<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 SECOND QUARTER ENDED JUNE 30, 1999
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 71,159,638 SHARES OF THE REGISTRANT'S COMMON STOCK, PAR VALUE $.0005
PER SHARE, OUTSTANDING ON JUNE 30, 1999.
<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 June 30, 1999 and December 31, 1998 3
Condensed Consolidated Statements of Income
for the quarters and six months ended June 30, 1999 and 1998 4
Condensed Consolidated Statements of Comprehensive Income
for the quarters and six months ended June 30, 1999 and 1998 5
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 1999 and 1998 6
Notes to Condensed Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations 17
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Part II. Other Information
Item 1. Legal Proceedings 28
Item 2. Changes in Securities 28
Item 3. Defaults upon Senior Securities 28
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 30
Item 6. Exhibits and Reports on Form 8-K 30
Signatures 31
</TABLE>
<PAGE> 3
PART I: ITEM 1
FINANCIAL INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------------- -------------
(UNAUDITED)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 118,190 $ 131,923
Short-term investments (Note 3) 104,175 102,011
Accounts receivable 26,201 20,226
Inventories (Note 4) 37,092 34,320
Other current assets and deferred taxes 21,603 18,712
--------- ---------
TOTAL CURRENT ASSETS 307,261 307,192
Property, plant and equipment, net (Note 5) 24,851 19,482
Long-term investment (Note 6) 5,000 1,500
Other assets 211 346
--------- ---------
TOTAL ASSETS $ 337,323 $ 328,520
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable $ 11,591 $ 6,358
Accrued expenses (Note 7) 20,861 27,002
Accrued income taxes 16,775 16,119
Current portion of note payable 31 --
--------- ---------
TOTAL CURRENT LIABILITIES 49,258 49,479
Note payable (Note 8) 1,742 --
--------- ---------
TOTAL LIABILITIES 51,000 49,479
--------- ---------
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 - 71,159,638 and 70,039,814
at June 30, 1999 and December 31, 1998, respectively 36 35
Additional paid-in capital 153,047 150,807
Deferred compensation (42) (84)
Accumulated other comprehensive loss (Note 9) (738) (501)
Retained earnings 134,020 128,784
--------- ---------
TOTAL STOCKHOLDERS' EQUITY 286,323 279,041
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 337,323 $ 328,520
========= =========
</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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- --------------------------
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES $ 61,171 $ 73,416 $ 122,067 $ 146,035
Cost of revenues 35,823 36,133 71,209 71,867
--------- --------- --------- ---------
Gross profit 25,348 37,283 50,858 74,168
--------- --------- --------- ---------
Operating expenses:
Research and development 10,497 9,822 20,623 19,358
Selling and marketing 8,272 7,584 16,170 14,789
General and administrative 3,605 3,471 7,180 6,554
Settlement of litigation 1,500 -- 1,500 --
--------- --------- --------- ---------
Total operating expenses 23,874 20,877 45,473 40,701
--------- --------- --------- ---------
INCOME FROM OPERATIONS 1,474 16,406 5,385 33,467
Write-off of long-term investment (1,500) -- (1,500) --
Interest and other income, net 2,389 2,100 4,821 4,192
--------- --------- --------- ---------
Income before income taxes 2,363 18,506 8,706 37,659
Provision for income taxes (Note 1) 1,313 6,754 3,470 13,745
--------- --------- --------- ---------
NET INCOME $ 1,050 $ 11,752 $ 5,236 $ 23,914
========= ========= ========= =========
Per Share Data (Note 1):
Earnings per share
Basic $ 0.01 $ 0.17 $ 0.07 $ 0.34
========= ========= ========= =========
Diluted $ 0.01 $ 0.16 $ 0.07 $ 0.32
========= ========= ========= =========
Average shares outstanding
Basic 71,010 70,120 70,681 69,832
========= ========= ========= =========
Diluted 75,549 75,111 75,021 75,157
========= ========= ========= =========
</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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 1,050 $ 11,752 $ 5,236 $ 23,914
-------- -------- -------- --------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments 62 (144) 183 (221)
-------- -------- -------- --------
Unrealized (losses) gains on securities:
Unrealized holding (losses) gains arising
during period (338) 133 (420) 188
Reclassification adjustment
for losses included in net -- (62) -- (82)
income
-------- -------- -------- --------
Net unrealized (losses) gains on securities (338) 71 (420) 106
-------- -------- -------- --------
Other comprehensive loss (Note 9) (276) (73) (237) (115)
-------- -------- -------- --------
Comprehensive income $ 774 $ 11,679 $ 4,999 $ 23,799
======== ======== ======== ========
</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>
SIX MONTHS ENDED JUNE 30,
1999 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,236 $ 23,914
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 5,926 4,845
Loss on sale of equipment -- 73
Loss on long-term investment 1,500 --
Change in operating assets and liabilities:
Accounts receivable (5,868) 2,078
Inventories (2,724) (10,069)
Other current assets (2,677) (1,301)
Other assets 46 65
Accounts payable 3,202 (867)
Accrued expenses (4,100) 1,320
Income taxes 2,858 1,973
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,399 22,031
--------- ---------
Cash flows from investing activities:
Net purchases of short-term investments (3,680) (14,441)
Purchases of property and equipment (10,310) (3,359)
Purchase of long-term investment (5,000) --
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (18,990) (17,800)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance, net of repurchases, of common stock 33 3,802
Proceeds from note payable 1,786 --
Payments on note payable (13) --
--------- ---------
NET CASH PROVIDED BY FINANCING ACTIVITIES 1,806 3,802
--------- ---------
Effect of exchange rate changes on cash balances 52 (221)
--------- ---------
(Decrease) increase in cash and cash equivalents (13,733) 7,812
Cash and cash equivalents at beginning of period 131,923 111,602
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 118,190 $ 119,414
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Income taxes paid $ 873 $ 14,297
========= =========
Income tax refunds $ 260 $ 2,508
========= =========
</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.
