<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 March 31, 1999
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 (IRS 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 April 30, 1999, was
8,313,000 of Class A Common Stock and 10,000,000 of Class B Common Stock.
<PAGE>
LARSCOM INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<S> <C>
PART I: FINANCIAL INFORMATION 3
ITEM I: 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
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 18
PART II: OTHER INFORMATION 19
ITEM 1: LEGAL PROCEEDINGS: 19
ITEM 2: CHANGES IN SECURITIES: 19
ITEM 3: DEFAULTS UPON SENIOR SECURITIES: 19
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS: 19
ITEM 5: OTHER INFORMATION: 19
ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K: 19
A: Exhibits 19
B: Form 8-K 19
SIGNATURES 20
</TABLE>
2
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
LARSCOM INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands) (Unaudited)
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
---------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $19,878 $10,265
Short-term investments 4,801 13,902
Accounts receivable, net 7,756 7,539
Inventories 7,614 8,613
Deferred income taxes 5,220 4,607
Income taxes receivable 2,764 2,508
Prepaid expenses and other current assets 1,395 1,542
-------- -------
Total current assets 49,428 48,976
Property and equipment, net 6,155 6,920
Intangible assets, net 627 687
Deferred income taxes 11,326 11,486
Other non-current assets 34 34
-------- -------
Total assets $67,570 $68,103
-------- -------
-------- -------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 152 $ 194
Accounts payable 3,202 3,705
Accrued expenses and other current liabilities 8,513 7,390
Due to Axel Johnson Inc. 346 547
-------- -------
Total current liabilities 12,213 11,836
Other non-current liabilities 433 416
-------- -------
Stockholders' equity:
Class A Common Stock 83 83
Class B Common Stock 100 100
Additional paid-in capital 81,738 81,637
Accumulated other comprehensive income (7) 2
Accumulated deficit (26,990) (25,971)
-------- -------
Total stockholders' equity 54,924 55,851
-------- -------
Total liabilities and stockholders' equity $67,570 $68,103
-------- -------
-------- -------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
3
<PAGE>
LARSCOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data) (Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Revenues $ 12,246 $ 22,330
Cost of revenues 6,558 10,161
-------- --------
Gross profit 5,688 12,169
-------- --------
Operating expenses:
Research and development 2,340 3,538
Selling, general and administrative 5,294 7,370
-------- --------
Total operating expenses 7,634 10,908
-------- --------
Income (loss) from operations (1,946) 1,261
Interest expense charged by Axel Johnson Inc. (19) (19)
Interest and other income 266 1,506
-------- --------
Income (loss) before income taxes (1,699) 2,748
Income tax provision (benefit) (680) 1,044
-------- --------
Net income (loss) $ (1,019) $ 1,704
-------- --------
-------- --------
Basic and diluted earnings (loss) per share $ (0.06) $ 0.09
-------- --------
-------- --------
Basic weighted average shares 18,297 18,172
Diluted weighted average shares 18,297 18,180
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
4
<PAGE>
LARSCOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1999 1998
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ (1,019) $ 1,704
Depreciation and amortization 889 1,515
Gain from sale of building - (1,329)
Deferred income taxes (453) (11)
Net increase (decrease) in working capital 1,418 (5,882)
--------- ----------
Net cash provided (used) by operating activities 835 (4,003)
--------- ----------
Cash flows from investing acitvities:
Purchases of property and equipment (149) (236)
Proceeds from sale of building - 1,700
Purchases of short-term investments (10,217) (33,576)
Sales of short-term investments 19,318 20,065
Maturities of short-term investments - 15,225
--------- ----------
Net cash provided by investing activities 8,952 3,178
--------- ----------
Cash flows from financing activities:
Repayments to Axel Johnson Inc. (201) (2,289)
Payment of capital lease obligations (74) (99)
Proceeds from issuances of Class A Common Stock 101 335
--------- ----------
