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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION



Washington, D.C. 20549



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FORM 10-K

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934





For the fiscal year ended December 31, 2002



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 Incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               |  |                                     
|1845 McCandless Drive                                          |  | 95035                               
|Milpitas, California (Address of principal executive offices)  |  | (ZIP Code)                          



(408)
941-4000

(Registrants telephone number, including area code)



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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.  x



Indicate by check
mark whether the registrant is an accelerated filer (as defined in exchange Exchange Act Rules 12b-2. Yes ̈No
  x



The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 28, 2002, was approximately $5,980,000.



The number of the registrants shares outstanding as of February 28, 2003, was 8,867,295 shares of Class A Common Stock and
10,000,000 shares of Class B Common Stock.



DOCUMENTS INCORPORATED BY REFERENCE:



Portions of the to-be-filed Proxy Statement for the Registrants 2002 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



|           |  |                                                                                                |  | Page
|---------- |  | ---------------------------------------------------------------------------------------------- |  | ----
|PART I     |  | 3                                                                                             
|Item 1.    |  | Business                                                                                       |  | 3   
|Item 2.    |  | Properties                                                                                     |  | 12  
|Item 3.    |  | Legal Proceedings                                                                              |  | 12  
|Item 4.    |  | Submission of Matters to a Vote of Security Holders                                            |  | 12  
|          
|PART II    |  | 13                                                                                            
|Item 5.    |  | Market for Registrants Common Equity and Related Shareholder Matters                          |  | 13  
|Item 6.    |  | Selected Consolidated Financial Data                                                           |  | 14  
|Item 7.    |  | Managements Discussion and Analysis of Financial Condition and Results of Operations          |  | 15  
|Item 7a.   |  | Quantitative and Qualitative Disclosures About Market Risk                                     |  | 28  
|Item 8.    |  | Financial Statements and Supplementary Data                                                    |  | 30  
|Item 9.    |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           |  | 54  
|          
|PART III   |  | 55                                                                                            
|Item 10.   |  | Directors and Executive Officers of the Registrant                                             |  | 55  
|Item 11.   |  | Executive Compensation                                                                         |  | 55  
|Item 12.   |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |  | 55  
|Item 13.   |  | Certain Relationships and Related Transactions                                                 |  | 55  
|Item 14.   |  | Controls and Procedures                                                                        |  | 55  
|          
|PART IV    |  | 56                                                                                            
|Item 15.   |  | Exhibits, Financial Statement Schedules and Reports on Form 8-K                                |  | 56  
|Signatures |  | 59                                                                                            



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PART I



Item 1.Business



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.
The actual results that we achieve may differ materially from those indicated in any forward-looking statements due to the risks and uncertainties set forth under the Certain Factors Affecting Future Operating Results section (in Part
II, Item 7) and elsewhere in this Form 10-K. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this report. Readers are urged to carefully review and
consider the various disclosures made by us in this report, and in our other reports filed with the Securities and Exchange Commission (the SEC), that attempt to advise interested parties on the risks and factors that may affect our
business.



You are advised to read this
Form 10-K in conjunction with other reports and documents that we file from time to time with the SEC. In particular, please read our Quarterly Reports on Form 10-Q and any Current Reports on Form 8-K that we may file from time to time. You may
obtain copies of these reports directly from us or from the SEC at the SECs Public Reference Room at 450 Fifth Street, N.W. Washington, D.C. 20549, and you may obtain information about obtaining access to the Reading Room by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains information for electronic filers (including us) at its web site www.sec.gov. We make available free of charge on or through our Internet website our SEC filings on Form 10-K, 10-Q and 8-Ks and
amendments thereto as soon as reasonably practicable after electronic filing with the SEC.



Overview



Larscom Incorporated manufactures and markets high-speed network-access products for telecommunication service providers (SPs), and corporate enterprise users. Our product offerings support bandwidth requirements ranging
from full and fractional T1/E1 to OC3. Additionally, our solutions support a number of networking protocols such as frame relay, asynchronous transfer mode (ATM), inverse multiplexing over ATM (IMA) and the Internet Protocol
(IP).



Prior to Larscoms
initial public offering in December 1996, Larscom was a wholly-owned subsidiary of Axel Johnson Inc. (Axel Johnson). Upon consummation of that offering Axel Johnson owned 55% of the Class A and B Common Stock of Larscom and controlled
83% of the voting interest. As of December 31, 2002, Axel Johnson owned 53% of the Class A and B Common Stock of Larscom and controlled 82% of the voting interest.



Industry Overview



As corporate users continue to seek out new and innovative ways to reduce their expenses and improve their productivity through networking
solutions, SPs and carriers continue to expand their service portfolios to meet growing customer demands. Local area networks (LANs) in todays enterprises are a necessity for connecting in-building PCs, servers, and voice
applications. However, it is less and less often the case that the information and tools required by the business all reside within a single building or campus. This, coupled with the increasingly global nature of business and the need to move
information quickly, has led to a greater reliance and need for strong corporate wide area networks (WANs).



The increased demand for greater WAN speed and capacity has been accompanied by increased demand for reliable, high-speed network-access
solutions. In addition to dedicated 56/64 Kbps and T1/E1 services, enterprise customers are now using private and public frame relay, ATM, digital subscriber line (DSL), cable and wireless services, all to enhance the productivity of
their employees. Increased pressure on service providers to deploy these new services quickly and efficiently has been a significant catalyst for growth in the market for advanced management solutions.



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As a result of
the increased demand for greater WAN capacity and the complexity and continuing evolution of service offerings, businesses have been transitioning from the use of private lines dedicated to individual businesses to greater use of public WANs (often
Internet or IP based). While reliance on the public infrastructure can often facilitate both deployment and access, it requires additional security measures to ensure traffic integrity. As this transition occurs, SPs, such as Internet service
providers and network service providers are being asked to provide an increasing variety of transmission and network management services. In addition, corporate users in many cases require SPs to assume full responsibility for the operation and
monitoring of the network and to guarantee certain levels of service.



SPs and corporate users want the ability to add more services and high-speed applications in a rapid and affordable manner. Accordingly, SPs and corporate users require telecommunications equipment that supports a broad
range of services and operates reliably, flexibly and consistently on a global basis.



2001 and 2002 were difficult years for many SPs. As a result, the overall capital spending for wire-line infrastructure significantly declined and it is anticipated that further reductions are likely
in 2003. This significant reduction in capital expenditures has impacted the telecommunications and data communications equipment industry negatively.



Products



We help make our customers successful in their business through the use of reliable products that are backed by our service and support
organization. The following describes the applications for each of our five product groups:



|Multiplexers:               |  | Products that enable several data-streams to be sent over a single physical line and be converted back to the
individual data-streams at the receiving end. Multiplexers help to provide more efficient utilization of network resources by allowing multiple data sources to share a single connection to the WAN. Many of our Multiplexers incorporate CSU/DSU
functionality. Multiplexers represented 46% of our sales in 2002.                                                                                                                                                          
|--------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                           
|Inverse Multiplexers:       |  | Products that enable a single data-stream to be sent over several physical lines and converted back to a single
data-stream at the receiving end. Larscom pioneered developments in inverse multiplexing to help customers bridge the bandwidth gap between T1/E1 and T3/E3. Fractional T3/E3 service, provided in this manner, allows SPs and corporate
users to leverage the existing T1/E1-based infrastructure to provide affordable and readily-available high-speed services with an increased degree of fault tolerance. Inverse Multiplexers represented 22% of our sales in 2002.
|                           
|Service-Delivery Platforms: |  | Products that enable service providers to have enhanced control and flexibility over the service they provide. Our
Service-Delivery Platforms allow SPs to deploy new services such as transparent LAN services, managed frame-relay services and multi-customer WAN services. Service-Delivery Platforms represented 4% of our sales in 2002.                                                                                                                                                                                                                                              
|                           
|CSU/DSUs:                   |  | Products that provide an interface between user data communications equipment and SPs. They perform framing,
line-conditioning and equalization functions. Channel service units/data service units (CSU/DSUs) provide interconnection between the LAN and the WAN. CSU/DSUs represented 5% of our sales in 2002.                                                                                                                                                                                                                                                                         
|                           
|Service:                    |  | Repair, maintenance, installation and training. Service represented 23% of our sales in 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               



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Specific
products that fall under each product grouping are discussed below:



Multiplexers:



Orion 5000.The Orion 5000 multiplexer is designed for high-density, optical-friendly traffic aggregation. With direct interface to both TDM and Synchronous Optical Network
(SONET)/Synchronous Digital Hierarchy (SDH) network architectures, the Orion 5000 is designed to enable the migration to fiber-based transports. Able to house up to seven redundant programmable M13 multiplexers (aggregating
up to 196 T1 lines or 147 E1 lines) in a compact two RU 23-inch chassis, the Orion 5000 is one of the densest M13 multiplexers on the market. The M13 multiplexer also has a programmable capability for either DS3 or STS-1 traffic. Taking T1/E1
traffic aggregation to the next evolutionary step, direct optical access is provided by the Orion 5000s OC3/STM-1 interface. The Orion 5000 consolidates up to three DS3s into an OC3/STM-1 connection.



Orion 5001.    The Orion 5001
provides M13 multiplexing in a compact, efficient form factor. Designed specifically to deliver a cost-effective solution with carrier-class reliability, the Orion 5001 multiplexes 28 T1s into a single T3. The compact Orion 5001 fits well as a
replacement for traditional bulky M13 multiplexers wherever rack space is at a premium. While SPs backhaul traffic between central offices on a T3, the Orion 5001 allows the enterprise to seamlessly distribute T1 service across its campus. Where
mission critical applications require an always-on connection, the twin M13 modules provide 1:1 redundancy. Rapid, configurable switching between modules minimizes frame loss. We believe that the Orion 5001 M13 multiplexer is among the most
power-efficient products in its class. The carrier-class Orion 5001 is NEBS level 3 compliant; creating an ideal fit for both co-location and carrier deployment.



Orion 5003.A natural extension to the Orion 5000 family of optical
multiplexers, the Orion 5003 provides, optical-friendly DS3 or STS-1 traffic aggregation. With direct interfaces to both TDM and SONET/SDH network architectures, the Orion 5003 is designed to enable the migration to fiber-based transport. This
OC-3/STM-1 multiplexer provides programmable support for DS3 or STS-1 traffic, allowing support of redundant Automatic Protection Switching (APS) optical pairs and multi-node Unidirectional Path-Switching Ring (UPSR)
applications. The Orion 5003 multiplexes up to three DS3/STS-1 (channelized or clear channel) data streams. With built-in OC-3/STM-1 module redundancy, a SONET GR-253 standard interface, and NEBS compliance, the Orion 5003 provides carrier-class DS3
traffic aggregation in a compact, one-RU, 19-inch chassis, making it ideal for deployment at the customers premises. The Orion 5003 offers field-programmable multiplexing, and extensive monitoring and diagnostic capabilities. Management and
redundant OC-3/STM-1 service modules provide protection from failure. NEBS level 3 compliance, low power consumption, and absence of fans make the Orion 5003 ideal for co-location and carrier deployment.



TerraMux.    The TerraMux
drop-and-insert multiplexing DSU is designed for businesses needing both voice and data services. By multiplexing two data ports and a voice port onto one full or fractional T1 or E1 line, TerraMux simplifies the network and reduces access costs.
With its unique LineLearn capability that automatically discerns how many and what types of lines are connected to a device, TerraMux automatically configures the network and drop-and-insert ports and sets the speed of the primary data
port to make network access simple and efficient. Management options include a built-in graphical test set, e-mail alerts for trouble-ticketing, web browser, Telnet access and simple network management protocol (SNMP). The TerraMux can
be used to manage up to nine TerraUnos or TerraMuxes.



Orion 4000.    The Orion 4000 is a versatile broadband access multiplexer with network connections that range from T1 or E1 to T3. The Orion 4000 is designed to enable functionality to be added in a modular
and cost-effective fashion. It is available in both 5-slot and 12-slot shelf configurations for both domestic and international markets. The Orion 4000 is distinctive in the role that it can play in providing an economical migration path from low to
high bandwidth, thereby ensuring protection of a customers legacy equipment investment.



The Orion 4000 is able to support full and fractional T3 networks. Its T1 and E1 inverse multiplexing modules provide transparent channels for applications such as LAN interconnection or video
transmission. The T3 Mux and T1 Mux modules provide flexibility in transporting T1 circuits across the network. They can be used



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to consolidate several fractional T3 applications onto a single T3 circuit, to act as a DS3 crossconnect, to combine T1 traffic from a
digital private branch exchange (PBX) or to serve as a T1 multiplexer with inverse multiplexed data. The T3 Clear single-density and double-density modules provide clear channel 45 Mbps transmission and are fully interoperable with our
Access-T45 products.



Orion
4500.    Linking one or two high-speed applications across a DS3 or E3 line, the Orion 4500 T3/E3 CSU/DSU Access Multiplexer serves a wide range of broadband applications. It is ideal for Internet backbones, scalable
fractional DS3/E3 Internet access services, and corporate and public organizations needing the broad bandwidth of DS3 or E3 for WAN connections. The Orion 4500 splits the DS3 or E3 bandwidth between two high-speed serial ports. Each port can be
configured in multiples of 3.158 Mbps (DS3, Larscom Access-T45 compatibility), 3.759 Mbps (E3 G.751 standard), or 3.072 Mbps (E3 G.832 standard), or one port can be used in clear-channel or unframed mode for full payload-line bandwidth. In addition,
the Orion 4500 can automatically reconfigure bandwidth allocation for peak and non-peak usage. The flexibility of the Orion 4500 extends to its management options, which includes an integral SNMP agent plus a menu-driven terminal interface with an
ASCII graphical test set. The Orion 4500 also provides detailed 24-hour performance histories, alarm logging and dial-out, and extensive loopback and test pattern options.



Orion 200/400/800.    The Orion 200/400/800 family is a set of advanced T1 and E1
access multiplexers that can accommodate from two to eight data ports and two network ports. Its primary application is LAN interconnection, often coupled with digital PBX traffic as well as videoconferencing. The Orion 200/400/800 family can
operate in both T1 and E1 networks, and can also perform a conversion between T1 and E1 circuits.



Access-T45.    The Access-T45 is a single-port or dual-port 45 Mbps multiplexer that provides a clear channel
T3 network interface. It is used for high-speed LAN inter-networking, for Internet access and backbones and for frame-relay access. The Access-T45 allocates bandwidth in increments of 3 Mbps, a function that has been used by SPs to control bandwidth
assignment for their customers. The asymmetrical Access-T45 allows customers to subscribe to varying amounts of bandwidth for transmit and receive applications.



Access-T and Split-T Products.    The Access-T family is a series of T1/FT1
multiplexing CSU/DSUs. 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 is a shelf-based version of the Access-T that
utilizes a hub and spoke architecture, allowing centralized network nodes to serve units at dispersed sites and to concentrate traffic in a single location where network hubs are constrained by lack of space. The Split-T is a stand-alone T1/FT1
CSU/DSU. It has a front panel that incorporates a liquid crystal display user interface for local configuration and is primarily used for LAN interconnection and digital PBX traffic.



Inverse Multiplexers:



Mega-T/E.    We pioneered
inverse-multiplexing solutions with the Mega-T, the first inverse multiplexer to bridge the bandwidth gap between T1 and T3. It provides economical access to greater than T1 bandwidth for high-speed applications, delivering a data channel of up to 6
Mbps from four T1 circuits. We also manufacture and market an E1 version of the product, the Mega-E, to bridge the bandwidth gap between E1 and E3. Our patented inverse-multiplexing algorithm used for the Mega-T/E handles alignment of the individual
T1s or E1s and allows for differential delay between individual T1s. This algorithm also allows the data transmission rate to be lowered automatically in the event that individual T1 circuits fail and to be raised automatically when the circuits are
restored. The Mega-T/E has the ability to identify individual T1/E1 circuits, thereby simplifying troubleshooting. The Mega-T/E is primarily used for transport for high-speed LAN Internetworking, as well as frame-relay network-access above T1 or E1
speeds and real-time compressed voice traffic.



Orion 2000.    The Orion 2000 ATM inverse multiplexer is designed to be used by SPs wishing to provide either native ATM services or ATM extensions at economical prices. It is compliant with the ATM Forum
IMA



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specification and can interface directly with an OC3 or DS3 ATM user-to-network interface or network-to-network interface on any ATM device.
The Orion 2000 offers ATM connectivity at speeds up to 12 Mbps (8 x T1) or up to 16 Mbps (8 x E1), with data packets having extremely low cell-delay variation, which is a requirement for delay-sensitive traffic such as video. The unit has
ASCII terminal and SNMP interfaces that enable local or remote configuration, performance monitoring, alarm notification and diagnostic testing. In addition, an optional graphical user interface offers point-and-click monitoring and control.



Service-Delivery Platforms:



Larscom 6000.    The Larscom 6000
is the first in a family of intelligent access devices, using the Frame-Relay Forums new standard for multilink frame relay (MFR) to provide inverse multiplexing benefits to frame-relay customers. With the addition of IP-forwarding
functions, the Larscom 6000 removes the need for routers, assisting SPs in offering advanced services at a low total cost of operation. The Larscom 6000 also provides integrated service level agreement management without any additional hardware or
monitoring/reporting systems, allowing customers to monitor performance statistics and to deliver them in a standardized format directly to a variety of core-management systems. Web-based device monitoring allows users to view the status of the
Larscom 6000 from any web-enabled computer.



Larscom 6200.    The Larscom 6200 is a multi-service platform designed for carriers and enterprises worldwide needing connectivity at DS3/E3 speeds. The Larscom 6200 handles traffic with up to 45 megabits
per second speeds (DS3/E3) in a single ATM connection, allowing data throughput to be maximized. The Larscom 6200 supports IP filtering and encapsulation over ATM as well as IP transport over ATM.



CSU/DSU:



TerraUno.    The TerraUno T1/E1
DSU is a network-access device optimized for connecting routers, bridges and other high-speed devices to E1 or T1 public network services such as the Internet and frame relay. The TerraUno is easy to install with its plug-and-play LineLearn
capability.



TerraBoss.    The TerraBoss has the same functionality as the TerraUno, plus extensive management features including SNMP, Telnet and web-browsing with e-mail alerts. The TerraBoss can be used to manage up
to nine TerraUno systems.



Customers



Our primary customers are SPs, distributors, systems
integrators, value-added resellers (VARs), federal, state and local government agencies and end-user corporations.



