______________________________________________________________
United States
Securities and Exchange Commission
Washington, D. C. 20549
FORM 10-Q
Quarterly report pursuant to section 13 or 15(d) of
the securities exchange act of 1934
For the Quarterly Period Ended November 30, 1997 Commission File No. 0-12867
or
Transition report pursuant to section 13 or 15(d) of
the securities exchange act of 1934
For the transition period from to
____________
3Com Corporation
(Exact name of registrant as specified in its charter)
Delaware 94-2605794
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5400 Bayfront Plaza 95052
Santa Clara, California (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code (408) 764-5000
Former name, former address and former fiscal year, if changed
since last report: N/A
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 ....XX.... No ..........
As of November 30, 1997, 354,562,107 shares of the Registrant's
Common Stock were outstanding.
This report contains a total of 27 pages of which this page is
number 1.
______________________________________________________________
3Com Corporation
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Operations
Three and Six Months Ended November 30, 1997 and 1996
Consolidated Balance Sheets
November 30, 1997 and May 31, 1997
Consolidated Statements of Cash Flows
Six Months Ended November 30, 1997 and 1996
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Signatures
3Com, AccessBuilder and U.S. Robotics are registered
trademarks of 3Com Corporation or its subsidiaries.
CoreBuilder, HiPer, Total Control, and x2 are trademarks of
3Com Corporation or its subsidiaries.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
3Com Corporation
Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Three Months Ended Six Months Ended
November 30, November 30,
------------------ ------------------
1997 1996 1997 1996
---- ---- ---- ----
Sales $1,220,253 $1,421,660 $2,821,115 $2,671,720
Cost of sales 651,094 738,252 1,483,902 1,395,649
--------- --------- --------- ---------
Gross margin 569,159 683,408 1,337,213 1,276,071
--------- --------- --------- ---------
Operating expenses:
Sales and marketing 337,594 243,893 638,901 449,350
Research and development 145,491 107,388 287,608 205,504
General and administrative 70,507 55,256 133,096 102,565
Purchased research and
development - 54,000 - 54,000
Merger-related charges and other - 6,600 426,000 6,600
--------- --------- --------- ---------
Total operating expenses 553,592 467,137 1,485,605 818,019
--------- --------- --------- ---------
Operating income (loss) 15,567 216,271 (148,392) 458,052
Interest and other income, net 7,637 4,133 10,598 7,106
--------- --------- --------- ---------
Income (loss) before income taxes 23,204 220,404 (137,794) 465,158
Income tax provision (benefit) 8,121 101,363 (6,057) 191,247
--------- --------- --------- ---------
Net income (loss) $ 15,083 $ 119,041 $ (131,737) $ 273,911
========= ========= ========= =========
Net income (loss) per common
and equivalent share:
Primary $ 0.04 $ 0.34 $ (0.37) $ 0.78
Fully diluted $ 0.04 $ 0.34 $ (0.37) $ 0.77
========= ========= ========= =========
Shares used in computing per share
amounts:
Primary 365,085 353,657 353,529 352,814
Fully diluted 365,105 355,158 353,539 353,772
========= ========= ========= =========
See notes to consolidated financial statements.
3Com Corporation
Consolidated Balance Sheets
(In thousands, except par values)
(Unaudited)
November 30, May 31,
1997 1997
---- ----
Current assets:
Cash and equivalents $ 539,748 $ 401,125
Short-term investments 596,062 538,706
Accounts receivable, net 927,504 1,234,227
Inventories, net 628,974 402,356
Deferred income taxes 296,337 165,731
Other 111,289 94,419
--------- ---------
Total current assets 3,099,914 2,836,564
Property and equipment, net 743,195 723,962
Deposits and other assets 80,093 112,644
--------- ---------
Total assets $3,923,202 $3,673,170
========= =========
Current liabilities:
Short-term debt $ 110,000 $ 60,700
Accounts payable 327,862 345,304
Other accrued liabilities 878,944 477,393
Income taxes payable 22,533 212,416
--------- ---------
Total current liabilities 1,339,339 1,095,813
Long-term obligations 46,717 170,457
Deferred income taxes 60,685 25,858
Stockholders' equity:
Preferred stock, no par value, 10,000 shares
authorized; none outstanding - -
Common stock, $.01 par value, 990,000 shares
authorized; shares outstanding: November 30, 1997:
354,562; May 31, 1997: 334,558 1,564,586 1,178,359
Retained earnings 917,755 1,209,861
Unrealized gain on investments, net 536 2,320
Unamortized restricted stock grants (4,912) (5,165)
Accumulated translation adjustments (1,504) (4,333)
--------- ---------
Total stockholders' equity 2,476,461 2,381,042
--------- ---------
Total liabilities and stockholders' equity $3,923,202 $3,673,170
========= =========
See notes to consolidated financial statements.
3Com Corporation
Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)
Six Months Ended
November 30,
----------------
1997 1996
---- ----
Cash flows from operating activities:
Net income (loss) $ (131,737) $ 273,911
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization 107,009 90,266
Deferred income taxes (113,642) (1,552)
Pooling of interests: OnStream - 4,850
U.S. Robotics (139,685) 71,632
Purchased research and development - 54,000
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable 306,723 (325,432)
Inventories (265,218) 12,682
Other current assets (20,630) (24,056)
Accounts payable (17,442) 50,246
Other accrued liabilities 142,794 66,294
Income taxes payable (39,524) 133,747
Merger-related reserves 426,000 -
--------- ---------
Net cash provided by operating activities 254,648 406,588
--------- ---------
Cash flows from investing activities:
Purchase of short-term investments (269,631) (225,283)
Proceeds from short-term investments 209,603 191,458
Purchase of property and equipment (193,041) (219,389)
Business acquired in purchase transaction - (66,547)
Other, net (25,418) (32,866)
--------- ---------
Net cash used for investing activities (278,487) (352,627)
--------- ---------
Cash flows from financing activities:
Issuance of common stock 234,110 48,237
Repayments of long-term obligations (71,704) (1,272)
Proceeds from long-term obligations - 32,500
Other, net 56 (44)
--------- ---------
Net cash provided by financing activities 162,462 79,421
--------- ---------
Increase in cash and equivalents 138,623 133,382
Cash and equivalents, beginning of period 401,125 233,573
--------- ---------
Cash and equivalents, end of period $ 539,748 $ 366,955
========= =========
Non-cash financing and investing activities:
Tax benefit on stock option transactions $ 131,351 $ 73,554
========= =========
Unrealized gain (loss) on investments, net $ (1,784) $ 1,923
========= =========
See notes to consolidated financial statements.
