<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 1996
COMMISSION FILE NUMBER 0-22202
PAIRGAIN TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0282809
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OF ORGANIZATION) IDENTIFICATION NO.)
14402 FRANKLIN AVENUE, TUSTIN, CALIFORNIA 92780-7013
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(714) 832-9922
(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
------ ------
THERE WERE 31,684,972 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE OF
$.0005 PER SHARE OUTSTANDING ON SEPTEMBER 30, 1996.
<PAGE> 2
PAIRGAIN TECHNOLOGIES, INC.
INDEX
Page
Part I Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at September 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Income for the
quarters and nine months ended September 30, 1996 4
and 1995
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 1996 and 1995 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 15
Part II. Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Defaults upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
<PAGE> 3
PART I: ITEM 1
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
--------- ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 39,828 $ 24,576
Short-term investments (Note 3) 51,283 31,149
Accounts receivable 20,692 13,044
Inventories (Note 4) 33,537 22,522
Other current assets and deferred taxes 4,686 4,870
--------- ---------
Total current assets 150,026 96,161
Property and equipment, net (Note 5) 9,354 6,402
Note receivable (Note 6) 2,708 2,708
Long-term investments (Note 7) 3,544 --
Other assets 73 55
--------- ---------
Total assets $ 165,705 $ 105,326
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other current liabilities $ 31,465 $ 11,395
Bank line of credit (Note 8) -- --
--------- ---------
Total current liabilities 31,465 11,395
Stockholders' equity (Notes 1 and 12):
Preferred stock, $.001 par value:
Authorized shares - 2,000,000; Issued
and outstanding shares - None -- --
Common stock, $.0005 par value:
Authorized shares - 60,000,000; Issued and
outstanding shares 31,684,972 and
30,354,534 at September 30, 1996 and
December 31, 1995, respectively 16 15
Additional paid-in capital 104,564 87,175
Deferred compensation (16) (82)
Unrealized gain on marketable securities 27 67
Retained earnings 29,649 6,756
--------- ---------
Total stockholders' equity 134,240 93,931
--------- ---------
Total liabilities and stockholders' equity $ 165,705 $ 105,326
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 4
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1995 1996 1995
------- ------- -------- --------
<S> <C> <C> <C> <C>
Revenues $54,609 $29,602 $142,359 $ 72,599
Cost of revenues 28,469 15,834 74,515 37,958
------- ------- -------- --------
Gross profit 26,140 13,768 67,844 34,641
------- ------- -------- --------
Operating expenses:
Research and development 5,000 2,804 13,096 7,565
Sales and marketing 4,686 2,736 12,768 6,827
General and administrative 2,596 1,769 7,347 4,857
------- ------- -------- --------
Total operating expenses 12,282 7,309 33,211 19,249
------- ------- -------- --------
Income from operations 13,858 6,459 34,633 15,392
Interest and other income, net 865 426 2,524 1,500
Gain on investments -- 56 -- 415
Unusual gain (loss) due to
unauthorized trading of
investments by third parties
(Note 9) -- 1,660 -- (25,114)
------- ------- -------- --------
Income (loss) before income 14,723 8,601 37,157 (7,807)
taxes
Provision for income taxes
(Note 10) 5,654 2,436 14,268 5,642
------- ------- -------- --------
Net income (loss) $ 9,069 $ 6,165 $ 22,889 $(13,449)
======= ======= ======== ========
PER SHARE DATA (Note 1):
Earnings (loss) per share $ 0.25 $ 0.18 $ 0.64 $ (0.47)
======= ======= ======== ========
Weighted average number of
common and common equivalent shares 36,368 34,102 35,893 28,730
======= ======= ======== ========
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
1996 1995
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 22,889 $(13,449)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 3,276 2,856
Gain on investments -- (415)
Unusual loss due to unauthorized trading of
investments by third parties -- 25,114
Change in operating assets and liabilities:
Accounts receivable (7,648) (1,500)
Inventories (11,015) (4,935)
Other current assets 203 435
Other assets (18) (42)
Accounts payable and other current liabilities 25,280 331
Federal income tax refund (Note 10) 6,900 --
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 39,867 8,395
-------- --------
Cash flows from investing activities:
Net purchases of short-term investments (20,873) (3,412)
Purchases of property and equipment (5,484) (5,064)
Purchases of long-term investments (3,544) --
Issuance of note receivable (Note 6) -- (1,354)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (29,901) (9,830)
-------- --------
Cash flows from financing activities:
Payments on bank line of credit -- (1,000)
Proceeds from issuance of common stock 5,286 14,669
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 5,286 13,669
-------- --------
Increase in cash and cash equivalents 15,252 12,234
Cash and cash equivalents at beginning of period 24,576 711
-------- --------
Cash and cash equivalents at end of period $ 39,828 $ 12,945
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid $ -- $ 18
======== ========
Income tax paid $ 149 $ 5,028
======== ========
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE> 6
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES
PairGain Technologies, Inc., (the "Company") designs, manufactures,
markets and supports a comprehensive line of digital telecommunications products
that enable telecommunication exchange carriers and private networks to more
efficiently provide high speed digital service to end users over the large
infrastructure of unconditioned copper wires.
INTERIM PERIOD ACCOUNTING POLICIES
In the opinion of the Company's management, the accompanying unaudited
condensed consolidated financial statements contain all normal recurring
adjustments necessary to present fairly the financial position as of September
30, 1996, and consolidated results of operations for the three and nine months
ended September 30, 1996, and September 30, 1995, and cash flows for the nine
months ended September 30, 1996, and September 30, 1995. Results of operations
for the three and nine months ended September 30, 1996, are not necessarily
indicative of results to be expected for the full year ending December 31, 1996.
Although the Company believes that the disclosures in the accompanying
financial statements are adequate to make the information presented not
misleading, certain information and footnote information normally included in
financial statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted pursuant to the rules and regulations
of the Securities and Exchange Commission, and these financial statements should
be read in conjunction with the Company's audited consolidated financial
statements included in the Company's Form 10-K for the year ended December 31,
1995.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries: PairGain Services Group, Inc., which provides
support services for the Company's customers throughout the United States;
PairGain Canada Inc., a sales company focused on the Canadian market; and
PairGain International Sales Corporation, a foreign sales corporation ("FSC").
All significant intercompany transactions have been eliminated in consolidation.
6
<PAGE> 7
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
TRANSLATION OF FOREIGN CURRENCIES
Foreign subsidiary financial statements are translated into U.S. dollars
in accordance with Statement of Financial Accounting Standards No. 52, "Foreign
Currency Translations". The functional currency of the Company's Canadian
subsidiary is the U.S. dollar, therefore, translation gains and losses are
included in results of operations. Transaction and translation gains and losses
were not significant in 1996 or 1995.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year presentation.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities at the
date of purchase of less than three months to be cash equivalents.
SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities". The adoption did not have a significant impact
on the Company's consolidated financial statements. Management determines the
appropriate classification of such securities at the time of purchase and
reevaluates such classification as of each balance sheet date. Based on its
intent, the Company's investments are classified as available-for-sale and are
carried at fair value, with unrealized gains and losses, net of tax, reported as
a separate component of stockholders' equity. The investments are adjusted for
amortization of premiums and discounts to maturity and such amortization is
included in interest income. Realized gains and losses and declines in value
judged to be other than temporary are determined based on the specific
identification method and are reported in the consolidated statements of income.
