<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, 1998
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 Identification No.)
incorporation of organization)
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 69,822,702 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.0005
PER SHARE, OUTSTANDING ON MARCH 31, 1998.
<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, 1998 and December 31, 1997 3
Condensed Consolidated Statements of Income
for the three months ended March 31, 1998 and 1997 4
Condensed Consolidated Statements of Comprehensive Income
for the three months ended March 31, 1998 and 1997 5
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1998 and 1997 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 16
Part II. Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 22
Item 3. Defaults upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signatures 23
</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,
1998 1997
--------- ---------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 116,290 $ 111,602
Short-term investments (Note 4) 71,777 64,983
Accounts receivable 37,360 35,429
Inventories (Note 5) 39,317 30,538
Other current assets and deferred taxes 21,168 19,074
--------- ---------
TOTAL CURRENT ASSETS 285,912 261,626
Property and equipment, net (Note 6) 16,999 17,423
Long-term investment (Note 7) 3,000 3,000
Other assets 486 370
--------- ---------
TOTAL ASSETS $ 306,397 $ 282,419
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 11,125 $ 8,527
Accrued expenses (Note 9) 21,491 21,702
Accrued income taxes 21,245 16,673
--------- ---------
TOTAL CURRENT LIABILITIES 53,861 46,902
--------- ---------
COMMITMENTS AND CONTINGENCIES
Stockholders' equity:
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 - 69,822,702 and
69,023,713 at March 31, 1998 and December 31, 1997, 35 34
respectively
Additional paid-in capital 151,079 146,277
Deferred compensation (142) (161)
Accumulated other comprehensive income (Note 10) 117 82
Retained earnings 101,447 89,285
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 252,536 235,517
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 306,397 $ 282,419
========= =========
</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,
----------------------------
1998 1997
----------- -----------
<S> <C> <C>
REVENUES (Note 3) $72,619 $70,749
Cost of revenues 35,734 35,780
------- -------
Gross profit 36,885 34,969
------- -------
Operating expenses:
Research and development 9,536 6,158
Selling and marketing 7,205 4,800
General and administrative 3,083 2,433
Merger expenses (Note 1) -- 2,642
------- -------
Total operating expenses 19,824 16,033
------- -------
INCOME FROM OPERATIONS 17,061 18,936
Interest and other income, net 2,092 1,249
------- -------
Income before income taxes 19,153 20,185
Provision for income taxes (Note 1) 6,991 8,811
------- -------
NET INCOME $12,162 $11,374
======= =======
Per Share Data (Note 1):
Earnings per common share
Basic $ 0.17 $ 0.17
======= =======
Diluted $ 0.16 $ 0.15
======= =======
Average shares outstanding
Basic 69,543 66,865
======= =======
Diluted 75,203 75,539
======= =======
</TABLE>
See notes to condensed consolidated financial statements.
4
<PAGE> 5
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------
1998 1997
----------- ---------------
<S> <C> <C>
Net income $12,162 $11,374
------- -------
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising during period 35 13
Less: reclassification adjustment for gains
included in net income -- --
------- -------
Net unrealized gains 35 13
------- -------
Other comprehensive income (Note 10) 35 13
------- -------
Comprehensive income $12,197 $11,387
======= =======
</TABLE>
See notes to condensed consolidated financial statements.
5
<PAGE> 6
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 12,162 $ 11,374
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 2,396 1,601
Loss on sale of equipment 73 --
Change in operating assets and liabilities:
Accounts receivable (1,931) (11,177)
Inventories (8,779) 2,895
Other current assets (2,115) 364
Other assets (38) 7
Accounts payable 2,598 1,029
Accrued expenses (152) 1,334
Income taxes 6,892 9,480
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 11,106 16,907
--------- ---------
Cash flows from investing activities:
Net purchases of short-term investments (7,046) (530)
Purchase of property and equipment (1,855) (2,482)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (8,901) (3,012)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 2,483 3,331
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 2,483 3,331
--------- ---------
Increase in cash and cash equivalents 4,688 17,226
Cash and cash equivalents at beginning of period 111,602 48,416
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 116,290 $ 65,642
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ 2,591 $ --
========= =========
Income tax refunds $ 2,500 $ 950
========= =========
</TABLE>
See notes to condensed consolidated financial statements.