3Com Corporation
Notes to Consolidated Financial Statements
1. Basis of Presentation
On June 12, 1997, 3Com Corporation (the Company)
completed the merger with U.S. Robotics Corporation (U.S.
Robotics), which was accounted for as a pooling-of-
interests. All financial data of the Company, including
the Company's previously issued financial statements for
the periods presented in this Form 10-Q, have been
restated to include the historical financial information
of U.S. Robotics in accordance with generally accepted
accounting principles and pursuant to Regulation S-X.
The unaudited consolidated financial statements have
been prepared by the Company and include the accounts of
the Company and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have
been eliminated. In the opinion of management, these
unaudited consolidated financial statements include all
adjustments necessary for a fair presentation of the
Company's financial position as of November 30, 1997, and
the results of operations and cash flows for the three
and six months ended November 30, 1997 and 1996.
On June 1, 1997, the Company adopted a 52-53 week
fiscal year ending on the Sunday nearest to May 31, which
for fiscal 1998 will be May 31, 1998. The Company does
not expect this change to have a material impact on the
Company's financial statements. The results of
operations for the three and six months ended November
30, 1997 may not necessarily be indicative of the results
to be expected for the fiscal year ending May 31, 1998.
These financial statements should be read in conjunction
with the consolidated financial statements and related
notes thereto included in the Company's Annual Report on
Form 10-K for the fiscal year ended May 31, 1997.
2. Inventories, net consisted of (in thousands):
November 30, May 31,
1997 1997
---- ----
Finished goods $ 459,692 $ 262,023
Work-in-process 53,620 35,462
Raw materials 115,662 104,871
--------- ---------
Total $ 628,974 $ 402,356
========= =========
3. Net Income (Loss) Per Common and Equivalent Share
Net income (loss) per common and equivalent share is
computed based on the weighted average number of common
shares and the dilutive effects of stock options
outstanding during the period using the treasury stock
method. Common equivalent shares were not included in
the calculation of earnings per share as they were
antidilutive for the six months ended November 30, 1997.
The effect of the assumed conversion of the 10.25 percent
convertible subordinated notes was antidilutive for all
periods presented.
4. Business Combination
On June 12, 1997 the Company merged with U.S. Robotics, a
leading supplier of products and systems for accessing
information across the wide area network, including
modems and remote access products. The Company issued
approximately 158 million shares of its common stock in
exchange for the outstanding common stock of U.S.
Robotics. The Company also assumed and exchanged all
options to purchase U.S. Robotics' stock for options to
purchase approximately 31 million shares of the Company's
common stock. The transaction was accounted for as a
pooling-of-interests. Fiscal 1998 will include the
results of the combined operations for the 12 months
commencing on June 1, 1997.
All financial data of the Company presented herein have
been restated to include the historical financial
information of U.S. Robotics. The combined balance sheet
as of May 31, 1997 includes the U.S. Robotics balance
sheet as of March 30, 1997. Results of operations of U.S.
Robotics for the two months ended May 25, 1997,
comprising the first eight weeks of what would otherwise
have been a 13-week quarter, reflected sales of $15.3
million and a net loss of $160.3 million. Sales for this
period principally reflected the following factors: the
historical non-linear sales pattern of U.S. Robotics, in
which sales were relatively low in the first two months
and significantly higher in the third month of a quarter;
efforts to reduce levels of channel inventory; a
provision for estimated returns, resulting from higher
returns, relative to both historical and anticipated
levels; and, to a lesser extent, a provision for price
protection. The net loss for the period, primarily
reflecting the factors affecting sales discussed above
and the relative linearity of operating expenses, was
recorded as a decrease to the Company's retained earnings
balance as of June 1, 1997.
The consolidated statements of operations and cash flows
for the three and six months ended November 30, 1996
include the U.S. Robotics statements of earnings and cash
flows for the three and six months ended September 29,
1996. The following information has been prepared for
comparative purposes only and does not purport to be
indicative of what would have occurred had this
transaction not been effected on the date indicated above
or of results which may occur in the future. Per share
data are presented after adjustment for the exchange of
1.75 shares of 3Com Common Stock for each share of U.S.
Robotics common stock.
Three Months Ended Six Months Ended
November 30, November 30,
1996 1996
------------------ ----------------
(Unaudited. In thousands, except per share amounts)
Sales:
3Com $ 820,296 $1,530,436
U.S. Robotics 611,410 1,158,195
Reclassifications to conform
financial statement presentation (10,046) (16,911)
Combined $1,421,660 $2,671,720
Net income:
3Com $ 105,569 $ 197,141
U.S. Robotics 13,472 76,770
Combined $ 119,041 $ 273,911
Net income per common and equivalent share
(on a fully diluted basis):
3Com $ 0.56 $ 1.06
U.S. Robotics 0.08 0.45
Combined $ 0.34 $ 0.77
The accompanying historical financial information as of
May 31, 1997 and for the three and six months ended
November 30, 1996 excludes the effect of conforming the
two companies' fixed asset capitalization policies, which
had reduced retained earnings by $41.4 million at May 31,
1997, as previously described in the Company's Form 10-Q
for the quarter ended August 31, 1997. In preparing the
Form 10-Q for the quarter ended November 30, 1997, the
Company determined that this change was not appropriate.
Eliminating this change did not have a material impact on
the Company's consolidated financial statements.
As a result of the merger, the Company recorded charges
of $426 million during the first quarter of fiscal 1998.
These charges include approximately $364 million of
integration expenses, $42 million of direct transaction
costs (consisting primarily of investment banking and
other professional fees) and $20 million of other merger
charges. Integration expenses included:
- - $105 million primarily associated with the
elimination and phase-out of duplicate wide area
networking and PC Card products (i.e., 3Com's
AccessBuilder (Registered Trademark) 2000, 4000, 5000 and 8000
products and U.S. Robotics'(Registered Trademark) TOTALswitch,
ATM switch, LANLinker switch and related small office home
office products,and Combo and LAN PC Cards), and the
discontinuance of U.S. Robotics' telephony products. The
provision includes an estimate for replacement of installed
AccessBuilder 5000 and 8000 products, inventory write-
offs associated with the discontinued products listed
above, and estimated returns of discontinued products
from the distribution channel;
- - $92 million associated with certain long-term
assets, primarily including duplicate finance,
manufacturing, human resource and other management
information systems, capitalized purchased research and
development costs in connection with a discontinued
product, and goodwill related to certain duplicate
international distribution operations;
- - $81 million related to the closure and elimination
of duplicate owned and leased facilities, primarily
corporate headquarters and domestic and European sales
offices;
- - $70 million for severance and outplacement costs
related to the merger. Employee groups impacted by the
merger include personnel involved in duplicate
corporate services, manufacturing and logistics,
product organizations and sales; and
- - $16 million related to an obligation under a
noncancelable research and development funding
contract, elimination of certain duplicate Asian
distribution operations, and repayment of a government
research grant associated with the discontinuance of
duplicate products.