Net cash used by financing activities (174) (2,053)
--------- ----------
Increase (decrease) in cash and cash equivalents 9,613 (2,878)
Cash and cash equivalents at beginning of period 10,265 8,254
--------- ----------
Cash and cash equivalents at end of period $ 19,878 $ 5,376
--------- ----------
--------- ----------
Supplemental disclosure of cash flow information
Interest paid $ 27 $ 19
--------- ----------
Income taxes paid $ 20 $ 1,368
--------- ----------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
5
<PAGE>
LARSCOM INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BASIS OF PRESENTATION:
The condensed consolidated financial statements for the three months ended
March 31, 1999 and 1998 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, 1998. The results of operations for the first three months of 1999 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>
March 31, December 31,
1999 1998
------ ------
<S> <C> <C>
Raw materials $2,125 $3,021
Work in process 1,121 1,053
Finished goods 4,368 4,539
------ ------
$7,614 $8,613
------ ------
------ ------
</TABLE>
NOTE 3--RESTRUCTURING:
In October 1998, Larscom announced a corporate restructuring to better
align its expenses with anticipated revenues and to tighten its focus on
opportunities that offer the best long-term growth potential. The restructuring
included a workforce reduction of approximately 16%. Details of the
restructuring expense are as follows:
<TABLE>
<CAPTION>
Asset
Employee Write
Severance Downs Other Total
--------- ----- ----- -----
(in thousands)
<S> <C> <C> <C> <C>
Restructuring charge $876 $ 89 $249 $1,214
Payments to date 714 89 167 970
--------- ----- ----- ------
Balance at March 31, 1999 $162 $ - $ 82 $ 244
--------- ----- ----- ------
--------- ----- ----- ------
</TABLE>
The Company expects to have paid all of these liabilities by September 30,
1999.
6
<PAGE>
NOTE 4--EARNINGS (LOSS) PER SHARE:
Basic earnings per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted-average number of common shares outstanding and the
dilutive effect of options to purchase common shares. The effect of options to
purchase common shares is excluded from the computation if their effect is
antidilutive.
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 March 31,
---------------------------
1999 1998
------- -------
<S> <C> <C>
Net income (loss) $(1,019) $ 1,704
Weighted average Class A and B Common Stock outstanding 18,297 18,172
Dilutive effect of options - 8
------- -------
Diluted average shares 18,297 18,180
------- -------
Basic and diluted earnings (loss) per share $ (0.06) $ 0.09
</TABLE>
NOTE 5--COMPREHENSIVE INCOME:
The Company adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"), in 1998. Comprehensive income, as
defined, includes all changes in equity during a period from non-owner sources.
The only item of other comprehensive income for all periods presented relates to
foreign currency translation adjustments. Such amounts were not material for all
periods presented.
7
<PAGE>
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. Because of the notification by GSA, the Company released the reserve
of $532,000 in the second quarter of 1998, which resulted in a reduction in
selling, general, and administrative expenses for the year. The Company believes
that no additional liabilities will result from this matter.
At the end of 1998, vendors of three integrated circuits ("ICs")
notified the Company of their intent to cease production of these ICs. As a
result of anticipated continued usage of these ICs, Larscom entered into
purchase commitments of approximately $1,250,000 in aggregate, representing
between one and two years expected demand for these components. At March 31,
1999, there remained $1,085,000 of those commitments. While the Company
believes that it will use all of the quantities it has agreed to purchase,
there can be no assurance that its estimates are correct. Any excess
quantities over expected needs in the future could result in a charge to net
income.
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 8--ACQUISITION:
On December 31, 1997, the Company completed a merger with NetEdge Systems
Inc. ("NetEdge"). The total merger consideration paid by Larscom consisted of
$25,793,000 in cash, acquisition costs of $1,182,000 and the assumption of
liabilities of $9,782,000.
