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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 September 30, 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 October 31, 1999, was
8,366,000 of Class A Common Stock and 10,000,000 of Class B Common Stock.
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LARSCOM INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
<S> <C>
Part I: Financial Information 3
Item 1: Financial Statements (Unaudited) 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 8
Item 3: Quantitative and Qualitative Disclosures about
Market Risk 17
Part II: Other Information 18
Item 1: Legal Proceedings 18
Item 2: Changes in Securities 18
Item 3: Defaults upon Senior Securities 18
Item 4: Submission of Matters to a Vote of Security Holders 18
Item 5: Other Information 18
Item 6: Exhibits and Reports on Form 8-K 18
A: Exhibits 18
B: 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) (Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1999 1998
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 6,699 $ 10,265
Short-term investments 20,203 13,902
Accounts receivable, net 7,263 7,539
Inventories 5,643 8,613
Deferred income taxes 4,392 4,607
Income taxes receivable 3,880 2,508
Prepaid expenses and other current assets 1,339 1,542
-------- --------
Total current assets 49,419 48,976
Property and equipment, net 5,090 6,920
Intangible and other non-current assets, net 542 721
Deferred income taxes 11,514 11,486
-------- --------
Total assets $ 66,565 $ 68,103
-------- --------
-------- --------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 92 $ 194
Accounts payable 3,280 3,705
Accrued expenses and other current liabilities 8,395 7,937
-------- --------
Total current liabilities 11,767 11,836
Other non-current liabilities 497 416
-------- --------
Stockholders' equity:
Class A Common Stock 84 83
Class B Common Stock 100 100
Additional paid-in capital 81,838 81,637
Accumulated other comprehensive income (1) 2
Accumulated deficit (27,720) (25,971)
-------- --------
Total stockholders' equity 54,301 55,851
-------- --------
Total liabilities and stockholders' equity $ 66,565 $ 68,103
-------- --------
-------- --------
</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) (Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues $ 13,265 $ 18,212 $ 38,709 $ 59,181
Cost of revenues 6,275 12,903 19,910 33,263
-------- -------- -------- --------
Gross profit 6,990 5,309 18,799 25,918
-------- -------- -------- --------
Operating expenses:
Research and development 1,701 2,828 6,157 9,131
Selling, general and administrative 5,443 6,423 16,183 20,184
-------- -------- -------- --------
Total operating expenses 7,144 9,251 22,340 29,315
-------- -------- -------- --------
Loss from operations (154) (3,942) (3,541) (3,397)
Interest expense charged by Axel Johnson Inc. (18) (19) (56) (57)
Interest and other income 313 222 870 1,913
-------- -------- -------- --------
Income (loss) before income taxes 141 (3,739) (2,727) (1,541)
Income tax provision (benefit) 169 (1,452) (978) (617)
-------- -------- -------- --------
Net loss $ (28) $ (2,287) $ (1,749) $ (924)
-------- -------- -------- --------
-------- -------- -------- --------
Basic and diluted loss per share $ 0.00 $ (0.13) $ (0.10) $ (0.05)
-------- -------- -------- --------
-------- -------- -------- --------
Basic and diluted weighted average shares 18,348 18,240 18,320 18,200
-------- -------- -------- --------
-------- -------- -------- --------
</TABLE>
See accompanying Notes to Condensed Consolidated Financial Statements
4
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LARSCOM INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) (Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
1999 1998
--------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,749) $ (924)
Depreciation and amortization 2,513 4,587
Gain from sale of building -- (1,329)
Deferred income taxes 187 (587)
Net decrease in working capital 3,055 97
-------- --------
Net cash provided by operating activities 4,006 1,844
-------- --------
Cash flows from investing activities:
Purchases of property and equipment (604) (1,347)
Proceeds from sale of building -- 1,700
Purchases of short-term investments (28,918) (96,478)
Sales of short-term investments 20,318 47,788
Maturities of short-term investments 2,300 46,731
-------- --------
Net cash used by investing activities (6,904) (1,606)
-------- --------
Cash flows from financing activities:
Repayments to Axel Johnson Inc. (706) (5,692)
Payment of capital lease obligations (161) (382)
Proceeds from issuances of Class A Common Stock 202 710
-------- --------
Net cash used by financing activities (665) (5,364)
-------- --------
Effect of exchange rates on cash (3) 7
-------- --------
Decrease in cash and cash equivalents (3,566) (5,119)
Cash and cash equivalents at beginning of period 10,265 8,254
-------- --------
Cash and cash equivalents at end of period $ 6,699 $ 3,135
-------- --------
-------- --------
Supplemental disclosure of cash flow information
Interest paid $ 56 $ 57
-------- --------
Income taxes paid $ 148 $ 3,949
-------- --------
</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 nine
months ended September 30, 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 nine 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>
SEPTEMBER 30, DECEMBER 31,
1999 1998
------------- ------------
<S> <C> <C>
Raw materials $1,451 $3,021
Work-in-process 1,525 1,053
Finished goods 2,667 4,539
------------- ------------
$5,643 $8,613
------------- ------------
------------- ------------
</TABLE>
NOTE 3--RESTRUCTURING:
In October 1998, Larscom announced a corporate restructuring to 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%. All
material liabilities established as a result of the restructuring have been
paid as of September 30, 1999.