INVENTORIES
Inventories are stated at lower of cost (determined on a first-in,
first-out basis) or market. The Company maintains allowances for estimated
obsolete and excess inventories based upon projected sales levels.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost. The Company provides for
depreciation and amortization using the straight-line method. The estimated
useful life of equipment is three years. Leasehold improvements are amortized
over the lesser of five years or the life of the lease.
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
REVENUE RECOGNITION
Revenue from product sales is recognized at the time of shipment.
Provision is made currently for estimated product returns. Revenue for
technology and licensing fees and royalty income is recognized when earned.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
PER SHARE INFORMATION
Net income per share is computed using the weighted average number of
common shares and common share equivalents outstanding during the periods
presented. Common share equivalents result from outstanding options and warrants
to purchase common stock and are calculated using the treasury stock method.
STOCK SPLIT
All share and per share amounts have been adjusted to reflect the
two-for-one stock split, effective June 18, 1996, for all periods presented (See
Note 12).
STATEMENT OF CASH FLOWS
During the nine months ended September 30, 1996, the Company recorded
noncash tax benefits from exercises of common stock options aggregating $12.1
million.
ACCOUNTING FOR STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("Statement No. 123"), which became effective for the Company
beginning January 1, 1996. Statement No. 123 requires expanded disclosures of
stock-based compensation arrangements with employees and encourages (but does
not require) compensation cost to be measured based on the fair value of the
equity instrument awarded. Companies are permitted, however, to continue to
apply APB Opinion No. 25, which recognizes compensation cost based on the
intrinsic value of the equity instrument awarded. The Company will continue to
apply APB Opinion No. 25 to its stock-based compensation awards to employees.
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
2. CONCENTRATION OF CREDIT RISK, MAJOR CUSTOMERS AND PRODUCTS
The Company markets its products principally to telephone companies in the
United States and Canada. Credit is extended based on an evaluation of the
customer's financial condition and collateral is not required. Credit losses are
provided for in the financial statements and consistently have been minimal.
A decision by a significant customer to substantially decrease or delay
purchases from the Company or the Company's inability to collect receivables
from these customers could have a material adverse effect on the Company's
financial condition and results of operations.
Revenues from HiGain products represented approximately 81% and 76% of the
Company's total revenues for the nine months ended September 30, 1996 and 1995,
respectively. A decline in demand for HiGain products, whether as a result of
competition, deployment of fiber cable, technological change or otherwise, could
have a material adverse effect on the Company's operating results.
3. SHORT-TERM INVESTMENTS
Short-term investments as of September 30, 1996 and December 31, 1995 are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------- ---------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
SEPTEMBER 30, 1996
Municipal bonds $51,239 $104 $(60) $51,283
DECEMBER 31, 1995
Municipal bonds $31,042 $107 $ -- $31,149
</TABLE>
There were no net realized gains for the three and nine months ended
September 30, 1996, compared to net realized gains of $56,000 and $415,000,
respectively, for the corresponding 1995 periods. During the three and nine
months ended September 30, 1995, the Company also realized a $1.7 million gain
and a $25.1 million loss, respectively, due to unauthorized trading of
investments by third parties (See Note 9). Unrealized gains on short-term
investments, net of tax, included as a separate component of stockholders'
equity were $27,000 at September 30, 1996 and $67,000 at December 31, 1995.
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
The amortized cost and estimated fair value of investments at September
30, 1996 by contractual maturity are shown below. Actual maturities may differ
from contractual maturities because the issuer of the securities may have the
right to repurchase such securities.
<TABLE>
<CAPTION>
COST FAIR VALUE
------- ----------
(IN THOUSANDS)
<S> <C> <C>
Due in one year or less $20,696 $20,764
Due after one year through three years 30,543 30,519
------- -------
$51,239 $51,283
======= =======
</TABLE>
4. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Raw materials $12,537 $ 4,987
Work in process 7,964 9,693
Finished goods 13,036 7,842
------- -------
$33,537 $22,522
======= =======
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Furniture and fixtures $ 174 $ 50
Machinery and equipment 14,815 9,722
Leasehold improvements 1,378 1,111
------- -------
16,367 10,883
Less accumulated depreciation and
amortization 7,013 4,481
------- -------
$ 9,354 $ 6,402
======= =======
</TABLE>
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
6. NOTE RECEIVABLE
In July 1995, the Company entered into certain agreements with Sourcecom
Corporation of Valencia, California ("Sourcecom"). Sourcecom develops,
manufactures and markets next generation access networking products. The
agreements provide for the incorporation of Sourcecom's networking technology
into the Company's current and future transmission products. Under the terms of
the agreements, the Company loaned Sourcecom $2.7 million and has rights to
purchase a minority ownership position. The note bears interest at the prime
rate less one percent (7.25% at September 30, 1996), payable monthly, with the
principal balance due July 1999.
7. LONG-TERM INVESTMENTS
In April 1996, the Company purchased approximately 150,000 shares of
Sourcecom's Series A Preferred Stock for an aggregate of $273,000. In September
1996, the Company purchased approximately 321,000 shares of Sourcecom's Common
Stock for an aggregate of $271,000. Shares purchased have been adjusted to
reflect Sourcecom's two-for-one stock split, effective September 24, 1996.
In June 1996, the Company made a minority investment in E/O Networks of
Hayward, California ("E/O"). E/O supplies low-density fiber optic access
equipment to public carriers both domestically and internationally. The Company
purchased approximately 545,000 shares of E/O's Series D Preferred Stock for an
aggregate of $3.0 million.
These investments are accounted for using the cost method.
8. BANK LINE OF CREDIT
The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5,000,000, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at prime (8.25%
at September 30, 1996). At September 30, 1996, the Company had no outstanding
borrowings under this line of credit. The debt agreement specifies certain
financial and other covenants. The Company was in compliance with the financial
and other covenants at September 30, 1996. The agreement expires May 1, 1997.
9. UNUSUAL LOSS DUE TO UNAUTHORIZED TRADING OF INVESTMENTS BY THIRD PARTIES
In 1993 and 1994, the Company invested a portion of its excess cash with
Capital Insight, Inc. ("Capital Insight"), a financial advisor and broker based
in Beverly Hills, California. The Company had no funds invested with Capital
Insight at either December 31, 1993 or December 31, 1994, as all such invested
funds were returned to the Company prior to the end of each of those years.
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
In early 1995, the Company again invested a portion of its excess cash
with Capital Insight, with instructions that the funds be invested solely in
U.S. Treasury securities with maturities of one year or less. These instructions
were consistent with the investment guidelines which had been approved by the
Company's Board of Directors in October 1994. However, these instructions were
violated and the funds were used to engage in unauthorized trading in options
and futures. In November 1995, the Company confirmed that it had incurred
non-recurring losses of $15.8 million resulting from these inappropriate and
unauthorized trading activities.