Of the cash consideration, $6,300,000 was placed into escrow pending
resolution of certain matters including purchase price adjustments and other
representations and warranties. In September 1998, $600,000 of the escrow amount
was paid to the Company and $400,000 was authorized by Larscom to be paid to the
shareholders of NetEdge. In January 1999 Larscom authorized an additional
$647,000 to be paid to the shareholders of NetEdge. There remained $4,653,000 in
escrow at March 31, 1999, portions of which will be released over a three year
period from the date of the acquisition.
NOTE 9--SALE OF BUILDING:
In March 1998, the Company recorded a gain of $1,329,000, before tax,
resulting from the sale of the Company's former headquarters by a partnership in
which the Company held a one-third interest.
NOTE 10--OPERATING SEGMENTS:
The Company believes that its two business units, the Network Systems Group
and the Digital Access Group, are operating segments as defined in Statement of
Financial Accounting Standard No. 131, "Disclosure About Segments of an
Enterprise and Related Information" ("SFAS 131"). However, the similarity of the
economic characteristics of the two segments is such that the Company believes
that aggregation is appropriate in accordance with SFAS 131. Changes in these
economic characteristics may require disclosure of segment information in the
future.
8
<PAGE>
LARSCOM INCORPORATED
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR THE HISTORICAL STATEMENTS CONTAINED HEREIN, THIS QUARTERLY
REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934. THE ACTUAL RESULTS THAT THE COMPANY ACHIEVES
MAY DIFFER MATERIALLY FROM THOSE INDICATED IN ANY FORWARD LOOKING STATEMENTS
DUE TO THE RISKS AND UNCERTAINTIES SET FORTH UNDER "MANAGEMENT'S DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS," "CERTAIN
FACTORS AFFECTING FUTURE OPERATING RESULTS" AND ELSEWHERE IN THIS FORM 10-Q.
THE COMPANY UNDERTAKES NO OBLIGATION TO REVISE ANY FORWARD LOOKING STATEMENTS
IN ORDER TO REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF
THIS REPORT. READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS
DISCLOSURES MADE BY THE COMPANY IN THIS REPORT AND IN THE COMPANY'S REPORTS
FILED WITH THE SECURITIES AND EXCHANGE COMMISSION THAT ATTEMPT TO ADVISE
INTERESTED PARTIES ON THE RISKS AND FACTORS THAT MAY AFFECT THE COMPANY'S
BUSINESS.
RESULTS OF OPERATIONS
The Company's products are split into two main categories - network systems
(broadband) and digital access (narrow band) 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. A high proportion of the Company's sales is made to a limited
number of network service providers ("NSPs") and internet service providers
("ISPs"). The Company is seeking to develop alternative distribution channels,
particularly for the digital access group products, but sales to distributors
have been limited to date. Sales outside the U.S. have not been significant to
date.
REVENUES. Revenues of $12,246,000 for the three months ended March 31,
1999, decreased by 45% from revenues of $22,330,000 during the comparable period
in 1998. During the three months ended March 31, 1999, network systems sales
decreased to $5,592,000 from $12,578,000 in the three months ended March 31,
1998. A large component of the decrease in network systems sales was lower sales
of the Orion 4000 product line and to a lesser extent decreased sales of Edge
and Mega-T product lines. During the three months ended March 31, 1999, digital
access product sales decreased to $5,591,000 from $8,897,000 in the three months
ended March 31, 1998. This decrease was principally due to lower sales of
Access-T and Split-T products.
The primary reason for the decrease in most product sales described
above was a reduction in orders from the Company's two largest customers.
Together they accounted for 42% of revenues in the first quarter of 1999 and
60% in the first quarter of 1998. MCI Worldcom (including UUNET), which
accounted for 29% of revenue in the 1999 first quarter, accounted for 43% of
revenue in the first quarter of 1998. This affected the Orion 4000 and
Split-T product line. AT&T (including the IBM Global Network which was
acquired by AT&T effective May 1999) accounted for 12% and 10% of revenues in
the first quarter of 1999 and 1998, respectively. The Access-T product line
was particularly affected by the reduction in revenue from AT&T. A reduction
in shipments to a third customer, accounting for less than 10% of sales in
the first quarter of 1999 and 1998, was the primary reason for the decrease
in Mega-E shipments and a portion of the Orion 4000 decrease.
