<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-Q
(Mark One)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to .
Commission File Number: 1-12491
LARSCOM INCORPORATED
(Exact name of registrant as specified in its charter)
Delaware 94-2362692
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1845 McCandless Drive
Milpitas, CA 95035
(408) 941-4000
(Address of principal executive offices, zip code and telephone number)
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 __
The number of the registrant's shares outstanding as of July 31, 1998 was
8,265,000 shares of Class A Common Stock and 10,000,000 shares of Class B
Common Stock.
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LARSCOM INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C> <C>
PART I: FINANCIAL INFORMATION .................................. 3
ITEM 1: FINANCIAL STATEMENTS ................................... 3
CONDENSED CONSOLIDATED BALANCE SHEETS .................. 3
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS ........ 4
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ........ 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.... 6
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .................... 9
PART II: OTHER INFORMATION ...................................... 17
ITEM 1: LEGAL PROCEEDINGS ...................................... 17
ITEM 2: CHANGES IN SECURITIES .................................. 17
ITEM 3: DEFAULTS UPON SENIOR SECURITIES ........................ 17
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .... 17
ITEM 5: OTHER INFORMATION ...................................... 18
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K ....................... 18
A: EXHIBITS ............................................ 18
B: REPORTS ON FORM 8-K ................................. 18
SIGNATURES ............................................. 19
</TABLE>
2
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PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
LARSCOM INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
ASSETS
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
------------ -------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,630 $ 8,254
Short-term investments 16,838 16,598
Accounts receivable, net 10,295 17,070
Inventories 14,823 13,328
Deferred income taxes 2,745 2,741
Prepaid expenses and other current assets 1,089 1,285
--------- --------
Total current assets 49,420 59,276
Property and equipment, net 8,286 9,703
Intangible assets, net 9,624 10,658
Deferred income taxes 8,074 8,062
Other assets 39 211
--------- --------
Total assets $ 75,443 $ 87,910
--------- --------
--------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations $ 134 $ 341
Accounts payable 4,208 8,219
Accrued expenses and other current liabilities 6,448 13,562
Due to Axel Johnson Inc. 322 3,243
--------- --------
Total current liabilities 11,112 25,365
--------- --------
Other non-current liabilities 385 318
--------- --------
Commitments and contingencies (Note 6)
Stockholders' equity:
Class A Common Stock 82 81
Class B Common Stock 100 100
Additional paid-in capital 81,263 80,929
Unrealized gain on short-term investments 19 -
Foreign currency translation adjustment 2 -
Accumulated deficit (17,520) (18,883)
--------- --------
Total stockholders' equity 63,946 62,227
--------- --------
Total liabilities and stockholders' equity $ 75,443 $ 87,910
--------- --------
--------- --------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
3
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LARSCOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -------------------------
1998 1997 1998 1997
-------------- ----------- --------- -------------
(Unaudited)
<S> <C> <C> <C> <C>
Revenues $ 18,639 $ 19,148 $ 40,969 $ 35,558
Cost of revenues 10,199 8,186 20,360 15,580
-------- -------- -------- --------
Gross profit 8,440 10,962 20,609 19,978
-------- -------- -------- --------
Operating expenses:
Research and development 2,765 2,400 6,303 4,616
Selling, general and administrative 6,391 5,011 13,761 10,191
-------- -------- -------- --------
Total operating expenses 9,156 7,411 20,064 14,807
-------- -------- -------- --------
Income (loss) from operations (716) 3,551 545 5,171
Interest expense charged by Axel Johnson Inc. (19) (18) (38) (37)
Interest and other income 185 469 1,691 920
-------- -------- -------- --------
Income (loss) before income taxes (550) 4,002 2,198 6,054
Income tax provision (benefit) (209) 1,461 835 2,179
-------- -------- -------- --------
Net income (loss) $ (341) $ 2,541 $ 1,363 $ 3,875
-------- -------- -------- --------
-------- -------- -------- --------
Basic and diluted earnings (loss) per share $ (0.02) $ 0.14 $ 0.07 $ 0.21
Basic and diluted weighted average shares 18,188 18,076 18,180 18,038
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
4
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LARSCOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
------------ ----------
(Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,363 $ 3,875
Depreciation and amortization 3,113 1,396
Gain from sale of building (1,329) -
Net increase in working capital (5,498) (3,759)
-------- ---------
Net cash (used) provided by operating activities (2,351) 1,512
-------- ---------
Cash flows from investing activities:
Purchases of property and equipment (868) (1,215)
Proceeds from sale of building 1,700 -
Purchases of short-term investments (53,609) (143,131)
Sales of short-term investments 30,499 23,608
Maturities of short-term investments 22,870 81,965
-------- ---------
Net cash provided (used) by investing activities 592 (38,773)
-------- ---------
Cash flows from financing activities:
Repayments to Axel Johnson Inc. (2,921) (1,666)
Payment of capital lease obligations (281) -
Proceeds from issuances of Class A Common Stock 335 3,827
-------- ---------
Net cash (used) provided by financing activities (2,867) 2,161
-------- ---------
Effect of exchange rates on cash 2 -
-------- ---------
Decrease in cash and cash equivalents (4,624) (35,100)
Cash and cash equivalents at beginning of period 8,254 46,403
-------- ---------
Cash and cash equivalents at end of period $ 3,630 $ 11,303
-------- ---------
-------- ---------
Supplemental disclosure of cash flow information
Interest paid $ 37 $ 37
-------- ---------
Income taxes paid $ 3,575 $ 2,356
-------- ---------
Supplemental disclosure of non-cash financing activities
Shares issued in connection with cancellation of the Company's
Long-Term Incentive Plans $ - $ 306
-------- ---------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
5
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LARSCOM INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION:
The condensed consolidated financial statements for the three and six
months ended June 30, 1998 and 1997 presented in this Quarterly Report on Form
10-Q are unaudited. In the opinion of management, these statements include all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair statement of the results for the interim periods presented. The condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto included in Larscom
Incorporated's (the "Company") Report on Form 10-K for the year ended December
31, 1997. The results of operations for the first six months of 1998 are not
necessarily indicative of the results to be expected for the full year.
