<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 THIRD QUARTER ENDED SEPTEMBER 30, 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 68,577,387 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE OF
$.0005 PER SHARE OUTSTANDING ON SEPTEMBER 30, 1997.
<PAGE> 2
PAIRGAIN TECHNOLOGIES, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
------
<S> <C> <C>
Part I Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
at September 30, 1997 and December 31, 1996 3
Condensed Consolidated Statements of Income for the
quarters and nine months ended September 30, 1997 and 1996 (restated) 4
Condensed Consolidated Statements of Cash Flows for the
nine months ended September 30, 1997 and 1996 (restated) 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 20
Item 2. Changes in Securities 20
Item 3. Defaults upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 20
Signatures 21
</TABLE>
2
<PAGE> 3
PART I: ITEM 1
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 106,504 $ 48,416
Short-term investments (Note 4) 58,333 65,779
Accounts receivable 32,444 23,888
Inventories (Note 5) 26,452 26,149
Other current assets and deferred taxes 15,302 13,857
--------- ---------
TOTAL CURRENT ASSETS 239,035 178,089
Property and equipment, net (Note 6) 16,806 10,390
Note receivable and long-term investments (Note 7) 5,708 6,252
Other assets 373 273
--------- ---------
TOTAL ASSETS $ 261,922 $ 195,004
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and other current liabilities $ 46,326 $ 37,408
Bank line of credit (Note 8) -- --
--------- ---------
TOTAL CURRENT LIABILITIES 46,326 37,408
COMMITMENTS AND CONTINGENCIES
Stockholders' equity (Notes 1 and 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 68,577,387 and 66,278,293 at
September 30, 1997 and December 31, 1996, respectively 34 33
Additional paid-in capital 138,964 116,081
Deferred compensation (180) (237)
Unrealized gain on marketable securities 239 71
Retained earnings 76,539 41,648
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 215,596 157,596
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 261,922 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1997 1996 1997 1996
-------- -------- -------- --------
(RESTATED) (RESTATED)
(SEE NOTES 1 (SEE NOTES 1
AND 2) AND 2)
<S> <C> <C> <C> <C>
REVENUES $ 70,697 $ 54,618 $207,815 $142,370
Cost of revenues 35,772 28,469 105,135 74,515
-------- -------- -------- --------
Gross profit 34,925 26,149 102,680 67,855
-------- -------- -------- --------
Operating expenses:
Research and development 8,694 5,453 22,387 13,764
Selling and marketing 5,868 4,763 16,609 12,850
General and administrative 2,778 2,678 7,680 7,485
Merger expenses (Note 1) -- -- 2,642 --
-------- -------- -------- --------
Total operating expenses 17,340 12,894 49,318 34,099
-------- -------- -------- --------
INCOME FROM OPERATIONS 17,585 13,255 53,362 33,756
Interest and other income, net 1,321 867 4,156 2,526
-------- -------- -------- --------
Income before income taxes 18,906 14,122 57,518 36,282
Provision for income taxes (Note 1) 7,109 5,654 22,627 14,268
-------- -------- -------- --------
NET INCOME $ 11,797 $ 8,468 $ 34,891 $ 22,014
======== ======== ======== ========
Per Share Data (Note 1):
Earnings per share $ 0.16 $ 0.11 $ 0.46 $ 0.30
======== ======== ======== ========
Weighted average number of common and
common equivalent shares 75,165 74,347 75,147 73,224
======== ======== ======== ========
</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>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1997 1996
--------------- --------------
(RESTATED)
(SEE NOTES 1
AND 2)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 34,891 $ 22,014
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 5,343 3,276
Merger expenses paid by former Avidia shareholders 1,184 --
Valuation adjustment for impairment to long-term asset 544 --
Change in operating assets and liabilities:
Accounts receivable (8,556) (7,648)
Inventories (303) (11,015)
Other current assets (1,549) 203
Other assets (100) (22)
Accounts payable and other current liabilities 23,419 32,302
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 54,873 39,110
--------- ---------
Cash flows from investing activities:
Net proceeds from (purchases of) short-term investments 6,870 (20,873)
Purchases of property and equipment (10,854) (5,523)
Purchases of long-term investments -- (3,544)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (3,984) (29,940)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 7,199 7,810
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 7,199 7,810
--------- ---------
Increase in cash and cash equivalents 58,088 16,980
Cash and cash equivalents at beginning of period 48,416 24,576
--------- ---------
Cash and cash equivalents at end of period $ 106,504 $ 41,556
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income tax paid $ 9,519 $ 149
========= =========
</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 three and nine months ended September 30, 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 September
30, 1997, and consolidated results of operations for the three and nine months
ended September 30, 1997, and September 30, 1996, and cash flows for the nine
months ended September 30, 1997, and September 30, 1996. Results of operations
for the three and nine months ended September 30, 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.