We believe that our relationship with large customers, particularly the SPs, will be critical to our future success. Our customers prefer
to purchase the majority of their network access solutions from a single vendor, which might benefit us if we broaden and enhance our product line. In 2002, 2001 and 2000 SPs represented 42%, 51% and 54%, respectively, of total revenues. The
following table summarizes the percentage of total revenues for customers accounting for more than 10% of our revenues:



|              |  | Year Ended December 31, |  
|------------- |  | ----------------------- | -
|              |  | 2002                    |  
|WorldCom Inc. |  | 20                      | %
|AT&T          |  | 14                      | %



None of
our customers are contractually obligated to purchase any quantity of products in any particular period, and product sales to major customers have varied widely from quarter-to-quarter and year-to-year. There can be no assurance that our current
customers will continue to place orders with us, that orders from existing



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customers will continue at the levels of previous periods or that we will be able to obtain orders from new customers. Loss of, or a material
reduction in, orders by one or more of our major customers could have a material adverse effect on our business and operating results.



The entire telecommunications industry, including our customers, is experiencing a significant slowdown. Our largest customer, WorldCom,
filed for bankruptcy in 2002. This slowdown has materially affected our business levels.



Backlog



Our
backlog at any point in time is usually small. Accordingly, sales in any quarter are largely dependent on orders received during that quarter. Furthermore, agreements with our customers typically provide that they can change delivery schedules and
cancel orders within specified time frames, typically up to 30 days before the scheduled shipment date, without penalty. Our 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 (including misjudgments about levels of future demand for their own services). Decisions by such customers to reduce their inventory levels could lead to reductions in purchases from us. Customer
decisions to delay delivery, cancel orders or reduce purchases could have a material adverse effect on our business and operating results.



Marketing and Sales



We sell our products in the U.S. primarily through our direct sales organization and to a lesser extent through VARs, systems integrators
and distributors. Sales to large SPs are handled by our direct sales force. We continue to develop an indirect distribution channel for sales to domestic customers. This channel consists primarily of a small group of master distributors, such as
Tech Data, and a number of authorized resellers. As part of this strategy we have appointed certain sales people to sign up resellers and assist them in their sales efforts. There are a number of risks associated with the development of an indirect
distribution channel. These include a reduction in our ability to forecast sales, potential reductions in customer satisfaction, loss of contact with users of our products and new methods of advertising and promoting the products, which will result
in additional expenses. These, and other factors, could adversely impact our business.



We market our products internationally through our own direct sales force, non-exclusive international distributors and systems integrators. The United Kingdom sales force focuses on sales in Europe,
the Middle East and Africa and the Hong Kong sales force focuses on the Asian market.



SPs require that products undergo extensive lab testing and field trials prior to their deployment in the network. Accordingly, we continually submit successive generations of our current products as
well as new products to our customers for evaluation and approval. Additionally, sales to international SPs require products that 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 and budgetary constraints of customers and regulatory issues.



Customer Service and Support



Our products are required to meet rigorous standards imposed by both customers and internal product quality
assurance testing procedures. The warranty period for most of our products is three years. We have service contracts with most of our major customers, and provide rapid-response service via arrangements with our service partner worldwide, NextiraOne
Solutions. These contracts typically establish response time and level of service commitments, without penalties for non-performance. We maintain a 24-hour, 7-day a week technical assistance support center, and provide rapid response with contracted
response times, plus a wide range of repair programs. We also provide technical applications assistance as well as customer and distributor product maintenance, installation services and training.



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Research and Development



We believe that our future success depends
on our ability to achieve technological leadership through timely enhancements of existing products and development of new products that meet customer needs. Our continued commitment to research and development, particularly related to emerging
technologies, will be required for us to remain competitive.



Our product families are designed specifically to meet the demands of our larger customers. Relationships with these customers provide us with insight into their evolving needs and allow us to anticipate new technology requirements.
Enhancements to our product families are being developed by including our major customers responses to our interview questions in the product definition and review process. Timely customer feedback is important to us in making modifications to
existing products and designing new products.





The development of new, technologically-advanced products is a complex and uncertain process, requiring high levels of innovation.
Expertise is required in the general areas of telephony, data networking and network management, as well as specific technologies such as Ethernet, DSL, ATM, SONET and SDH. Further, the telecommunications industry is characterized by the need to
design products that meet industry standards. Such industry standards are often changing or incomplete as new and emerging technologies and service offerings are introduced by SPs. As a result, there is a potential for delays in product development
due to the need to comply with new or modified standards. The introduction of new and enhanced products also requires that we manage the transitions from older products so as 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 we will be successful in developing, introducing or managing the transition to new or enhanced products or that any
such products will be responsive to technological changes or will gain acceptance in the market place.



Manufacturing and Quality Assurance



Our manufacturing operations consist of materials procurement, third-party assembly of printed circuit boards and chassis, product testing and inspection and system configuration for shipment. We have
contracted primarily with one local source for our third-party manufacturing and have been able to implement quality control systems through the entire manufacturing process, including statistically monitored process control programs. We utilize
traditional procurement methods with our suppliers, using standard purchase orders and blanket orders for scheduling and commitments. Most purchase-order payment terms are standard, with payment due in 30 days and with some orders negotiated to net
45 days payment terms. We use automated functional product testing to remain flexible to customers needs while maintaining control of the quality of the manufacturing process.



Turnkey-based manufacturing is utilized primarily for our higher-volume, repetitive production assemblies. In
turnkey manufacturing, unlike manufacturing on consignment, the contract manufacturer is responsible for procuring the components utilized in the manufacturing process. This approach transfers some of the economic risks of material cost fluctuation,
excess inventory, scrap, inventory obsolescence and working capital management to the vendor. Consigned kits may be utilized on lower-volume assemblies. We are, in most cases, required to commit to purchase certain volumes within various time
frames. Although we believe that the benefits of turnkey manufacturing outweigh the risks, it is possible that our dependence on turnkey manufacturing will impact our ability to alter the manufacturing schedule rapidly enough to satisfy changes in
customer demand, especially in an environment of increasing component lead times. We continue to perform final assembly and testing of non-turnkey finished products.



On-time delivery of our products is dependent upon the availability of components used in our products. We
purchase parts and components for assembly from a variety of pre-approved suppliers through a worldwide



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procurement-sourcing program. We attempt to manage risks by developing alternate sources and by maintaining long-term relationships with our
suppliers. We acquire certain components from sole sources, either to achieve economies of scale or because of proprietary technical features designed into our products. To date, we have been able to obtain adequate supplies of required components
in a timely manner from existing sources or, when necessary, from alternate sources. A substantial portion of our shipments in any fiscal period relate to orders received in that period. In addition, a significant percentage of our orders are
shipped within three business days of receiving the order. To meet this demand, we maintain a supply of finished goods inventories at our manufacturing facility. There can be no assurance that interruptions or delays in supplies of key components
will not occur. Any interruptions or delays in supplies of key components could have an adverse impact on our business and operating results.



We have achieved and maintain ISO 9001 quality certification and employ a comprehensive quality control program. However, complex products
such as ours might contain undetected errors or failures when first introduced or as new versions are released. Despite testing by our customers and us, there can be no assurance that existing or future products will not contain undetected errors or
failures when first introduced or as new versions are released. We provide a three-year warranty for most of our products.



Competition



The markets for our products are intensely competitive and we expect competition to intensify in the future. Our products compete
primarily with Quick Eagle Networks, Verilink, Kentrox, Cisco Systems, Alcatel, ADTRAN, RAD, Telco Systems, Carrier Access and Paradyne. We compete to a lesser extent with other telecommunications equipment companies. We believe that our 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, product line breadth, experienced sales, marketing and service
organizations and evolving industry standards. Certain competitors have more broadly developed distribution channels and have made greater advances than we have in certain emerging technologies. Cisco Systems and Alcatel are two of the largest
telecommunications equipment companies in the world. There can be no assurance that we will be able to continue to compete successfully with existing or new competitors.



Our business is being materially adversely affected by the integration of CSU/DSU and inverse multiplexing
functionality into switches and routers. New technologies could further displace some parts of the T1/E1 CSU/DSU product line. For example, symmetrical and high bit rate digital subscriber line (SDSL and HDSL) are subscriber
loop technologies that enable service providers to deploy high-bandwidth services that could replace more traditional T1/FT1 services, upon which most of our products are based.



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. We rely upon a combination of trade secrets, contractual restrictions, copyrights, trademark laws and patents to establish and protect proprietary rights in our products and technologies. We have been issued only
one U.S. patent to date. We believe that the success of our business depends primarily on our proprietary technology, information, processes and expertise, rather than patents. From time to time, third parties may assert exclusive patent, copyright,
trademark and other intellectual property rights to technologies that are important to us. We have not conducted a formal patent search relating to the technology used in our 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 ours that could relate to our products. The scope of protection accorded to patents
covering software-related inventions is evolving and is subject to uncertainty, which may increase the risk and cost to us if we discover third-party patents related to our software products or if such patents are asserted against us in the future.
In our distribution agreements, we typically agree to indemnify our customers for any expenses or liability resulting from claimed infringements of patents, trademarks or copyrights of third



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parties. In the event of litigation to determine the validity of any third-party claims, such litigation, whether or not determined in favor
of us, could result in significant expense to us and divert the efforts of our technical and management personnel. In the event of an adverse ruling in such litigation, we might be required to pay damages, discontinue the use and sale of infringing
products, and 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 us and our failure to develop or license a substitute technology could have an adverse impact on our business and operating results.



The laws of certain foreign countries in which our products are or may be developed, manufactured or sold may not protect our products or
intellectual property rights as effectively as the laws of the US, thus making the possibility of misappropriation of our technology and products more likely.



Employees



As of December 31, 2002, we had 94 full-time employees compared to 120 full-time employees on December 31, 2001. We have never experienced
any work stoppage and none of our employees are represented by a labor union. We believe our relationship with our employees is good.



Management



The executive officers of Larscom Incorporated are as follows:



|Name                  |  | Age |  | Position                                           
|--------------------- |  | --- |  | ---------------------------------------------------
|Daniel L. Scharre     |  | 52  |  | President, Chief Executive Officer and Director    
|Leonard J. Eisenstein |  | 56  |  | Vice President, Worldwide Sales                    
|Gurdip Jande          |  | 41  |  | Vice President, Marketing                          
|Donald W. Morgan      |  | 57  |  | Vice President, Finance and Chief Financial Officer



Daniel
L. Scharre has served as president, chief executive officer and a member of the Board since November 2001. Prior to joining Larscom, Mr. Scharre served as chairman, president and chief executive officer of Adaptive Broadband Corp., a provider of
high-speed, wireless last-mile access equipment, from April 2001 to October 2001, as president and chief executive officer from January 2001 to April 2001, as president and chief operating officer from July 2000 to January 2001, as Executive Vice
President from April 1998 to June 2000 and as vice president and chief technology officer from September 1997 to April 1998. Adaptive Broadband Corporation filed for bankruptcy in July of 2001. Prior to his four-year tenure at Adaptive Broadband,
Mr. Scharre held executive positions at ComStream Inc., Ilex Systems, and Loral Western Development Labs, all providers of digital telecommunications equipment and systems. Mr. Scharre holds a BS in physics from the California Institute of
Technology, a Ph.D. in physics from the University of California, Berkeley, and an MBA from Santa Clara University. He previously served on the faculty at Stanford University.



Leonard J. Eisenstein joined Larscom as vice president of worldwide sales in June 2002. Prior to joining
Larscom, Mr. Eisenstein was employed by Intel Corporation from January 2001 to May 2002 where he was responsible for Intels New Venture Program aimed at developing start-up business and investment. From April 1999 to December 2000, Mr.
Eisenstein was Worldwide Sales Director at Trillium Digital Systems (acquired by Intel Corporation). He served as a sales consultant for Hayes Microcomputer from September 1998 to March 1999. From July 1997 to August 1998, he was vice president,
worldwide sales at Ariel Corporation. Prior to that, he was vice president of sales at Dagaz Technologies from January 1995 to June 1997. He also held senior sales and marketing positions at Integrated Network Corporation, Telco Systems, Infotron
Systems, General DataComm and AT&T. Mr. Eisenstein earned a BS in electrical engineering from the City University of New York and an MBA in finance and marketing from the Bernard Baruch College in New York City.



Gurdip Jande joined Larscom as vice president of marketing in
February 2002. Prior to joining Larscom, Mr. Jande served in various positions at Nortel Networks, a voice and date communications equipment



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manufacturing company, including as vice president, corporate strategic business development from January 2000 to December 2001, vice
president marketing, emerging service providers from October 1999 to December 1999, vice president, market development from March 1998 to September 1999, and as director, business development from January 1997 to February 1998. Mr. Jande earned a BS
in electrical engineering from the University of Ottawa, Canada, and an MBA from the University of Miami.



Donald W. Morgan has served as vice president of finance and chief financial officer of Larscom since October 1999. Prior to joining
Larscom, Mr. Morgan was an independent tax and financial consultant to several small-business and start-up technology firms from December 1997 to September 1999. He served as vice president of finance and administration for Inrange Technologies
Corporation, a data communications equipment manufacturing company from July 1991 to November 1997. Prior to that, Mr. Morgan served in a number of senior financial positions with UNISYS Corporation. Mr. Morgan earned a BS degree in business
administration from Northeastern University and an MS degree in finance from the University of Illinois.



There is no family relationship among any directors or executive officers of Larscom Incorporated.



Item 2.Properties



We currently lease a 119,000 square-foot facility located in Milpitas, California and a 27,000 square-foot facility in Durham, North Carolina. At the Milpitas facility, 39,000 square feet are sublet
and at the Durham, North Carolina facility, the entire 27,000 square-foot facility was sublet effective February 15, 2002. All of our manufacturing, sales, administration, customer service, marketing and research and development are performed at our
Milpitas facility. We also occupy various small offices throughout the U.S. for sales activities, one office in the United Kingdom for sales activities in Europe, the Middle East and Africa and an office in Hong Kong for sales activities in Asia. We
believe that our existing facilities are adequate for our current needs.



Item 3.Legal Proceedings



We are 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, 2002.



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PART II



Item  5.Market for Registrants Common Equity and Related Shareholder Matters



The following table sets forth the high and low bid prices for our Class A Common Stock as reported on the
Nasdaq National Market from January 1, 2001 through October 22, 2002 and on the Nasdaq SmallCap Market from October 23, 2002 through December 31, 2002. These prices reflect inter-dealer prices, without retail markup, markdown or commission, and may
not necessarily represent actual transactions.



|               |  | 2002       |        | 2001
|-------------- |  | ---------- | ------ | ----
|               |  | Bid Prices
|               |  | High       |        | Low 
|First quarter  |  | $          | 1.7900 |     
|Second quarter |  | $          | 1.3600 |     
|Third quarter  |  | $          | 0.7000 |     
|Fourth quarter |  | $          | 0.5000 |     



As of
February 28, 2003, there were 92 holders of record of our Class A Common Stock and 1 holder of record of our Class B Common Stock. We had an estimated 2,427 beneficial holders of our Class A Common Stock, held in street name, as of February 28,
2003.



We currently intend to retain any future
earnings for use in our business and do not anticipate paying any cash dividends in the foreseeable future.



Please see Item 12 for additional information required by this item.



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Item  6.Selected Consolidated Financial Data



|                                           |  | Years Ended December 31,              |       
|------------------------------------------ |  | ------------------------------------- | ------
|                                           |  | 2002                                  |       
|                                           |  | (In thousands, except per share data) |       
|Consolidated Statement of Operations Data: |  |                                       |       
|Product revenues                           |  | $                                     | 17,977
|Service revenues                           |  |                                       | 5,510 
|                                           |  |                                       |       
|Total revenues                             |  |                                       | 23,487
|                                           |  |                                       |       
|                                          
|Product cost of revenues                   |  |                                       | 9,276 
|Service cost of revenues                   |  |                                       | 1,071 
|                                           |  |                                       |       
|Total cost of revenues                     |  |                                       | 10,347
|                                           |  |                                       |       
|Gross profit                               |  |                                       | 13,140
|                                           |  |                                       |       
|                                          
|Operating expenses:                        |  |                                       |       
|Research and development                   |  |                                       | 4,199 
|Selling, general and administrative        |  |                                       | 16,051
|Restructuring                              |  |                                       | 254   
|Other nonrecurring charges                 |  |                                       |      
|                                           |  |                                       |       
|Total operating expenses                   |  |                                       | 20,504
|                                           |  |                                       |       
|                                          
|Loss from operations                       |  |                                       | (7,364
|Other income, net                          |  |                                       | 356   
|                                           |  |                                       |       
|Loss before income taxes                   |  |                                       | (7,008
|Income tax (benefit) provision             |  |                                       | (2,113
|                                           |  |                                       |       
|Net Loss                                   |  | $                                     | (4,895
|                                           |  |                                       |       
|                                          
|Basic and diluted loss per share           |  | $                                     | (0.26 
|                                           |  |                                       |       
|Basic and diluted weighted average shares  |  |                                       | 18,854
|                                           |  |                                       |       
|                                          
|                                           |  | December 31,                          |       
|                                           |  | 2002                                  |       
|                                           |  | (In thousands)                        |       
|Consolidated Balance Sheet Data:           |  |                                       |       
|Working capital                            |  | $                                     | 17,399
|Total assets                               |  |                                       | 28,060
|Total stockholders equity                 |  |                                       | 17,907
|Other non-current liabilities              |  |                                       | 1,618 



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Item  7.Managements Discussion and Analysis of Financial Condition and Results of Operations



Summary of Critical Accounting Policies



Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to uncollectible receivables, investment values, income taxes, restructuring
and contingencies. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of
assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions.



We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our
consolidated financial statements:



Revenue
Recognition



Revenue from product sales is
generally recognized when products are shipped to our customers. However, some of our distributors, who maintain significant inventories of our products, have a right to return products that remain unsold. In the case where the distributor has a
right to return products, we do not recognize revenue until the distributor notifies us that the products have been shipped to the end user. Service revenue earned from providing maintenance, installation, training or other miscellaneous services is
recognized when those services are provided to the customer. If we believe that collection is not probable at the time of shipment, we elect to defer the revenue until the cash is collected.



Investment and Accounts Receivable Risk



We invest cash in excess of our daily needs in financial
instruments issued by banks, government agencies or large corporations. Our policy is to invest these funds in financial instruments that are rated by Standard and Poors (or other rating agency equivalents) as A- or better in the case of general
debt instruments or A-1 in the case of commercial paper. Our policy restricts us from investing more than $5 million or 20% of the total investment in any one institution or from investing in financial instruments that mature in more than 1 year.
While we believe, in our judgment, these policies are protective of the Companys funds; a default of any one institution would lead to our incurring a significant loss of cash.