The remaining merger-related accrual at November 30,
1997 was approximately $324 million. Total expected cash
expenditures relating to the merger charge are estimated to
be approximately $193 million, of which approximately $64 million
was disbursed prior to November 30, 1997. Termination
benefits paid to 561 employees terminated through
November 30, 1997 (approximately 56 percent of the total
planned severances) were approximately $29 million. The
remaining severance and outplacement amounts are expected
to be paid within the next nine months.
5. Litigation
The Company is a party to lawsuits in the normal course
of its business. The Company notes that (i) litigation
in general and patent litigation in particular can be
expensive and disruptive to normal business operations
and (ii) the results of complex legal proceedings can be
very difficult to predict with any certainty.
Securities Litigation
In December 1997 and January 1998, several putative
shareholder class action lawsuits were filed against the
Company and certain of its officers and directors in the
United States District Court for the Northern District of
Illinois and in the United States District Court for the
Northern District of California. The complaints allege
violations of the federal securities laws, specifically
Sections 10(b) and 20(a) of the Securities and Exchange
Act of 1934. The complaints allege class periods between
May 19, 1997 and November 14, 1997 and do not specify the
damages sought. The Company believes it has meritorious
defenses to the claims and intends to contest the
lawsuits vigorously. An unfavorable resolution of the
actions could have a material adverse effect on the
business, results of operations or financial condition of
the Company.
U.S. Robotics, certain of its directors, and the Company
were named as defendants in shareholder class actions
relating to the merger between the Company and U.S.
Robotics. (In re: U.S. Robotics Corporation Shareholders
Litigation, Delaware Chancery Court Consolidated Civil
Action No. 15580). On October 7, 1997, all claims
related to such suits were settled pursuant to a
settlement approved by the Delaware Chancery Court.
Results of the settlement did not have a material effect
on the Company's results of operations or financial
condition.
On March 24, and May 5, 1997, putative shareholder class
action lawsuits, entitled Hirsch v. 3Com Corporation, et
al., Civil Action No. CV764977, and Kravitz v. 3Com
Corporation, et al., Civil Action No. CV765962,
respectively, were filed against the Company and certain
of its officers and directors in the California Superior
Court, Santa Clara County (the Superior Court).
Following resolution of a demurrer filed by the Company,
the remaining causes of action in the complaints allege
violations of the state securities laws, specifically
sections 25400 and 25500 of the California Corporations
Code. The complaints, which cover a putative period of
September 24, 1996 through February 10, 1997, do not
specify the damages sought. The Company believes it has
meritorious defenses to the claims and intends to contest
the lawsuits vigorously. An unfavorable resolution of
the actions could have a material adverse effect on the
business, results of operations or financial condition of
the Company.
Intellectual Property Litigation
In September 1997, Livingston Enterprises, Inc.
(Livingston) filed suit against U.S. Robotics in the
United States District Court for the Northern District of
California (Livingston Enterprises, Inc. v. U.S. Robotics
Access Corporation, Case No. C-97-3551(CRB)), claiming
copyright infringement, misappropriation of trade
secrets, breach of contract and unfair competition with
respect to certain software code previously licensed to
U.S. Robotics for incorporation in certain of its remote
access server and concentrator products. Livingston
seeks injunctive relief and damages that are not
specified as to amount. The Company believes it has
meritorious defenses to Livingston's claims and intends
to contest the lawsuit vigorously. In September 1997,
Livingston filed a separate action in the same federal
court (Livingston Enterprises, Inc. v. U.S. Robotics
Access Corporation, Case No. C-97-3487 (CRB)) seeking a
declaratory judgment to the effect that one of U.S.
Robotics' U.S. patent is invalid and not infringed by
Livingston's products, as well as unspecified damages.
U.S. Robotics has answered this complaint and filed
counterclaims alleging infringement of such patent by
Livingston. An unfavorable resolution of the action could
have a material adverse effect on the business, results
of operations or financial condition of the Company.
On April 26, 1997, Xerox Corporation filed suit against
U.S. Robotics in the United States District Court for the
Western District of New York (Xerox Corporation v. U.S.
Robotics Corporation and U.S. Robotics Access
Corporation, No. 97-CV-6182T), claiming infringement of
one United States Patent related to handwriting
recognition. The complaint alleges willful infringement
and prays for unspecified damages and injunctive relief.
The Company believes it has meritorious defenses to the
claims and intends to contest the lawsuit vigorously. An
unfavorable resolution of the action could have a
material adverse effect on the business, results of
operations or financial condition of the Company.
On February 13, 1997, Motorola, Inc. filed suit against
U.S. Robotics in the United States District Court for the
District of Massachusetts (Motorola, Inc. v. U.S.
Robotics Corporation, et al., Civil Action No. 97-
10339RCL), claiming infringement of eight United States
patents. The complaint alleges willful infringement and
prays for unspecified damages and injunctive relief.
U.S. Robotics has filed an answer to Motorola's claims
setting forth its defenses and asserting counterclaims
which allege infringement of a U.S. Robotics patent,
violation of antitrust laws, promissory estoppel and
unfair competition. The Company believes it has
meritorious defenses to the claims and intends to contest
the lawsuit vigorously. An unfavorable resolution of the
action could have a material adverse effect on the
business, results of operations or financial condition of
the Company.
Consumer Litigation
During 1997, three putative class action lawsuits
were filed against the Company or its subsidiary, U.S.
Robotics in the state courts of California and Illinois.
Each of the actions seeks damages as a result of alleged
misrepresentations by the Company or U.S. Robotics in
connection with the sale of its new x2TM products and
products upgradeable to x2 under various California and
Illinois consumer fraud statutes and under common law
theories including fraud and negligent misrepresentation.
