<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FIRST QUARTER ENDED MARCH 31, 1997
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 67,415,390 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.0005
PER SHARE, OUTSTANDING ON MARCH 31, 1997.
<PAGE> 2
PAIRGAIN TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
Page
-----------
<S> <C>
Part I. Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at March 31, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income
for the three months ended March 31, 1997 and 1996 4
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1997 and 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 14
Part II. Other Information
Item 1. Legal Proceedings 18
Item 2. Changes in Securities 18
Item 3. Defaults upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
Signatures 19
</TABLE>
2
<PAGE> 3
PART I: ITEM 1
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
--------- -----------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 65,642 $ 48,416
Short-term investments (Note 4) 66,021 65,779
Accounts receivable 35,065 23,888
Inventories (Note 5) 23,254 26,149
Other current assets and deferred taxes 14,677 13,857
--------- ---------
TOTAL CURRENT ASSETS 204,659 178,089
Property and equipment, net (Note 6) 11,592 10,390
Note receivable and long-term investments (Note 7) 6,252 6,252
Other assets 266 273
--------- ---------
TOTAL ASSETS $ 222,769 $ 195,004
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other current liabilities $ 41,604 $ 37,408
Bank line of credit (Note 8) -- --
--------- ---------
TOTAL CURRENT LIABILITIES 41,604 37,408
--------- ---------
COMMITMENTS AND CONTINGENCIES
Stockholders' equity (Note 9):
Preferred stock, $.001 par value:
Authorized shares - 2,000,000
Issued and outstanding shares - None -- --
Common stock, $.0005 par value:
Authorized shares - 175,000,000
Issued and outstanding shares - 67,415,390 and 66,278,293 at March
31, 1997 and December 31, 1996, respectively 34 33
Additional paid-in capital 128,243 116,081
Deferred compensation (218) (237)
Unrealized gain on marketable securities 84 71
Retained earnings 53,022 41,648
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 181,165 157,596
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 222,769 $ 195,004
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
3
<PAGE> 4
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1996
------- -------
(RESTATED)
(SEE NOTES 1 AND 2)
<S> <C> <C>
REVENUES $70,749 $40,511
Cost of revenues 35,780 21,472
------- -------
Gross profit 34,969 19,039
------- -------
Operating expenses:
Research and development 6,158 3,648
Selling and marketing 4,800 3,724
General and administrative 2,433 2,335
Merger expenses (Note 1) 2,642 --
------- -------
Total operating expenses 16,033 9,707
------- -------
INCOME FROM OPERATIONS 18,936 9,332
Interest and other income, net 1,249 765
------- -------
Income before income taxes 20,185 10,097
Provision for income taxes (Note 1) 8,811 3,875
------- -------
NET INCOME $11,374 $ 6,222
======= =======
Per Share Data (Note 1):
Earnings per share $ 0.15 $ 0.09
======= =======
Weighted average number of common and common equivalent shares
75,539 71,772
======= =======
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1996
-------- --------
(RESTATED)
(SEE NOTES 1 AND 2)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 11,374 $ 6,222
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 1,601 975
Merger expenses paid by former Avidia shareholders 1,184 --
Change in operating assets and liabilities:
Accounts receivable (11,177) (918)
Inventories 2,895 (2,711)
Other current assets (820) 426
Other assets 7 --
Accounts payable and other current liabilities 10,893 6,894
Federal income tax refund 950 6,900
-------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES 16,907 17,788
-------- --------
Cash flows from investing activities:
Net purchases of short-term investments (530) (272)
Purchase of property and equipment (2,482) (995)
-------- --------
NET CASH USED IN INVESTING ACTIVITIES (3,012) (1,267)
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock 3,331 1,690
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES 3,331 1,690
-------- --------
Increase in cash and cash equivalents 17,226 18,211
Cash and cash equivalents at beginning of period 48,416 24,576
======== ========
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 65,642 $ 42,787
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ -- $ --
======== ========
</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., ("PairGain" or the "Company") designs,
manufactures, markets and supports products that allow telecommunications
carriers and private network owners to more efficiently provide high-speed
digital services to end users over the large existing infrastructure of
unconditioned copper wires. These services enable high-speed data transmission
for applications such as T1/E1, high-speed Internet access, telecommuting, wide
area networking and video conferencing.
