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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
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
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LARSCOM INCORPORATED
(Exact name of registrant as specified in its charter)
DELAWARE 94-2362692
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
1845 MCCANDLESS DRIVE 95035
MILPITAS, CALIFORNIA (ZIP Code)
(Address of principal executive
offices)
(408) 941-4000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
CLASS A COMMON STOCK, $.01 PAR VALUE
(TITLE OF CLASS)
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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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 28, 1998, was approximately $70,639,000.
The number of the registrant's shares outstanding as of February 28, 1998,
was 8,190,000 of Class A Common Stock and 10,000,000 of Class B Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of
Stockholders (the "Proxy Statement") are incorporated by reference in Part III
of this Annual Report on Form 10-K.
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TABLE OF CONTENTS
PART I
ITEM 1. BUSINESS.................................................................. 3
ITEM 2. PROPERTIES................................................................ 14
ITEM 3. LEGAL PROCEEDINGS......................................................... 14
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................... 14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS..... 15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA...................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.............................................................. 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK................ 26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA............................... 27
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.............................................................. 48
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................ 48
ITEM 11. EXECUTIVE COMPENSATION.................................................... 48
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............ 48
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................ 48
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......... 49
2
PART I
ITEM 1. BUSINESS
EXCEPT FOR THE HISTORICAL STATEMENTS CONTAINED HEREIN, THIS ANNUAL REPORT ON
FORM 10-K 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, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS, OR STRATEGIES REGARDING THE FUTURE.
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 RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-K.
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.
OVERVIEW
Larscom Incorporated (the "Company" or "Larscom") develops, manufactures and
markets a broad range of high speed global internetworking solutions for network
service providers ("NSPs"), Internet Service Providers ("ISPs") and corporate
users. Larscom's products provide access to fractional T1 ("FT1"), E1, T1/E1,
frame relay, fractional T3/E3, channelized T3 services, Clear Channel ATM
("CCA") inverse multiplexing, clear channel T3 and asynchronous transfer mode
("ATM"), with Inverse Multiplexing for ATM ("IMA") under development. Larscom's
newest products, the Edge family, supports transparent or native LAN services,
virtual private networks, high speed internet access and intranet/extranet
services.
Prior to the Company's initial public offering ("IPO") in December 1996, the
Company was a wholly owned subsidiary of Axel Johnson Inc. ("Axel Johnson").
Upon consummation of the IPO, Axel Johnson owned 55% of the Class A and B Common
Stock of the Company and controlled 83% of the voting interest. These ownership
and control percentages remain current.
INDUSTRY OVERVIEW
The proliferation of personal computers and the continuing need of users to
disseminate and share information, often across an enterprise and from remote
locations, have created increased demand for both local area networks ("LANs")
which connect computing resources within an enterprise and wide area networks
("WANs") which permit interconnection across wide geographic areas. As networks
extend beyond the enterprise and reach around the world, demand for WAN capacity
and higher speed WAN access has grown dramatically. More recently, this demand
has been further fueled by the growth in Internet usage among both individuals
and businesses, as well as the emergence of more bandwidth intensive
applications such as video and imaging.
The increased demand for WAN speed and capacity has been accompanied by
increased complexity in available network services. In addition to dedicated
56/64 kbps and T1/FT1 services, both private and public frame relay, ISDN basic
rate and primary rate and ATM are available. This large variety of services has
also been coupled with an escalation in the variety and complexity of LAN
technology (10 Mbps Ethernet, 100 Mbps Ethernet, Fiber Distributed Data
Interface ("FDDI"), switched Ethernet and Gigabit Ethernet). ATM, in particular,
adds complexity to network demands. As an alternative to current circuit based
(or Time-Division Multiplexing ("TDM")) services, ATM is a new cell based
service which allows corporate users and NSPs to combine all types of
traffic--data, voice, video and image--across the same network. ATM is expected
to become more widely available as standards evolve. Since it utilizes cell
based technology rather than traditional circuit based TDM technology, ATM poses
significant network hardware and software challenges. To date, ATM has been
deployed in the backbone infrastructure of the NSPs
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and ISPs. Although NSPs and ISPs have yet to use the technology widely to
transport ATM traffic, they have used ATM as a backbone technology for other
offerings such as frame relay, internet and transparent LAN services.
As a result of both the increased demand for WAN capacity and the complexity
and continuing evolution of service offerings, businesses have been
transitioning from the use of private WANs dedicated to individual businesses to
greater use of public WANs maintained by NSPs and ISPs. As this transition
occurs, NSPs and ISPs are being asked to provide an increasing variety of
transmission services and network management services. In addition, corporate
users in many cases are requiring NSPs to assume full responsibility for
operation and monitoring of the network and to guarantee certain levels of
service.
NSPs, ISPs and corporate users require equipment that supports higher
bandwidth than provided by common T1 and E1 services. In addition, NSPs, ISPs
and corporate users increasingly are seeking a solution that bridges the
technology gap by providing connectivity to both the currently ubiquitous TDM
network environment and the emerging ATM environment without requiring that one
technology be dropped in favor of the other. Moreover, many businesses need to
operate on a global basis with networks that cross international boundaries.
Furthermore, NSPs and corporate users require the ability to add more services
and high-speed applications in a rapid and affordable manner. Accordingly, NSPs
and corporate users require telecommunications equipment that supports a broad
range of services and that will operate reliably, flexibly and consistently in
all the required countries. The complexity and variety of services and products
have prompted NSPs, ISPs and corporate users alike to consolidate their
purchasing activity by using fewer vendors who offer reliable and affordable
equipment throughout the world.
THE LARSCOM SOLUTION
The Company's broad range of product offerings provides access to both ATM
and TDM services across a variety of international standards at speeds ranging
from 56 kbps to 155 Mbps. The Company's products have modular architectures that
simplify the provisioning of new services by NSPs and ISPs and lower the cost
for large corporate users of obtaining additional bandwidth.
PROVIDING MULTI-SERVICES/MULTI-CUSTOMER SOLUTIONS. Although ATM equipment
has seen success in the carrier infrastructure, widely available ATM service has
yet to meet previous industry predictions. ATM as an access technology, however,
is beginning to gain acceptance, becoming the technology of choice for many
network service providers as the vehicle to offer multiple services--cell,
frame, circuit, Internet, intranet, extranet, transparent LAN or virtual private
networks. ATM's greatest benefit is its ability to transport a variety of media
types seamlessly across the network, as it is already doing in many of the
backbone infrastructures of carriers today. The Edge family of ATM edge access
products provides economic multi-services solutions to NSPs and ISPs, and
addresses the need to service multiple clients through a common and secure
platform.
BRIDGING THE TECHNOLOGY GAP. To address the gap between emerging and
existing technologies, in particular between ATM and TDM, the Company has
developed a broad range of network communications products that provide its
corporate customers with reliable and flexible network access. The Company
offers its NSP and ISP customers easily deployable, well managed solutions to
provision new network services quickly. In the broadband market, for example,
the Orion 4000 is unique in its ability to accommodate both ATM and TDM
connectivity within the same multiplexing architecture. The Edge family allows
Ethernet, fast Ethernet, FDDI, and Token Ring LANs to operate seamlessly across
long distances.
BRIDGING THE BANDWIDTH GAP. Through its Mega-T and Orion 4000 products,
Larscom pioneered the use of multiple T1 and E1 inverse multiplexing, which
enables users to achieve higher bandwidth capacity than offered by a single T1
line, thereby bridging the bandwidth gap between T1 and T3. Fractional T3
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service, provided in this manner, allows the NSP to leverage the existing T1
based infrastructure and provides the corporate user with ready access to
affordable and ubiquitous high speed bandwidth.
SCALEABILITY AND MODULARITY. The Company has incorporated flexibility and
modularity into its products as network complexity and bandwidth increase, as
industry standards evolve and as NSPs, ISPs and corporate users seek to meet
multiple needs. The Company's upgradeable software and plug in modules allow
services to be added rapidly and cost effectively as demand changes and industry
standards evolve.
RELIABILITY AND QUALITY. The Company has earned a strong reputation for the
quality of its products, as well as its responsive service. The Company's
products are manufactured to meet the highest standards of reliability and
quality, including intensive system level testing in development and
manufacturing. Larscom has responded to its customers' needs by providing
telecommunications equipment that operates reliably and consistently across the
globe. The Orion and Edge product families are designed, tested and certified
for use in major international markets.
CUSTOMER SERVICE AND SUPPORT. The Company offers real-time service and
support through various stages of the customer relationship. The Company's
service and support function begins by working closely with customers at the
product definition and design stage. To meet its customers' unpredictable
purchasing patterns, the Company's sales and operations departments are
organized to respond quickly to short lead-time orders. Finally, Larscom
provides post-sale service and support of its products through technical
consulting, installation assistance and maintenance.
PRODUCTS
The Company's principal products consist of broadband access solutions such
as the Orion 4000 and Edge product families and digital access solutions such as
the Orion 200 and Access-T products. Broadband products address transmission
speeds greater than 2 Mbps and digital access products address speeds less than
2 Mbps. The Company's principal product platforms feature modular software and
hardware, which can be adapted to changing industry standards and customer
needs. The products can be upgraded in the field, for new features or standards,
by downloading new software. In addition, several of the products are designed
to permit ready addition of modules to provide new functions or interfaces. This
provides an NSP, ISP or corporate user with the components necessary to design
an entire system to interconnect multiple locations in a cost effective and
manageable network.
In order to enhance its current and future broadband product line the
Company purchased NetEdge Systems, Inc. ("NetEdge") in December 1997. NetEdge,
with the Edge product line, offers an advanced ATM-based technology platform for
service providers to offer transparent or native LAN service, virtual private
networks, high-speed Internet access, and intranet/extranet services.
BROADBAND PRODUCTS
Larscom entered the broadband market in 1991 with the acquisition of T3
Technologies, Inc. Larscom's broadband product line consists of a range of
products that include the Orion 4000 broadband access multiplexer, a family of
inverse multiplexers, a single function T3 Digital Service Unit ("DSU") and most
recently, the Edge Series ATM edge access products. In 1997, broadband product
revenues were 40% of total 1997 revenues.
ORION 4000. The Orion 4000 is a highly versatile broadband access
multiplexer with a unique architecture that handles both ATM and TDM traffic
using a dual, redundant, 155 Mbps bus structure. Prices for the Orion 4000 start
at $20,500 for a basic system equipped with a single inverse-multiplexing
module. The Orion 4000 accommodates data applications operating at speeds from
1.54 Mbps up to 50 Mbps, as well as network connections that range from T1 or E1
to 155 Mbps. The Orion 4000 is designed to enable different functionality to be
added in a modular and cost effective fashion. It is available in both 5 slot
and 12 slot shelf configurations, both of which have met the requirements of CE
(European Union
5
Certification) for international markets. The Orion 4000 is distinctive in the
role that it can play in hybrid networks (TDM networks with ATM applications)
and in providing an economic migration path from low bandwidth to high, thereby
ensuring legacy equipment investment protection.
The Orion 4000 is able to support full and fractional T3 networks. Its T1
and E1 inverse multiplexing modules, introduced in 1994 and 1995, respectively,
provide transparent channels for applications such as LAN interconnection or
video transmission. The T3mux and Tmux modules, introduced in 1995, provide
greater flexibility in transporting T1 circuits across the network. They can be
used to consolidate several fractional T3 applications onto a single T3 circuit
and combine T1 traffic from a digital Private Branch Exchange ("PBX") or a T1
multiplexer with inverse multiplexed data. In early 1997, the T3 Clear module
for the Orion 4000 was introduced. This application module provides clear
channel 45 Mbps transmission and is fully interoperable with the Access-T45,
Larscom's standalone T3 DSUs.
EDGE SERIES PRODUCTS. The Edge family of products consists of the Edge 40,
65, 70 and 80, which were developed to fulfill NSP and ISP needs for
service-enabling intelligence at the edge of their networks. A single Edge
multiservice system installed in an office building, office park or other
carrier point of presence can aggregate and concentrate Ethernet, Fast Ethernet,
FDDI and Token Ring LAN traffic from multiple customers to a high-speed ATM link
operating at speeds up to 155 Mbps. Each customer appears to have its own
secure, private virtual network, operating at the same native speed as its LAN.
With the Edge product family, network service providers can maximize service
revenue from an ATM link and end users can subscribe to a number of tailored,
flexible services. In late 1997, circuit-based service support was added to the
Edge family. Edge products have list prices starting at $15,000.
OTHER BROADBAND PRODUCTS. The Mega-T, introduced in 1993, is the first
inverse multiplexer to bridge the bandwidth gap between T1 and T3. Priced from
$7,750, it provides economic access to greater than T1 bandwidth for high speed
applications, deriving a data channel of up to 6 Mbps from four T1 circuits.
Larscom's patented inverse multiplexing algorithm, used for both the Mega-T and
Orion 4000, handles alignment of the individual T1s and allows for differential
delay between individual T1s. This algorithm also allows the data transmission
rate to be lowered should individual T1 circuits fail and to be raised when the
circuits are restored. The Mega-T shares with the Orion 4000 the unique ability
to identify individual T1 circuits, thereby simplifying trouble shooting. The
Mega-T is primarily used for high speed LAN internetworking, as well as frame
relay network access above T1 speed and broadcast quality digital video.
The Access T45, introduced in 1992, is a dual port, 45 Mbps DSU that
provides a clear channel T3 network interface. Priced at $7,000, it is used for
very high-speed LAN internetworking, for Internet access and backbones and for
channel extension. The Access T45 allocates bandwidth in increments of 3 Mbps, a
functionality which has been used by some ISPs to control bandwidth assignment
for their customers. In addition, it is capable of scrambling LAN data in a
manner which ensures the successful receipt of transmitted data.
EtherSpan, introduced in 1996, is an advanced Ethernet bridge that can
handle a sustained data rate of 10 Mbps. It offers cost effective, high speed
WAN connectivity for Ethernet LANs, with one 10Base-T Ethernet LAN port and a
single WAN port that utilizes either HSD or HSSI standards.
DIGITAL ACCESS PRODUCTS
Larscom entered the digital access market in 1986 with emphasis on
performance monitoring of T1 lines. Larscom's pioneering efforts to deliver an
advanced network diagnostic system within a Channel Service Unit ("CSU")
resulted in its TNDS (T1 Network Diagnostic System) product line. The advanced
performance monitoring capabilities, which were featured in the first TNDS and
enhanced and complemented in subsequent CSU and CSU/DSU products, continue to be
a hallmark of Larscom throughout its product lines. In 1997, digital access
product revenues were 56% of total 1997 revenues.
6
ORION 200 FAMILY. The Orion 200 family, introduced in 1994, is an advanced
T1 and E1 access multiplexer that can accommodate from two to eight data ports
and two network ports. Priced from $4,395, its primary application is for LAN
interconnection, often coupled with digital PBX traffic, as well as video
conferencing. The Orion 200 family can operate in both T1 and E1 networks, and
can also perform conversion between T1 and E1 standards.