NOTE 2--INVENTORIES:
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- -------------------
<S> <C> <C>
Raw materials $ 5,154 $ 4,266
Work in process 1,749 3,047
Finished goods 7,920 6,015
------- -------
$14,823 $13,328
------- -------
------- -------
</TABLE>
NOTE 3--COMMON STOCK ISSUANCES:
In December 1996, the Company completed an initial public offering of
7,000,000 shares of Class A Common Stock at a price of $12 per share of which
5,800,000 were sold by the Company and 1,200,000 shares were sold by Axel
Johnson Inc. ("Axel Johnson"). After deducting the underwriting discount of
$4,872,000 and issuance costs of $1,449,000 the Company received net proceeds
of $63,279,000 in December 1996. In January 1997, the underwriters exercised
their over-allotment option to sell additional shares and sold an additional
1,050,000 shares of which the Company sold 350,000 and Axel Johnson sold
700,000. Net proceeds to the Company in January 1997 were $3,827,000 after
deducting the underwriting discount of $294,000 and additional selling
expenses of $79,000.
In March 1997, 25,518 shares were issued to certain employees, at a
cost of $12 per share, in connection with the cancellation of the Company's
Long-Term Incentive Plans. In August 1997, the Company issued 61,769 shares
of Class A Common Stock for consideration of $408,000 under the Company's
Employee Stock Purchase Plan. In January 1998, the Company issued 50,762
shares of Class A Common Stock for consideration of $335,000 under the
Company's Employee Stock Purchase Plan.
6
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NOTE 4--EARNINGS PER SHARE:
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 128 ("SFAS 128"), "Earnings per Share" which
established a different method of computing earnings per share. Under SFAS 128,
the Company is required to present both basic earnings per share and diluted
earnings per share. Earnings per share for prior periods have been restated in
accordance with SFAS 128. The following table sets forth the computation of
basic and diluted earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ------------------------
1998 1997 1998 1997
-------------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Net income (loss) $ (341) $ 2,541 $ 1,363 $ 3,875
--------- -------- -------- --------
--------- -------- -------- --------
Weighted average Class A and B
Common Stock outstanding 18,188 18,076 18,180 18,038
Dilutive effect of options - - - -
--------- -------- -------- --------
Diluted average shares 18,188 18,076 18,180 18,038
--------- -------- -------- --------
--------- -------- -------- --------
Basic and diluted earnings (loss) per share $ (0.02) $ 0.14 $ 0.07 $ 0.21
</TABLE>
NOTE 5--COMPREHENSIVE INCOME:
As of January 1, 1998, the Company adopted Statement of Financial
Accounting Standard No. 130 ("SFAS 130"), "Reporting Comprehensive Income".
SFAS 130 establishes new rules for the reporting and display of comprehensive
income and its components; however, the adoption of this Statement had no
material impact on the Company's net income or stockholders' equity. SFAS 130
requires separate reporting of comprehensive income which is defined as "the
change in equity of a business enterprise during a period from transactions
and other events and circumstances from nonowner sources". The only items
included in other comprehensive income are foreign currency translation
adjustments and unrealized gain on short-term investments.
The components of comprehensive income are as follows:
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
-------------------------
1998 1997
----------- ----------
<S> <C> <C>
Net income $1,363 $2,541
Other comprehensive income:
Foreign currency translation adjustment 2 -
Unrealized gain on short-term investments 19 -
------ ------
Comprehensive income $1,384 $2,541
------ ------
------ ------
</TABLE>
The components of accumulated other comprehensive income, net
of related tax effects, are as follows:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
------------ ----------------
<S> <C> <C>
Foreign currency translation adjustment $ 2 $ -
Unrealized gain on short-term investments 19 -
---- ----
$21 $ -
---- ----
---- ----
</TABLE>
7
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NOTE 6--COMMITMENTS AND CONTINGENCIES:
In April 1998, the Company received notification from the General
Services Administration ("GSA") that it had completed its audit of the
Company's two product supply contracts which were subject to GSA regulations.