6
<PAGE> 7
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 a comprehensive line of digital
telecommunications products that allow telecommunications carriers and private
network owners to more efficiently provide high-speed digital services to end
users over the large 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.
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,
1998, and consolidated results of operations, comprehensive income and cash
flows for the three months ended March 31, 1998 and March 31, 1997. Results of
operations for the three months ended March 31, 1998, are not necessarily
indicative of results to be expected for the full year ending December 31, 1998.
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, 1997.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. 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 and Swiss subsidiaries 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 1998 or 1997.
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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, 1998 and
December 31, 1997. 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.
COMPREHENSIVE INCOME
Pursuant to SFAS No. 130, "Reporting Comprehensive Income," the Company
has included Consolidated Statements of Comprehensive Income for the periods
ended March 31, 1998 and 1997. See Note 10 for further discussion.
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
Short-term investments are accounted for in accordance with SFAS 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 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.
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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 lives of equipment is three to five years. Leasehold improvements are
amortized over the lesser of five years or the life of the lease.
WARRANTY RESERVE
The Company accrues warranty reserves, which are charged against cost of
goods sold, based upon historical rates and estimated future costs.
CONTINGENCIES
The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation matters,
individually or in the aggregate, will have a material adverse effect on its
financial position or results of operations.
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.
INCOME TAXES
Income taxes are provided at the rate expected to be in effect for the
entire year.
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
PER SHARE INFORMATION
Pursuant to SFAS No. 128, "Earnings Per Share," ("SFAS No. 128"), the
Company provides dual presentation of "Basic" and "Diluted" earnings per share
("EPS"). SFAS No. 128 replaced "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.
EPS for the quarter ended March 31, 1997 has been restated to reflect
the adoption of SFAS No. 128.
The following table reconciles the weighted average shares outstanding
for basic and diluted earnings per share for the periods presented.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
----------- ------------
(IN THOUSANDS EXCEPT PER
SHARE AMOUNTS)
<S> <C> <C>
Net income $ 12,162 $ 11,374
======== ========
Basic earnings per common share:
Weighted average of common shares outstanding 69,543 66,865
======== ========
Basic earnings per common share $ 0.17 $ 0.17
======== ========
Diluted earnings per common share:
Weighted average of common shares outstanding 69,543 66,865
Weighted average of common share equivalents:
Weighted average warrants outstanding 40 127
Weighted average options outstanding 11,167 12,327
Anti-dilutive options (1,802) --
Shares assumed to be repurchased using the treasury
stock method (2,821) (2,420)
Shares assumed to be repurchased to reflect the
effects of tax benefits (924) (1,360)
-------- --------
Weighted average number of common and common equivalent
shares 75,203 75,539
======== ========
Diluted earnings per common share $ 0.16 $ 0.15
======== ========
</TABLE>
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("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 customer. The disclosures prescribed by
SFAS No. 131 are effective for calendar 1998, however, the standard need not be
applied to interim financial statements in the initial year of its application.
The Company is still evaluating the impact of adopting SFAS No. 131 and plans to
implement this new standard in its 1998 year-end financial statements.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," ("SFAS No. 132"). This
statement revises and standardizes employers' disclosure requirements about
pension and other postretirement benefit plans, requires additional information
on changes in the benefit obligations and fair values of plan assets that will
facilitate financial analysis and eliminates certain disclosures that are not
longer useful. The Company does not maintain an employee pension plan or any
other postretirement benefit plans.
STATEMENT OF CASH FLOWS
The Company recorded noncash tax benefits from exercises of common stock
options aggregating approximately $2.3 million and $7.6 million during the
quarters ended March 31, 1998 and 1997, respectively.
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.
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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 historically 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 63% and 75% of
the Company's total revenues for the quarters ended March 31, 1998 and 1997,
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.