Our accounts receivable are largely from customers in the United States. We perform ongoing credit
evaluations of our customers, and generally require no collateral from our customers. We maintain reserves for potential credit losses based on our evaluation of the customers financial condition, industry conditions and general economic
conditions. While our reserves have historically been within our expectations, we cannot guarantee that our evaluation of the credit risk of our customers will be correct. In addition, since our accounts receivable are concentrated in a relatively
few number of customers a significant change in the financial position of any one of these customers could have a material impact on the collectibility of our accounts receivable. To date, we have reserves for $528,000 in receivables associated with
the 2002 bankruptcy filing of WorldCom. Receivables from our two largest customers (WorldCom and AT&T) represented 38% and 59% of net accounts receivable at December 31, 2002 and 2001, respectively.



Inventories



Inventories are stated at the lower of standard cost or
market. Write-downs of inventory are generally taken, when in our estimate, future demand will not consume existing inventories over the next twelve months. If actual future demand or market conditions are less favorable than those projected by
management, additional inventory write-downs may be required.



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Restructuring Reserves



Restructuring reserves are based on estimates of the salary and benefit obligations to terminated employees, amounts necessary to write off assets no longer utilized by the Company and for contractual payments we expect to
continue to make for property no longer in use. Although we do not anticipate significant changes, the actual costs may differ from these estimates.



Warranty



We provide a three-year warranty for most of our products. We provide for the estimated cost of warranty at the time we record revenue for
a product based on our historical costs, which includes material, labor and overhead. While we believe that our reserves for estimated future warranty costs are adequate, there are inherent risks associated with these estimates, especially for those
estimates related to products that have been recently introduced.



Sales Return Allowance



We provide a sales return allowance for possible customer returns, based on historical information that may be due to changes in customer circumstances or a misjudgment of either party in assessing the customers needs.



Income Taxes



Deferred tax assets and liabilities are recognized for the
temporary timing differences between the tax bases of assets and liabilities and the amounts reported in financial statements. A valuation allowance is provided against deferred tax assets if, in managements judgment, it is more likely than
not that the potential future benefits of these assets will not be realized.



Results of Operations



The market for telecommunications equipment is going through a period of rationalization and contraction as SPs digest the network overbuild of the late 1990s and early 2000s. This excess has left most SPs,
our primary customers, cutting capital equipment budgets, and focusing on squeezing efficiencies out of the existing network infrastructure. While our business is generally suffering as a result, our restructuring programs have substantially reduced
our operating expense levels in 2002 versus the operating expense levels during 2001.



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The following
table sets forth the percentage of revenues represented by certain items in our consolidated statements of operations for the periods indicated:



|                                    |  | Years Ended December 31, |   
|----------------------------------- |  | ------------------------ | --
|                                    |  | 2002                     |   
|Product revenues                    |  | 77                       | % 
|Service revenues                    |  | 23                       |   
|                                    |  |                          |   
|Total revenues                      |  | 100                      |   
|                                    |  |                          |   
|                                   
|Product cost of revenues            |  | 39                       |   
|Service cost of revenues            |  | 5                        |   
|                                    |  |                          |   
|Total cost of revenues              |  | 44                       |   
|                                    |  |                          |   
|Gross profit                        |  | 56                       |   
|                                    |  |                          |   
|                                   
|Operating expenses:                 |  |                          |   
|Research and development            |  | 18                       |   
|Selling, general and administrative |  | 68                       |   
|Restructuring                       |  | 1                        |   
|                                    |  |                          |   
|Total operating expenses            |  | 87                       |   
|                                    |  |                          |   
|                                   
|Loss from operations                |  | (31                      | ) 
|Other income, net                   |  | 1                        |   
|                                    |  |                          |   
|Loss before income taxes            |  | (30                      | ) 
|Income tax (benefit) provision      |  | (9                       | ) 
|                                    |  |                          |   
|Net Loss                            |  | (21                      | )%
|                                    |  |                          |   



Year Ended December
31, 2002 Compared to Year Ended December 31, 2001



Revenues.    Our consolidated revenues of $23,487,000 for the year ended December 31, 2002 were 44% lower than 2001s annual revenues of $41,871,000. The primary reason was the industry-wide slowdown.
Our Multiplexer and Inverse Multiplexer product lines accounted for the major portion of the decrease from last year with a combined revenue reduction of $17,609,000 or 96% of the total revenue reduction.



By channel of distribution, the majority of the revenue
reduction for 2002 versus the comparable period of 2001 was attributable to lower direct sales to SPs and domestic distributors. Shipments to international locations represented 18% of total revenues during 2002 compared to 16% of total revenues
during 2001. On a twelve-month comparative basis, 2002 international revenues were 40% less than 2001 international revenues.



The combined revenues from WorldCom, Inc. and AT&T, our two largest customers, accounted for 34% of the total revenues for 2002 versus
47% for 2001. The financial difficulties at WorldCom, including its bankruptcy filing, had, and we expect it to continue to have, a major adverse impact on our revenues. The following table is the percentage of total revenues for our two largest
customers:



|               |  | Twelve Months Ended December 31, |  
|-------------- |  | -------------------------------- | -
|               |  | 2002                             |  
|WorldCom, Inc. |  | 20                               | %
|AT&T           |  | 14                               | %



Gross
Profit.    Our total gross profit dollars for 2002 were $13,140,000 versus $17,020,000 million for 2001. The reduction in gross profit dollars for the 2002 periods versus the 2001 periods was primarily due to



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sales volume declines partially offset by improvements to our gross margin percentage. Our gross profit percentage in 2001 was 41% or 15
percentage points lower than this years result of 56 percent. The 15 percentage point improvement from 2001 to 2002 was primarily due to an asset impairment charge in 2001, higher 2001 excess and obsolete inventory charges as well as higher
2001 Orion 5000 manufacturing costs, overall material costs and warranty costs.



Research and Development.    Research and development expenses totaled $4,199,000 for 2002, which was $2,580,000 or 38% below 2001s spending of $6,779,000. The
reduction was primarily due to lower employee related expenses ($2,194,000) and lower recruiting and relocation costs ($433,000) all of which resulted from the restructuring and reduction in force programs enacted in 2001 and 2002. We had 19
research and development employees at the end of the 2002 compared to 29 at the end of 2001.



Selling, General and Administrative.    Selling, general and administrative expenses decreased 22% to $16,051,000 during 2002, as compared to $20,680,000 for 2001. The lower
expenses were due primarily to reductions in employee related expenses ($2,392,000), commission expense ($1,054,000), outside services ($460,000), travel ($391,000) and communication expenses ($368,000) associated with the 2001 and 2002
restructuring and reduction in force programs.



Selling, general and administrative expenses include contractual charges from Axel Johnson for providing certain services to us related to treasury, accounting, tax, internal audit, legal and human resources. The costs of these
services have been allocated to us based on estimates by Axel Johnson of actual costs incurred. We believe that such allocations are reasonable. Such charges and allocations are not necessarily indicative of the costs that would have been incurred
if we had internally provided such services. The allocated costs of these services amounted to $465,000 for 2002, which was the same as 2001.



Restructuring.    In May and October of 2002, we announced additional corporate restructurings as a result of
the ongoing stagnation of the telecom market. Over these two restructurings, 30 positions were eliminated from our workforce with a charge to operating results of $570,000. Partially offsetting this charge was a $194,000 reduction to the prior
restructuring reserves primarily for outplacement services, which were not fully utilized by some of the laid-off employees and $122,000 in rent collected under the sublease agreement with Silicon Wireless Corporation. That compares to a $5,772,000
restructuring charge for 2001 when we reduced our workforce by 88 people, closed our leased facility in Durham, North Carolina and wrote-off assets associated with the closing.



The following table provides details on the staff reductions for our restructuring and reduction in force
programs in 2002 and 2001:



|                |  | Manufacturing |  | Research& Development |  | Selling, General& Administration |  | Total
|--------------- |  | ------------- |  | --------------------- |  | -------------------------------- |  | -----
|June of 2001    |  | 3             |  | 24                    |  | 26                               |  | 53   
|October of 2001 |  | 12            |  | 5                     |  | 18                               |  | 35   
|May of 2002     |  | 4             |  | 4                     |  | 8                                |  | 16   
|October of 2002 |  |              |  | 6                     |  | 8                                |  | 14   
|                |  |               |  |                       |  |                                  |  |      
|Total           |  | 19            |  | 39                    |  | 60                               |  | 118  
|                |  |               |  |                       |  |                                  |  |      



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Interest
and Other Income.    Interest and other income amounted to $356,000 for 2002 as compared to $1,198,000 for 2002. Interest income, which is the major component of Interest and Other Income, was $408,000 for 2002, versus
$1,243,000 for 2001. The lower interest income for the current year was attributed to lower interest rates as well as lower cash and short-term investment balances. The average interest rate for 2002 was 2% versus an average interest rate in 2001 of
5%, for a 3 percentage point decline. Average interest bearing cash and short-term balances declined by 17% to $20,421,000 from $24,749,000. Our investment portfolio generally is comprised of commercial paper rated A1/P1; bank certificates of
deposit rated A- or better and corporate medium-term notes and bonds rated A- or better.



Provision for Income Taxes.    The tax benefit of $2,113,000 for 2002 is comprised primarily of an income tax refund of $1,894,000 for taxes paid in 1996, 1997 and 1998, as a
result of a 2002 change in the federal income tax code and $262,000 for the release of an accrual related to prior years closed audits. The tax code change allowed corporations with certain tax losses to file for refunds for taxes paid in previous
years. Last years tax provision was $15,866,000.



Net loss.    The net loss for 2002 was $4,895,000, as compared to a net loss of $30,879,000 for the same period of 2001. The lower net loss for 2002 versus 2001 was primarily due to the booking in 2001of an
valuation allowance charge against the deferred tax assets ($15,981,000), restructuring costs ($5,772,000), asset impairment charges ($1,911,000), excess and obsolete inventory write-downs ($1,891,000) and higher manufacturing costs for the Larscom
5000 M13 multiplexer product ($1,000,000).



Year Ended
December 31, 2001 Compared to Year Ended December 31, 2000



Revenues.    Our consolidated revenues of $41,871,000 for the year ended December 31, 2001 were 23% lower than 2000s annual revenues of $54,664,000. The primary reason was the industry-wide slowdown,
which has continued. Our Multiplexer and Inverse Multiplexer product lines accounted for the major portion of the decrease from last year with a combined revenue reduction of $11,495,000. The most dramatic effect of the slowdown, however, was the
failure of some of our newer products, such as the service-delivery platforms, to grow as we hoped.



By channel of distribution, the bulk of the revenue reduction for 2001 versus the comparable period of 2000 was attributable to lower
direct sales to SPs and domestic distributors. Shipments to international locations represented 16% of total revenues during 2001 compared to 14% of total revenues during 2000. Also, on a twelve-month comparative basis, 2001 international revenues
were 6% less than 2000 international revenues.



The combined revenues from WorldCom, Inc. and AT&T, our two largest customers, accounted for 47% of the total revenues for 2001 versus 40% for 2000.Sales to these two customers were down in absolute dollars.



Gross Profit.    As a
percentage of revenues, gross profit for 2001 dropped by 12 percentage points to 41%, as compared to 53% for the same period of 2000. The percentage point decline in gross profits for 2001, as compared to 2000, was largely related to asset
impairment charges ($1,911,000), excess and obsolete inventory write-downs ($1,891,000), higher manufacturing costs for the Larscom 5000 M13 multiplexer product (1,000,000), higher warranty costs and the impact of lower sales volume on overhead per
unit cost.



Research and
Development.    Research and development expenses totaled $6,779,000 for 2001, which was $3,121,000 or 32% below 2000s spending of $9,900,000. The reduction was mainly due to lower staffing levels ($1,798,000), lower
software expenses ($934,000) and a decline in material cost ($329,000). The June 2001 restructuring program and the October 2001 reduction in force were the primary reasons for the lower staffing levels in research and development. We had 29
research and development employees at the end of 2001 compared to 54 at the end of 2000.



Selling, General and Administrative.    Selling, general and administrative expenses decreased 14% to $20,680,000 during 2001, as compared to $24,116,000 for the same period
of 2000. The lower spending was due



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primarily to reductions in staff levels ($1,116,000), commission expense ($804,000), tax and license expense ($739,000), travel ($426,000)
and advertising expense ($367,000) associated with the 2001 restructuring programs and reductions in force.



Selling, general and administrative expenses include contractual charges from Axel Johnson for legal, accounting, tax, treasury, human
resources and administrative services of $465,000 for 2001, as compared to $452,000 for 2000.



Restructuring.    On June 22, 2001, we announced a corporate restructuring program in response to our own reduced revenues, negative macro-economic conditions and declining
demand in our markets. This initiative was designed to focus our business on improving operating performance by reducing expenses. The restructuring program included a workforce reduction of approximately 25% (53 people), the closing of our facility
in North Carolina and a write-down of fixed assets. The effect of implementing this program was a one-time charge to results in the second quarter of $4,761,000, consisting of: $2,293,000 for employee termination costs, $2,080,000 for the closing of
our facility in North Carolina and $388,000 for a fixed asset write-down. The facility in North Carolina was sublet in 2002 (see Notes to Financial Statements, Note 5).



On October 18, 2001, due to the continued decline in the telecommunications business and the difficult
economic environment, we announced a reduction in force of approximately 17% (35 people) to align our expenses with our anticipated revenue levels. This resulted in an additional charge to operations in the fourth quarter of 2001 totaling
$1,011,000.



The following table provides details
on the staff reductions for our restructuring and reduction in force programs in 2001:



|                |  | Manufacturing |  | Research & Development |  | Selling, General & Administration |  | Total
|--------------- |  | ------------- |  | ---------------------- |  | --------------------------------- |  | -----
|June of 2001    |  | 3             |  | 24                     |  | 26                                |  | 53   
|October of 2001 |  | 12            |  | 5                      |  | 18                                |  | 35   
|                |  |               |  |                        |  |                                   |  |      
|Total           |  | 15            |  | 29                     |  | 44                                |  | 88   
|                |  |               |  |                        |  |                                   |  |      



Interest and Other Income.    Interest and other income amounted to $1,198,000 for 2001 as compared to $1,760,000 for 2000. Interest income, which is the major component of Interest and Other Income, was
$1,243,000 for 2001, versus $1,843,000 for 2000. The lower interest income for the year was attributed to lower interest rates as well as lower cash and short-term investment balances. Average interest bearing cash and short-term balances declined
by 15% to $24,357,000 from $28,723,000. Our investment portfolio generally is comprised of commercial paper rated A1/P1; bank certificates of deposit rated A- or better and corporate medium-term notes and bonds rated A- or better.



Provision for Income Taxes.    In
2001, as our business continued to fail to achieve profitability, we recorded a non-cash charge of $15,981,000 to provide a full-valuation allowance against our deferred tax assets in compliance with Statement of Financial Accounting Standards No.
109 (SFAS 109), Accounting for Income Taxes. SFAS 109 requires the establishment of a valuation allowance for deferred tax assets when it is more likely than not that these assets will not be realized. We will continue to
review whether a valuation allowance is warranted.



Net loss.    The net loss for 2001 was $30,879,000, as compared to a net loss of $2,499,000 for the same period of 2000. The higher net loss for 2001 versus 2000 was primarily due to a valuation allowance
charge against the deferred tax assets ($15,981,000), restructuring costs ($5,772,000), asset impairment charges ($1,911,000), excess and obsolete inventory write-downs ($1,891,000) and higher manufacturing costs for the Larscom 5000 M13 multiplexer
product (1,000,000).





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Liquidity and Capital Resources



At December 31, 2002, we had cash and cash equivalents of $15,643,000 and short-term investments of $2,014,000. Cash, cash equivalents and
short-term investments declined by approximately 16% from $21,005,000 on December 31, 2001 to $17,657,000 on December 31, 2002. The $3,348,000 decrease in cash and short-term investments in 2002 is primarily attributable to the net loss, after
depreciation and amortization, for the year of $3,365,000.



Capital expenditures for 2002 were $220,000. These expenditures consisted principally of the purchase of computers, software and test equipment. We anticipate capital expenditures to total approximately $608,000 for 2003.



We have a revolving line of credit of
$15,000,000 under a credit agreement with Axel Johnson Inc. (the Credit Agreement). The Credit Agreement expires in December 2003. We currently have a letter from Axel Johnson Inc. dated August 8, 2002, stating that it is Axel
Johnsons intent to allow borrowings under the credit line, provided we do not experience any material adverse change after August 8, 2002. Upon an event of default or upon election by Axel Johnson if it no longer holds at least a majority of
our outstanding voting power or it has elected less than a majority of our directors, any borrowings under the line of credit shall become payable in full.



We believe our cash and short-term investments, after consideration of future operations, will be sufficient to fund our cash
requirements, at least through the end of 2003. Nonetheless, future events, such as a further economic downturn, the potential use of cash to fund any significant losses that we might incur or acquisitions we might undertake, might require us to
request borrowings under the Credit Agreement or seek additional capital from other sources. In that event, it is possible we would not be able to make the representations and warranties necessary to effect a borrowing under the Credit Agreement or
obtain adequate capital from other sources, other than, Axel Johnson Inc.



Operating lease commitments are related principally to our buildings in Milpitas, California and Durham, North Carolina and have terms that expire in 2004 and 2007, respectively. Total rent expense in 2002, 2001 and 2000,
was $1,950,000, $2,217,000 and $2,343,000, respectively. Sublease rental income was $922,000, $1,041,000 and $955,000 in 2002, 2001 and 2000, respectively. Future annual minimum lease payments under all non-cancelable operating leases and sublease
rental income as of December 31, 2002 are as follows (in thousands):



|                          |  |   | Lease Payments |  |   | Sublease Rental Income
|------------------------- |  | - | -------------- |  | - | ----------------------
|                          |  |   |                |  |   |                       
|Years ending December 31, |  |   |                |  |   |                       
|2003                      |  | $ | 2,387          |  | $ | 640                   
|2004                      |  |   | 1,617          |  |   | 502                   
|2005                      |  |   | 338            |  |   | 264                   
|2006                      |  |   | 347            |  |   | 272                   
|2007 and thereafter       |  |   | 29             |  |   | 23                    
|                          |  |   |                |  |   |                       
|                          |  | $ | 4,718          |  | $ | 1,701                 
|                          |  |   |                |  |   |                       



The
effects of inflation on our revenues and operating income have not been material to date.



Related Party Transactions



As of December 31, 2002, Axel Johnson owned 53% of Class A and B Common Stock of Larscom and controlled 82% of the voting interest. See Note 6-Related Party Transactions to the Consolidated Financial



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Statements. Related party transactions with Axel Johnson disclosed in the consolidated financial statements are as follows:



Employee Health and Welfare Programs



We participate in various employee benefits programs
sponsored by Axel Johnson. These programs include medical, dental and life insurance and workers compensation. In general, we reimburse Axel Johnson for our 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 changes in reserves for incurred but not reported claims. We recorded expenses related to the reimbursement of these costs of approximately $663,000,
$737,000 and $728,000 in 2002, 2001 and 2000, respectively. We believe the allocation by Axel Johnson of the proportionate cost is not necessarily indicative of the costs that would have been incurred had we maintained our own benefit plans.