OTHER DIGITAL ACCESS PRODUCTS. The Access-T family, introduced in 1991, is
a series of T1/FT1 CSU/ DSUs. Pricing starts at $1,595 for a single port DSU.
The primary use of the Access-T family is for LAN interconnection, often coupled
with the multiplexing of digital PBX traffic onto a single T1/FT1 circuit. The
Access-T 1500, a shelf based version introduced in 1992, utilizes a hub and
spoke architecture that allows centralized network nodes to serve units at
dispersed sites and to concentrate traffic in a single location where network
hubs are constrained for space. In 1996, the Access-T 100S, a low cost, smaller
version of a single port Access T, was introduced, allowing the Company to
respond to downward price pressure in the digital access market.
The Split-T, introduced in 1990, is a stand alone T1/FT1 CSU/DSU, with
prices starting at $2,795. It has a front panel that incorporates an LCD user
interface for local configuration and is primarily used for LAN interconnection
and digital PBX traffic.
In addition, Larscom offers a family of T1 CSU products, introduced in 1986,
centered on the TNDS family of fully featured T1 CSUs. These products offer a T1
network interface with advanced performance monitoring and diagnostic
capabilities.
CUSTOMERS
The Company's customers principally consist of NSPs, ISPs, Fortune 500
corporations, systems integrators, value added resellers ("VARs") and federal,
state and local government agencies.
The Company believes that its relationships with large customers,
particularly the NSPs and ISPs, will be critical to its future success. These
customers prefer to purchase the majority of their network access solutions from
a single vendor, which may benefit the Company as it broadens and enhances its
product line. In 1997, 1996 and 1995, NSPs and ISPs represented 63%, 62% and
48%, respectively, of total revenues and the Company's top five customers
accounted for 54%, 52% and 48% of revenues in 1997, 1996 and 1995, respectively.
The following table summarizes the percentage of total revenues for customers
accounting for more than 10% of the Company's revenues:
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----- ----- -----
MCI.................................................................... 25% 21% 18%
IBM/Advantis........................................................... 14% 13% 14%
None of the Company's customers are contractually obliged to purchase any
quantity of products in any particular period, and product sales to major
customers have varied widely from quarter to quarter and year to year. There can
be no assurance that the Company's current customers will continue to place
orders with the Company, that orders from existing customers will continue at
the levels of previous periods or that the Company will be able to obtain orders
from new customers. Loss of, or a material reduction in orders by, one or more
of the Company's major customers could have a material adverse effect on the
Company's business and operating results.
BACKLOG
The Company's backlog at any point in time is typically limited.
Accordingly, sales in any quarter are largely dependent on orders received
during that quarter. Furthermore, the Company's agreements with its
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customers typically provide that they may change delivery schedules and cancel
orders within specified time frames, typically up to 30 days prior to the
scheduled shipment date, without penalty. The Company's customers have in the
past built, and may in the future build, significant inventory in order to
facilitate more rapid deployment of anticipated major projects or for other
reasons. Decisions by such customers to reduce their inventory levels could lead
to reductions in purchases from the Company. Therefore, customer decisions to
delay delivery, cancel orders or reduce purchases could have a material adverse
effect on the Company's business and operating results.
MARKETING AND SALES
The Company sells its products in the U.S. primarily through its direct
sales organization, with products also being sold through original equipment
manufacturers ("OEMs"), VARs and systems integrators. The Company seeks to
continue the expansion of its customer base through both direct and alternate
distribution channels. Developments in broadband and digital access platforms
will continue to be handled by a direct sales organization experienced in system
level sales. Additionally, the Company seeks to extend its market reach to the
Fortune 2000 corporations in the U.S. through the development of alternate
distribution channels and supporting services, with the intent to have such
channels in operation by the end of 1998. The Company markets its products
internationally through non-exclusive distribution agreements with VARs and
systems integrators. In international markets, the Company is seeking to develop
partnerships with international NSPs and to develop its own sales and support
organization, beginning in 1998, to complement existing distributor
relationships. The Company believes the acquisition of NetEdge will assist in
the development of international markets as a large proportion of Edge product
sales were in Europe which was supported by a team of four sales and support
personnel based in the United Kingdom.
NSPs require that products undergo extensive lab testing and field trials
prior to their deployment in the network. Accordingly, the Company is
continually submitting successive generations of its current products as well as
new products to its customers for evaluation and approval. Additionally,
international NSPs require products to meet country specific certification
standards for safety, emissions and network connectivity. The length of the
various approval processes is affected by a number of factors, including the
complexity of the product involved, the priorities of the customer, budgets and
regulatory issues.
CUSTOMER SERVICE AND SUPPORT
The Company's products are required to meet rigorous standards imposed by
both customers and internal product quality assurance testing procedures. The
Company has service contracts with most of its major customers, and provides on
site service via arrangements with a number of service partners worldwide such
as Racal Datacom and Netcom Solutions in the U.S., Data General in Europe and
Datacraft in the Pacific Rim. These contracts typically establish response time
and level of service commitments, with penalties for non-performance. Larscom
maintains a 24 hour, 7 days a week technical assistance support center, and
provides on site support with contracted response times, plus a wide range of
repair programs. The Company also provides technical applications assistance, as
well as customer and distributor product maintenance and installation training.
Prior to January 1997, all of the Company's products carried a two-year
warranty, which generally covered defects in materials and workmanship. In
January 1997, the Company changed the warranty period for most of its products
to three years. In the past, the Company's warranty expenses have been
relatively insignificant and the Company does not expect this to change as a
result of the increase in the warranty period.
8
RESEARCH AND DEVELOPMENT
Larscom believes that its future success depends on its ability to maintain
technological leadership through timely enhancements of existing products and
development of new products that meet customer needs. During 1997, 1996 and
1995, total research and development expenses were $9.9 million, $8.1 million
and $7.1 million, respectively. In addition, during 1997, the Company incurred a
charge of $20.1 million related to in-process research and development
associated with the acquisition of NetEdge. The Company believes that a
continued commitment to research and development, particularly related to
broadband products and emerging technologies, in response to customer demands
will be required to remain competitive. Accordingly, the Company is increasing
its engineering staff and anticipates research and development expenses to
increase in future periods.
The Company's research and development programs are focused on its modular
platforms (the Orion 4000 family, the Edge family, the Orion 200 family and the
Access-T family), which allow new technologies to be incorporated and new
services supported through incremental modules. The Company will continue to
expand the capabilities of the Orion 4000 and the Edge products to address
additional broadband technologies such as ATM inverse multiplexing, Synchronous
Optical Network ("SONET") and Synchronous Digital Hierarchy ("SDH").
The Orion 4000 product family was designed specifically to meet the demands
of its major customers. These relationships provide the Company with advanced
insight into the evolving needs of customers and allow the Company to anticipate
new technology requirements. Enhancements to these product families are being
developed by including major customers in the product definition and review
process. Timely customer feedback is important to the Company in making
modifications to existing products and designing new products.
The rapid development of new technologies increases the risk that current or
new competitors could develop products that would reduce the competitiveness of
the Company's products. The Company's success will depend to a substantial
degree upon its ability to respond to changes in technology and customer
requirements. This will require the timely selection, development and marketing
of new products and enhancements on a cost effective basis. The development of
new, technologically advanced products is a complex and uncertain process,
requiring high levels of innovation. For the network access market, expertise is
required in the general areas of telephony, data networking and network
management, as well as specific technologies such as ISDN, ATM and SONET.
Further, the telecommunications industry is characterized by the need to design
products which meet industry standards for safety, immunity, emissions and
network connection. Such industry standards are often changing or incomplete as
new and emerging technologies and service offerings are introduced by NSPs. As a
result, there is a potential for product development delay due to the need for
compliance with new or modified standards. The introduction of new and enhanced
products also requires that the Company manage transitions from older products
in order to minimize disruptions in customer orders, avoid excess inventory of
old products and ensure that adequate supplies of new products can be delivered
to meet customer orders. 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 acceptance in the market. The Company's business and
operating results could be materially adversely affected if the Company were to
be unsuccessful, or to incur significant delays, in developing and introducing
such new products or enhancements.
MANUFACTURING AND QUALITY ASSURANCE
The Company's manufacturing operations consist of materials procurement,
third party assembly of final product based on printed circuit boards, product
testing and inspection and system configuration for shipment. The Company has
maintained a long term relationship with its third party printed circuit board
assembler, Top Line Electronics Corporation, which has allowed the Company to
implement total quality
9
control in the entire manufacturing process, including statistically monitored
process control programs. The Company utilizes traditional procurement methods
with its suppliers, using standard purchase orders for all scheduling and
commitments. Most purchase order payment terms are standard with payment due in
30 days, with some orders negotiated to net 45 days payment. The Company uses
automated functional product testing to remain flexible to customers' needs
while maintaining control of the quality of the manufacturing process. During
1996, the Company increased its emphasis on aggressively monitoring software
quality in its products by implementing automated system test programs that
verify product performance concurrent with product development and prior to
product release.
During 1998, the Company expects to select one or two turnkey manufacturers
to produce the main printed circuit board assemblies for its Access-T and
Split-T product lines, and may choose to add additional products in the future.
In turnkey manufacturing, unlike manufacturing on consignment, the vendor is
responsible for procuring the components utilized in the manufacturing process.
This approach transfers some of the economic risks of material cost fluctuation,
excess scrap, inventory obsolescence and working capital management to the
vendor. The Company will have to commit to purchase certain volumes within
various time frames. While management believes that the benefits of turnkey
manufacturing outweigh the risks, it is possible that the change will impact the
Company's ability to alter the manufacturing schedule in a short time frame in
order to satisfy changes in customer demand. The Company will still be
responsible for final assembly and testing of finished products.
On time delivery of the Company's products is dependent upon the
availability of quality components used in its products. The Company purchases
parts and components for assembly from a variety of pre-approved suppliers
through a worldwide procurement-sourcing program. The Company attempts to manage
risks through developing alternate sources and by maintaining quality
relationships with its suppliers. To date, the Company has been able to obtain
adequate supplies of required components in a timely manner from existing
sources or, when necessary, from alternate sources. The Company does acquire
certain components from sole sources, either to achieve economies of scale or
because of proprietary technical features designed into the Company's products.
Sole sourced components come from suppliers such as Waferscale, Vicor and PMC
Sierra. A substantial portion of the Company's shipments in any fiscal period
relates to orders received in that period. To meet this demand, the Company
maintains a supply of finished goods inventories at its manufacturing facility
and safety stock of critical components at the suppliers' stocking location. In
addition, a significant percentage of the Company's orders are shipped within
three business days of receiving the order. There can be no assurance that
interrupted or delayed supplies of key components will not occur which could
have a material adverse effect on the Company's business and operating results.
The Company maintains a comprehensive quality control program. However,
complex products such as those offered by the Company may contain undetected
errors or failures when first introduced or as new versions are released.
Despite testing by the Company and its customers, there can be no assurance that
existing or future products based upon the Orion 4000 or Edge architectures or
other technologies will not contain undetected errors or failures when first
introduced or as new versions are released. While the Company believes that its
reserves for estimated future warranty costs are adequate there are inherent
risks associated with these estimates particularly for those estimates related
to products which have been recently introduced such as the Orion 4000. Warranty
claims in excess of those expected by the Company could have a material adverse
effect on the Company's business and operating results.
COMPETITION
The markets for the Company's products are intensely competitive and the
Company expects competition to increase in the future. In the broadband market,
the Company competes primarily with Digital Link, ADC Kentrox, RAD Data
Communications, 3Com's Broadband Division (previously OnStream Networks) , Xylan
and Sonoma. In the digital access market, the Company competes against
traditional CSU/DSU vendors, such as ADC Kentrox, Verilink and Digital Link, and
relatively newer
10
entrants to the market such as ADTRAN and TxPort. The Company competes to a
lesser extent with other telecommunications equipment companies. The Company
believes that its ability to compete successfully depends upon a number of
factors, including timely development of new products and features, product
quality and performance, price, announcements by competitors, experienced sales,
marketing and service organizations and evolving industry standards. The Company
believes that it generally competes favorably in these areas. However, certain
competitors have more broadly developed distribution channels and are further
along in certain emerging technologies, such as ATM and SONET. There can be no
assurance that the Company will be able to continue to compete successfully with
existing or new competitors.
In the broadband market, the Company believes that it competes favorably due
to the wide functionality of its products and its superior customer service and
support. In particular, the Orion 4000 platform has a unique WAN access
architecture that supports both cell and circuit traffic, providing flexibility
for hybrid networks. Also, the Orion 4000, in conjunction with the Mega-T and
Access-T45, provides cost effective and competitively distinctive hub and spoke
concentration. Further, the Edge products provide entry into the ATM WAN access
market and are engineered to enable service providers to offer value-added
services, including internet access, to their customers. However, sales of the
Company's broadband products could be adversely affected by slower ATM
deployment or by more rapid growth in the SONET/SDH market. Some of the
Company's competitors have developed partnerships with third parties for joint
marketing or development efforts that could place the Company at a relative
disadvantage.
In the digital access market, the Company believes that it competes
favorably due to its commitment to reliability, service and support. Since price
is increasingly important, the Company will provide competitively priced
products such as the Access-T100S. However, some of the Company's competitors
are more advanced in developing indirect sales channels which may be a
disadvantage to the Company's sales of digital access products. The Company's
digital access products could also be materially adversely affected by the
integration of CSU/DSU functionality into switches and routers, by the entry of
LAN equipment vendors into the Company's markets, or by the requirement for
alternative methods of performance monitoring for services such as frame relay.
There is also a risk to the digital access market generally from new
technologies that could displace some parts of the T1/E1 CSU/DSU product line.
For example, Asymmetrical, Symmetrical and High-Speed Digital Subscriber Line
("ADSL", "SDSL" and "HDSL") are subscriber loop technologies that can enable
service providers to deploy T1/FT1 services. These new technologies may
ultimately enlarge the total addressable market for digital access products and
services.