Export sales represented 20% and 16% of product revenue during the three
months ended March 31, 1998 and 1997, respectively. Product sales by
geographical region is summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
United States $56,370 $59,549
Canada 6,077 7,066
Other international 8,249 3,992
------- -------
Total product revenues 70,696 70,607
Royalty income and technology and licensing fees 1,923 142
------- -------
Total revenues $72,619 $70,749
======= =======
</TABLE>
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
4. SHORT-TERM INVESTMENTS
Short-term investments as of March 31, 1998 and December 31, 1997 are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
-------- ---------- --------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
MARCH 31, 1998
Municipal bonds $69,433 $ 152 $ -- $69,585
Other short-term investments 2,160 32 -- 2,192
------- ------- --------- -------
$71,593 $ 184 $ -- $71,777
======= ======= ========= =======
DECEMBER 31, 1997
Municipal bonds $62,695 $ 140 $ -- $62,835
Other short-term investments 2,160 -- (12) 2,148
------- ------- --------- -------
$64,855 $ 140 $ (12) $64,983
======= ======= ========= =======
</TABLE>
There were no realized gains or losses on short-term investments during
the three months ended March 31, 1998 and 1997. Unrealized holding gains on
short-term investments, net of tax, included in accumulated other comprehensive
income in stockholders' equity at March 31, 1998 and December 31, 1997 were
$117,000 and $82,000, respectively.
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Finished goods $19,398 $14,119
Work in process 7,489 6,982
Raw materials 12,430 9,437
------- -------
$39,317 $30,538
======= =======
</TABLE>
13
<PAGE> 14
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,
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment $ 30,018 $ 28,555
Leasehold improvements 3,560 3,444
-------- --------
33,578 31,999
Less accumulated depreciation and amortization (16,579) (14,576)
-------- --------
$ 16,999 $ 17,423
======== ========
</TABLE>
7. LONG-TERM INVESTMENT
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. This investment is 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 the prime rate
(8.5% at March 31, 1998). At March 31, 1998 and December 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, 1998 and December 31, 1997.
The agreement expires May 1, 1999.
9. ACCRUED EXPENSES
Accrued expenses consist of:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
Accrued compensation and related expenses $ 7,531 $ 8,836
Accrued warranty 9,596 9,161
Other accrued expenses 4,364 3,705
------- -------
$21,491 $21,702
======= =======
</TABLE>
14
<PAGE> 15
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
10. OTHER COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE INCOME
The gross amount and related tax effects allocated to each component of
other comprehensive income consist of:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------------------
1998 1997
---------------------------------------------------------------------------------------
GROSS AMOUNT INCOME TAX NET AMOUNT GROSS AMOUNT INCOME TAX NET AMOUNT
------------ ---------- ---------- ------------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Unrealized holding gains
arising during period $56 $21 $35 $22 $ 9 $13
Less: reclassification
adjustment for gains -- -- -- -- -- --
realized in net income
--- --- --- --- --- ---
Net unrealized gains 56 21 35 22 9 13
--- --- --- --- --- ---
Other comprehensive income $56 $21 $35 $22 $ 9 $13
=== === === === === ===
</TABLE>
The sole component of accumulated other comprehensive income at March
31, 1998 and December 31, 1997 was unrealized gains on securities.
<TABLE>
<CAPTION>
(IN THOUSANDS)
<S> <C>
Balance at December 31, 1997 $ 82
Other comprehensive income for the three months ended March 31, 1998 35
----
Balance at March 31, 1998 $117
====
</TABLE>
15
<PAGE> 16
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. The following discussion should be read in
conjunction with the audited consolidated financial statements and related
notes in the Company's Form 10-K/A for the year ended December 31, 1997, as
well as the section entitled "Risk Factors" in Item 1 of the 1997 Form
10-K/A. The Company's future operating results may be affected by various
trends and factors which are beyond the Company's control and could cause
actual results to differ materially from those in the forward-looking
statements. These include, among other factors, economic, competitive,
governmental and technological factors affecting the Company's operations,
markets, products, services and prices. Accordingly, past results and trends
should not be used by investors to anticipate future results or trends.
RESULTS OF OPERATIONS (quarter ended March 31, 1998, compared to quarter ended
March 31, 1997)
REVENUES
Revenues for the three months ended March 31, 1998 increased to $72.6
million, compared to $70.7 million for the three months ended March 31, 1997.