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 June 30,
1999, and consolidated results of operations, comprehensive income and cash
flows for the three and six months ended June 30, 1999 and June 30, 1998.
Results of operations for the three and six months ended June 30, 1999, are not
necessarily indicative of results to be expected for the full year ending
December 31, 1999.
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 for the year ended
December 31, 1998.
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 Swiss
subsidiary is the Swiss Franc. The functional currency of the Company's Canadian
subsidiary is the Canadian Dollar. Assets and liabilities of these subsidiaries
are translated at the exchange rate in effect at each year-end. Income statement
accounts are translated at the average rate of exchange prevailing during the
year. Translation adjustments arising from differences in exchange rates from
period to period are included as accumulated other comprehensive loss
within stockholders' equity. Realized gains or losses from foreign currency
transactions are included in operations as incurred, and have historically been
insignificant.
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 June 30, 1999 and
December 31, 1998. 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 Condensed Consolidated Statements of Comprehensive Income for the
three and six month periods ended June 30, 1999 and 1998. (See Note 9)
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 loss 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, PLANT AND EQUIPMENT
Property, plant 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.
Buildings are depreciated over twenty years.
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. Advance payments
are classified as deferred revenue.
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.
The following table reconciles the weighted average shares outstanding
for basic and diluted earnings per share for the periods presented.
10
<PAGE> 11
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $ 1,050 $ 11,752 $ 5,236 $ 23,914
======== ======== ======== ========
Basic earnings per common share:
Weighted average of common shares outstanding 71,010 70,120 70,681 69,832
======== ======== ======== ========
Basic earnings per common share $ 0.01 $ 0.17 $ 0.07 $ 0.34
======== ======== ======== ========
Diluted earnings per common share:
Weighted average of common shares outstanding 71,010 70,120 70,681 69,832
Weighted average of common share equivalents:
Weighted average warrants outstanding 3 24 12 32
Weighted average options outstanding 11,200 11,058 11,502 11,113
Anti-dilutive options (285) (2,561) (407) (2,182)
Shares assumed to be repurchased using the
treasury stock method (4,989) (2,704) (5,520) (2,763)
Shares assumed to be repurchased to reflect the
effects of tax benefits (1,390) (826) (1,247) (875)
-------- -------- -------- --------
Weighted average number of common and common
equivalent shares 75,549 75,111 75,021 75,157
======== ======== ======== ========
Diluted earnings per common share $ 0.01 $ 0.16 $ 0.07 $ 0.32
======== ======== ======== ========
</TABLE>
STATEMENT OF CASH FLOWS
The Company recorded noncash tax benefits from exercises of common stock
options aggregating approximately $2.2 million and $4.4 million during the six
months ended June 30, 1999 and 1998, 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."
11
<PAGE> 12
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
2. CONCENTRATION OF CREDIT RISK, MAJOR CUSTOMERS AND PRODUCTS
The Company engages in business activity in only one operating segment
which entails the design, manufacture and sale of 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. The
Company offers a wide variety of products for sale which are manufactured at
common production facilities. The Company sells all of its products to a similar
customer base made up of telecommunications carriers and private network owners
through a common sales organization.
Credit is extended based on an evaluation of the customer's financial
condition and collateral is not required. Credit losses are provided for in the
financial statements and consistently have been minimal. A decision by a
significant customer to substantially decrease or delay purchases from the
Company or the Company's inability to collect receivables from these customers
could have a material adverse effect on the Company's financial condition and
results of operations.
Comparative product revenues as a percentage of sales during the three
and six months ended June 30, 1999 and 1998 were:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
1999 1998 1999 1998
-------- ---------- --------- --------
<S> <C> <C> <C> <C>
HiGain / ETSI 57% 65% 55% 65%
Subscriber Carrier 25% 22% 28% 21%
Campus 11% 5% 8% 7%
Megabit Access 3% 2% 3% 2%
OEM 3% 3% 2% 2%
Royalty 1% 3% 4% 3%
--- --- --- ---
Total Revenues 100% 100% 100% 100%
=== === === ===
</TABLE>
Export sales represented 24% and 21% of product revenue during the three
months ended June 30, 1999 and 1998, respectively. During the first half of 1999
and 1998, export sales represented 22% and 20% of product revenues,
respectively. Product sales by geographical region are summarized as follows:
12
<PAGE> 13
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
-------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
United States $ 46,156 $ 56,686 $ 90,906 $113,056
Canada 5,626 5,534 11,282 11,611
Other international 8,707 9,096 15,097 17,345
-------- -------- -------- --------
Total product revenues 60,489 71,316 117,285 142,012
Royalty income and technology licensing fees 682 2,100 4,782 4,023
-------- -------- -------- --------
Total revenues $ 61,171 $ 73,416 $122,067 $146,035
======== ======== ======== ========
</TABLE>
3. SHORT-TERM INVESTMENTS
Short-term investments as of June 30, 1999 and December 31, 1998 are
summarized as follows:
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
-------- ---------- ---------- ---------
(IN THOUSANDS)
JUNE 30, 1999
<S> <C> <C> <C> <C>
Municipal bonds $104,256 $ -- $ (81) $104,175
======== ========== ========== ========
DECEMBER 31, 1998
Municipal bonds $101,432 $ 579 $ -- $102,011
======== ========== ========== ========
</TABLE>
There were no realized gains or losses on short-term investments during
the six months ended June 30, 1999 and 1998. Unrealized holding (losses) gains
on short-term investments, net of tax, included in accumulated other
comprehensive loss in stockholders' equity at June 30, 1999 and December 31,
1998 were ($53,000) and $367,000, respectively.
4. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------- ---------
(IN THOUSANDS)
<S> <C> <C>
Finished goods $21,537 $18,489
Work in process 2,738 1,647
Raw materials 12,817 14,184
------- -------
$37,092 $34,320
======= =======
</TABLE>
13
<PAGE> 14
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
5. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
---------- ---------------
(IN THOUSANDS)
<S> <C> <C>
Land $ 1,995 $ --
Building 2,939 --
Production and engineering equipment 24,263 22,169
Computers, software, furniture and other 19,037 16,155
Leasehold improvements 4,719 4,129
-------- --------
52,953 42,453
Less accumulated depreciation and amortization (28,102) (22,971)
-------- --------
$ 24,851 $ 19,482
======== ========
</TABLE>
6. LONG-TERM INVESTMENTS
In March 1999, the Company made a minority investment in ANDA Networks,
Inc., a California-based private company which develops next generation access
systems. The Company purchased approximately 2,500,000 shares of ANDA's Series C
Preferred Stock for an aggregate of $5.0 million.
In June 1996, the Company made a minority investment in E/O Networks of
Hayward, California ("E/O"). E/O supplied 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. In the fourth quarter of 1998, the Company recorded
an impairment adjustment of $1.5 million to reflect an impairment in its
investment in E/O.
During the second quarter of 1999, E/O filed for protection under
Chapter 11 of the U.S. Bankruptcy Act. Following notification of the bankruptcy
filing, the Company wrote off the remaining $1.5 million investment in E/O
during the second quarter of 1999.
The Company accounts for long-term investments using the cost method.
However, when it is determined that an investment is permanently impaired, the
Company records an impairment adjustment.
14
<PAGE> 15
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
7. ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
--------- ---------------
(IN THOUSANDS)
<S> <C> <C>
Accrued compensation and related expenses $10,188 $ 9,343
Accrued warranty 5,887 7,413
Deferred revenue -- 3,500
Other accrued expenses 4,786 6,746
------- -------
$20,861 $27,002
======= =======
</TABLE>
8. NOTE PAYABLE
In May 1999, the Company purchased its Tustin, California headquarters
facility. The purchase price was $4.9 million, which was paid with $3.1 million
in cash and assumption of a $1.8 million note. The note bears interest at 8.25%
and is due December 1, 2005.
9. OTHER COMPREHENSIVE INCOME AND ACCUMULATED OTHER COMPREHENSIVE INCOME
The gross amount and related tax effects allocated to each component of
other comprehensive income (loss) consist of:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------------
GROSS AMOUNT INCOME TAX NET AMOUNT GROSS AMOUNT INCOME TAX NET AMOUNT
------------ ---------- ---------- ------------ ---------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Foreign currency
translation adjustments $ 62 $ -- $ 62 $(144) $ -- $(144)
Unrealized (losses)
gains on securities:
Unrealized holding
(losses) gains arising
during period (513) (175) (338) 209 76 133
Reclassification
adjustment for losses
included in net income -- -- -- (97) (35) (62)
----- ----- ----- ----- ----- -----
Net unrealized (losses)
gains on securities (513) (175) (338) 112 41 71
----- ----- ----- ----- ----- -----
Other comprehensive
income (loss) $(451) $(175) $(276) $ (32) $ 41 $ (73)
===== ===== ===== ===== ===== =====
</TABLE>
15
<PAGE> 16
PAIRGAIN TECHNOLOGIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
---------------------------------------------------------------------------
1999 1998
------------------------------------- -------------------------------------
GROSS AMOUNT INCOME TAX NET AMOUNT GROSS AMOUNT INCOME TAX NET AMOUNT
------------ ---------- ---------- ------------ ---------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Foreign currency
translation adjustments $ 183 $ -- $ 183 $(221) $ -- $(221)
Unrealized (losses)
gains on securities:
Unrealized holding
(losses) gains arising
during period (660) (240) (420) 297 109 188
Reclassification
adjustment for losses
included in net income -- -- -- (129) (47) (82)
----- ----- ----- ----- ----- -----
Net unrealized (losses)
gains on securities (660) (240) (420) 168 62 106
----- ----- ----- ----- ----- -----
Other comprehensive
income (loss) $(477) $(240) $(237) $ (53) $ 62 $(115)
===== ===== ===== ===== ===== =====
</TABLE>
The components of accumulated other comprehensive loss at June 30, 1999
and December 31, 1998 included foreign currency translation adjustments and
unrealized gains (losses) on securities.
<TABLE>
<CAPTION>
FOREIGN ACCUMULATED
CURRENCY UNREALIZED OTHER
TRANSLATION GAINS (LOSSES) COMPREHENSIVE
ADJUSTMENT ON SECURITIES LOSS
------------ -------------- ---------------
(IN THOUSANDS)
<S> <C> <C> <C>
Balance at December 31, 1998 $(868) $ 367 $(501)
Other comprehensive income (loss) for the
six months ended June 30, 1999 183 (420) (237)
----- ----- -----
Balance at June 30, 1999 $(685) $ (53) $(738)
===== ===== =====
</TABLE>
16
<PAGE> 17
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 PairGain's
Form 10-K for the year ended December 31, 1998, 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. We disclaim 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 PairGain.