At December 31, 1997, the Company had a reserve of $532,000 to cover
potential pricing deficiencies, associated audit and legal costs and
penalties under these contracts. As a result of the notification by GSA, the
Company released the reserve of $532,000 which resulted in a reduction in
selling, general and administrative expenses in the three and six months
ended June 30, 1998. The Company believes that no additional liabilities will
result from this matter.
On December 31, 1997, the Company completed its acquisition of
NetEdge Systems, Inc. A portion of the purchase consideration was paid into
escrow pending resolution of certain matters including purchase price
adjustments and other representations and warranties. Resolution of these
matters is still pending.
In its distribution agreements, the Company typically agrees to
indemnify its customers for any expenses or liabilities resulting from
claimed infringements of patents, trademarks or copyrights of third parties.
NOTE 7--SALE OF BUILDING:
In March 1998, the Company recorded as other income a one-time,
pre-tax gain of $1,329,000 from the sale of its former headquarters by a
partnership in which the Company holds a one-third interest.
NOTE 8--RECENT ACCOUNTING PRONOUNCEMENTS:
In June 1997, the Financial Accounting Standards Board issued
Statement No. 131 ("SFAS 131"), "Disclosures About Segments of An Enterprise
and Related Information". SFAS 131 will require the Company to use the
"management approach" in disclosing segment information. The adoption of this
statement is not expected to have a material impact on the Company's segment
disclosures.
8
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LARSCOM INCORPORATED
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THE STATEMENTS CONTAINED IN THIS REPORT ON FORM 10-Q THAT ARE NOT
PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, INCLUDING STATEMENTS REGARDING
THE COMPANY'S EXPECTATIONS, HOPES, INTENTIONS OR STRATEGIES REGARDING THE
FUTURE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON
INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE COMPANY
ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. THE
FORWARD-LOOKING STATEMENTS CONTAINED HEREIN ARE SUBJECT TO CERTAIN FACTORS
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN SUCH
FORWARD-LOOKING STATEMENTS. SUCH FACTORS INCLUDE BUT ARE NOT LIMITED TO THE
FACTORS SET FORTH IN THE COMPANY'S 1997 ANNUAL REPORT ON FORM 10-K AND THIS
QUARTERLY REPORT ON FORM 10-Q.
RESULTS OF OPERATIONS
The Company's products can be split into two main categories --
network systems (broadband) and digital access (narrowband), based upon the
bandwidth of the products supplied. The Company sells these products
primarily through a direct sales force and, to a lesser extent, through a
variety of resellers including original equipment manufacturers, value-added
resellers, system integrators and distributors. An increasing proportion of
the Company's sales are made to a limited number of network service providers
("NSPs") and internet service providers ("ISPs"). Network systems sales
represent an increasing percentage of total revenues, a trend the Company
expects to continue.
REVENUE. Revenues of $18,639,000 for the three months ended June 30,
1998 decreased by 3% from $19,148,000 in the comparable period in 1997.
Revenues of $40,969,000 for the six months ended June 30, 1998 grew by 15%
over revenues of $35,558,000 during the comparable period in 1997. During the
three and six months ended June 30, 1998, network systems sales were 48% and
53% of total revenues, respectively, as compared to 38% and 36% in the
corresponding respective periods of 1997. The increase in network systems
sales in the six months ended June 30, 1998, as compared to the corresponding
1997 period, was due to higher sales of the Orion 4000 product line and, to a
lesser extent, sales of Edge products following the acquisition of NetEdge on
December 31, 1997. The increase in network systems sales in the three months
ended June 30, 1998, as compared to the corresponding 1997 period, was due to
sales of Edge products. Network systems sales decreased in the second quarter
of 1998 as compared to the first quarter primarily due to reduced shipments
to one of the Company's large customers. Digital access product sales
decreased in both the three and six months ended June 30, 1998, when compared
to the corresponding 1997 periods, primarily as a result of lower demand from
two of the company's larger customers. Digital access product sales have
decreased as a percentage of total revenues and in absolute dollars.
GROSS PROFIT. As a percentage of revenue, gross profit for the three
and six months ended June 30, 1998 decreased to 45% and 50%, respectively, as
compared to 57% and 56% in the comparable respective periods of 1997. During
the first six months of 1998, gross profit included amortization of purchased
technology of $430,000 that was not included in the corresponding 1997
periods. The lower gross margin in the first quarter of 1998 also reflected
lower margins on sales of finished goods acquired as part of the NetEdge
acquisition as well as high manufacturing costs incurred at the NetEdge
facility, both of which are not expected to recur in future periods. The
lower gross margin in the second quarter of 1998, as compared to the
corresponding period in the prior year, also reflected lower production
volumes and an increase in inventory reserves. Inventory reserves are
established based on the Company's current expectations of future orders and
product sales as compared to inventory on hand. If actual results differ from
expectations additional reserves could be required, which would further
negatively affect gross margins and operating results. In the future gross
profits as a percentage of revenues may also fluctuate depending upon a
number of other factors, but primarily as a result of changes in product mix
and production volume, competitive pricing and price discounts given, as well
as inventory levels as compared to changing future inventory requirements.