Administrative Services



Axel Johnson provides certain functional services to us,
including certain treasury, accounting, tax, internal audit, legal and human resources. The costs of these services have been allocated to us based on estimates by Axel Johnson of actual costs incurred. We believe that such allocations are
reasonable. Such charges and allocations are not necessarily indicative of the costs that would have been incurred if we had been a separate entity. The allocated costs of these services amounting to $465,000, $465,000 and $452,000 in 2002, 2001 and
2000, respectively, have been included in selling, general and administrative expenses in the consolidated statements of operations.



Credit Agreement



We and Axel Johnson entered into a Credit Agreement, pursuant to which Axel Johnson has agreed to provide a revolving credit/working
capital facility to us in an aggregate amount of $15,000,000. The Credit Agreement expires in December 2003. Any loans under the Credit Agreement 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 successive calendar quarter. Additionally, we are required to pay a commitment fee of 0.5% per
annum on the unused portion of the Credit Agreement. As of December 31, 2002, $15,000,000 was available, and during 2002, 2001 and 2000, no borrowings were made under the Credit Agreement.



Recent Accounting Pronouncements



In January 2003, the Financial Accounting Standards Board (FASB or the Board) issued
Interpretation No. 46 (FIN 46) Consolidation of Variable Interest Entities. Until this interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity
through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entitys activities or entitled to receive a majority
of the entitys residual returns. Management is currently evaluating the effect of this statement on the Companys results of operations and financial position. FIN 46 is effective for public entities for the first interim period beginning
after June 15, 2003 except for Variable interest entities created after January 31, 2003 where it is effective immediately. We do not currently anticipate this statement to have any effect on our financial statements.



In December 2002, the FASB issued Statement of Financial
Accounting Standards No. 148 (SFAS 148), Accounting for Stock-Based CompensationTransition and DisclosureAn Amendment of FASB Statement No. 123. SFAS 148 requires companies to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 amends the disclosure requirements of SFAS 123, Accounting for Stock-Based Compensation to require prominent



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disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results. The transition and annual disclosure provisions of FAS 148 are effective for fiscal years ending after December 15, 2002. The new interim disclosure provisions are effective for the first interim period
beginning after December 15, 2002. We do not currently anticipate this statement to have any effect on our financial statements.



In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21 (EITF 00-21), Revenue
Arrangements with Multiple Deliverables. EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will
apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company does not believe the adoption of EITF 00-21 will have a material impact on its financial position or results of operations.



In November 2002, the Board issued FASB Interpretation No. 45
(FIN 45 or the Interpretation), Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and
Rescission of FASB Interpretation No. 34.FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies (FAS 5), relating to the guarantors accounting for, and disclosure of, the issuance of certain
types of guarantees. Fin 45 is effective for guarantees entered into after December 31, 2002, however, Note 12Guarantees, discusses historical obligations as of December 31, 2002.



In May 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No.
13, and Technical Corrections (SFAS 145). Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the
provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. We do not currently anticipate this statement to have any effect on our financial
statements.



In July 2002, the FASB issued SFAS
No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues
Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a liability for costs
associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002.
We do not currently anticipate this statement to have any effect on our financial statements.



CERTAIN FACTORS AFFECTING FUTURE OPERATING RESULTS



Our entire industry is in an extended downturn.    The downturn for the United States economy and the rapid and
severe downturn for the domestic telecommunications industry, beginning in late 2000, have negatively affected demand for our products. In addition to the deteriorating domestic economic environment, the worldwide telecommunications market is
experiencing reduced demand. This decreased demand has led to fluctuating order forecasts from some of our customers. There can be no certainty as to the degree of severity or duration of this economic downturn or the reduced demand in the
telecommunications industry. We also cannot predict the extent and timing of the impact of the economic downturn in the United States and the worldwide downturn for the telecommunications industry on economies in Canada, Europe and other countries
and geographic regions. For 2002, order demand from our customers continued to decline as they experienced the impact of the downturn in the telecommunications market.



We expect to continue to incur operating losses and may not be profitable in the
future.    We have experienced substantial net losses, including a net loss of $4,895,000 in 2002 and $30,879,000 in 2001 and had



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an accumulated deficit of $65,516,000 as of December 31, 2002. A continued decrease in revenues could have an adverse impact on our finances.
There can be no assurance as to when or if we will achieve profitability.



Our prospects for growth depend on recently-introduced products, products under development and products licensed from others.    We expect sales of our established products
to decline over time. Therefore, our future operating results are highly dependent on market acceptance of our recently-introduced products, products that may be introduced in the future and products that we license from others. These include, for
example, the Larscom 6200 and the Orion 5000, 5001 and 5003 and the Orion 4500, all of which have only recently been introduced. There can be no assurance that such products will achieve widespread market acceptance, and, in fact, some other
products we introduced in recent years have failed to meet our sales expectations. The industry-wide downturn has caused sales of new products, such as ours, to be well below expectations. In addition, we have licensed the intellectual property and
development rights for the Orion 5000, 5001 and 5003. Our dependence on others for the initial design of this product increases the risk that we may not be successful with future enhancements to the product line. We have, in the past, experienced
delays and changes in course in the development of new products and the enhancement of existing products, and such delays and changes in course may occur in the future. Our inability to develop and introduce new products or product versions in a
timely manner, due to resource constraints or technological or other reasons, or to achieve timely and widespread market awareness and acceptance of our new products or releases, would have a material adverse effect on our business and operating
results.



We conducted four rounds of
restructuring/layoffs in the past nineteen months.    Our June 22, 2001 restructuring included a workforce reduction of approximately 25% (53 people) and the closure of our North Carolina facility. On October 18, 2001, we
announced additional reductions in force of approximately 17% (35 people) of the base 2001 workforce. On May 31, 2002 we announced another reduction in force of approximately 13% (16 people) of our remaining workforce. On October 21, 2002, we
announced an additional reduction of 13% of our workforce (14 people). Thirty-three percent (39 people) of the total reductions in employees were from engineering personnel. Although the restructuring actions taken have lowered our expense base, we
expect operating losses to continue in 2003. Therefore, there can be no assurance that another material restructuring and/or workforce reduction will not be required. In addition, our workforce reductions may deprive us of the human capital we would
need to take full advantage of any upturn in the business cycle in our industry. There can be no assurance that we will not lose employees in the future as a result of the restructuring/layoffs, or that we will be able to recruit suitable
replacements.



Rapid technological change
could hurt our ability to compete.    The telecommunications equipment industry is characterized by rapidly-changing technologies and frequent new product introductions. The rapid development of new technologies increases the
risk that current or new competitors could develop products that would reduce the competitiveness of our products. Our success will depend to a substantial degree upon our ability to respond to changes in technology and customer requirements. This
will require the timely development and marketing of new products and enhancements on a cost-effective basis. There can be no assurance that we will be successful in developing, introducing or managing the transition to new or enhanced products or
that any such products will be responsive to technological changes or will gain market acceptance. In the past, some of the products we have planned and introduced have not met our sales expectations.



Our business could be materially and adversely affected by
shifts in the use of technology common throughout the industry today. Three shifts affecting our products and industry are: the integration of CSU/DSU technology into routers and switches, a move from T1/E1 services to more Ethernet-based services
and the increase in demand for more managed, customer-premise-based services. The failure to accommodate these shifts in technology could impact sales of our products and have a material adverse affect on our business and operating results.



The absence of long-term backlog makes us
vulnerable in periods of weak demand.    None of our customers are contractually obligated to purchase any quantity of products in any particular period, and product sales to major customers have varied widely from
quarter-to-quarter and from year-to-year. Our current customers might



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not continue to place orders with us, orders from existing customers might not continue at the levels of previous periods and we might not be
able to obtain orders from new customers. Over the last several years, there has been a reduction of equipment demand throughout the telecommunications industry. Because of our limited backlog, this tends to have an immediate negative effect on our
operations, which we cannot fully offset on a timely basis by implementing reductions in expenses.



We depend upon a small number of customers.    A small number of customers have accounted for a significant
percentage of our sales. Therefore, sales for a given quarter generally depend on orders received from, and product shipments to, a limited number of customers. Sales to individual large customers are often related to the customers specific
equipment deployment projects, the timing of which is subject to change on limited notice, in addition to the ebbs and flows in our customers business conditions and the effect of competitors product offerings. We have in the past
experienced both accelerations and slowdowns in orders related to such projects, causing changes in the sales level of a given quarter relative to both the preceding and subsequent quarters. Since most of our sales are in the form of large orders
with short delivery times to a limited number of customers, our backlog and consequently our ability to predict revenues will continue to be limited. In addition, announcements by us or our competitors of new products and technologies could cause
customers to defer, limit or end purchases of our existing products. In the event that we lose one or more large customers, anticipated orders from major customers fail to materialize, or delivery schedules are deferred or canceled as a result of
the above, or other unanticipated factors, our business and operating results would be materially adversely affected. Our largest customer, WorldCom, filed for bankruptcy in 2002, which could lead to a substantial loss in their customer base or a
major reorganization, all of which could influence their order levels to us. In 2002 revenue from sales to WorldCom decreased 71% from sales to WorldCom in 2001.



Our 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 our control.    Consequently, we believe that period-to-period comparisons of our operating results are not necessarily meaningful and
should not be relied upon as indicative of future performance.



Results in any period could also be affected by changes in:



| | · |  | market demand,
| | - |  | --------------



| | · |  | competitive market conditions,
| | - |  | ------------------------------



| | · |  | market acceptance of new or existing products,
| | - |  | ----------------------------------------------



| | · |  | sales channel development costs,
| | - |  | --------------------------------



| | · |  | the cost and availability of components,
| | - |  | ----------------------------------------



| | · |  | the mix of our customer base and sales channels,
| | - |  | ------------------------------------------------



| | · |  | the mix of products sold,
| | - |  | -------------------------



| | · |  | our sales promotion activities,
| | - |  | -------------------------------



| | · |  | our ability to expand or contract our sales and marketing organizations effectively,
| | - |  | ------------------------------------------------------------------------------------



| | · |  | our ability to attract and retain key technical and managerial employees and
| | - |  | ----------------------------------------------------------------------------



| | · |  | general economic conditions.
| | - |  | ----------------------------



We established our expense levels for product development and other operating expenses based on projected sales levels and margins, but
expenses are relatively fixed in the short term. Accordingly, when sales are below expectations in any given period, our inability to adjust spending proportionally in the short term may exacerbate the adverse impact of a revenue shortfall on our
operating results.



Because of all of the
foregoing factors, our operating results in one or more future periods may be subject to significant fluctuations. In the event these factors result in financial performance below the expectations of public market analysts and investors, the price
of our Class A Common Stock could be materially adversely affected.



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We depend
heavily on component availability and key suppliers.    On-time delivery of our products depends upon the availability of components and subsystems used in our products. We depend upon our suppliers to manufacture, assemble
and deliver components in a timely and satisfactory manner. We obtain components and license certain embedded software from several single sources. We do not believe we would be able to develop alternative sources for certain essential components
used in our products without incurring significant costs. In addition, while we believe we would be able to develop alternative sources for most of the other components and software used in our products there can be no assurance that we would be
able to do so, in a timely manner without incurring substantial additional costs, if required. Any inability by our suppliers to meet our demand or any prolonged interruption in supply, or a significant increase in the price of one or more
components or in the price of software, would likely have an adverse impact on our business and operating results. We generally do not have any long-term contracts with our suppliers and, in fact, we have made a recent decision to change our major
supplier for contract manufacturing. It is possible that our new major contract supplier and other suppliers will not continue to be able and willing to meet our future requirements.



The market for our products is intensely competitive, and our failure to compete effectively could reduce
our revenues and margins.    Competition in the market place for high-speed network-access products is intense. Our products compete primarily with Quick Eagle Networks, Verilink, Kentrox, Cisco Systems, Alcatel, ADTRAN, RAD,
Telco Systems, Carrier Access and Paradyne. We compete to a lesser extent with other telecommunications equipment companies. Many of our competitors have more broadly developed distribution channels and have made greater advances than we have in
emerging technologies. Cisco Systems and Atcatel are two of the largest communications equipment companies in the world. There can be no assurance that we will be able to continue to compete successfully with existing or new competitors.



We are controlled by Axel Johnson
Inc.    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
Inc. is the sole holder of the Class B Common Stock. As a result, Axel Johnson Inc. has sufficient combined voting power to control the direction and policies of Larscom absolutely, including mergers, the payment of dividends, consolidations, the
sale of all or substantially all of the assets of Larscom and the election of the Board of Directors of Larscom, and to prevent or cause a change in control of Larscom. There can be no assurance that Axel Johnson will not affect our corporate
actions in a manner that conflicts with the interest of our other stockholders.



During growth periods, it is difficult to hire all the qualified personnel we need.    To grow our business, we must continue to attract, train, motivate and manage
new employees successfully, integrate new management and employees into our overall operations and continue to improve our operational, financial and management systems. Availability of qualified sales and technical personnel is limited, and
competition for experienced sales and technical personnel in the telecommunications equipment industry is intense during times when business in the telecommunications equipment industry is strong. In the past, we have had difficulty in filling all
of our hiring requisitions. Our failure to manage the retention of key employees effectively could have a material adverse effect on our business and operating results.



We are significantly engaged in selling in international markets, which results in operational
difficulties and risks.    Sales outside the U.S. approximated 18% of our revenues for 2002. The conduct of business outside the U.S. is subject to certain customary risks, including unexpected changes in regulatory
requirements and tariffs, difficulties in staffing and managing foreign operations, longer payment cycles, greater difficulty in accounts receivable collection, currency fluctuations, possible expropriation and potentially adverse tax consequences.
In addition, to sell our products internationally, we must meet standards established by telecommunications authorities in a variety of countries as well as recommendations of the International Telecommunications Union. A delay in obtaining, or the
failure to obtain, certification of our products in countries outside the U.S. could inhibit or preclude our marketing and sales efforts in such countries, which could have an adverse impact on our business and operating results.



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We have
recently reorganized our sales force.    In October 2002, we reorganized our sales force to concentrate on four account types:



| | · |  | major accounts,
| | - |  | ---------------



| | · |  | carrier accounts,
| | - |  | -----------------



| | · |  | US indirect channels (distributors and resellers) and enterprise customers and
| | - |  | ------------------------------------------------------------------------------



| | · |  | overseas accounts.
| | - |  | ------------------



As part of this reorganization we have reassigned certain of our sales people to different, specific customer accounts and different types of customers.
There is a risk that the new relationships with customers resulting from the reorganization might not be as productive as the prior organization in the near term or at all. Failure of the new organization to achieve sales productivity goals could
have an adverse impact on our business and operating results.



We have developed an indirect distribution channel for sales to domestic customers.    This channel consists primarily of a small group of master distributors, such as Tech Data, and a number of authorized
resellers. There are a number of risks associated with an indirect distribution channel. The risks include a reduction in our ability to forecast sales, reduced average selling prices, potential reductions in customer satisfaction, loss of contact
with users of our products, a potential build-up of inventories at resellers and new methods of advertising and promoting products that will result in additional expenses. All of these risk factors could have an adverse impact on our business and
operating results.



We must comply with
regulations and evolving industry standards.    The market for our products is characterized by the need to comply with a significant number of communications regulations and standards, some of which are evolving as new
technologies are deployed. In the U.S., our products must comply with various regulations defined by the Federal Communications Commission and standards established by Underwriters Laboratories, as well as industry standards established by various
organizations. As standards for services such as Asynchronous Transfer Mode, Frame Relay, Internet Protocol and Synchronous Optical Network/Synchronous Digital Hierarchy evolve, we may be required to modify our existing products or develop and
support new versions of our products. The failure of our products to comply, or delays in compliance, with the various existing and evolving industry standards could delay introduction of or affect the marketability of our products, which in turn
could have an adverse impact on our business and operating results.



We may not be able to protect our intellectual property and proprietary information.    We rely upon a combination of trade secrets, contractual restrictions, copyrights, trademark laws and patents
to establish and protect proprietary rights in our products and technologies. We believe that the success of our business depends primarily on our proprietary technology, information, processes and expertise, rather than patents. Much of our
proprietary information and technology is not patented and may not be patentable. We have been issued only one U.S. patent to date. There can be no assurance that we will be able to protect our technology or that competitors will not be able to
develop similar technology independently. We have entered into confidentiality and invention assignment agreements with employees, and into non-disclosure agreements with suppliers, distributors and appropriate customers so as to limit access to and
disclosure of our proprietary information. There can be no assurance that these statutory and contractual arrangements will deter misappropriation of our technologies or discourage independent third-party development of similar technologies. In the
event such arrangements are insufficient, our business and operating results could be adversely impacted.



We have not conducted a formal patent search relating to the technology used in our products.    From
time to time, third parties may assert exclusive patent, copyright, trademark and other intellectual property rights to technologies that are important to us. Since patent applications in the U.S. are not publicly disclosed immediately, applications
which we do not know about, may have been filed by competitors of ours that could relate to our products. The scope of protection accorded to patents covering software-related inventions is evolving and is subject to uncertainty, which may increase
the risk and cost to us if we discover third-party



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patents related to our software products or if such patents are asserted against us in the future. In the event of litigation to determine
the validity of any third-party claims, such litigation, whether or not determined in favor of us, could result in significant expense to us and divert the efforts of our technical and management personnel. In the event of an adverse ruling in such
litigation, we might be required to pay damages, discontinue the use and sale of infringing products, and 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 us and our failure to develop or license a substitute technology could have an adverse impact on our business and operating results.



We provideour customers a three-year
or longer warranty on most product lines.    Complex products such as ours might contain undetected errors or failures when first introduced or as new versions are released. Although we believe that our reserves for estimated
future warranty costs are adequate, our estimates, particularly those related to products that have been recently introduced, might not be correct. Warranty claims in excess of those expected could have an adverse impact on our business and
operating results.