NOTE 4--LOSS PER SHARE:
Basic loss per share is computed using the weighted-average number of
common shares outstanding during the period. Diluted loss 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 shows how basic and diluted loss per share are computed
(in thousands, except per share data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1999 1998 1999 1998
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net loss $ (28) $(2,287) $(1,749) $ (924)
------- ------- ------- -------
------- ------- ------- -------
Weighted average Class A and B
Common Stock outstanding 18,348 18,240 18,320 18,200
Dilutive effect of options -- -- -- --
------- ------- ------- -------
Diluted average shares 18,348 18,240 18,320 18,200
------- ------- ------- -------
------- ------- ------- -------
Basic and diluted loss per share $ 0.00 $ (0.13) $ (0.10) $ (0.05)
------- ------- ------- -------
------- ------- ------- -------
</TABLE>
6
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NOTE 5--COMPREHENSIVE INCOME:
The Company adopted a new accounting standard in 1998, Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS
130"). "Comprehensive income" includes all changes in equity from non-owner
sources during the period. The only item of comprehensive income for the periods
presented related to foreign currency translation adjustments. Such amounts were
immaterial for the periods presented.
NOTE 6--COMMITMENTS AND CONTINGENCIES:
In April 1998, the General Services Administration ("GSA") notified the
Company that they had completed their audit of two product supply contracts that
were subject to GSA regulations. The Company had previously established 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. This 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.
The Company typically indemnifies its customers for any expenses or
liabilities resulting from claims by third parties that our products infringe
the patents, trademarks or copyrights of third parties.
NOTE 8--ACQUISITION:
The Company acquired NetEdge Systems Inc. ("NetEdge") on December 31, 1997.
The Company paid total consideration of $25,793,000 in cash, incurred
acquisition costs of $1,182,000 and assumed liabilities of $9,782,000.
Of the cash consideration, $6,300,000 was placed into escrow pending
resolution of certain matters. These matters included potential purchase price
adjustments and potential claims for breach of representations and warranties.
In September 1998, $600,000 of the escrow amount was paid to the Company as a
result of certain claims made, and $400,000 was released to the shareholders of
NetEdge. In January 1999 an additional $647,000 was released to the shareholders
of NetEdge. There remained $4,653,000 in escrow on September 30, 1999.
NOTE 9--SALE OF BUILDING:
In March 1998, the Company recorded a one-time gain of $1,329,000, before
tax, as a result of the sale of the Company's former headquarters by a
partnership in which the Company held a one-third interest.
7
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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," "RISK FACTORS" 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
During the third quarter of 1999, we changed the way that we look at
product sales. Previously we split our products into two main categories based
upon the bandwidth of the products supplied.
- Network systems (broadband)
- Digital access (narrow band)
Now we view our products based on the function they perform. The following
describes the function for each of the five product groups.
<TABLE>
<S> <C>
Multiplexers: Products that enable several data streams to be sent
over a single physical line and be converted back to
the individual data streams at the receiving end.
Inverse Multiplexers: Products that enable a single data stream to be sent
over several physical lines and be converted back to
the single data stream at the receiving end.
ATM Access: Products that interface with traffic of multiple
types from the user data communications equipment
and interface that traffic via ATM to the Network
Service Provider network.
CSU/DSU: Products that interface user data communications
equipment to a carrier T1 service. They perform
framing, certain line-conditioning and equalization
functions.