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
PairGain
6
<PAGE> 7
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
Wallingford Design Center, Inc. (formerly Avidia Systems, Inc.). 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 September 30, 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 three months or less to be cash equivalents.
SHORT-TERM INVESTMENTS
The Company accounts for short-term investments pursuant to Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities". 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
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
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 machinery and 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
were charged against the operations of the Company in the quarter ended March
31, 1997.
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
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
from outstanding options and warrants to purchase common stock and are
calculated using the treasury stock method.
RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1997, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 128, "Earnings Per Share", ("SFAS No. 128"). This statement is
effective for the Company's quarter ending December 31, 1997 and requires
restatement of all prior periods. The Statement redefines earnings per share
("EPS") under generally accepted accounting principles, 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, are shown in the table below:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1997 September 30, 1997
------------------- ------------------
<S> <C> <C>
Basic EPS $0.17 $0.52
Diluted EPS $0.16 $0.46
</TABLE>
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive
Income", ("SFAS No. 130"). This statement establishes standards for the
reporting of comprehensive income and its components in a financial statement
that is displayed with the same prominence as other financial statements.
Comprehensive income, as defined, includes all changes in equity (net assets)
during a period from non-owner sources. Examples of items to be included in
comprehensive income, which are excluded from net income, include foreign
currency translation adjustments and unrealized gain/loss on available-for-sale
securities. The disclosures prescribed by SFAS No. 130 are effective beginning
with the first quarter of calendar 1998.
In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments
of an Enterprise and Related Information", ("SFAS No. 131"). This statement
establishes standards for the way companies report information about operating
segments in annual financial statements. It also establishes standards for
related disclosure about products and services, geographic areas and major
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
customer. The Company has not yet determined the impact, if any, of adopting
this new standard. The disclosures prescribed by SFAS No. 131 are effective for
calendar 1998.
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 $14.5 million and $12.1 million during the
nine months ended September 30, 1997 and 1996, respectively. In the nine months
ended September 30, 1997, the Company recorded a contribution to capital of $1.2
million related to the merger expenses paid by former Avidia shareholders.
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 2,235,697
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.
In July 1997, Avidia's name was changed to PairGain Wallingford Design
Center, Inc.
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.
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
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 71% and 81% of
the Company's total revenues for the nine months ended September 30, 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.
4. SHORT-TERM INVESTMENTS
Short-term investments as of September 30, 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>
SEPTEMBER 30, 1997
Municipal bonds $51,971 $ 114 $ -- $52,085
Other short-term investments 5,979 269 -- 6,248
------- ------- --------- -------
$57,950 $ 383 $ -- $58,333
======= ======= ========= =======
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>
For the three and nine months ended September 30, 1997 there was a net
realized gain of $23,000. There were no net realized gains for the corresponding
1996 periods. Unrealized gains on short-term investments, net of tax, included
as a separate component of stockholders' equity at September 30, 1997 and
December 31, 1996 were $239,000 and $71,000, respectively.
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
5. INVENTORIES
Inventories consist of:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Raw materials $ 7,435 $ 5,801
Work in process 6,325 9,745
Finished goods 12,692 10,603
-------- --------
$ 26,452 $ 26,149
======== ========
</TABLE>
6. PROPERTY AND EQUIPMENT
Property and equipment consist of:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment $ 25,933 $ 16,991
Leasehold improvements 3,432 1,520
-------- --------
29,365 18,511
Less accumulated depreciation and amortization (12,559) (8,121)
-------- --------
$ 16,806 $ 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"). 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 had rights to purchase a minority
ownership position. The note bears interest at the prime rate less one percent
(7.5% at September 30, 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 Sourcecom's two-for-one stock split, effective September 24, 1996.
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
In the third quarter of 1997, Sourcecom filed for protection from
creditors under the U.S. Bankruptcy Act. In addition, Sourcecom sold all of its
assets to an unrelated third party for $8.0 million. The proceeds from the sale
of Sourcecom assets have been placed in a trust account pending the outcome of
its plan of reorganization and approval thereof by the bankruptcy court.
Based upon the information available, the Company recorded a valuation
adjustment of $544,000 during the third quarter of 1997 to reflect an impairment
in its investment in Sourcecom. Additional adjustments, if any, may be recorded
as more information becomes available or at such time that the final resolution
of Sourecom's plan of reorganization has been approved by the court.
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.
The Company accounts for long-term investments using the cost method.