On February 27, 1997, the Company acquired Avidia Systems, Inc.
("Avidia"). (See Note 2) Avidia is engaged in the business of developing,
manufacturing and marketing xDSL aggregation products and network switching
products based on Asynchronous Transfer Mode ("ATM") technology.
The accompanying condensed consolidated financial statements as of
December 31, 1996 and for the quarter ended March 31, 1996 have been restated to
reflect the business combination between PairGain and Avidia accounted for on a
pooling-of-interests basis and are based on each company's respective historical
financial statements and notes thereto.
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 March 31,
1997, and consolidated results of operations for the three months ended March
31, 1997, and March 31, 1996, and cash flows for the three months ended March
31, 1997, and March 31, 1996. Results of operations for the three months ended
March 31, 1997, are not necessarily indicative of results to be expected for the
full year ending December 31, 1997.
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 (the "SEC"), 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/A for the year ended
December 31, 1996 and the audited supplemental consolidated financial statements
included in Form S-3, as amended, filed with the SEC on May 1, 1997.
6
<PAGE> 7
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
PRINCIPLES OF CONSOLIDATION
The condensed 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 worldwide; PairGain
Canada Inc., a sales company focused on the Canadian market; PairGain
International Sales Corporation, a foreign sales corporation ("FSC") and Avidia.
All significant intercompany transactions have been eliminated in consolidation.
TRANSLATION OF FOREIGN CURRENCIES
Foreign subsidiary financial statements are translated into U.S.
dollars in accordance with Statement of Financial Accounting Standards ("SFAS")
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 1997 or 1996.
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.
RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform with the
current year presentation.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Pursuant to SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments", the Company is required to estimate the fair value of all
financial instruments included on its balance sheet at March 31, 1997 and
December 31, 1996. The Company considers the carrying value of such amounts in
the financial statements to approximate their fair value due to the relatively
short period of time between origination of the instruments and their expected
realization or the overall immateriality of the amounts.
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.
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Company adopted the provisions of SFAS
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.
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.
MERGER EXPENSES
All expenses related to the Company's business combination with Avidia
have been charged against the operations of the Company in the quarter ended
March 31, 1997.
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
INCOME TAXES
Income taxes are provided at the rate expected to be in effect for the
entire year.
PER SHARE INFORMATION
Earnings 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.
RECENTLY ISSUED ACCOUNTING STANDARDS
The Financial Accounting Standards Board issued SFAS No. 128, "Earnings
Per Share," ("SFAS No. 128"), in March 1997, effective for financial statements
issued after December 15, 1997. The statement provides simplified standards for
the computation and presentation of earnings per share ("EPS"), making EPS
comparable to international standards. SFAS No. 128 requires dual presentation
of "Basic" and "Diluted" EPS, by entities with complex capital structures,
replacing "Primary" and "Fully diluted" EPS under Accounting Principles Board
("APB") Opinion No. 15.
Basic EPS excludes dilution from common stock equivalents and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS reflects
the potential dilution from common stock equivalents, similar to fully diluted
EPS, but uses only the average stock price during the period as part of the
computation.
The Company will adopt the provisions of SFAS No. 128 within the 1997
year-end consolidated financial statements. Basic and diluted EPS, as computed
under SFAS No. 128, would have been $0.17 and $0.15 per share, respectively, for
the three months ended March 31, 1997.
STOCK SPLITS
All share and per share amounts have been adjusted to reflect the
two-for-one stock splits, effective June 18, 1996 and December 18, 1996, for all
periods presented. (See Note 9)
STATEMENT OF CASH FLOWS
The Company recorded noncash tax benefits from exercises of common
stock options aggregating approximately $7.6 million and $3.5 million during
the quarters ended March 31, 1997 and 1996, respectively. In the quarter ended
March 31, 1997, the Company recorded a contribution to capital of $1.2 million
related to the merger expenses paid by former Avidia shareholders.
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for stock-based awards to employees using the
intrinsic value method in accordance with APB Opinion No. 25, "Accounting for
Stock Issued to Employees."