9
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RESEARCH AND DEVELOPMENT. Research and development expenses increased
15% to $2,765,000 in the three months ended June 30, 1998 from $2,400,000 in
the comparable period in 1997. During the six months ended June 30, 1998
research and development expenses increased 37% from $4,616,000 to
$6,303,000. These increases in research and development expenses were due
primarily to increased headcount associated with the purchase of NetEdge as
well as continuing investment in product enhancements and new products. The
Company expects that research and development expenses will continue to
increase in absolute dollars.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and
administrative expenses increased 28% to $6,391,000 during the three months
ended June 30, 1998 as compared to $5,011,000 in the comparable 1997 period.
During the first six months of 1998, selling, general and administrative
expenses increased by 35% to $13,761,000 from $10,191,000. These increases
were due to additional personnel costs associated with the acquisition of
NetEdge, including expenses associated with an office in the United Kingdom.
These increases in expenses were offset in part in the second quarter of 1998
by the release of the unused reserve of $532,000 that had been established
for potential unasserted claims related to two General Services
Administration contracts. See Note 6 of the Notes to the Condensed
Consolidated Financial Statements for more details. The Company anticipates
that selling, general and administrative expenses will increase in absolute
dollars in the future as a result of the Company's continued investment in
the expansion of its sales, service and support organizations and the
development of its distribution channels, particularly outside the United
States.
Selling, general and administrative expenses include charges from
Axel Johnson for legal, accounting, tax, treasury, human resources and
administrative services in the amounts of $106,000 and $156,000 during the
three months ended June 30, 1998 and 1997, respectively, and $212,000 and
$311,000 during the six months ended June 30, 1998 and 1997, respectively.
INTEREST EXPENSE CHARGED BY AXEL JOHNSON. Interest expense includes
charges for the unused portion of the line of credit available under the
Credit Agreement that the Company entered into with Axel Johnson in December
1996. See Liquidity and Capital Resources for more details.
INTEREST AND OTHER INCOME. Interest income was $185,000 and $362,000
for the three and six month periods ending June 30, 1998, respectively,
compared to $469,000 and $920,000 for the corresponding periods of the prior
year. The reduction in interest income is due to lower cash balances
resulting from cash paid for the acquisition of NetEdge in December 1997 and
the subsequent payment of liabilities assumed.
In March 1998, the Company also recorded a one-time, pre-tax gain of
$1,329,000 from the sale of its former headquarters by a partnership in which
the Company holds a one-third interest.
PROVISION FOR INCOME TAXES. The Company's effective tax rate was 38%
and 36% for the six months ended June 30, 1998 and 1997, respectively. These
rates differ from the federal statutory rate primarily due to state taxes
which were offset by non-taxable interest income received on the Company's
cash equivalents and short-term investments. The higher effective tax rate in
the 1998 period was primarily due to a decrease in non-taxable interest
income as a result of reduced funds available for investment.
10
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LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities used cash of $2,351,000 during the
six months ended June 30, 1998 as compared to providing $1,512,000 in the
same period in 1997. The cash used during the 1998 period was primarily a
result of an increase in inventories and decreases in accounts payable and
accrued expenses and other current liabilities, offset in part by net income
and a reduction in accounts receivable.
From its acquisition by Axel Johnson in 1987 until its initial public
offering in December 1996, the Company has met its operating and capital
requirements primarily from cash flow from operations and advances from Axel
Johnson. Upon consummation of the IPO, the Company entered into a credit
agreement with Axel Johnson (the "Credit Agreement") under which the Company
has available a revolving line of credit of $15,000,000 which expires in
December 1998. As of June 30, 1998, there were no amounts outstanding under
this line of credit. The Company believes that it would be able to replace
the expiring line of credit with another line with similar terms and
conditions provided by either Axel Johnson or a third party. There can be no
assurance, however, that such financing will be available.
The Company expects that total capital expenditures during 1998 will
be approximately $3,300,000, of which $868,000 was spent in the six months
ended June 30, 1998.
As of June 30, 1998, the Company had working capital of $38,308,000,
including $20,468,000 in cash, cash equivalents and short-term investments.
The Company believes that working capital, together with the Company's line
of credit and funds generated from operations will provide adequate liquidity
to meet the Company's operating and capital requirements for at least the
next twelve months. There can, however, be no assurance that future events,
such as the potential use of cash to fund acquisitions, will not require the
Company to seek additional capital at an earlier date or, if so required,
that adequate capital will be available on terms acceptable to the Company,
or at all.
11
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued
Statement No. 131 ("SFAS 131"), "Disclosures About Segments of An Enterprise
and Related Information." SFAS 131 will require the Company to use the
"management approach" in disclosing segment information. The adoption of this
statement is not expected to have a material impact on the Company's segment
disclosures.
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
CERTAIN OF THE STATEMENTS ABOVE ARE FORWARD-LOOKING STATEMENTS. IN
ADDITION, THE COMPANY MAY FROM TIME TO TIME MAKE ORAL FORWARD-LOOKING
STATEMENTS. THE FOLLOWING ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN ANY SUCH FORWARD-LOOKING
STATEMENTS.