Service: Repair, maintenance and training.
</TABLE>
We sell our products primarily through a direct sales force and, to a
lesser extent, through a variety of resellers. Our resellers include original
equipment manufacturers, value-added resellers, system integrators and
distributors. We make a high proportion of our sales to a limited number of
voice and data network service providers. We are seeking to develop alternative
distribution channels, particularly for our CSU/DSU products.
REVENUES. Our revenues were $13,265,000 for the three months ended
September 30, 1999. This was a 27% decrease from revenues of $18,212,000 during
the comparable period in 1998. Our revenues were $38,709,000 for the nine months
ended September 30, 1999, a 35% decrease from revenues of
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$59,181,000 during the comparable period in 1998. The primary reason for the
declines in revenues was a reduction in orders from our large customers for
Multiplexer and ATM Access products. We believe these lower levels of revenue
are due primarily to changes in the demand for voice and data services which
use our equipment as well as increased competition.
MCI WorldCom, which accounted for 26% of revenue in the first nine
months of 1999, accounted for 33% of revenue in the first nine months of
1998. The reduced orders from MCI Worldcom primarily affected sales of the
Multiplexer and ATM Access products. AT&T (including IBM Global Network,
which was acquired by AT&T in May 1999) accounted for 16% and 12% of revenues
in the first nine months of 1999 and 1998, respectively. Reduced orders from
AT&T primarily affected sales of Multiplexer products. A third customer
accounted for 1% of revenue in the first nine months of 1999 sales and 8% in
the first nine months of 1998. This customer's reduced orders in 1999
primarily affected sales of the Multiplexer and Inverse Multiplexer products.
Shipments to international locations represented 13% of total revenues
during the first three quarters of 1999 as compared to 6% in the same period
of 1998. This increase was primarily due to higher sales of the Multiplexer
and Inverse Multiplexer products in Europe.
GROSS PROFIT. As a percentage of revenues, gross margin for the three
months and nine months ended September 30, 1999 increased to 53% and 49%,
respectively, as compared to 29% and 44% for each of the comparable
respective periods of 1998. The increases in gross margin from 1998 primarily
resulted from lower inventory reserves, given the 1998 reserves were
unusually high, and amortization expenses offset by higher per-unit
manufacturing costs resulting from lower production volumes.
RESEARCH AND DEVELOPMENT. Research and development expenses declined by 40%
to $1,701,000 in the three months ended September 30, 1999, from $2,828,000 in
the three months ended September 30, 1998. Research and development expenses
declined by 33% to $6,157,000 in the nine months ended September 30, 1999, from
$9,131,000 in the nine months ended September 30, 1998. The declines were
primarily due to lower headcount and better control of other expenses following
our late 1998 restructuring. We believe that a continued commitment to research
and development, particularly related to emerging technologies, will be required
to respond to customer demand and to remain competitive.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses decreased 15% to $5,443,000 during the three months ended September
30, 1999, as compared to $6,423,000 in the comparable 1998 period. Selling,
general and administrative expenses decreased 20% to $16,183,000 during the
nine months ended September 30, 1999, as compared to $20,184,000 in the
comparable 1998 period. The decrease was due primarily to lower headcount and
better control of other expenses following our late 1998 restructuring as we
sought to reduce overall expense levels.
Selling, general and administrative expenses include charges from Axel
Johnson for legal, accounting, tax, treasury, human resources and administrative
services as follows (in thousands):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Three months ended September 30, $110 $106
Nine months ended September 30, $329 $319
</TABLE>
INTEREST EXPENSE CHARGED BY AXEL JOHNSON. Interest expense includes credit
line fees paid to Axel Johnson under the Credit Agreement. See Liquidity and
Capital Resources for more details.
INTEREST AND OTHER INCOME. Interest income was $313,000 for the three
months ended September 30, 1999, as compared to $222,000 for the same period in
1998. Interest income was $870,000 for the nine months ended September 30, 1999,
as compared to $584,000 for the same period in 1998. We invested
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primarily in taxable securities during the nine months ended September 30,
1999. This provided higher interest income than during the same period in
1998. During 1998, we were investing primarily in federal-income-tax-exempt
securities. In March 1998, we also recorded a gain of $1,329,000 from the
sale of our former headquarters by a partnership in which we held a one-third
interest.