Product revenues remained flat as increased unit sales of the Company's HiGain
product were offset by decreases in the average selling price and sales of the
Company's PG-2 products declined when compared to the prior year period. These
declines were offset by sales of the Company's newer PG-Flex, PG-Plus and
megabit access product lines, which increased fivefold over the prior year. In
addition, the Company had revenue from royalty and technology fees of $1.9
million in the first quarter of 1998, largely the result of an agreement entered
into for licensing of the Company's Falcon chip. Royalty income in the first
quarter of 1997 was $142,000.
GROSS PROFIT
Gross profit represents total revenues for a period, including royalty
income and technology fees, 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 $1.9 million, to $36.9 million for the three months ended March 31,
1998 compared to $35.0 million for the same period in the prior year. This
growth in gross profit was principally attributed to an increase in royalty
income and technology fees.
As a percentage of revenues, gross profit was 51% for the quarter ended
March 31, 1998, compared to 49% in the 1997 quarter. The higher gross profit
percentage resulted from an increase in revenue from royalty income and
technology fees. The Company's continuing effort toward cost reduction through
engineering design changes, reduced prices for components, increased
manufacturing efficiencies and increases in volume was offset by decreases in
average sales prices.
16
<PAGE> 17
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.
OPERATING EXPENSES
Operating expenses, excluding merger expenses, increased $6.4 million,
or 48%, for the three months ended March 31, 1998 as compared with the same
period in the prior year. Nearly half of this increase was due to the addition
of engineering, sales and marketing personnel. The Company plans to continue to
increase its relative spending in engineering and field sales support in an
effort to continue to develop and market new products and technologies such as
the small subscriber and megabit access product lines and the newly released
Falcon DMT ADSL chip. As a percentage of revenues, operating expenses increased
to 27% in the 1998 period from 23% in the 1997 quarter.
Research and development expense increased 55%, to $9.5 million, for the
three months ended March 31, 1998 compared to $6.2 million in the prior year
period. This increase was primarily due to the addition of personnel including
those specific to product and technology development, payments to consultants
where specific resources were needed in the development process and prototype
expenditures associated with new products. Costs for developmental tools and
software and depreciation on additions of capital equipment also increased over
the prior year period. The Company anticipates that research and development
expenses will continue to increase as new products are further developed and
other xDSL technologies and applications are pursued.
Selling and marketing expense increased to $7.2 million in the 1998
quarter compared to $4.8 million in the prior year quarter. The increase in
expense levels was primarily due to the addition of personnel and the associated
increase in salaries, benefits and travel expenses, and additional advertising,
trade show and related promotional expenditures designed to market the Company's
new products and technology. In addition, costs related to the expansion of the
Company's presence in the international market increased over 75% from the prior
year period. Selling and marketing expense as a percentage of revenues was 10%
in the 1998 quarter compared to 7% in 1997.
General and administrative expense was $3.1 million for the quarter
ended March 31, 1998 compared to $2.4 million in the same period in the prior
year. Increases in payroll due to the addition of information management
personnel and increases in legal fees were offset by decreases in certain
benefit costs and provisions for bad debts. As a percentage of revenues, general
and administrative expense were 4% in the first quarter of 1998 compared to 3%
in 1997.
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
17
<PAGE> 18
consisted of $1.8 million in investment banking 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 overall increase in operating expenses, income from
operations for the quarter ended March 31, 1998 decreased to $17.1 million,
compared to $18.9 million for the 1997 quarter. As a percentage of revenues,
income from operations was 23% in the 1998 quarter compared to 27% in 1997.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $2.1 million for the three months ended
March 31, 1998 from $1.2 million in the 1997 quarter. The increase in interest
income was the result of increased average cash balances.
PROVISION FOR INCOME TAXES
The provision for income taxes was $7.0 million, for the three months
ended March 31, 1998, compared to $8.8 million for the same period in the prior
year. The Company's estimated effective tax rate for 1998 decreased to 37%. The
estimated effective tax rate of 44% in the 1997 quarter was due to the
non-deductibility of merger expenses. Without the effect of the merger expenses,
the Company's estimated effective rate was 39% in the three months ended March
31, 1997.
NET INCOME AND EARNINGS PER SHARE
Net income for the three months ended March 31, 1998 was $12.2 million,
or $0.17 per share, compared to $11.4 million or $0.17 per share for the 1997
quarter.
