

		361,524		317,328
Less - Accumulated depreciation and amortization		142,392		132,744

		219,132		184,584
GOODWILL		229,181		235,209
INTANGIBLE ASSETS		27,888		37,636
DEFERRED INCOME TAXES		41,709		30,867
OTHER ASSETS		79,239		73,619

TOTAL ASSETS	$	2,412,509	$	2,269,627

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES
Current maturities of long-term debt	$	1,326	$	1,265
Accounts payable		166,318		171,589
Accrued liabilities		86,498		101,132
Deferred revenue		16,378		18,053
Income taxes currently payable		13,584		13,663

TOTAL CURRENT LIABILITIES		284,104		305,702

LONG-TERM DEBT, LESS CURRENT MATURITIES		7,061		7,698
NON-CURRENT DEFERRED REVENUE		8,964		7,885
OTHER LIABILITIES		161,882		144,985
STOCKHOLDERS’ EQUITY
Preferred stock, authorized 50,000,000 shares; no shares issued		—		—
Common stock, $0.50 par value, authorized 350,000,000 shares; issued 164,992,376 shares at April 1 and July 2		82,496		82,496
Additional paid-in capital		565,125		561,636
Retained earnings		1,469,578		1,300,691
Accumulated other comprehensive income, net of taxes of $23,352 at April 1 and $19,506 at July 2		47,153		39,516

		2,164,352		1,984,339
Less - Treasury stock, at cost (12,709,893 shares at April 1 and 11,614,954 shares at July 2)		213,854		180,982

		1,950,498		1,803,357

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	2,412,509	$	2,269,627

SEE ACCOMPANYING NOTES

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SCIENTIFIC-ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)


	Nine Months Ended
	April 1, 2005			April 2, 2004
NET CASH PROVIDED BY OPERATING ACTIVITIES	$	278,651		$	210,832

INVESTING ACTIVITIES:
Purchases of short-term investments		(1,298,204	)		(973,326	)
Proceeds from sales of short-term investments		1,254,090			753,566
Purchases of property, plant, and equipment		(67,855	)		(19,733	)
Proceeds from the sale of an investment in a marketable security		—			16,573
Payment of purchase price adjustment on business sold to ViaSat, Inc.		—			(9,000	)
Other		178			361

Net cash used in investing activities		(111,791	)		(231,559	)

FINANCING ACTIVITIES:
Purchases of common stock		(50,703	)		—
Issuance of common stock from treasury		8,281			56,226
Dividends paid		(4,574	)		(4,560	)
Principal payments on debt		(962	)		(885	)

Net cash provided by (used in) financing activities		(47,958	)		50,781

INCREASE IN CASH AND CASH EQUIVALENTS		118,902			30,054

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD		285,106			195,937

CASH AND CASH EQUIVALENTS AT END OF PERIOD	$	404,008		$	225,991

SUPPLEMENTAL CASH FLOW DISCLOSURES
Cash paid during the period:
Interest	$	472		$	584

Income taxes, net	$	66,952		$	38,162

SEE ACCOMPANYING NOTES

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SCIENTIFIC ATLANTA, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(IN THOUSANDS)

(UNAUDITED)


	Three Months Ended						Nine Months Ended
	April 1, 2005			April 2, 2004			April 1, 2005			April 2, 2004
NET EARNINGS	$	61,739		$	53,953		$	176,310		$	147,754
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX⁽¹⁾
Net foreign currency translation adjustments		(9,960	)		(6,430	)		9,260			11,917
Net unrealized holding gains (losses) on short-term investments		(826	)		(174	)		(1,629	)		59
Net unrealized holding losses on available-for-sale marketable securities, net of reclassification adjustments of $0 in the three and nine months ended April 1, 2005 and $1,349 and $2,225 in the three months and nine months ended April 2, 2004, respectively		(5	)		(972	)		(5	)		(512	)
Net change in fair value of derivatives		(366	)		(165	)		11			(123	)

COMPREHENSIVE INCOME	$	50,582		$	46,212		$	183,947		$	159,095

⁽¹⁾	Assumed average 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 are of a normal recurring nature, except as noted below.

During fiscal year 2004, we identified certain cash equivalents and short-term investments which were misclassified. We have reclassified $39,479 and $27,514 from Cash and cash equivalents to Short-term investments at April 2, 2004 and June 27, 2003, respectively. In addition, in the third quarter of fiscal year 2005, we began classifying all auction rate securities and variable rate demand obligations as Short-term investments. We have reclassified $157,076, $178,478 and $136,329 from Cash and cash equivalents to Short-term investments at July 2, 2004, April 2, 2004 and June 27, 2003, respectively, related to these securities and obligations. The Consolidated Statements of Cash Flows for the nine months ended April 1, 2005 and April 2, 2004 have been reclassified to reflect these adjustments. These reclassifications also decreased net cash used in investing activities by $157,076 for the nine months ended April 1, 2005 and increased net cash used in investing activities by $60,168 for the nine months ended April 2, 2004.

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 third quarter of fiscal year 2005 and 2004 each included thirteen weeks. The nine months ended April 1, 2005 included thirty-nine weeks while the nine months ended April 2, 2004 included forty 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.

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Basic and diluted earnings per share are computed as follows:


	In Thousands			Per Share Amount
	Net Earnings		Shares	Per Share Amount
Quarter Ended April 1, 2005
Basic earnings per common share	$	61,739	152,146	$	0.41
Effect of dilutive stock options		—	2,115		(0.01	)

Diluted earnings per common share	$	61,739	154,261	$	0.40

Quarter Ended April 2, 2004
Basic earnings per common share	$	53,953	152,569	$	0.35
Effect of dilutive stock options		—	2,736		—

Diluted earnings per common share	$	53,953	155,305	$	0.35

Nine Months Ended April 1, 2005
Basic earnings per common share	$	176,310	152,657	$	1.15
Effect of dilutive stock options		—	2,079		(0.01	)

Diluted earnings per common share	$	176,310	154,736	$	1.14

Nine Months Ended April 2, 2004
Basic earnings per common share	$	147,754	151,802	$	0.97
Effect of dilutive stock options		—	2,735		(0.01	)

Diluted earnings per common share	$	147,754	154,537	$	0.96

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The following information pertains to options to purchase shares of common stock which were not included in the computation of diluted earnings per common share because the option’s exercise price was greater than the average market price of the common shares:


	April 1, 2005		April 2, 2004
Number of options outstanding		14,193,736		11,816,147
Weighted average exercise price	$	44.62	$	47.74

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 SFAS 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				Nine Months Ended
	April 1, 2005		April 2, 2004		April 1, 2005		April 2, 2004
Net earnings as reported	$	61,739	$	53,953	$	176,310	$	147,754
Deduct: Pro forma compensation expense, net of tax		6,660		8,903		22,206		29,690

Pro forma net earnings	$	55,079	$	45,050	$	154,104	$	118,064

Earnings per share:
Basic
As reported	$	0.41	$	0.35	$	1.15	$	0.97

Pro forma	$	0.36	$	0.30	$	1.01	$	0.78

Diluted
As reported	$	0.40	$	0.35	$	1.14	$	0.96

Pro forma	$	0.36	$	0.29	$	1.00	$	0.76

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 $16.09 and $21.29 per option for grants in the third quarter of fiscal years 2005 and 2004, respectively, and $16.06 and $21.22 per option for grants in the nine months ended April 1, 2005 and April 2, 2004, respectively. The following weighted-average assumptions were used in the pricing model for grants in the three and nine months ended April 1, 2005 and April 2, 2004:


	Three Months Ended						Nine Months Ended
	April 1, 2005			April 2, 2004			April 1, 2005			April 2, 2004
Risk free interest rate		3.81	%		4.07	%		3.80	%		4.08	%
Expected term		4.8 years			5.0 years			4.8 years			5.0 years
Volatility		59	%		75	%		59	%		75	%
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 third quarter of fiscal year 2005, we determined that the expected term of our stock option grants was 4.8 years rather than 5.0 years and we have adjusted our assumptions accordingly.

