<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON DC 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE THIRD QUARTER ENDED SEPTEMBER 30, 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
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 70,779,904 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.0005
PER SHARE, OUTSTANDING ON SEPTEMBER 30, 1998.
<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,
1998 and December 31, 1997 3
Condensed Consolidated Statements of Income for the quarters
and nine months ended September 30, 1998 and 1997 4
Condensed Consolidated Statements of Comprehensive Income
for the quarters and nine months ended September 30, 1998
and 1997 5
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 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 18
Part II. Other Information
Item 1. Legal Proceedings 26
Item 2. Changes in Securities 26
Item 3. Defaults upon Senior Securities 26
Item 4. Submission of Matters to a Vote of Security Holders 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 26
Signatures 27
</TABLE>
<PAGE> 3
PART I: ITEM 1.
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 118,141 $ 111,602
Short-term investments (Note 4) 102,835 64,983
Accounts receivable 28,709 35,429
Inventories (Note 5) 37,337 30,538
Other current assets and deferred taxes 20,735 19,074
--------- ---------
TOTAL CURRENT ASSETS 307,757 261,626
Property and equipment, net (Note 6) 17,692 17,423
Long-term investment (Note 7) 3,000 3,000
Other assets 369 370
--------- ---------
TOTAL ASSETS $ 328,818 $ 282,419
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 6,562 $ 8,527
Accrued expenses (Note 9) 24,093 21,702
Accrued income taxes 16,388 16,673
--------- ---------
TOTAL CURRENT LIABILITIES 47,043 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 - 70,779,904 and 69,023,713
at September 30, 1998 and December 31, 1997, respectively 35 34
Additional paid-in capital 156,259 146,277
Deferred compensation (103) (161)
Accumulated other comprehensive income (Note 10) 399 82
Retained earnings 125,185 89,285
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 281,775 235,517
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 328,818 $ 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES $ 76,386 $ 70,697 $222,421 $207,815
Cost of revenues 39,520 35,772 111,387 105,135
-------- -------- -------- --------
Gross profit 36,866 34,925 111,034 102,680
-------- -------- -------- --------
Operating expenses:
Research and development 9,244 8,694 28,602 22,387
Selling and marketing 7,404 5,868 22,193 16,609
General and administrative 3,416 2,778 9,970 7,680
Merger expenses -- -- -- 2,642
-------- -------- -------- --------
Total operating expenses 20,064 17,340 60,765 49,318
-------- -------- -------- --------
INCOME FROM OPERATIONS 16,802 17,585 50,269 53,362
Interest and other income, net 2,075 1,321 6,267 4,156
-------- -------- -------- --------
Income before income taxes 18,877 18,906 56,536 57,518
Provision for income taxes (Note 1) 6,891 7,109 20,636 22,627
-------- -------- -------- --------
NET INCOME $ 11,986 $ 11,797 $ 35,900 $ 34,891
======== ======== ======== ========
Per Share Data (Note 1):
Earnings per share
Basic $ 0.17 $ 0.17 $ 0.51 $ 0.52
======== ======== ======== ========
Diluted $ 0.16 $ 0.16 $ 0.48 $ 0.46
======== ======== ======== ========
Average shares outstanding
Basic 70,589 68,387 70,084 67,697
======== ======== ======== ========
Diluted 74,632 75,165 74,982 75,147
======== ======== ======== ========
</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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income $11,986 $11,797 $35,900 $34,891
------- ------- ------- -------
Other comprehensive income, net of tax:
Unrealized gains on securities:
Unrealized holding gains arising
during period 211 69 317 168
Less: reclassification adjustment for
gains included in net income -- -- -- --
------- ------- ------- -------
Net unrealized gains 211 69 317 168
------- ------- ------- -------
Other comprehensive income (Note 10) 211 69 317 168
------- ------- ------- -------
Comprehensive income $12,197 $11,866 $36,217 $35,059
======= ======= ======= =======
</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>
NINE MONTHS ENDED
SEPTEMBER 30,
-------------------------
1998 1997
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 35,900 $ 34,891
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 7,362 5,343
Loss on sale of equipment 73 --
Valuation adjustment for impairment to long-term asset -- 544
Change in operating assets and liabilities:
Accounts receivable 6,720 (8,556)
Inventories (6,799) (303)
Other current assets (1,844) (365)
Other assets 79 (100)
Accounts payable (1,965) 3,945
Accrued expenses 2,450 6,364
Income taxes 4,928 13,110
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 46,904 54,873
--------- ---------
Cash flows from investing activities:
Net (purchases of) proceeds from short-term investments (38,406) 6,870
Purchases of property and equipment (6,729) (10,854)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (45,135) (3,984)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock 4,770 7,199
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,770 7,199
--------- ---------
Increase in cash and cash equivalents 6,539 58,088
Cash and cash equivalents at beginning of period 111,602 48,416
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 118,141 $ 106,504
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ 18,194 $ 10,469
========= =========
Income tax refunds $ 2,508 $ 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 September
30, 1998, and consolidated results of operations, comprehensive income and cash
flows for the three and nine months ended September 30, 1998 and September 30,
1997. Results of operations for the three and nine months ended September 30,
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.