9
<PAGE>
GROSS PROFIT. As a percentage of revenues, gross profit for the three
months ended March 31, 1999 decreased to 46% as compared to 54% in the same
period in 1998. This decrease was primarily the result of additional inventory
reserves, lower production volumes and lower average unit selling prices,
offset by lower intangible asset amortization. The Company expects gross margin
percentages to increase slightly during the rest of the year.
RESEARCH AND DEVELOPMENT. Research and development expenses decreased 34%
to $2,340,000 in the three months ended March 31, 1999 from $3,538,000 in the
three months ended March 31, 1998. The decrease is primarily due to lower
headcount, however, the Company believes that a continued commitment to research
and development, particularly related to broadband products and emerging
technologies, will be required to respond to customer demand and to remain
competitive. Accordingly, the Company does not anticipate any further reduction
in research and development spending.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 28% to $5,294,000 during the three months ended March 31,
1999, as compared to $7,370,000 in the comparable 1998 period. The decrease
was due to lower headcount. Selling, general and administrative expenses
include charges from Axel Johnson for legal, accounting, tax, treasury and
administrative services of $110,000 and $106,000 during the three months
ended March 31, 1999 and 1998, 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 with Axel Johnson Inc. See Liquidity and Capital Resources for more
details.
INTEREST AND OTHER INCOME. Interest income was $266,000 for the three
months ended March 31, 1999, as compared to $177,000 for the same period in
1998. The Company invested primarily in taxable securities during the three
months ended March 31, 1999, which caused interest income to be higher than the
same period in 1998 when the Company was investing primarily in
federal-income-tax-exempt securities. In March 1998, the Company also recorded a
gain of $1,329,000 arising from the sale of the Company's former headquarters by
a partnership in which the Company held a one-third interest.
PROVISION FOR INCOME TAXES. The effective tax benefit rate of 40% for the
three months ended March 31, 1999, differs from the federal statutory rate
primarily due to state income taxes.
At March 31, 1999, the Company had recorded deferred tax assets of
$16,546,000, primarily relating to the future tax benefits of amortization of
intangible assets and an in-process research and development charge which are
deductible ratably over the next 14 years. The remaining tax benefit relates to
inventory reserves and accrued expenses. In accordance with Statement of
Financial Accounting Standard No. 109 ("SFAS 109"), "Accounting for Income
Taxes" the Company has not recorded any valuation allowance against those assets
because management has determined that it is more likely than not that all of
these assets will be realized. Realization of these assets is primarily
dependent on the ability of the Company to generate taxable income in the
future. Some of the factors that the Company used to make this determination
are: the Company has a strong earnings history; a significant portion of the
deferred tax assets are deductible over fourteen years; tax losses can be
carried forward for twenty years and a portion of the losses can be carried back
to prior years. The Company has switched its investments to taxable securities
from non-taxable securities. The amount of the deferred tax assets considered
realizable could be reduced in the near term if the Company's estimates of
future taxable income are reduced. This could have a material adverse effect on
the Company's results of operations and financial condition.
10
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities provided cash of $835,000 during the
three months ended March 31, 1999. This compares with cash used by operating
activities of $4,003,000 in the corresponding period in 1998. The cash provided
by operations during the 1999 period was comprised primarily of a decrease in
inventory and an increase in accrued expenses offset by net losses.
Historically, the Company has met its operating and capital requirements
primarily from cash flow from operations and advances from Axel Johnson. The
Company does not expect capital expenditures during 1999 to exceed $2,500,000.
Approximately $149,000 was spent on capital equipment in the three months ended
March 31, 1999.