The information contained in this Form 10-Q is not a complete description of
our business or the risks associated with an investment in PairGain. You are
urged to carefully review and consider the various disclosures made by us in
this Form 10-Q and in our other filings with the SEC, including our 1998
Form 10-K, that attempt to advise interested parties of certain risks,
uncertainties and other factors that may affect our business.
RESULTS OF OPERATIONS (quarter and six months ended June 30, 1999, compared to
quarter and six months ended June 30, 1998)
REVENUES
Revenues for the quarter ended June 30, 1999 were $61.2 million,
compared to $73.4 million in the corresponding 1998 quarter. Product revenues
for all product lines except the PG-Plus, megabit access and Campus products
decreased when compared to the 1998 quarter. This decrease in product revenues
resulted primarily from a decrease in average selling prices for the second
quarter of 1999 across virtually all product lines when compared to average
selling prices during the second quarter of 1998. Second quarter 1999 unit
shipments of the T1/E1 access products increased 38% over the 1998 quarter, but
were not sufficient to offset decreases in average selling prices of 45%. In the
Subscriber Carrier product family, revenue from sales of the PG-Plus products
increased 15% in the 1999 quarter over the prior year quarter, while revenues
from sales of PG-Flex products declined slightly, despite a 17% increase in unit
sales volume. Revenue from shipments of Campus products increased 60% over the
same quarter in 1998, in spite of a 30% decrease in average selling prices.
Revenue from royalty income and technology licensing fees was $682,000 for the
June 1999 quarter, compared to $2.1 million for the second quarter of 1998 which
included a $1.5 million development and licensing fee for our Falcon chip.
17
<PAGE> 18
During the second quarter of 1999, a large customer informed us that we
no longer held primary supplier status with them. We previously supplied the
dominant share of HDSL product to this customer. The customer did not elaborate
as to the level of orders they would continue to place, if any. If there is a
significant decline in HDSL revenue sold to this account, it could have a
material adverse effect on our future operating results.
Revenues for the six months ended June 30, 1999, decreased to $122.1
million compared to $146.0 million for the first six months of 1998. Product
revenues decreased 17%, which resulted primarily from a decrease in average
selling prices for the first half of 1999 across virtually all product
lines when compared to average selling prices during the first half of 1998.
During the first six months of 1999, unit sales volume of our T1/E1 access
products increased 24% over the same period in 1998, but 41% declines in average
selling prices resulted in lower T1/E1 revenues in 1999. Sales of our PG-Flex
and PG-Plus product lines in the first half of 1999 were 27% and 43% higher,
respectively, than sales of those products in the same 1998 period. Sales of our
Campus and megabit access products were essentially flat when compared to levels
sold during the first half of 1998. Sales of our PG-2 products declined
substantially from last year. Revenue from royalty income and technology
licensing fees for the first six months of 1999 was $4.8 million compared to
$4.0 million in the first half of 1998.
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 decreased to $25.4 million for the three months ended June 30, 1999
compared to $37.3 million for the same period in the prior year. As a percentage
of revenues, gross profit was 41% for the quarter ended June 30, 1999, a decline
from 51% in the second quarter of 1998, but relatively consistent with a gross
margin of 42% in the first quarter of 1999. Gross margin for the first half of
1999 decreased to $50.9 million, or 42% of revenues, compared to $74.2 million,
or 51% of revenues, in the first half of 1998. The decrease in gross margin and
gross margin percentage was largely the result of decreases in average selling
prices, lower manufacturing absorption caused by decreased product volume and
lower royalty income. These effects were partially offset by our cost reduction
efforts. We expect that increased competition will continue to place downward
pressure on average selling prices. To the extent that we are unable to offset
these decreases with our cost reduction efforts, or to introduce and sell new
products with higher gross product margins, we will continue to experience a
decline in our gross margin.
OPERATING EXPENSES
Operating expenses increased $3.0 million, or 14%, for the three months
ended June 30, 1999 as compared with the same period in the prior year. For the
six month period, operating expenses increased $4.8 million, or 12%, over the
prior year. The impact of a $1.5 million litigation settlement and costs
relating to the addition of personnel represented the majority of these
increases. As a percentage of revenues, operating expenses were 39% and 37%,
respectively, in the three and six month periods in 1999, compared to 28% in
each of the respective 1998 periods. Operating expenses, excluding the
18
<PAGE> 19
litigation settlement, increased $1.5 million, or 7%, for the three months ended
June 30, 1999 as compared with the same period in the prior year. For the six
month period, operating expenses, excluding the litigation settlement, increased
$3.3 million, or 8%, over the prior year. As a percentage of revenues, operating
expenses, excluding the litigation settlement, were 37% and 36%, respectively,
in the three and six month periods in 1999.
Research and development expense increased $675,000 and $1.3 million,
respectively, for the quarter and six months ended June 30, 1999, a 7% increase
over each of the comparable 1998 periods. These increases were primarily due to
the addition of personnel including those specific to technology development for
the subscriber carrier and megabit access product lines, and outside development
consulting fees and temporary labor costs. Research and development expense as a
percentage of revenues was 17% in both the 1999 quarter and six month period,
compared to 13% in each of the corresponding 1998 periods.
Selling and marketing expense increased $688,000 and $1.4 million,
respectively, for the quarter and six months ended June 30, 1999, a 9% increase
over each of the comparable 1998 periods. The increase in expense levels was
primarily due to the addition of personnel and the associated increase in
salaries, benefits and travel expenses, which was partially offset by a
reduction in advertising, technical documentation and channel marketing
expenses. Selling and marketing expense as a percentage of revenues was 14% and
13% in the 1999 quarter and six month period, respectively, compared to 10% in
each of the corresponding 1998 periods.