As part of the strategy
for growth and expansion of our business, we may make acquisitions that could disrupt our business or harm our financial condition.    As part of our business strategy, we may invest in or acquire other businesses,
technologies or assets, or enter into strategic relationships with third parties. For such acquisitions, we may issue additional stock, incur debt, assume liabilities, incur impairment charges related to goodwill and other intangible assets or incur
other large and immediate write-offs. With the exception of our acquisition of NetEdge in 1997, we have no recent experience in integrating acquired businesses with our existing business. Our operation of any acquired business would involve numerous
risks including:



| | · |  | problems integrating any acquired operations with our own,
| | - |  | ----------------------------------------------------------



| | · |  | unanticipated costs,
| | - |  | --------------------



| | · |  | diversion of managements attention from our core business,
| | - |  | -----------------------------------------------------------



| | · |  | adverse effects on existing business relationships with customers,
| | - |  | ------------------------------------------------------------------



| | · |  | risks associated with entering markets in which we have no or limited experience
| | - |  | --------------------------------------------------------------------------------



| | · |  | the potential loss of key employees, particularly those of the purchased organization and
| | - |  | -----------------------------------------------------------------------------------------



| | · |  | decrease our cash position.
| | - |  | ---------------------------



Our Class A Common Stock has traded below one dollar and may be subject to de-listing from the Nasdaq SmallCap
Market.    On July 16, 2002, we received a notice from Nasdaq that our Common Stock had failed to maintain the required minimum closing bid price of $1.00 for a period of 30 consecutive trading days as well as the minimum
requirements for market value of publicly traded shares on the Nasdaq National Market. As a result, Nasdaq provided us 90 calendar days, or until October 14, 2002 to regain compliance with this requirement or face de-listing from trading on the
Nasdaq National Market. Prior to our de-listing, we submitted an application to Nasdaq for transfer to their SmallCap market. The application was approved and our stock began trading on the Nasdaq SmallCap market effective on October 23, 2002. There
can be no assurance that our trading price will be at or above Nasdaqs SmallCap requirements for the necessary time periods mandated by Nasdaq. If we are unable to meet Nasdaqs SmallCap listing requirements our Class A Common Stock could
trade on the OTC Bulletin Board or in the pink sheets maintained by the National Quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our Class A
Common Stock, could be adversely impacted as a result.



Item 7a.Quantitative and Qualitative Disclosures About Market Risk



Interest Rate Risk.    We do not use derivative financial instruments in our investment portfolio. Our
investment portfolio generally has been comprised of commercial paper rated A1/P1, bank certificates of deposit



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rated A- or better and corporate medium-term notes and bonds rated A- or better. These securities mature within one year and are classified
as available for sale in accordance with SFAS No. 115 (SFAS 115), Accounting for Certain Investments in Debt and Equity Securities.



At December 31, 2002, our investment portfolio included fixed-income securities, of the quality described above, with a fair market
value of approximately $2,014,000. These securities are subject to interest-rate risk, and will decline in value if interest rates rise. Due to the short duration of our investment portfolio, an immediate, hypothetical 10% decrease in interest rates
would not have a material effect on our current year financial condition or results of operations. Because the securities are so short in duration, their principal value would not be materially affected. The new securities we replace them with when
they mature would yield us less interest income, but the amount of the reduction would not be material to us. If a 10% reduction in interest rates on our investments occurred on January 1, 2003 and remained in effect throughout 2003, our interest
income and our cash flow would be reduced by approximately $1,031 in 2003. We do not hold any long-term fixed instruments.



Foreign Currency Exchange Rate Risk. Our international sales are typically made in U.S. dollars and are generally not subjected to
foreign currency exchange rate risk. However, certain of our sales and marketing expenses are incurred in local currencies, principally the British Pound. Consequently, our international results of operations are subject to foreign exchange rate
fluctuations. We do not currently hedge against foreign currency rate fluctuations. Gains and losses from such fluctuations have not been material to our consolidated results. The effect of an immediate, hypothetical 10% change in exchange rate for
the British Pound or any other foreign currency would not be material to us.



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##### Table of Contents



Item 8.Financial Statements and Supplementary Data



LARSCOM INCORPORATED

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|Consolidated Financial Statements:                                                                                                   |  | Page
|------------------------------------------------------------------------------------------------------------------------------------ |  | ----
|Report of
Independent Accountants                                                                                                    |  | 31  
|Consolidated Balance Sheets as of December 31, 2002 and 2001                                                                         |  | 32  
|Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000                                           |  | 33  
|Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000                                           |  | 34  
|Consolidated Statements of
Stockholders Equity and Comprehensive Income (Loss) for the years ended December 31, 2002, 2001 and 2000 |  | 35  
|Notes to
Consolidated Financial Statements                                                                                           |  | 36  



Financial Statement
Schedules:



All schedules, with the
exception of Schedule II Valuation and Qualifying Accounts (see Part IV Item 14), are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.



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##### Table of Contents



Report of
Independent Accountants



To the board of directors and
stockholders of Larscom Incorporated



In our
opinion, the consolidated financial statements listed in the accompanying indexpresent fairly, in all material respects, the financial position of Larscom Incorporated and its subsidiaries at December 31, 2002 and 2001, and the results of
theiroperations and theircash flows for each of the three years in the period ended December 31, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the
financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Larscom Incorporated management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits
of these statements in accordance with auditing standards generally accepted in the United States of America, 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 disclosuresin 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 our opinion.



PricewaterhouseCoopers LLP



San Jose, California

February 11, 2003



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LARSCOM
INCORPORATED



CONSOLIDATED BALANCE SHEETS



(in thousands, except per share data)



|                                                                                                                                                       |  | December 31, |        
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------ | -------
|                                                                                                                                                       |  | 2002         |        
|ASSETS                                                                                                                                                 |  |              |        
|Current assets:                                                                                                                                        |  |              |        
|Cash and cash equivalents                                                                                                                              |  | $            | 15,643 
|Short-term investments                                                                                                                                 |  |              | 2,014  
|Accounts receivable, net                                                                                                                               |  |              | 3,079  
|Inventories                                                                                                                                            |  |              | 3,816  
|Income taxes receivable                                                                                                                                |  |              | 60     
|Due from Axel Johnson                                                                                                                                  |  |              |       
|Prepaid expenses and other current assets                                                                                                              |  |              | 1,322  
|                                                                                                                                                       |  |              |        
|Total current assets                                                                                                                                   |  |              | 25,934 
|Property and equipment, net                                                                                                                            |  |              | 1,918  
|Other non-current assets, net                                                                                                                          |  |              | 208    
|                                                                                                                                                       |  |              |        
|Total assets                                                                                                                                           |  | $            | 28,060 
|                                                                                                                                                       |  |              |        
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                                                                                   |  |              |        
|Current liabilities:                                                                                                                                   |  |              |        
|Accounts payable                                                                                                                                       |  | $            | 1,898  
|Accrued expenses and other current liabilities                                                                                                         |  |              | 4,510  
|Deferred Revenue                                                                                                                                       |  |              | 2,102  
|Due to Axel Johnson                                                                                                                                    |  |              | 25     
|                                                                                                                                                       |  |              |        
|Total current liabilities                                                                                                                              |  |              | 8,535  
|Other non-current liabilities                                                                                                                          |  |              | 1,618  
|                                                                                                                                                       |  |              |        
|Total liabilities                                                                                                                                      |  |              | 10,153 
|                                                                                                                                                       |  |              |        
|Commitments and contingencies (see Note 10)                                                                                                            |  |              |        
|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; 8,861 shares and 8,833
shares issued and outstanding for 2002 and 2001, respectively |  |              | 89     
|Class B Common Stock, $0.01 par value; 11,900 shares authorized; 10,000 issued and
outstanding                                                         |  |              | 100    
|Additional paid-in capital                                                                                                                             |  |              | 83,231 
|Accumulated other comprehensive loss                                                                                                                   |  |              | (1     
|Unrealized investment gain                                                                                                                             |  |              | 4      
|Accumulated deficit                                                                                                                                    |  |              | (65,516
|                                                                                                                                                       |  |              |        
|Total stockholders equity                                                                                                                             |  |              | 17,907 
|                                                                                                                                                       |  |              |        
|Total liabilities and stockholders equity                                                                                                             |  | $            | 28,060 
|                                                                                                                                                       |  |              |        





The accompanying notes are an integral part of these financial statements.



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LARSCOM INCORPORATED



CONSOLIDATED STATEMENTS OF OPERATIONS



(in thousands, except per share data)



|                                          |  | Years Ended December 31, |       
|----------------------------------------- |  | ------------------------ | ------
|                                          |  | 2002                     |       
|Product revenues                          |  | $                        | 17,977
|Service revenues                          |  |                          | 5,510 
|                                          |  |                          |       
|Total revenues                            |  |                          | 23,487
|                                          |  |                          |       
|                                         
|Product cost of revenues                  |  |                          | 9,276 
|Service cost of revenues                  |  |                          | 1,071 
|                                          |  |                          |       
|Total cost of revenues                    |  |                          | 10,347
|                                          |  |                          |       
|Gross profit                              |  |                          | 13,140
|                                          |  |                          |       
|                                         
|Operating expenses:                       |  |                          |       
|Research and development                  |  |                          | 4,199 
|Selling, general and administrative       |  |                          | 16,051
|Restructuring                             |  |                          | 254   
|                                          |  |                          |       
|Total operating expenses                  |  |                          | 20,504
|                                          |  |                          |       
|                                         
|Loss from operations                      |  |                          | (7,364
|Interest and other income                 |  |                          | 356   
|                                          |  |                          |       
|Loss before income taxes                  |  |                          | (7,008
|Income tax (benefit) provision            |  |                          | (2,113
|                                          |  |                          |       
|Net loss                                  |  | $                        | (4,895
|                                          |  |                          |       
|                                         
|Basic and diluted net loss per share      |  | $                        | (0.26 
|Basic and diluted weighted average shares |  |                          | 18,854









The accompanying notes are an integral part of these financial statements.



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##### Table of Contents

LARSCOM INCORPORATED



CONSOLIDATED STATEMENTS OF CASH FLOWS



(in thousands)



|                                                                        |  | Years Ended December 31, |       
|----------------------------------------------------------------------- |  | ------------------------ | ------
|                                                                        |  | 2002                     |       
|Cash flows from operating activities:                                   |  |                          |       
|Net loss                                                                |  | $                        | (4,895
|Adjustments to reconcile net loss to net cash used in operations:       |  |                          |       
|Depreciation & amortization                                             |  |                          | 1,530 
|Write-down of inventory                                                 |  |                          | 767   
|Non-cash restructuring and cost of revenue charges                      |  |                          |      
|Deferred income taxes                                                   |  |                          |      
|Allowance for doubtful accounts                                         |  |                          | 504   
|Other noncash items                                                     |  |                          | (70   
|Changes in assets and liabilities:                                      |  |                          |       
|Accounts receivable                                                     |  |                          | 644   
|Inventories                                                             |  |                          | (1,008
|Income taxes receivable                                                 |  |                          |      
|Prepaid expenses and other assets                                       |  |                          | 443   
|Accounts payable                                                        |  |                          | (216  
|Accrued expenses and other current liabilities                          |  |                          | (1,702
|Deferred Revenue                                                        |  |                          | 1,194 
|Liabilities long-term                                                   |  |                          | (443  
|                                                                        |  |                          |       
|Net cash used in operating activities                                   |  |                          | (3,252
|                                                                        |  |                          |       
|Cash flows from investing activities:                                   |  |                          |       
|Purchases of short-term investments                                     |  |                          | (9,248
|Sales and maturities of short-term investments                          |  |                          | 18,449
|Purchase of property and equipment                                      |  |                          | (220  
|Purchase of software licenses                                           |  |                          | (500  
|                                                                        |  |                          |       
|Net cash provided by investing activities                               |  |                          | 8,481 
|                                                                        |  |                          |       
|                                                                       
|Cash flows from financing activities:                                   |  |                          |       
|Net proceeds from sales of Class A Common Stock                         |  |                          | 22    
|Payments from (to) Axel Johnson                                         |  |                          | 599   
|                                                                        |  |                          |       
|Net cash provided by financing activities                               |  |                          | 621   
|                                                                        |  |                          |       
|Effect of
unrealized investment gain and foreign exchange rates on cash |  |                          | 4     
|                                                                        |  |                          |       
|Increase in cash and cash equivalents                                   |  |                          | 5,854 
|Cash and cash equivalents at beginning of year                          |  |                          | 9,789 
|                                                                        |  |                          |       
|Cash and cash equivalents at end of year                                |  | $                        | 15,643
|                                                                        |  |                          |       
|                                                                       
|Supplemental disclosure of cash flow information:                       |  |                          |       
|Interest paid                                                           |  | $                        | 3     
|                                                                        |  |                          |       
|Income taxes paid                                                       |  | $                        | 40    
|                                                                        |  |                          |       
|Interest received                                                       |  | $                        | 408   
|                                                                        |  |                          |       
|Income tax refunds received                                             |  | $                        | 1,894 
|                                                                        |  |                          |       



The
accompanying notes are an integral part of these financial statements.



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LARSCOM
INCORPORATED



CONSOLIDATED STATEMENTS OF
STOCKHOLDERS EQUITY

AND COMPREHENSIVE INCOME (LOSS)



(in thousands)



|                                        |  | Class ACommon Stock |  | Class BCommon Stock |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|--------------------------------------- |  | ------------------- |  | ------------------- | -- | ----------------- | ------ | ------ | ----------- | ------- |  | ------------- | ------ |  | ------------- | -- | - | ------
|                                        |  |                     |  | Additional          |    | Accumulated Other |        |        |             |         |  | Total Stock-  |        |  | Comprehensive |   
|                                        |  |                     |  | Paid-In             |    | Comprehensive     |        |        | Accumulated |         |  | holders'      |        |  | Income        |   
|                                        |  | Shares              |  | Amount              |    | Shares            |        | Amount |             | Capital |  | Income (loss) |        |  | Deficit       |    |   | Equity
|Balance at December 31, 1999            |  | 8,379               |  |                     | 84 |                   | 10,000 |        |             | 100     |  |               | 81,860 |  |               | (6 | ) |       
|Comprehensive income (loss):            |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Net loss                                |  |                    |  |                     |   |                   |       |        |             |        |  |               |       |  |               |   |   |       
|Foreign currency translation adjustment |  |                    |  |                     |   |                   |       |        |             |        |  |               |       |  |               | 5  |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Comprehensive loss                      |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Issuance under stock plans              |  | 337                 |  |                     | 3  |                   |       |        |             |        |  |               | 738    |  |               |   |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Balance at December 31, 2000            |  | 8,716               |  | $                   | 87 |                   | 10,000 |        | $           | 100     |  | $             | 82,598 |  | $             | (1 | ) |       
|Comprehensive income (loss):            |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Net loss                                |  |                    |  |                     |   |                   |       |        |             |        |  |               |       |  |               |   |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Comprehensive loss                      |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Issuance under stock plans              |  | 117                 |  |                     | 1  |                   |       |        |             |        |  |               | 612    |  |               |   |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Balance at December 31, 2001            |  | 8,833               |  | $                   | 88 |                   | 10,000 |        | $           | 100     |  | $             | 83,210 |  | $             | (1 | ) |       
|Comprehensive income (loss):            |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Net loss                                |  |                    |  |                     |   |                   |       |        |             |        |  |               |       |  |               |   |   |       
|Unrealized investment gain adjustment   |  |                    |  |                     |   |                   |       |        |             |        |  |               |       |  |               | 4  |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Comprehensive loss                      |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Issuance under stock plans              |  | 28                  |  |                     | 1  |                   |       |        |             |        |  |               | 21     |  |               |   |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       
|Balance at December 31, 2002            |  | 8,861               |  | $                   | 89 |                   | 10,000 |        | $           | 100     |  | $             | 83,231 |  | $             | 3  |   |       
|                                        |  |                     |  |                     |    |                   |        |        |             |         |  |               |        |  |               |    |   |       









The accompanying notes are an integral part of these financial statements



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##### Table of Contents



LARSCOM
INCORPORATED



NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS



Note 1The Company and a
Summary of Significant Accounting Policies:



Larscom Incorporated (Larscom or the Company), a majority-owned subsidiary of Axel Johnson, develops, manufactures and markets a broad range of high-speed, internetworking products for SPs, ISPs and corporate
users. We operate in one industry segment.



Principles of Consolidation



The consolidated financial statements include the accounts of Larscom Incorporated and our wholly-owned subsidiary. All material intercompany transactions and account balances have been eliminated in consolidation.



Concentrations of Credit Risk and Customer Concentration



Financial instruments, which subject us to
concentrations of credit risk, consist primarily of investments in certain debt securities and accounts receivable. We are 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. Our accounts receivable are derived from sales to customers primarily in the United States. We perform ongoing credit evaluations of our customers, and generally require no collateral from our customers. We maintain reserves
for potential credit losses, and to date have not experienced any material losses. However, during 2002, as a result of WorldCom filing for bankruptcy, we established reserves of $528,000 for accounts receivable owed to us by WorldCom prior to their
bankruptcy filing. While we have filed our claim with the bankruptcy court for the total amount reserved, we expect to receive substantially less than the full amount owed to us. Net receivables from the two largest customers represented 38% and 59%
of net accounts receivable at December 31, 2002 and 2001, respectively.



The following table summarizes the percentage of total revenues for customers accounting for more than 10% of our revenues:





|              |  | Years Ended December 31, |  
|------------- |  | ------------------------ | -
|              |  | 2002                     |  
|WorldCom Inc. |  | 20                       | %
|AT&T          |  | 14                       | %



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 these 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-term maturity of those investments and the financial stability of the issuers.



We participate in Axel Johnsons centralized cash management system. In general, all of our cash receipt and disbursement
transactions are processed through the Axel Johnson centralized cash management system.



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1The Company and a Summary of Significant Accounting Policies: (Continued)



Short-term Investments



We account for our short-term investments by determining the
appropriate classification of our investments in debt and equity securities at the time of purchase based on maturity and re-evaluate such determination at each balance sheet date. All of the securities we owned at December 31, 2002 and 2001
consisted of fixed and variable rate commercial paper rated A1/P1, bank certificates of deposit rated A- or better and corporate medium-term notes and bonds rated A- or better. These securities have contractual maturity dates of less than one year
and have been classified as available-for-sale. The fair value of our short-term investments approximates their carrying value due to the short maturity of those investments. The cost of securities sold is based on the specific identification
method.



Inventories



Inventories are stated at the lower of standard cost or
market. Standard cost approximates actual average cost. Write-downs of inventory are generally taken, when in our estimate, future demand will not consume existing inventories over the next twelve months. If actual future demand or market conditions
are less favorable than those projected by management, additional inventory write-downs may be required.



Prepaid Royalties



The net book value of prepaid royalties (which are included in Prepaid expenses and other current assets on the Consolidated Balance
Sheet) was $100,000 and $175,000 at December 31, 2002 and 2001, respectively. Prepaid royalties are amortized over the shorter of the anticipated useful life of the technology or the contractual royalty period.