7
<PAGE> 8
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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 the nine months ended September 30,
1998 or the year ended December 31, 1997.
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, 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 three and
nine month periods ended September 30, 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.
8
<PAGE> 9
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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 holding gains
and losses, net of tax, included in accumulated other comprehensive income in
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 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
revenues, 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 from royalty
income and technology licensing fees is recognized when earned.
9
<PAGE> 10
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are expensed as incurred.
INCOME TAXES
Income taxes are provided at the rate expected to be in effect for the
entire year.
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 and nine months ended September 30, 1997 have been
restated to reflect the adoption of SFAS No. 128.
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1998 1997 1998 1997
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 11,986 $ 11,797 $ 35,900 $ 34,891
======== ======== ======== ========
Basic earnings per common share:
Weighted average of common shares outstanding 70,589 68,387 70,084 67,697
======== ======== ======== ========
Basic earnings per common share $ 0.17 $ 0.17 $ 0.51 $ 0.52
======== ======== ======== ========
Diluted earnings per common share:
Weighted average of common shares outstanding 70,589 68,387 70,084 67,697
Weighted average of common share equivalents:
Weighted average warrants outstanding 20 40 28 69
Weighted average options outstanding 10,725 11,799 10,983 11,969
Anti-dilutive options (4,197) (1,640) (2,853) (1,132)
Shares assumed to be repurchased using the
treasury stock method (1,814) (2,324) (2,446) (2,261)
Shares assumed to be repurchased to reflect
the effects of tax benefits (691) (1,097) (814) (1,195)
-------- -------- -------- --------
Weighted average number of common and common
equivalent shares 74,632 75,165 74,982 75,147
======== ======== ======== ========
Diluted earnings per common share $ 0.16 $ 0.16 $ 0.48 $ 0.46
======== ======== ======== ========
</TABLE>
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 customers. 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.
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
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.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," ("SFAS No. 133"). This statement
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities. The Company does not invest in derivative investments nor
does it engage in hedging activity.
STATEMENT OF CASH FLOWS
The Company recorded noncash tax benefits from exercises of common stock
options aggregating approximately $5.2 million and $14.5 million during the nine
months ended September 30, 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.
12
<PAGE> 13
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
customers could have a material adverse effect on the Company's financial
condition and results of operations.
