PAIR: REPORTS 1Q 1999 RESULTS--BUY
Bankers Trust Research/BT Alex. Brown Research
Christopher Crespi,Alexander Williamson
April 14, 1999
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PAIRGAIN TECHNOLOGIES, INC. [PAIR] "BUY"
Reports 1Q 1999 Results
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Date: 04/13/1999 EPS 1998A 1999E 2000E
Price: 12.5 1Q 0.16 0.06A NE
52-Wk Range: 24 - 6 2Q 0.16 0.07 NE
Ann Dividend: 0.0 3Q 0.16 0.10 NE
Ann Div Yld: 0.00% 4Q 0.05* 0.12 NE
Mkt Cap (mm): 931 FY(Dec.) 0.53 0.34 0.48
3-Yr Growth: 32% FY P/EPS 23.6X 36.8X 26.X
CY EPS 0.53 0.34 0.48
Est. Changed Yes CY P/EPS 23.6X 36.8X 26.X
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* Includes charges
HIGHLIGHTS:
--Located in Tustin, California, PairGain is a market leader in the
design, manufacturing and marketing of communications systems based on
high-speed digital subscriber line technology known as xDSL (digital
subscriber line).
--PairGain reported first quarter 1999 revenue of $60.9 million and fully
diluted EPS of $0.06. Our estimates were revenue of $59.0 million with
EPS of $0.06. The First Call consensus EPS estimate was $0.07. If
PairGain had used our tax rate of 36.5% instead of 34% the Company would
have reported EPS of $0.05.
--Interest in the xDSL space appears to be accelerating as a result of
increased carrier emphasis on bandwidth access technologies, which has
put the xDSL equipment vendors in play. However, we believe that the
fundamentals will not show improvement until the second half of calendar
year 1999.
--We maintain our "buy" investment rating on the stock because we continue
to believe that PairGain is an attractive acquisition candidate due to
its strong customer relationships and technology.
--We are slightly lowering our 1999 quarterly estimates and are
introducing year 2000 estimates of $316 million in revenues and $0.48
per share.
DETAILS:
PairGain reported first quarter 1999 revenue of $60.9 million and fully
diluted EPS of $0.06. Our estimates were revenue of $59.0 million with EPS
of $0.06. The First Call consensus estimate was $0.07 per share. The
reported tax rate for the quarter was 34%. Had the Company used our
expected tax rate of 36.5%, PairGain would have reported EPS of $0.05.
The following table compares the reported quarter with our estimates and
the year ago quarter. Variance refers to the difference between the
reported quarter and our estimates.
($Mil, except per share data) 1Q99 BTAB Est. 1Q98 Variance
Revenue $60.9 $59.0 $72.6 $1.9
Gross Profit $25.5 $26.1 $36.9 ($0.6)
Gross Margin 41.9% 44.3% 50.8% (2.4%)
Operating Profit $3.9 $5.3 $17.1 ($1.4)
Operating Margin 6.4% 9.0% 23.5% (2.6%)
Net Income $4.2 $4.8 $12.2 ($0.6)
Net Margin 6.9% 8.1% 16.7% (1.2%)
EPS $0.06 $0.06 $0.16 $0.00
Shares Outstanding (MM) 74.5 75.1 75.2 (0.6)
Source: Company data and BT Alex. Brown Incorporated.
Gross margins decreased to 41.9% from 42.0% in 4Q 1998 and from 50.8% in
the year ago quarter. Gross margin declined 240 basis points from our
estimate of 44.1%. The decline continues to be the result of price erosion
in the Company's T1/E1 access business. Management expects gross margin to
trend in the low 40% range for 2Q and 3Q 1999, eventually increasing to the
mid 40s by 4Q 1999 as the Company's higher margin Avidia product begins
shipping in volume quantities.
International sales accounted for 10% of total revenue in the quarter
compared to 13% in 4Q 1998. Sales to Europe were strong whereas sales to
Latin America were weak. The Company is currently looking for a new VP of
International sales and expects to hire someone in the next few weeks.