Property and Equipment



Property and equipment are recorded at cost. Depreciation,
other than for leasehold improvements, 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 amortized using the straight-line method over the
shorter of the estimated useful lives or the lease term of the respective assets. When property and equipment are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or
loss is included in the results of the current operations. Costs of repairs and maintenance are expensed as incurred. The Company periodically evaluates the recoverability of its long-lived assets based on the expected, undiscounted cash flows and
the market valuation approach.



Intangible
Assets



At each balance sheet date, an
evaluation was performed by management to ascertain whether the goodwill and intangible assets were impaired by comparing the carrying value with the estimated future, non-discounted cash flows. We record impairment of the carrying value, if any,
based on the difference between the carrying value and the fair market value of intangible assets.



Warranty



We provide a three-year warranty for most of our products. A provision for the estimated cost of warranty, which is based on our
historical costs and includes material, labor and overhead, is recorded at the time revenue



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1The Company and a Summary of Significant Accounting Policies: (Continued)



is recognized. While we believe that our 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.



Revenue Recognition



Revenue from product sales is generally recognized upon
shipment of the product. We do not recognize revenue to distributors when a right of return exists until we are notified by the distributor that the products have been shipped to the end user. Service revenue is recognized over the contractual
period or as services are rendered and accepted, if applicable, by the customer. Shipping and handling costs, which are re-billed to the customers, are included in product revenue.



Research and Development



Research and development costs are charged to expense as incurred.



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. A valuation allowance is provided against deferred tax assets if it is more likely than not that they
will not be realized. Our provision for income taxes is calculated on a separate-return basis.



Loss per Share



Basic loss per share excludes any dilutive effects of options, warrants and convertible securities. Basic loss per share is computed using the weighted-average number of common shares outstanding during the period. Diluted
loss per share is computed using the weighted-average number of common and common stock equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon the exercise of stock options
(using the Treasury Stock Method). Common equivalent shares are excluded from the computation if their effect is antidilutive.



The following table sets forth the computation of basic and diluted loss per share:



|                                                        |  | Years Ended December 31,              |       
|------------------------------------------------------- |  | ------------------------------------- | ------
|                                                        |  | 2002                                  |       
|                                                        |  | (in thousands, except per share data) |       
|Net loss                                                |  | $                                     | (4,895
|Weighted average Class A and B Common Stock outstanding |  |                                       | 18,854
|Basic and diluted loss per share                        |  | $                                     | (0.26 



Outstanding stock options are not included in diluted loss per share because their effect would have been antidilutive for all periods presented. These stock options could be dilutive in the future. See Note 9 for details of options
issued.



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 1The Company and a Summary of Significant Accounting Policies: (Continued)



Stock-Based Compensation



As permitted under Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), we are continuing to measure compensation costs 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 required by SFAS 123 as amended by
FASB 148, are presented here.



For purposes of
pro forma disclosures, the estimated fair value of the options under the Stock Incentive Plan, Stock Options Plan for Non-Employee Director and Employee Stock Purchase Plan is amortized to expense over the vesting period of the respective options.
Our pro forma information for the years ended December 31 is as follows (in thousands, except per share information):



|                                                 |  | 2002 |        |   | 2001 |   |         | 2000 | 
|------------------------------------------------ |  | ---- | ------ | - | ---- | - | ------- | ---- | 
|Net lossas reported                             |  | $    | (4,895 | ) |      | $ | (30,879 | )    | 
|Compensation expenses net of tax                 |  | $    | (656   | ) |      | $ | (879    | )    | 
|Net losspro forma                               |  | $    | (5,551 | ) |      | $ | (31,758 | )    | 
|Basic and
diluted net loss per shareas reported |  | $    | (0.26  | ) |      | $ | (1.64   | )    | 
|Basic and diluted net loss per sharepro forma   |  | $    | (0.29  | ) |      | $ | (1.69   | )    | 



Fair
Value of Financial Instruments



For all
financial instruments, including short-term investments, accounts receivable, accounts payable and accrued liabilities, the carrying value is considered to approximate fair value due to the relatively short- term maturities of the respective
instruments.



Foreign Currency Translation



Assets and liabilities of our foreign
subsidiary are translated from its functional currency at exchange rates in effect at the balance sheet date and revenues and expenses are translated at average exchange rates prevailing during the year. Because the functional currency is the local
currency, the resulting translation adjustments are reflected as a separate component of stockholders equity.



Recent Accounting Pronouncements



In January 2003, the Board issued Interpretation No. 46 Consolidation of Variable Interest Entities. Until this
interpretation, a company generally included another entity in its consolidated financial statements only if it controlled the entity through voting interests. FIN 46 requires a variable interest entity to be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest entitys activities or entitled to receive a majority of the entitys residual returns. Management is currently evaluating the effect of this statement on the
Companys results of operations and financial position. FIN 46 is effective for public entities for the first interim period beginning after June 15, 2003 except for Variable interest entities created after January 31, 2003 where it is
effective immediately. We do not currently anticipate this statement to have any effect on our financial statements.



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 1The Company
and a Summary of Significant Accounting Policies: (Continued)



In December 2002, the Board issued Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based CompensationTransition and DisclosureAn Amendment of FASB Statement No. 123.
SFAS 148 requires companies to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. SFAS 148 amends the disclosure requirements of SFAS 123,
Accounting for Stock-Based Compensation to require prominent disclosures both in annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported
results. The transition and annual disclosure provisions of FAS 148 are effective for fiscal years ending after December 15, 2002. The new interim disclosure provisions are effective for the first interim period beginning after December 15, 2002. We
do not currently anticipate this statement to have any effect on our financial statements.



In November 2002, the Emerging Issues Task Force reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. EITF 00-21 provides guidance on how to account for
arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company does not believe the adoption of EITF 00-21 will have a material impact on its financial position or results of operations.



In November 2002, the Board issued FASB Interpretation No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and Rescission of FASB Interpretation No. 34. FIN 45 clarifies the requirements of FASB Statement No. 5, Accounting for Contingencies,
relating to the guarantors accounting for, and disclosure of, the issuance of certain types of guarantees. Fin 45 is effective for guarantees entered into after December 31, 2002, however, Note 12Guarantees, discusses historical
obligations as of December 31, 2002.



In May
2002, the Board issued SFAS No. 145, Rescission of SFAS Nos. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections. Among other things, SFAS 145 rescinds various pronouncements regarding early extinguishment of debt and
allows extraordinary accounting treatment for early extinguishment only when the provisions of Accounting Principles Board Opinion No. 30, Reporting the Results of OperationsReporting the Effects of Disposal of a Segment of a Business,
and Extraordinary, Unusual and Infrequently Occurring Events and Transactions are met. SFAS 145 provisions regarding early extinguishment of debt are generally effective for fiscal years beginning after May 15, 2002. We do not currently
anticipate this statement to have any effect on our financial statements.



In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS
146 requires that a liability for costs associated with an exit or disposal activity be recognized and measured initially at fair value only when the liability is incurred. The provisions of SFAS 146 are effective for exit or disposal activities
that are initiated after December 31, 2002. We do not currently anticipate this statement to have any effect on our financial statements.



40



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 2Liquidity
and Capital Resources:



We have a revolving
line of credit of $15,000,000 under our Credit Agreement with Axel Johnson. The Credit Agreement expires in December 2003. This 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, we have not found it necessary to use this line of credit.



At December 31, 2002, we had cash and cash equivalents of $15,643,000 and short-term investments of
$2,014,000. The Company has incurred operating losses in 2002, 2001 and 2000 and has an accumulated deficit of $65,516,000 as of December 31, 2002. Also, the Company has experienced negative cash flow from operations for the years of 2002, 2001 and
2000. Cash, cash equivalents and short-term investments declined from $21,005,000 at December 31, 2001 to $17,657,000 at December 31, 2002. We believe our cash and short-term investments, after consideration of future operations and capital
expenditures, will be sufficient to fund our cash requirements, at least through the end of 2003. Nonetheless, future events might require us to seek additional capital. In that event, it is possible we would not be able to obtain adequate capital
on terms acceptable to us, or at all.



Note 3Short-Term
Investments:



The following tables summarize
our investments in available-for-sale securities.



|                             |  | For the year ended December 31, 2002 
|---------------------------- |  | -------------------------------------
|                             |  | Gross Amortized Cost                 
|                             |  | (in thousands, except per share data)
|Certificates of Deposit      |  | $                                    
|                             |  |                                      
|                             |  | $                                    
|                             |  |                                      
|                            
|                             |  | For the year ended December 31, 2001 
|                             |  | Gross Amortized Cost                 
|                             |  | (in thousands, except per share data)
|U.S. Government and agencies |  | $                                    
|Certificates of Deposit      |  |                                      
|Commercial Paper             |  |                                      
|                             |  |                                      
|                             |  | $                                    
|                             |  |                                      



41



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 4Balance
Sheet Components:



|                                                                                                                                      |  | 2002           |         |   | 2001 |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ---- | -
|                                                                                                                                      |  | (in thousands) |        
|Accounts receivable, net:                                                                                                             |  |                |         |   |      |  
|Gross accounts receivable                                                                                                             |  | $              | 4,390   |   |      | $
|Less: Allowance for doubtful accounts                                                                                                 |  |                | (1,311  | ) |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  | $              | 3,079   |   |      | $
|                                                                                                                                      |  |                |         |   |      |  
|Inventories:                                                                                                                          |  |                |         |   |      |  
|Raw materials                                                                                                                         |  | $              | 916     |   |      | $
|Work in process                                                                                                                       |  |                | 521     |   |      |  
|Finished goods                                                                                                                        |  |                | 2,379   |   |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  | $              | 3,816   |   |      | $
|                                                                                                                                      |  |                |         |   |      |  
|Property and equipment, net:                                                                                                          |  |                |         |   |      |  
|Machinery and equipment                                                                                                               |  | $              | 8,965   |   |      | $
|Computers and software                                                                                                                |  |                | 8,040   |   |      |  
|Leasehold improvements                                                                                                                |  |                | 2,194   |   |      |  
|Furniture and fixtures                                                                                                                |  |                | 1,305   |   |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  |                | 20,504  |   |      |  
|Less: Accumulated depreciation                                                                                                        |  |                | (18,586 | ) |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  | $              | 1,918   |   |      | $
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                     
|The depreciation charge for the years ending December 31, 2002, 2001 and 2000 was
$1,405,000, $1,843,000 and $2,180,000 respectively. |  |                |         |   |      |  
|                                                                                                                                     
|Other non-current assets, net:                                                                                                        |  |                |         |   |      |  
|Goodwill                                                                                                                              |  | $              | 854     |   |      | $
|Other intangible assets                                                                                                               |  |                | 2,192   |   |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  |                | 3,046   |   |      |  
|Less: Accumulated amortization                                                                                                        |  |                | (3,046  | ) |      |  
|Licenses                                                                                                                              |  |                | 208     |   |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  | $              | 208     |   |      | $
|                                                                                                                                      |  |                |         |   |      |  
|Accrued expenses and other current liabilities:                                                                                       |  |                |         |   |      |  
|Accrued compensation and related expenses                                                                                             |  | $              | 1,305   |   |      | $
|Accrued warranty                                                                                                                      |  |                | 732     |   |      |  
|Restructuring                                                                                                                         |  |                | 419     |   |      |  
|Other current liabilities                                                                                                             |  |                | 2,054   |   |      |  
|                                                                                                                                      |  |                |         |   |      |  
|                                                                                                                                      |  | $              | 4,510   |   |      | $
|                                                                                                                                      |  |                |         |   |      |  



42



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note
5Restructuring And Cost Of Revenues Charges:



During 2001 we announced two corporate restructuring programs in response to our own reduced revenues, negative macro-economic conditions and declining demand in our markets. These initiatives were focused on improving operating
performance by reducing expenses. The restructuring programs included workforce reductions of approximately 42% (88 people), the closing of our facility in Durham, North Carolina and the write-off of fixed assets due primarily to the workforce
reduction and facility closing. Implementing these programs led to charges to results in the second and fourth quarters of 2001 totaling $5,772,000. In May and October of 2002, we announced additional corporate restructuring as a result of the
ongoing stagnation of the telecom market. Consequently, 30 positions were eliminated from our workforce with a charge to operating results of $570,000. Partially offsetting this charge was a $194,000 reduction to the prior restructuring reserves
primarily for outplacement services, which were not fully utilized by some of the laid-off employees and $122,000 in rent collected under the sublease agreement with Silicon Wireless Corporation.



A sublease agreement was signed on February 27, 2002, between
us and Silicon Wireless Corporation, a start-up company that had a commencement date of February 15, 2002 and is for the entire 27,000 square-foot facility in Durham, North Carolina. The agreement included an initial four-and-one-half-months
free-rent period. Due to the uncertainty of the receipt of income under the sublease, we have decided to release the associated real-estate accrual as the sublease income is received. During 2002, restructuring expense was reduced by $122,000 as a
result of rent collected from Silicon Wireless Corporation for our facility. We expect the remaining real estate lease obligation will be paid-out by January 2007.



The following table provides details on the activity and remaining balances of the 2001 and 2002
restructuring charges as of December 31, 2002:



|                           |  | TotalCharges   |       | CumulativeCashCharges |   |        | CumulativeNon-CashCharges &Adjustments |  |   | ReserveDecember 31,2002
|-------------------------- |  | -------------- | ----- | --------------------- | - | ------ | -------------------------------------- |  | - | -----------------------
|June 2001 Restructuring    |  | (in thousands)
|Employee termination costs |  | $              | 2,293 |                       | $ | (1,782 | )                                      |  | $ | (511                   
|Real estate lease          |  |                | 2,080 |                       |   | (666   | )                                      |  |   | 407                    
|Fixed asset write-down     |  |                | 388   |                       |   |       |                                        |  |   | (388                   
|                           |  |                |       |                       |   |        |                                        |  |   |                        
|Total                      |  | $              | 4,761 |                       | $ | (2,448 | )                                      |  | $ | (492                   
|                           |  |                |       |                       |   |        |                                        |  |   |                        



|                           |  | TotalCharges   |       | CumulativeCashCharges |   |      | CumulativeNon-CashCharges &Adjustments |  |   | ReserveDecember 31,2002
|-------------------------- |  | -------------- | ----- | --------------------- | - | ---- | -------------------------------------- |  | - | -----------------------
|October 2001 Restructuring |  | (in thousands)
|Employee termination costs |  | $              | 966   |                       | $ | (892 | )                                      |  | $ | (74                    
|Real estate lease          |  |                | 45    |                       |   | (39  | )                                      |  |   |                       
|Fixed asset write-down     |  |                |      |                       |   |     |                                        |  |   |                       
|                           |  |                |       |                       |   |      |                                        |  |   |                        
|Total                      |  | $              | 1,011 |                       | $ | (931 | )                                      |  | $ | (74                    
|                           |  |                |       |                       |   |      |                                        |  |   |                        



|                           |  | TotalCharges   |     | CumulativeCashCharges |   |      | CumulativeNon-CashCharges &Adjustments |  |   | ReserveDecember 31,2002
|-------------------------- |  | -------------- | --- | --------------------- | - | ---- | -------------------------------------- |  | - | -----------------------
|May 2002 Restructuring     |  | (in thousands)
|Employee termination costs |  | $              | 394 |                       | $ | (358 | )                                      |  | $ | (36                    
|Real estate lease          |  |                |    |                       |   |     |                                        |  |   |                       
|Fixed asset write-down     |  |                |    |                       |   |     |                                        |  |   |                       
|                           |  |                |     |                       |   |      |                                        |  |   |                        
|Total                      |  | $              | 394 |                       | $ | (358 | )                                      |  | $ | (36                    
|                           |  |                |     |                       |   |      |                                        |  |   |                        





43



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note
5Restructuring And Cost Of Revenues Charges: (Continued)



|October 2002 Restructuring |  | TotalCharges   |     | CumulativeCashCharges |   |      | CumulativeNon-CashCharges &Adjustments |  | ReserveDecember 31,2002
|-------------------------- |  | -------------- | --- | --------------------- | - | ---- | -------------------------------------- |  | -----------------------
|                           |  | (in thousands)
|Employee termination costs |  | $              | 176 |                       | $ | (146 | )                                      |  | $                      
|Real estate lease          |  |                |    |                       |   |     |                                        |  |                        
|Fixed asset write-down     |  |                |    |                       |   |     |                                        |  |                        
|                           |  |                |     |                       |   |      |                                        |  |                        
|Total                      |  | $              | 176 |                       | $ | (146 | )                                      |  | $                      



The
following table provides details on the staff reductions for our restructuring and reduction in force programs in 2002 and 2001:



|                |  | Manufacturing |  | Research &Development |  | Selling,General &Administration |  | Total
|--------------- |  | ------------- |  | --------------------- |  | ------------------------------- |  | -----
|June of 2001    |  | 3             |  | 24                    |  | 26                              |  | 53   
|October of 2001 |  | 12            |  | 5                     |  | 18                              |  | 35   
|May of 2002     |  | 4             |  | 4                     |  | 8                               |  | 16   
|October of 2002 |  |              |  | 6                     |  | 8                               |  | 14   
|                |  |               |  |                       |  |                                 |  |      
|Total           |  | 19            |  | 39                    |  | 60                              |  | 118  
|                |  |               |  |                       |  |                                 |  |      



Note 6Related
Party Transactions:



Transactions with Axel Johnson



As of December 31, 2002, Axel Johnson owned
53% of the Class A and B Common Stock of Larscom and controlled 82% of the voting interest. Related party transactions with Axel Johnson not disclosed elsewhere in the consolidated financial statements are as follows:



(Due to) Due from Axel Johnson



Amounts (due to) or due from Axel Johnson consist of cash
remittances made by us to Axel Johnson from our operating bank accounts offset by cash advances to us from Axel Johnson for purchases of property and equipment and fluctuating working capital needs. Neither Axel Johnson nor Larscom Incorporated has
charged interest on the balances due. The average month-end balances due from or (due to) Axel Johnson were as follows: $31,000 for 2002, ($182,000) for 2001and ($533,000) for 2000. The following is an analysis of the balance (due to) or due from
Axel Johnson:



|                                                       |  | Years Ended December 31, |       
|------------------------------------------------------ |  | ------------------------ | ------
|                                                       |  | 2002                     |       
|                                                       |  | (in thousands)           |       
|Balance at beginning of year                           |  | $                        | 574   
|Cash remittances to Axel Johnson, net of cash advances |  |                          | 2,707 
|Charges to (from) Axel Johnson for:                    |  |                          |       
|Pension and thrift plan                                |  |                          | (1,299
|Health insurance and workers compensation             |  |                          | (663  
|Administrative services                                |  |                          | (465  
|Property, liability and general insurance              |  |                          | (889  
|Line of credit fees                                    |  |                          | (76   
|Other credits/(charges)                                |  |                          | 86    
|                                                       |  |                          |       
|Balance at end of year                                 |  | $                        | (25   
|                                                       |  |                          |       



44



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 6Related
Party Transactions: (Continued)



Employee
Health and Welfare Programs



We participate
in various employee benefits programs sponsored by Axel Johnson. These programs include medical, dental and life insurance and workers compensation. In general, we reimburse Axel Johnson for our 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 changes in reserves for incurred but not reported claims. We recorded expenses related to the reimbursement of these
costs of approximately $663,000, $737,000 and $728,000 in 2002, 2001 and 2000, respectively. We believe the allocation by Axel Johnson of the proportionate cost is not necessarily indicative of the costs that would have been incurred had we
maintained our own benefit plans.