The Company has a revolving line of credit of $15,000,000 under a credit
agreement with Axel Johnson ("the Credit Agreement"). The Credit Agreement
expires in December 2000. The Credit Agreement contains various representations,
covenants and events of default typical for financing a business of a similar
size and nature. Upon an event of default any borrowings under the line of
credit shall become payable in full. To date the Company has not found it
necessary to use this line of credit. In addition to such Credit Agreement, the
Company and Axel Johnson entered into an administrative service agreement and a
tax sharing agreement for the purposes of defining the on-going relationship
between them.
As of March 31, 1999, the Company had cash and cash equivalents of
$19,878,000, short-term investments of $4,801,000 and other net working capital
of $12,536,000. The Company believes that these assets, 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 any significant losses that
the Company might incur or acquisitions the Company might undertake, 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
<PAGE>
CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS
EXCEPT FOR THE HISTORICAL STATEMENTS CONTAINED HEREIN, THIS QUARTERLY
REPORT ON FORM 10-Q CONTAINS CERTAIN FORWARD LOOKING STATEMENTS WITHIN THE
MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE
SECURITIES EXCHANGE ACT OF 1934. THE ACTUAL RESULTS THAT THE COMPANY ACHIEVES
MAY DIFFER MATERIALLY FROM THOSE INDICATED IN ANY FORWARD LOOKING STATEMENTS DUE
TO THE RISKS AND UNCERTAINTIES SET FORTH BELOW AND SET FORTH IN OTHER FILINGS
THE COMPANY MAKES WITH THE SECURITIES AND EXCHANGE COMMISSION. THE COMPANY
UNDERTAKES NO OBLIGATION TO REVISE ANY FORWARD LOOKING STATEMENTS IN ORDER TO
REFLECT EVENTS OR CIRCUMSTANCES THAT MAY ARISE AFTER THE DATE OF THIS REPORT.
READERS ARE URGED TO CAREFULLY REVIEW AND CONSIDER THE VARIOUS DISCLOSURES MADE
BY THE COMPANY IN THIS REPORT AND IN THE COMPANY'S REPORTS FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION THAT ATTEMPT TO ADVISE INTERESTED PARTIES ON
THE RISKS AND FACTORS THAT MAY AFFECT THE COMPANY'S BUSINESS.
CUSTOMER CONCENTRATION. The Company believes that its relationships with
large customers, particularly NSPs and ISPs, will be critical to its future
success. A small number of customers accounted for a high proportion of the
Company's revenues in each of the past several years. During 1998, 1997 and
1996, two customers, MCI WorldCom and its subsidiaries (including UUNET) and
AT&T, (including IBM Global Network which was purchased by AT&T effective May
1999) together accounted for 44%, 55% and 54% of the Company's revenues,
respectively. Accordingly, the Company's revenue is currently highly dependent
on continued orders from these two customers.
None of the Company's customers is contractually obligated 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. 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. 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 from one or more of the Company's major customers could
have a materially adverse effect on the Company's business and operating
results. Reductions in orders from certain large customers contributed
significantly to the Company's lower revenues in the most recent four quarters
as compared to the corresponding quarters a year earlier. For example, in one
quarter of 1998, sales to one of the Company's largest customers varied by $4.4
million from sales in the previous quarter.
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. A small
number of customers have accounted for a significant percentage of the Company's
sales. Therefore, sales for a given quarter generally depend to a significant
degree upon orders received from and product shipments to a limited number of
customers. 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 will continue to be limited.
In addition, announcements by the Company or its competitors of new products and
technologies could cause customers to defer, limit, or end purchases of the
Company's existing products. In the event that the Company were to lose one or
more large customers, anticipated orders from major customers were to fail to
materialize or delivery schedules were to be deferred or canceled as a result of
the above factors or other unanticipated factors, the Company's business and
operating results would be materially adversely affected.