Revenues from HiGain products represented approximately 61% and 71% of
the Company's total revenues for the nine months ended September 30, 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 14% of product revenue during the three
months ended September 30, 1998 and 1997, respectively. During the first nine
months of 1998 and 1997, export sales represented 20% and 17% of product
revenues, respectively. Product sales by geographical region are summarized as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
United States $ 60,082 $ 61,085 $173,138 $172,052
Canada 6,308 2,949 17,919 17,230
Other international 8,396 6,663 25,741 18,375
-------- -------- -------- --------
Total product revenues 74,786 70,697 216,798 207,657
Royalty income and technology licensing fees 1,600 -- 5,623 158
-------- -------- -------- --------
Total revenues $ 76,386 $ 70,697 $222,421 $207,815
======== ======== ======== ========
</TABLE>
13
<PAGE> 14
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
4. SHORT-TERM INVESTMENTS
Short-term investments as of September 30, 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>
SEPTEMBER 30, 1998
Municipal bonds $100,046 $ 465 $ -- $100,511
Other short-term investments 2,161 163 -- 2,324
-------- -------- --------- --------
$102,207 $ 628 $ -- $102,835
======== ======== ========= ========
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 nine months ended September 30, 1998 and 1997. Unrealized holding gains on
short-term investments, net of tax, included in accumulated other comprehensive
income in stockholders' equity at September 30, 1998 and December 31, 1997 were
$399,000 and $82,000, respectively.
5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ----------
(IN THOUSANDS)
<S> <C> <C>
Finished goods $17,281 $14,119
Work in process 4,111 6,982
Raw materials 15,945 9,437
------- -------
$37,337 $30,538
======= =======
</TABLE>
14
<PAGE> 15
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
6. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------ ------------
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment $ 34,519 $ 28,555
Leasehold improvements 3,933 3,444
-------- --------
38,452 31,999
Less accumulated depreciation and amortization (20,760) (14,576)
-------- --------
$ 17,692 $ 17,423
======== ========
</TABLE>
Included in machinery and equipment is approximately $800,000 in
software capitalized under the provisions of AICPA Statement of Position 98-1
("SOP 98-1"), "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998, however, earlier adoption is
encouraged.
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 September 30, 1998). At September 30, 1998 and December 31, 1997, the
Company had no outstanding borrowings under this line of credit. The debt
agreement contains certain financial and other covenants. The Company was in
compliance with the financial and other covenants at September 30, 1998 and
December 31, 1997. The agreement expires May 1, 1999.
15
<PAGE> 16
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
9. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(IN THOUSANDS)
<S> <C> <C>
Accrued compensation and related expenses $ 9,507 $ 8,836
Accrued warranty 8,685 9,161
Other accrued expenses 5,901 3,705
------- -------
$24,093 $21,702
======= =======
</TABLE>
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 SEPTEMBER 30,
--------------------------------------------------------------------------
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 $ 332 $ 121 $ 211 $ 107 $ 38 $ 69
Less: reclassification
adjustment for gains -- -- -- -- -- --
realized in net income
----- ----- ----- ----- ----- -----
Net unrealized gains 332 121 211 107 38 69
----- ----- ----- ----- ----- -----
Other comprehensive income $ 332 $ 121 $ 211 $ 107 $ 38 $ 69
===== ===== ===== ===== ===== =====
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------------
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 $ 500 $ 183 $ 317 $ 272 $ 104 $ 168
Less: reclassification
adjustment for gains -- -- -- -- -- --
realized in net income
----- ----- ----- ----- ----- -----
Net unrealized gains 500 183 317 272 104 168
----- ----- ----- ----- ----- -----
Other comprehensive income $ 500 $ 183 $ 317 $ 272 $ 104 $ 168
===== ===== ===== ===== ===== =====
</TABLE>
16
<PAGE> 17
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
The sole component of accumulated other comprehensive income at
September 30, 1998 and December 31, 1997 was unrealized gains on securities.
(IN THOUSANDS)
--------------
Balance at December 31, 1997 $ 82
Other comprehensive income for the nine months
ended September 30, 1998 317
------
Balance at September 30, 1998 $ 399
======
11. SUBSEQUENT EVENT
On October 14, 1998 the Company announced that its Board of Directors
approved a plan to repurchase up to 7,000,000 shares, or approximately 10%, of
the Company's outstanding common shares. See further discussion under "Liquidity
and Capital Resources" in Item 2, Management's Discussion and Analysis of
Financial Condition and Results of Operations in this Report.
17
<PAGE> 18
PART I: ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
PAIRGAIN TECHNOLOGIES, INC.