Administrative Services



Axel Johnson provides certain functional services to us, including certain treasury, accounting, tax, internal audit, legal and human resources. The costs of these services have been allocated to us based on estimates by Axel Johnson
of actual costs incurred. We believe that such allocations are reasonable. Such charges and allocations are not necessarily indicative of the costs that would have been incurred if we had been a separate entity. The allocated costs of these services
amounting to $465,000, $465,000 and $452,000 in 2002, 2001 and 2000, respectively, have been included in selling, general and administrative expenses in the consolidated statements of operations.



Credit Agreement



Larscom Incorporated and Axel Johnson entered into our Credit
Agreement, pursuant to which Axel Johnson has agreed to provide a revolving credit/working capital facility to us in an aggregate amount of $15,000,000. The Credit Agreement expires in December 2003. This agreement contains various representations,
covenants, conditions and events of default typical for financing a business of a similar size and nature, including a condition to any drawdown that no material adverse change has occurred in the Companys financial condition or results of
operation. We currently have a letter from Axel Johnson Inc. dated August 8, 2002, stating that it is Axel Johnsons intent to allow borrowings under the credit line, provided we do not experience any material adverse change after August 8,
2002. Upon an event of default or upon election by Axel Johnson if it no longer holds at least a majority of our outstanding voting power or it has elected less than a majority of our directors, any borrowings under the line of credit shall become
payable in full. Any loans under the Credit Agreement 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 successive calendar quarter. Additionally, we are required to pay a commitment fee of 0.5% per annum on the unused portion of the Credit Agreement. As of December 31, 2002, $15,000,000 was
available, and during 2002, 2001 and 2000, no borrowings were made under the Credit Agreement.



Note 7Capital Stock:



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 Stock on a share-for-share basis, subject to adjustment
for dividends, stock splits, subdivisions or combinations. Axel Johnson owns all of our issued and outstanding Class B Common Stock.



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.



45



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 8Income
Taxes:



The income tax (benefit) provision
consists of the following:



|                               |  | Years Ended December 31, |       
|------------------------------ |  | ------------------------ | ------
|                               |  | 2002                     |       
|                               |  | (in thousands)           |       
|Current:                       |  |                          |       
|Federal                        |  | $                        | (2,156
|State                          |  |                          | 14    
|Foreign                        |  |                          | 29    
|                               |  |                          |       
|                               |  |                          | (2,113
|                               |  |                          |       
|Deferred:                      |  |                          |       
|Federal                        |  |                          |      
|State                          |  |                          |      
|                               |  |                          |       
|                               |  |                          |      
|                               |  |                          |       
|Income tax (benefit) provision |  | $                        | (2,113
|                               |  |                          |       



We are
not part of the Axel Johnson tax group, except for the purposes of filing a California franchise tax return.



The following is a reconciliation of the U.S. federal income tax rate to our effective income tax rate:



|                                                |  | Years Ended December 31, |   
|----------------------------------------------- |  | ------------------------ | --
|                                                |  | 2002                     |   
|Provision at statutory rate                     |  | (35                      | )%
|Research and development credit                 |  | (15                      | ) 
|State income taxes, net of federal tax benefits |  | (9                       | ) 
|Valuation allowance deferred tax assets         |  | 26                       |   
|Other                                           |  | 3                        |   
|                                                |  |                          |   
|Effective income tax rate                       |  | (30                      | )%
|                                                |  |                          |   



The tax
rate for 2002 included a benefit of $2,113,000 comprised primarily of an income tax refund of $1,894,000 for taxes paid in 1996, 1997 and 1998, as a result of a 2002 change in the federal income tax code and $262,000 for the release of an accrual
related to prior years closed audits.



46



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 8Income
Taxes: (Continued)



Deferred income taxes
reflect the temporary differences between the carrying value of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The components of the deferred tax assets are as follows:



|                              |  | December 31,   |        
|----------------------------- |  | -------------- | -------
|                              |  | 2002           |        
|                              |  | (in thousands) |        
|Deferred tax assets:          |  |                |        
|Inventory                     |  | $              | 2,696  
|Accrued expenses              |  |                | 1,779  
|Reserves                      |  |                | 1,201  
|Intangible assets             |  |                | 5,428  
|Depreciation and amortization |  |                | 3,438  
|NOL carry-forward             |  |                | 8,640  
|Valuation allowance           |  |                | (23,182
|                              |  |                |        
|Net deferred tax asset        |  | $              |       
|                              |  |                |        



At
December 31, 2002, we had total gross deferred tax assets of $23,182,000, as compared to $21,341,000 at December 31, 2001. These assets included temporary differences related to intangible assets associated with the acquisition of NetEdge Systems
Inc. in 1997, inventory write-downs, accrued expenses and net operating losses that carry forward. In the second quarter ended June 30, 2001, we concluded that a deferred tax asset valuation allowance should be established due to the uncertainty of
realizing the tax loss carry-forwards and other deferred tax assets in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Our assessment was based principally on the historical losses
experienced by the Company in the U.S., and uncertainty of future taxable income, unfavorable macro-economic conditions and capital expenditure reductions announced by several SPs.



SFAS 109 requires the establishment of a valuation allowance for deferred tax assets when it is more likely
than not that these assets will not be realized. The deferred tax assets will be recognized in future periods to the extent that we can reasonably expect such assets to be realized. We will evaluate the probability of realizing our deferred tax
assets on a quarterly basis. If we determine that a portion or all of the deferred tax assets are realizable, we will reduce the income tax valuation allowance accordingly.



As of December 31, 2002, the Companys federal and state net operating loss carry-forwards for income
tax purposes were approximately $19,100,000 and $900,000 respectively. If not utilized, the federal and state net operating loss carry-forwards will begin to expire in 2021 and 2005 respectively. The Companys federal research tax credit
carry-forwards for income tax purposes are approximately $1,000,000. If not utilized, the federal tax credit carry-forwards will begin to expire in 2018. The Company has a valuation allowance for deferred tax assets because of uncertainty regarding
their realization.



Deferred tax assets of
approximately $300,000 as of December 31, 2002 pertain to certain net operating loss carry-forwards resulting from the exercise of employee stock options. When recognized, the tax benefit of these loss carry-forwards are accounted for as a credit to
additional paid-in capital rather than a reduction of the income tax provision.



47



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 9Employee
Benefit Plans:



Thrift Plan



We participate 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. Effective February 1, 2000 we matched 100% of employee contributions made on a pre-tax basis and 30% of employee contributions made on an after-tax basis, subject to a maximum of 6% of total eligible employee compensation. As of January
1, 2003, we reduced the Company match to 60% of the first 6% of total eligible employee compensation. Company contributions vest after five years of service or two years of plan participation, whichever occurs first. Contributions by Larscom
Incorporated under the Thrift Plan amounted to $467,000, $773,000 and $880,000 in 2002, 2001 and 2000, respectively.



Pension Plan



Effective March 31, 1998, our employees ceased to accrue benefits under the Axel Johnson sponsored defined benefit pension plan, the Axel
Johnson Inc. Retirement Plan. Accrued liabilities prior to March 31, 1998 will remain in the Axel Johnson pension plan until benefits are paid to employees upon termination or retirement in a manner prescribed by the plan. After March 1998, our
employees also ceased to accrue benefits under Axel Johnsons unfunded pension plan, the Axel Johnson Inc. Retirement Restoration Plan, for employees whose benefits under the defined pension plan are reduced due to limitations under federal tax
laws.



The following sets forth our benefit
obligation and the net periodic pension costs for both plans as required by Statement of Financial Accounting Standards No. 132, Employers Disclosures about Pensions and Other Post-retirement Benefits:



|                                                |  | 2002           |       |   | 2001 |  
|----------------------------------------------- |  | -------------- | ----- | - | ---- | -
|                                                |  | (in thousands) |      
|Reconciliation of projected benefit obligation  |  |                |       |   |      |  
|Projected benefit obligation at January 1,      |  | $              | 5,559 |   |      | $
|Service cost                                    |  |                | 16    |   |      |  
|Interest cost                                   |  |                | 402   |   |      |  
|Actuarial loss                                  |  |                | 677   |   |      |  
|Benefits paid                                   |  |                | (204  | ) |      |  
|                                                |  |                |       |   |      |  
|Projected benefit obligation at December 31,    |  | $              | 6,450 |   |      | $
|                                                |  |                |       |   |      |  
|Weighted-average assumptions as of December 31, |  |                |       |   |      |  
|Discount rate                                   |  |                | 6.75  | % |      |  
|Expected return on plan assets                  |  |                | 8.50  | % |      |  
|Rate of compensation increase                   |  |                | 4.25  | % |      |  
|Components
of net periodic (benefit) cost       |  |                |       |   |      |  
|Service cost                                    |  | $              | 16    |   |      | $
|Interest cost                                   |  |                | 402   |   |      |  
|Expected return on assets                       |  |                | (443  | ) |      |  
|Net amortization                                |  |                | 7     |   |      |  
|                                                |  |                |       |   |      |  
|Net periodic benefit                            |  | $              | (18   | ) |      | $
|                                                |  |                |       |   |      |  



48



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Note 9Employee Benefit Plans: (Continued)



Certain elements of pension cost, including expected return
on assets and net amortization, were allocated based on the relationship of the projected benefit obligation (PBO) for Larscom Incorporated to the total PBO of the defined benefit pension plan. Based on this same relationship, our
portion of the unfunded PBO for the Axel Johnson Inc. Retirement Plan is $1,988,000 and $748,000 as of December 31, 2002 and 2001, respectively. The PBO for our employees with accrued benefits in the unfunded Retirement Restoration Plan is $469,000
and $329,000 as of December 31, 2002 and 2001, respectively.



Employee Stock Purchase Plan



On October 11, 1996, we adopted an Employee Stock Purchase Plan (the Purchase Plan), for which 685,000 shares of Class A Common Stock were reserved for issuance. The Board of Directors and stockholders approved
an additional 100,000-share allotment for the Purchase Plan in 2000. 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 Class A Common Stock in any one calendar year, or 1,000 shares in each offering period. A total of 28,000, 59,000 and 92,000 shares of Class A Common Stock were issued under the Purchase Plan in 2002, 2001 and 2000,
respectively. Effective February 1, 2003, the Employee Stock Purchase Plan was eliminated.



Stock Option Plan for Non-Employee Directors



On October 11, 1996, we adopted and the Board of Directors and Stockholders approved a Stock Option Plan for Non-Employee Directors (the
Directors Plan) and reserved a total of 205,000 shares of Class A Common Stock for issuance thereunder. The Board of Directors and stockholders approved an additional 100,000-share allotment for the Directors Plan in 2000.
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 Larscom Incorporated or of Axel Johnson with regard to their service as
directors. Each non-employee director will receive 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 will receive 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 installments and each annual grant vests in full in the third year following the date of
grant. Options expire one year after termination of Board service or ten years after the date of grant. In February 2003, the Board of Directors approved the termination of the Directors Plan pending Stockholder approval of an amendment to the
Incentive Plan (as defined below).



Stock
Incentive Plan



On October 11, 1996, we
adopted and the Board of Directors and Stockholders approved a Stock Incentive Plan (the Incentive Plan) under which 3,985,000 shares of Class A Common Stock have been reserved for issuance. The Board of Directors and stockholders
approved an additional 2,800,000-share allotment for the Incentive Plan in 2000. 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 Compensation Committee of the Board of Directors administers the Incentive Plan. 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% or more stockholder). Options granted prior to May 2000 generally vest over a four-year period from the date of grant. Options granted in May 2000 and thereafter generally vest over a three-year period. In
February 2003, the Board of Directors approved an amendment to the Incentive Plan, subject to Stockholder approval, to allow for grants of stock awards under the Incentive Plan to non-employee directors.



49



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 9Employee
Benefit Plans: (Continued)



The following
table summarizes activity under the Directors and Incentive Plans:



|                                         |  | Options Outstanding
|---------------------------------------- |  | -------------------
|                                         |  | Directors Plan    
|                                         |  | Number of Shares   
|                                         |  | (in thousands)     
|December 31, 1999                        |  | 78                 
|Granted                                  |  | 30                 
|Exercised                                |  |                   
|Canceled                                 |  | (6                 
|                                         |  |                    
|December 31, 2000                        |  | 102                
|Granted                                  |  | 18                 
|Exercised                                |  |                   
|Canceled                                 |  |                   
|                                         |  |                    
|December 31, 2001                        |  | 120                
|Granted                                  |  | 12                 
|Exercised                                |  |                   
|Canceled                                 |  |                   
|                                         |  |                    
|December 31, 2002                        |  | 132                
|                                         |  |                    
|Options exercisable at December 31, 2002 |  | 84                 



The
following table summarizes information about stock options outstanding at December 31, 2002, under the Directors Plan and the Incentive Plan (number of options in thousands) combined:



|                         |  | Options Outstanding                     |  | Options Exercisable                                
|------------------------ |  | --------------------------------------- |  | ---------------------------------------------------
|Range of Exercise Prices |  | Number Outstanding at December 31, 2002 |  | Weighted Average Remaining Contractual Life (years)
|$ 0.01-$ 0.30            |  | 24                                      |  | 9.80                                               
|$ 0.31-$ 1.00            |  | 17                                      |  | 9.64                                               
|$ 1.01-$ 3.00            |  | 1,432                                   |  | 8.28                                               
|$ 3.01-$ 6.00            |  | 534                                     |  | 7.48                                               
|$ 6.01-$ 9.00            |  | 74                                      |  | 7.23                                               
|$ 9.01-$12.00            |  | 60                                      |  | 4.35                                               
|                         |  |                                         |  |                                                    
|Total/Average            |  | 2.141                                   |  | 7.96                                               
|                         |  |                                         |  |                                                    



Pro
Forma Information



As permitted under SFAS
123, we are continuing to measure compensation cost for stock-based compensation plans using the intrinsic value method prescribed by APB 25. The pro forma disclosures of the difference between compensation cost included in net loss and the related
cost measured by the fair value method are described below.



50



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##### Table of Contents

LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 9Employee
Benefit Plans: (Continued)



The fair value
of these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:



|                        |  | Directors and Incentive Stock Option Plans |   |  | Employee Stock Purchase Plan |  
|----------------------- |  | ------------------------------------------- | - |  | ---------------------------- | -
|                        |  | 2002                                        |   |  | 2001                         |  
|Risk-free interest rate |  | 4.28                                        | % |  | 3.94                         | %
|Expected volatility     |  | 90                                          | % |  | 88                           | %
|Expected dividend yield |  | 0                                           | % |  | 0                            | %
|Expected life           |  | 4.92                                        |   |  | 2.76                         |  



The
weighted average estimated fair value of options granted under the Directors Plan, the Incentive Plan and the Purchase Plan were as follows:



|             |  | Directors Plan |      | Incentive Plan |   | Employee Stock Purchase Plan
|------------ |  | --------------- | ---- | -------------- | - | ----------------------------
|2000 grants  |  | $               | 3.21 |                | $ | 2.63                        
|2001 grants. |  | $               | 1.69 |                | $ | 0.80                        
|2002 grants  |  | $               | 0.61 |                | $ | 0.83                        



Note
10Commitments and Contingencies:



Commitments:



Operating
lease commitments are related principally to our buildings in Milpitas, California and Durham, North Carolina and have terms that expire in 2004 and 2007, respectively. Total rent expense in 2002, 2001 and 2000, was $1,950,000, $2,217,000 and
$2,343,000, respectively. Sublease rental income was $922,000, $1,041,000 and $955,000 in 2002, 2001 and 2000, respectively. Future annual minimum lease payments under all non-cancelable operating leases and sublease rental income as of December 31,
2002 are as follows (in thousands):



|                          |  | Lease Payments |       | Sublease Rental Income
|------------------------- |  | -------------- | ----- | ----------------------
|Years ending December 31, |  |                |       |                       
|2003                      |  | $              | 2,387 |                       
|2004                      |  |                | 1,617 |                       
|2005                      |  |                | 338   |                       
|2006                      |  |                | 347   |                       
|2007 and thereafter       |  |                | 29    |                       
|                          |  |                |       |                       
|                          |  | $              | 4,718 |                       
|                          |  |                |       |                       



Contingencies:



In our
distribution agreements, we typically agree to indemnify our customers for any expenses or liabilities resulting from claimed infringements of patents, trademarks or copyrights of third parties. There have been no material payments made under our
customer indemnification for the years 2002, 2001 and 2000.



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LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 11Geographic
Information:



Revenue and long-lived assets
related to operations in the United States and other countries for the years ended and as of December 31, 2002, 2001 and 2000 are as follows (in thousands):



|                |  | Revenues (a) |        | Long-lived Assets
|--------------- |  | ------------ | ------ | -----------------
|                |  | December 31, |        | December 31,     
|                |  | 2002         |        | 2001             
|United States   |  | $            | 19,356 |                  
|Other countries |  |              | 4,131  |                  
|                |  |              |        |                  
|Total           |  | $            | 23,487 |                  
|                |  |              |        |                  

---

|(a) |  | Revenues are reported by shipment to the final destination as determined by records required to comply with U.S. Department to Commerce regulations.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



Note 12Guarantees:



In November 2002, the FASB issued FASB Interpretation No. 45,
Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 requires that upon issuance of certain guarantees, a guarantor must recognize a liability for the
fair value of an obligation assumed under the guarantee. FIN 45 also requires significant new disclosures, in both interim and annual financial statements, by a guarantor, about obligations associated with guarantees issued. FIN 45 disclosure
requirements are effective for our fiscal year ended December 31, 2002 and the initial recognition and measurement provisions are applicable on a prospective basis to guarantees issued or modified after December 31, 2002.



We, as the guarantor, enter into one category of guarantee,
namely performance guarantees. Performance guarantees include contracts that contingently require us to make payments to the beneficiary of the guarantee based on our failure to perform under an obligating agreement. These obligating agreements
consist primarily of manufacturing services agreements, non-cancelable and non-returnable purchase orders and technology acquisition agreements.



The term of the guarantees is less than one year. We have not recorded any liabilities for these potential future payments either because
they are not probable or we have yet to incur the expense. The guarantees do not have a third party recourse provision.