The weighted average number of common shares outstanding was 69.5
million and 66.9 million for the three months ended March 31, 1998 and 1997,
respectively. This increase in common shares was attributable to the exercise of
stock options and warrants and the issuance of shares under the Employee Stock
Purchase Plan.
Earnings per share, taking into account the dilutive effects of common
stock options and warrants, were $0.16 per share and $0.15 per share for the
three months ended March 31, 1998 and 1997, respectively. The weighted average
number of common and common equivalent shares outstanding were 75.2 million in
1998 and 75.5 million in 1997.
18
<PAGE> 19
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1998, the Company had $188.1 million in cash, cash
equivalents and short-term investments and $232.1 million in working capital.
This is an increase of $11.5 million in cash, cash equivalents and short-term
investments and $17.3 million in working capital over the December 31, 1997
amounts. These increases are primarily attributable to cash generated from
operations of $11.1 million and $2.5 million from the exercise of stock options,
offset by capital expenditures of $1.9 million. Accounts receivable increased to
$37.4 million at March 31, 1998, compared to $35.4 million at December 31, 1997.
This increase in receivables was primarily due to a larger proportion of total
revenue for the 1998 quarter being shipped during the last four weeks of the
quarter. Gross inventories increased $8.0 million to $58.7 million at March 31,
1998 compared to $50.6 million at December 31, 1997. Approximately $4.5 million
of the increase came from the purchase of long lead-time integrated circuits
including SPAROW II chips. In addition, finished goods inventory of certain
products increased $5.3 million. Reserves for inventory obsolescence, excess
quantities, cost reductions and test and evaluation inventories decreased to
$19.3 million at March 31, 1998 compared to $20.1 million at December 31, 1997.
The primary reason for the decrease in these reserves was the disposal of
obsolete inventory. As a result of the increase in gross inventories, net
inventory turns decreased to four times for the first quarter of 1998 versus six
times in the 1997 quarter.
Capital expenditures relating primarily to the purchase of computer
equipment, machinery and test equipment amounted to $1.9 million during the
first quarter of 1998. Capital expenditures in the 1997 quarter aggregated
approximately $2.5 million, primarily related to expenditures for computer
equipment, machinery and test equipment and improvements to the Company's
engineering and production facility adjacent to its Tustin facility.
Accounts payable and other current liabilities increased to $53.9
million at March 31, 1998 from $46.9 million at December 31, 1997. The primary
reason for the increase was an increase in income taxes payable and trade
payables.
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 1998. 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.
Use of Proceeds From Registered Securities
The effective date of the Company's first registration statement (the
"Registration Statement") filed on Form S-1 (Registration No. 33-66680) under
the Securities Act of 1993, as amended, was September 13, 1993. The class of
securities registered was Common Stock. The offering commenced on September 15,
1993 and all securities were sold in the offering. The managing underwriters for
the offering were Lehman Brothers, Inc. and Hambrecht & Quist, Inc.
Pursuant to the Registration Statement, the Company sold 4,140,000
shares of its Common Stock for an aggregate offering price of $58.0 million, and
certain selling shareholders sold 632,500 shares of the Common Stock of the
Company for an aggregate offering price of $8.9 million.
19
<PAGE> 20
The Company incurred expenses of $4.7 million of which $4.1 million
represented underwriting discounts and commissions and $573,000 represented
other expenses. All such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after total expenses was $53.3 million.
Of the net proceeds from the offering, $5.3 million was used to pay off
indebtedness in 1993 and $48.0 million has been invested in short-term
investments. In 1995, the Company realized a $15.8 million unauthorized trading
loss. See Notes 15 and 16 of Notes to Consolidated Financial Statements
contained in the Company's Form 10-K/A for the year ended December 31, 1997.
The use of the proceeds from the offering does not represent a material
change in the use of the proceeds described in the prospectus which is part of
the Registration Statement.
YEAR 2000 ISSUE
The following discussion should be read in conjunction with the section
entitled "Year 2000 Issue" in Item 7 of the Company's Annual Report on Form
10-K/A for the year ended December 31, 1997.