The Company's outside directors retained independent legal counsel and
forensic accountants to determine the facts and circumstances surrounding this
matter. This investigation revealed no improper involvement by any Company
director, officer or employee in the unauthorized trading. Additionally, the
investigation found that the Company was provided with fictitious statements by
Capital Insight, and the Company had actually incurred substantial losses in the
second quarter of 1995. During the third and fourth quarters of 1995, the
unauthorized trading generated significant gains resulting in net trading losses
of $15.8 million for the year. Furthermore, it was determined that the 1994
statements provided by this advisor and relied upon by the Company for its
quarterly reporting were also incorrect. Although total financial results for
1994 were not impacted by these false statements, previously reported 1994
quarterly financial statements did not reflect the proper periods in which the
trading gains and losses occurred. Based on the results of the investigation,
the Company has amended its quarterly reports for both 1994 and 1995 to reflect
the proper reporting of the trading gains and losses.
10. INCOME TAXES
Income taxes are provided at the rate expected to be in effect for the
entire year.
During the quarter ended March 31, 1996, the Company received a $6.9
million refund of its Federal income taxes paid for the year ended December 31,
1995. This refund arises out of certain deductions the Company claimed in its
tax return for the year ended December 31, 1995. Until the Internal Revenue
Service audits the Company's 1995 income tax return, the treatment of these
deductions is uncertain. The Company believes the ultimate resolution of these
uncertainties will not have a material adverse effect on the Company's financial
statements.
11. CONTINGENCIES
In January 1996, the Company received a copy of a complaint, filed
derivatively by a Company stockholder on behalf of the Company, naming as
defendants the Company's directors and certain officers, as well as Mr. S. Jay
Goldinger and Capital Insight, Inc., a third party investment advisor. This suit
arose out of losses incurred by the Company in 1995 of approximately $15.8
million in connection with the losses through unauthorized trading of
investments made by Mr. Goldinger and Capital Insight on the Company's behalf
(see Note 9, above, for a description of such losses). The derivative complaint
alleged causes of action for breach of fiduciary duty, abuse of control,
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
constructive fraud, gross mismanagement and waste of corporate assets. The
complaint sought in excess of $15.8 million in damages and legal fees and
expenses in connection with the loss by the Company of the funds it provided to
Mr. Goldinger and Capital Insight. The suit was filed in Superior Court of the
State of California, County of Orange. Additionally, the same stockholder filed
a separate, related complaint, brought derivatively on behalf of the Company, in
the Orange County Superior Court, against a brokerage firm involved in the
Capital Insight matter.
In September 1996, the Company and other parties to the derivative suits
described above executed definitive settlement agreements to settle and dismiss
the derivative suits. Under the proposed settlement, among other things, the
Company will receive $2.5 million from a brokerage firm involved in processing
the investments for Capital Insight, and the Company will pay plaintiff's
attorneys $450,000. The settlement is subject to final approval by the Court,
and a hearing is scheduled at 3:30 p.m. on November 19, 1996 for that purpose.
The impact of the proposed settlement will be recorded in the Company's
financial statements when approved and all related contingencies have been
removed.
In January 1996, the Company filed suit, in Los Angeles federal court,
against Mr. S. Jay Goldinger and Capital Insight, Inc. charging unauthorized
trading, fraudulent misrepresentation, violation of federal securities laws and
breach of fiduciary duties. The suit seeks $15.8 million in damages by reason of
the losses incurred by the Company, as well as punitive damages and legal fees.
As has been reported in the public media, various government and
regulatory agencies (including the Securities and Exchange Commission and
U.S. Attorney) are, or have been, investigating the activities of Capital
Insight and Mr. Goldinger, including transactions with the Company, and the
Company's accounting therefor.
The Company does not maintain Directors and Officers liability insurance.
However, under the terms of its certificate of incorporation, the Company
indemnifies its directors and officers for damages and legal fees arising from
litigation matters.
13
<PAGE> 14
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)
12. STOCKHOLDERS' EQUITY
In March 1995, the Company completed a secondary public offering and sold
1,000,000 shares of its common stock at a price of $11.8125 per share. The net
proceeds raised by the Company were approximately $10,970,000. In connection
with the offering, certain outstanding warrants were exercised to purchase
2,875,310 shares of common stock at an aggregate exercise price of $2,717,000.
In June 1996, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation (the "Amendment") to increase the
authorized Common Stock of the Company from 30 million, par value $.001, to 60
million, par value $.0005, and to effect a two-for-one stock split (the "Stock
Split") of all outstanding common stock, options and warrants. The Amendment and
Stock Split were effective June 18, 1996.
Additionally, in June 1996, the Company's stockholders approved the 1996
Non-Employee Directors Stock Option Plan (the "Directors Plan"). Under the terms
of the Directors Plan, 200,000 shares of Common Stock have been reserved for
issuance to non-employee members of the Board. Following the 1996 Annual
Meeting, initial options to purchase 20,000 shares of the Company's Common Stock
were granted to each non-employee director who had not previously received any
stock option grants from the Company. Beginning with the 1997 Annual Meeting, an
option to purchase an additional 10,000 shares of Common Stock will be granted
to each individual who is to continue to serve as a non-employee Board member.
There is no limit to the number of such annual 10,000-share option grants any
one non-employee Board member may receive over his or her period of continued
Board service during the term of the Directors Plan. Each option will have an
exercise price per share equal to 100% of the fair market value per share of
Common Stock on the option grant date and a maximum term of ten years measured
from the option grant date. Initial option grants vest over four years and
additional option grants vest over one year. The term of the Directors Plan is
ten years.
14
<PAGE> 15
PART I: ITEM 2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
PAIRGAIN TECHNOLOGIES, INC.
Except for the historical information contained herein, the matters discussed
in this Form 10-Q are forward-looking statements which involve risk and
uncertainties, including but not limited to economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices and other factors discussed in the
Company's filings with the Securities and Exchange Commission.
RESULTS OF OPERATIONS (quarter and nine months ended September 30, 1996,
compared to quarter and nine months ended September 30, 1995)
All share and per share amounts have been adjusted to reflect the
two-for-one stock split effective June 18, 1996.
REVENUES
Revenues for the quarter ended September 30, 1996, increased $25.0 million
or 84% as compared with the 1995 quarter. Product revenues increased $25.4
million, offset by a decrease in royalty income of $381,000. The increase in
product revenue was primarily due to a 105% increase in the unit sales volume of
the Company's HiGain product. Increases in the unit sales volume of the
Company's PG-2 and Campus products, 78% and 106%, respectively, also contributed
to the increased product revenue. These increases were partially offset by
declines in the average sales prices of all three product lines.
Revenues for the nine months ended September 30, 1996, increased $69.8
million or 96%, over the nine month period in the prior year. This increase in
revenues consisted of increases in product revenues of $70.7 million and
decreases in royalty income of $903,000. The increase in product revenue was
primarily due to a 109% increase in the unit sales volume of the Company's
HiGain product. A less significant portion of the increase was attributed to 73%
and 63% increases in unit sales volume of the Company's PG-2 and Campus
products, respectively. These increases were partially offset by declines in the
average sales prices of HiGain and Campus products.