CUSTOMER CONCENTRATION. The Company believes that its relationships
with large customers, particularly the NSPs and telecommunication companies,
will be critical to its future success. A small number of customers have
accounted for a majority of the Company's revenues in each of the past
several years. During the six months ended June 30, 1998, three customers
each accounted for more than 10% of the Company's revenue. Two of these
customers, WorldCom including its subsidiaries and MCI, which accounted for
21% and 15% of revenues in the first six months of 1998, respectively, have
agreed to merge, subject to regulatory approval. Accordingly, the Company's
revenue is currently highly dependent on continued orders from one group of
related companies. None of the Company's customers are contractually obliged
to purchase any quantity of products in any particular period, and product
sales to major customers have varied widely from quarter to quarter and year
to year. There can be no assurance that the Company's current customers will
continue to place orders with the Company, that orders from existing
customers will continue at the levels of previous periods or that the Company
will be able to obtain orders from new customers. Loss of, or a material
reduction in orders by, one or more of the Company's major customers could
have a material adverse effect on the Company's business and operating
results.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; ABSENCE OF SIGNIFICANT
BACKLOG. The Company's operating results have fluctuated significantly in the
past and may fluctuate in the future on a quarterly and annual basis as a
result of a number of factors, many of which are beyond the Company's
control. The Company's sales historically have been concentrated in a small
number of customers. Therefore, sales for a given quarter may depend to a
significant degree upon orders received from and product shipments to a
limited number of customers. Sales to individual large customers are often
related to the customer's specific equipment deployment projects, the timing
of which are subject to change on limited notice. The Company has experienced
both acceleration and slowdown in orders related to such projects, causing
changes in the sales level of a given quarter relative to both the preceding
and subsequent quarters. Since 1994, sales to MCI, IBM/Advantis, AT&T, and
WorldCom including its subsidiaries and other current customers (excluding
the impact of sales of NetEdge products to the Company's existing customers)
have occasionally varied by up to $1.5 million from quarter to quarter and by
$3.0 million in the second quarter of 1998. Since most of the Company's sales
are in the form of large orders with short delivery times to a limited number
of customers, the Company's backlog and consequent ability to predict
revenues is limited. One of the Company's largest customers, WorldCom, has
changed to a just-in-time ordering pattern such that it expects vendor
deliveries only when equipment is needed. The Company believes that this had
a negative impact on revenues during the second quarter of 1998 and could
impact future quarters particularly if the WorldCom/MCI merger is
consummated. In addition, announcements by the Company or its competitors of
new products and technologies could cause customers to defer purchases of the
Company's existing products. In the event that anticipated orders from major
customers fail to materialize, or delivery schedules are deferred or canceled
as a result of the above factors or other unanticipated factors, the
Company's business and operating results could be materially adversely
affected. As a result, the Company believes that period to period comparisons
of its operating results are not necessarily meaningful and should not be
relied upon as indicative of future performance.
12
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The Company's backlog at any point in time is typically limited. Accordingly,
sales in any quarter are largely dependent on orders received during that
quarter. Furthermore, the Company's agreements with its customers typically
provide that they may change delivery schedules and cancel orders within
specified timeframes, typically up to 30 days prior to the scheduled shipment
date, without penalty. The Company's customers have in the past built, and
may in the future build, significant inventory to facilitate more rapid
deployment of anticipated major projects or for other reasons. Decisions by
such customers to reduce their inventory levels could lead to reductions in
purchases from the Company. Therefore, customer decisions to delay delivery,
cancel orders or reduce purchases could have a material adverse effect on the
Company's business and operating results.
The Company's gross margin is affected by a number of factors,
including additional inventory reserves, product mix, production volume,
product pricing, costs of components, manufacturing costs, amortization of
certain intangible assets and price discounts given. For example, a price
reduction of a particular product in response to competitive pressure which
is not offset by a reduction in production costs or by sales of other
products with higher gross margins would decrease the Company's overall gross
margin and could have a material adverse effect on the Company's business and
operating results.
The Company anticipates an increase in overall spending in future
periods in order to pursue new market opportunities, which increase could
affect operating margins. The Company establishes its expenditure levels for
product development and other operating expenses based on projected sales
levels and margins. However, expenses are relatively fixed in the short term.
Accordingly, if sales are below expectations in any given period, the adverse
impact of the revenue shortfall on the Company's operating results may be
greater due to the Company's inability to adjust spending in the short term
to compensate for the shortfall.
Results in any period could also be affected by changes in market
demand, competitive market conditions, market acceptance of new or existing
products, the cost and availability of components, the mix of the Company's
customer base and sales channels, the mix of products sold, sales promotion
activities by the Company, the Company's ability to expand its sales and
marketing organization effectively, the Company's ability to attract and
retain key technical and managerial employees and general economic
conditions. Due to all of the foregoing factors, the Company's operating
results in one or more future periods may be subject to significant
fluctuations. In the event this results in the Company's financial
performance being below the expectations of public market analysts and
investors, the price of the Company's Class A Common Stock could be
materially adversely affected.
DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS AND PRODUCTS UNDER
DEVELOPMENT. The Company's future operating results are highly dependent on
continuing market acceptance of the Company's newest products, particularly
in the network systems group. Network systems product sales represented 40%
of revenues during 1997 and 53% of revenues in the first six months of 1998.
Network systems product sales are expected to continue to increase as a
percentage of overall revenues in the longer term although the proportion of
network systems sales to total revenues may vary from quarter to quarter.
There can be no assurance that these products or any future products will
continue to achieve widespread market acceptance. In addition, the Company
has in the past experienced delays in the development of new products and the
enhancement of existing products, and such delays may occur in the future.
The Company's potential inability to develop and introduce new products or
versions in a timely manner, due to resource constraints or technological or
other reasons, or to achieve timely and widespread market acceptance of its
new products or releases could have a material adverse effect on the
Company's business and operating results.
13
<PAGE>
YEAR 2000 COMPLIANCE. The Company is aware of the issues associated
with the programming code in existing computer systems as the millennium
("Year 2000") approaches. The Year 2000 problem is pervasive and complex as
virtually every computer operation could be affected in some way by the
rollover of the two-digit year value to 00. Systems that do not properly
recognize date sensitive information when the year changes to 2000 could
generate erroneous data or cause a system to fail. Significant uncertainty
exists concerning the potential effects associated with such compliance.
Larscom products use a two-digit year value rather than a four-digit value.
Based on preliminary tests performed on products that account for
substantially all of the Company's revenues, the Company believes that there
will be no significant impact in the Company's products performance as the
year changes from 1999 to 2000. This is because the dates carried in the
internal workings of the Company's products do not affect the operation of
the networks of which these products are a part. The Company is in the
process of performing additional testing procedures to clarify any other
issues that may exist related to the Year 2000 and does not believe that the
costs of this testing will be material or that the costs of potential changes
to products will be material. Nonetheless, failure of the Company's products
to perform, including system malfunctions due to the onset of the calendar
year 2000, could result in claims against the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
The Company is also currently in the process of evaluating its
information technology infrastructure for Year 2000 compliance. This includes
reviewing what actions are required to make all software systems used
internally Year 2000 compliant, as well as actions needed to mitigate
vulnerability to problems with suppliers and other third parties' systems.
While the Company continues to assess the extent of the necessary
modifications to its computer software, management does not currently
anticipate that the Company will incur significant operating expenses or be
required to invest heavily in computer system improvements to be Year 2000
compliant. However, there can be no assurance that such measures will
alleviate all Year 2000 problems, and any failure to do so could have a
material adverse effect upon the Company's business, operating results and
financial condition.
DEPENDENCE ON COMPONENT AVAILABILITY AND KEY SUPPLIERS. On-time
delivery of the Company's products depends upon the availability of
components and subsystems used in its products. The Company depends upon its
suppliers to manufacture, assemble and deliver components in a timely and
satisfactory manner. The Company obtains components and licenses certain
embedded software from numerous single sources. Other than components
provided by Waferscale, Vicor, Xilinx and PMC-Sierra, the Company believes
that it would be able to develop alternative sources for components and
software used in its products without incurring substantial additional costs.
However, there can be no assurance that the Company would be able to develop
any such alternative sources, if required. Any inability by the Company's
suppliers to meet the Company's demand or any prolonged interruption in
supply or a significant price increase of one or more components or software
could have a material adverse effect on the Company's business and operating
results. The Company generally does not have any long-term contracts with
such suppliers. There can be no assurance that these suppliers will continue
to be able and willing to meet the Company's requirements.
RAPID TECHNOLOGICAL CHANGE. The telecommunications equipment industry
is characterized by rapidly changing technologies and frequent new product
introductions. The rapid development of new technologies increases the risk
that current or new competitors could develop products that would reduce the
competitiveness of the Company's products. The Company's success will depend
to a substantial degree upon its ability to respond to changes in technology
and customer requirements. This will require the timely selection,
development and marketing of new products and enhancements on a cost
effective basis. There can be no assurance that the Company will be
successful in developing, introducing or managing the transition to new or
enhanced products or that any such products will be responsive to
technological changes or will gain market acceptance. If the Company were to
be unsuccessful or to incur significant delays in developing and introducing
such new products or enhancements, the Company's business and operating
results could be materially adversely affected.
14
<PAGE>
SOURCES OF ADDITIONAL FINANCE. The Company has access, subject to
certain conditions, to a $15,000,000 credit facility provided by Axel
Johnson. However, there can be no assurance that alternative sources of
financing will be available upon the expiration or termination of such
facility or that additional sources of funding will be available on terms
favorable to the Company if the Company's borrowing requirements exceed the
amount of the facility.
MANAGEMENT OF EXPANDING OPERATIONS. The growth in the Company's
business, has placed a significant strain on the Company's personnel,
management and other resources, and is expected to continue to do so. In
order to manage any future expansion effectively, including acquisitions such
as NetEdge, the Company must attract, train, motivate and manage new
employees successfully, integrate new management and employees into its
overall operations and continue to improve its operational, financial and
management systems. Availability of qualified sales and technical personnel
is limited, and competition for experienced sales and technical personnel in
the telecommunications equipment industry is intense. Moreover, the Company
expects to increase significantly the size of its domestic and international
sales support staff and expand the scope of its sales and marketing
activities. The Company's failure to manage any expansion effectively,
including the above factors, could have a material adverse effect on the
Company's business and operating results.