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D.	Inventories consist of the following:


	April 1, 2005		July 2, 2004
Raw materials and work-in-process	$	77,029	$	99,872
Finished goods		35,515		30,058

Total inventory	$	112,544	$	129,930

During the nine months ended April 1, 2005, 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 April 1, 2005, there were 7,604,700 shares available that may yet be purchased under this plan. No shares were purchased during the nine months ended April 2, 2004.

Other expense of $1,202 for the three months ended April 1, 2005 included a charge of $2,797 from the other-than-temporary decline in the fair value of an investment in a privately-held company. This charge was partially offset by a gain of $1,617 from the reversal of reserves related to claims against a company we acquired following a favorable court ruling. In addition, other expense of $2,057 for the nine months ended April 1, 2005 included losses on short-term investments and from the other-than-temporary decline in the fair value of another 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 for the quarter ended April 2, 2004 of $4,638 included a gain of $2,156 from the sale of a marketable security and various other items which resulted in additional income, none of which was significant individually.

In addition to the gain on the sale of a marketable security, other income of $5,945 for the nine months ended April 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 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 previously been reserved for. In addition to the gains from the sales of marketable securities discussed above, other income for the nine months ended April 2, 2004 included a gain of $1,907 from the sale of another 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						Nine Months Ended
	April 1, 2005			April 2, 2004			April 1, 2005			April 2, 2004
Service cost	$	1,914		$	1,757		$	5,742		$	5,271
Interest cost		1,379			1,397			4,137			4,192
Expected return on plan assets		(1,691	)		(1,627	)		(5,073	)		(4,880	)
Amortization of transition net asset		(12	)		(12	)		(36	)		(35	)
Amortization of prior service cost		7			7			21			20
Amortization of net actuarial loss		46			—			138			—

Pension expense	$	1,643		$	1,522		$	4,929		$	4,568

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				Nine Months Ended
	April 1, 2005		April 2, 2004		April 1, 2005		April 2, 2004
Service cost	$	341	$	379	$	1,023	$	1,137
Interest cost		532		566		1,596		1,698
Amortization of prior service cost		47		47		141		141
Amortization of net actuarial loss		428		243		1,284		729

Pension expense	$	1,348	$	1,235	$	4,044	$	3,705

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				Nine Months Ended
	April 1, 2005		April 2, 2004		April 1, 2005		April 2, 2004
Service cost	$	13	$	12	$	39	$	36
Interest cost		169		183		507		549
Amortization of prior service cost		11		11		33		33
Amortization of net actuarial loss		65		51		195		153

Postretirement expense	$	258	$	257	$	774	$	771

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 nine months ended April 1, 2005, severance costs of $23 were paid under the restructuring plan. We also reduced the restructuring liability related to contractual obligations under a canceled lease as we finalized negotiations with the lessor.

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 April 1, 2005:


	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		(1,007	)		(23	)		(1,030	)
Adjustments		(307	)		—			(307	)

Balance at April 1, 2005	$	10		$	—		$	10

Since the initiation of these restructurings, we have incurred expenses of $5,898 from the write-off of fixed assets, $6,531 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				Nine Months Ended
	April 1, 2005		April 2, 2004		April 1, 2005		April 2, 2004
Depreciation expense	$	11,465	$	10,296	$	34,538	$	32,628
Amortization expense:
Intangible assets		3,819		3,917		11,397		11,336
Capitalized software		2,821		2,446		8,414		6,434
Premiums on short-term investments		1,831		2,022		6,037		6,054

Total	$	19,936	$	18,681	$	60,386	$	56,452

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 generally 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 April 1, 2005 consisted of $16,654 in Accrued liabilities and $26,843 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 April 1, 2005:


Accrued warranty at July 2, 2004	$	36,233
Reductions for payments		(15,481	)
Additions for warranties issued during the period		19,276
Other adjustments		3,469

Accrued warranty at April 1, 2005	$	43,497

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 $59,000 of undistributed earnings of foreign subsidiaries; however, this amount may be adjusted based on changes in business, economic or other conditions. At April 1, 2005, approximately $34,000 of such undistributed earnings had been indefinitely reinvested.

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 nine 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 November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of ARB No. 43, Chapter 4.” SFAS No. 151 requires that abnormal amounts of idle facility expense, freight, handling costs, and spoilage, be charged to expense in the period they are incurred rather than capitalized as a component of inventory costs. SFAS No. 151 is effective for inventory costs incurred in fiscal periods beginning after June 15, 2005. The adoption of this standard may result in higher expenses in periods where production levels are lower than normal ranges of production. Because actual future production levels are subject to many factors, including demand for our products, we cannot determine if the adoption of SFAS No. 151 will have a material impact on future results of operations.

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 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 results 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. 123 in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123R 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 $3,486 and $17,208 for the nine months ended April 1, 2005 and April 2, 2004, respectively.

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The FASB also recently issued FSP No. 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. 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. 109-1, the deduction will be treated as a “special deduction” as described in SFAS No. 109, “Accounting for Income Taxes.” 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. 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 $1,000. 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 April 1, 2005 were $489.5 million, an increase of 12 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 (HD) functionality, and cable modems. Gross margins of 36.9 percent were unchanged from the prior year. Operating expenses increased $3.3 million due primarily to incremental hiring of engineers related to new set-top designs. Net earnings for the three months ended April 1, 2005 of $61.7 million were $7.8 million higher than the prior year driven primarily by the higher sales volume in the third 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. We continued negotiations in the third quarter of fiscal year 2005; however, no final agreement has been reached. 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 $2.0 billion and cash on hand was $404.0 million at April 1, 2005. Cash provided by operating activities for the nine months ended April 1, 2005 of $278.7 million included net earnings of $176.3 million and depreciation and amortization of $60.4 million. Reductions in accounts receivable and inventory contributed $16.1 million and $17.4 million, respectively, to cash provided by operating activities. During the nine months ended April 1, 2005, 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 sources of cash provided by operating activities were offset in part by a reduction in accrued liabilities of $14.6 million primarily due to the payment of fiscal year 2004 incentives on performance-based plans.

During the nine months ended April 1, 2005, we acquired property, plant and equipment for $67.9 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 6.4:1 at April 1, 2005, up from 5.6:1 at July 2, 2004. At April 1, 2005, we had debt of $8.4 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 and short-term investment balances, and our available senior credit facility will be sufficient to support operations.