The decrease in royalty income was due to a reduction in royalty fees
generated by Alcatel for the use of the Company's HDSL technology as a result of
the renegotiation and termination of its agreement with Alcatel in the fourth
quarter of 1995. As part of terminating the agreement, the Company granted
royalty-free licenses of current Company technology to Alcatel and Alcatel
granted a royalty-free license of its network management software to the
Company. The agreement also reduced the royalty rate for standalone T1 products
which incorporate the Company's HDSL technology being sold by Alcatel.
Consequently, technology licensing fees and royalty income will continue to
decline in the future.
15
<PAGE> 16
GROSS PROFIT
Gross profit represents total revenues for a period, including technology
fees and royalty income, less the cost of revenues for such period. Cost of
revenues represents primarily product costs, together with associated overhead
expenditures. Gross profit increased $12.4 million or 90% and $33.2 million or
96% for the quarter and nine months ended September 30, 1996, as compared with
the prior year periods. This growth in gross profit was principally attributed
to the increase in the Company's revenues.
As a percentage of revenues, gross profit was 48% for the quarter and nine
month period ended September 30, 1996 compared to 47% and 48% for the quarter
and nine month period, respectively, in 1995. Gross profit has remained
consistently strong despite reductions in the average selling prices of the
Company's products primarily because of the Company's emphasis on cost reduction
through engineering design changes, reduced prices for components, increased
manufacturing efficiencies and increases in production volume.
The Company expects that increased competition will continue to place
downward pressure on the average selling prices of its existing products.
Declining average selling prices may adversely affect gross product margins on
the Company's existing products if the Company is unable to fully offset such
price reductions by reductions in the Company's per unit cost. The Company's
ability to mitigate future declines in its gross product margin will depend in
part upon its ability to introduce and sell new products with higher gross
product margins and further reduce its per unit costs.
OPERATING EXPENSES
In order to support the growth of its business, the Company significantly
expanded its levels of operations in all areas. Accordingly, operating expenses
increased $5.0 million, or 68%, for the three months ended September 30, 1996 as
compared with the same period in the prior year. For the nine month period,
operating expenses increased $14.0 million or 73%. Costs relating to the
addition of personnel represented approximately 54% and 50%, respectively, of
these increases over the three and nine month periods. However, as a percentage
of revenues, operating expenses decreased to 23% in the 1996 periods from 25%
and 27% for the quarter and nine months, respectively, in 1995.
Research and development expense increased $2.2 million or 78% and $5.5
million or 73%, respectively, for the quarter and nine months ended September
30, 1996, as compared with the same periods in the prior year. These increases
were primarily due to the addition of personnel and prototype expenditures
associated with new products. In addition, the 1996 periods include expenses
related to the Company's Raleigh, North Carolina design center, which was
established in the fourth quarter of 1995. Research and development expense as a
percentage of revenues was 9% for the quarter and nine month period in 1996,
compared to 9% and 10%, respectively, for the corresponding periods in 1995. The
Company plans to continue to expend at least 9% of its revenues on new product
development, product enhancements and continuing efforts toward product cost
reductions.
Selling and marketing expense increased $2.0 million or 71% and $5.9
million or 87%, respectively, for the quarter and nine months ended September
30, 1996, as compared with the same periods in the prior year. Additional sales
and marketing support personnel, commissions, advertising,
16
<PAGE> 17
trade show and travel costs primarily accounted for the increase in
expenditures. Selling and marketing expense as a percentage of revenues was 9%
in 1996 and 1995.
General and administrative expense increased $827,000 or 47% and $2.5
million or 51%, respectively, for the quarter and nine months ended September
30, 1996, as compared with the same periods in the prior year. These increases
were primarily due to increases in personnel associated costs, increased legal
fees, consulting fees related to upgrading the Company's information system
capabilities and an overall increase in the level of purchasing associated with
general supplies and non-capitalized equipment. General and administrative
expense as a percentage of revenues was 5% in the 1996 quarter and nine month
period compared to 6% and 7%, respectively, in the corresponding 1995 periods.
INCOME FROM OPERATIONS
As a result of the above, income from operations for the quarter ended
September 30, 1996 increased 115% to $13.9 million, compared to $6.5 million for
the 1995 quarter. Income from operations for the nine months ended September 30,
1996 increased 125% to $34.6 million, compared to $15.4 million for the first
nine months of 1996. As a percentage of revenues, income from operations was 25%
and 24%, respectively, for the quarter and nine months in 1996, compared to 22%
and 21% in the respective 1995 periods.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $865,000 and $2.5 million for the three
and nine months ended September 30, 1996, respectively, from $426,000 and $1.5
million in the corresponding 1995 periods. These increases resulted primarily
from higher average cash levels available for investment. There was no interest
expense during the first nine months of 1996 or 1995.
GAIN ON INVESTMENTS
During the quarter and nine months ended September 30, 1995, gains from
the sale of investments were $56,000 and $415,000, respectively. There were no
corresponding investment sales during 1996.
UNUSUAL GAIN (LOSS) DUE TO UNAUTHORIZED TRADING BY THIRD PARTIES
In 1993 and 1994, the Company invested a portion of its excess cash with
Capital Insight, Inc. ("Capital Insight"), a financial advisor and broker based
in Beverly Hills, California. The Company had no funds invested with Capital
Insight at either December 31, 1993 or December 31, 1994, as all such invested
funds were returned to the Company prior to the end of each of those years.
In early 1995, the Company again invested a portion of its excess cash
with Capital Insight, with instructions that the funds be invested solely in
U.S. Treasury securities with maturities of one year or less. These instructions
were consistent with the investment guidelines which had been approved by the
Company's Board of Directors in October 1994. However, these instructions were
violated and the funds were used to engage in unauthorized trading in options
and futures. In
17
<PAGE> 18
November 1995, the Company confirmed that it had incurred non-recurring losses
of $15.8 million resulting from these inappropriate and unauthorized trading
activities.
The Company's outside directors retained independent legal counsel and
forensic accountants to determine the facts and circumstances surrounding this
matter. This investigation revealed no improper involvement by any Company
director, officer or employee in the unauthorized trading. Additionally, the
investigation found that the Company was provided with fictitious statements by
Capital Insight, and the Company had actually incurred substantial losses in the
second quarter of 1995. During the third and fourth quarters of 1995, the
unauthorized trading generated significant gains resulting in net trading losses
of $15.8 million for the year. Furthermore, it was determined that the 1994
statements provided by this advisor and relied upon by the Company for its
quarterly reporting were also incorrect. Although total financial results for
1994 were not impacted by these false statements, previously reported 1994
quarterly financial statements did not reflect the proper periods in which the
trading gains and losses occurred. Based on the results of the investigation,
the Company has amended its quarterly reports for both 1994 and 1995 to reflect
the proper reporting of the trading gains and losses.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 1996, was $5.7 million and $14.3 million, respectively, compared
to $2.4 million and $5.6 million for the three and nine months ended September
30, 1995. The Company did not record any tax benefit from its unusual trading
gains or losses in 1995. The Company's effective rate increased to 38% in 1996
from 35% in the 1995 quarter and nine month period as tax credits and tax-free
interest income represented a smaller proportion of total pre-tax income as a
result of the earnings growth. The Company expects to maintain its tax rate at
38% for the remainder of 1996.