Cash decreased by approximately $6 million sequentially to $228 million
compared to $234 million in 4Q 1998. Cash declined as a result of the
repurchase of 200,000 shares of the Company's stock during the quarter as
well as a $5 million minority investment in ANDA Networks, a privately-held
manufacturer of next generation access technologies. Since October 1998,
PairGain has repurchased a total of 1.2 million shares.
DSOs increased over the quarter to 38.1 from 30.0.
Inventory turns increased to 4.3 from 3.9.
Products
HiGain
The Company's HiGain HDSL products accounted for 54% of total revenues,
down from 58% in 4Q 1998 and down from 68% in 1Q 1998. The decline is
primarily the result of stiff price competition in the T1/E1 access market.
Last quarter, PairGain lost primary supplier status for HDSL at Bell
Atlantic to Adtran. Management expects a further decline in HDSL sales to
Bell Atlantic but noted that the Company enjoys healthy sales to Bell
Atlantic for its PG-Flex and PG-Plus product lines. Unit shipments of
T1/E1 products were up 8% over the year ago quarter but revenues declined
34% reflecting the impact of price competition.
The Company's higher margin HiGain98 product has met approval from most
customers with sales expected in the current quarter. Management also
noted that it expects to ship its HDSL2 product line in the current
quarter, with sales ramping in 3Q 1999. Management noted that its Wideband
3190 product has received a favorable endorsement from Nextlink and Level 3
with deployment underway.
PG-2/PG-Plus/PG-Flex
All small subscriber line products (PG-2/PG-Plus/PG-Flex) represented
approximately 31% of total sales, up from 27% of total sales in 4Q 1998.
This reflects an increase of 75% year over year and a 15% increase
sequentially. Management expects these products to grow to a $100 million
business in 1999.
xDSL
Megabit Access products include the Company's modem and DSLAM product lines
as well as the Company's new Avidia platform. Megabit Access products and
campus products accounted for approximately 8% of total revenue in the
quarter.
Avidia trials were successful in the quarter and the product is currently
in the certification process. There were no Avidia trials among the RBOCs
and the product is currently being targeted to the independent telcos,
CLECs and IXCs. MCI WorldCom and Sprint are evaluating the product.
Avidia sales are expected to ramp up in the third and fourth quarters of
1999.
Rockwell
Royalty revenue from the Company's relationship with Rockwell increased to
approximately $4 million from $3 million in the fourth quarter of 1998.
Management expects this to decline to roughly $1 million per quarter for
the next several quarters.
OUTLOOK
Renewed interest and speculation regarding xDSL has contributed to the
recent increase in PairGain's shares, in our view. The xDSL space has
recently been in play and the equipment providers have benefited more from
positive sentiment than from improving fundamentals. We believe that there
is increasing pressure on the RBOCs to deploy xDSL service from both the
AT&T/TCI front as well as from the data CLECs (Covad and Frontier).
However, we believe the RBOCs are unlikely to make a serious commitment
until the second half of calendar year 1999 and into year 2000. As a
result, we expect PairGain to show revenue and earnings acceleration
towards the second half of 1999 as reflected in our model. We continue to
believe that PairGain is an ideal acquisition candidate based on its solid
technology platform, strong customer relationships and profitable financial
position. Primarily for this reason, we are maintaining our "buy"
investment rating on the stock. With respect to our model, we are slightly
revising quarterly estimates for 1999, and are introducing year 2000
estimates of $316 million in revenues and $0.48 per share.
Our revised estimates and quarterly 1999 estimates follow:
Previous Estimates 2Q99 3Q99 4Q99 FY99
Revenue (MM) $64.2 $70.8 $76.8 $270.8
EPS $0.08 $0.11 $0.12 $0.38
Revised Estimates 2Q99 3Q99 4Q99 FY99
Revenue (MM) $62.5 $68.0 $73.4 $264.8
EPS $0.07 $0.10 $0.12 $0.34
Introducing year 2000 estimates:
Year 2000 FY00
Revenue (MM) $316.0
EPS $0.48
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