12
<PAGE>
The Company expects gross profit margins for the whole of 1999 to be higher
than in 1998 due to the one-time impact in 1998 of additional inventory
reserves and intangible asset charges. However, the Company does not expect
gross margins to reach the levels achieved prior to 1998. This is due to lower
average selling prices on the Company's principal products as they continue to
age. In addition, the Company is currently seeking to develop an indirect
distribution channel that typically yields lower margins on sales than direct
sales. A number of additional factors could cause gross profits to fluctuate as
a percentage of revenue, including changes in product mix, price discounts
given, costs of components, manufacturing costs and production volume.
Results in any period could also be affected by changes in market demand,
competitive market conditions, market acceptance of new or existing products,
increasing sales channel development costs, 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. Because of 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 these factors result 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.
The Company has experienced only a slight improvement in orders in the
first part of the second quarter of 1999 as compared to the first quarter.
Nonetheless the Company has decided to maintain current levels of investment
in research and development and market development. Other operating expenses
are relatively fixed in the short term. There can be no assurances that the
Company will realize the increased sales levels required to return to
profitability. Indeed, there can be no assurance that the Company will return
to profitability at all without further spending cuts.
RESTRUCTURING. On October 15, 1998, Larscom announced a corporate
restructuring plan designed to better align its expenses with anticipated
revenues and to allow the Company to focus on opportunities that offer the
greatest potential for long-term growth. The restructuring included a workforce
reduction of approximately 16%. Some engineers have resigned since the
restructuring but the Company does not believe that the impact on its research
and development efforts has been significant. The Company has found it more
difficult to replace these employees than in the past. There can be no assurance
that the Company will not lose additional employees in the future or that it
will be able to recruit suitable replacements, particularly since the demand for
such employees is high. In November 1998, in order to retain and motivate its
existing employees, the Company canceled the existing employee stock options and
issued replacement options with exercise prices equal to the then fair market
value of the Company's Class A Common Stock.
The Company is continuing its search for a new Chief Executive Officer. If
the Company cannot complete the search in a relatively short period, its
business could be materially adversely affected.
13
<PAGE>
DEVELOPMENT OF ALTERNATIVE DISTRIBUTION CHANNELS. The Company is currently
seeking to develop an indirect distribution channel for sales to domestic
customers. This channel will consist primarily of a small group of master
distributors, such as Tech Data, and a number of authorized resellers. It is
intended that sales through this channel will consist primarily of digital
access products, particularly the WANmaker product, and, to a lesser extent,
network systems group products. Sales to large NSPs and ISPs will be handled by
the Company's direct sales force. As part of this strategy, the Company has
appointed certain sales people to sign up resellers and assist them in their
sales efforts. There are a number of risks associated with the development of an
indirect distribution channel. These include a reduction in the Company's
ability to forecast sales, reduced average selling prices, management's
inexperience in establishing and managing a distribution channel, potential
reductions in customer satisfaction, loss of contact with users of the Company's
products and new methods of advertising and promoting the products which will
result in additional expenses. These, and other factors, could cause results of
operations and financial condition to be materially adversely affected.
The Company markets its products internationally through non-exclusive
distribution agreements with VARs and systems integrators. To date the use of a
distribution channel outside the US has not been particularly successful. To
focus on sales to Europe, the Middle East and Africa, the Company has created a
regional sales and service team, headquartered in the United Kingdom. The United
Kingdom team focuses on direct sales to large NSPs while also supporting its
distributors for sales to smaller customers.
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. The Company's future success will
be largely dependent on the market success of recently introduced products and
products that may be introduced in the future. These include, for example, the
WANmaker line of digital access products and the Orion 2000 product line, which
have only recently been introduced. There can be no assurance that such products
will achieve widespread market acceptance. In the past, the Company has
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 materially adverse effect on the Company's business and
operating results.