PROVISION FOR INCOME TAXES. The effective tax benefit rate of 36% for the
nine months ended September 30, 1999, differs from the federal statutory rate
primarily because of state income taxes.
At September 30, 1999, we had deferred tax assets of $15,906,000. This
asset primarily relates to expected future tax benefits from the amortization of
intangible assets. The amortization of the intangible assets is deductible for
tax purposes in equal amounts over the next 13 years. The remaining deferred tax
asset relates to inventory reserves and accrued expenses. We have not taken a
valuation allowance against the deferred tax assets because we believe it is
more likely than not that they are realizable. However, realization of these
assets is primarily dependent on our ability to generate taxable income in the
future. If we were to reduce significantly our estimate of future taxable
income, we would probably have to record an allowance against our deferred tax
asset. Such a change could have a materially adverse effect on our results of
operations and financial condition.
The determination of our ability to use the deferred tax assets is based on
a number of factors, including:
- Our earnings history
- A significant portion of the deferred tax assets is deductible
over 13 years
- Tax losses can be carried forward for 20 years
- A portion of the losses can be carried back to prior years
LIQUIDITY AND CAPITAL RESOURCES
Our operating activities provided cash of $4,025,000 during the nine months
ended September 30, 1999. This compares with cash provided by operating
activities of $1,844,000 in the corresponding period in 1998. The cash provided
by operations during the 1999 period was generated primarily by net income
before depreciation and amortization, a decrease in inventory and an increase in
accrued expenses.
Historically, we have met our operating and capital cash requirements
primarily from cash flow from operations and advances from Axel Johnson. For the
nine months ended September 30, 1999, approximately $6,300,000 of cash was used
to purchase short-term investments. We spent approximately $604,000 on capital
equipment in the nine months ended September 30, 1999.
We have a $15 million revolving line of credit with Axel Johnson. This line
of credit 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. If we default under the agreement, any
borrowings under the line of credit become payable in full. We have not used
this line of credit to date. We have also entered into an administrative service
agreement and a tax-sharing agreement with Axel Johnson for the purposes of
defining our on-going relationship.
As of September 30, 1999, we had cash and cash equivalents of $6,699,000,
short-term investments of $20,203,000 and other net working capital of
$10,750,000. We believe that these assets, together with the line of credit and
funds generated from operations, will provide adequate liquidity to meet our
operating and capital requirements for at least the next 12 months. Nonetheless,
future events could require us to seek additional capital at an earlier date.
These events might include significant future losses or acquisitions for cash.
If we do need additional capital in the future, we may not be able to obtain
adequate capital on terms acceptable to us, or at all.
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RISK FACTORS
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. OUR ACTUAL RESULTS MAY
DIFFER MATERIALLY FROM THOSE INDICATED IN ANY FORWARD-LOOKING STATEMENTS DUE TO
THE RISKS AND UNCERTAINTIES SET FORTH BELOW AS WELL AS OTHER RISKS AND
UNCERTAINTIES WE MAY DESCRIBE FROM TIME TO TIME IN OTHER FILINGS WITH THE
SECURITIES AND EXCHANGE COMMISSION. WE UNDERTAKE 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 REVIEW CAREFULLY AND
CONSIDER THE VARIOUS RISKS AND UNCERTAINTIES WE DESCRIBE IN THIS REPORT AND IN
OTHER REPORTS WE FILE WITH THE SECURITIES AND EXCHANGE COMMISSION.
CUSTOMER CONCENTRATION. Our revenues largely come from a small number of
customers. During 1998, 1997 and 1996, two customers, MCI WorldCom and AT&T
(including IBM Global Network which was purchased by AT&T in May 1999) accounted
for 44%, 55% and 53% of revenues, respectively. Therefore, our results are
highly dependent on continued orders from these two customers. We believe that
our relationships with these and other large customers will be critical to our
future success.