However, when it is determined that the investments are permanently impaired,
the Company records a valuation adjustment.
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 September 30, 1997). At September 30, 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 September 30, 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.
13
<PAGE> 14
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(Unaudited)
All references in the accompanying condensed 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 September 30, 1997 and expire
beginning in May 1998 through September 1999.
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, 1997,
compared to quarter and nine months ended September 30, 1996)
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.
REVENUES
Revenues for the quarter ended September 30, 1997, increased $16.1
million or 29% as compared with the 1996 quarter. The increase in revenue was
primarily due to a 31% increase in the unit sales volume of the Company's HiGain
product, offset partially by a decrease in the per unit average selling price.
Increases in the unit sales volume of the Company's PG-2 and Campus products,
21% and 19%, respectively, also contributed to the increased product revenue.
Another factor that contributed to the increase in revenues was the continuing
success of the recently introduced ETSI product line, which enabled
international sales to increase by 173% over the prior year quarter.
International revenues were 9% of total sales in the third quarter of 1997,
compared to 4% in the 1996 quarter. Finally, sales of the Company's PG-Flex
product increased substantially over the third quarter of 1996 to $5 million.
Revenues for the nine months ended September 30, 1997, increased $65.4
million or 46%, over the nine month period in the prior year. This increase in
revenues was primarily due to a 41% increase in the unit sales volume of the
Company's HiGain product. A less significant portion of the increase was
attributed to 48% and 56% 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 all product lines. International sales
for the first nine months of 1997 increased 156% over the same period in 1996,
and represented 9% of total revenues, compared to 5% for the first nine months
of 1996.
15
<PAGE> 16
GROSS PROFIT
Gross profit increased $8.8 million or 34% for the quarter ended
September 30, 1997, as compared with the prior year quarter. Gross profit for
the first nine months of 1997 increased $34.8 million or 51% over the
corresponding 1996 period. 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 and
nine month period ended September 30, 1997 compared to 48% for the corresponding
1996 periods. 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 and increased manufacturing efficiencies.
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
Operating expenses increased $4.4 million to $17.3 million for the three
months ended September 30, 1997 as compared with the same period in the prior
year. For the nine month period, operating expenses, excluding merger expenses,
increased $12.6 million to $46.7 million. Costs relating to the addition of
personnel represented 40% of these increases. The majority of the increase in
operating expenses was in the area of research and development in order to
support the development of new products. As a percentage of revenues, operating
expenses, excluding merger expenses, were 25% and 22%, respectively, for the
three and nine month periods in 1997 compared to 24% for the 1996 periods.
Research and development expense increased $3.2 million or 59% and $8.6
million or 63%, respectively, for the quarter and nine months ended September
30, 1997, as compared with the same periods in the prior year. These increases
were primarily due to the addition of personnel including those specific to
technology development, costs for developmental tools, supplies, equipment and
consulting services and depreciation on test and computer equipment. Research
and development expense as a percentage of revenues was 12% and 11% in the 1997
quarter and nine month period, respectively, compared to 10% in each of the 1996
periods.
Selling and marketing expense increased $1.1 million or 23% and $3.8
million or 29%, respectively, for the quarter and nine months ended September
30, 1997, as compared with the same periods in the prior year. Additional sales
and marketing support personnel, commissions, and travel costs primarily
accounted for the increase in expenditures. In addition, costs related to the
international sales force increased overall, as the Company continued to expand
its overseas presence. Selling and marketing expense as a percentage of revenues
was 8% in 1997 compared to 9% in 1996.
16
<PAGE> 17
General and administrative expense increased $100,000 or 4% and $195,000
or 3%, respectively, for the quarter and nine months ended September 30, 1997,
as compared with the same periods in the prior year. Increases in
personnel associated costs and expenditures for computer equipment, software
maintenance and consulting fees related to upgrading the Company's information
system capabilities were offset by decreases in legal fees and provisions for
bad debts. As a percentage of revenues, general and administrative expense
dropped to 4% in the 1997 periods from 5% in 1996.
MERGER EXPENSES
Expenses related to the acquisition of 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 $1.8 million in investment
banker fees, $588,000 in legal fees, $120,000 in accounting fees and $121,000 in
other expenses.
INCOME FROM OPERATIONS
As a result of the above, income from operations for the quarter ended
September 30, 1997 increased 33% to $17.6 million, compared to $13.3 million for
the 1996 quarter. Income from operations for the nine months ended September 30,
1997 increased 58% to $53.4 million, compared to $33.8 million for the first
nine months of 1996. As a percentage of revenues, income from operations was 25%
and 26%, respectively, for the quarter and first nine months in 1997, compared
to 24% in the 1996 periods.