Plaintiffs in Bendall, et al. v. U.S. Robotics
Corporation, et al., (No. 170441, Superior Court of Marin
County, California), Lippman, et al v. 3Com, (No. 97 CH
09773, Circuit Court of Cook County, Illinois), and
Michaels, et al. v. U.S. Robotics Access Corporation et
al., (No. 94 CH 14417, Circuit Court of Cook County,
Illinois) seek certification respectively of nationwide
classes of purchasers of x2 technology during the
approximate period November 1996 through at least May
1997. U.S. Robotics' motion to dismiss the Bendall
action is presently pending; the Lippman action presently
is stayed, and a responsive pleading is not yet due in
the Michaels action. The complaints seek injunctive
relief and an unspecified amount of damages. Two other
actions purporting to be brought in the public interest
have also been filed against U.S. Robotics in state court
in California under California statutes arising out of
U.S. Robotics alleged misrepresentation in connection
with the sale of the x2 products. Levy v. U.S. Robotics
Corporation, (No. 170968, Superior Court of Marin County,
California) and Intervention Inc. v. U.S. Robotics
Corporation, (No. 984352, Superior Court of San
Francisco, California) seek injunctive and unspecified
monetary relief. The Company believes it has meritorious
defenses to these lawsuits and intends to contest the
lawsuits vigorously. An unfavorable resolution of the
actions could have a material adverse effect on the
business, results of operations or financial condition of
the Company.
6. Effects of Recent Accounting Pronouncements
In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards No. 128 (SFAS 128), "Earnings per Share." This
Statement establishes and simplifies standards for
computing and presenting earnings per share. SFAS 128
will be effective for the Company's third quarter of
fiscal 1998, and requires restatement of all previously
reported earnings per share data that are presented.
Early adoption of this Statement is not permitted. SFAS
128 replaces primary and fully diluted earnings per share
with basic and diluted earnings per share. The Company
expects that basic earnings per share amounts will be
accretive compared to the Company's primary earnings per
share amounts, and diluted earnings per share amounts
will not be materially different from the Company's fully
diluted earnings per share amounts.
In June 1997, the FASB issued SFAS 130, "Reporting
Comprehensive Income." This statement establishes
standards for the reporting and display of comprehensive
income and its components. SFAS 130 will be effective
for the Company's fiscal year 1999 and requires
reclassification of financial statements for earlier
periods for comparative purposes.
In June 1997, the FASB issued SFAS 131, "Disclosures
About Segments of an Enterprise and Related Information."
This statement requires that financial information be
reported on the basis used internally for evaluating
segment performance and deciding how to allocate
resources to segments. SFAS 131 is effective for the
Company's fiscal year 1999 and requires restatement of
all previously reported information for comparative
purposes.
7. Subsequent Events
On December 17, 1997, the Company's Board of Directors
approved the repricing of certain employee stock options
with an exercise price in excess of the fair market value
of the Company's common stock on January 12, 1998. The
exercise price of such employee stock options was reset
to the closing market price on January 12, 1998. All
such options retain their original vesting schedules but
are subject to a nine-month period in which exercises are
prohibited. Stock options held by executive officers and
directors were not eligible for such repricing.
On December 23, 1997, the Company redeemed its
convertible subordinated notes totaling $110 million.
Under the terms of the note agreement, cash payments
related to principal, accrued interest and prepayment
penalties totaled approximately $115 million.
3Com Corporation
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Results of Operations
The following table sets forth, for the periods indicated, the
percentage of total sales represented by the line items
reflected in the Company's consolidated statements of
operations:
Three months ended Six months ended
November 30, November 30,
------------------ ----------------
1997 1996 1997 1996
---- ---- ---- ----
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 53.4 51.9 52.6 52.2
----- ----- ----- -----
Gross margin 46.6 48.1 47.4 47.8
Operating expenses:
Sales and marketing 27.7 17.2 22.6 16.8
Research and development 11.9 7.6 10.2 7.7
General and administrative 5.8 3.9 4.7 3.8
Purchased research
and development - 3.8 - 2.0
Merger-related charges - 0.4 15.2 0.3
and other ----- ----- ----- -----
Total operating expenses 45.4 32.9 52.7 30.6
----- ----- ----- -----
Operating income (loss) 1.2 15.2 (5.3) 17.2
Interest and other income, net 0.6 0.3 0.4 0.2
----- ----- ----- -----
Income (loss) before income taxes 1.8 15.5 (4.9) 17.4
Income tax provision (benefit) 0.6 7.1 (0.2) 7.1
----- ----- ----- -----
Net income (loss) 1.2% 8.4% (4.7)% 10.3%
===== ===== ===== =====
Excluding merger-related charges:
Total operating expenses 45.4% 28.6% 37.6% 28.3%
Operating income 1.2 19.5 9.8 19.4
Net income 1.2 12.6 6.6 12.5
Sales in the second quarter of fiscal 1998 totaled $1.2
billion, a decrease of $201.4 million or 14 percent from the
corresponding quarter a year ago. Sales of network systems
products (e.g., switches, routers, hubs, and remote access
concentrators) in the second quarter of fiscal 1998 decreased
two percent from the same quarter one year ago and decreased
13 percent compared to the first quarter of fiscal 1998.
Sales of network systems products represented 51 percent of
total sales in the second quarter of fiscal 1998, compared to
44 percent in the year ago quarter. Sales of client access
products (e.g., modems and network interface cards [NICs]) in
the second quarter of fiscal 1998 decreased 24 percent from
the same quarter one year ago and 32 percent from the first
quarter of fiscal 1998. Sales of client access products in
the second quarter of fiscal 1998 represented 49 percent of
total sales compared to 56 percent in the second quarter of
fiscal 1997. Domestic sales represented 58 percent of total
sales for the second quarter of fiscal 1998. Domestic and
international sales decreased 16 percent and 11 percent,
respectively when compared to the second quarter of fiscal
1997. The Company also experienced a sequential decline from
the first quarter of fiscal 1998 in domestic and international
sales of 21 percent and 28 percent, respectively.
Sales in the first six months of fiscal 1998 totaled $2.8
billion, an increase of $149.4 million or six percent from the
corresponding period a year ago. Sales of network systems
products in the first six months of fiscal 1998 increased 15
percent from the same period one year ago, and represented 47
percent of total sales, compared to 44 percent in the year ago
period. Sales of client access products in the first six
months of fiscal 1998 decreased 2 percent from the same period
one year ago, and represented 53 percent of total sales,
compared to 56 percent in the first six months of fiscal 1997.