PROPRIETARY RIGHTS
The telecommunications equipment industry is characterized by the existence
of a large number of patents and frequent litigation based on allegations of
patent infringement. From time to time, third parties may assert exclusive
patent, copyright, trademark and other intellectual property rights to
technologies that are important to the Company. The Company has not conducted a
formal patent search relating to the technology used in its products, due in
part to the high cost and limited benefits of a formal search. In addition,
since patent applications in the U.S. are not publicly disclosed until the
patent is issued, applications may have been filed by competitors of the
Company, which could relate to the Company's products. Software comprises a
substantial portion of the technology in the Company's products. The scope of
protection accorded to patents covering software related inventions is evolving
and is subject to a degree of uncertainty which may increase the risk and cost
to the Company if the Company discovers third party patents related to its
software products or if such patents are asserted against the Company in the
future. The Company may receive communications from third parties in the future
asserting that the Company's products infringe or may infringe on the
proprietary rights of such third parties. In its distribution agreements, the
Company typically agrees to indemnify its customers for any expenses or
liability, resulting from claimed infringements of patents, trademarks or
copyrights of third parties. In the event of litigation to determine the
validity of any third party claims, such litigation, whether or not
11
determined in favor of the Company, could result in significant expense to the
Company and divert the efforts of the Company's technical and management
personnel. In the event of an adverse ruling in such litigation, the Company
might be required to discontinue the use and sale of infringing products, expend
significant resources to develop non-infringing technology or obtain licenses
from third parties. There can be no assurance that licenses from third parties
would be available on acceptable terms, if at all. A successful claim against
the Company and the failure of the Company to develop or license a substitute
technology could have a material adverse effect on the Company's business and
operating results. In addition, the laws of certain foreign countries in which
the Company's products are or may be developed, manufactured or sold may not
protect the Company's products or intellectual property rights to the same
extent as do the laws of the U.S. and thus make the possibility of
misappropriation of the Company's technology and products more likely.
EMPLOYEES
As of December 31, 1997, excluding employees of NetEdge, the Company had 258
full time employees of whom 73 were primarily engaged in research and
development, 55 in manufacturing and quality control, 69 in marketing and sales,
27 in customer service and 34 in administration and finance. The Company also
employed a total of 9 temporary and contract personnel. Full time employees
added as a result of the NetEdge acquisition were 52 which is expected to
decline to approximately 45 as a result of the elimination of duplicate
functions. A collective bargaining unit represents none of the Company's
employees nor has the Company ever experienced any work stoppage. The Company
believes its relationship with its employees is good.
MANAGEMENT
The executive officers and directors of the Company are as follows:
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------------
Deborah M. Soon 45 President, Chief Executive Officer and Director
Bruce D. Horn 46 Vice President, Finance and Chief Financial Officer
Jeffrey W. Reedy 39 Vice President, Engineering
Paul A. Strudwick 46 Vice President, Strategic Planning
George M. Donohoe 60 Executive Vice President, Network Systems Group
William H. Cory 44 Vice President, Operations
Paul E. Graf 54 Chairman of the Board (2)
Donald G. Heitt 62 Director (2)
Kevin N. Kalkhoven 52 Director (1)
Harvey L. Poppel 59 Director (1)(2)
Joseph F. Smorada 51 Director (1)
- ------------------------
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
Deborah M. Soon has served as President and Chief Executive Officer of the
Company since July 1994 and as a director since June 1996. Previously, she
served as Vice President of Marketing and Sales from June 1993 to June 1994, as
Vice President of Marketing from January 1991 to May 1993, and as Director of
Marketing from May 1990 to December 1990. Prior to joining the Company, Ms. Soon
held
12
management positions in engineering, marketing and sales with AT&T, Prime
Computers, BBN Communications Corporation and Data Architects Systems Inc. Ms.
Soon earned a BA in Mathematics from the University of California, San Diego and
an MBA from the Harvard Graduate School of Business. She has also completed
special undergraduate studies at Cambridge University in England.
Bruce D. Horn has served as Vice President of Finance and Chief Financial
Officer of the Company since January 1993. Previously, he served as Director of
Finance and Chief Financial Officer from March 1991 to December 1992. Prior to
joining the Company, Mr. Horn was Director of Finance at Insystems, Inc. and
Corporate Controller at Anicon, Inc. Mr. Horn earned a BA in Accounting from the
University of Northern Iowa and an MBA in Finance from California State
University, Hayward.
Jeffrey W. Reedy has served as Vice President of Engineering of the Company
since August 1994. Previously, he served as Vice President/Division Manager from
January 1993 to August 1994 and Director of Engineering from November 1991 to
January 1993. Prior to November 1991, Mr. Reedy was the co-founder and Vice
President of Engineering at T3 Technologies, Inc. (which was acquired by the
Company in 1991). Mr. Reedy earned a BSE in Electrical Engineering and Computer
Science from Duke University and an MSEE from Stanford University.
Paul A. Strudwick has served as Vice President of Strategic Planning since
January 1998. Previously he served as Vice President of Marketing of the Company
from August 1994 to December 1997 and as Director of Product Management from
March 1992 to August 1994. Prior to joining the Company, he was Product
Management/Marketing Consultant for PolyCom, Inc. from October 1991 to February
1992. Prior to October 1991, he was Director of Product Line Management with
Northern Telecom, Inc. and held a number of positions with Bell Northern
Research in Canada. Mr. Strudwick earned a BSc from the University of Sussex in
England.
George M. Donohoe has served as Executive Vice President responsible for the
Network Systems Group since January 1998. Previously he served as Vice President
of Sales from August 1994 to December 1997 and as Director of Telco Sales from
April 1994 to August 1994 and Western Region Sales Manager from November 1993 to
March 1994. Prior to joining the Company, Mr. Donohoe was Director of LAN
Product Sales at Teleglobe from February 1993 to October 1993, and Vice
President of Sales at Halley Systems from December 1989 to January 1993. Other
professional affiliations include Luxcom, Infinet, Honeywell Information Systems
and IBM. Mr. Donohoe earned a BS in Industrial Engineering and Management
Sciences from the University of South Dakota.
William H. Cory has served as Vice President of Operations of the Company
since February 1990. Prior to joining the Company, Mr. Cory was Director of
Quality Assurance for Verilink, Vice President for Wyken Technology, Director of
Quality Assurance for Compression Labs., Inc. and Manager of Quality Assurance
for Drivetec Inc. Mr. Cory earned a BS in Industrial Engineering and Management
Science from Northwestern University.
Donald G. Heitt has served as a director since November 1996. He has been
the Chairman of the Board of Voysys Corporation since December 1995. From April
1990 to January 1996, Mr. Heitt was the President and Chief Executive Officer of
Voysys Corporation. Prior to 1990, Mr. Heitt served as Senior Vice President of
Telebit Corporation, Vice President of Sales and Marketing and President of the
computer division of General Automation, Inc., and Vice President of Honeywell
Information Systems, Inc. Mr. Heitt earned a BBA from the University of Iowa.
Kevin N. Kalkhoven has served as a director since November 1996. He has been
the President and Chief Executive Officer of Uniphase since 1992. Mr. Kalkhoven
joined Uniphase in January 1992 and has been a member of its board of directors
since February 1992. Prior to joining Uniphase, Mr. Kalkhoven held executive
positions at a variety of software companies. He served as President and Chief
Executive
13
Officer of Demax Software and as President and Chief Executive Officer of AIDA
Corporation. Previously, he was Vice President of Marketing for the European
division of Comshare Corporation and Group Vice President for its U.S.
subsidiary.
Paul E. Graf has served as Chairman of the Board of Directors of the Company
since June 1990. Mr. Graf has served as President and Chief Executive Officer
for Axel Johnson since 1989. Prior to joining Axel Johnson, Mr. Graf held
various senior executive positions with Schroders, a venture capital company,
Conrac Corporation and Texas Instruments. Mr. Graf earned a BS in Electrical
Engineering from Rensselear Polytechnic Institute and an MBA from Boston
University.
Harvey L. Poppel has served as a director since November 1996. He served as
Managing Director at Broadview Associates L.L.C. from January 1985 until his
retirement in December 1996 and as President of Poptech, Inc. since 1984.
Previously, he was Senior Vice President, Board Member and Managing Officer of
the Information Industry Practice at Booz, Allen & Hamilton and managed
communications software development at both Western Union and Westinghouse
Electric. He also is a director of Cotelligent Group, Inc., a professional
services firm. Mr. Poppel holds an MS and a BS from Rensselear Polytechnic
Institute.
Joseph F. Smorada has served as a Director of the Company since June 1992.
Mr. Smorada has served as Senior Vice President and Chief Financial Officer of
Axel Johnson since April 1992. Prior to joining Axel Johnson, Mr. Smorada was
Senior Vice President and Chief Financial Officer for Lone Star Industries, Inc.
from September 1988 to April 1992. Prior to 1988, Mr. Smorada held senior
executive positions with Conrac Corporation and Continental Group, Inc. Mr.
Smorada earned a BA in Economics from California University of Pennsylvania.
ITEM 2. PROPERTIES
In September 1997, the Company moved into a new 119,000 square foot leased
facility located in Milpitas, California. The Company is using approximately
80,000 square feet of the new facility and the remainder is sublet. The company
vacated its previous premises in Santa Clara, California. All of the Company's
manufacturing, sales and marketing, customer service and administration and some
research and development are performed at the Company's Milpitas facility.
In connection with the acquisition of NetEdge, the company assumed their
lease for 40,000 square feet in Research Triangle Park (RTP), North Carolina.
After the transition of the manufacturing and administration of NetEdge to
Milpitas, the company expects to vacate its existing facility in RTP, comprising
16,000 square feet, and relocate to the new facility. The old facility in RTP
will be subleased to new tenants through the end of its term. The new facility
in RTP will primarily be used for research and development with some marketing
personnel. The Company also leases space for small sales offices throughout the
U.S. and has one sales office in the UK.
In March 1998, the Company sold its interest in a partnership from whom it
leased its previous facility until September 1997 for gross proceeds of
$1,700,000.
The Company believes that its existing facilities are adequate for its
current needs and that additional space will be available as required.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of stockholders during the quarter ended
December 31, 1997.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company made its initial public offering ("IPO") of Class A Common Stock
on December 18, 1996, at $12.00 per share, and the Class A Common Stock of the
Company began trading in the over-the-counter market on the NASDAQ National
Market on December 19, 1996, under the symbol "LARS." The following table sets
forth the high and low sales prices for the Company's Class A Common Stock as
reported on the NASDAQ National Market from December 19, 1996 through December
31, 1997. These prices reflect inter-dealer prices, without retail mark-up,
markdown or commission, and may not necessarily represent actual transactions.
HIGH LOW
---------- -----------
December 19 to December 31, 1996............................................ $ 12 $ 111/8
1997
First quarter............................................................. $ 153/8 $ 81/8
Second quarter............................................................ $ 133/8 $ 6
Third quarter............................................................. $ 113/8 $ 71/16
Fourth quarter............................................................ $ 133/8 $ 71/2
As of February 28, 1998, there were 33 holders of record of the Company's
Class A Common Stock and 1 holder of record of the Company's Class B Common
Stock. The Company had an estimated 3,170 beneficial holders of its Class A
Common Stock as of March 4, 1998.
The Company received net proceeds of $67,106,000 in December 1996 and
January 1997 from its IPO.
From December 18, 1996, the effective date of the Registration Statement, to
December 31, 1997, net proceeds were used for the payment of a note and accrued
interest of $25,627,000, capital expenditures of approximately $1,515,000,
working capital of approximately $17,571,000 and general corporate expenses of
approximately $22,393,000. None of such payments consisted of direct or indirect
payments to directors, officers, 10% stockholders or affiliates of the Company
except the note and accrued interest paid of $25,627,000 to Axel Johnson, Inc.
The Company currently intends to retain any future earnings for use in its
business and does not anticipate paying any cash dividends in the foreseeable
future.
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues................................................... $ 75,955 $ 66,444 $ 48,663 $ 36,550 $ 39,035
Cost of revenues........................................... 32,718 29,949 21,147 15,037 14,989
--------- --------- --------- --------- ---------
Gross profit........................................... 43,237 36,495 27,516 21,513 24,046
--------- --------- --------- --------- ---------
Operating expenses:
Research and development................................. 9,943 8,123 7,143 6,703 6,269
Selling, general and administrative...................... 21,145 19,408 15,762 13,385 13,629
In-process research and development charge related to
acquisition............................................ 20,120 -- -- -- --
--------- --------- --------- --------- ---------
Total operating expenses............................... 51,208 27,531 22,905 20,088 19,898
--------- --------- --------- --------- ---------
Operating income (loss).................................... (7,971) 8,964 4,611 1,425 4,148
Non-operating income (expense), net........................ 1,726 (597) 3 9 --
--------- --------- --------- --------- ---------
Income (loss) before income taxes.......................... (6,245) 8,367 4,614 1,434 4,148
Income tax provision (benefit)............................. (2,486) 3,437 2,085 773 1,853
--------- --------- --------- --------- ---------
Net income (loss).......................................... $ (3,759) $ 4,930 $ 2,529 $ 661 $ 2,295
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic and diluted earnings (loss) per share................ $ (0.21) $ 0.41 $ 0.21 $ 0.06 $ 0.19
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic and diluted weighted average shares.................. 18,078 12,170 11,900 11,900 11,900
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Cash dividends per share................................... $ -- $ 2.10 $ -- $ -- $ --
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Shares used to compute cash dividends per share............ -- 11,900 -- -- --
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
DECEMBER 31,
-----------------------------------------------------
1997 1996 1995 1994 1993
--------- --------- --------- --------- ---------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Working capital............................................ $ 33,911 $ 55,944 $ 8,605 $ 7,520 $ 7,620
Total assets............................................... 87,910 73,043 25,739 21,772 19,526
Total stockholders' equity................................. 62,227 61,445 18,236 15,707 15,046
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXCEPT FOR THE HISTORICAL STATEMENTS CONTAINED HEREIN, THIS ANNUAL REPORT ON
FORM 10-K 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, INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE
COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS, OR STRATEGIES REGARDING THE FUTURE.
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 RISK FACTORS" AND ELSEWHERE IN THIS FORM 10-K.
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.
Over the past several years, Larscom has transitioned its business from
supplying single purpose T1 and FT1 wide area network customer premises
equipment ("CPE") to Fortune 500 corporations, to providing high speed network
access platform solutions predominantly to NSPs. From 1986 through 1991, Larscom
engaged primarily in the development, marketing and support of T1 CSU/DSUs and
T1 diagnostic equipment. In October 1991, the Company acquired T3 Technologies
Inc. ("T3T"), a broadband products company. The first broadband products
developed by Larscom after the acquisition of T3T were the Access T45, one of
the first T3 DSUs, and the Mega-T, the first multiple T1 inverse multiplexer.
Since then, the Company has invested significant resources in developing a suite
of broadband capabilities for the Orion 4000 platform. Sales related to the
Company's broadband products--Access T45, EtherSpan, Mega-T and Orion
4000--represented 40% and 31% of total revenues in 1997 and 1996, respectively.
In December 1997, the Company completed the acquisition of NetEdge further
expanding its broadband product line.
A small number of customers, consisting of NSPs and resellers, have
accounted for a majority of the Company's revenues in each of the past several
years. Sales to the Company's top five customers accounted for 54%, 52%, and 48%
of revenues in 1997, 1996 and 1995, respectively. Sales to NSPs represented 63%,
62% and 48% in 1997, 1996 and 1995, respectively.