YEAR 2000. As the year 2000 approaches, the challenges associated with
moving into a new millennium have become a critical business concern around the
world. The Company recognizes the importance of addressing this situation in a
timely, proactive manner. In early 1998, the Company established a Year 2000
Compliance Program to ensure that the Company's products and internal systems
currently in use continue to function properly into the next century. As such,
the Company has placed a high level of emphasis on preserving the integrity and
continuity of the business processes and activities that are vitally necessary
for the business to continue. The Company initially focused its compliance
efforts on the evaluation of products sold to customers. The Company has
committed the necessary resources to make the Company's current product
offerings Year 2000 compliant and has completed the testing and remediation
phases. All of the Company's current product offerings are Year 2000 compliant.
In those cases where products not currently offered were found not to be in
compliance, the information was communicated to the Company's customers via
written notification. In most cases, an upgrade path has been provided to these
customers.
14
<PAGE>
Larscom is reviewing and obtaining the required resources to move into the
implementation phase for its internal infrastructure. The Company is upgrading
its primary business system for Year 2000 compliance and anticipates the
implementation phase to be completed by June 1999. Additionally, the Company is
assessing and implementing necessary changes for all areas of the Company's
business that could be impacted. These include manufacturing plant floor
equipment, system test laboratories, engineering laboratories and the building
infrastructure.
Based on assessments completed to date and compliance plans in process,
Larscom does not expect that the Year 2000 issue, including the cost of making
its products and critical systems compliant, will have a material effect on its
business operations or cash flow. Direct costs related to all Year 2000
compliance testing and remediation are estimated to be approximately $365,000
over a two year period of which approximately $350,000 had been incurred as of
March 31, 1999.
Larscom is engaged in the process of evaluating the Year 2000 readiness of
suppliers. If Larscom determines that critical suppliers are not Year 2000
ready, Larscom will monitor their progress and take appropriate actions. Based
on current progress and future plans, Larscom believes that the Year 2000 date
change will not significantly affect Larscom's ability to deliver products and
services to its customers on a timely basis. However there can be no assurances
that the Year 2000 date change will not have a materially adverse affect on the
Company's results of operations or financial condition.
The Company is in the process of creating contingency plans to safeguard
against failures of the Company's own products, suppliers and vendors and
internal information systems related to the Year 2000 issue.
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. The Company does not believe it would be able to
develop alternative sources for certain essential components used in its
products. In addition, while the Company believes it would be able to develop
alternative sources for most of the other components and software used in its
products without incurring substantial additional costs, there can be no
assurance that the Company would be able to do so, 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 would likely have a materially 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.
At the end of 1998, vendors of three integrated circuits ("ICs") notified
the Company of their intent to cease production. Larscom anticipates that it
will continue to use these ICs and therefore entered into purchase commitments
of approximately $1,250,000 in the aggregate, representing between one and two
years expected demand for these components. The Company will consider
redesigning its products to replace those ICs. The Company has attempted to take
into account factors such as the ability to replace the particular IC with a
similar part and the estimated life of the Company's products in determining the
quantities to purchase. While the Company believes that it will use all of the
quantities it has agreed to purchase, there can be no assurance that its
estimates are correct. If the Company's estimates are not correct and
requirements for these ICs are less than anticipated, it could have a materially
adverse effect on the Company's business and results of operations.
15
<PAGE>
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 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. For example, the
Company is aware of a competing technology with network monitoring capabilities
that can be used instead of the Split-T product that the Company sells primarily
to MCI WorldCom. If MCI WorldCom's customers were to opt for the alternative
technology as part of their services, the Company's business and operating
results would be materially adversely affected.
SOURCES OF ADDITIONAL FINANCE. The Company has access, subject to certain
conditions, to a $15,000,000 credit facility provided by Axel Johnson. In
December 1998, this agreement was amended and the termination date of the
facility was extended until December 2000. There can be no assurance that
alternative sources of financing will be available upon the expiration of such
facility in December 2000, 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 OPERATIONS. The recent downturn in the Company's business and
related restructuring has placed a significant strain on the Company's
personnel, management and other resources. The Company's future success depends
on its ability to recruit and retain employees following the recent
restructuring and the Company's recent financial performance shortfalls. To grow
its business, the Company must continue to 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. The Company's failure to
manage any expansion effectively could have a materially 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. The issuance of Preferred Stock could 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.