CONTROL BY AXEL JOHNSON. Holders of Class A Common Stock are entitled
to one vote per share and holders of Class B Common Stock are entitled to
four votes per share, subject to adjustment, to preserve the initial voting
ratio. Axel Johnson is the sole holder of the Class B Common Stock. As a
result, Axel Johnson has sufficient voting power to control the direction and
policies of the Company, including mergers, the payment of dividends,
consolidations, the sale of all or substantially all of the assets of the
Company and the election of the Board of Directors of the Company, and to
prevent or cause a change in control of the Company. In addition, the
authorized but unissued capital stock of the Company includes 5,000,000
shares of preferred stock (the "Preferred Stock"). The Board of Directors is
authorized to provide for the issuance of Preferred Stock in one or more
series and to fix the designations, preferences, powers and relative,
participating, optional or other rights and restrictions thereof.
Accordingly, the Company may issue a series of Preferred Stock in the future
that will have preference over both classes of the Company's Common Stock
with respect to the payment of dividends and upon liquidation, dissolution or
winding up or which could otherwise adversely affect holders of the Common
Stock or discourage or make difficult any attempt to obtain control of the
Company. Such control may have the effect of discouraging certain types of
transactions involving an actual or potential change of control of the
Company, including transactions in which the holders of Class A Common Stock
might otherwise receive a premium for their shares over the then current
market price.
RISKS ASSOCIATED WITH ENTRY INTO INTERNATIONAL MARKETS. The Company
has had minimal sales to international customers to date, and has had little
experience in international markets. The Company believes that international
sales will increase due in large part to the acquisition of NetEdge and
increased international sales of the Company's existing products. The conduct
of business outside the U.S. is subject to certain risks, including
unexpected changes in regulatory requirements and tariffs, difficulties in
staffing and managing foreign operations, longer payment cycles, greater
difficulty in accounts receivable collection, currency fluctuations,
expropriation and potentially adverse tax consequences. In addition, in order
to sell its products internationally, the Company must meet standards
established by telecommunications authorities in various countries, as well
as recommendations of the International Telecommunications Union. A delay in
obtaining, or the failure to obtain, certification of its products in
countries outside the U.S. could deny or preclude the Company's marketing and
sales efforts in such countries, which could have a material adverse effect
on the Company's business and operating results.
15
<PAGE>
COMPLIANCE WITH REGULATIONS AND EVOLVING INDUSTRY STANDARDS. The
market for the Company's products is characterized by the need to meet a
significant number of communications regulations and standards, some of which
are evolving as new technologies are deployed. In the U.S. the Company's
products must comply with various regulations defined by the Federal
Communications Commission and standards established by Underwriters
Laboratories, as well as industry standards established by various
organizations. As standards for new services such as ATM evolve, the Company
may be required to modify its existing products or develop and support new
versions of its products. The failure of the Company's products to comply, or
delays in compliance, with the various existing and evolving industry
standards could delay introduction of the Company's products, which in turn
could have a material adverse effect on the Company's business and operating
results.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS. An important element of
the Company's strategy is to review acquisition prospects that would
complement its existing product offerings, augment its market coverage,
enhance its technological capabilities or offer growth opportunities, as
evidenced by the acquisition of NetEdge in December 1997. The Company has no
current agreements or negotiations underway with respect to any such
acquisitions. Future acquisitions by the Company could result in potentially
dilutive issuance of equity securities and/or the incurrence of debt and the
assumption of contingent liabilities, any of which could have a material
adverse effect on the Company's business and operating results and/or the
price of the Company's Class A Common Stock. In this regard, as a result of
the ownership interest of Axel Johnson in the Company, the Company will not
be able to use pooling of interests accounting for any future acquisition.
Accordingly, such acquisitions could result in amortization of goodwill and
other charges (including the immediate write-off of purchased research and
development in process) typically associated with purchase accounting.
Acquisitions entail numerous risks, including difficulties in the
assimilation of acquired operations, technologies and products, diversion of
management's attention from other business concerns, risks of entering
markets in which the Company has limited or no prior experience and potential
loss of key employees of acquired organizations. The Company's management has
limited prior experience in assimilating acquired organizations. No assurance
can be given as to the ability of the Company to successfully integrate any
businesses, products, technologies or personnel that might be acquired in the
future, and the failure of the Company to do so could have a material adverse
effect on the Company's business and operating results.
Although it is too early to determine whether the acquisition of
NetEdge has been successful, to date the Company believes that the
integration efforts have gone according to plan. Almost all of the finance,
administrative and manufacturing functions have been consolidated into the
Company's existing infrastructure in Milpitas, California. It is not yet
possible to determine whether, in the longer term, the Company will be able
to sustain or increase current sales of NetEdge products, or whether the
Company will be able to retain key engineering talent both of which are
important factors in the successful completion of the acquisition.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY; PROPRIETARY INFORMATION.