2. ACQUISITION OF AVIDIA
On February 27, 1997, the Company acquired Avidia pursuant to an
Agreement and Plan of Reorganization (the "Merger Agreement") among Avidia and
others, with Avidia surviving as a wholly-owned subsidiary of the Company (the
"Acquisition") in a transaction accounted for as a pooling-of-interests.
Pursuant to the Merger Agreement, the Company issued approximately 2,235,637
shares of PairGain Common Stock to Avidia stockholders in exchange for all
outstanding Avidia Common Stock and Preferred Stock and vested warrants to
purchase Avidia Common Stock. In addition, outstanding options and unvested
warrants to purchase Avidia Common Stock were exchanged for options and warrants
to purchase approximately 232,521 and 131,168 shares, respectively of the
Company's Common Stock. The Company's historical consolidated financial
statements have been restated to reflect the financial position and results of
operations of Avidia.
3. 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 75% and 82% of
the Company's total revenues for the quarters ended March 31, 1997 and 1996,
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.
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
4. SHORT-TERM INVESTMENTS
Short-term investments as of March 31, 1997 and December 31, 1996 are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
------- ------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
MARCH 31, 1997
Municipal bonds $59,906 $ 7 $ 27 $59,886
Other short-term investments 5,982 153 -- 6,135
------- ------- --------- -------
$65,888 $ 160 $ 27 $66,021
======= ======= ========= =======
DECEMBER 31, 1996
Municipal bonds $59,686 $ 41 $ -- $59,727
Other short-term investments 5,982 70 -- 6,052
------- ------- --------- -------
$65,668 $ 111 $ -- $65,779
======= ======= ========= =======
</TABLE>
There were no realized gains or losses during the three months ended
March 31, 1997 and 1996. Unrealized gains on short-term investments, net of tax,
included as a separate component of stockholders' equity at March 31, 1997 and
December 31, 1996 were $84,000 and $71,000, respectively.
5. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Finished goods $10,694 $10,603
Work in process 6,895 9,745
Raw materials 5,665 5,801
------- -------
$23,254 $26,149
======= =======
</TABLE>
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment $ 19,013 $ 16,991
Leasehold improvements 1,980 1,520
-------- --------
20,993 18,511
Less accumulated depreciation and amortization (9,401) (8,121)
-------- --------
$ 11,592 $ 10,390
======== ========
</TABLE>
7. NOTE RECEIVABLE AND LONG-TERM INVESTMENTS
In July 1995, the Company entered into certain agreements with
Sourcecom Corporation of Westlake, California ("Sourcecom"). Sourcecom designs,
manufactures and markets remote networking devices which enable the integration
of Ethernet local area networks with wide area networking over copper wire. 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 (7.5% at March 31, 1997), payable monthly, with the
principal balance due July 1999.
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 Source'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.
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
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 the prime rate
(8.5% at March 31, 1997). At March 31, 1997, 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 March 31, 1997. The agreement expires May 1, 1998.
9. STOCKHOLDERS' EQUITY
STOCK SPLITS
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 shares, par value $.001,
to 60 million shares, par value $.0005, and to effect a two-for-one stock split
(the "Stock Split").
In December 1996, the Company's stockholders approved an amendment to
the Company's Amended and Restated Certificate of Incorporation (the "Second
Amendment") to increase the authorized Common Stock of the Company from 60
million shares, par value $.0005, to 175 million shares, par value $.0005. The
Second Amendment was proposed to facilitate a two-for-one stock split (the
"Second Stock Split") which was effected in the form of a 100% stock dividend.
All references in the accompanying consolidated financial statements
related to Common Stock, Common Stock options, Common Stock warrants and
earnings per share have been adjusted to reflect both stock splits.
STOCK OFFERINGS
In a series of private placements during 1996, Avidia sold common and
preferred shares which converted in the Merger into 2,235,697 of the Company's
shares. The net proceeds raised were approximately $3,015,000.
WARRANTS
In 1996, Avidia granted warrants to certain stockholders which
converted in the Merger into the right to purchase approximately 131,168 shares
of the Company's Common Stock at exercise prices of $3.77. Such warrants were
exercised in February 1997.