Sales to NSPs and resellers are often difficult to forecast due to the
relatively long sales cycle and acceleration or delays in the timing of specific
equipment deployment projects for which the NSP or reseller is acquiring
equipment. The Company has experienced fluctuations in both annual and quarterly
revenues due to the timing of receipt of customer orders as well as decisions
from time to time by major customers to cease marketing, purchasing and
reselling the Company's products. Since the Company continues to have
significant sales to a small number of customers, similar sales fluctuations may
occur in the future.
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 ability to
predict revenues is limited. In addition, announcements by the Company or its
competitors of new products and technologies could cause customers to defer
purchases of the Company's existing products. In the event that anticipated
orders from major customers fail to materialize, or delivery schedules are
deferred or canceled as a result of the above factors or other unanticipated
factors, the Company's business and operating results could be materially
adversely affected.
The Company establishes its expenditure levels for product development and
other operating expenses based on projected sales levels and margins, however,
expenses are relatively fixed in the short term. Accordingly, if sales are below
expectations in any given period, the adverse impact of the revenue shortfall on
the Company's operating results may be greater due to the Company's inability to
adjust spending in the short term to compensate for the shortfall. As a result,
the Company believes that period-
17
to-period comparisons of its operating results are not necessarily meaningful
and should not be relied upon as indicative of future performance.
The Company sells its products primarily through a direct sales force and to
a lesser extent through a variety of resellers, including OEMs, VARs, systems
integrators and distributors. Sales outside the U.S. have not been significant
to date.
On December 2, 1997, Larscom entered into an Agreement and Plan of
Reorganization ("the Agreement"). The agreement provided for the merger of a
wholly-owned subsidiary of the Company with and into NetEdge Systems Inc.
("NetEdge") a privately-held designer and manufacturer of ATM edge access
equipment, headquartered in Research Triangle Park, North Carolina, which was
consummated on December 31, 1997. The total merger consideration paid by Larscom
consisted of $25,793,000 in cash and acquisition costs of $1,182,000. The
transaction was accounted for as a purchase and, on this basis, the excess
purchase price over the estimated fair value of the tangible assets acquired and
liabilities assumed has been allocated to various intangible assets, primarily
consisting of in-process research and development, current technology,
trademarks and goodwill based on an independent third-party valuation. The
Company recorded a charge to earnings of $20.1 million for acquired in-process
research and development related to NetEdge.
RESULTS OF OPERATIONS
The following table sets forth the percentage of revenues represented by
certain items in the Company's consolidated statements of operations for the
periods indicated:
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
Revenues........................................................... 100% 100% 100%
Cost of revenues................................................... 43 45 43
--- --- ---
Gross profit................................................... 57 55 57
--- --- ---
Operating expenses:
Research and development......................................... 13 12 15
Selling, general and administrative.............................. 28 29 33
In-process research and development charge related to
acquisition.................................................... 26 -- --
--- --- ---
Total operating expenses....................................... 67 41 48
--- --- ---
Operating income (loss)............................................ (10) 14 9
Non-operating income (expense), net................................ 2 (1) --
--- --- ---
Income (loss) before income taxes.................................. (8) 13 9
Income tax provision (benefit)..................................... (3) 6 4
--- --- ---
Net income (loss).................................................. (5)% 7% 5%
--- --- ---
--- --- ---
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES. Revenues increased 14% to $75,955,000 in 1997 from $66,444,000 in
1996. The growth in revenues reflected increased sales of the Company's
broadband products, particularly the Orion 4000, which were partially offset by
a small decrease in sales of digital access products. Sales to NSPs continue to
account for an increasing percentage of total revenue. The Company expects sales
of broadband products to increase both on an absolute basis and as a percentage
of revenues due to increased sales of the Edge product line and increases in
sales of Orion 4000 products.
18
GROSS PROFIT. As a percentage of revenues, gross profit increased to 57% in
1997 from 55% in 1996. This increase was primarily a result of changes in
revenue mix to higher margin broadband products and to a lesser extent lower per
unit material costs, offset by declining prices of digital access products.
Gross profits in 1998 and future years, as compared to 1997, will be reduced by
$1,718,000 due to the annual amortization of purchased technology related to the
acquisition of NetEdge. Gross profits as a percentage of revenues will also
fluctuate depending upon a number of other factors, but primarily as a result of
changes in product mix, discounts given and changes in production volume. The
Company is continuing to seek to increase broadband product sales and to reduce
the cost of its broadband products as well as its digital access products. There
can be no assurance that such efforts will be sufficient to offset the
anticipated decline in the average selling prices of both broadband and digital
access products.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 22%
to $9,943,000 in 1997 from $8,123,000 in 1996. As a percentage of revenues,
research and development expenses increased to 13% in 1997 from 12% in 1996
primarily due to increased headcount working on both the broadband and digital
access product lines. The Company believes that a continued commitment to
research and development, particularly related to broadband products and
emerging technologies in response to customer demands, will be required to
remain competitive, although research and development as a percentage of
revenues should remain relatively constant.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 9% to $21,145,000 in 1997 from $19,408,000 in 1996. As a
percentage of revenues, selling, general and administrative expenses declined to
28% in 1997 from 29% in 1996. The increase in absolute dollars was due primarily
to additional personnel costs in the sales, marketing and administrative
functions. This was offset by lower commissions and amortization expense.
Selling, general and administrative expenses also include a charge from Axel
Johnson for legal, accounting, tax, treasury and administrative services. For
1997 and 1996, these charges were approximately $622,000 and $527,000,
respectively. The Company anticipates that selling, general and administrative
expenses will increase in absolute dollars in the future as a result of the
Company's continued investment in the expansion of its sales, service and
support organizations, the development of its distribution channels
(particularly outside the United States) and the acquisition of NetEdge. The
Company expects these costs to be partially offset by reductions in the charge
for administrative services from Axel Johnson.
IN-PROCESS RESEARCH AND DEVELOPMENT. In-process research and development
represents charges incurred as a result of the Company's acquisition of NetEdge
in December 1997. See Footnote 9 of the Notes to the Consolidated Financial
Statements for additional information.
NON-OPERATING INCOME (EXPENSE), NET. Net non-operating income of $1,726,000
during 1997 principally represents federal income tax exempt interest from the
Company's cash equivalents and short-term investments. The expense during 1996
of $597,000 primarily represents interest charged on the $25,000,000 note
payable to Axel Johnson, which was paid with the proceeds of the initial public
offering.
INCOME TAXES PROVISION (BENEFIT). The effective tax benefit rate for 1997
of 40% differs from the federal statutory rate of 34% primarily as a result of
state taxes. As a result of the acquisition of NetEdge, the Company recorded a
deferred tax asset of $7,480,000 related to the Company's in-process research
and development charge discussed above. The Company believes that recovery of
its deferred tax assets is more likely than not and accordingly has not
established any valuation allowance against it. In future periods, if it is
anticipated that the Company is not able to generate sufficient taxable profits
to recover its deferred tax assets it will necessary to record a valuation
allowance against this asset which could have a significant impact on earnings.
The effective tax rate of 41% for 1996 differed from the federal statutory rate
as a result of non-deductible goodwill amortization and state taxes.
19
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES. Revenues increased 37% to $66,444,000 in 1996 from $48,663,000 in
1995. The growth in revenues reflected increased sales across the Company's
product lines, particularly sales of broadband products such as the Access T45
and Orion 4000 to NSPs.
GROSS PROFIT. As a percentage of revenues, gross profit declined to 55% in
1996 from 57% in 1995. This decrease was primarily the result of lower average
unit selling prices of digital access products, partially offset by increased
sales of higher margin broadband products.
RESEARCH AND DEVELOPMENT. Research and development expenses increased 14%
to $8,123,000 in 1996 from $7,143,000 in 1995. As a percentage of revenues,
research and development expenses declined to 12% in 1996 from 15% in 1995 due
to increased revenues which were offset by an increase in research and
development expenses. The increase in research and development expenses in 1996
was due primarily to a 45% increase in headcount during 1996, as well as
increased costs associated with product safety and country specific product
certification.
SELLING, GENERAL AND ADMINISTRATIVE. Selling, general and administrative
expenses increased 23% to $19,408,000 in 1996 from $15,762,000 in 1995. As a
percentage of revenues, selling, general and administrative expenses declined to
29% in 1996 from 33% in 1995. The increase in absolute dollars was due to
additional personnel costs associated with expansion of the Company's sales and
marketing resources, as well as higher selling expenses associated with higher
revenues. Selling, general and administrative expenses included the amortization
of goodwill of approximately $356,000 and $988,000 during 1996 and 1995,
respectively, related to the acquisition of Larscom by Axel Johnson in 1987 and
the acquisition of T3T by Larscom in 1991. Goodwill relating to these
acquisitions was fully amortized as of December 31, 1996. Selling, general and
administrative expenses also include a charge from Axel Johnson for legal,
accounting, tax, treasury and administrative services. For 1996 and 1995, these
charges were approximately $527,000 and $549,000, respectively.
NON-OPERATING INCOME (EXPENSE), NET. Net non-operating expense during 1996
of $597,000 primarily represents interest charged on the $25,000,000 note
payable to Axel Johnson, which was paid with the proceeds of the initial public
offering.
PROVISION FOR INCOME TAXES. The effective tax rates of 41% and 45% for 1996
and 1995, respectively, differed from the federal statutory rates as a result of
non deductible goodwill amortization and state taxes, offset in part by research
and development tax credits in 1995. The effective tax rate decreased in 1996 as
the non-deductible items constituted a relatively lower percentage of pre-tax
income during that period.
LIQUIDITY AND CAPITAL RESOURCES
Since its acquisition by Axel Johnson in 1987 and until its initial public
offering in December 1996, the Company met its operating and capital
requirements primarily from cash flow from operations and advances from Axel
Johnson.
The Company's operating activities generated $3,829,000 in cash in 1997.
Cash generated by operations was primarily the result of net income, before the
in-process research and development charge, and increases in accounts payable,
offset by increases in accounts receivable and inventory. Operating activities
generated $4,710,000 of cash in 1996 primarily as a result of net income and
increases in accrued expenses and other liabilities, offset by increases in
accounts receivable and inventories.
On December 18, 1996, the Company sold 5,800,000 shares of Class A Common
Stock at a price per share of $12 in its initial public offering. During 1996,
net proceeds of the offering were $63,279,000 after issuance costs of $1,449,000
and the underwriting discount of $4,872,000. In January 1997, the underwriters
exercised their option to sell an additional 350,000 shares and the Company
received net proceeds of $3,827,000.
20
In December 1996, the Company entered into a credit agreement with Axel
Johnson ("the Credit Agreement") under which the Company has available a
revolving line of credit of $15,000,000. 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 utilize 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. See Footnotes 1 and 3 of the Notes to the
Consolidated Financial Statements.
In December 1997, the Company paid cash of $25,793,000 and incurred
acquisition costs of $1,182,000 to purchase NetEdge. The transaction was
accounted for as a purchase and, on this basis, the excess purchase price over
the estimated fair value of the tangible assets acquired and liabilities assumed
has been allocated to various intangible assets, primarily consisting of
in-process research and development, current technology, trademarks and goodwill
based on an independent third-party valuation. The Company estimated that the
useful economic lives of the current technology, trademarks and goodwill were
five, seven and six years, respectively. The Company recorded a charge to
earnings of $20.1 million for acquired in-process research and development
related to NetEdge.
Capital expenditures in 1997 of $4,645,000 were principally for the purchase
of computers, software and test equipment as well as leasehold improvements on
the new building occupied in September 1997. The Company expects capital
expenditures during 1998 to be approximately $4,500,000.
The Company believes that working capital together with the Company's line
of credit and funds generated from operations will provide adequate liquidity to
meet the Company's operating and capital requirements at least through 1998.
There can, however, be no assurance that future events, such as the potential
use of cash to fund acquisitions, will not require the Company to seek
additional capital at an earlier date or, if so required, that adequate capital
will be available on terms acceptable to the Company, or at all.
The effects of inflation on the Company's revenues and operating income have
not been material.
21
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" ("SFAS 130") and Statement No. 131,
"Disclosures About Segments of An Enterprise and Related Information" ("SFAS
131"). SFAS 130 established rules for reporting and displaying comprehensive
income. SFAS 131 will require the Company to use the "management approach" in
disclosing segment information. Both statements are effective for the Company
during 1998. The Company does not believe that the adoption of either SFAS 130
or SFAS 131 will have a material impact on the Company's results of operations,
cash flows or financial position.
CERTAIN RISK FACTORS
YEAR 2000 COMPLIANCE. The Company is aware of the issues associated with
the programming code in existing computer systems as the millennium ("Year
2000") approaches. The Year 2000 problem is pervasive and complex as virtually
every computer operation could be affected in some way by the rollover of the
two-digit year value to 00. Systems that do not properly recognize date
sensitive information when the year changes to 2000 could generate erroneous
data or cause a system to fail. Significant uncertainty exists concerning the
potential effects associated with such compliance. Larscom products use a
two-digit year value rather than a four digit value. Based on preliminary tests
performed on products that account for substantially all of our revenues we
believe that there will be no significant impact as the year changes from 1999
to 2000. This is because the date carried in the internal workings of the
Company's products do not affect the operation of the networks of which these
products are a part. The Company is in the process of performing additional
testing procedures to clarify any other issues that may exist related to the
Year 2000 but does not believe that the costs of this testing will be material
or that the costs of potential changes to products will be material. Any failure
of the Company's products to perform, including system malfunctions due to the
onset of the calendar year 2000, could result in claims against the Company,
which could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company is also currently in the process of evaluating its information
technology infrastructure for Year 2000 compliance, including reviewing what
actions are required to make all software systems used internally Year 2000
compliant as well as actions needed to mitigate vulnerability to problems with
suppliers and other third parties' systems. The Company is assessing the extent
of the necessary modifications to its computer software, and management does not
anticipate that the Company will incur significant operating expenses or be
required to invest heavily in computer system improvements to be Year 2000
compliant. There can be no assurance that such measures will alleviate the Year
2000 problems which could have a material adverse effect upon the Company's
business, operating results and financial condition.
CUSTOMER CONCENTRATION. The Company believes that its relationships with
large customers, particularly the NSPs and telecommunications companies, will be
critical to its future success. A small number of customers have accounted for a
majority of the Company's revenues in each of the past several years. In 1997,
1996 and 1995, NSPs and ISPs represented 63%, 62% and 48%, respectively, of
total revenues and the Company's top five customers accounted for 54%, 52%, and
48% of revenues in 1997, 1996 and 1995, respectively. None of the Company's
customers are contractually obliged to purchase any quantity of products in any
particular period, and product sales to major customers have varied widely from
quarter to quarter and year to year. There can be no assurance that the
Company's current customers will continue to place orders with the Company, that
orders from existing customers will continue at the levels of previous periods
or that the Company will be able to obtain orders from new customers. Loss of,
or a material reduction in orders by, one or more of the Company's major
customers could have a material adverse effect on the Company's business and
operating results.