Domestic sales for the first six months of fiscal 1998
comprised 56 percent of total sales compared to 60 percent in
the same period a year ago. Domestic sales decreased one
percent while international sales increased 16 percent when
compared to the first six months of fiscal 1997. During the
quarter, the Company began transitioning to next generation
platforms across several major product categories. For
example, the Company introduced and began shipping new
CoreBuilderTM High-Function Switches and began shipping the
Total ControlTM HiPerTM Access System. In addition, the
pricing environment continued to be very competitive, and
although the Company experienced significant year-over-year
unit growth in key products such as Fast Ethernet NICs and
workgroup switches, these gains were partially offset by
declines in average selling prices.
The Company believes that the year-over-year decrease in
second quarter sales and the sequential decrease in sales from
the first quarter of fiscal 1998 is due to a variety of
factors, including those discussed below.
In light of information received late in the second
quarter, the Company adopted a new inventory business model.
The new model generally calls for fewer weeks supply of
inventory in the channel. In order to begin implementing the
new model, the Company constrained sales into its distribution
channels. The Company made progress during the second quarter
in implementing the new model.
The Company believes another factor affecting sales, in
particular modem and remote access concentrator sales, was the
failure of the International Telecommunications Union (ITU) to
determine a standard for 56 Kbps technology. The Company
believes that the delay in finalizing such standards resulted
in customers postponing buying decisions.
During the second quarter of fiscal 1998, sales in the
Asia Pacific region compared to the second quarter of fiscal
1997 and the first quarter of fiscal 1998 decreased five
percent and 32 percent, respectively. Historically, the Asia
Pacific region had been a high growth region for the
networking industry and the Company. During the second
quarter of fiscal 1998, however, several Asian countries
experienced a weakening of their local currencies and turmoil
in their financial markets and institutions, which the Company
believes adversely affected financial results for the second
quarter of fiscal 1998.
An additional factor affecting second quarter results was
an apparent slowdown in the growth of the networking industry.
Recent reports by industry sources indicated that the
networking industry worldwide grew by less than 20 percent
during 1997, well below historical growth rates.
Gross margin as a percentage of sales was 46.6 percent in
the second quarter of fiscal 1998, compared to 48.1 percent in
the second quarter of fiscal 1997 and 48.0 percent in the
first quarter of fiscal 1998. The decline in margins during
the second quarter of fiscal 1998 resulted, in part, from
period costs being a higher percentage of sales. Margins also
reflected a higher mix of certain NICs and workgroup switching
products which have lower margins than other NICs and
workgroup switching products. These factors were partially
offset by an increased mix of higher margin modem products,
such as the U.S. Robotics brand 56 Kbps modem with x2
technology. Gross margin as a percentage of sales was 47.4
percent in the first six months of fiscal 1998, compared to
47.8 percent for the first six months of fiscal 1997.
Operating expenses in the second quarter of fiscal 1998
were $553.6 million or 45.4 percent of sales, compared to
$467.1 million or 32.9 percent of sales in second quarter of
fiscal 1997 and $932.0 million or 58.2 percent of sales in the
first quarter of fiscal 1998. Operating expenses in the first
six months of fiscal 1998 were $1,485.6 million or 52.7
percent of sales, compared to $818.0 million or 30.6 percent
of sales in first six months of fiscal 1997. Operating
expenses as a percentage of sales were higher than historical
levels primarily due to the reduced level of sales for the
second quarter of fiscal 1998, as discussed above. Excluding
charges of $54.0 million for purchased research and
development associated with U.S. Robotics' acquisition of
Scorpio Communications, Ltd. (Scorpio) and a charge of $6.6
million associated with 3Com's acquisition of OnStream
Networks, Inc. (OnStream), operating expenses would have
increased 36 percent from $406.5 million or 28.6 percent of
sales in the second quarter of fiscal 1997 and would have
increased 40 percent from $757.4 million or 28.3 percent of
sales in the first six months of fiscal 1997. Excluding the
pre-tax merger-related charge of $426.0 million related to the
merger with U.S. Robotics, operating expenses for the first
quarter of fiscal 1998 were $506.0 million, or 31.6 percent of
sales and $1,059.6 million, or 37.6 percent of sales for the
first six months of fiscal 1998.
Sales and marketing expenses in the second quarter of
fiscal 1998 increased $93.7 million or 38 percent from the
second quarter of fiscal 1997 and $36.3 million or 12 percent
from the first quarter of fiscal 1998. Sales and marketing
expenses as a percentage of sales increased to 27.7 percent of
sales in the second quarter of fiscal 1998, from 17.2 percent
in the corresponding fiscal 1997 period and 18.8 percent in
the first quarter of fiscal 1998. Sales and marketing
expenses in the first six months of fiscal 1998 increased
$189.6 million or 42 percent from the first six months of
fiscal 1997. The increase in absolute dollars primarily
reflected an increase in field sales, marketing and customer
support.
Research and development expenses in the second quarter
of fiscal 1998 increased $38.1 million or 35 percent from the
year-ago period, and $3.4 million or 2 percent from the first
quarter of fiscal 1998. Research and development expenses
increased to 11.9 percent of total sales in the second quarter
of fiscal 1998, compared to 7.6 percent in second quarter of
fiscal 1997 and 8.9 percent in the first quarter of fiscal
1998. Research and development expenses in the first six
months of fiscal 1998 increased $82.1 million or 40 percent
from the year-ago six-month period. The increase in research
and development expenses in absolute dollars was primarily
attributable to the cost of developing the Company's new
products, primarily client access, switching, and network
management, and its expansion into new technologies and
markets. The Company believes the timely introduction of new
technologies and products is crucial to its success, and plans
to continue to make acquisitions or strategic investments to
accelerate time to market where appropriate.
General and administrative expenses in the second quarter
of fiscal 1998 increased $15.3 million or 28 percent from the
same period a year ago, and $7.9 million or 13 percent from
the first quarter of fiscal 1998. General and administrative
expenses increased to 5.8 percent of total sales in the second
quarter of fiscal 1998, compared to 3.9 percent in the second
quarter of fiscal 1997 and the first quarter of fiscal 1998.
General and administrative expenses in the first six months of
fiscal 1998 increased $30.5 million or 30 percent from the
same period a year ago. The increase in general and
administrative expenses in absolute dollars primarily
reflected an expansion of the Company's infrastructure.
Interest and other income, net increased $3.5 million or
85 percent compared to the second quarter of fiscal 1997 and
$4.7 million compared to the first quarter of fiscal 1998.
Interest and other income, net increased approximately $3.5
million in the first six months of fiscal 1998 compared to the
first six months of fiscal 1997. Such increases were due to
higher interest income in the second quarter of fiscal 1998
and lower foreign currency losses. The majority of the
Company's sales are denominated in U.S. Dollars. Where
available, the Company enters into foreign exchange forward
contracts to hedge certain balance sheet exposures and
intercompany balances against future movements in foreign
exchange rates.