Many of the world's computer systems currently record years in a
two-digit format. Such computer systems will be unable to properly interpret
dates beyond the year 1999, which could lead to business disruptions in the U.S.
and internationally (the "Year 2000" issue). The potential costs and
uncertainties associated with the Year 2000 issue will depend on a number of
factors, including software, hardware and the nature of the industry in which a
company operates. Additionally, companies must coordinate with other entities
with which they electronically interact, such as customers, creditors and
borrowers.
The Company will utilize both internal and external resources to
reprogram, or replace, and test its software for Year 2000 modifications. The
total cost to the Company of these Year 2000 issue activities has not been, and
is not anticipated to be, material to its financial position or results of
operations in any given year. Costs incurred related to the Year 2000 issue are
being funded through operating cash flows.
The above was based upon management's best estimates, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area, the
ability to locate and correct all relevant computer codes, the nature and amount
of programming required to upgrade or replace each of the affected programs, the
rate and magnitude of related labor and consulting costs and the success of the
Company's external customers and suppliers in addressing the Year 2000 issue.
20
<PAGE> 21
PART II. OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
See Item 3. Legal Proceedings in the Company's Annual Report on Form
10-K/A for the year ended December 31, 1997. There were no changes to
these matters during the period ended March 31, 1998.
In April 1998, Harris Corporation ("Harris") filed a complaint in
California Superior Court against the Company and others, alleging
claims for breach of contract, breach of the implied covenant of good
faith and fair dealing, breach of fiduciary duty, intentional or
negligent interference of contractual relations and prospective
economic advantage and violation of California Business and Professions
Code Section 17200 et seq. These claims relate to an alleged agreement
giving Harris the right to buy the Company's Falcon 1A chipset and the
impingement of this alleged agreement by the Company in entering into a
licensing agreement in March 1998 with respect to the Falcon 1A
chipset. Under this licensing agreement, the Company has granted a
third party the right to manufacture and sell the Falcon 1A chipset to
the Company and others. Harris's complaint seeks specific performance,
declaratory relief, an accounting and unspecified compensatory and
punitive damages. If Harris is successful in its claim, it may be
entitled to certain rights to purchase the Falcon 1A chipset from the
Company. Harris has also threatened to seek to enjoin performance of
the third party licensing agreement at some point in the future. The
Company believes that it has well-taken defenses to the complaint,
including but not limited to the fact that no joint venture ever
existed between itself and Harris, that the Company never reached an
agreement with Harris to license the Falcon chipsets and that the
Company has competed fairly. The Company intends to vigorously defend
itself against Harris in this matter. The Company and Harris are
currently engaged in discovery and the Company plans to file a response
to the Harris complaint in the near future.
The Company is involved from time to time in litigation incidental to
its business. The Company believes that none of its pending litigation
matters, individually or in the aggregate, will have a material adverse
effect on its financial position or results of operations.
21
<PAGE> 22
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
27.1 Financial Data Schedule
(B) Reports on Form 8-K
None.
22
<PAGE> 23
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 13, 1998 /s/ Charles W. McBrayer
-------------------------------------
Charles W. McBrayer
Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial Officer)
Date: May 13, 1998 /s/ Robert R. Price
--------------------------------------
Robert R. Price
Vice President and Corporate Controller
(Principal Accounting Officer)
23
<PAGE> 24
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 116,290
<SECURITIES> 71,777
<RECEIVABLES> 37,360
<ALLOWANCES> 0
<INVENTORY> 39,317
<CURRENT-ASSETS> 285,912
<PP&E> 33,578
<DEPRECIATION> 16,579
<TOTAL-ASSETS> 306,397
<CURRENT-LIABILITIES> 53,861
<BONDS> 0
0
0
<COMMON> 35
<OTHER-SE> 252,501
<TOTAL-LIABILITY-AND-EQUITY> 306,397
<SALES> 70,696
<TOTAL-REVENUES> 72,619
<CGS> 35,734
<TOTAL-COSTS> 35,734
<OTHER-EXPENSES> 19,824
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (2,092)
<INCOME-PRETAX> 19,153
<INCOME-TAX> 6,991
<INCOME-CONTINUING> 12,162
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,162
<EPS-PRIMARY> 0.17
<EPS-DILUTED> 0.16
</TABLE>