22
DEPENDENCE ON RECENTLY INTRODUCED PRODUCTS AND PRODUCTS UNDER
DEVELOPMENT. The Company's future operating results are highly dependent on
continuing market acceptance of the Company's newest products, particularly in
the broadband area. Broadband product sales represented 40% of revenues during
1997 and are expected to continue to increase as a percentage of overall
revenues in the longer term although the proportion of broadband sales to total
revenues may vary from quarter to quarter. There can be no assurance that these
products or any future products will continue to achieve widespread market
acceptance. In addition, the Company has in the past experienced delays in the
development of new products and the enhancement of existing products, and such
delays may occur in the future. The Company's potential inability to develop and
introduce new products or versions in a timely manner, due to resource
constraints or technological or other reasons, or to achieve timely and
widespread market acceptance of its new products or releases could have a
material adverse effect on the Company's business and operating results.
DEPENDENCE ON COMPONENT AVAILABILITY AND KEY SUPPLIERS. On-time delivery of
the Company's products depends upon the availability of components and
subsystems used in its products. The Company depends upon its suppliers to
manufacture, assemble and deliver components in a timely and satisfactory
manner. The Company obtains components and licenses certain embedded software
from numerous single sources. Other than components and software supplied by
Waferscale, Vicor, Xilinx and PMC-Sierra, the Company believes it would be able
to develop alternative sources for components and software used in its products
without incurring substantial additional costs. However, there can be no
assurance that the inability of the Company to develop alternative sources, if
required, an inability by such suppliers to meet the Company's demand or a
prolonged interruption in supply or a significant price increase of one or more
components or software will not occur, each of which could have a material
adverse effect on the Company's business and operating results. The Company
generally does not have any long-term contracts with such suppliers. There can
be no assurance that these suppliers will continue to be able and willing to
meet the Company's requirements. Any significant interruption in the supply or
degradation in the quality of any such item could have a material adverse effect
on the Company's business and operating results.
RAPID TECHNOLOGICAL CHANGE. The telecommunications equipment industry is
characterized by rapidly changing technologies and frequent new product
introductions. The rapid development of new technologies increases the risk that
current or new competitors could develop products that would reduce the
competitiveness of the Company's products. The Company's success will depend to
a substantial degree upon its ability to respond to changes in technology and
customer requirements. This will require the timely selection, development and
marketing of new products and enhancements on a cost effective basis. There can
be no assurance that the Company will be successful in developing, introducing
or managing the transition to new or enhanced products or that any such products
will be responsive to technological changes or will gain market acceptance. If
the Company were to be unsuccessful or to incur significant delays in developing
and introducing such new products or enhancements, the Company's business and
operating results could be materially adversely affected.
LIMITED INDEPENDENT OPERATING HISTORY. The Company has been a wholly owned
subsidiary of Axel Johnson since 1987 until the date of the Company's IPO and
accordingly, has had limited independent operating history. The Company will be
required to further develop financial, management, administrative and other
resources previously provided by Axel Johnson which are necessary to operate
successfully as an independent public company. Although the Company and Axel
Johnson have entered into several agreements that are intended to ease the
Company's transition to an independent public company, there can be no assurance
that the Company will be able to manage this transition or to develop these
independent resources successfully. The Company has access, subject to certain
conditions, to a $15,000,000 credit facility provided by Axel Johnson, however
there can be no assurance that alternative sources of financing will be
available upon the expiration or termination of such facility or that additional
sources of funding will be available on terms favorable to the Company if the
Company's borrowing requirements exceed the amount of the facility.
23
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS; ABSENCE OF SIGNIFICANT
BACKLOG. The Company's operating results have fluctuated significantly in the
past and may fluctuate in the future on a quarterly and annual basis as a result
of a number of factors, many of which are beyond the Company's control. The
Company's sales historically have been concentrated in a small number of
customers. Therefore, sales for a given quarter may depend to a significant
degree upon product shipments to a limited number of customers. Sales to
individual large customers are often related to the customer's specific
equipment deployment projects, the timing of which are subject to change on
limited notice. The Company has experienced both acceleration and slowdown in
orders related to such projects, causing changes in the sales level of a given
quarter relative to both the preceding and subsequent quarters. For example,
since 1994 sales to MCI, IBM/Advantis, AT&T, UUNET and other current customers
have occasionally varied by up to $1.2 million from quarter to quarter. Since
most of the Company's sales are in the form of large orders with short delivery
times to a limited number of customers, the Company's backlog and consequent
ability to predict revenues is limited. In addition, announcements by the
Company or its competitors of new products and technologies could cause
customers to defer purchases of the Company's existing products. In the event
that anticipated orders from major customers fail to materialize, or delivery
schedules are deferred or canceled as a result of the above factors or other
unanticipated factors, the Company's business and operating results could be
materially adversely affected. As a result, the Company believes that period to
period comparisons of its operating results are not necessarily meaningful and
should not be relied upon as indicative of future performance.
The Company's backlog at any point in time is typically limited.
Accordingly, sales in any quarter are largely dependent on orders received
during that quarter. Furthermore, the Company's agreements with its customers
typically provide that they may change delivery schedules and cancel orders
within specified timeframes, typically up to 30 days prior to the scheduled
shipment date, without penalty. The Company's customers have in the past built,
and may in the future build, significant inventory to facilitate more rapid
deployment of anticipated major projects or for other reasons. Decisions by such
customers to reduce their inventory levels could lead to reductions in purchases
from the Company. Therefore, customer decisions to delay delivery, cancel orders
or reduce purchases could have a material adverse effect on the Company's
business and operating results.
The Company's gross margin is affected by a number of factors, including
product mix, product pricing, cost of components, manufacturing costs and
amortization of certain intangible assets. For example, a price reduction of a
particular product in response to competitive pressure which is not offset by a
reduction in production costs or by sales of other products with higher gross
margins would decrease the Company's overall gross margin and could have a
material adverse effect on the Company's business and operating results. The
Company's anticipated increase in overall spending in future periods in order to
pursue new market opportunities might also affect operating margins. The Company
establishes its expenditure levels for product development and other operating
expenses based on projected sales levels and margins, however, expenses are
relatively fixed in the short term. Accordingly, if sales are below expectations
in any given period, the adverse impact of the revenue shortfall on the
Company's operating results may be greater due to the Company's inability to
adjust spending in the short term to compensate for the shortfall.
Results in any period could also be affected by changes in market demand,
competitive market conditions, market acceptance of new or existing products,
the cost and availability of components, the mix of the Company's customer base
and sales channels, the mix of products sold, sales promotion activities by the
Company, the Company's ability to expand its sales and marketing organization
effectively, the Company's ability to attract and retain key technical and
managerial employees and general economic conditions. Due to all of the
foregoing factors, the Company's operating results in one or more future periods
may be subject to significant fluctuations. In the event this results in the
Company's financial performance being below the expectations of public market
analysts and investors, the price of the Company's Class A Common Stock could be
materially adversely affected.
24
CONTROL BY AXEL JOHNSON. Holders of Class A Common Stock are entitled to
one vote per share and holders of Class B Common Stock are entitled to four
votes per share, subject to adjustment, to preserve the initial voting ratio.
Axel Johnson is the sole holder of the Class B Common Stock. As a result, Axel
Johnson has sufficient voting power to control the direction and policies of the
Company, including mergers, the payment of dividends, consolidations, the sale
of all or substantially all of the assets of the Company and the election of the
Board of Directors of the Company, and to prevent or cause a change in control
of the Company. In addition, the authorized but unissued capital stock of the
Company includes 5,000,000 shares of preferred stock (the "Preferred Stock").
The Board of Directors is authorized to provide for the issuance of Preferred
Stock in one or more series and to fix the designations, preferences, powers and
relative, participating, optional or other rights and restrictions thereof.
Accordingly, the Company may issue a series of Preferred Stock in the future
that will have preference over both classes of the Company's Common Stock with
respect to the payment of dividends and upon liquidation, dissolution or winding
up or which could otherwise adversely affect holders of the Common Stock or
discourage or make difficult any attempt to obtain control of the Company. Such
control may have the effect of discouraging certain types of transactions
involving an actual or potential change of control of the Company, including
transactions in which the holders of Class A Common Stock might otherwise
receive a premium for their shares over the then current market price.
RISKS ASSOCIATED WITH ENTRY INTO INTERNATIONAL MARKETS. The Company has had
minimal sales to international customers to date, and has had little experience
in international markets. The Company believes that international sales will
increase due in large part to the acquisition of NetEdge and also to increased
international sales of the Company's existing products. The conduct of business
outside the U.S. is subject to certain risks, including unexpected changes in
regulatory requirements and tariffs, difficulties in staffing and managing
foreign operations, longer payment cycles, greater difficulty in accounts
receivable collection, currency fluctuations, expropriation and potentially
adverse tax consequences. In addition, in order to sell its products
internationally, the Company must meet standards established by
telecommunications authorities in various countries, as well as recommendations
of the International Telecommunications Union. A delay in obtaining, or the
failure to obtain, certification of its products in countries outside the U.S.
could deny or preclude the Company's marketing and sales efforts in such
countries, which could have a material adverse effect on the Company's business
and operating results.
MANAGEMENT OF EXPANDING OPERATIONS. The growth in the Company's business
has placed a significant strain on the Company's personnel, management and other
resources, and is expected to continue to do so. In order to manage any future
expansion effectively, the Company must attract, train, motivate and manage new
employees successfully, integrate new management and employees into its overall
operations and continue to improve its operational, financial and management
systems, particularly as the Company continues to transition from services
previously provided by Axel Johnson. Availability of qualified sales and
technical personnel is limited, and competition for experienced sales and
technical personnel in the telecommunications equipment industry is intense.
Moreover, the Company expects to increase significantly the size of its domestic
and international sales support staff and expand the scope of its sales and
marketing activities. The Company's failure to manage any expansion effectively,
including the above factors, could have a material adverse effect on the
Company's business and operating results.
COMPLIANCE WITH REGULATIONS AND EVOLVING INDUSTRY STANDARDS. The market for
the Company's products is characterized by the need to meet a significant number
of communications regulations and standards, some of which are evolving as new
technologies are deployed. In the U.S. the Company's products must comply with
various regulations defined by the Federal Communications Commission and
standards established by Underwriters Laboratories, as well as industry
standards established by various organizations. As standards for new services
such as ATM evolve, the Company may be required to modify its existing products
or develop and support new versions of its products. The failure of the
Company's products to comply, or delays in compliance, with the various existing
and evolving industry standards
25
could delay introduction of the Company's products, which in turn could have a
material adverse effect on the Company's business and operating results.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS. An important element of the
Company's strategy is to review acquisition prospects that would complement its
existing product offerings, augment its market coverage, enhance its
technological capabilities or offer growth opportunities. The Company has no
current agreements or negotiations underway with respect to any such
acquisitions. Future acquisitions by the Company could result in potentially
dilutive issuances of equity securities and/or the incurrence of debt and the
assumption of contingent liabilities, any of which could have a material adverse
effect on the Company's business and operating results and/or the price of the
Company's Class A Common Stock. In this regard, as a result of the ownership
interest of Axel Johnson in the Company, the Company will not be able to use
pooling of interests accounting for any future acquisition. Accordingly, such
acquisitions could result in amortization of goodwill and other charges
(including the immediate write-off of purchased research and development in
process) typically associated with purchase accounting. Acquisitions entail
numerous risks, including difficulties in the assimilation of acquired
operations, technologies and products, diversion of management's attention from
other business concerns, risks of entering markets in which the Company has
limited or no prior experience and potential loss of key employees of acquired
organizations. The Company's management has limited prior experience in
assimilating acquired organizations. No assurance can be given as to the ability
of the Company to successfully integrate any businesses, products, technologies
or personnel that might be acquired in the future, and the failure of the
Company to do so could have a material adverse effect on the Company's business
and operating results.
RISKS ASSOCIATED WITH THE ACQUISITION OF NETEDGE. In addition to risks
described under "--Risks Associated with Potential Acquisitions," the Company
faces significant risks associated with its recent acquisition of NetEdge. There
can be no assurance that the Company will realize the desired benefits of this
acquisition. In order to successfully integrate NetEdge, the Company must, among
other things, continue to attract and retain key personnel, integrate the
acquired products from both engineering and sales and marketing perspectives,
and consolidate facilities. Difficulties encountered in the integration process
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company used purchase accounting in connection with the acquisition of
NetEdge, resulting in a charge to be taken each of the next five to seven years
for the amortization of intangible assets. As a result, the Company expects that
the acquisition will be dilutive to earnings in 1998.
LIMITED PROTECTION OF INTELLECTUAL PROPERTY; PROPRIETARY INFORMATION. The
Company relies upon a combination of trade secrets, contractual restrictions,
copyrights, trademark laws and patents to establish and protect proprietary
rights in its products and technologies. Although the Company has been issued
only one U.S. patent to date, it believes that the success of its business
depends primarily on its proprietary technology, information and processes and
know-how, rather than patents. Much of the Company's proprietary information and
technology is not patented and may not be patentable. There can be no assurance
that the Company will be able to protect its technology or that competitors will
not be able to develop similar technology independently. The Company has entered
into confidentiality and invention assignment agreements with all of its
employees, and enters into non-disclosure agreements with its suppliers,
distributors and appropriate customers so as to limit access to and disclosure
of its proprietary information. There can be no assurance that these statutory
and contractual arrangements will deter misappropriation of the Company's
technologies or discourage independent third-party development of similar
technologies. In the event such arrangements are insufficient, the Company's
business and operating results could be materially adversely affected.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
26
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Larscom Incorporated
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of cash flows and of stockholders' equity
present fairly, in all material respects, the financial position of Larscom
Incorporated and its subsidiaries at December 31, 1997 and 1996, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ Price Waterhouse LLP
PRICE WATERHOUSE LLP
San Jose, California
January 21, 1998, except for Note 10
which is as of March 25, 1998.