The Company's effective income tax rate was approximately
35.0 percent in the second quarter of fiscal 1998 compared to
46.0 percent in the second quarter of fiscal 1997. Excluding
the purchased research and development and merger-related
charges associated with Scorpio and OnStream, the pro forma
income tax rate was 36.1 percent for the second quarter of
fiscal 1997. The Company's effective income tax rate on the
pre-tax loss of $137.8 million was a benefit of 4.4 percent in
the first six months of fiscal 1998 compared to an effective
rate of approximately 41.1 percent in the first six months of
fiscal 1997. Excluding the pre-tax merger-related charge
associated with U.S. Robotics, which was not fully deductible,
the pro forma income tax rate was 35.0 percent for the first
six months of fiscal 1998. Excluding the purchased research
and development and merger-related charges associated with
Scorpio and OnStream, the pro forma income tax rate was 36.4
percent for the first six months of fiscal 1997.
Net income for the second quarter of fiscal 1998 was
$15.1 million, or $0.04 per share, compared to net income of
$119.0 million, or $0.34 per share, for the second quarter of
fiscal 1997. Excluding the purchased research and development
and merger-related charges associated with Scorpio and
OnStream, net income was $179.6 million, or $0.51 per share
for the second quarter of fiscal 1997. Net loss for the first
six months of fiscal 1998 was $131.7 million, or $0.37 per
share, compared to net income of $273.9 million, or $0.77 per
share, for the first six months of fiscal 1997. Excluding the
merger-related charge associated with U.S. Robotics, net
income was $187.3 million, or $0.52 per share for the first
six months of fiscal 1998. Excluding the purchased research
and development and merger-related charges associated with
Scorpio and OnStream, net income was $334.5 million, or $0.95
per share for the first six months of fiscal 1997.
Business Environment and Risk Factors
This report contains certain forward looking statements,
including statements regarding future trends in market growth,
sales, gross margins, and inventory levels. Actual results
could vary materially based on a number of factors, including
but not limited to those set forth below.
The Company participates in a highly volatile industry
which is characterized by vigorous competition for market
share, rapid technological development, consolidations, and
uncertainty over adoption of industry standards. This has in
the past resulted and could in the future result in aggressive
pricing practices and increased competition, both from start-
up companies and from well-capitalized computer systems,
communications and other major technology companies. For
example, in the third quarter of fiscal 1997, a major
competitor reduced its average selling prices on Fast Ethernet
NIC products by approximately 40 percent. The Company
immediately responded with similar price cuts. As a result,
the Company experienced a significant downward pressure on
this product's gross margin and an accelerated transition from
10 Mbps Ethernet to Fast Ethernet NICs. In addition, as new
competitors enter the market and offer competing products,
pricing may be affected. The Company believes there is a risk
of downward pricing pressure on the Company's products,
including products incorporating 56 Kbps modem technology.
Pricing pressure intensified across a variety of the Company's
products during the second quarter of fiscal 1998, and may
intensify in coming quarters.
Recently, market researchers have reported slower
industry growth worldwide in calendar 1997 than in the past.
Although market researchers generally forecast a small
increase in networking growth rates in calendar 1998 from 1997
levels, there can be no assurance that this will occur.
Similarly, there can be no assurances that the Company's
results in any particular quarter will fall within market
researchers' forecasted ranges.
The Company sells a significant portion of its products
to distributors and resellers. In turn, such distributors and
resellers maintain significant levels of the Company's
products in their inventories. The Company attempts to ensure
appropriate levels of inventory are available to end users by
working closely with these resellers and distributors. In
light of information received late in the second quarter, the
Company adopted a new inventory business model. The new model
generally calls for fewer weeks supply of inventory in the
channel. In order to begin implementing the new model, the
Company constrained sales into its distribution channels. The
Company made progress during the second quarter in
implementing the new model. However, the Company anticipates
that the full implementation of the new inventory business
model will require additional reductions in channel inventory
during the third quarter and possibly beyond. Such reductions
could adversely affect the Company's sales and results of
operations.
The Company distributes a significant portion of its
products through third party distributors and resellers. Due
to consolidation in the distribution and reseller channels and
the Company's increased volume of sales into these channels,
the Company has experienced an increased concentration of
credit risk. While the Company continually monitors and
manages this risk, financial difficulties on the part of one
or more of the Company's resellers may have a material adverse
effect on the Company's results of operations.
The Company's operations in certain markets, which are
characterized by economic and political instability and
currency fluctuations, may subject the Company's resellers to
financial difficulties which may have an adverse impact on the
Company. For example, the recent instability in the Asian
financial markets appears to have negatively impacted sales,
and may continue to negatively impact sales in those markets
in a number of ways, including: increasing competition from
local competitors that offer sales terms in local currencies,
reducing access to sources of capital needed by customers to
make purchases, and slowing end user purchases. Should the
Asian economic environment fail to improve, the Company would
consider continuing to expand its exposure to foreign
currencies to preserve long-term customer relationships. A
significant fluctuation in foreign currency could have an
adverse impact on the Company. Finally, the aforementioned
instability may increase credit risks as the recent weakening
of certain Asian currencies may result in insolvencies or
otherwise impair customers' ability to repay existing
obligations. Depending on the situation in Asia in coming
quarters, any or all of these factors could adversely impact
the Company's financial results in future quarters.
Typically, quarterly sales and results of operations
depend on the volume and timing of orders, and the ability to
fulfill them within the quarter. The Company's customers
historically request fulfillment of orders in a short period
of time, resulting in a minimal backlog and limited visibility
to future sales trends. Should incoming order rates decline,
if ordered products are not readily available, or if the
Company does not immediately fill orders in an attempt to
further reduce channel inventory levels, the Company's results
of operations could be adversely affected.
The Company historically has sold a large percentage of
its products in the third month of each quarter. This
subjects the Company to additional business risks due to
unexpected disruptions in functions, including but not limited
to manufacturing, order management, information systems and
shipping, which could have an adverse affect on the Company's
results of operations.