Excluding merger expenses, income from operations for the first nine
months of 1997 increased 66% over the prior year period, and was 27% of
revenues.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $1.9 and $4.7 million for the three and
nine months ended September 30, 1997, respectively, from $867,000 and $2.5
million in the corresponding 1996 periods. These increases resulted primarily
from higher average cash levels available for investment. There was no interest
expense during the first nine months of 1997 or 1996.
In the quarter ended September 30, 1997, the Company recorded a
valuation adjustment of $544,000 related to its equity investment in Sourcecom
Corporation, which had the effect of reducing interest and other income. See
Note 7 of Notes to Condensed Consolidated Financial Statements.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 1997, was $7.1 million and $22.6 million, respectively, compared
to $5.7 million and $14.3 million for the three and nine months ended September
30, 1996. The Company's effective tax rate for the first nine months in 1997 was
39% compared to 39% in the 1996 period. Excluding non-deductible merger
expenses, the 1997 effective tax rate was 38%.
17
<PAGE> 18
NET INCOME AND EARNINGS PER SHARE
Net income for the three months ended September 30, 1997 was $11.8
million, compared to $8.5 million in 1996, or a 39% increase. Net income for the
first nine months of 1997 was $34.9 million, compared to $22.0 million in the
first nine months of 1996. Excluding merger expenses, net income for the first
nine months of 1997 was $37.5 million, a 70% increase over the prior year
period.
Earnings per share for the three months ended September 30, 1997 were
$0.16 compared to $0.11 for the 1996 quarter. Earnings per share for the nine
months ended September 30, 1997 were $0.46 compared to $0.30 for the first nine
months of 1996. Excluding merger expenses, earnings per share for the first nine
months of 1997 were $0.50.
The weighted average number of common and common equivalent shares
outstanding was 75.2 million and 74.3 million for the three months ended
September 30, 1997 and 1996, respectively. The weighted average number of common
and common equivalent shares outstanding was 75.1 million and 73.2 million for
the first nine months of 1997 and 1996, respectively. The increase in common and
common equivalent shares was primarily attributable to an increase in actual
shares outstanding as a result of the exercise of employee stock options.
18
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1997, the Company had $164.8 million in cash, cash
equivalents and short-term investments and $192.7 million in working capital.
These figures represent an increase of $50.6 million in cash, cash equivalents
and short-term investments and $52.0 million in working capital over December
31, 1996. These increases were primarily attributable to cash generated from
operations of $54.9 million and $7.2 million from the exercise of stock options,
offset by capital expenditures of $10.9 million. Accounts receivable increased
to $32.4 million at September 30, 1997, compared to $23.9 million at December
31, 1996. The increase in accounts receivable was due to higher revenue levels
and an increase in accounts receivable days outstanding from 35 at December 31,
1996 to 42 at September 30, 1997. Gross inventories at September 30, 1997
increased $5.3 million from December 31, 1996 levels to $46.1 million. Reserves
for inventory obsolescence, excess quantities, cost reductions and test and
evaluation inventories increased to $19.6 million at September 30, 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.
Annualized net inventory turns increased from 3.3 times for the first nine
months of 1996 to 5.4 times in the same period in 1997.
Capital expenditures during the nine month period ended September 30,
1997 were $10.9 million, consisting primarily of purchases of computer
equipment, test equipment, payments for a manufacturing and material handling
system and improvements to the Company's new engineering and production facility
adjacent to its Tustin facility. The material handling system is expected to
cost $1.2 million at completion, which is anticipated in the fourth quarter of
1997. As of September 30, 1997, the Company has spent $1.8 million on
improvements to a newly leased facility where it has consolidated its warehouse
and distribution departments previously located in other Tustin and Santa Ana
locations and will allow for further expansion requirements. The Company
anticipates spending a total of $2.5 million to complete all improvements.
Capital expenditures in the first nine months of 1996 aggregated approximately
$5.5 million, primarily related to expenditures for computer equipment,
machinery and test equipment.
Accounts payable and other current liabilities increased to $46.3
million at September 30, 1997 from $37.4 million at December 31, 1996. The
primary reason for the increase was an increase in accounts payable, accrued
compensation and other accrued expenses, offset by a decrease in accrued income
taxes. For the first nine months of 1997, the Company made estimated tax
payments of $10.5 million and received refunds totaling $1.0 million.
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.
19
<PAGE> 20
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 Calculation of Per Share Earnings
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
-------------
(B) Reports filed on Form 8-K during the period:
None.