The following table discloses our obligations under guarantees as of December 31, 2002 (in thousands):



|                                                  |  | Maximum Potential Amount of  Future Payments
|------------------------------------------------- |  | --------------------------------------------
|Manufacturing services agreements                 |  | $                                           
|Non-cancelable and non-returnable purchase orders |  |                                             
|Contingent payment for licensed technology        |  |                                             
|                                                  |  |                                             
|Total                                             |  | $                                           
|                                                  |  |                                             



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LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note
12Guarantees: (Continued)



The
following table depicts product warranty during the fiscal year ended December 31, 2002 (in thousands):



|                                                                             |  | Dollar Amount of  Liability Debit/(credit) |      
|---------------------------------------------------------------------------- |  | ------------------------------------------ | -----
|Balance at December 31, 2001                                                 |  | $                                          | 1,430
|Accrual for new warranties                                                   |  |                                            | 408  
|Accruals related to pre-existing warranties (including changes in
estimates) |  |                                            | (887 
|Settlements made in cash or in kind during the period                        |  |                                            | (219 
|                                                                             |  |                                            |      
|Balance at December 31, 2002                                                 |  | $                                          | 732  
|                                                                             |  |                                            |      



We also,
as permitted under Delaware law and in accordance with our Bylaws, indemnify our officers and directors for certain events or occurrences, subject to certain limits, while the officer is or was serving at our request in such capacity. The term of
the indemnification period is for the officers or directors lifetime. The maximum amount of potential future indemnification is unlimited; however, we have a Director and Officer Insurance Policy that limits our exposure and enables us
to recover a portion of any future amounts paid. As a result of our insurance policy coverage we believe the fair value of these indemnification agreements is minimal.



In our sales agreements, we typically agree to indemnify our customers for any expenses or liability
resulting from claimed infringements of patents, trademarks or copyrights of third parties. The terms of these indemnification agreements is generally perpetual any time after execution of the agreement. The maximum amount of potential future
indemnification is unlimited. To date we have not paid any amounts to settle claims or defend lawsuits.



Note 13Subsequent Event:



A sublease agreement was signed on February 11, 2003, between us and Promise Technology, Inc., which has a commencement date of March 1, 2003 and is for 20,000 square-feet in the Milpitas, California
facility. Minimum future sublease income on this sublease agreement is as follows (in thousands):



|Years ending December 31, |  | Milpitas Sublease Rental Income
|------------------------- |  | -------------------------------
|2003                      |  | $  92                          
|2004                      |  | 54                             
|                          |  |                                
|                          |  | $146                           
|                          |  |                                



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LARSCOM INCORPORATED



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)





Note 14Unaudited
Quarterly Consolidated Financial Data:



|                                 |  | Quarters Ended                        |       
|-------------------------------- |  | ------------------------------------- | ------
|                                 |  | March 31, 2002                        |       
|                                 |  | (in thousands, except per share data) |       
|Revenues                         |  | $                                     | 7,716 
|Gross profit                     |  | $                                     | 4,669 
|Net loss                         |  | $                                     | 1,363 
|Basic and diluted loss per share |  | $                                     | 0.07  
|                                
|                                 |  | Quarters Ended                        |       
|                                 |  | March 31, 2001                        |       
|                                 |  | (in thousands, except per share data) |       
|Revenues                         |  | $                                     | 12,214
|Gross profit                     |  | $                                     | 5,620 
|Net loss                         |  | $                                     | (1,496
|Basic and diluted loss per share |  | $                                     | (0.08 



Note:    (a) The net loss for the quarter ended June 30, 2002 included a net restructuring charge of $253,000. (b) The net loss for the quarter ended September 30, 2002 included a credit against restructuring
charges of $61,000. (c) The net loss for the quarter ended December 31, 2002 included a net restructuring charge of $62,000. (d) The net loss for the quarter ended June 30, 2001 included a non-cash charge of $16,450,000 to provide a valuation
allowance against the deferred tax assets in compliance with SFAS 109, restructuring charges of $4,761,000 and asset impairment charges of $1,911,000. (e) The net loss for the quarter ended December 31, 2001 included restructuring charges of
$1,011,000.



Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure



Not applicable.



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##### Table of Contents



PART III



Item  10.Directors and Executive Officers of the Registrant



Other than the information regarding our executive officers contained in Part I of this Form 10-K report, the information required by this
Item is incorporated by reference to the definitive Larscom Incorporated Proxy Statement to be filed within 120 days after fiscal year end.



Item  11.Executive Compensation



The information required by this Item is incorporated by reference to the definitive Larscom Incorporated Proxy Statement to be filed
within 120 days after fiscal year end.



Item  12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters



The information required by this Item is incorporated by reference to the definitive Larscom Incorporated
Proxy Statement to be filed within 120 days after fiscal year end.



Item  13.Certain Relationships and Related Transactions



The information required by this Item is incorporated by reference to the definitive Larscom Incorporated Proxy Statement to be filed
within 120 days after fiscal year end.



Item  14.Controls and Procedures



Evaluation of Controls and Procedures



Within 90 days before the date of this report, our disclosure committee carried out an evaluation, under the supervision and with the
participation of the Companys management, including the Companys Chief Executive Officer, Daniel L. Scharre, and Chief Financial Officer, Donald W. Morgan, of the effectiveness of the design and operation of the Companys disclosure
controls and procedures (as defined in Rules 13a-14(c) and 15d-14(c)). Based upon that evaluation, Mr. Scharre and Mr. Morgan concluded that the Companys disclosure controls and procedures are effective in causing material information to be
collected, communicated and analyzed by management of the Company on a timely basis.



Changes in Controls and Procedures



There were no significant changes in the Companys internal controls or in other factors that could significantly affect these internal controls after the date of our most recent evaluation.



Limitations on the Effectiveness of Controls



The Companys management, including the chief executive
officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by
management override of the control. The design of any system of controls also is



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##### Table of Contents

based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent
limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



PART IV



Item 15.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.    Financial Statement
Schedule.



SCHEDULE II VALUATION AND QUALIFYING
ACCOUNTS



|Description                     |  | Balance at beginning of period |     | Additions: cost and expense |   | Charges to other accounts |  | Deductions: items written-off |   | Balance at end of period
|------------------------------- |  | ------------------------------ | --- | --------------------------- | - | ------------------------- |  | ----------------------------- | - | ------------------------
|Allowance for doubtful accounts |  |                                |     |                             |   |                           |  |                               |   |                         
|December 31, 2000               |  | $                              | 505 |                             | $ | 102                       |  | $                             |  |                         
|December 31, 2001               |  | $                              | 580 |                             | $ | 252                       |  | $                             |  |                         
|December 31, 2002               |  | $                              | 807 |                             | $ | 548                       |  | $                             |  |                         



3.    Exhibits



|Exhibit Number |  |     |  |                                                                                                                                           
|-------------- |  | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------
|3.2            |  | (1) |  | Amended and Restated Certificate of Incorporation of the Registrant as filed in the State of Delaware on December 11,
1996.               
|              
|3.4            |  | (1) |  | Amended By-laws of the Registrant.                                                                                                        
|              
|10.1           |  | (1) |  | Form of Larscom Incorporated Stock Option Plan For Non-Employee Directors.                                                                
|              
|10.1.1         |  | (6) |  | Certificate of Amendment of Stock Option Plan for Non-Employee Directors.                                                                 
|              
|10.2           |  | (1) |  | From of Larscom Incorporated Stock Incentive Plan.                                                                                        
|              
|10.2.1         |  | (6) |  | Certificate of Amendment of Stock Incentive Plan.                                                                                         
|              
|10.3           |  | (1) |  | Form of Larscom Incorporated Stock Purchase Plan.                                                                                         
|              
|10.3.1         |  | (6) |  | Certificate of Amendment of Employee Stock Purchase Plan.                                                                                 
|              
|10.4           |  | (7) |  | Separation of Employment Due to Reduction-in-Force Layoff by and between Larscom Incorporated and Liam McManus
effective January 1, 2002. 
|              
|10.5           |  | (7) |  | Employment Offer Letter Agreement by and between Larscom Incorporated and Gurdip Jande dated January 25, 2002,
accepted February 11, 2002.
|              
|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.                                                                            
|              
|10.7.1         |  | (1) |  | 2000 Amendments to the Credit Agreement between Axel Johnson and Larscom Incorporated.                                                    
|              
|10.7.2         |  | (6) |  | 2001 Amendments to the Credit Agreement between Axel Johnson and Larscom Incorporated.                                                    



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|Exhibit Number |  |     |  |                                                                                                                                                            
|-------------- |  | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|10.7.3         |  | (9) |  | Letter dated August 8, 2002 from Axel Johnson Inc. to waive the No MAC Condition to the Credit Agreement between
Larscom Incorporated and Axel Johnson Inc.
|              
|10.8           |  | (1) |  | Form of Tax-Sharing Agreement between Axel Johnson and the Company.                                                                                        
|              
|10.9           |  | (7) |  | Letter Agreement Regarding Interest-Free Loan Obligation by and between Larscom Incorporated and Joseph A. Pendergast
dated March 20, 2002.                
|              
|10.10          |  | (1) |  | From of Registration Rights Agreement between Axel Johnson and the Company.                                                                                
|              
|10.11          |  | (2) |  | Lease Agreement between Berg & Berg Enterprises Inc. and the Company.                                                                                      
|              
|10.13          |  | (3) |  | Software License Agreement by and between Larscom Incorporated and 3NO Systems, Inc. dated September 21,
2000.                                             
|              
|10.14          |  | (4) |  | Lease Agreement between Technology IX, LLC, Keystone Corporation and Larscom Incorporated.                                                                 
|              
|10.15          |  | (5) |  | Original Equipment Manufacturing/Private Label Agreement by and between Larscom Incorporated and G3M Corporation dated
January 4, 2001.                    
|              
|10.16          |  | (5) |  | Non-Exclusive OEM Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 1,
2001.                                                 
|              
|10.16.1        |  | (6) |  | Amendment No. 1 to the Non-Exclusive OEM Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated
September 7, 2001.                    
|              
|10.17          |  | (6) |  | Sublease Agreement between Silicon Wireless Corporation and Larscom Incorporated.                                                                          
|              
|10.18          |  | (6) |  | General Release and Settlement Agreement by and between Larscon Incorporated and Robert Coackley dated July 1,
2001.                                       
|10.19          |  | (6) |  | General Release of All Claims (California-With Attachment A) by and between Larscon Incorporated and George Donohoe
dated June 22, 2001.                   
|              
|10.20          |  | (6) |  | Employment Agreement by and between Larscom Incorporated and Daniel L. Scharre dated November 26,
2001.                                                    
|              
|10.21          |  | (8) |  | Amended and Restated Promissory Note (No. 1) by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 13,
2002.                               
|              
|10.22          |  | (8) |  | Amended and Restated Promissory Note (No. 2) by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 13,
2002.                               
|              
|10.23          |  | (8) |  | Restructuring Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 13,
2002.                                                    
|              
|10.24          |  | (8) |  | Intellectual Property Security Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated
May 13, 2002.                                   
|              
|10.25          |  | (8) |  | License Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 13,
2002.                                                          
|              
|10.26          |  | (8) |  | Supply Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated May 13,
2002.                                                           
|              
|10.27          |  | (8) |  | Employment Offer Letter Agreement by and between Larscom Incorporated and Leonard Eisentein dated May 3,
2002.                                             
|              
|10.28          |  | (8) |  | Letter Agreement by and between Larscom Incorporated and Oasys Telecom, Inc. dated April 9,
2002.                                                          
|              
|10.29          |  |     |  | Electronic Manufacturing Services Agreement by and between Larscom Inc. and Sparqtron Manufacturing Corp. dated
October 21, 2002.                          



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|Exhibit Number |  |  |  |                                                                                                                                                                        
|-------------- |  |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.30          |  |  |  | Consultant Agreement by and between Larscom Incorporated and Richard Pospisil dated November 22,
2002.                                                                 
|              
|11.1           |  |  |  | Statement re: computation of per share earnings.                                                                                                                       
|              
|21.1           |  |  |  | Subsidiaries of the Registrant.                                                                                                                                        
|              
|23.1           |  |  |  | Consent of Independent Accountants.                                                                                                                                    
|              
|24.1           |  |  |  | Power of Attorney ( see Signatures page 59).                                                                                                                         
|              
|99.1           |  |  |  | Periodic Report Certification filed pursuant to Section 906 of the Public Company Accounting Reform and Investor
Protection Act of 2002 (18 U.S.C. § 1350, as adopted).

---

|(1) |  | Incorporated by reference to identically numbered Exhibit to Larscom Incorporated 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 exhibit in registrants Form 10-K for the fiscal year ended December 31, 1996.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------



|(3) |  | Incorporated by reference to numbered exhibit 10.1 in registrants Form 10-Q for the third quarter ended September 30, 2000.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------



|(4) |  | Incorporated by reference to identically numbered exhibit in registrants Form 10-K for the fiscal year ended December 31, 2000.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------



|(5) |  | Incorporated by reference to exhibits 10.1 and 10.2 in registrants Form 10-Q for the second quarter ended June 30, 2001.
|--- |  | -------------------------------------------------------------------------------------------------------------------------



|(6) |  | Incorporated by reference to identically numbered exhibit in registrants Form 10-K for the fiscal year ended December 31, 2001.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------



|(7) |  | Incorporated by reference to exhibits 10.1, 10.2, and 10.3 in registrants Form 10-Q for the first quarter ended March 30, 2002.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------



|(8) |  | Incorporated by reference to exhibits 10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7 and 10.8 in registrants Form 10-Q for the second quarter ended June 30,
2002.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



|(9) |  | Incorporated by reference to exhibits 10.1 and 10.28 in registrants Form 10-Q for the third quarter ended September 30, 2002.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------



| | b) |  | Reports on Form 8-K
| | -- |  | -------------------



We did not file any reports on Form 8-K during the fourth quarter of 2002.



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SIGNATURES



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 INCORPORATEDBy:

/s/    DONALD W.
MORGANDonald W. Morgan Vice President, Finance and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer)




Date: March 12,
2003

POWER OF ATTORNEY



Know all these persons by these presents, that each person whose signature appears below continues and appoints Daniel L. Scharre and
Donald W. Morgan and each of them, jointly and severally, his attorneys-in-fact, each with full power of substitution, for him in any and all capacities, to sign any and all amendments to this Form 10-K, and to file the same, with exhibits thereto
and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each said attorneys-in-fact or his substitute or substitutes may do or cause to be done by virtue hereof.



Pursuant to the requirements of the
Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|Name                                              |  | Title                                                                                                              |  | Date          
|------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------ |  | --------------
|                                                 
|/s/    DANIEL L.
SCHARREDaniel L. Scharre         |  | President and Chief Executive Officer and Director (Principal Executive
Officer)                                   |  | March 12, 2003
|                                                 
|/s/    DONALD W.
MORGANDonald W. Morgan           |  | Vice President, Finance and Chief Financial Officer (Principal Financial Officer and
Principal Accounting Officer) |  | March 12, 2003
|                                                 
|/s/    ALLEN R.
ADAMSAllen R. Adams               |  | Director                                                                                                           |  | March 12, 2003
|                                                 
|/s/    DONALD G.
HEITTDonald G. Heitt             |  | Director                                                                                                           |  | March 12, 2003
|                                                 
|/s/    LAWRENCE D.
MILLIGANLawrence D. Milligan   |  | Chairman of the Board                                                                                              |  | March 12, 2003
|                                                 
|/s/    RICHARD E.
POSPISILRichard E. Pospisil     |  | Vice Chairman of the Board                                                                                         |  | March 12, 2003
|                                                 
|/s/    JOSEPH F.
SMORADAJoseph F. Smorada         |  | Director                                                                                                           |  | March 12, 2003
|                                                 
|/s/    DESMOND P. WILSON
IIIDesmond P. Wilson
III |  | Director                                                                                                           |  | March 12, 2003



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CERTIFICATIONS



I, Daniel L. Scharre, certify that:



1.    I have reviewed this annual report on Form 10-K of Larscom Incorporated;



2.    Based on my knowledge, this annual
report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this annual report;



3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this annual report;



4.    The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:



a)    Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is being prepared;



b)    Evaluated the effectiveness of the registrants disclosure controls and procedures as of a
date within 90 days prior to the filing date of this annual report (the Evaluation Date); and



c)    Presented in this annual report our conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the Evaluation Date;



5.    The registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent function):



a)    All significant deficiencies in the design or operation of internal controls which could
adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and



b)    Any fraud, whether
or not material, that involves management or other employees who have a significant role in the registrants internal controls; and



6.    The registrants other certifying officer and I have indicated in this annual report whether there were
significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and
material weaknesses.



Date:  March 12, 2003



|   
|---
|By:
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I, Donald W. Morgan, certify that:

1.    I have reviewed this annual report on Form 10-K of Larscom Incorporated;



2.    Based on my knowledge, this annual
report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this annual report;



3.    Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in this annual report;



4.    The registrants other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:



a)    Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is being prepared;



b)    Evaluated the effectiveness of the registrants disclosure controls and procedures as of a
date within 90 days prior to the filing date of this annual report (the Evaluation Date); and



c)    Presented in this annual report our conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the Evaluation Date;



5.    The registrants other certifying officer and I have disclosed, based on our most recent evaluation, to the registrants auditors and the audit committee of
registrants board of directors (or persons performing the equivalent function):



a)    All significant deficiencies in the design or operation of internal controls which could
adversely affect the registrants ability to record, process, summarize and report financial data and have identified for the registrants auditors any material weaknesses in internal controls; and



b)    Any fraud, whether
or not material, that involves management or other employees who have a significant role in the registrants internal controls; and



6.    The registrants other certifying officer and I have indicated in this annual report whether or not there
were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and
material weaknesses.



Date:  March 12, 2003



|   
|---
|By:
|   



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EXHIBIT
INDEX



|Exhibit No. |  |                                                                                                                                                                        
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------
|           
|10.29       |  | Electronic Manufacturing Services Agreement by and between Larscom Inc. and Sparqtron Manufacturing Corp. dated
October 21, 2002.                                      
|           
|10.30       |  | Consultant Agreement by and between Larscom Incorporated and Richard Pospisil dated November 22,
2002.                                                                 
|           
|11.1        |  | Statement re: computation of per share earnings.                                                                                                                       
|           
|21.1        |  | Subsidiaries of the Registrant.                                                                                                                                        
|           
|23.1        |  | Consent of Independent Accountants.                                                                                                                                    
|           
|99.1        |  | Periodic Report Certification filed pursuant to Section 906 of the Public Company Accounting Reform and Investor
Protection Act of 2002 (18 U.S.C. § 1350, as adopted).