16
<PAGE>
RISKS ASSOCIATED WITH ENTRY INTO INTERNATIONAL MARKETS. The Company has had
minimal sales to international customers to date, and has little experience in
international markets. Although the acquisition of NetEdge increased the
exposure of the Company to international markets to some extent, sales outside
the U.S. continue to account for less than 10% of the Company's revenues. The
conduct of business outside the U.S. is subject to certain customary 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, 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 materially adverse effect on the Company's
business and operating results.
COMPLIANCE WITH REGULATIONS AND EVOLVING INDUSTRY STANDARDS. The market for
the Company's products is characterized by the need to comply with 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 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 materially adverse effect on the Company's business
and operating results.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS. As part of its efforts to
grow its business, the Company reviews acquisition prospects that could
potentially complement its existing product offerings, augment its market
coverage, enhance its technological capabilities or offer growth opportunities.
The Company acquired NetEdge in December 1997; however, this acquisition has not
been a success. Any future acquisitions by the Company could result in
potentially dilutive issuances of equity securities and/or the incurrence of
debt and the assumption of contingent liabilities, any of which could have a
materially 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, because 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 in-process research and
development) 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. 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 materially adverse effect on the Company's business and operating
results.
17
<PAGE>
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
expertise, 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 enters into confidentiality and invention assignment agreements with all
of its employees, and enters into non-disclosure agreements with its suppliers,
distributors and appropriate customers 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.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. The Company does not use derivative financial
instruments in its investment portfolio. The Company's investment portfolio is
generally comprised of federal government securities that mature within one
year. The Company places investments in instruments that meet high credit
standards. These securities are subject to interest rate risk, and could decline
in value if interest rates increase. Due to the short duration and conservative
nature of the Company's investment portfolio, the Company does not expect any
material loss with respect to its investment portfolio.
FOREIGN CURRENCY EXCHANGE RATE RISK. Certain of the Company's sales,
service and marketing expenses are incurred in foreign currencies. Consequently,
the Company's international results of operations are subject to foreign
exchange rate fluctuations. The Company does not currently hedge against foreign
currency rate fluctuations. Gains and losses from such fluctuations have not
been material to the Company's' consolidated results of operations.
18
<PAGE>
PART II: OTHER INFORMATION
<TABLE>
<S> <C>
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:
Not Applicable.
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:
No reports on Form 8-K were filed during the three months ended March 31, 1999.
</TABLE>
19
<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 May 13, 1999 BY /s/ Bruce D. Horn
---------------------- ------------------------------
Bruce D. Horn
Vice President, Finance and Chief
Financial Officer (Principal Financial
and Accounting Officer)
20
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF LARSCOM INCORPORATED FOR THE THREE MONTHS ENDED MARCH
31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 19,878
<SECURITIES> 4,801
<RECEIVABLES> 8,423
<ALLOWANCES> 666
<INVENTORY> 7,614
<CURRENT-ASSETS> 49,428
<PP&E> 18,917
<DEPRECIATION> 12,762
<TOTAL-ASSETS> 67,570
<CURRENT-LIABILITIES> 12,213
<BONDS> 0
0
0
<COMMON> 183
<OTHER-SE> 54,741
<TOTAL-LIABILITY-AND-EQUITY> 67,570
<SALES> 12,246
<TOTAL-REVENUES> 12,246
<CGS> 6,558
<TOTAL-COSTS> 7,634
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (247)
<INCOME-PRETAX> (1,699)
<INCOME-TAX> (680)
<INCOME-CONTINUING> (1,019)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,019)
<EPS-PRIMARY> (0.06)<F1>
<EPS-DILUTED> (0.06)
<FN>
<F1>Represents basic earnings per share
</FN>
</TABLE>