The following discussion and other sections of this Form 10-Q may
contain forward-looking statements within the meaning of the private
securities Litigation Reform Act of 1995, Section 21E of the Securities
Exchange Act of 1934, as amended, and Section 27A of the Securities Act of
1933, as amended, and is subject to the safe harbors created by those sections.
These forward-looking statements are subject to significant risks and
uncertainties, including without limitation those identified in the Company's
Form 10-K/A for the year ended December 31, 1997, as filed with the Securities
and Exchange Commission (the "SEC"). Such risks and uncertainties may cause
actual results to differ materially and adversely from those discussed in such
forward-looking statements. The forward-looking statements within this Form
10-Q are identified by words such as "believes," "anticipates," "expects,"
"intends," "may" and other similar expressions. However, these words are not
the exclusive means of identifying such statements. In addition, any statements
that refer to expectations, projections or other characterizations of future
events or circumstances are forward-looking statements. The Company disclaims
any obligation to publicly release the results of any revisions to these
forward-looking statements which may be made to reflect events or circumstances
occurring subsequent to the filing of this Form 10-Q with the SEC or otherwise
to revise or update any oral or written forward-looking statement that may be
made from time to time by or on behalf of the Company.
The information contained in this Form 10-Q is not a complete
description of the Company's business or the risks associated with an
investment in the Company. Readers are urged to carefully review and consider
the various disclosures made by the Company in this Report and in the Company's
other filings with the SEC, including its 1997 Form 10-K/A, that attempt to
advise interested parties of certain risks, uncertainties and other factors
that may affect the Company's business.
RESULTS OF OPERATIONS
(quarter and nine months ended September 30, 1998, compared to quarter
and nine months ended September 30, 1997)
REVENUES
Revenues for the quarter ended September 30, 1998 increased to $76.4
million, compared to $70.7 million in the corresponding 1997 quarter. Product
revenues increased $4.1 million, or 6%, over the prior year quarter. Unit sales
of the Company's T1/E1 access products, which includes the HiGain product line,
increased 36% over the third quarter of 1997. However, due to declines in
average selling prices as a result of significant price competition, T1/E1
access revenues were essentially flat compared to the corresponding 1997
quarter. Revenues from sales of the Company's PG-Flex, PG-Plus and megabit
access product lines were more than double the 1997 levels. Sales of the
Company's PG-2 products decreased 23% from the 1997 levels, as a result of
competition and customers switching to PG-Plus products. Sales of the Company's
Campus product also declined when compared to the prior year period. The Company
had revenue from royalty income and technology licensing fees of $1.6 million
during the third quarter of 1998, as a result of an agreement entered into
during the first quarter of 1998 for licensing of the Company's Falcon chip.
There was no royalty income in the third quarter of 1997.
Revenues for the nine months ended September 30, 1998, increased to
$222.4 million compared to $207.8 million for the first nine months in 1997.
Product revenues increased $9.1 million, or 4%. During the first nine months of
1998, unit sales volume of the Company's T1/E1 access products increased 33%
over the same period in 1997, but significant declines in average selling prices
resulted in 4% lower T1/E1 revenues in 1998. Sales of the Company's PG-Flex,
PG-Plus and megabit access product lines in the first nine months of 1998 were
more than three-and-a-half times the sales in the first nine months of 1997.
Sales of the Company's PG-2 and Campus products declined 33% from levels sold
during the first nine months of 1997. Royalty income and technology licensing
fees for the first nine months of 1998 were $5.6 million, primarily the result
of the Falcon chip licensing agreement entered into during the first quarter of
1998. Royalty income in the first nine months of 1997 was $158,000.
18
<PAGE> 19
Subsequent to September 30, 1998, a large customer awarded a primary
source HDSL contract to one of the Company's competitors. The Company previously
supplied the dominant share of HDSL product to this account. The Company expects
there will be a decline in HDSL revenue sold to this account, although the
amount of the decline is not known. This decline could have a material adverse
effect on the Company's future operating results.
GROSS PROFIT
Gross profit represents total revenues for a period, including royalty
income and technology licensing 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 or 6% and $8.4 million or 8% for the quarter and
nine months ended September 30, 1998, respectively, as compared with the prior
year periods.