NET INCOME (LOSS) AND EARNINGS (LOSS) PER SHARE
As a result of the above, net income for the three months ended September
30, 1996 was $9.1 million, compared to $6.2 million in 1995, or a 47% increase.
Net income for the first nine months of 1996 was $22.9 million, compared to a
loss of $13.4 million in the first nine months of 1995. Without the unusual
trading gains and losses, net of tax, net income for the first nine months of
1995 would have been $11.3 million.
Earnings per share for the three months ended September 30, 1996 were
$0.25 compared to $0.18 for the 1995 quarter. Earnings per share for the nine
months ended September 30, 1996 were $0.64 compared to a loss of $0.47 for the
first nine months of 1995. Without the unusual trading gains and losses,
earnings per share for the three and nine month periods in 1995 would have been
$0.13 and $0.34, respectively.
The weighted average number of common and common equivalent shares
outstanding was 36.4 million and 34.1 million for the three months ended
September 30, 1996 and 1995, respectively. The increase in common and common
equivalent shares was primarily attributable to the granting of options to key
employees of the Company and the reduction in the number of shares assumed to be
repurchased upon the exercise of options and warrants, using the treasury stock
method, as a result of the Company's higher stock price in 1996 over 1995.
18
<PAGE> 19
The weighted average number of common and common equivalent shares
outstanding was 35.9 million and 28.7 million for the first nine months of 1996
and 1995, respectively. The increase in common and common equivalent shares was
primarily attributable to the issuance of 1,000,000 shares in the Company's
secondary offering in March 1995 which were outstanding for the entire first
quarter of 1996, the granting of options to key employees of the Company, and
the reduction in the number of shares assumed to be repurchased upon the
exercise of options and warrants, using the treasury stock method, as a result
of the Company's higher stock price in 1996 over 1995. In addition, due to the
net loss for the nine month period in 1995, the weighted average common and
common equivalent shares does not include outstanding options and warrants, as
these would be anti-dilutive on the loss per share.
19
<PAGE> 20
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1996, the Company had $91.1 million in cash, cash
equivalents and short-term investments and $118.6 million in working capital.
These figures represent an increase of $35.4 million in cash, cash equivalents
and short-term investments and $33.8 million in working capital over the
December 31, 1995 amounts. These increases were primarily attributable to cash
generated from operations of $34.4 million (net of capital expenditures of
$5.5 million) and $5.3 million from the exercise of stock options, offset by
$3.5 million used for the purchase of long-term investments. The increase in the
Company's accounts receivable to $20.7 million at September 30, 1996, compared
to $13.0 million at December 31, 1995, was primarily reflective of higher
revenue levels. Accounts receivable days outstanding were 35 at September 30,
1996 and 34 at December 31, 1995. The increase in inventory to $33.5 million at
September 30, 1996, compared to $22.5 million at December 31, 1995, was due to
increased stocking and production levels to support future shipments. The
Company has historically maintained relatively high levels of inventory.
However, annualized inventory turnover increased to 3.4 and 3.0 times for the
quarter and nine month period ended September 30, 1996, compared to 3.0 and 2.4
times for the corresponding 1995 periods.
Capital expenditures increased by $417,000 in the nine month period ended
September 30, 1996 compared to the 1995 period. The higher levels in 1996
resulted primarily from greater expenditures on production test equipment.
The Company maintains an unsecured line of credit with a bank. The line
allows maximum borrowings of $5,000,000, including the issuance of letters of
credit and foreign exchange contracts. The line bears interest at prime (8.25%
at September 30, 1996). At September 30, 1996, the Company had no outstanding
borrowings under this line of credit. The debt agreement specifies certain
financial and other covenants. The Company was in compliance with the financial
and other covenants at September 30, 1996. The agreement expires May 1, 1997.
During 1996, the Company made investments in Sourcecom Corporation
("Sourcecom") and E/O Networks ("E/O") of $544,000 and $3.0 million,
respectively. Sourcecom, of Valencia, California, develops, manufactures and
markets next generation access networking products. Hayward, California-based
E/O supplies low-density fiber optic access equipment to public carriers
worldwide. Both investments were made with internally generated funds.
The Company has no material near-term commitments for its funds. The
Company believes that the current cash, cash equivalents and short-term
investment balances and internally generated cash flow will be sufficient to
meet its working capital and capital expenditure requirements through 1996. To
the extent that the Company's existing resources, together with future earnings,
are insufficient to fund the Company's future activities, the Company may need
to raise additional funds through public or private financings.
20
<PAGE> 21
PART II. OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
As previously reported in Securities and Exchange Commission filings, the
Company was involved in certain derivative suits. For a discussion of
these suits and the proposed settlement thereof, see Notes 9 and 11 of
Notes to Condensed Consolidated Financial Statements for the period ended
September 30, 1996 and Exhibit 20.1, Notice to Company Shareholders of
Hearing on Proposed Settlement of Derivative Action, Case No. 758117,
filed herewith.
Item 2. Changes in Securities
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits:
11.1 Calculation of Per Share Earnings
20.1 Notice to Company Shareholders of Hearing on Proposed
Settlement of Derivative Action, Case No. 758117
27.1 Financial Data Schedule
-----------
(B) Reports filed on Form 8-K during the period:
None.
21
<PAGE> 22
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 under
signed thereunto duly authorized.
PairGain Technologies, Inc.
--------------------------------------
(Registrant)
Date: November 8, 1996 /S/ Charles W. McBrayer
------------------ --------------------------------------
Charles W. McBrayer
Vice President, Finance and
Administration
Chief Financial Officer
(Duly Authorized Officer)
Date: November 8, 1996 /S/ Robert R. Price
------------------ --------------------------------------
Robert R. Price
Corporate Controller
(Chief Accounting Officer)
22
<PAGE> 1
PAIRGAIN TECHNOLOGIES, INC.