RESULTS OF OPERATIONS

Sales of subscriber products for the quarter ended April 1, 2005 increased 18 percent from the prior year’s third quarter to $375.3 million. The year-over-year increase was due to the mix shift toward higher-end digital set-top products and higher sales of cable modems, partially offset by lower selling prices for all set-top models. In the third quarter of fiscal year 2005, we sold 1,099 thousand Explorer digital set-tops as compared to 997 thousand in the prior year. The 1,099 thousand digital set-tops sold included 496 thousand dual-tuner Explorer 8000 DVR (digital video recorder) set-tops, an increase from 307 thousand sold during the third quarter of the prior year. Of the total of 496 thousand Explorer 8000 DVR set-tops sold, 263 thousand were Explorer 8000HD DVR set-tops. We sold a total of 436 thousand HD set-tops, including the Explorer 8000HD DVR set-tops, during the third quarter of fiscal year 2005, up from 198 thousand HD set-tops in the comparable period of the prior year. During the third quarter of fiscal year 2005, we also sold 622 thousand WebSTAR^™ cable modems, up from 399 thousand in the prior year. This included sales of voice modems, which exceeded 250 thousand during the quarter. No such modems were sold in the comparable period of the prior year.

Sales of transmission products during the quarter ended April 1, 2005 totaled $114.2 million, a decline of 4 percent from the comparable period of the prior year. Sales to customers in our North America region declined, but were partially offset by an increase in sales to customers in both Europe and Latin America.

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International sales in the third quarter of fiscal year 2005 were $101.8 million, an increase of 24 percent from the comparable period of the prior year. Compared with last year’s third quarter, sales increased in all of our geographic regions except for Asia, where sales were flat.

At times, our customers will require testing of our products by their test laboratories prior to acceptance of our products. One of our set-top products has been deployed by some customers in Japan; however, we have not completed the acceptance process with one customer. We will continue to work closely with that customer on a plan to meet their product requirements and to achieve completion of their acceptance process. If we are unable to achieve acceptance, we may incur additional costs to rework these set-tops, whose design is unique to this customer, in order to sell them to other customers and/or incur charges to reduce the carrying value of these set-tops to net realizable value.

Sales for the nine months ended April 1, 2005 were $1,383.9 million, up 11 percent from $1,249.2 million in the first nine months of the prior year. Sales of subscriber products were $1,036.0 million, an increase of 16 percent from the prior year. We sold approximately 3.0 million digital set-tops during the nine months ended April 1, 2005, compared to approximately 2.9 million during the first nine months of the prior fiscal year. Included in the approximately 3.0 million digital set-tops sold were more than 1.3 million Explorer 8000 DVR set-tops, an increase from approximately 744 thousand shipped during the nine months ended April 2, 2004. Of the 1.3 million Explorer 8000 DVR set-tops sold, approximately 605 thousand were Explorer 8000HD DVR set-tops. We sold a total of 981 thousand HD set-tops, including the Explorer 8000HD set-tops, during the nine months ended April 1, 2005, up from 359 thousand HD set-tops in the comparable period of the prior year. During the nine months ended April 1, 2005, we also sold 1.5 million WebSTAR cable modems, up from 916 thousand in the comparable period of the prior year. Sales of transmission products were $347.8 million, a decline of 3 percent from the first nine months of last year. International sales totaled $316 million, an increase of 24 percent from last year. The increase from the prior year was due primarily to an increase in shipments to customers in all of our geographic regions except for Asia, which was down from the first nine months of last year.

Gross margin was 36.9 percent of sales for the three months ended April 1, 2005, flat compared to the comparable quarter of the prior year. The negative impact of declines in the average selling prices of products was offset by the favorable impact of the increase in sales volume, procurement savings, our continuing efforts in engineering design, and improved efficiencies in manufacturing. 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.

Gross margin was 36.9 percent of sales for the nine months ended April 1, 2005, down 0.4 percentage points from 37.3 percent reported during the first nine months of last year. The decline was related to the reduction in the average selling prices of products coupled with a shift to a higher mix of the Explorer 8000 DVR digital set-tops, which historically have had a lower gross margin than the company average. The negative impact of these items was partially offset by the benefits received from the increase in volume, procurement savings, our continuing efforts in engineering design, and improved manufacturing efficiencies. Currently, DVR margins approximate the average margin of our other digital set-tops.

Research and development expenses for the three and nine months ended April 1, 2005 were $42.8 million and $119.0 million, respectively, up ten percent and eight percent, respectively, 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 $51.6 million and $148.2 million in the three and nine months ended April 1, 2005, respectively, were flat compared to the comparable periods of the prior year.

Interest income of $8.0 million and $20.5 million in the three and nine months ended April 1, 2005, 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.

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Other expense of $1.2 million for the three months ended April 1, 2005 included a charge of $2.8 million from the other-than-temporary decline in the fair value of an investment in a privately-held company. This charge was partially offset by a gain of $1.6 million from the reversal of reserves related to claims against a company we acquired following a favorable court ruling.

Other expense of $2.1 million for the nine months ended April 1, 2005 included losses on short-term investments and from the other-than-temporary decline in the fair value of another 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 for the quarter ended April 2, 2004 of $4.6 million included a gain of $2.2 million from the sale of a marketable security and various other items which resulted in additional income, none of which was individually significant.

In addition to the gain on the sale of a marketable security, other income of $5.9 million for the nine months ended April 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 second quarter of fiscal year 2003, foreign exchange gains, gains 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 million had previously been reserved for. In addition to the gains from the sales of marketable securities discussed above, other income for the nine months ended April 2, 2004 included a gain of $1.9 million from the sale of another 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 $93.1 million and $261.1 million in the three and nine months ended April 1, 2005, 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 three months ended April 1, 2005 was 34 percent of pre-tax earnings, up from 32 percent in the prior year. The lower rate in fiscal year 2004 was due primarily to changes in various estimates in the quarter after completing and reconciling the fiscal year 2003 U.S. federal income tax return to the fiscal year 2003 federal income tax provision.

The effective tax rate for the nine months ended April 1, 2005 was 33 percent of pre-tax earnings, down from 34 percent in the prior year. The effective rate for the nine months ended April 1, 2005 was 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 $59.0 million of undistributed earnings of foreign subsidiaries; however, this amount may be adjusted based on changes in business, economic or other conditions. At April 1, 2005, approximately $34.0 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 $1 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.

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Under the guidance in FSP No. 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.

Critical Accounting Policies

Note 1 to the Consolidated Financial Statements in our 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.

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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.

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

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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 $43.5 million and $36.2 million at April 1, 2005 and July 2, 2004, respectively. A rollforward of the warranty liability from July 2, 2004 to April 1, 2005 is included in Note J in this Form 10-Q.

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. 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, “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. 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 $3.0 million and $6.5 million were included in Other assets in the Consolidated Statements of Financial Position at April 1, 2005 and July 2, 2004, respectively.

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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.