General and administrative expense increased $134,000, or 4%, and
$626,000, or 10%, respectively, for the quarter and six months ended June 30,
1999, as compared with the same periods in the prior year. The majority of these
increases resulted from incremental payroll expenses due to the addition of
information management personnel and increases in expenditures for computer
software and hardware maintenance, and payments to outside firms assisting us
with upgrades to our software systems and our Year 2000 compliance project. As a
percentage of revenues, general and administrative expense was 6% in each of the
1999 quarter and six month period, respectively, compared to 5% and 4%,
respectively, in the corresponding 1998 periods.
SETTLEMENT OF LITIGATION
In May 1999, we reached an agreement with Harris Corporation ("Harris")
to settle and dismiss a lawsuit brought by Harris against us in April 1998.
Under the terms of the settlement, in order to avoid further litigation and
19
<PAGE> 20
controversy, we agreed to pay the sum of $1.5 million to Harris and both parties
agreed to dismiss their actions with prejudice. The impact of the settlement was
recorded in our financial statements for the quarter ended June 30, 1999.
INCOME FROM OPERATIONS
As a result of the above, income from operations for the quarter ended
June 30, 1999 decreased 91% to $1.5 million, compared to $16.4 million for the
1998 quarter. Income from operations for the six months ended June 30, 1999
decreased 84% to $5.4 million, compared to $33.5 million for the first half of
1998. As a percentage of revenues, income from operations was 2% and 4%,
respectively, for the quarter and six month period in 1999, compared to 22% for
the 1998 quarter and 23% for the first six months of 1998. Excluding the effect
of the litigation settlement, income from operations was $3.0 million, or 5% of
revenues, for the second quarter of 1999 and $6.9 million, or 6% of revenue, for
the first six months of 1999.
INTEREST AND OTHER INCOME, NET
Net interest income increased to $2.4 million and $4.8 million for the
three and six months ended June 30, 1999, respectively, from $2.1 million and
$4.2 million in the corresponding 1998 periods. These increases resulted
primarily from higher average cash levels available for investment. There was no
interest expense during the first half of 1999 or 1998.
WRITE-OFF OF LONG-TERM INVESTMENT
In June 1996, we made a minority investment in E/O Networks of Hayward,
California ("E/O"). E/O supplied low-density fiber optic access equipment to
public carriers both domestically and internationally. We purchased
approximately 545,000 shares of E/O's Series D Preferred Stock for an aggregate
of $3.0 million. In the fourth quarter of 1998, we recorded an impairment
adjustment of $1.5 million to reflect an impairment in our investment in E/O.
During the second quarter of 1999, E/O filed for protection under
Chapter 11 of the U.S. Bankruptcy Act. Following notification of the bankruptcy
filing, we wrote off the remaining $1.5 million investment in E/O during the
second quarter of 1999.
PROVISION FOR INCOME TAXES
The provision for income taxes for the three and six months ended June
30, 1999, was $1.3 million and $3.5 million, respectively, compared to $6.8
million and $13.7 million, for the three and six months ended June 30, 1998. The
estimated effective tax rate in the second quarter of 1999 was 56% and 40% for
the first six months of 1999, due to the non-deductibility of the long-term
investment write-off. Without the effect of the investment write-off, our 1999
estimated effective tax rate is 34%. Our effective tax rate for 1998 was 37%.
NET INCOME AND EARNINGS PER SHARE
Net income was $1.1 million and $5.2 million for the three and six
months ended June 30, 1999, respectively. Net income in the corresponding 1998
periods was $11.8 million and $23.9 million.
20
<PAGE> 21
Excluding the effects of the litigation settlement and investment write-off, net
income was $3.5 million and $7.7 million for the second quarter and first half
of 1999, respectively.
Basic earnings per share for the three and six months ended June 30,
1999 were $0.01 per share and $0.07 per share, respectively, compared to $0.17
per share and $0.34 per share for the quarter and first half of 1998. Excluding
the effects of the litigation settlement and investment write-off, basic
earnings per share for the second quarter and first half of 1999 were $0.05 and
$0.11 per share, respectively.
The weighted average number of common shares outstanding was 71.0
million and 70.1 million for the three months ended June 30, 1999 and 1998,
respectively. The weighted average number of common shares outstanding was 70.7
million and 69.8 million for the first half of 1999 and 1998, 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,
offset by shares repurchased.
Dilutive earnings per share, which take into account the dilutive
effects of common stock options and warrants, were $0.01 per share and $0.07 per
share, respectively, for the three and six months ended June 30, 1999, compared
to $0.16 per share and $0.32 per share for the second quarter and first half of
1998. Excluding the effects of the litigation settlement and investment
write-off, dilutive earnings per share were $0.05 per share and $0.10 per share
for the second quarter and first half of 1999. The weighted average number of
common and common equivalent shares outstanding was 75.5 million and 75.1
million for the three months ended June 30, 1999 and 1998, respectively. The
weighted average number of common and common equivalent shares outstanding was
75.0 million and 75.2 million for the first half of 1999 and 1998, respectively.