27
LARSCOM INCORPORATED
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
DECEMBER 31,
--------------------
1997 1996
--------- ---------
Current assets:
Cash and cash equivalents................................................................. $ 8,254 $ 46,403
Short-term investments.................................................................... 16,598 --
Accounts receivable, net.................................................................. 17,070 9,478
Inventories............................................................................... 13,328 8,654
Deferred income taxes..................................................................... 2,741 2,026
Prepaid expenses and other current assets................................................. 1,285 722
--------- ---------
Total current assets.................................................................... 59,276 67,283
Property and equipment, net................................................................. 9,703 5,530
Intangible assets, net...................................................................... 10,658 92
Deferred income taxes....................................................................... 8,062 --
Other assets................................................................................ 211 138
--------- ---------
Total assets............................................................................ $ 87,910 $ 73,043
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of capital lease obligations.............................................. $ 341 $ --
Accounts payable.......................................................................... 8,219 2,569
Accrued expenses and other current liabilities............................................ 13,562 7,441
Due to Axel Johnson....................................................................... 3,243 1,329
--------- ---------
Total current liabilities............................................................... 25,365 11,339
Capital lease obligations................................................................... 208 --
Deferred income taxes....................................................................... -- 259
Other non-current liabilities............................................................... 110 --
--------- ---------
Total liabilities....................................................................... 25,683 11,598
--------- ---------
Commitments and contingencies (Notes 7 and 8)
Stockholders' equity:
Preferred Stock, $0.01 par value; 5,000 shares authorized; no shares issued or
outstanding............................................................................. -- --
Class A Common Stock, $0.01 par value; 100,000 shares authorized; 8,137 and 7,000 shares
issued and outstanding, respectively.................................................... 81 70
Class B Common Stock, $0.01 par value; 11,900 shares authorized; 10,000 and 10,700 shares
issued and outstanding, respectively.................................................... 100 107
Additional paid-in capital................................................................ 80,929 76,392
Accumulated deficit....................................................................... (18,883) (15,124)
--------- ---------
Total stockholders' equity.............................................................. 62,227 61,445
--------- ---------
Total liabilities and stockholders' equity.............................................. $ 87,910 $ 73,043
--------- ---------
--------- ---------
The accompanying notes are an integral part of these financial statements.
28
LARSCOM INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
Revenues......................................................................... $ 75,955 $ 66,444 $ 48,663
Cost of revenues................................................................. 32,718 29,949 21,147
--------- --------- ---------
Gross profit................................................................. 43,237 36,495 27,516
--------- --------- ---------
Operating expenses:
Research and development....................................................... 9,943 8,123 7,143
Selling, general and administrative............................................ 21,145 19,408 15,762
In-process research and development charge related to acquisition.............. 20,120 -- --
--------- --------- ---------
Total operating expenses..................................................... 51,208 27,531 22,905
--------- --------- ---------
Income (loss) from operations.................................................... (7,971) 8,964 4,611
Interest expense charged by Axel Johnson......................................... -- (630) --
Interest income.................................................................. 1,726 33 3
--------- --------- ---------
Income (loss) before income taxes................................................ (6,245) 8,367 4,614
Income tax provision (benefit)................................................... (2,486) 3,437 2,085
--------- --------- ---------
Net income (loss)................................................................ $ (3,759) $ 4,930 $ 2,529
--------- --------- ---------
--------- --------- ---------
Basic and diluted earnings (loss) per share...................................... $ (0.21) $ 0.41 $ 0.21
Basic and diluted weighted average shares........................................ 18,078 12,107 11,900
The accompanying notes are an integral part of these financial statements.
29
LARSCOM INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
----------- ---------- ---------
Cash flows from operating activities:
Net income (loss)........................................................... $ (3,759) $ 4,930 $ 2,529
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation.............................................................. 2,431 1,959 1,535
Amortization.............................................................. 77 434 1,109
Deferred income taxes..................................................... (9,036) (929) (132)
In-process research and development charge................................ 20,120 -- --
Loss on disposal of property and equipment................................ 207 -- --
Changes in assets and liabilities, net of acquisition effects:
Accounts receivable..................................................... (5,555) (3,054) (1,449)
Inventories............................................................. (3,120) (1,404) (1,063)
Prepaid expenses and other current assets............................... (489) (310) 77
Accounts payable........................................................ 2,545 153 233
Income taxes payable.................................................... 62 -- --
Accrued expenses and other current liabilities.......................... 346 2,931 1,195
----------- ---------- ---------
Net cash provided by operating activities..................................... 3,829 4,710 4,034
----------- ---------- ---------
Cash flows from investing activities:
Purchases of short-term investments......................................... (223,285) -- --
Sales of short-term investments............................................. 148,360 -- --
Maturities of short-term investments........................................ 58,327 -- --
Purchase of property and equipment.......................................... (4,645) (3,131) (2,087)
Purchase of NetEdge Systems, Inc., net of $91 cash acquired................. (26,884) -- --
----------- ---------- ---------
Net cash used by investing activities......................................... (48,127) (3,131) (2,087)
----------- ---------- ---------
Cash flows from financing activities:
Net proceeds from Common Stock offering..................................... 4,235 63,279 --
Payment of dividend to Axel Johnson......................................... -- (25,000) --
Advances from (repayments to) Axel Johnson.................................. 1,914 6,515 (2,011)
----------- ---------- ---------
Net cash provided (used) by financing activities.............................. 6,149 44,794 (2,011)
----------- ---------- ---------
Increase (decrease) in cash and cash equivalents.............................. (38,149) 46,373 (64)
Cash and cash equivalents at beginning of period.............................. 46,403 30 94
----------- ---------- ---------
Cash and cash equivalents at end of period.................................... $ 8,254 $ 46,403 $ 30
----------- ---------- ---------
----------- ---------- ---------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid................................................................. $ -- $ 630 $ --
----------- ---------- ---------
Income taxes paid............................................................. $ 5,799 $ 4,366 $ 2,217
----------- ---------- ---------
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING ACTIVITIES:
The Company purchased all of the capital stock of NetEdge Systems, Inc. for
$26,975, including acquisition expenses of $1,182. See note 9 regarding
acquisition of NetEdge Systems, Inc.
The accompanying notes are an integral part of these financial statements.
30
LARSCOM INCORPORATED
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
CLASS A CLASS B RETAINED
COMMON STOCK COMMON STOCK ADDITIONAL EARNINGS/
------------------------ ---------------------- PAID-IN (ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT)
----------- ----------- --------- ----------- ----------- ------------
Balance at December 31, 1994.................. -- $ -- 11,900 $ 119 $ 13,171 $ 2,417
Net income.................................... -- -- -- -- -- 2,529
----- ----- --------- ----- ----------- ------------
Balance at December 31, 1995.................. -- -- 11,900 119 13,171 4,946
Conversion of Class B Common Stock to Class A
Common Stock................................ 1,200 12 (1,200) (12) -- --
Sale of Class A Common Stock, net............. 5,800 58 -- -- 63,221 --
Dividend paid................................. -- -- -- -- -- (25,000)
Net income.................................... -- -- -- -- -- 4,930
----- ----- --------- ----- ----------- ------------
Balance at December 31, 1996.................. 7,000 70 10,700 107 76,392 (15,124)
Conversion of Class B Common Stock to Class A
Common Stock................................ 700 7 (700) (7) -- --
Sale of Class A Common Stock, net............. 350 3 -- -- 3,824 --
Issuance under stock plans and other
issuances................................... 87 1 -- 713 --
Net loss...................................... -- -- -- -- -- (3,759)
----- ----- --------- ----- ----------- ------------
Balance at December 31, 1997.................. 8,137 $ 81 10,000 $ 100 $ 80,929 $ (18,883)
----- ----- --------- ----- ----------- ------------
----- ----- --------- ----- ----------- ------------
TOTAL
STOCKHOLDERS'
EQUITY
-------------
Balance at December 31, 1994.................. $ 15,707
Net income.................................... 2,529
-------------
Balance at December 31, 1995.................. 18,236
Conversion of Class B Common Stock to Class A
Common Stock................................ --
Sale of Class A Common Stock, net............. 63,279
Dividend paid................................. (25,000)
Net income.................................... 4,930
-------------
Balance at December 31, 1996.................. 61,445
Conversion of Class B Common Stock to Class A
Common Stock................................ --
Sale of Class A Common Stock, net............. 3,827
Issuance under stock plans and other
issuances................................... 714
Net loss...................................... (3,759)
-------------
Balance at December 31, 1997.................. $ 62,227
-------------
-------------
The accompanying notes are an integral part of these financial statements.
31
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-- THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES:
Larscom Incorporated (the "Company"), a majority owned subsidiary of Axel
Johnson Inc. ("Axel Johnson"), develops, manufactures and markets a broad range
of high speed, global internetworking solutions for network service providers
and corporate users. The Company operates in one industry segment.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiaries. All material intercompany transactions and
balances have been eliminated in consolidation. The Company's investment in a
less than 50% owned entity is accounted for using the equity method.
CONCENTRATIONS OF CREDIT RISK
Financial instruments, which subject the Company to concentrations of credit
risk, consist primarily of investments in certain debt securities and accounts
receivable. The Company primarily invests its excess cash in municipal bonds
rated AA or better. The Company is exposed to credit risks in the event of
default by the financial institutions or issuers of investments to the extent
recorded on the balance sheet. The Company's accounts receivable are derived
from sales to customers primarily in the United States. The Company performs
ongoing credit evaluations of its customers, and generally requires no
collateral from its customers. The Company maintains reserves for potential
credit losses, and to date has not experienced any material losses. Receivables
from two customers represented 13% and 18%, and 18% and 23% of accounts
receivable at December 31, 1997 and 1996, respectively.
MANAGEMENT ESTIMATES AND ASSUMPTIONS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include all cash and highly liquid investments
with original maturities of ninety days or less. The carrying amount of cash and
cash equivalents approximates fair value because of the short maturity of those
investments and the financial stability of the issuers.
The Company participates in Axel Johnson's centralized cash management
system. Prior to the Company's IPO in December 1996, the cash funding
requirements of the Company were met by, and all cash generated by the Company
was transferred to, Axel Johnson. Although the Company continues to participate
in the Axel Johnson centralized cash management system, the control of the cash,
cash equivalents and short-term investments is now maintained by Larscom
management.
SHORT-TERM INVESTMENTS
The Company accounts for its short-term investments in accordance with SFAS
No. 115 "Accounting for Certain Investments in Debt and Equity Securities".
Accordingly, the Company determines the appropriate classification of its
investments in debt and equity securities at the time of purchase and
32
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1-- THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES: (CONTINUED)
reevaluates such determinations at each balance sheet date. All of the
securities owned by the Company at December 31, 1997 consisted of fixed and
variable rate municipal debt securities and have been classified as
available-for-sale. Due to the short-term nature of such securities, fair value
approximates carrying amount. Gains and losses on sales of available-for-sale
securities have been immaterial. The cost of securities sold is based on the
specific identification method.
INVENTORIES
Inventories are stated at the lower of cost, determined using the first-in
first-out method, or market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method based upon the estimated useful lives of the assets,
which range from three to five years. Leasehold improvements are depreciated
using the straight-line method over the shorter of the estimated useful lives or
the lease term of the respective assets.
INTANGIBLE ASSETS
Purchased identifiable intangible assets are amortized using the
straight-line method over their estimated useful lives of five to seven years.
Goodwill, representing the excess of purchase price over the fair value of net
assets acquired is amortized over periods ranging from five to six years on a
straight line basis. At each balance sheet date, a review is performed by
management to ascertain whether intangibles have been impaired based on several
criteria, including, but not limited to, revenue trends, non-discounted
operating cash flows and other operating factors.
WARRANTY
The Company provides a three-year warranty for its products. A provision for
the estimated cost of warranty, which includes material, labor and overhead, is
recorded at the time revenue is recognized. While the Company believes that its
reserves for estimated future warranty costs are adequate, there are inherent
risks associated with these estimates particularly for those estimates related
to products that have been recently introduced.
PENSIONS
Axel Johnson has a noncontributory funded defined benefit pension plan and
an unfunded retirement restoration plan covering substantially all the Company's
employees. In general, the cost of these plans has been allocated to the Company
based on the compensation of the Company's employees. Amounts so allocated are
not necessarily indicative of the pension cost that would have been incurred if
the Company maintained its own benefit plans. See Note 6 for details. The
Company's exposure to retirement benefits is limited to the cost so allocated.
REVENUE RECOGNITION
Revenue from product sales is recognized upon shipment of the product. The
Company, in general, does not grant a right of return to its customers.
33
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1-- THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES: (CONTINUED)
The following table summarizes the percentage of total revenues for
customers accounting for more than 10% of the Company's revenues:
YEARS ENDED
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
MCI.............................................................................. 25% 21% 18%
IBM/Advantis..................................................................... 14% 13% 14%
RESEARCH AND DEVELOPMENT
All research and development costs, including software development costs
discussed below, are charged to expense as incurred.
SOFTWARE DEVELOPMENT COSTS
Software development costs incurred prior to establishment of technological
feasibility are expensed as research and development costs. Costs incurred
subsequent to the establishment of technological feasibility, and prior to the
general release of the product to the public, were not significant for all
periods presented and accordingly have been expensed.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their financial statement reported amounts. Prior to the
Company's IPO, current tax expense was determined as if the Company were a
separate taxpayer. In December 1996, the Company entered into an income tax
sharing agreement with Axel Johnson, pursuant to which the Company made a
payment to Axel Johnson of an amount in respect of income taxes attributable to
the Company for the period from January 1, 1996 to December 18, 1996, the date
of the Company's IPO, when the Company ceased to be a member of the Axel Johnson
consolidated group.
EARNINGS (LOSS) PER SHARE
In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 128 "Earnings per Share" ("SFAS 128") which
established a different method of computing earnings per share. Under SFAS 128,
the Company is required to present both basic earnings per share and diluted
earnings per share. Unlike diluted earnings per share, basic earnings per share
excludes any dilutive effects of options, warrants and convertible securities.
As the Company reported a loss for 1997, the impact of any options would have
been to reduce the loss per share, therefore basic and diluted net loss
34
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1-- THE COMPANY AND A SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES: (CONTINUED)
per share are the same. Earnings per share for years prior to 1997 have been
restated in accordance with SFAS 128. The following table sets forth the
computation of basic and diluted earnings (loss) per share:
YEARS ENDED
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
Net income (loss)...................................................... $ (3,759) $ 4,930 $ 2,529
--------- --------- ---------
Weighted average Class A and B Common Stock outstanding................ 18,078 12,107 11,900
Dilutive securities:
Stock options........................................................ -- -- --
--------- --------- ---------
Weighted average diluted shares outstanding............................ 18,078 12,107 11,900
--------- --------- ---------
--------- --------- ---------
Basic and diluted earnings (loss) per share............................ $ (0.21) $ 0.41 $ 0.21
As of December 31, 1997, 1,690,000 options at a weighted average exercise
price of $11.73 were excluded from the computation because the exercise price
was greater than the average market price of the common shares.
STOCK-BASED COMPENSATION
As permitted under Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123") the Company is continuing
to measure compensation cost for stock-based compensation plans using the
intrinsic value method prescribed by APB Opinion No. 25 "Accounting for Stock
Issued to Employees." SFAS 123 defines a "fair value" method of accounting for
an employee stock option or similar equity instrument and encourages, but does
not require, entities to adopt that method of accounting for their employee
stock compensation plans. The pro forma disclosures of the difference between
compensation cost included in net income and the related cost measured by the
fair value method are presented in Note 6.