Pro forma stock-based compensation expense, net of tax, was $22.2 million and $29.7 million for the nine months ended April 1, 2005 and April 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.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs,” an Amendment of ARB No. 43, Chapter 4.” SFAS No. 151 requires that abnormal amounts of idle facility expense, freight, handling costs, and spoilage, be charged to expense in the period they are incurred rather than capitalized as a component of inventory costs. SFAS No. 151 is effective for inventory costs incurred in fiscal periods beginning after June 15, 2005. The adoption of this standard may result in higher expenses in periods where production levels are lower than normal ranges of production. Because actual future production levels are subject to many factors, including demand for our products, we cannot determine if the adoption of SFAS No. 151 will have a material impact on future results of operations.

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 results 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. 123 in prior periods, the impact of that standard would have approximated the impact of SFAS No. 123R 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 $3.5 million and $17.2 million for the nine months ended April 1, 2005 and April 2, 2004, respectively.

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income tax return. FSP No. 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 $1 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.

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 April 1, 2005 were as follows:


	Euros		Canadian Dollars	UK Pounds
Notional amount of forward buy (sales) contracts	(9,212	)	7,800	(5,280	)
Average contract amount (Foreign currency/United States dollar)	0.77		1.24	0.54

At April 1, 2005, we had unrealized losses of $317, net of tax benefits of $203, 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 nine months ended April 1, 2005 and April 2, 2004, we recorded losses of $41 and gains of $110, 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 losses of $5 and gains of $1,028 in the first nine months of fiscal year 2005 and 2004, respectively. Realized gains and losses and declines in value judged to be other-than-temporary are included in Other (income) expense. We recorded realized gains of $4,496 on the sale of non-current marketable securities in the first nine months of fiscal year 2004. No such gains or losses were recorded in the first nine months of fiscal year 2005. We recorded no losses in the first nine 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 nine months of fiscal years 2005 and 2004, we recorded unrealized losses of $55 and $236, 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 $3,489 and $1,831 in the first nine 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 $2,976 and $6,464 were included in Other assets in the Consolidated Statements of Financial Position at April 1, 2005 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 third 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. Adelphia has agreed to a tentative settlement with the Justice Department and the SEC. 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. The SEC has taken testimony from certain company officers and employees. 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.

As previously disclosed, there are five civil actions that relate to, among other issues, the marketing support agreement between Scientific-Atlanta and Adelphia. These suits have now all been transferred to the MDL proceeding in the U.S. District Court for the Southern District of New York (03MD1529(LLM)).

As previously disclosed, the plaintiffs in a securities class action against Charter and other defendants added Scientific-Atlanta as a defendant in connection with allegations concerning certain marketing support transactions with Charter. The trial court dismissed Scientific-Atlanta as a defendant, and the plaintiffs have appealed that ruling.

Class Action-Related Legal Proceedings

In the Thompson derivative suit, plaintiffs are appealing the dismissal of the complaint with prejudice.

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 and third quarters 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 fourth 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 fourth 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. With respect to the pending cases themselves, the multi-district patent and antitrust proceedings, and the Scientific-Atlanta patents proceeding were administratively closed by the Atlanta federal court on March 31, 2005, with leave to re-open the cases at any time upon notice to the court.

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PMC Media Communications Proceeding

On March 28, 2002, Personalized Media Communications, LLC (PMC) filed a patent infringement action against Scientific-Atlanta in the U.S. District Court for the Northern District of Georgia. PMC seeks an injunction and unspecified monetary damages. On August 5, 2002, we filed a motion to join Gemstar. The court granted that motion and Gemstar was added to the case. Discovery is ongoing and a “Markman” hearing relating to claim construction of the PMC patents took place in February 2004.

On March 1, 2005, the special master issued a report and recommendation on claim construction. The parties have filed their objections. The court has not yet issued its order on claim construction.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.

During the three months ended April 1, 2005, no purchases of our common stock were made by or on behalf of Scientific-Atlanta.

In February 2003, we announced a program to buy back up to 10,000,000 shares of our common stock. Purchases of our common stock during the second quarter of fiscal year 2005 were made under this plan. As of April 1, 2005, 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 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

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: May 10, 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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EX-31.1 2 dex311.htm SECTION 302 CEO CERTIFICATION Section 302 CEO Certification

Exhibit 31.1

CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002

I, James F. McDonald, the Chief Executive Officer of Scientific-Atlanta, Inc., certify that:

1.	I have reviewed this quarterly report on Form 10-Q for the quarter ended April 1, 2005 of Scientific-Atlanta, Inc.;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(c)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 10, 2005


		/s/ JAMES F. MCDONALD
Name:		James F. McDonald
Title:		Chairman of the Board, President and Chief Executive Officer

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EX-31.2 3 dex312.htm SECTION 302 CFO CERTIFICATION Section 302 CFO Certification

Exhibit 31.2

CERTIFICATIONS OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE

SARBANES-OXLEY ACT OF 2002

I, Julian W. Eidson, the Chief Financial Officer of Scientific-Atlanta, Inc., certify that:

1.	I have reviewed this quarterly report on Form 10-Q for the quarter ended April 1, 2005 of Scientific-Atlanta, Inc.;

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

(a)

(b)

(c)

5.	The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions);

(a)

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: May 10, 2005


		/s/ JULIAN W. EIDSON
Name:		Julian W. Eidson
Title:		Senior Vice President, Chief Financial Officer and Treasurer

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EX-32.1 4 dex321.htm SECTION 906 CEO CERTIFICATION Section 906 CEO Certification

EXHIBIT 32.1

CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 906 OF THE

SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report on Form 10-Q for the quarter ended April 1, 2005 (the “Report”) filed by Scientific-Atlanta, Inc. (the “Company”) with the Securities and Exchange Commission, I, James F. McDonald, the Chief Executive Officer of the Company, pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) hereby certify that to the best of my knowledge:

•

the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

•

the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


		/s/ JAMES F. MCDONALD
Name:		James F. McDonald
Date:		May 10, 2005

This certification accompanies the Report pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not, except to the extent required by the Sarbanes Oxley Act of 2002, be deemed filed by Scientific-Atlanta for purposes of Section 18 of the Securities Exchange Act of 1934, as amended.

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EX-32.2 5 dex322.htm SECTION 906 CFO CERTIFICATION Section 906 CFO Certification

EXHIBIT 32.2

CERTIFICATIONS OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 906 OF THE

SARBANES-OXLEY ACT OF 2002

In connection with the quarterly report on Form 10-Q for the quarter ended April 1, 2005 (the “Report”) filed by Scientific-Atlanta, Inc. (the “Company”) with the Securities and Exchange Commission, I, Julian W. Eidson, the Chief Financial Officer of the Company, pursuant to Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350) hereby certify that to the best of my knowledge:

•

the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

•

the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


		/s/ JULIAN W. EIDSON
Name:		Julian W. Eidson
Date:		May 10, 2005

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EX-99.1 6 dex991.htm CAUTIONARY STATEMENTS Cautionary Statements

EXHIBIT 99.1

CAUTIONARY STATEMENTS

General

From time to time, Scientific-Atlanta may publish, verbally or in written form, forward-looking statements relating to such matters as anticipated financial or operational performance, business prospects, technological developments, new products, research and development activities and similar matters. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. These Cautionary Statements are being made pursuant to the provisions of the Private Securities Litigation Reform Act and with the intention of obtaining the benefits of the “safe harbor” provisions of the Act.