21
<PAGE> 22
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, we had $222.4 million in cash, cash equivalents and
short-term investments and $258.0 million in working capital. These figures
represent a decrease of $11.6 million in cash, cash equivalents and short-term
investments and an increase of $290,000 in working capital over the year ended
December 31, 1998. The decrease in cash, equivalents and investments was
primarily attributable to cash generated from operations of $3.4 million, the
assumption of a note for $1.8 million related to the purchase of a building and
$4.4 million from the issuance of stock under our 1993 Stock Option Plan and
Employee Stock Purchase Plan, offset by capital expenditures of $10.3 million, a
long-term investment of $5.0 million and repurchases of PairGain common stock of
$4.4 million. Accounts receivable increased to $26.2 million at June 30, 1999,
compared to $20.2 million at December 31, 1998. Accounts receivable days
outstanding were 39 at June 30, 1999 compared to 30 at December 31, 1998. Gross
inventories decreased $454,000 to $51.3 million at June 30, 1999, compared to
$51.7 million at December 31, 1998. Raw materials decreased $2.8 million, while
finished goods and work in process increased $2.4 million. Reserves for
inventory obsolescence, excess quantities, cost reductions and test and
evaluation inventories decreased to $14.2 million at June 30, 1999 compared to
$17.4 million at December 31, 1998. The primary reason for the decrease in these
reserves was the disposal of obsolete inventories. Accounts payable and other
current liabilities decreased to $49.3 million at June 30, 1999 from $49.5
million at December 31, 1998.
Capital expenditures during the six month period ended June 30, 1999
were $10.3 million, consisting primarily of the purchase of our Tustin,
California headquarters facility for $4.9 million, and purchases of computer
hardware and software, machinery and test equipment. The $4.9 million purchase
of the Tustin facility was paid with $3.1 million in cash and assumption of a
$1.8 million note. The note bears interest at 8.25% and is due December 1, 2005.
Capital expenditures in the first half of 1998 aggregated approximately $3.4
million, primarily related to expenditures for computer equipment and software,
machinery and test equipment.
During the third quarter of 1999, we plan to vacate one of our existing
facilities in Tustin and move into a 41,000 square foot facility located near
our headquarters facility. We plan to spend approximately $1.5 million in
leasehold improvements at this new facility during the third and fourth quarters
of 1999.
On October 14, 1998, we announced that our Board of Directors approved a
plan to repurchase up to 7,000,000 shares, or approximately 10%, of our
outstanding common shares. As of June 30, 1999, we had repurchased 1,200,000
shares at a cost of approximately $9.1 million. Future repurchases of shares
under this plan, if any, will be made with existing cash balances.
We believe that our current cash, cash equivalents and short-term
investment balances and internally generated cash flow will be sufficient to
meet our working capital and capital expenditure requirements through 1999. To
the extent that our existing resources, together with future earnings, are
insufficient to fund our future activities, we may need to raise additional
funds through public or private financings.
22
<PAGE> 23
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 globally
(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: our state of readiness; the costs to address
our Year 2000 Issues; the risks of our Year 2000 Issues; and our contingency
plans.
Our State of Readiness
In determining our state of readiness regarding the Year 2000 Issue,
management is assessing compliance in the following areas: our products, our
internal systems and the readiness of our key suppliers and major customers.
We have implemented a Year 2000 Project (the "Project") to address and
correct Year 2000 compliance issues with regard to our operating systems and the
readiness of our suppliers and customers. The Project is administered by a
Steering Committee, which includes senior representatives from
23
<PAGE> 24
operations, engineering, finance, information management and independent outside
consultants. The Project is composed of five phases:
- Awareness;
- Inventory and Assessment;
- Replacement and Upgrade;
- Testing and Validation; and
- Implementation and Post-Implementation.
The AWARENESS phase is intended to ensure that our 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 we, including all of our
departments, business partners, properties and interfaces to vendors, use in all
aspects of our 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 Building systems including elevators,
applications HVAC, life safety systems, public utilities
and others
o Mainframe hardware, software and o Facsimile and photocopy machines
applications
o Telephone systems o Alarms
o Local Area Networks hardware, software and o Access systems and door locks
applications
</TABLE>
Our products that are currently being sold or that have been sold in the
past will be classified into three main categories.
- No Impact: Units with no internal electronics or processing
capabilities or units with processing capabilities that do not
perform date math calculations.
- Minor Impact: Units that possess date math processing
capabilities, but any Year 2000 related failure would either
have no impact on the actual performance of the unit (i.e.,
incorrect date display only), or would require a one-time user
intervention to rest the unit once the clock turned from
December 31, 1999 to January 1, 2000. Units in this category
will be reviewed on a case by case basis by the Product Manager
to determine whether or not testing is warranted.
- Major Impact: Units that possess significant date math
processing capabilities. Every unit in this classification will
be tested for Year 2000 compliance.
We have adopted BellCore GR-2945-CORE, Issue 1 standard for definition
of "Year 2000 Compliant" products as the majority of our products are sold to
Bell operating companies. Testing of our products is being completed by
Nationally Recognized Test Labs. To date, all PairGain products tested have been
Year 2000 compliant without modification. If any products are subsequently
24
<PAGE> 25
determined not to be compliant, we have pledged to immediately notify all
customers who have purchased any of the non-complaint products and to upgrade or
replace any of the installed, non-compliant products in accordance with our
standard warranty policy, regardless of whether the equipment is still in the
warranty period.
Inventory of our internal systems has been completed. An assessment of
the readiness of the external entities with which we interface such as vendors,
customers, payment systems and others is ongoing. Letters were sent to 100 of
our suppliers. Responses have been received from 90% of those companies with 35%
indicating they were already Year 2000 compliant and the remaining indicating
that they are still working on the issue. We have multiple sources for almost
every part that we use in our products. If any one supplier cannot, for one
reason or another, comply with the Year 2000 requirements, we anticipate being
able to procure the parts from another supplier who is compliant. We plan to
work closely with those suppliers who provide sole source components to ensure
that they are Year 2000 compliant before any interruption occurs or will address
the sole source issue in other ways.