20
<PAGE> 21
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 13, 1997 /S/ CHARLES W. MCBRAYER
-------------------- --------------------------------------------
Charles W. McBrayer
Vice President, Finance and Administration
Chief Financial Officer
(Duly Authorized Officer)
Date: November 13, 1997 /S/ ROBERT R. PRICE
-------------------- --------------------------------------------
Robert R. Price
Corporate Controller
(Chief Accounting Officer)
21
<PAGE> 22
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<S> <C>
11.1 Calculation of Per Share Earnings
27.1 Financial Data Schedule
27.2 Restated Financial Data Schedule
</TABLE>
22
<PAGE> 1
EXHIBIT 11.1
PAIRGAIN TECHNOLOGIES, INC.
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------- -------------------------------
PRIMARY EARNINGS PER SHARE 1997 1996 1997 1996
-------- -------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net income $ 11,797 $ 8,468 $ 34,891 $ 22,014
======== ======== ======== ========
Calculation of weighted average
number of common and common
equivalent shares:
Weighted average of common shares
outstanding 68,387 64,581 67,697 63,679
Weighted average of common share
equivalents:
Weighted average warrants 40 108 69 81
outstanding
Weighted average options
outstanding 10,159 13,348 10,837 13,138
Shares assumed to be repurchased
using the treasury stock method (2,324) (2,314) (2,261) (2,362)
Shares assumed to be repurchased
to reflect the effects of tax
benefits (1,097) (1,376) (1,195) (1,312)
-------- -------- -------- --------
Weighted average number of common
and common equivalent shares 75,165 74,347 75,147 73,224
======== ======== ======== ========
Earnings per share $ 0.16 $ 0.11 $ 0.46 $ 0.30
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
QUARTER ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
--------------------------- -------------------------------
FULLY DILUTED EARNINGS PER SHARE 1997 1996 1997 1996
-------- -------- -------- --------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net income $ 11,797 $ 8,468 $ 34,891 $ 22,014
======== ======== ======== ========
Calculation of weighted average
number of common and common
equivalent shares:
Weighted average of common shares
outstanding 68,387 64,581 67,697 63,679
Weighted average of common share
equivalents:
Weighted average warrants
outstanding 40 108 69 81
Weighted average options
outstanding 11,591 13,348 11,314 13,138
Shares assumed to be repurchased
using the treasury stock method (3,248) (1,938) (2,570) (1,964)
Shares assumed to be repurchased
to reflect the effects of tax
benefits (1,160) (1,418) (1,216) (1,358)
-------- -------- -------- --------
Weighted average number of common
and common equivalent shares 75,610 74,681 75,294 73,576
======== ======== ======== ========
Earnings per share $ 0.16 $ 0.11 $ 0.46 $ 0.30
======== ======== ======== ========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<CASH> 106,504
<SECURITIES> 58,333
<RECEIVABLES> 32,444
<ALLOWANCES> 0
<INVENTORY> 26,452
<CURRENT-ASSETS> 239,035
<PP&E> 29,365
<DEPRECIATION> 12,559
<TOTAL-ASSETS> 261,922
<CURRENT-LIABILITIES> 46,326
<BONDS> 0
0
0
<COMMON> 34
<OTHER-SE> 215,562
<TOTAL-LIABILITY-AND-EQUITY> 261,922
<SALES> 207,815
<TOTAL-REVENUES> 207,815
<CGS> 105,135
<TOTAL-COSTS> 105,135
<OTHER-EXPENSES> 49,318
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (4,156)
<INCOME-PRETAX> 57,518
<INCOME-TAX> 22,627
<INCOME-CONTINUING> 34,891
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 34,891
<EPS-PRIMARY> 0.46
<EPS-DILUTED> 0.46
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 41,556
<SECURITIES> 51,283
<RECEIVABLES> 20,692
<ALLOWANCES> 0
<INVENTORY> 33,537
<CURRENT-ASSETS> 151,754
<PP&E> 16,406
<DEPRECIATION> 7,013
<TOTAL-ASSETS> 167,475
<CURRENT-LIABILITIES> 31,587
<BONDS> 0
0
0
<COMMON> 33
<OTHER-SE> 135,855
<TOTAL-LIABILITY-AND-EQUITY> 167,475
<SALES> 142,370
<TOTAL-REVENUES> 142,370
<CGS> 74,515
<TOTAL-COSTS> 74,515
<OTHER-EXPENSES> 34,099
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (2,526)
<INCOME-PRETAX> 36,282
<INCOME-TAX> 14,268
<INCOME-CONTINUING> 22,014
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,014
<EPS-PRIMARY> 0.30
<EPS-DILUTED> 0.30
</TABLE>