None of our customers is contractually obligated to purchase any quantity
of products in any particular period. Product sales to major customers have
varied widely from quarter to quarter and year to year. For example, in one
quarter of 1998 sales to one of our largest customers varied by $4.4 million
from sales in the previous quarter. Reductions in orders from certain large
customers contributed significantly to the Company's lower revenues during the
past year. The primary reasons for these reductions were as follows:
- Changes in the demand for voice and data services
- Increased competition
- Competing products that incorporate certain functions of our products
We may continue to experience declines in orders from our large customers
because of continuing consolidation in their businesses and other competitive
factors. We also face the risk that we could lose all of the business of one or
more of these customers. Our operating revenues and financial condition could be
materially and adversely affected if we lose all or a significant portion of the
business of any of our large customers.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. The results of operations for
any quarter are not necessarily indicative of results in any future period. Our
operating results have been and may continue to be subject to quarterly
fluctuations because of many factors that are beyond our control. These factors
include:
- Increased competition in the networking industry
- The overall trend toward industry consolidation
- The introduction and market acceptance of new technologies and
standards
- Variations in sales channels, product costs, or mix of products sold
- Customer concentration
- Large orders with short delivery times
- Limited backlog
- Manufacturing lead times
- Changes in general economic conditions
- Specific economic conditions in the computer and networking industries
We experienced a slight improvement in orders in the third quarter of 1999
as compared to the first two quarters. However, the improvement was modest and
we may not be able to continue to improve our revenue levels. Nonetheless, we
have decided to maintain and perhaps increase current levels of investment in
research and development and marketing. Other operating expenses are relatively
fixed in the short term. There can be no assurances that we will realize the
increased sales levels required to return
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to profitability. Indeed, there can be no assurance that we would return to
profitability at all, even if we enacted further spending cuts.
DEVELOPMENT OF ALTERNATIVE DISTRIBUTION CHANNELS. We are 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. We give some of these
customers the right to return inventory and to receive credits for changes in
our selling prices. We believe we maintain appropriate accruals and allowances
for such exposures. Sales through this channel have not been significant.
Our initial intent was primarily to sell digital access products through
this distribution channel, particularly the WANmaker product line. We continue
to handle sales to large voice and data network service providers with our
direct sales force. As part of this strategy, we have 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 that could cause results of operations and financial condition to be
materially adversely affected. These factors include:
- A reduction in our ability to forecast sales
- Reduced average selling prices
- Increased credit risk
- Management's inexperience in establishing and managing a distribution
channel
- Potential reductions in customer satisfaction
- Loss of contact with end users of our products
- Additional expenses from new methods of advertising and promoting the
products
DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS AND PRODUCTS UNDER DEVELOPMENT.
Our future operating results will be largely dependent on the market success of
recently introduced products and products that may be introduced in the future.
This is particularly true in light of the increasing incorporation of our
product functionality into related products offered by competitive network
equipment providers. Products recently introduced include the WANmaker and the
Orion 2000 product lines. There can be no assurance that these products will
achieve widespread market acceptance. In the past, we have experienced delays in
the development of new products and the enhancement of existing products, and
such delays may occur in the future. If we are unable to develop new products,
or new versions of existing products, in a timely manner, it could have a
materially adverse effect on our 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. We recognize the importance of addressing this situation in a timely,
proactive manner. In early 1998, we established a Year 2000 compliance program
to ensure that our products and internal systems continue to function properly
in the next century. We have verified that all of our current product offerings
are Year 2000 ready. In cases where products not currently offered were found
non-compliant, we told the customers in writing. In most cases, we provided an
upgrade path for these customers.
We are currently operating on a live version of our primary business system
that we believe is Year 2000 ready. Additionally, we have completed our
assessment of all other 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. We found no major
problems that would inhibit normal operations in the Year 2000 and beyond. Any
necessary remediation efforts are complete.
Based on assessments completed to date and compliance plans in process, we
do not expect that the Year 2000 issue, including the cost of making products
and critical systems compliant, will have a material
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effect on our business operations or cash flow. Direct costs that related to
all Year 2000 compliance testing and remediation are estimated to be
approximately $465,000 over a two-year period. Approximately $430,000 has
been incurred as of September 30, 1999.
We have contacted all critical suppliers and sought to assess their ability
to continue to deliver products and services in the Year 2000. Based on the
responses we received, we have no reason to expect that any interruption in
business will result from any Year 2000 issues among our suppliers.
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 our results of operations or financial condition. As a result, we have
created contingency plans to safeguard against failures of our own products,
suppliers and vendors and internal information systems related to the Year 2000
issue. These contingency plans should be approved in November 1999.