Our major customers have disclosed their intent to be Year 2000
compliant by December 31, 1999 in recent SEC filings and on public websites. We
continue to have formal communications with all of our significant suppliers and
large customers to determine the extent, if any, to which we are vulnerable to
those third parties' failure to remedy their own Year 2000 Issue. There can be
no guarantee that our systems or the systems of other companies will be
compliant in a timely manner. We are aggressively seeking resolution to those
situations which might carry a material impact and might adversely affect us.
During the REPLACEMENT AND UPGRADE phase of the Project, our 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. It is our intention to
gain Year 2000 compliance assurances with all new contracts and leases, renewals
of existing contracts and purchases of software applications.
During the TESTING AND VALIDATION phase, a standard test methodology
will be used to ensure that all components of our products correctly handle the
century date changes and that those changes do not adversely impact current
functionality and operation of the components. A checklist of ten minimum
requirements was created to certify an internal system or application is
compliant. Testing and validation of these systems will continue through the end
of 1999 to ensure successful business operations.
During the IMPLEMENTATION AND POST-IMPLEMENTATION phase, components of
our products will be implemented into production upon completion of upgrade and
testing, and operated in a production environment. Constant monitoring and
communication will also be a focus point and objective. A system change control
process will be used to ensure that subsequent changes are not made to Year 2000
compliant components unless those changes have been tested for compliance. A
team will be established to cater to all questions and issues that may arise
during and after January 1, 2000. Post-implementation, including continued
monitoring and communication, will continue through March 31, 2000 to ensure our
successful operation after January 1, 2000.
25
<PAGE> 26
The Costs to Address Our Year 2000 Issues
The total cost to address our Year 2000 Issue is not expected to be
material to our financial condition. We are using both internal and external
resources to reprogram, or replace, and test our products and systems for Year
2000 modifications. We do not separately track internal costs incurred on the
Year 2000 Project, which principally include payroll and related costs for our
Information Management employees that are being expensed as incurred. Excluding
internal costs, we have budgeted approximately $1.1 million for activities
specific to the Year 2000 compliance of our 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. Purchased hardware and software will be capitalized in
accordance with our standard capitalization policy. All other costs related to
the Project are being expensed as incurred. Budgeted amounts are expected to be
spent during 1998 and 1999 but will not be incurred equally over all phases of
the Project. As of June 30, 1999 we had spent approximately $5.0 million of
these budgeted amounts. These costs are being funded through operating cash
flows.
The Risks of Our Year 2000 Issues
We have placed great importance on our Year 2000 Project and anticipate
that our systems will be Year 2000 compliant before the end of 1999. The
following are representative of the types of risks that could result in the
event that we are not fully compliant by the end of 1999:
- Legal risks, including customer, supplier, employee or
shareholder lawsuits over failure to deliver contracted services
or product failure.
- Loss of sales due to failure to meet customer quality
expectations or inability to ship products.
- Increased operational costs due to manual processing, data
corruption or disaster recovery.
- Inability to bill or invoice customers and collect payments in a
timely manner.
In addition to the Year 2000 compliance issues we face with respect to
our own systems, we face risks that our vendors' and/or customers' systems,
which are not directly under our 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 a disruption of our service, our 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. Because we market our products
principally to telephone companies in the United States and Canada, a reduction
in telecommunications equipment spending could reduce our revenues and have a
material adverse effect on our financial condition and results of operations.
Our Contingency Plans
A contingency plan has not yet been developed for dealing with the most
reasonably likely worst case scenario with respect to our Year 2000 compliance,
and such scenario has not yet been clearly identified. It is impossible to fully
assess the potential consequences in the event service interruptions from
suppliers occur or in the event that there are disruptions in such
infrastructure areas as utilities,
26
<PAGE> 27
communications, transportation, banking and government. Assuming no major public
infrastructure service disruption occurs, we believe that we will be able to
manage our Year 2000 transition without a material effect on our results of
operations or financial condition. We have not completed contingency plans in
the event that a disruption in the public infrastructure does occur.
The above information 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. There can be no assurance that these estimates can 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 our
external customers, suppliers and governmental agencies in addressing the Year
2000 Issue.
The above discussion regarding the Year 2000 Issue contains many
statements that are "forward-looking" within the meaning of the Private
Securities Litigation Reform Act of 1995. When used in the Year 2000 discussion,
the words "believes," "expects," "estimates," "planned," "could" and similar
expression are intended to identify forward-looking statements. Forward-looking
statements included, without limitation, our expectations as to when we will
complete the remediation and testing phases of our Year 2000 Project as well as
any contingency plans we formulate; our estimated cost of achieving Year 2000
readiness; and our belief that our internal systems and equipment will be Year
2000 compliant in a timely manner.
PART I: ITEM 3
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
PAIRGAIN TECHNOLOGIES, INC.
At June 30, 1999, we had an investment portfolio of fixed income
securities, including those classified as cash equivalents, of $214.6 million.
These securities are subject to interest rate fluctuations. An increase in
interest rates could adversely affect the market value of our fixed income
securities.
We limit our exposure to interest rate and credit risk by establishing
and strictly monitoring clear policies and guidelines for our fixed income
portfolios. At the present time, the maximum average maturity of our overall
investment portfolio is limited by policy to 36 months. The guidelines also
establish credit quality standards, limits on exposure to one issue, issuer, as
well as the type of instrument. Due to the limited duration and credit risk
criteria established in our guidelines, the exposure to market and credit risk
is not expected to be material. Accordingly, we do not use derivative financial
instruments in our investment portfolio to manage interest rate risk.