In 1995, the Company granted warrants for the purchase of 40,000 shares
of its Common Stock at exercise prices of $5.00 to $6.25 per share in exchange
for services. Such warrants were outstanding at March 31, 1997 and expire
beginning in May 1998 through September 1999.
13
<PAGE> 14
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 ended March 31, 1997, compared to quarter ended
March 31, 1996)
REVENUES
Revenues for the three months ended March 31, 1997 increased 75%, to
$70.7 million, compared to $40.5 million for the three months ended March 31,
1996. This increase in revenue was primarily due a 63% increase in the unit
sales volume of the Company's HiGain product, and to a lesser extent, an 88% and
55% increase in unit sales volume of the Company's PG-2 and Campus products,
respectively. These increases were partially offset by declines in the average
selling prices of HiGain and PG-2 products.
GROSS PROFIT
Gross profit represents total revenues for a period, less the cost of
revenues for such period. Cost of revenues represents primarily product costs,
together with associated overhead expenditures and provisions for inventory and
related reserves. Gross profit increased $15.9 million, or 84%, to $35.0 million
for the three months ended March 31, 1997 compared to $19.0 million for the same
period in the prior year. This growth in gross profit was principally attributed
to the increase in the Company's revenues.
As a percentage of revenues, gross profit was 49% for the quarter ended
March 31, 1997, compared to 47% in the 1996 quarter. This increase in gross
profit percentage occurred in spite of decreases in average sales prices and
increases in overhead spending and provisions for inventory and related
reserves. The Company's continuing effort toward cost reduction through
engineering design changes, reduced prices for components, increased
manufacturing efficiencies and increases in volume, was the primary reason that
the Company was able to increase gross profit margins.
The Company expects that increased future competition will continue to
place downward pressure on the average sales prices of its existing products.
Declining average sales prices may adversely affect gross product margins on the
Company's existing products if the Company is unable to fully offset such
reductions in average sales prices 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 of existing
products.
14
<PAGE> 15
OPERATING EXPENSES
In order to support the growth of its business, the Company continued
to expand its levels of operations in research and development and sales and
marketing. Accordingly, operating expenses, excluding merger expenses, increased
$3.7 million, or 38%, for the three months ended March 31, 1997 as compared with
the same period in the prior year. Approximately 75% of this increase was due to
the addition of personnel. However, as a percentage of revenues, operating
expenses decreased to 19% in the 1997 period from 24% in the 1996 quarter.
Research and development expense increased 69%, to $6.2 million, for
the three months ended March 31, 1997 compared to $3.6 million in the prior year
period. This increase was primarily due to the addition of personnel including
those specific to technology development, costs for developmental tools,
supplies and equipment, depreciation on additions of capital equipment and
prototype expenditures associated with new products.
Selling and marketing expense increased to $4.8 million in the 1997
quarter compared to $3.7 million in the prior year quarter. The addition of
personnel and trade show and travel costs primarily accounted for the increase
in expenditures. A portion of this increase was the result of the Company's
efforts to expand its presence in the international market. Selling and
marketing expense as a percentage of revenues was 7% in the 1997 quarter
compared to 9% in 1996.
General and administrative expense was $2.4 million for the quarter
ended March 31, 1997 compared to $2.3 million in the same period in the prior
year. This increase in general and administrative expenses represents an overall
increase in these expenses offset by declines in legal fees and provision for
bad debts as compared to the prior year. As a percentage of revenues, general
and administrative expense decreased to 3% in the first quarter of 1997 from 6%
in 1996.
MERGER EXPENSES
Expenses related to the Merger with Avidia aggregating approximately
$2.6 million were charged against the operations of the Company in the quarter
ended March 31, 1997. These expenses consisted of approximately $1.8 million in
investment banker fees, $588,000 in legal fees, $120,000 in accounting fees and
$121,000 in miscellaneous expenses.
INCOME FROM OPERATIONS
As a result of the above, income from operations for the quarter ended
March 31, 1997 increased 103% to $18.9 million, compared to $9.3 million for the
1996 quarter. As a percentage of revenues, income from operations was 27% in the
1997 quarter compared to 23% in 1996.