FAIR VALUE OF FINANCIAL INSTRUMENTS
For all financial instruments, including short-term investments, accounts
receivable, accounts payable, accrued expenses and other liabilities, the
carrying value is considered to approximate fair value due to the relatively
short maturities of the respective instruments.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement No.
130, "Reporting Comprehensive Income" ("SFAS 130") and Statement No. 131,
"Disclosures About Segments of An Enterprise and Related Information" ("SFAS
131"). SFAS 130 established rules for reporting and displaying comprehensive
income. SFAS 131 will require the Company to use the "management approach" in
disclosing segment information. Both statements are effective for the Company
during 1998. The Company does not believe that the adoption of either SFAS 130
or SFAS 131 will have a material impact on the Company's results of operations,
cash flows or financial position.
35
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2--BALANCE SHEET COMPONENTS
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(IN THOUSANDS)
Accounts receivable:
Gross accounts receivable................................................................. $ 17,201 $ 9,603
Less: Allowance for doubtful accounts..................................................... (131) (125)
--------- ---------
$ 17,070 $ 9,478
--------- ---------
--------- ---------
Inventories:
Raw materials............................................................................. $ 4,266 $ 1,508
Work in process........................................................................... 3,047 1,823
Finished goods............................................................................ 6,015 5,323
--------- ---------
$ 13,328 $ 8,654
--------- ---------
--------- ---------
Property and equipment:
Machinery and equipment................................................................... $ 8,444 $ 6,751
Computers and software.................................................................... 7,289 5,136
Leasehold improvements.................................................................... 2,244 1,069
Furniture and fixtures.................................................................... 1,341 742
--------- ---------
19,318 13,698
Less: Accumulated depreciation............................................................ (9,615) (8,168)
--------- ---------
$ 9,703 $ 5,530
--------- ---------
--------- ---------
Intangible assets:
Goodwill.................................................................................. $ 1,493 $ 2,375
Other intangible assets (see Note 9)...................................................... 9,816 1,013
--------- ---------
11,309 3,388
Less: Accumulated amortization............................................................ (651) (3,296)
--------- ---------
$ 10,658 $ 92
--------- ---------
--------- ---------
Accrued expenses and other current liabilities:
Accrued compensation...................................................................... $ 7,006 $ 4,807
Accrued warranty.......................................................................... 1,643 458
Income taxes payable...................................................................... 1,318 --
Other current liabilities................................................................. 3,595 2,176
--------- ---------
$ 13,562 $ 7,441
--------- ---------
--------- ---------
36
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--RELATED PARTY TRANSACTIONS:
TRANSACTIONS WITH AXEL JOHNSON
Related party transactions with Axel Johnson not disclosed elsewhere in the
consolidated financial statements are as follows:
DUE FROM/(TO) AXEL JOHNSON
Amounts due from/(to) Axel Johnson consist of cash remittances made by the
Company to Axel Johnson from its operating bank accounts offset by cash advances
to the Company from Axel Johnson for purchases of property and equipment and
fluctuating working capital needs. Amounts due to Axel Johnson or due from Axel
Johnson are settled when the balance exceeds an agreed upon amount. Neither Axel
Johnson nor the Company has charged interest on the balances due. The following
is an analysis of the balance due from/(to) Axel Johnson:
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Balance at beginning of the period...................................... $ (1,329) $ 5,186 $ 3,175
Cash remittances to Axel Johnson, net of cash advances.................. 2,618 1,818 6,563
Charges from Axel Johnson for:
Income taxes.......................................................... (1,021) (4,366) (2,217)
Pension and thrift plan............................................... (1,371) (1,028) (898)
Health insurance and workers' compensation............................ (488) (512) (534)
Administrative services............................................... (622) (527) (549)
Interest on note payable.............................................. -- (630) --
Property, liability and general insurance............................. (596) (633) (193)
IPO related costs..................................................... (134) (401) --
Other charges......................................................... (300) (236) (161)
--------- --------- ---------
Balance at the end of the period........................................ $ (3,243) $ (1,329) $ 5,186
--------- --------- ---------
--------- --------- ---------
NOTE PAYABLE TO AXEL JOHNSON
In August 1996, the Company declared a dividend of $25,000,000, evidenced by
a note payable to Axel Johnson, bearing interest at a rate of 7.5% per annum.
The principal and accumulated interest were paid out of the proceeds of the
Company's IPO on December 24, 1996.
EMPLOYEE BENEFIT PROGRAMS
The Company participates in various employee benefit programs, which are
sponsored by Axel Johnson. These programs include medical, dental and life
insurance and workers' compensation. In general the Company reimburses Axel
Johnson for its proportionate cost of these programs based on historical
experience and relative headcount. The costs reimbursed to Axel Johnson include
costs for reported claims, as well as incurred but not reported claims. The
Company recorded expenses related to the reimbursement of these costs of
approximately $488,000, $512,000 and $534,000 in 1997, 1996 and 1995,
respectively. The Company believes the allocation by Axel Johnson of the
proportionate cost is reasonable but is not necessarily indicative of the costs
that would have been incurred had the Company maintained its own benefit plans.
37
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3--RELATED PARTY TRANSACTIONS: (CONTINUED)
ADMINISTRATIVE SERVICES
Axel Johnson provides limited services to the Company, including certain
treasury, accounting, tax, internal audit, legal and human resources functions.
The costs of these functions have been allocated to the Company based on
estimates of actual costs incurred. Management believes that such allocations
are reasonable. Such charges and allocations are not necessarily indicative of
the costs that would have been incurred if the Company had been a separate
entity or after the IPO, had not entered into a management services agreement
with Axel Johnson. The allocated costs of these services amounting to $622,000,
$527,000 and $549,000 in 1997, 1996 and 1995, respectively, have been included
in selling, general and administrative expenses in the consolidated statements
of operations.
CREDIT AGREEMENT
The Company and Axel Johnson entered into a credit agreement, pursuant to
which Axel Johnson has agreed to provide a revolving credit/working capital
facility (the "Credit Agreement") to the Company in an aggregate amount of
$15,000,000. The Credit Agreement expires in December 1998 and any loans
thereunder bear interest during each calendar quarter at a rate per annum equal
to the sum of the three month London Interbank Offered Rate (LIBOR), plus 2.0%
initially on the date when the loan is made and adjusted thereafter on the first
business day of each calendar quarter. Additionally, the Company is required to
pay a commitment fee of 0.5% per annum on the unused portion of the Credit
Agreement. The Company is required to maintain compliance with certain covenants
under the Credit Agreement. As of December 31, 1997, $15,000,000 was available,
and during 1997 and 1996, no borrowings were made under the Credit Agreement.
LARVAN LEASE
Prior to September 1997, the Company leased its principal facility from
Larvan Properties ("Larvan"), a general partnership in which the Company owns a
one third interest. The Company paid $278,000, $278,000 and $278,000 in rent
expense to Larvan and earned partnership income of $21,000, $36,000 and $36,000
in 1997, 1996 and 1995, respectively. In September, the Company moved to a new
facility in Milpitas, which is leased from a third party.
NOTE 4--CAPITAL STOCK:
In October 1996, the Company's Board of Directors approved a plan to
recapitalize the Company by authorizing (i) Class A Common Stock consisting of
100,000,000 shares, (ii) Class B Common Stock consisting of 11,900,000 shares
and (iii) 5,000,000 shares of undesignated Preferred Stock. Additionally, the
Company's existing Common Stock was reclassified as Class B Common Stock and a
1,190 to one stock split of the Class B Common Stock was effected. Such
recapitalization was effected on December 11, 1996. These consolidated financial
statements have been restated to reflect the recapitalization and the stock
split in all periods presented.
The rights, preferences and privileges of each class of Common Stock are
identical except for voting rights. Each share of Class A Common Stock entitles
its holder to one vote and each share of Class B Common Stock entitles its
holder to four votes for each share of Class A Common Stock into which Class B
Common Stock is convertible. The Class B Common Stock is convertible into Class
A Common
38
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 4--CAPITAL STOCK: (CONTINUED)
Stock on a share-for-share basis, subject to adjustment for dividends, stock
splits, subdivisions or combinations.
The Board of Directors has the authority to issue up to 5,000,000
undesignated shares of Preferred Stock in one or more series and to fix the
rights, preferences, privileges and restrictions thereof, including dividend
rights, conversion rights, voting rights, terms of redemption, liquidation
preferences, sinking fund terms and the number of shares constituting any series
or the designation of such series, without any further vote or action by
stockholders.
In December 1996, the Company completed an initial public offering of
7,000,000 shares of Class A Common Stock at a price of $12 per share of which
5,800,000 were sold by the Company and 1,200,000 shares were sold by Axel
Johnson. After deducting underwriting discount of $4,872,000 and issuance costs
of $1,449,000 the Company received net proceeds of $63,279,000 in December 1996.
In January 1997, the underwriters exercised their over-allotment option to sell
additional shares and sold an additional 1,050,000 shares of which 350,000 were
sold by the Company and 700,000 were sold by Axel Johnson. Net proceeds to the
Company in January 1997 were $3,827,000 after deducting the underwriting
discount of $294,000 and additional selling expenses of $79,000. After the IPO
Axel Johnson owned all the of the Company's issued and outstanding Class B
Common Stock.
In March 1997, 25,518 shares of Class A Common Stock were issued to certain
employees at a cost of $12 per share in connection with the cancellation of the
Company's Long-Term Incentive Plan. An additional 61,769 shares of Class A
Common Stock were issued for consideration of $408,000 under the Company's
Employee Stock Purchase Plan.
NOTE 5--INCOME TAXES:
The provision for income taxes consists of the following:
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Current:
Federal................................................................. $ 5,261 $ 3,481 $ 1,782
State................................................................... 1,203 885 435
--------- --------- ---------
6,464 4,366 2,217
--------- --------- ---------
Deferred:
Federal................................................................. (7,028) (731) (63)
State................................................................... (1,922) (198) (69)
--------- --------- ---------
(8,950) (929) (132)
--------- --------- ---------
Income tax provision/(benefit)............................................ $ (2,486) $ 3,437 $ 2,085
--------- --------- ---------
--------- --------- ---------
39
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5--INCOME TAXES: (CONTINUED)
The following is a reconciliation of the U.S. federal income tax rate to the
Company's effective income tax rate:
YEARS ENDED
DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----- -----
Provision at statutory rate..................................................... (34)% 34% 34%
Federal tax exempt interest income.............................................. (6 ) -- --
State income taxes, net of federal tax benefits................................. (6 ) 5 5
Research and development credits................................................ -- (1 ) (2 )
Non deductible goodwill amortization............................................ -- 2 7
Other........................................................................... 6 1 1
-- -- --
Effective rate.................................................................. (40 )% 41% 45%
-- -- --
-- -- --
Deferred tax assets/liabilities are comprised of the following:
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(IN THOUSANDS)
Deferred tax assets:
Inventory.............................................................. $ 1,354 $ 838
Accrued expenses....................................................... 1,628 1,047
Reserves............................................................... 748 257
In-process research and development.................................... 7,480 --
Other.................................................................. -- 99
--------- ---------
11,210 2,241
--------- ---------
Deferred tax liabilities:
Depreciation and amortization.......................................... 390 474
Other.................................................................. 17 --
--------- ---------
407 474
--------- ---------
Net deferred tax asset................................................... $ 10,803 $ 1,767
--------- ---------
--------- ---------
NOTE 6--EMPLOYEE BENEFIT PLANS:
THRIFT PLAN
The Company participates in the Axel Johnson Thrift Plan (the "Thrift Plan")
qualified under Section 401(k) of the Internal Revenue Code. The Thrift Plan
allows employees to defer up to 21% of their compensation not to exceed the
amount allowed by the applicable Internal Revenue Service guidelines. The
Company matches 60% of employee contributions made on a pre-tax basis and 30% of
employee contributions made on a after-tax basis, subject to a maximum of 6% of
total eligible employee compensation. Company contributions vest ratably over
five years of service or two years of plan participation, whichever occurs
first. Contributions by the Company under the Thrift Plan amounted to $503,000,
$379,000 and $345,000 in 1997, 1996 and 1995, respectively.
40
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--EMPLOYEE BENEFIT PLANS: (CONTINUED)
PENSION PLAN
The Company's employees participate in a noncontributory defined benefit
pension plan sponsored by Axel Johnson. Benefits under the plan are based on
years of service and employees' compensation. The plan's assets are invested
principally in equity and fixed income securities. It is Axel Johnson's policy
to satisfy the minimum funding requirements of the Employee Retirement Income
Security Act of 1974 (ERISA).
Net periodic pension cost was determined by measuring the Projected Benefit
Obligation ("PBO") for the Company's employees using a discount rate of 7.5%,
7.3% and 8.5%, and an assumed long term rate of compensation of 4.5%, 4.5% and
5.3% in 1997, 1996 and 1995, respectively. The PBO for such employees was
determined using a discount rate of 7.3% and 7.5% at December 31, 1997 and 1996,
respectively. The PBO so measured was $3,678,000 and $3,819,000 at December 31,
1997 and 1996, respectively.
Certain elements of pension cost, including expected return on assets (which
was 9.5% in 1997, 9.5% in 1996 and 9% in 1995), and net amortization, were
allocated based on the relationship of the PBO for the Company to the total PBO
of the defined benefit pension plan. The elements of pension cost allocated to
the Company using this method were:
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
(IN THOUSANDS)
Service cost........................................................ $ 779 $ 556 $ 496
Interest cost....................................................... 309 273 245
Net amortization.................................................... (2) (2) (7)
Expected return on assets........................................... (355) (261) (213)
--------- --------- ---------
Net periodic pension cost....................................... $ 731 $ 566 $ 521
--------- --------- ---------
--------- --------- ---------
The Company's employees also are eligible to participate in the Axel Johnson
retirement restoration plan. This plan is for employees whose benefits under the
defined benefit pension plans are reduced due to limitations under federal tax
laws. The Company's pension expense for this plan, using the same methodology as
described above, was $137,000, $83,000 and $32,000 in 1997, 1996 and 1995,
respectively. The PBO at December 31, 1997 and 1996, was $338,000 and $370,000,
respectively.
EMPLOYEE STOCK PURCHASE PLAN
Effective October 1996, the Company's Board of Directors adopted an Employee
Stock Purchase Plan (the "Purchase Plan"), for which 310,000 shares of Class A
Common Stock have been reserved for issuance. The Purchase Plan permits eligible
employees to purchase Class A Common Stock at the beginning or at the end of
each six-month offering period subject to various limitations. The offering
periods commence each February and August. Eligible employees may designate not
more than 10% of their cash compensation to be deducted each pay period for the
purchase of common stock under the Purchase Plan, and participants may purchase
not more than $25,000 of common stock in any one calendar year, or 1,000 shares
in each offering period. In 1997, employees purchased 61,769 shares for
consideration of $408,000.