The Company's success depends, in substantial part, on
the timely and successful introduction of new products. An
unexpected change in one or more of the technologies affecting
network communications, or in market demand for products based
on a particular technology, or entry by new competitors, could
lead to a slowdown in sales of certain products, and could
have a material adverse effect on the Company's operating
results if the Company does not respond timely and effectively
to such changes. The Company is engaged in research and
development activities in certain emerging LAN and WAN high-
speed standards and high-speed technologies, such as: Fast
Ethernet, Gigabit Ethernet, ATM, 56 Kbps, ISDN, xDSL and data-
over-cable. As the industry standardizes on high-speed
technologies, there can be no assurance that the Company will
be able to respond promptly and cost-effectively to compete in
the marketplace.
The Company's success depends, in substantial part, on
the adoption of industry standards, the timely and successful
introduction of products that are compliant with new industry
standards, and the Company's ability to address competing
technological and product developments. Delays in adoption of
industry standards or adoption of standards incorporating
competing technologies or competitors' intellectual property
could adversely affect the Company's sales or operating
margins. In December, a technical compromise was reached
among ITU members that may result in the determination of a
standard for 56 Kbps technology in January 1998 with official
adoption in September. While the Company believes that it will
be able to comply quickly with this proposed standard and
offer its customers software upgrades to the new standard,
there can be no assurances that the development of this
standard and the Company's compliance with it will proceed as
rapidly or smoothly as expected or that these events will
result in increased demand for the Company's 56 Kbps products.
Any benefits which the Company may derive from the expected
adoption of this proposed standard will continue to be
dependent upon the timing and extent to which the standard 56
Kbps technology is deployed by Internet Service Providers and
accepted by Internet users. Moreover, consumer confusion
regarding 56 Kbps technology, which has negatively impacted
sales to date, may persist notwithstanding final determination
of the ITU standard.
The Company operates in an industry in which the ability
to compete is dependent on the development or acquisition and
protection of proprietary technology, which must be protected
both to secure the benefits of the Company's innovations in
its own products and to better enable the Company to license
proprietary technology from others on acceptable terms. The
Company attempts to perfect and preserve intellectual property
rights in the technologies it develops through a combination
of trade secrets, patents, copyrights and trademarks. There
can be no assurance that the steps taken by the Company will
be sufficient to prevent misappropriation or infringement of
its intellectual property or that competitors will not
independently develop technologies or procure intellectual
property rights that are equivalent or superior to those of
the Company.
The Company, from time to time, must negotiate licenses
with third parties in order to obtain rights to incorporate
proprietary technologies, including de facto and official
standard networking and communications protocols and
specifications, into its products. In most instances, the
owners of intellectual property rights covering technologies
required to implement official standards have undertaken to
license such rights on reasonable and non-discriminatory
terms, and as a general rule the Company has no reason to
believe that these parties will fail to honor their
undertakings and the Company anticipates that it will be able
to enter into licenses with such parties on reasonable terms
that will be comparable to those available to its competitors.
There can be no assurances in this regard, however, and there
is always the potential for disputes and litigation, even
where a third party owner of intellectual property rights has
undertaken to make licenses generally available or has
actually entered into licenses upon which the Company has
relied in designing and making its products. By way of
example, the Company is currently involved in disputes with
Motorola, Inc. over patents related to certain modem standards
and with Livingston Enterprises, Inc. over certain software
previously licensed by U.S. Robotics. See Part II. Item 1.
Legal Proceedings. The Company's failure to obtain and
maintain licenses for all of the third party intellectual
property rights required for the manufacture, sale and use of
its products, particularly those which must comply with industry
standard protocols and specifications in order to be commercially
viabe, could have a material adverse effect on the Company's
business, results of operation, and financial condition.
The Company derives a portion of its sales from original
equipment manufacture (OEM) partners including PC companies
who bundle 3Com network interface cards and modems, and
incorporate chip-sets into their products. The Company
believes that future sales growth of these products is
dependent, in part, on the Company's ability to strengthen
relationships and increase business with OEM partners. OEM
sales are characterized as having lower average selling prices
and gross margins. Consequently, the Company's overall gross
margin percentage may be adversely impacted if OEM sales
become a larger percentage of the Company's business. Certain
OEMs in the PC industry are integrating communication
subsystems on the PC motherboard. If such integration becomes
a trend, the Company's future sales growth may be adversely impacted.
Acquisitions of complementary businesses and
technologies, including technologies and products under
development, are an active part of the Company's overall
business strategy. Certain of the Company's major competitors
have also been engaged in merger and acquisition transactions.
Such consolidations by competitors are creating entities with
increased market share, customer base, technology and
marketing expertise, sales force size, or proprietary
technology in segments in which the Company competes. These
developments may adversely affect the Company's ability to
compete in such segments.
In June 1997, the Company merged with U.S. Robotics, the
largest acquisition in the history of the networking industry.
Large acquisitions are challenging, in general, and there can
be no assurance that products, technologies, distribution
channels, customer support operations, management information
systems, key personnel and businesses of U.S. Robotics or
other acquired companies will be effectively assimilated into
the Company's business or product offerings, or that such
integration will not adversely affect the Company's business,
financial condition or results of operations. The inability
of management to successfully integrate the operations of the
two companies in a timely manner could have a material adverse
effect on the business, results of operations, and financial
condition of the Company.
The high-growth nature of the computer networking
industry, coupled with critical time-to-market factors, has
caused increased competition and consolidation. As a result,
there has been a significant increase in the cost of acquiring
computer networking companies. There can be no assurance that
the Company will continue to be able to identify and
consummate suitable acquisition transactions in the future.
However, should the Company consummate acquisitions in the
future, the impact may result in increased dilution of the
Company's future earnings.
The Company's products are covered by warranties and the
Company is subject to contractual commitments. If unexpected
circumstances arise such that the product does not perform as
intended and the Company is not successful in resolving
product quality or performance issues, there could be an
adverse impact on the financial results of the Company.
Some key components of the Company's products are
currently available only from single sources. There can be no
assurance that in the future the Company's suppliers will be
able to meet the Company's demand for components in a timely
and cost-effective manner. The Company's operating results
and customer relationships could be adversely affected by
either an increase in prices for, or an interruption or
reduction in supply of, any key components.
Recruiting and retaining skilled personnel, especially in
certain locations in which the Company operates, is highly
competitive. Recently, for example, recruiting of qualified
engineers has been extremely competitive. If the Company
cannot successfully recruit and retain such skilled personnel,
the Company's financial results may be adversely affected.
The Company is in the process of transitioning its
manufacturing requirements planning, accounts payable,
purchasing and intercompany accounting systems to a new set of
applications which operate on a client server based platform.
The third quarter of fiscal 1998 will be the first quarter in
which some of the Company's major manufacturing sites utilize
the new system. As a result of the planned transition to the
new client server platform, the Company may experience
production, development, sales processing, financial system,
or other disruptions, which may have an adverse financial
effect on the Company.