As a percentage of revenues, gross profit was 48% for the quarter ended
September 30, 1998 compared to 49% for the same 1997 quarter. The decline in the
gross profit for the 1998 quarter was due to lower average selling prices, which
resulted from significant price competition that has been ongoing for the past
several quarters. Gross profit was 50% and 49% of revenues for the nine month
periods ended September 30, 1998 and 1997, respectively. The higher gross profit
percentage for the 1998 period resulted from an increase in royalty income and
technology licensing fees over the prior year.
The Company expects that increased competition will continue to place
downward pressure on the average selling prices of its existing products. The
Company continues to place emphasis on continuing cost reduction through
engineering design changes, reduced prices for components, increased
manufacturing efficiencies and increase in volume to offset declining average
selling prices of its products. However, if the Company is unable to fully
offset reductions to its average selling prices by reductions in the unit
costs, gross product margins on the Company's existing products could be
adversely affected. 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 $2.7 million, or 16%, for the three months
ended September 30, 1998 as compared with the same 1997 quarter. For the nine
month period ended September 30, 1998, operating expenses, excluding merger
expenses, increased $14.1 million, or 30%. Costs relating to personnel
represented approximately 54% of the increases for the quarter and 49% of the
increases for the nine month period. As a percentage of revenues, operating
expenses, excluding merger expenses, were 26% and 27% in the three and nine
month periods in 1998 compared to 25% and 22% in the respective 1997 periods.
Research and development expense increased $550,000 or 6% and $6.2
million or 28%, respectively, for the quarter and nine months ended September
30, 1998, as compared with the same periods in the prior year. These increases
were primarily related to the addition of personnel, outside
19
<PAGE> 20
development consulting fees and costs for developmental tools, supplies,
equipment and other costs specific to achieving new product approval, but were
partially offset by reimbursement for development services sold to outside
parties. Research and development expense as a percentage of revenues was 12%
for the 1998 quarter and 13% for the first nine months of 1998, compared to 12%
and 11% in the corresponding 1997 periods.
Selling and marketing expense increased $1.5 million or 26% and $5.6
million or 34%, respectively, for the quarter and nine months ended September
30, 1998, as compared with the same periods in the prior year. Additional sales
and marketing support personnel, and advertising, trade show, sales promotion
and travel costs primarily accounted for the increase in expenditures. Selling
and marketing expense as a percentage of revenues was 10% in each of the quarter
and nine month period ended September 30, 1998, respectively, compared to 8% in
each of the corresponding 1997 periods.
General and administrative expense increased $638,000 or 23% and $2.3
million or 30%, respectively, for the quarter and nine months ended September
30, 1998, as compared with the same periods in the prior year. Incremental
payroll expenses, fees for outside services related to the upgrade of the
Company's software systems, and increases in expenditures for computer software
and equipment repair and maintenance and legal fees represented the majority of
these increases. As a percentage of revenues, general and administrative expense
was 4% in each of the 1998 and 1997 quarter and nine month periods.
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
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 above, income from operations for the quarter ended
September 30, 1998 decreased 4% to $16.8 million, compared to $17.6 million for
the 1997 quarter. Income from operations for the nine months ended September 30,
1998 decreased $3.1 million, or 6%, to $50.3 million, compared to $53.4 million
for the first nine months of 1997. As a percentage of revenues, income from
operations was 22% and 23%, respectively, for the quarter and nine month period
ended September 30, 1998, compared to 25% for the corresponding 1997 quarter
and 26% for the first nine months of 1997. Excluding merger expenses, income
from operations for the first nine months of 1997 was 22% of revenues.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $2.1 million and $6.3 million for the
three and nine months ended September 30, 1998, respectively, from $1.3 million
and $4.2 million in the corresponding 1997 periods. These increases resulted
primarily from higher average cash levels available for investment. There was no
interest expense during the first nine months of 1998 or 1997.