EXHIBIT 11.1--COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
PRIMARY EARNINGS PER SHARE 1996 1995 1996 1995
-------- -------- -------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net income (loss) $ 9,069 $ 6,165 $ 22,889 $ (13,449)
======== ======== ======== =========
Calculation of weighted
average number of common and
common equivalent shares:
Weighted average of common
shares outstanding 31,528 30,032 31,144 28,730
Weighted average of common
share equivalents:
Weighted average warrants 20 33 20 n/a
outstanding
Weighted average options 6,665 6,254 6,566 n/a
outstanding
Shares assumed to be
repurchased using the (1,157) (1,716) (1,181) n/a
treasury stock method
Shares assumed to be
repurchased to reflect the (688) (501) (656) n/a
effects of tax benefits
-------- -------- -------- ---------
Weighted average number of
common and common equivalent 36,368 34,102 35,893 28,730
shares
======== ======== ======== =========
Earnings (loss) per share $ 0.25 $ 0.18 $ 0.64 $ (0.47)
======== ======== ======== =========
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ----------------------
FULLY DILUTED EARNINGS PER SHARE 1996 1995 1996 1995
-------- -------- -------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net income (loss) $ 9,069 $ 6,165 $ 22,889 $ (13,449)
======== ======== ======== =========
Calculation of weighted
average number of common and
common equivalent shares:
Weighted average of common
shares outstanding 31,528 30,032 31,144 28,730
Weighted average of common
share equivalents:
Weighted average warrants 20 33 20 n/a
outstanding
Weighted average options 6,665 6,254 6,566 n/a
outstanding
Shares assumed to be
repurchased using the (969) (1,407) (982) n/a
treasury stock method
Shares assumed to be
repurchased to reflect the (709) (524) (679) n/a
effects of tax benefits
-------- -------- -------- ---------
Weighted average number of
common and common equivalent 36,535 34,388 36,069 28,730
shares
======== ======== ======== =========
Earnings (loss) per share $ 0.25 $ 0.18 $ 0.63 $ (0.47)
======== ======== ======== =========
</TABLE>
<PAGE> 1
EXHIBIT 20.1
SUPERIOR COURT OF THE STATE OF CALIFORNIA
COUNTY OF ORANGE
HANNAH KOGUT, Derivatively on Behalf of PAIRGAIN )
TECHNOLOGIES, INC., ) Case No. 758117
)
) DERIVATIVE ACTION
Plaintiff, ) -----------------
vs. )
)
CHARLES S. STRAUCH, HOWARD S. FLAGG, CHARLES W. )
McBRAYER, BENEDICT ITRI, DENNIS YOUNG, ROBERT C. )
HAWK, ROBERT A. HOFF, BRIAN KOURI, B. ALLEN LAY, )
CAPITAL INSIGHT BROKERAGE, S. JAY GOLDINGER, REFCO, )
INC., and DOES 1 THROUGH 100, INCLUSIVE, )
)
Defendants, )
)
- and - )
)
PAIRGAIN TECHNOLOGIES, INC., )
)
Nominal Defendant. )
______________________________________________________)
NOTICE OF HEARING ON PROPOSED SETTLEMENT OF DERIVATIVE ACTION
-------------------------------------------------------------
TO: ALL HOLDERS OF PAIRGAIN TECHNOLOGIES, INC. COMMON STOCK AS OF JULY 15, 1996:
PLEASE READ THIS NOTICE CAREFULLY --
IT MAY AFFECT YOUR RIGHTS
THIS NOTICE RELATES TO A PROPOSED SETTLEMENT OF A SHAREHOLDERS'
DERIVATIVE ACTION AND CLAIMS ASSERTED THEREIN.
HOLDERS OF PAIRGAIN TECHNOLOGIES, INC. ("PAIRGAIN") COMMON STOCK AS OF
JULY 15, 1996, ARE ENTITLED TO OBJECT, IF THEY DESIRE, TO THE SETTLEMENT OF THE
RELEASED CLAIMS AS DESCRIBED HEREIN. IF THE COURT APPROVES THE DERIVATIVE
SETTLEMENT, THEY WILL BE BARRED FROM CONTESTING THE FAIRNESS, REASONABLENESS OR
ADEQUACY OF THE PROPOSED SETTLEMENT AND FROM PURSUING THE RELEASED CLAIMS
AGAINST THE RELEASED PERSONS.
This Notice is given pursuant to an Order of the Superior Court for
the County of Orange, California (the "Court"). The purpose of the Notice is
to advise you that the above-entitled action (the "Litigation") is now pending
in the Court and that certain parties to the Litigation have reached a
settlement (the "Settlement") which would fully, finally and forever resolve
the Litigation as between plaintiff and the Settling Defendants, as defined
herein, on the terms and conditions summarized in this Notice.
This Notice is not intended to be and should not be construed as an
expression of any opinion by the Court with respect to the truth of the
allegations of the claims in the Litigation or the merits of the claims or
defenses asserted. This Notice is merely to advise you of the pendency and
proposed Settlement of the Litigation and of your rights thereunder.
I. DESCRIPTION OF THE LITIGATION
-----------------------------
On January 10, 1996, the following derivative action was filed in the
Superior Court of the State of California for the County of Orange on behalf of
nominal defendant PairGain: Kogut v. Strauch, et al., Case No. 758117 (the "D&O
case"). The D&O case alleged breach of fiduciary duty, abuse of control,
constructive fraud and gross mismanagement by the Individual Defendants. On May
31, 1996, a separate derivative action was filed in the Court on behalf of
nominal defendant PairGain: Kogut v. Refco, Inc., Case No. 764514 (the "Refco
case"). The Refco case alleged breach of fiduciary duty, conspiracy, fraud,
negligence and gross negligence by Refco. The D&O case and the Refco case are
collectively referred to as the "Litigation." For purposes of effectuating the
Settlement the D&O case and the Refco case will be consolidated into a single
action.
<PAGE> 2
The D&O case was brought pursuant to Section 800 of the California
Corporations Code for the benefit of PairGain against its Board of Directors,
certain of its officers, the Company's outside investment advisor, S. Jay
Goldinger ("Goldinger"), and Capital Insight Brokerage, Inc., ("Capital"), the
money management firm owned and operated by Goldinger. The complaint alleged
that in early December 1995 it was revealed that PairGain had suffered losses
of at least $16 million due to reckless and inappropriate investments of $28
million of its cash reserves by Goldinger and Capital.
On February 24, 1996, defendants Capital and Goldinger filed their
answer to the complaint. Defendant Goldinger generally invoked his privilege
against self-incrimination under both the federal and California Constitution,
neither admitting nor denying most of the allegations in the complaint.
On April 1, 1996, defendant PairGain filed its general demurrer to the
complaint claiming that when it discovered the $15.8 million loss as a result
of unauthorized trading activity by Goldinger and Capital, PairGain
investigated and, on January 24, 1996, filed suit in federal court against
Goldinger and Capital alleging, inter alia, commodities fraud, unauthorized
trading, breach of fiduciary duty, and conversion. However, the Company
claimed that two weeks before PairGain could file its suit against Goldinger
and Capital, plaintiff Kogut filed her own suit. PairGain claimed that
plaintiff Kogut's filing ignored the requirement that, as a potential
derivative action plaintiff, she must first demand that PairGain bring an
action itself before initiating her own action.
On April 1, 1996, the Individual Defendants in the D&O case filed
their demurrer to the complaint, charging that the plaintiff seeks to have the
Court second guess their proper business decision to invest a portion of
PairGain's surplus funds with Capital. The Individual Defendants claimed
plaintiff's "Monday morning quarter-backing," was prohibited by the business
judgment rule under Delaware law.
On March 8-9, 1996, plaintiff served her first request for production
of documents on PairGain, the D&O Defendants, Capital and Goldinger. On April
2, 1996, PairGain and the D&O Defendants filed their objections and responses
to plaintiff's first request for production of documents. On April 4, 1996,
Capital and Goldinger filed their responses to plaintiff's first request for
production of documents.
On May 31, 1996, the related case, Kogut v. Refco, Inc., was filed in
Orange County Superior Court and assigned to Judge C. Robert Jameson. The
action against Refco was brought pursuant to Section 800 of the California
Corporations Code for the benefit of PairGain against the Chicago-based
commodities trading house. The complaint charged that Refco cleared
Goldinger's trades for PairGain, and that Refco was willing to facilitate
Goldinger's wrongdoing to generate commissions.