27
<PAGE> 28
PART II. OTHER INFORMATION
PAIRGAIN TECHNOLOGIES, INC.
Item 1. Legal Proceedings
As discussed in Item 3. Legal Proceedings in our Annual Report on Form
10-K for the year ended December 31, 1998, 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.
As discussed in Item 1. Legal Proceedings in our Quarterly Report on
Form 10-Q for the first quarter ended March 31, 1999, the U.S. Attorney
has named PairGain, Charles S. Strauch, our Chairman, and Charles W.
McBrayer, our Chief Financial Officer, as targets of its criminal
investigation. As noted in the March 1999 Form 10-Q, no final decision
has been made whether to pursue charges against PairGain, Mr. Strauch or
Mr. McBrayer by the U.S. Attorney. There were no changes to these
matters during the period ended June 30, 1999.
In May 1999, we reached an agreement with Harris Corporation ("Harris")
to settle and dismiss the lawsuit brought by Harris against PairGain and
others, which lawsuit is described in our Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1998. Under the terms of the
settlement, in order to avoid further litigation and controversy, we
agreed to pay the sum of $1.5 million to Harris and both parties agreed
to dismiss their actions with prejudice. The impact of the settlement
was recorded in our financial statements for the quarter ended June 30,
1999.
We are involved from time to time in litigation incidental to our
business. We believe that none of our pending litigation matters,
individually or in the aggregate, will have a material adverse effect on
our financial position or results of operations.
28
<PAGE> 29
Item 2. Changes in Securities
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
At the Annual Meeting of Stockholders held on June 16, 1999, the
stockholders:
- ratified the appointment of Michael Pascoe to serve on the Board
of Directors until the 2001 Annual Meeting;
- elected Charles S. Strauch, Robert C. Hawk and Robert A. Hoff to
serve on the Board of Directors until the 2002 Annual Meeting;
- approved a series of amendments to the 1993 Stock Option/Stock
Issuance Plan including:
- an increase in the number of common stock available for
issuance under the Plan by an additional 2,000,000
shares;
- a requirement that all option grants and direct stock
issuances be made at not less than 100% of the fair
market value of the shares on the grant or issue date;
- an elimination of the option cancellation/regrant
provisions; and
- an elimination of the financing provisions of the 1993
Plan; and
- approved the selection of Deloitte & Touche LLP as the Company's
independent auditor for the fiscal year ending December 1999.
Results of the voting are shown below:
TO RATIFY THE APPOINTMENT OF THE FOLLOWING DIRECTOR TO SERVE FOR A TERM
OF TWO YEARS:
<TABLE>
<CAPTION>
Votes For Votes Withheld
----------- ---------------
<S> <C> <C>
Michael Pascoe 59,321,425 1,073,084
</TABLE>
TO ELECT THE FOLLOWING DIRECTORS TO SERVE FOR A TERM OF THREE YEARS:
<TABLE>
<CAPTION>
Votes For Votes Withheld
----------- ---------------
<S> <C> <C>
Charles S. Strauch 59,023,682 1,370,827
Robert C. Hawk 59,021,994 1,372,515
Robert A. Hoff 59,022,794 1,371,715
</TABLE>
TO APPROVE THE AMENDMENTS TO THE 1993 STOCK OPTION/STOCK ISSUANCE PLAN:
<TABLE>
<CAPTION>
For Against Abstain
------------------- -------------------- ------------------
<S> <C> <C>
45,739,116 14,270,045 385,348
</TABLE>
29
<PAGE> 30
TO APPROVE THE SELECTION OF DELOITTE & TOUCHE LLP AS THE COMPANY'S
INDEPENDENT AUDITOR FOR THE FISCAL YEAR ENDING DECEMBER 1999:
<TABLE>
<CAPTION>
For Against Abstain
------------------- -------------------- ------------------
<S> <C> <C>
59,972,750 223,938 197,821
</TABLE>
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.
30
<PAGE> 31
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: August 13, 1999 /s/ Charles W. McBrayer
---------------------- ------------------------------------------
Charles W. McBrayer
Executive Vice President,
Chief Financial Officer and Secretary
(Principal Financial Officer)
Date: August 13, 1999 /s/ Robert R. Price
---------------------- ------------------------------------------
Robert R. Price
Vice President and Corporate Controller
(Principal Accounting Officer)
31
<PAGE> 32
EXHIBIT LIST
<TABLE>
<CAPTION>
Exhibits
- --------
<S> <C>
27.1 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 118,190
<SECURITIES> 104,175
<RECEIVABLES> 26,201
<ALLOWANCES> 0
<INVENTORY> 37,092
<CURRENT-ASSETS> 307,261
<PP&E> 52,953
<DEPRECIATION> 28,102
<TOTAL-ASSETS> 337,323
<CURRENT-LIABILITIES> 49,258
<BONDS> 0
0
0
<COMMON> 36
<OTHER-SE> 286,287
<TOTAL-LIABILITY-AND-EQUITY> 337,323
<SALES> 117,285
<TOTAL-REVENUES> 122,067
<CGS> 71,209
<TOTAL-COSTS> 71,209
<OTHER-EXPENSES> 45,473
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (3,321)
<INCOME-PRETAX> 8,706
<INCOME-TAX> 3,470
<INCOME-CONTINUING> 5,236
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,236
<EPS-BASIC> 0.07
<EPS-DILUTED> 0.07
</TABLE>