41
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--EMPLOYEE BENEFIT PLANS: (CONTINUED)
STOCK OPTION PLAN FOR NON-EMPLOYEE DIRECTORS
In October 1996, the Company adopted a Stock Option Plan for Non-Employee
Directors (the "Directors' Plan") and reserved a total of 205,000 shares of the
Company's Class A Common Stock for issuance thereunder. The Directors' Plan
provides for the grant of stock options pursuant to an automatic grant mechanism
to members of the Board of Directors who are not employees of the Company or of
Axel Johnson. Each non-employee director receives an initial grant, upon first
becoming a director to purchase a total of 18,000 shares of Class A Common
Stock, and each year thereafter receives an option to purchase a total of 6,000
shares of Class A Common Stock. Each option is granted at an exercise price
equal to fair market value on date of grant. Each initial grant vests in three
equal annual occurrences, and each annual grant vests in full approximately on
the third anniversary following the date of grant. Options expire as of the
earlier of one year after termination of Board Service or ten years after the
date of grant.
STOCK INCENTIVE PLAN
In October 1996, the Company's Board of Directors approved a Stock Incentive
Plan (the "Incentive Plan") for which 2,485,000 shares of Class A Common Stock
have been reserved for issuance thereunder. The Incentive Plan provides for the
grant of incentive stock options, non-qualified stock options, stock
appreciation rights and stock bonus awards to employees and eligible
consultants. The Incentive Plan is administered by the Compensation Committee of
the Board of Directors (the "Administrator"). With respect to any participant
who owns stock possessing more than ten percent of the voting power of all
classes of the Company's outstanding capital stock (a 10% stockholder), the
exercise price of any incentive stock option granted must equal 110% of the fair
market value on the grant date. The exercise price of incentive stock options
for all other employees shall be no less than 100% of the fair market value per
share on the date of the grant. The maximum term of an option granted under the
Incentive Plan may not exceed ten years from the date of grant (five years in
the case of an incentive stock option granted to a 10% stockholder). Options
generally vest over a five year period from the date of grant.
42
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--EMPLOYEE BENEFIT PLANS: (CONTINUED)
The following table summarizes activity under the Directors' and the
Incentive Plans:
OPTIONS OUTSTANDING
----------------------------------------------------------
DIRECTORS' PLAN INCENTIVE PLAN
---------------------------- ----------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE EXERCISE
PRICE PRICE
----------- NUMBER OF -----------
NUMBER OF SHARES
SHARES ---------------
--------------- (IN THOUSANDS)
(IN THOUSANDS)
December 31, 1995............................................ -- $ -- -- $ --
Granted...................................................... 54 12.00 1,298 12.00
Exercised.................................................... -- -- -- --
Forfeited.................................................... -- -- -- --
----- -----
December 31, 1996............................................ 54 12.00 1,298 12.00
Granted...................................................... 18 11.00 468 11.00
Exercised.................................................... -- -- -- --
Forfeited.................................................... -- -- (147) 11.85
----- -----
December 31, 1997............................................ 72 11.75 1,619 11.72
----- -----
----- -----
Options exercisable at December 31, 1996..................... -- -- -- --
Options exercisable at December 31, 1997..................... 18 $ 12.00 235 $ 12.00
The following table summarizes information about stock options outstanding
at December 31, 1997 under both the Directors' Plan and the Incentive Plan
(number of options in thousands):
OPTIONS OUTSTANDING
---------------------------------------------------
WEIGHTED OPTIONS EXERCISABLE
AVERAGE ------------------------------------
OUTSTANDING AT REMAINING NUMBER
DECEMBER 31, CONTRACTUAL WEIGHTED AVERAGE EXERCISABLE AT WEIGHTED AVERAGE
RANGE OF EXERCISE PRICES 1997 LIFE EXERCISE PRICE DECEMBER 31, 1997 EXERCISE PRICE
- ----------------------------------- --------------- --------------- ----------------- ----------------- -----------------
$7.01 - $ 8.00..................... 13 9.6 $ 8.00 -- $ --
$10.01 - $11.00.................... 80 9.3 $ 11.00 -- $ --
$11.01 - $12.00.................... 1,598 9.1 $ 11.79 253 $ 12.00
--
----- ------ --- ------
1,691 9.1 $ 11.73 253 $ 12.00
--
--
----- ------ --- ------
----- ------ --- ------
PRO FORMA INFORMATION
As permitted under Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"), the Company is
continuing to measure compensation cost for stock-based compensation plans using
the intrinsic value method prescribed by APB Opinion No. 25 "Accounting for
Stock Issued to Employees." The pro forma disclosures of the difference between
compensation cost included in net income and the related cost measured by the
fair value method as defined by SFAS 123 are described below.
43
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6--EMPLOYEE BENEFIT PLANS: (CONTINUED)
The fair value of these options was estimated at the date of grant using a
Black-Scholes option-pricing model with the following assumptions:
DIRECTORS' AND INCENTIVE EMPLOYEE
STOCK
STOCK OPTION PLANS PURCHASE
PLAN
------------------------ -----------
1997 1996 1997
----------- ----------- -----------
Risk-free interest rate.......................................................... 5.85% 6.00% 5.30%
Expected volatility.............................................................. 60% 47% 60%
Expected dividend yield.......................................................... 0% 0% 0%
Expected life.................................................................... 4.04 4.04 0.50
The weighted average estimated fair value of options granted under the
Directors' Plan, the Incentive Plan and the Purchase Plan were as follows:
DIRECTORS' INCENTIVE EMPLOYEE STOCK
PLAN PLAN PURCHASE PLAN
--------- --------- --------------
1996 grants................................................................ $5.76 $5.15 N/A
1997 grants................................................................ $6.36 $5.54 $3.05
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the vesting period of the respective
options. The Company's pro forma information for the years ended December 31 is
as follows (in thousands, except earnings per share information):
1997 1996
--------- ---------
Net income (loss) -- as reported............................................................. $ (3,759) $ 4,930
Net income (loss) -- pro forma............................................................... $ (6,822) $ 4,930
Basic and diluted earnings (loss) per share -- as reported................................... $ (0.21) $ 0.41
Basic and diluted earnings (loss) per share -- pro forma..................................... $ (0.38) $ 0.41
NOTE 7--LEASES:
Prior to September 1997, the Company leased its primary facilities from a
related party under a lease which expired in January 1998 (See Notes 3 and 10).
Lease commitments are related primarily to the Company's buildings in Milpitas,
California and Research Triangle Park, North Carolina and have terms which
expire in 2004 and 2010, respectively. Total rent expense in 1997, 1996 and
1995, was $1,404,000,
44
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7--LEASES: (CONTINUED)
$552,000, and $515,000, respectively. Future annual minimum lease payments under
all noncancelable operating leases as of December 31, 1997 are as follows (in
thousands):
AMOUNT
-------------
(IN
THOUSANDS)
Years ending December 31,
1998......................................................................... $ 2,196
1999......................................................................... 2,297
2000......................................................................... 2,386
2001......................................................................... 2,389
2002 and thereafter.......................................................... 9,363
-------------
$ 18,631
-------------
-------------
NOTE 8--COMMITMENTS AND CONTINGENCIES:
There are potential unasserted claims against the Company relating to
pricing deficiencies under two product supply contracts subject to General
Services Administration ("GSA") regulations. Management has completed an
assessment of its performance under the GSA contracts, assessed its potential
liability with the assistance of the Company's outside experts and legal
counsel, and voluntarily disclosed the identified pricing deficiencies to the
GSA contracting officer responsible for the Company's contracts. In periods
prior to December 31, 1996, the Company recorded accruals which management
believes, after consultation with its outside experts and legal counsel, are
sufficient to cover potential liabilities and other costs related to this matter
so that its ultimate resolution will not have a material adverse effect on the
Company's financial position or results of operations.
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 9--ACQUISITION:
On December 31, 1997, the Company completed its acquisition of NetEdge
Systems, Inc. ("NetEdge"). The transaction was accounted for as a purchase and,
on this basis, the excess purchase price over the estimated fair value of the
tangible assets acquired and liabilities assumed has been allocated to various
intangible assets, primarily consisting of in-process research and development,
current technology, trademarks and goodwill based on an independent third-party
valuation. The Company estimated that the useful economic lives of the current
technology, trademarks and goodwill were five, seven and six years,
respectively. The Company recorded a charge to earnings of $20,120,000 for
in-process research and
45
LARSCOM INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9--ACQUISITION: (CONTINUED)
development related to the NetEdge acquisition. The allocation of the cash paid,
liabilities assumed and acquisition costs to fair values of assets acquired is
as follows (in thousands):
Cash consideration................................................. $ 25,793
Acquisition costs.................................................. 1,182
---------
$ 26,975
---------
---------
Fair value of net assets acquired
Tangible assets.................................................. $ 5,994
Current technology............................................... 8,590
Trademarks....................................................... 560
Goodwill......................................................... 1,493
In-process research and development.............................. 20,120
Liabilities assumed.............................................. (9,782)
---------
$ 26,975
---------
---------
Liabilities assumed include capital lease obligations totaling $549,000
which expire in 2000.
The unaudited consolidated results of operations on a pro forma basis for
the years ended December 31, 1997 and 1996 as if Larscom had acquired NetEdge at
the beginning of 1997 and 1996 are as follows (in thousands, except per share
amounts):
YEARS ENDED
DECEMBER 31,
--------------------
1997 1996
--------- ---------
(IN THOUSANDS)
Revenues.................................................................................... $ 86,916 $ 83,754
Net income (loss)........................................................................... 908 (3,306)
Earnings (loss) per share................................................................... 0.05 (0.27)
The proforma results for the year ended December 31, 1997 exclude the
non-recurring charge for in-process research and development related to the
acquisition.
NOTE 10--SUBSEQUENT EVENT:
In March 1998, the Company sold its interest in the Larvan partnership for
gross proceeds of $1,700,000.
Effective March 31, 1998, the Company's employees will cease to accrue
benefits under the Axel Johnson sponsored defined benefit pension plan.
46
NOTE 11--UNAUDITED QUARTERLY CONSOLIDATED FINANCIAL DATA:
QUARTERS ENDED
----------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997
----------- --------- --------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales.............................................................. $ 16,410 $ 19,148 $ 19,336 $ 21,061
Gross profit....................................................... $ 9,016 $ 10,962 $ 11,102 $ 12,157
Net income......................................................... $ 1,334 $ 2,541 $ 2,457 $ (10,091)
Basic and diluted earnings (loss) per share(1)..................... $ 0.07 $ 0.14 $ 0.14 $ (0.56)
QUARTERS ENDED
--------------------------------------------
MARCH 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996 1996 1996
----------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales................................................................ $ 11,848 $ 18,776 $ 18,357 $ 17,463
Gross profit......................................................... $ 6,422 $ 10,442 $ 10,156 $ 9,475
Net income........................................................... $ 357 $ 2,190 $ 1,554 $ 829
Basic and diluted earnings per share................................. $ 0.03 $ 0.18 $ 0.13 $ 0.07
- ------------------------
(1) Includes acquired in-process research and development charge of $20,120,000
and related tax affects.
47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no disagreements with accountants on accounting and financial
disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated by reference to the
Company's Proxy Statement.
48
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
a) The following documents are filed as a part of this Report:
1. Financial statements--See Item 8 of this report
2. Exhibits
EXHIBIT
NUMBER
- ---------
2.1 (3) Agreement and Plan or Reorganization, dated as of December 2, 1997, among Larscom Incorporated,
a Delaware corporation, LPH Acquisition Corp., a Delaware corporation and a wholly-owned
subsidiary of Larscom, and NetEdge Systems, Inc., a Delaware corporation.
3.1 (1) Certificate of Incorporation of the Registrant
3.2 (1) Amended and Restated Certificate of Incorporation of the Registrant as filed in the State of
Delaware on December 11, 1996
3.3 (1) By-laws of the Registrant
3.4 (1) Form of Amended By-laws of the Registrant
10.1 (1) Form of Larscom Incorporated Stock Option Plan For Non-Employee Directors
10.2 (1) Form of Larscom Incorporated Stock Incentive Plan
10.3 (1) Form of Larscom Incorporated Stock Purchase Plan
10.4 (1) Lease Agreement between Larvan Properties and the Company
10.5 (1) Partnership Agreement among Vanderson Construction, Donn H. Byrne, John D. Brady, Thomas J.
Cunningham, Jr. and the Company
10.6 (1) Form of Services Agreement between Axel Johnson and the Company
10.7 (1) Form of Credit Agreement between Axel Johnson and the Company
10.8 (1) Form of Tax Sharing Agreement between Axel Johnson and the Company
10.9 (1) Note between Axel Johnson and the Company dated August 23, 1996
10.10 (1) Form of Registration Rights Agreement between Axel Johnson and the Company
10.11 (2) Lease Agreement between Berg & Berg Enterprises Inc. and the Company
11.1 (4) Statement re computation of per share earnings
21.1 (4) Subsidiaries of the Registrant
23.1 (4) Consent of Independent Accountants
24 (4) Power of Attorney
27.1 (4) Financial Data Schedule
27.2 (4) Financial Data Schedule
- ------------------------
(1) Incorporated by reference to identically numbered Exhibit to the Company's
Registration Statement on Form S-1 (Commission File No.333-14001), which
became effective on December 18, 1996.
(2) Incorporated by reference to identically numbered exhibits filed in response
to Item 14(a), "Exhibits," of the Registrant's Report on Form 10-K for the
fiscal year ended December 31, 1996.
(3) Incorporated by reference to identically numbered exhibits filed in response
to Item 2 of the Registrant's Report on Form 8-K filed with the Commission
on January 2, 1998.
(4) Filed herewith
b) Reports on Form 8-K
(i) A report on Form 8-K (File No. 001-12491) was filed pursuant to the
Securities Exchange Act of 1934, as amended, on December 22, 1997,
relating to the Company's announcements in an interview with the Dow
Jones Newswire.
49
(ii) A report on Form 8-K (File No. 001-12491) was filed pursuant to the
Securities Exchange Act of 1934, as amended, on January 2, 1998, relating
to the December 31, 1997 completion of the acquisition of NetEdge
Systems, Inc.
(iii)(ii)An amended report on Form 8-K (File No. 001-12491) was filed
pursuant to the Securities Exchange Act of 1934, as amended, on March 16,
1998, to include financial statements of NetEdge Systems, Inc. and pro
forma financial information as required.
c) Exhibits
See Item 14(a) 2 above.
d) Exhibits
50
Pursuant to the requirements of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Larscom Incorporated
/s/ DEBORAH M. SOON
------------------------------------------
(Deborah M. Soon, President and Chief
By Executive Officer)
51