20
<PAGE> 21
PROVISION FOR INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 1998, was $6.9 million and $20.6 million, respectively, compared
to $7.1 million and $22.6 million, for the three and nine months ended September
30, 1997. The Company's estimated effective tax rate for the third quarter and
the first nine months of 1998 was 37%. The estimated effective tax rate in the
third quarter of 1997 was 38%. The Company's effective tax rate for the first
nine months in 1997 was 39%, due to the non-deductibility of merger expenses.
Without the effect of the merger expenses, the Company's estimated effective tax
rate was 38% for the first nine months of 1997.
NET INCOME AND EARNINGS PER SHARE
Net income for the three months ended September 30, 1998 was $12.0
million compared to $11.8 million in the corresponding 1997 quarter. Net income
for the first nine months of 1998 was $35.9 million, compared to $34.9 million
in the same of 1997 period. Excluding merger expenses, net income for the first
nine months of 1997 was $37.5 million.
Basic earnings per share for the three and nine months ended September
30, 1998 were $0.17 per share and $0.51 per share, respectively, compared to
$0.17 per share and $0.52 per share for the quarter and first nine months of
1997. Excluding merger expenses, basic earnings per share for the first nine
months of 1997 were $0.55 per share.
The weighted average number of common shares outstanding was 70.6
million and 68.4 million for the three months ended September 30, 1998 and 1997,
respectively. The weighted average number of common shares outstanding was 70.1
million and 67.7 million for the first nine months of 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 Company's
Employee Stock Purchase Plan.
Dilutive earnings per share, which take into account the dilutive
effects of common stock options and warrants, were $0.16 per share and $0.48 per
share, respectively, for the three and nine months ended September 30, 1998,
compared to $0.16 per share and $0.46 per share for the quarter and first nine
months of 1997. Excluding merger expenses, dilutive earnings per share for the
first nine months of 1997 were $0.50 per share. The weighted average number of
common and common equivalent shares outstanding was 74.6 million and 75.2
million for the three months ended September 30, 1998 and 1997, respectively.
The weighted average number of common and common equivalent shares outstanding
was 75.0 million and 75.1 million for the first nine months of 1998 and 1997,
respectively.
21
<PAGE> 22
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 1998, the Company had $221.0 million in cash, cash
equivalents and short-term investments and $260.7 million in working capital.
These figures represent an increase of $44.4 million in cash, cash equivalents
and short-term investments and $46.0 million in working capital over the year
ended December 31, 1997. These increases were primarily attributable to cash
generated from operations of $46.9 million and $4.8 million from the exercise of
stock options, offset by capital expenditures of approximately $6.7 million.
Accounts receivable decreased to $28.7 million at September 30, 1998, compared
to $35.4 million at December 31, 1997. Accounts receivable days outstanding
improved to 34 at September 30, 1998 compared to 43 at December 31, 1997. Gross
inventories increased $4.3 million to $54.9 million at September 30, 1998,
compared to $50.6 million at December 31, 1997. Reserves for inventory
obsolescence, excess quantities, cost reductions and test and evaluation
inventories decreased to $17.6 million at September 30, 1998 compared to $20.1
million at December 1997 as a portion of surplus, scrap and returned material
inventories were written off. Accounts payable and other current liabilities
were $47.0 million at September 30, 1998 compared to $46.9 million at December
31, 1997.
Capital expenditures during the nine month period ended September 30,
1998 were $6.7 million, consisting primarily of purchases of computer equipment
and software, machinery, and test equipment, and leasehold improvements related
to the Company's new data center located next door to its Tustin headquarters.
Capital expenditures during the first nine months of 1997 aggregated
approximately $10.9 million, primarily related to expenditures for computer
equipment and test equipment, payments for a manufacturing and material handling
system and improvements to the Company's engineering and production facility
adjacent to its Tustin headquarters facility.
On October 14, 1998 the Company announced that its Board of Directors
approved a plan to repurchase up to 7,000,000 shares, or approximately 10%, of
the Company's outstanding common shares. The Company intends to use its current
cash for any repurchase of shares under this plan.
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.
22
<PAGE> 23
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 READINESS DISCLOSURE
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
suppliers.