On July 8, 1996, Refco filed a notice of removal to the United States
District Court for the Central District of California, based on original
jurisdiction under 28 U.S.C. Section 1332, and removal provisions of 28 U.S.C.
Section 1332, Section 1441(a) and (b), and Section 1446. Refco, pursuant to
Local Rule 4.3 for the Central District of California, served notice that the
Kogut v. Refco action was related to (i) PairGain's federal action against
Goldinger and Capital; (ii) Refco v. PairGain, in the United States District
Court for the Northern District of Illinois; and (iii) the original D&O case.
II. DEFINITIONS
-----------
As used in the Stipulation, the following terms have the meanings
specified below:
o "Defendants" means the Individual Defendants, Refco, Capital
Insight Brokerage, S. Jay Goldinger and nominal defendant PairGain.
o "Individual Defendants" means, as the context requires, the
defendants Charles S. Strauch, Howard S. Flagg, Charles W. McBrayer, Benedict
Itri, Dennis Young, Robert C. Hawk, Robert A. Hoff, Brian Kouri and B. Allen
Lay.
o "Non-Settling Defendants" means Capital Insight Brokerage and S.
Jay Goldinger.
o "Person" means an individual, corporation, partnership, limited
partnership, association, joint stock company, estate, legal representative,
trust, unincorporated association, government or any political subdivision or
agency thereof, and any business or legal entity and their spouses, heirs,
predecessors, successors, representatives or assignees.
o "Plaintiff" means Hannah Kogut.
o "Plaintiff's Settlement Counsel" means one of the counsel for the
Plaintiff in the Litigation: Milberg Weiss Bershad Hynes & Lerach LLP, William
S. Lerach, Keith F. Park, James A. Caputo, Joy Ann Bull, 600 W. Broadway, Suite
1800, San Diego, CA 92101-5050.
-2-
<PAGE> 3
o "Refco" means "Refco, Inc." an Illinois Corporation and, as the
context requires, all of its predecessors, successors, and all of its present
and former parents, subsidiaries, divisions and related or affiliated entities.
o "Related Parties" of a Person means each of such Person's past or
present directors, officers, employees, partners, principals, insurers,
co-insurers, reinsures, controlling shareholders, any entity in which the
Person has a controlling interest, attorneys, accountants, auditors, banks or
investment bankers, advisors, agents, employees, personal or legal
representatives, predecessors, successors, parents, subsidiaries, divisions,
joint venturers, assigns, spouses, heirs, associates, related or affiliated
entities, any members of their immediate families, or any trust of which any
Person is the settlor or which is for the benefit of any Person and/or
member(s) of his or her family. Related Parties specifically do not include
the Non-Settling Defendants.
o "Released Persons" means each and all of the Settling Defendants
and their Related Parties and specifically does not include the Non-Settling
Defendants.
o "Settling Defendants" means the Individual Defendants, Refco and
nominal defendant PairGain.
o "Settling Parties" means, collectively, each of the Settling
Defendants, PairGain and the Plaintiff on behalf of herself, the shareholders
of PairGain and derivatively on behalf of PairGain.
III. THE PROPOSED SETTLEMENT
-----------------------
1. Counsel for the plaintiff have investigated the facts and the
applicable law regarding the claims of the person on whose behalf they are
acting and the potential defenses thereto. Based on this investigation, the
plaintiff has agreed that it is in the best interests of PairGain and its
shareholders to settle the Litigation. The following description of the
proposed Settlement is only a summary, and reference is made to the text of the
Stipulation, on file with the Court, for a full statement of its provisions.
In sum, as a result of the Litigation and negotiations among counsel, the
Settling Parties have agreed to the following:
(a) The D&O case and the Refco case shall be consolidated
for purposes of the Stipulation and settlement;
(b) By separate agreement, (hereinafter "Refco Settlement
Agreement") Refco has agreed to pay to PairGain, subject to certain conditions
contained in the Refco Settlement Agreement, the sum of $2,500,000 Dollars
($2.5 million) in consideration of a settlement and release of all claims and
allegations raised or which could have been raised in the Refco case or
otherwise by PairGain relating to the subject matter of the Refco case;
(c) The Board of Directors of PairGain has adopted
certain procedures and policies governing the investment and management of
PairGain's cash and excess capital. Plaintiff's counsel have reviewed such
procedures and policies and agree they are acceptable and appropriate;
(d) PairGain will continue to pursue and control the
prosecution of the action entitled PairGain Technologies, Inc. v. S. Jay
Goldinger, et al., Case No. 96-0487 RAP(RMCx), pending in the U.S. District
Court for the Central District of California; and
(e) For their efforts in filing and prosecuting the
Litigation, and their role in obtaining for PairGain the settlement with Refco
described in (b) above, PairGain has agreed, subject to approval of the
settlement by the Court, to pay plaintiff's attorneys the sum of $450,000 as
fees and expenses. This principal amount shall accrue interest from June 27,
1996, until the date paid to the Escrow Agent at the same rate as earned on
PairGain's corporate funds invested in U.S. Government Treasury Notes or Bills.
2. If the Proposed Settlement is approved by the Court, the Court
will enter a judgment which will dismiss the Litigation as against the Settling
Defendants (Individual Defendants, Refco, PairGain) with prejudice, and all
shareholders of PairGain and PairGain shall be barred and enjoined from
asserting any Released Claims against any of the Released Persons and each and
all shareholders of PairGain and PairGain shall conclusively be deemed to have
released any and all such Released Claims as against all of the Released
Persons.
3. As used above, the "Released Claims" shall mean and include
any and all claims, causes of action, demands, rights, or liabilities,
including, however described or denominated, but not limited to, claims for
negligence, gross negligence, professional negligence, breach of duty of care
and/or breach of duty of loyalty, fraud, breach of fiduciary duty, malpractice,
breach of contract, negligent misrepresentation, corporate waste,
mismanagement, violations of any state or federal statutes, rules or
regulations and any Unknown Claims as defined in V 1.18 herein, that have been
or that could have been asserted in this or any other forum by plaintiff, by or
on behalf of PairGain, or by any of its stockholders derivatively on its
behalf, regardless of the Released Claims' nature against the Released Persons
arising out of, relating to or in connection with
-3-
<PAGE> 4
(1) any of the facts, circumstances, allegations, claims,
causes of action, representations, statements, reports, disclosures,
transactions, events, occurrences, acts, omissions or failures to act, of
whatever kind or character whatsoever, irrespective of the state of mind of the
actor performing or omitting to perform the same that have been or could have
been alleged in any pleading, amended pleading, argument, complaint, amended
complaint, brief, motion, report or filing in the Litigation; and/or
(2) any claims for expenses, costs or fees incurred by
PairGain for or on behalf of itself or any of the Released Persons in
connection with the investigation, defense and/or settlement of the Litigation,
or proceedings related to the subject matters thereof including, but not
limited to, attorneys' fees, costs and any settlement or other expenses
(collectively "Defense Expenses");
(3) Notwithstanding anything otherwise encompassed by
subparagraphs (1) and (2), above, this definition explicitly does not include,
and the parties to this Stipulation expressly reserve and do not release, any
obligations, claims or rights any of them may have under this Stipulation;
(4) Notwithstanding anything otherwise encompassed by
subparagraphs (1), (2) and (3), above, this definition does not include, and
PairGain and each of the Released Persons expressly reserve and do not hereby
release, any rights of reimbursement under available insurance policies in
their respective names or on their behalf against other than the Released
Persons; and
(5) Notwithstanding anything otherwise encompassed by
subparagraphs (1), (2), (3) and (4) above, or elsewhere in this Stipulation,
this definition does not include, and PairGain expressly reserves and does not
hereby release, any claims or rights to pursue any of the Released Claims in
its own name and on its own behalf against the Non-Settling Defendants or any
Person other than the Released Persons.