Excluding merger expenses, income from operations for the 1997 quarter
increased 131% over the prior year period, and was 30% of revenues.
15
<PAGE> 16
INTEREST AND OTHER INCOME, NET
Net interest income increased to $1.2 million for the three months
ended March 31, 1997 from $765,000 in the 1996 quarter. This increase resulted
primarily from higher average cash levels available for investment. There was no
interest expense for the 1997 or 1996 quarters.
PROVISION FOR INCOME TAXES
The provision for income taxes increased to $8.8 million, for the three
months ended March 31, 1997, from $3.9 million for the same period in the prior
year. The Company's effective rate increased to 44% in the 1997 quarter from 38%
in the 1996 quarter, due to the non-deductibility of merger expenses. Without
the effect of the merger expenses, the Company's effective rate increased to 39%
in the three months ended March 31, 1997, as tax credits and tax-free interest
income represented a smaller proportion of total pre-tax income as a result of
the earnings growth.
NET INCOME AND EARNINGS PER SHARE
Net income for the three months ended March 31, 1997 was $11.4 million,
or $0.15 per share, compared to $6.2 million or $0.09 per share for the 1996
quarter. Excluding merger expenses, net income for the 1997 quarter increased
125% to $14.0 million, or $0.19 per share.
The weighted average number of common and common equivalent shares
outstanding was 75.5 million and 71.8 million for the three months ended March
31, 1997 and 1996, respectively. This increase in common and common equivalent
shares was primarily attributable to the exercise of employee stock options, the
granting of options to key employees of the Company and a 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 1997 over 1996.
16
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1997, the Company had $131.7 million in cash, cash
equivalents and short-term investments and $163.1 million in working capital.
This is an increase of $17.5 million in cash, cash equivalents and short-term
investments and $22.4 million in working capital over the December 31, 1996
amounts. These increases are primarily attributable to cash generated from
operations of $16.9 million and $3.3 million from the exercise of stock options,
offset by capital expenditures of $2.5 million. Accounts receivable increased to
$35.1 million at March 31, 1997, compared to $23.9 million at December 31, 1996.
This increase in receivables was primarily due to higher revenue levels and a
larger proportion of total revenue for the 1997 quarter being shipped during the
last four weeks of the quarter. Gross inventories increased $1.1 million to
$41.8 million at March 31, 1997 compared to $40.7 million at December 31, 1996.
Reserves for inventory obsolescence, excess quantities, cost reductions and test
and evaluation inventories increased to $18.6 million at March 31, 1997 compared
to $14.6 million at December 31, 1996. The primary reasons for the increase in
these reserves were: (a) an increase in excess and obsolete inventories; (b)
valuation reductions due to product cost reduction programs; and (c) an increase
in test and evaluation inventories of new products on trial at customers. Net
inventory turns increased from four times for the first quarter of 1996 to six
times in the 1997 quarter.
Capital expenditures relating primarily to the purchase of computer
equipment, machinery and test equipment and improvements to the Company's new
engineering and production facility adjacent to its Tustin facility amounted to
$2.5 million during the first quarter of 1997. The Company anticipates spending
a total of $2.5 million in improvements to its new facility. Once the
improvements are completed, the Company plans to use the building to consolidate
its personnel and warehouse and distribution presently located in other Tustin
and Santa Ana locations and to allow for its further expansion requirements. In
addition, during the first quarter, the Company has committed to purchase
approximately $1.5 million in manufacturing and material handling equipment.
Payment for this equipment will occur during the second and third quarters of
1997. Capital expenditures in the 1996 quarter aggregated approximately $1.0
million, primarily related to expenditures for computer equipment, machinery and
test equipment.
Accounts payable and other current liabilities increased to $41.6
million at March 31, 1997 from $37.4 million at December 31, 1996. The primary
reason for the increase was an increase in income taxes payable, accounts
payable, accrued compensation and other accrued expenses.
The Company believes that its 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 1997. 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.
17
<PAGE> 18
PART II. OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
None.