The following discussion addresses the manner in which the Year 2000
Issue affects PairGain, including: the Company's state of readiness; the
costs to address the Company's Year 2000 issues; the risks of the Company's Year
2000 issues; and the Company's contingency plans.
The Company's State of Readiness
In determining the Company's state of readiness regarding the Year 2000
Issue, management is assessing the compliance in the following areas: the
Company's products, the Company's internal systems and the readiness of the
Company's key suppliers and major customers.
The Company has implemented a Year 2000 Project (the "Project") to
address and correct Year 2000 compliance issues with regards to its operating
systems and the readiness of its suppliers and customers. The Project is
administered by a Steering Committee which includes senior representatives from
operations, engineering, finance, information management and independent outside
consultants. The Project is composed of five phases:
o Awareness;
o Inventory and Assessment;
o Replacement and Upgrade;
o Testing and Validation; and
o Implementation and Post-Implementation.
23
<PAGE> 24
The AWARENESS phase is intended to ensure that the Company's senior
management, Board of Directors, associates and customers are aware of the Year
2000 Issue and the possible problems it may cause. Initial contact has been
completed, and communication will continue throughout the span of the
Project and beyond December 31, 1999 to ensure successful business operation
after the Year 2000.
The INVENTORY AND ASSESSMENT phase of the Project will assess the
readiness of all computer hardware and software that the Company, including all
its departments, business partners, properties and interfaces to vendors, uses
in all aspects of its business operations. This includes, but is not limited to,
information technology systems and non-information technology systems (which may
include embedded technology such as microcontrollers) as follows:
<TABLE>
<CAPTION>
Information Technology Systems Non-Information Technology Systems
----------------------------------------------- --------------------------------------------------
<S> <C>
o Personal computer hardware, software and o Alarms
applications o Access systems and door locks
o Local Area Networks hardware, software and o Building systems including elevators, HVAC,
applications life safety systems, public utilities and others
o Mainframe hardware, software and applications o Facsimile and photocopy machines
o Telephone systems
</TABLE>
Inventory of the Company's internal systems has been completed. An
assessment of the readiness of the external entities with which the Company
interfaces such as vendors, customers, payment systems and others is ongoing.
The Company has established a target date of February 28, 1999 for completion of
this task. The Company's major customers have disclosed their intent to be Year
2000 compliant by December 31, 1999 in recent SEC filings and on public
websites. The Company continues to have formal communications with all of its
significant suppliers and large customers to determine the extent, if any, to
which PairGain is vulnerable to those third parties' failure to remedy their own
Year 2000 Issue. There can be no guarantee that the Company's systems or the
systems of other companies will be compliant in a timely manner. The Company is
aggressively seeking resolution to those situations which might carry a material
impact and might adversely affect the Company.
During the REPLACEMENT AND UPGRADE phase of the Project the Company's
internal software and systems that are not Year 2000 compliant will be repaired
or replaced. In addition, vendor monitoring will be performed to ensure and
oversee efforts made by vendors regarding Year 2000 compliance. This phase is
expected to be completed by July 1, 1999.
During the TESTING AND VALIDATION phase, a standard test methodology
will be used to ensure that all components correctly handle the century date
changes and that those changes do not adversely impact current functionality and
operation of the components. The target date for completion of the initial
testing and validation of components has been set for May 1, 1999. Testing and
validation of these systems will continue through the end of 1999 to ensure
successful business operations.
IMPLEMENTATION of the Project is expected to be completed by July 31,
1999. Post-implementation, including continued monitoring and communication,
will continue through March 31, 2000 to ensure successful operation of the
Company after January 1, 2000.
24
<PAGE> 25
The Costs to Address the Company's Year 2000 Issues
The Company is utilizing both internal and external resources to
reprogram, or replace, and test its software for Year 2000 modifications. The
Company has budgeted approximately $1.1 million for activities specific to the
Year 2000 compliance of its information systems. An additional $5.0 million has
been budgeted for various other upgrades to software and hardware related to
operational functionality which will also make those systems Year 2000
compliant. These budgeted amounts are expected to be spent during 1998 and
1999. Purchased hardware and software will be capitalized in accordance
with the Company's standard capitalization policy. Personnel and all other costs
related to the project are being expensed as incurred. As of September 30, 1998
the Company had spent approximately $2.0 million of these budgeted amounts.