This Form 10-Q (or any other periodic reporting documents required by the Exchange Act) may contain forward-looking statements reflecting our current views concerning potential future events or developments. The words “may,” “will,” “should,” “could,” “continue,” “future,” “potential,” “believe,” “expect,” “anticipate,” “project,” “plan,” “intend,” “seek,” “estimate,” “predict” and similar expressions identify forward-looking statements. We caution investors that any forward-looking statements made by us are not guarantees of future performance and that a variety of factors, including those discussed below, could cause our actual results and experience to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. We describe in more detail below the risks and uncertainties which may affect the operations, performance, development and results of our business. We caution readers not to place undue reliance on any such forward-looking statement, which speak only as of the date the statement was made.

Dependence on Principal Product Line. Sales of our Explorer digital set-tops constituted approximately 62 percent, 56 percent and 52 percent of Scientific-Atlanta’s total sales in fiscal years 2004, 2003 and 2002, respectively. In the first nine months of fiscal year 2005, we sold 3.0 million Explorer digital set-tops. At April 1, 2005, backlog contained orders for more than 1.3 million Explorer digital set-tops. We expect that sales of our Explorer set-tops will continue to account for a significant portion of our revenues for the foreseeable future. As a result, our financial performance will continue to depend in significant part on:

•

whether there will be continued market acceptance of the Explorer digital set-top, including high-end set-tops with digital video recorder and/or high-definition television capabilities,

•

the development and timing of the introduction of hardware features and/or software applications for the Explorer network,

•

the average selling price for Explorer digital set-tops,

•

the gross margins on our digital set-top products, and

•

our ability to continue to design cost-reduced Explorer set-tops.

Our sales are affected by the average selling prices for Explorer digital set-tops. The Explorer 8000 set-tops (which contain integrated hard drives and a single user interface for digital video recording capabilities) and high-definition television set-tops currently sell for significantly higher average selling prices than the average sales prices for our earlier generation set-top models. The selling prices of digital set-top models declined on average by approximately ten percent in the first nine months of fiscal year 2005 as compared to the first nine months of fiscal year 2004. We are currently designing high-end Explorer set-tops with new features, such as the Explorer set-top with a DVD burner. However, there can be no assurance that a high-end Explorer set-top with new features will sell for a significantly higher price than our earlier generation set-top models, and there is no assurance that we will be able to continue to introduce new features to the Explorer digital set-top that the market would accept at a significantly higher price. Although the price of individual models of digital set-tops may decline in the future, the combined average selling prices of digital set-tops in any one quarter will vary based on the mix of models sold during the period. As a result, the mix of models of Explorer set-tops sold during a fiscal period, which we cannot predict, can affect our sales for that fiscal period.

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Our results of operations are affected by the gross margins on Explorer digital set-tops. Gross margins on newly introduced products are typically lower than the average margins for our products. We continue to attempt to improve gross margins on our digital set-top products through cost reductions from product design, procurement and manufacturing. Currently, margins on set-tops with DVR functionality approximate the average margin of our other digital set-tops. However, the introduction of new features with respect to the Explorer digital set-top, such as an Explorer set-top with a DVD burner, may affect our ability to improve gross margins on these digital set-top models in the future. As a result, the mix of models of Explorer set-tops sold during the quarter, which we cannot predict, can affect our results of operations for that quarter.

Our sales and results of operations for a fiscal period may also be affected by our product mix generally. For example, the year-to-year increase in sales of subscriber products during the third quarter of fiscal year 2005 was partly due to higher sales of cable modems, which have a lower gross margin that the company average margin. In the third quarter, the company sold 1.099 million Explorer digital set-tops and 622 thousand WebSTAR^™ cable modems. The mix of business, such as third party product sales or higher content of service in contracts, might also affect our sales and results of operations.

Uncertainties Related to Our Markets. There are currently two fundamental changes in the way end-user consumers watch television. Those two changes are the shift from analog television to high-definition television, and the shift from broadcast programming to on-demand programming. Our success is dependent upon the acceptance of (1) network-based services, such as digital cable, high-definition television services, high-speed data services, video-on-demand, voice over IP and/or IP television; and (2) device-based features, such as digital video recorders and removable media features, by end-user consumers, and purchases by our customers of our products and services to satisfy such consumer demand. High-definition television and digital video recording (DVR) continue to be the trends that drive our subscriber business. In addition, digital cable and high-speed data services have a significant impact on our business. During first nine months of fiscal year 2005, we sold 1,342,000 set-tops with digital video recording capability (DVR), including 737,000 units of the standard-definition model and 605,000 units with high definition DVRs. Together with the high-definition DVRs mentioned previously, we sold 981,000 high-definition set-tops during the first nine months of fiscal year 2005. Our sales and results of operations could be materially adversely affected by the failure of these services or our products to:

•

help our customers effectively compete against other service providers, such as direct broadcast satellite (DBS) service providers and wireless television providers;

•

appeal to enough end-user consumers;

•

be available at prices consumers are willing to pay;

•

function as expected; or

•

be delivered in a timely fashion by our cable operator customers to consumers.

The sale of these products and services is an evolving business, and therefore there are many characteristics of this business that are not yet fully known by us. These characteristics include:

•

the extent to which demand for our products and services will be variable,

•

sensitivity to the economy,

•

consumer demand for various types of interactive applications,

•

the proper pricing levels and models for various applications,

•

the level of penetration of digital services into the subscriber base,

•

the number of digital set-tops per household,

•

the customer churn rate to be expected,

•

the extent to which digital cable interactive services will successfully compete against DBS service providers,

•

rapid changes in technology that create opportunities for us to innovate and for our customers to provide new services to customers, and

•

international demand for the products.

Dependence on Key Customers. Although the domestic cable television industry is comprised of thousands of cable systems, a small number of MSOs own a large portion of the cable television systems and account for a significant portion of the capital expenditures made by cable television system operators. Historically, a significant majority of our sales have been to relatively few customers, who have served North American markets. Customers that accounted for 10 percent or more of our total sales in fiscal years 2004, 2003 or 2002 were as follows:


	2004		2003		2002
Time Warner Inc.	19	%	21	%	25	%
Cablevision Systems Corporation	15	%	19	%	—	%
Comcast Corporation	11	%	11	%	7	%
Cox Communications, Inc.	9	%	6	%	12	%
Charter Communications, Inc.	6	%	5	%	14	%
All other customers	40	%	38	%	42	%

Total	100	%	100	%	100	%

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Prior year percentages for Time Warner have been adjusted to reflect the deconsolidation by Time Warner of a partnership in a cable television operator.

Accounts receivable at July 2, 2004 included $69.0 million from customers who accounted for 10 percent or more of our total sales in fiscal year 2004.

A failure to maintain our relationships with customers that make significant purchases of our products and services could harm our business and results of operations. A decline in revenue from one of our key customers or the loss of a key customer could have a material adverse effect on our business and results of operations.