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 Computation of Earnings Per Share
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
(B) Reports on Form 8-K
A Form 8-K was filed on March 5, 1997 reporting the Company's
acquisition of Avidia Systems, Inc. on February 27, 1997. Form
8-K/A was filed on April 25, 1997 to submit audited financial
statements of Avidia Systems, Inc. for the year ended December
31, 1996, and pro forma combined financial information.
18
<PAGE> 19
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.
PairGain Technologies, Inc.
-----------------------------------------
(Registrant)
Date: May 15, 1997 /s/ Charles W. McBrayer
------------ ------------------------------------------
Charles W. McBrayer
Vice President, Finance and Administration
Chief Financial Officer
(Duly Authorized Officer)
Date: May 15, 1997 /s/ Robert R. Price
------------ ------------------------------------------
Robert R. Price
Corporate Controller
(Chief Accounting Officer)
19
<PAGE> 1
PAIRGAIN TECHNOLOGIES, INC.
EXHIBIT 11.1--COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1997 1996
-------- --------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C>
PRIMARY EARNINGS PER SHARE
Net income $ 11,374 $ 6,222
======== ========
Calculation of weighted average number of common
and common equivalent shares:
Weighted average of common shares outstanding 66,864 62,680
Weighted average of common and common share equivalents:
Weighted average warrants outstanding 127 40
Weighted average options outstanding 12,327 13,006
Shares assumed to be repurchased using the treasury stock method (2,419) (2,731)
Shares assumed to be repurchased to reflect the effects of tax benefits (1,360) (1,223)
-------- --------
Weighted average number of common and common equivalent shares 75,539 71,772
======== ========
Earnings per share $ 0.15 $ 0.09
======== ========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------
1997 1996
-------- --------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C>
FULLY DILUTIVE EARNINGS PER SHARE
Net income $ 11,374 $ 6,222
======== ========
Calculation of weighted average number of common
and common equivalent shares:
Weighted average of common shares outstanding 66,864 62,680
Weighted average of common and common share equivalents:
Weighted average warrants outstanding 127 40
Weighted average options outstanding 12,327 13,006
Shares assumed to be repurchased using the treasury stock method (2,419) (2,313)
Shares assumed to be repurchased to reflect the effects of tax benefits (1,360) (1,262)
-------- --------
Weighted average number of common and common equivalent shares 75,539 72,151
======== ========
Earnings per share $ 0.15 $ 0.09
======== ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 65,642
<SECURITIES> 66,021
<RECEIVABLES> 35,065
<ALLOWANCES> 0
<INVENTORY> 23,254
<CURRENT-ASSETS> 204,659
<PP&E> 20,993
<DEPRECIATION> 9,401
<TOTAL-ASSETS> 222,769
<CURRENT-LIABILITIES> 41,604
<BONDS> 0
0
0
<COMMON> 34
<OTHER-SE> 181,131
<TOTAL-LIABILITY-AND-EQUITY> 222,769
<SALES> 70,607
<TOTAL-REVENUES> 70,749
<CGS> 35,780
<TOTAL-COSTS> 35,780
<OTHER-EXPENSES> 16,033
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,249)
<INCOME-PRETAX> 20,185
<INCOME-TAX> 8,811
<INCOME-CONTINUING> 11,374
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,374
<EPS-PRIMARY> 0.15
<EPS-DILUTED> 0.15
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-31-1996
<CASH> 42,786
<SECURITIES> 31,276
<RECEIVABLES> 13,962
<ALLOWANCES> 0
<INVENTORY> 25,233
<CURRENT-ASSETS> 117,670
<PP&E> 11,878
<DEPRECIATION> 5,212
<TOTAL-ASSETS> 127,099
<CURRENT-LIABILITIES> 21,690
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 105,394
<TOTAL-LIABILITY-AND-EQUITY> 127,100
<SALES> 40,511
<TOTAL-REVENUES> 40,511
<CGS> 21,472
<TOTAL-COSTS> 21,472
<OTHER-EXPENSES> 9,707
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (765)
<INCOME-PRETAX> 10,097
<INCOME-TAX> 3,875
<INCOME-CONTINUING> 6,222
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,222
<EPS-PRIMARY> 0.09
<EPS-DILUTED> 0.09
</TABLE>