The Company relies upon a combination of trade secrets, contractual
restrictions, copyrights, trademark laws and patents to establish and protect
proprietary rights in its products and technologies. Although the Company has
been issued only one U.S. patent to date, it believes that the success of its
business depends primarily on its proprietary technology, information and
processes and know-how, rather than patents. Much of the Company's
proprietary information and technology is not patented and may not be
patentable. There can be no assurance that the Company will be able to
protect its technology or that competitors will not be able to develop
similar technology independently. The Company has entered into
confidentiality and invention assignment agreements with all of its
employees, and enters into non-disclosure agreements with its suppliers,
distributors and appropriate customers so as to limit access to and
disclosure of its proprietary information. There can be no assurance that
these statutory and contractual arrangements will deter misappropriation of
the Company's technologies or discourage independent third-party development
of similar technologies. In the event such arrangements are insufficient, the
Company's business and operating results could be materially adversely
affected.
16
<PAGE>
PART II: OTHER INFORMATION
Item 1: Legal Proceedings
The Company is not currently involved in any material
legal proceedings.
Item 2: Changes in Securities
Not Applicable
Item 3: Defaults upon Senior Securities
Not Applicable
Item 4: Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders was held on May 28, 1998.
In connection with the meeting, proxies were solicited
pursuant to the Securities Exchange Act of 1934. The
following are the voting results on proposals considered and
voted upon at the meeting, all of which were described in the
proxy statement:
1. To elect five (5) directors to serve until the next Annual
Meeting of Stockholders or until their successors are elected
and qualified.
<TABLE>
<CAPTION>
Class A Common Shares
----------------------
For Withheld
--------- --------
<S> <C> <C>
Deborah M. Soon 6,878,754 271,464
Paul E. Graf 6,881,514 268,704
Donald G. Heitt 6,881,514 268,704
Harvey L. Poppel 6,878,754 271,464
Joseph F. Smorada 6,881,114 269,104
Class B Common Shares
-----------------------
For Withheld
---------- --------
<S> <C> <C>
Deborah M. Soon 10,000,000 -
Paul E. Graf 10,000,000 -
Donald G. Heitt 10,000,000 -
Harvey L. Poppel 10,000,000 -
Joseph F. Smorada 10,000,000 -
</TABLE>
2. To ratify the appointment of Price Waterhouse LLP as
independent accountants of the Company for the fiscal year
ending December 31, 1998.
<TABLE>
<CAPTION>
For Against Abstain
------------ ----------- --------------
<S> <C> <C> <C>
Class A Common Stock 7,129,904 8,050 12,264
Class B Common Stock 10,000,000 - -
</TABLE>
17
<PAGE>
3. To approve an amendment to the Company's Stock Incentive
Plan to increase the number of shares of Class A Common Stock
reserved for issuance by 1,500,000 shares, bringing the total
to 3,985,000 shares.
<TABLE>
<CAPTION>
For Against Abstain
------------ ----------- --------------
<S> <C> <C> <C>
Class A Common Stock 1,681,290 2,249,873 17,431
Class B Common Stock 10,000,000 - -
</TABLE>
4. To approve an amendment to the Company's Employee Stock
Purchase Plan to increase the number of shares of Class A
Common Stock reserved for issuance by 375,000 shares, bringing
the total to 685,000 shares.
<TABLE>
<CAPTION>
For Against Abstain
------------ ----------- --------------
<S> <C> <C> <C>
Class A Common Stock 2,922,574 1,128,609 11,730
Class B Common Stock 10,000,000 - -
</TABLE>
Item 5: Other Information
Not Applicable
Item 6: Exhibits and Reports on Form 8-K
A: Exhibits
27 Financial Data Schedule
B: Reports on Form 8-K
There were no reports on Form 8-K filed during the
quarter ended June 30, 1998.
18
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
LARSCOM INCORPORATED
Date August 13, 1998 By /s/ Bruce D. Horn
-------------------- ---------------------------
Bruce D. Horn
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
19
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF LARSCOM INCORPORATED FOR THE THREE AND SIX MONTHS ENDED
JUNE 30, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> JUN-30-1998
<CASH> 3,630
<SECURITIES> 16,838
<RECEIVABLES> 10,827
<ALLOWANCES> 532
<INVENTORY> 14,823
<CURRENT-ASSETS> 49,420
<PP&E> 19,710
<DEPRECIATION> 11,424
<TOTAL-ASSETS> 75,443
<CURRENT-LIABILITIES> 11,112
<BONDS> 0
0
0
<COMMON> 182
<OTHER-SE> 63,764
<TOTAL-LIABILITY-AND-EQUITY> 75,443
<SALES> 40,969
<TOTAL-REVENUES> 40,969
<CGS> 20,360
<TOTAL-COSTS> 20,064
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 38
<INCOME-PRETAX> 2,198
<INCOME-TAX> 835
<INCOME-CONTINUING> 1,363
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,363
<EPS-PRIMARY> 0.07<F1>
<EPS-DILUTED> 0.07
<FN>
<F1>Item consists of basic earnings per share
</FN>
</TABLE>