4. "Unknown Claims" as used in the above definition of Released
Claims means any Released Claims which PairGain or the plaintiff or any
shareholder of PairGain does not know or suspect to exist in his, her or its
favor at the time of the release of the Released Persons which, if known by
him, her or it, might have affected his, her or its settlement with and release
of the Released Persons, or might have affected his, her or its decision not to
object to this Settlement. With respect to any and all Released Claims, upon
the Effective Date, PairGain, the plaintiff and the shareholders of PairGain
shall be deemed to have, and by operation of the Judgment shall have, expressly
waived and relinquished, to the fullest extent permitted by law, the
provisions, rights and benefits of Section 1542 of the California Civil Code,
which provides:
A general release does not extend to claims which the creditor does
not know or suspect to exist in his favor at the time of executing the
release, which if known by him must have materially affected his
settlement with the debtor.
PairGain, the plaintiff and the shareholders of PairGain, upon the Effective
Date, shall be deemed to have, and by operation of the Judgment shall have,
waived any and all provisions, rights and benefits conferred by any law of any
state or territory of the United States, or principle of common law, which is
similar, comparable or equivalent to Section 1542 of the California Civil Code.
PairGain, the plaintiff and the shareholders of PairGain may hereafter discover
facts in addition to or different from those which he, she or it now knows or
believes to be true with respect to the subject matter of the Released Claims,
but each of PairGain, plaintiff and the shareholders of PairGain, upon the
Effective Date, shall be deemed to, and by operation of the Judgment shall have
fully, finally and forever settled and released any and all Released Claims,
known or unknown, suspected or unsuspected, contingent or non-contingent,
whether or not concealed or hidden, which now exist or heretofore have existed
upon any theory of law or equity now existing or coming into existence in the
future, including, but not limited to, conduct which is negligent, intentional,
with or without malice, or a breach of any duty, law or rule, without regard to
the subsequent discovery or existence of such different or additional facts.
IV. NOTICE TO BANKS, BROKERS, AND OTHER NOMINEES
--------------------------------------------
5. Banks, brokerage firms, institutions, and other persons who
are nominees who currently hold the common stock of PairGain for the beneficial
interest of other persons who were PairGain shareholders on July 15, 1996, are
requested within ten (10) days of receipt of the Notice, to (1) provide
PairGain with the names and addresses of such beneficial purchasers or (2)
forward a copy of the Notice to each such beneficial purchaser and provide
PairGain with written confirmation that the notice has been so forwarded. Your
reasonable costs and expenses of complying with this provision will be paid
upon submission of appropriate documentation to PairGain. Additional postage
pre-paid copies of the Notice may be obtained from PairGain for forwarding to
such beneficial owners. All such correspondence should be addressed as
follows:
PairGain Derivative Litigation
P.O. Box 18644
Irvine, CA 92623-8644
-4-
<PAGE> 5
V. THE HEARING
-----------
6. A hearing (the "Settlement Hearing") will be held before the
Honorable Ronald C. Kline, Orange County Superior Court Judge, at 3:30 p.m. on
November 19, 1996, at the Orange County Superior Court, 700 Civic Center Drive
West, Santa Ana, California 92702, for the purpose of determining whether the
proposed Settlement is fair, reasonable and adequate and whether it should be
approved by the Court; and whether Judgment should be entered dismissing the
Litigation with prejudice as against the Settling Defendants. The Settlement
Hearing may be continued or adjourned from time to time by the Court at the
Settlement Hearing or any continued or adjourned session thereof without
further notice.
7. Any shareholder of PairGain as of July 15, 1996 (the "Record
Date"), may appear at the Settlement Hearing to show cause why the proposed
Settlement should not be approved or why a judgment should or should not be
entered thereon; provided, however, that no such person shall be heard, unless
his or her objection or opposition including the basis therefor is made in
writing and is filed with the Court, together with copies of all other papers
and briefs to be submitted by him or her to the Court at the Settlement
Hearing, no later than November 4, 1996, and showing due proof of service on
Plaintiffs' Settlement Counsel:
MILBERG WEISS BERSHAD
HYNES & LERACH
JOY ANN BULL
600 West Broadway, Suite 1800
San Diego, CA 92101
and Counsel for Individual Defendants:
IRELL & MANELLA LLP
DAVID SIEGEL
PATRICK O. HUNNIUS
1800 Avenue of the Stars
Suite 900
Los Angeles, CA 90067-4276
Unless otherwise ordered by the Court, any shareholder of PairGain who does not
make his, her or its objection or opposition in the manner provided shall be
deemed to have waived all objections and opposition to the fairness,
reasonableness and adequacy of the proposed settlement.
VI. EXAMINATION OF PAPERS AND INQUIRIES
-----------------------------------
This notice contains only a summary of the terms of the proposed
Settlement. For a more detailed statement of the matters involved in this
action, reference is made to the pleadings, to the Stipulation of Settlement
and to other papers filed in this action which may be inspected at the Office
of the Clerk of the Orange County Superior Court, 700 Civic Center Drive West,
Santa Ana, California during business hours of each business day.
Inquiries regarding this action should be addressed to Plaintiff's
Settlement Counsel at the above address.
DO NOT CONTACT THE COURT OR THE CLERK'S OFFICE REGARDING THIS NOTICE.
DATED: September 30, 1996 BY ORDER OF THE SUPERIOR COURT
OF THE STATE OF CALIFORNIA,
COUNTY OF ORANGE
-5-
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<CASH> 39,828
<SECURITIES> 51,283
<RECEIVABLES> 20,692
<ALLOWANCES> 0
<INVENTORY> 33,537
<CURRENT-ASSETS> 150,026
<PP&E> 16,367
<DEPRECIATION> 7,013
<TOTAL-ASSETS> 165,705
<CURRENT-LIABILITIES> 31,465
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 134,224
<TOTAL-LIABILITY-AND-EQUITY> 165,705
<SALES> 142,359
<TOTAL-REVENUES> 142,359
<CGS> 74,515
<TOTAL-COSTS> 74,515
<OTHER-EXPENSES> 33,211
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (2,524)
<INCOME-PRETAX> 37,157
<INCOME-TAX> 14,268
<INCOME-CONTINUING> 22,889
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,889
<EPS-PRIMARY> 0.64
<EPS-DILUTED> 0.63
</TABLE>