These costs are being funded through operating cash flows.
The Risks of the Company's Year 2000 Issues
The Company has placed great importance on its Year 2000 Project and
anticipates that its systems will be Year 2000 compliant before the end of
1999. In addition to the Year 2000 compliance issues the Company faces with
respect to its own systems, the Company faces risks that vendors' and/or
customers' systems, which are not directly under the Company's control, may not
become compliant prior to January 1, 2000. In addition, if certain public
infrastructure interruptions in areas such as utilities (electricity, water or
telephone), transportation, banking or government, result in disruption of
service to the Company, the Company's operations at individual facilities could
be impacted for the duration of the disruption.
As companies shift their information technology budgets toward Year 2000
compliance requirements, it is possible that a reduction in spending for
telecommunications equipment could occur in 1999. Since the Company markets its
products principally to telephone companies in the United States and Canada, a
reduction in telecommunications equipment spending could reduce the Company's
revenues and have a material adverse effect on the Company's financial condition
and results of operations.
The Company's Contingency Plans
Assuming no major public infrastructure service disruption occurs, the
Company believes that it will be able to manage its Year 2000 transition without
a material effect on the Company's results of operations or financial condition.
The Company has not yet completed contingency plans in the event that a
disruption in the public infrastructure does occur.
The above is 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.
25
<PAGE> 26
PART II
OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
As previously reported in Item 3. Legal Proceedings in the Company's
Annual Report on Form 10-K/A for the year ended December 31, 1997, the
U.S. Attorney's office and the Securities and Exchange Commission have
been investigating S. Jay Goldinger and Capital Insight, Inc. in
connection with their 1995 loss of nearly $100 million of their clients'
funds, including $15.8 million of PairGain's funds. The U.S. Attorney
and the SEC are also investigating whether PairGain and some of its past
and present officers and employees engaged in any wrongdoing with
respect to PairGain's investment of its excess cash with Capital
Insight, the disclosure of such investments and the disclosure of losses
incurred. There were no changes to these matters during the period ended
September 30, 1998.
See Item 1. Legal Proceedings in the Company's Quarterly Report on Form
10-Q for the first quarter ended March 31, 1998 for disclosure regarding
Harris Corporation's suit against the Company and others. There were no
changes to these matters during the period ended September 30, 1998.
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.
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.
26
<PAGE> 27
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, 1998 /s/ Charles W. McBrayer
----------------- ---------------------------------------
Charles W. McBrayer
Senior Vice President,
Chief Financial Officer and Secretary
(Principal Financial Officer)
Date: November 13, 1998 /s/ Robert R. Price
----------------- ---------------------------------------
Robert R. Price
Vice President and Corporate Controller
(Principal Accounting Officer)
27
<PAGE> 28
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<CURRENCY> U.S. DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 118,141
<SECURITIES> 102,835
<RECEIVABLES> 28,709
<ALLOWANCES> 0
<INVENTORY> 37,337
<CURRENT-ASSETS> 307,757
<PP&E> 38,452
<DEPRECIATION> 20,760
<TOTAL-ASSETS> 328,818
<CURRENT-LIABILITIES> 47,043
<BONDS> 0
0
0
<COMMON> 35
<OTHER-SE> 281,740
<TOTAL-LIABILITY-AND-EQUITY> 328,818
<SALES> 216,798
<TOTAL-REVENUES> 222,421
<CGS> 111,387
<TOTAL-COSTS> 111,387
<OTHER-EXPENSES> 60,765
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (6,267)
<INCOME-PRETAX> 56,536
<INCOME-TAX> 20,636
<INCOME-CONTINUING> 35,900
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 35,900
<EPS-PRIMARY> 0.51
<EPS-DILUTED> 0.48
</TABLE>