Industry Consolidation and Acquisitions. There has been a trend toward consolidation in the cable television industry. Comcast completed its combination with AT&T Broadband during November 2002. In April 2005, Time Warner and Comcast reached an agreement to acquire certain assets of Adelphia Communications. Adelphia accounted for 7 percent, 5 percent and 7 percent of our sales during fiscal years 2004, 2003 and 2002, respectively. We believe that a trend toward industry consolidation, particularly in the North American MSO base, may continue as companies attempt to strengthen or hold their market positions in an evolving industry. Industry consolidations could adversely affect our sales and results of operations. In addition, cable system consolidations, such as the sale of Adelphia systems to Time Warner and Comcast, may result in a delay or acceleration in capital spending by these customers.

Bookings Tend to be Highly Variable. Bookings are orders received by Scientific-Atlanta that are eligible for inclusion in backlog. In general, Scientific-Atlanta’s policy is to place in its backlog firm orders for product scheduled for shipment within six months from the end of the reported quarter. Our bookings and sales, and consequently backlog, are affected by uncertainties relating to plans and commitments of our major customers, and changes in order patterns of our major customers. Bookings from our major customers generally tend to be highly variable within a quarter, and they often vary considerably from one quarter to the next. Historically, many of our major customers establish their budgets on a calendar year basis and until they set those budgets they tend to hold orders. As a result, we believe that short-term measurements of new order activity are often less useful than longer-term measurements that span several quarters. Also, a significant decline in backlog may adversely affect our sales and results of operations. In addition, although we have established controls for a highly variable business environment, due to the reasons described above, we are unable to predict with any certainty the timing of bookings or sales or the level of backlog.

Dependence on the General Business and Economic Condition of the Cable Television Industry and Cable Television Capital Spending. The majority of our revenues come from sales of systems and equipment to the cable television industry. Demand for these products depends primarily on capital spending by cable television system operators for constructing, rebuilding or upgrading their systems and/or providing new subscriber services. There can be no assurance that cable television capital spending will increase from historical levels, that existing levels of cable television capital spending will be maintained, or that cable operators will allocate their limited capital spending to uses that are of the greatest benefit to Scientific-Atlanta. The amount of capital spending in the cable television industry, and, therefore, our sales and profitability, have been, and in the future may be, affected by a variety of factors, including:

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the financial condition of domestic and international cable television system operators and distributors, and their access to financing, which may be adversely affected by increases in interest rates,

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declines in capital spending by our customers if credit markets tighten and customer credit ratings are lowered,

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delays in capital spending due to cable system consolidation or restructuring of the cable television industry,

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technological developments that impact the deployment of equipment, and

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new legislation and regulations, or regulatory uncertainties, affecting the equipment used by cable television system operators and their customers, such as uncertainties related to government regulation of basic cable or equipment rates or other terms of “digital must-carry,” “forced access,” “plug and play,” common carrier and other requirements of the Federal Communications Commission (FCC) and other regulatory bodies.

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In addition, the amount of capital spending in the cable television industry and our financial performance may be affected by the ability of cable television system operators to compete against telephone companies offering video programming, direct broadcast satellite service providers offering digital video recorder capabilities, wireless television providers and providers of high-speed data transmission. Telephone companies may have significantly greater resources, financial and otherwise, than cable television system operators.

Ability to Broaden Our Customer Base for Our Technology. Our future financial performance will depend in significant part on our ability to broaden our customer base. We believe that technology will continue to provide opportunities for new products and new markets. Cable companies, telephone companies, computer companies and consumer electronics makers are competing to provide the next generation of high tech entertainment, a home network that takes advantage of the convergence of computing, communications and entertainment. Telephone companies, including SBC Communications Inc. and Verizon Communications Inc., have announced that they are planning to invest billions of dollars to deliver broadcast and on-demand programming over their networks. We have announced that SBC has awarded Scientific-Atlanta a multi-year contract with an estimated value of up to $195 million to provide IP-based video equipment, including advanced encoders, for their Project Lightspeed. Through this initiative, SBC plans to expand its fiber-optic network to deliver a variety of services, including switched digital television. In the third quarter, Scientific-Atlanta booked orders totaling $22.0 million related to Project Lightspeed, which the company expects to ship over the next six months. Our SBC bookings, including services bookings, are dependent on the successful rollout of SBC’s planned IPTV services on schedule. There can be no assurance that we will book the entire estimated value of $195 million related to the SBC contract.

Advances in technology and our innovative solutions are also allowing us to address opportunities to broaden our customer base for our digital set-top products. We have launched our “overlay” technology in a number of Time Warner systems. With the purchase of certain Adelphia assets by Time Warner, this could represent a significant expansion of our served market in North America. As we broaden our customer base and introduce new hardware features and/or software applications for the Explorer network, we may incur additional research and development and other expenses that are not incurred in the same period as the revenue they may ultimately generate. These expenses could adversely affect our financial condition and results of operations.

Rapid Changes in Technology and New Product Introductions. The markets for our products are characterized by rapidly changing technology, evolving industry standards, frequent new product introductions and evolving methods of building and operating networks. Our future operating results may be adversely affected if we are unable to continue to develop, manufacture and market innovative products and services that meet customer requirements for performance and reliability on a timely basis. The process of developing our new high technology products is inherently complex and uncertain.

The success of our existing and future products is dependent on several factors, including proper product definition, acceptable product cost, timely completion and introduction of new products, differentiation of new products from those of our competitors and market acceptance of these products. If our products are not updated to incorporate in a timely manner the latest technology to service providers, including but not limited to frequent silicon chip innovations, disk drive improvements, DVD drive capabilities, advanced encoding and signal processing, switched digital broadcast capabilities, rapid technology advancement in the fiber optics transport industry and software enhancements, features and capabilities, our products may become noncompetitive with respect to price and/or features, and our sales and results of operations may be adversely affected. In addition, our products are becoming increasingly complex at the device and system level due to rapid advances in technology.

We have in the past experienced delays in product development and introduction, and there can be no assurance that we will not experience further delays in connection with our current product development or future development activities. Delays in development, testing, manufacture and/or deployment of new products, including but not limited to new digital set-top products and encoder products, could adversely affect our sales and results of operations. In addition, there can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner and achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.

Sales and Implementation Cycles for our Solutions can be Lengthy. Our products are part of complex systems, and the sales cycles for these products can be lengthy. The sales and implementation process may involve a significant technical evaluation and commitment of capital and other resources by our customers. The sale and implementation of our products may be subject to delays due to our customers’ internal procedures for approving large capital expenditures and deploying new technologies. At times, our customers will require testing of our products by their test laboratories prior to acceptance of our products. In addition, as we introduce an increasing number of new products, in part due to rapidly changing technology, the testing resources of our customers may be constrained, and this may impact the timing of the acceptance of our products by our customers.

One of our set-top products has been deployed by some customers in Japan; however, we have not completed the acceptance process with one customer. Scientific-Atlanta worked closely with that customer during its third quarter on a plan to meet their

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product requirements and to achieve completion of their acceptance process. We have a plan to complete acceptance, but we are unable to control many factors that will influence whether our products will satisfy their testing criteria and other acceptance procedures, and these factors may have a material adverse effect on our business and results of operations. If we are unable to achieve acceptance, we may incur additional costs to rework these set-tops, whose design is unique to this customer, in order to sell them to other customers and/or incur charges to reduce the carrying value of the set-tops to net realizable value.