DEPENDENCE ON COMPONENT AVAILABILITY AND KEY SUPPLIERS. To meet our
production needs we depend on our suppliers to provide components and subsystems
in a timely manner. We obtain certain of our essential components and license
certain embedded software from single sources. We do not believe we would be
able to develop alternative sources for these essential components if the
supplier were not to meet our production needs. For most other components, we
believe alternative sources are available. However, there is no guarantee they
will be available without incurring substantial costs, or that they will be
available at all. Any inability of suppliers to meet our 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 our
business and operating results. We generally do 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 our requirements.
At the end of 1998, vendors of three integrated circuits ("ICs") notified
us of their intent to cease production. Since we anticipated the continued use
of these ICs, we committed to purchase approximately $1,250,000 of these
components. This represents between one and two years expected demand for these
components. We currently have a minimum of one year's supply of these
components. We will consider redesigning our products to replace those ICs or
design new products to replace the current product that uses the discontinued
ICs. We have attempted to take into account factors such as the ability to
replace the particular IC with a similar part and the estimated life of our
products in determining the quantities to purchase. Although we believe that we
will use all of the quantities we have agreed to purchase, there can be no
assurance that these estimates are correct. If our estimates are not correct and
requirements for these ICs are less than anticipated, we may have to write off
the cost of excess supplies. This could have a materially adverse effect on our
results of operations. Conversely, if our estimates are not correct and the
requirements for these IC's are greater than anticipated and further supplies
are unavailable or we have not redesigned our products to replace these IC's, we
could see our revenues negatively impacted. This would have a materially adverse
effect on our results of operations.
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 our products. This requires us to continually develop and
introduce new products that meet changing market needs and customer
requirements. We also must market these products in a timely manner and on a
cost-effective basis. There can be no assurance that we 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 gain
market acceptance. If we were to be unsuccessful or to incur significant delays
in developing and introducing such new products or enhancements, our business
and operating results could be materially adversely affected.
14
<PAGE>
SOURCES OF ADDITIONAL FINANCE. We have access, subject to certain
conditions, to a $15,000,000 credit facility provided by Axel Johnson. In
December 1998, this agreement was amended and extended until December 2000.
There can be no assurance that funding will be available under the terms of this
credit agreement if we need such funding in the future. In addition, alternative
sources of financing may not be available at such time or if needed after
expiration of the Axel Johnson facility in December 2000.
MANAGEMENT OF OPERATIONS. The recent downturn in our business and related
restructuring has placed a significant strain on our personnel, management and
other resources. Our future success depends on our ability to recruit and retain
employees following the recent restructuring and our recent financial
performance shortfalls. To grow the business, we must continue to attract,
train, motivate and manage new employees successfully, integrate new management
and employees into our overall operations and continue to improve our
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. Our
failure to manage any expansion effectively could have a materially adverse
effect on the business and operating results.
CONTROL BY AXEL JOHNSON. Each share of Class B common stock has four votes
and each share of Class A common stock has one vote. Axel Johnson is the sole
holder of the Class B common stock. Consequently, Axel Johnson has sufficient
voting power to control our direction and policies, including:
- Mergers
- Payment of dividends
- Consolidations
- The sale of all or substantially all assets
- The election of the Board of Directors
- To prevent or cause a change in control
Our authorized, but unissued capital stock, includes 5,000,000 shares of
preferred stock. The Board of Directors is authorized to issue and fix the terms
of the preferred stock. Accordingly, we may issue preferred stock in the future
that will have preference over both classes of our common stock with respect to
the payment of dividends and upon liquidation, dissolution or winding up of the
business. This could adversely affect holders of the common stock or discourage
any attempt to obtain control of our company. This control by Axel Johnson may
discourage potential acquisitions and prevent a situation where Class A common
stock holders might otherwise receive a premium for their shares over the then
current market price.
RISKS ASSOCIATED WITH ENTRY INTO INTERNATIONAL MARKETS. We market our
products internationally primarily through non-exclusive distribution agreements
with VARs and systems integrators. To focus on sales to Europe, the Middle East
and Africa, we have created a regional sales and service team, headquartered in
the United Kingdom. The United Kingdom team focuses on direct sales to large
customers while supporting its distributors for sales to smaller customers. We
may not be able to generate increased international sales through these efforts.
We have had minimal sales to international customers to date, and we have little
experience in international markets. Sales to international customers were 13%
of total revenues during the first three quarters of 1999 compared to 6% in the
same period of 1998. Most of the increase was in Europe. 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
- Potentially adverse tax consequences
15
<PAGE>
In addition, to sell our products internationally, we 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 our products in countries
outside the U.S. could deny or preclude our marketing and sales efforts in such
countries, which could have a materially adverse effect on our business and
operating results.