Dependence on Financial Stability of Customers and Distributors. Several of our customers, distributors and potential customers have encountered significant financial difficulties that have affected their ability to pay for product that has shipped, take delivery of orders they have previously placed or raise additional capital to fund the purchase of equipment and services. Certain of our MSO customers also have had significant amounts of debt. Customers with significant debt levels may have difficulty obtaining financing to fund planned capital expenditures. The difficulty of our customers to obtain such financing could have an adverse effect on our sales to these customers, which sales we are not able to predict. In addition, MSOs had been measured historically by the investment community on earnings before interest, taxes, depreciation and amortization (EBITDA). More recently, we believe the focus has shifted toward the point at which the MSOs will produce positive free cash flow, which is generally defined as EBITDA reduced by capital expenditures, interest and dividends. MSOs may reduce their capital spending and existing debt to improve free cash flow. Declines in capital spending by our customers may adversely affect our sales, which sales we are not able to predict.

Reliance on Suppliers. Our growth and ability to meet customer demands depend in part on the following factors, which may affect the operations, performance, development and results of our business:

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our ability to obtain timely deliveries of parts from our suppliers;

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the pricing and availability of equipment, materials and inventories;

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performance issues with key suppliers and subcontractors; and

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financial condition of suppliers.

From time to time, we could experience shortages of certain electronic components from our suppliers, and these shortages may have a material effect on our operations. Certain of the components contained in our products are custom components, such as silicon semiconductor products and lasers that can be supplied only by a sole vendor that may concentrate the manufacture of such component in only one location. A reduction, delay or interruption in supply or a significant change in price of one or more of these components could adversely affect our business, operating results and financial condition. In addition, improvements in our results of operations are, in part, dependent on our ability to maximize material costs savings in order to outpace set-top price reductions.

Suppliers that are significant to our business include vendors who provide us with parts that are critical to delivery of our principal products and vendors who provide us with material amounts of supplies. Significant suppliers include the following:

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STMicroelectronics, Intel Corporation, Analog Devices, Inc., Advanced Micro Devices, and Broadcom Corporation are our primary suppliers of a variety of semiconductor products (including ASICs), which are used as components in an array of products, including set-tops;

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Microtune is our primary supplier of silicon tuners for our subscriber products;

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Anadigics, Inc. is a provider of CATV integrated circuits for use in our RF distribution products;

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Infineon Technologies North America Corporation is the sole provider of the QPSK receiver device for certain of our Explorer models;

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JDS Uniphase and Emcore Corporation are our primary suppliers of optical transmitters;

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Microcast, Inc. and Shanghai Skyrock Industry are our primary suppliers of die-castings for our RF distribution products;

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Philips Semiconductors B.V. and Freescale Semiconductor, Inc. (formerly part of Motorola, Inc.) are our primary providers of cable television hybrids for use in our RF distribution products and subscriber products;

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Askey Corporation and ASUSTek Computer, Inc. are our suppliers of cable modem products;

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Maxtor Corporation and Western Digital Corporation are our providers of hard drives;

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Matsushita Electronics Components Corporation of America and its affiliates are our primary suppliers of “canned” tuners and RF modulators for subscriber products; and

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Cablevision Electronics Co., Ltd. and Zinwell Corporation are our primary suppliers of taps, and we also are part of a joint venture in Shanghai, China that provides us with taps. During the fourth quarter of fiscal year 2005, we reached agreement with all of the other partners in the Shanghai joint venture to purchase all of their interests in it, subject to regulatory and certain other closing conditions.

Concentration of Manufacturing. Our key manufacturing facilities are located in Juarez, Mexico and Kortrijk, Belgium. Currently, greater than 90 percent of our in-house manufacturing is being performed in our Juarez facility. At full operation, the Juarez factory has the capability to run three shifts during the week and additional weekend shifts, if needed. During fiscal year 2005, we ran a third shift and weekend shifts on certain products to satisfy product demand and to meet production schedules. Due to our concentration of manufacturing in Juarez, we have considered appropriate business continuity and disaster recovery plans. However, we are unable to predict the impact on our results of operations, which may be materially adverse, of any type of disaster at this facility.

We manufacture nearly all of our Explorer set-top boxes at the Juarez facility, and as we shift our product mix to higher end set-tops, such as the digital video recorders and high-definition television models, vertically integrate components and use finer-pitch placement technologies, we have upgraded and may continue to upgrade equipment at this facility. Additionally, as this mix shift occurs our overall capacity has been and may continue to be impacted. For example, as of April 1, 2005, using the current mix of products and current manufacturing configuration during the third quarter of fiscal year 2005, the Juarez facility maximum capacity was approximately 1.2 million Explorer set-top units per quarter. We believe that we could increase this capacity by approximately ten percent with the addition of additional shifts. We are unable to predict our set-top product mix and our ability to increase capacity in both amount of the increase and timing of the increase. Additionally, improvements in our results of operations are, in part, dependent on our ability to minimize conversion costs in order to outpace set-top price reductions.

International. The economic and other conditions in various geographic regions have impacted and are expected to continue to impact our sales and results of operations as follows:

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We have made significant sales to customers outside the United States. International sales were 20 percent, 22 percent and 20 percent of total sales in fiscal years 2004, 2003 and 2002, respectively.

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We have and will continue to have significant international operations. Our key manufacturing facilities are located in Juarez, Mexico and Kortrijk, Belgium. We now perform greater than 90 percent of our in-house manufacturing in our Juarez, Mexico facility. Additionally, our business and results of operations may be affected by foreign currency fluctuations in the euro and the peso.

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A majority of the parts and products that we obtain from outside suppliers are obtained from suppliers in the Asia-Pacific region.

As a result, our future sales and results of operations could be adversely affected by a variety of political, economic and other factors in various geographic regions, including foreign currency fluctuations, changes in a specific country’s or region’s political conditions or changes or continued weakness in economic conditions, trade protection measures, import or export licensing requirements or policies, global trade policies, the overlap of different tax structures, unexpected changes in regulatory requirements, health epidemics and earthquakes.

Competition. Our products compete with those of a substantial number of companies worldwide. Our Explorer digital set-tops, digital headends, and related software products compete with products from a number of companies. These include:

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Companies that develop and sell substitute products that are distributed by DBS service providers through a variety of channels, including retail channels. These products may be subsidized by DBS operators, and they may be sold together with services that are not available from cable operators. Although these products are not directly competitive with respect to sales of our products to our MSO customers, these substitute products are competitive with our MSO customers’ cable services and products, and affect the end-user consumer demand for our products.

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Companies that develop and sell products entirely of their own design and companies that license technology from us. It is possible that some of these directly competitive products could be sold through retail channels, and thus, we may be subject to competition from a variety of companies with retail brands that are more familiar to consumers than ours. These competitors may include companies in the personal computer and consumer electronics industries.