COMPLIANCE WITH REGULATIONS AND EVOLVING INDUSTRY STANDARDS. Our products
must comply with a significant number of communications regulations and
standards. Some of these standards are evolving as new technologies are
deployed. In the U.S., we 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. Outside the U.S. we need to meet the standards established by
telecommunications authorities in various countries, as well as recommendations
of the International Telecommunications Union. As standards for services such as
ATM evolve, we may be required to modify our existing products or develop and
support new versions of our products. If we cannot comply with these standards
readily, it could delay introduction of our products. This could have a
materially adverse effect on our business and operating results.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS. As part of our efforts to
grow our business, from time to time we consider acquisition prospects that
could potentially complement existing product offerings, augment market
coverage, enhance technological capabilities or offer growth opportunities. We
acquired NetEdge in December 1997, but this acquisition has not been a success.
Any future acquisitions 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 business
and operating results. We are currently unable to use pooling of interests
accounting because we do meet the requirements of generally accepted accounting
principles. Accordingly, such acquisitions could result in significant
accounting charges for amortization of goodwill and other charges typically
associated with purchase accounting (including the immediate write-off of
purchased in-process research and development). Acquisitions also entail
numerous operating 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 we have limited or
no prior experience and potential loss of key employees of acquired
organizations. We can give no assurance as to our ability to integrate
successfully any acquisition.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY; PROPRIETARY INFORMATION. We
seek to protect our products and technologies primarily through proprietary
technology, information, processes and expertise. We also rely, to a lesser
extent, on a combination of contractual restrictions, copyrights, trademark laws
and patents. We have been issued one U.S. patent to date. Much of our
proprietary information and technology is not patented and may not be
patentable. There can be no assurance that we will be able to protect our
technology successfully, or that competitors will not be able to develop similar
technology independently. We enter into confidentiality and invention assignment
agreements with all of our employees, and enter into non-disclosure agreements
with our 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 our
technologies or discourage independent third-party development of similar
technologies. In the event such arrangements are insufficient, our business and
operating results could be materially adversely affected.
16
<PAGE>
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
INTEREST RATE RISK. We do not invest in derivative financial instruments.
Our investment portfolio is generally comprised of securities that mature within
one year. We place 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
our investment portfolio, we do not expect any material loss in our investment
portfolio.
FOREIGN CURRENCY EXCHANGE RATE RISK. We incur certain sales, service, and
marketing expenses in foreign currencies. Consequently, our international
results of operations are subject to foreign exchange rate fluctuations.
However, our foreign activities have been limited to date. Accordingly, we do
not currently hedge against foreign currency rate fluctuations. Gains and losses
from such fluctuations have not been material to our consolidated results of
operations.
17
<PAGE>
<TABLE>
<CAPTION>
PART II: OTHER INFORMATION
<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:
Larscom did not file any reports on Form 8-K during
the three months ended September 30, 1999.
</TABLE>
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 November 12, 1999 BY /s/ Robert Coackley
---------------------- ------------------------------
Robert Coackley
Chief Executive Officer and President
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 NINE MONTHS ENDED
SEPTEMBER 30, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 6,699
<SECURITIES> 20,203
<RECEIVABLES> 7,912
<ALLOWANCES> 649
<INVENTORY> 5,643
<CURRENT-ASSETS> 49,419
<PP&E> 19,309
<DEPRECIATION> 14,219
<TOTAL-ASSETS> 66,565
<CURRENT-LIABILITIES> 11,767
<BONDS> 0
0
0
<COMMON> 184
<OTHER-SE> 54,117
<TOTAL-LIABILITY-AND-EQUITY> 66,565
<SALES> 38,709
<TOTAL-REVENUES> 38,709
<CGS> 19,910
<TOTAL-COSTS> 22,340
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 56
<INCOME-PRETAX> (2,727)
<INCOME-TAX> (978)
<INCOME-CONTINUING> (1,749)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,749)
<EPS-BASIC> (0.10)<F1>
<EPS-DILUTED> (0.10)
<FN>
<F1>REPRESENTS BASIC EARNINGS PER SHARE
</FN>
</TABLE>