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The FCC has mandated that digital tuners be incorporated into all television sets greater than 13 inches and all television receiving equipment such as VCRs and DVD players by July 1, 2007. Digital tuners were mandated for fifty percent of a manufacturer’s televisions greater than 36 inches starting July 1, 2004, and one hundred percent of televisions greater than 36 inches starting July 1, 2005. Fifty percent of a manufacturer’s television between 24 and 35 inches must include digital tuners starting July 1, 2005, with one hundred percent including such tuners effective July 1, 2006. Thus, television manufacturers are already integrating into their products some of the technology that also is available in our set-top products, and will be integrating such technology into most of their products by July 1, 2007.

On October 9, 2003, the FCC released rules for digital “plug and play” cable compatibility. The new rules generally follow, with some modification, the technical, labeling and encoding rules originally set forth in a December 19, 2002 Memorandum of Understanding (MOU) between various cable television and consumer electronics companies. The MOU contained both voluntary and inter-industry agreements and a package of regulatory proposals. The new rules will permit consumer electronics companies to manufacture television sets or other consumer electronics products with “plug and play” functionality for one-way digital cable services, including typical cable programming as well as premium services. Consumers with such television sets will need to obtain a security card also known as a CableCARD to be inserted in the television set in order to receive such cable services. In accordance with the FCC rules, we made available CableCARDs compatible with our Explorer set-top products and our PowerKey^{^®} encryption and conditional access system before July 1, 2004.

Related to the FCC “plug and play” rules, companies in a variety of businesses, including cable television, direct broadcast satellite, television and movie production, consumer electronics, retail, software products, and communications technology products, have held a series of meetings with the objective of establishing a standard for a two-way CableCARD. Such a device would enable consumers with compatible television sets or other consumer electronics products to receive services requiring two-way communications, such as interactive program guides, video-on-demand, subscription video-on-demand, and free on-demand services without a set-top. Consumers with such television sets would need to obtain a two-way CableCARD to be inserted in the television set or other consumer electronics equipment in order to receive such cable services. At this time, the FCC has not established a completion date for this effort, though it has mandated that various cable companies file reports with the FCC commencing August 1, 2005 and every ninety days thereafter, detailing CableCARD deployment and support thereof. The FCC further mandated that the NCTA and the Consumer Electronics Association file reports commencing August 1, 2005 and every sixty days thereafter on the progress of agreement on two-way plug and play and a software-based conditional access agreement.

Other companies may have developed an alternative method of providing conditional access on cable networks that proposes to encrypt only a portion of digital video stream. If this alternative conditional access method provides to be technologically and commercially feasible, it may be adopted by our customers.

Our cable modem products and our products that transmit signals from the cable operator to the end-user customer compete with products from a large number of companies.

Our products that are used by operators to process and transmit entertainment, information, and communications over their networks compete with products from a number of companies. These products increasingly conform to standards widely adopted in the information technology and telecommunications industries and, as a result, new competitors may enter the markets for these products.

In each of these current and future competitive scenarios, some of the competitors have significantly greater resources, financial and otherwise, than we do. We believe that our ability to compete in the industry has resulted from our marketing strategies, engineering skills, product features, product performance, ability to provide post-purchase services, ability to provide quality products at competitive prices, and broad coverage of the market by our sales personnel and the alternate channels of distribution we utilize.

Reliance on Employees. It may be difficult for us to recruit and retain the types of highly skilled employees that are necessary to remain competitive. Competition for key technical and engineering personnel in our industry is common. We believe that our future success depends in large part on our continued ability to hire, assimilate and retain qualified employees at all levels.

Acquisitions. Our industry is highly competitive, and as such, our growth is dependent upon market growth and our ability to enhance our existing products and services. Accordingly, one of the ways we may address the need to enhance products and services is through acquisitions of other companies, but future acquisitions may involve numerous risks, including the following: difficulties in integration of the operations, technologies and products of the acquired companies; the risk of diverting management’s attention from normal daily operations of the business; and the potential loss of key employees of the acquired company. Failure to manage growth effectively and successfully integrate acquisitions made by us could materially harm our business and operating results.

Compromise of Signal Security. Our MSO customers rely on our conditional access system to protect content they transport through our subscriber network and media networks systems. If the security of either system were compromised, we may be required to implement system countermeasures that may include distribution of equipment to prevent such compromise, which could have a material adverse effect on our results of operations.

Intellectual Property. We generally rely upon patent, copyright, trademark and trade secret laws to establish and maintain our proprietary rights in our technology and products. However, there can be no assurance that any of our proprietary rights will provide significant competitive advantage or will not be challenged, invalidated or circumvented. Other companies are filing and have filed

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patents with respect to digital video technology and these third parties may claim that the technology in our set-top boxes infringes their intellectual property rights. We diligently review the technology in our products to minimize exposure due to intellectual property infringement, but there can be no assurance that third parties will not claim that we have infringed their intellectual property. Third parties have claimed, and may claim in the future, that we have infringed their existing or future, intellectual property rights. Regardless of merit, any claims could be time-consuming, result in costly litigation, cause product shipment delays, or require us to enter into royalty or licensing agreements, any of which could seriously harm our business, financial condition, and results of operations. There can be no assurance that any required royalty or licensing agreements would be available, or available on terms acceptable to us. Additionally, there can be no assurance that we will prevail in any intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation. In the event an intellectual property claim against us were successful and we could not obtain a license on acceptable terms or license a substitute technology or redesign to avoid infringement, our business, financial condition, and results of operations could be seriously harmed. Even if we prevailed in litigation, the expense of litigation could be significant and could seriously harm our business, financial condition, and results of operations.

Stock Volatility and Stock Repurchases. The trading price of our common stock tends to be volatile. The stock market in general, and the market for technology companies in particular, has, from time to time, experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may significantly affect the trading price of our common stock, regardless of our actual operating performance. The trading price of our common stock could be affected by a number of factors, including: changes in expectations of our future financial performance; changes in securities analysts’ estimates (or the failure to meet such estimates); announcements of technological innovations; customer relationship developments; conditions affecting our targeted markets in general; and quarterly fluctuations in our revenue and financial results. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has been instituted. Such litigation is expensive, and legal expenses and settlements may adversely affect our results of operations.

In addition, in February 2003, we announced a program to buy back up to 10 million shares of our common stock. During the quarter ended December 31, 2004, we purchased 1,836,600 shares of our common stock at an aggregate cost of $50.7 million under this program. As of April 1, 2005, there were 7,604,700 shares available that may yet be purchased under the February 2003 stock repurchase plan. We expect to repurchase our common stock under this plan from time to time in the open market or in private transactions. Such repurchases are subject to market conditions and restrictions under the federal securities laws, including requirements under Rules 10b-5 and 10b-18 of the Securities Exchange Act of 1934.

Use of Estimates and Assumptions in Preparation of Financial Statements. 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. Changes in these estimates and assumptions could have a significant impact on our operating results. These risks are discussed in greater detail in Management’s Discussion and Analysis of Financial Condition and Results of Operations, Critical Accounting Policies.

Uncertain Legal Environment. We believe that we operate in an uncertain legal environment and that our legal environment is becoming increasingly litigious. Such litigation is expensive, and legal expenses and settlements may adversely affect our results of operations. For a description of legal matters, see generally Part II – Other Information, Item 1, Legal Proceedings.

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