Many computer systems were not designed with the year
2000 issues in mind, and may require significant hardware and
software modifications. During the next few years, companies
owning and operating such systems may plan to devote a
substantial portion of their information spending to make such
modifications and divert spending away from networking
solutions. This could have an adverse impact on the Company's
sales and results of operations. The Company believes the
majority of its major systems are currently Year 2000
compliant, and costs to transition the Company's remaining
systems to Year 2000 compliance are not anticipated to be
material.
The market price of the Company's common stock has been,
and may continue to be, extremely volatile. Factors such as
new product, pricing or acquisition announcements by the
Company or its competitors, quarterly fluctuations in the
Company's operating results, challenges associated with
integration of businesses and general conditions in the data
networking market, such as a decline in industry growth rates,
may have a significant impact on the market price of the
Company's common stock. These conditions, as well as factors
which generally affect the market for stocks of high
technology companies, could cause the price of the Company's
stock to fluctuate substantially over short periods.
Because of the foregoing factors, as well as other
factors affecting the Company's operating results, past trends
and performance should not be presumed by investors to be an
accurate indicator of future results or trends.
Liquidity and Capital Resources
Cash, equivalents and short-term investments at November
30, 1997 were $1.1 billion, increasing $196.0 million from May
31, 1997.
For the six months ended November 30, 1997, net cash
generated from operating activities was $254.6 million.
Accounts receivable at November 30, 1997 decreased $306.7
million from May 31, 1997 to $927.5 million. Days sales
outstanding in receivables decreased to 68 days at November
30, 1997, compared to 74 days at May 31, 1997 due to a lower
concentration of sales in the third month of the quarter.
Inventory levels at November 30, 1997 increased $226.6
million, of which $197.7 million was finished goods, from the
prior fiscal year-end to $628.9 million. Inventory turnover
was 5.0 turns at November 30, 1997, compared to 7.5 turns at
May 31, 1997 primarily as a result of the increase in the
Company's inventory due to reduced sales levels, as previously
discussed.
During the six months ended November 30, 1997, the
Company made $193.0 million in capital expenditures. Major
capital expenditures included upgrades and expansion of the
Company's facilities in the U.K., Santa Clara, California and
Illinois and the continuing development of the Company's
worldwide information systems. As of November 30, 1997, the
Company had approximately $170 million in capital expenditure
commitments outstanding primarily associated with the
construction and expansion of office and manufacturing space
in Santa Clara, Illinois, the U.K., and Singapore.
During the first six months of fiscal 1998, the Company
received cash of $234.1 million from the sale of its common
stock to employees through its employee stock purchase and
option plans.
During the first quarter of fiscal 1998, the Company
signed a lease, which replaces a previous land lease, for
300,000 square feet of office and research and development
space and a data center to be built on land adjacent to the
Company's headquarters site. The lease expires in August
2002, with an option to extend the lease term for two
successive periods of five years each. The Company has an
option to purchase the property for $83.6 million, or at the
end of the lease arrange for the sale of the property to a
third party with the Company retaining an obligation to the
owner for the difference between the sale price and $83.6
million, subject to certain provisions of the lease.
Construction of the buildings began in July 1997, and the
Company anticipates that it will occupy and begin lease
payments in the second quarter of fiscal 1999.
During the first quarter of fiscal 1998, the Company
signed a lease, which replaces a previous land lease, for
525,000 square feet of office, research and development and
manufacturing space to be built on land in Marlborough,
Massachusetts. The lease expires in August 2002, with an
option to extend the lease term for two successive periods of
five years each. The Company has an option to purchase the
property for $86.0 million, or at the end of the lease arrange
for the sale of the property to a third party with the Company
retaining an obligation to the owner for the difference
between the sale price and $86.0 million, subject to certain
provisions of the lease. Construction of the buildings began
in the first quarter of fiscal 1998, and the Company
anticipates that it will occupy and begin lease payments in
the third quarter of fiscal 1999.
During the first quarter of fiscal 1998, the Company
signed a lease for an existing 400,000 square foot building
and for 100,000 square feet to be built on adjacent land in
Rolling Meadows, Illinois. The new and renovated facility
will be used for research and development and office space.
The lease expires in September 2002, with an option to extend
the lease term for two successive periods of five years each.
The Company has an option to purchase the property for $95.0
million, or at the end of the lease arrange for the sale of
the property to a third party with the Company retaining an
obligation to the owner for the difference between the sale
price and $95.0 million, subject to certain provisions of the
lease. The lessor began construction of the buildings in the
second quarter of fiscal 1998, and the Company anticipates it
will occupy and begin lease payments in the first quarter of
fiscal 1999.
The three aforementioned leases require the Company to
maintain specified financial covenants, all of which the
Company was in compliance with as of November 30, 1997.
The Company has a $100 million revolving bank credit
agreement which expires December 20, 1999. Payment of cash
dividends are permitted under the credit agreement, subject to
certain limitations based on net income levels of the Company.
The Company has not paid and does not anticipate it will pay
cash dividends on its common stock. The credit agreement
requires the Company to maintain specified financial
covenants. As of November 30, 1997, there were no outstanding
borrowings under the credit agreement and the Company was in
compliance with all required covenants. During the quarter
ended August 31, 1997, the Company retired certain debt owed
by the heritage U.S. Robotics organization, which included
approximately $170 million of borrowings that occurred during
the April and May time period, which was not reflected in the
restated May 31, 1997 balance sheet.
On December 23, 1997, the Company redeemed convertible
subordinated notes totaling $110 million. Under the terms of
the agreement, the Company paid cash of approximately $115
million for principal, accrued interest and early payment
penalties.
During the quarter ended August 31, 1997, the Company
completed the merger transaction with U.S. Robotics. As a
result, the Company recorded merger-related charges of $426
million. Total expected cash expenditures relating to the
merger-related charges are approximately $193 million, of
which approximately $64 million was disbursed prior to
November 30, 1997.
Based on current plans and business conditions, the
Company believes that its existing cash and equivalents,
temporary cash investments, cash generated from operations and
the available revolving credit agreement will be sufficient to
satisfy anticipated operating cash requirements for at least
the next twelve months.
Effects of Recent Accounting Pronouncements
In February 1997, the Financial Accounting Standards
Board (FASB) issued Statement of Financial Accounting
Standards No. 128 (SFAS 128), "Earnings per Share." This
Statement establishes and simplifies standards for computing
and presenting earnings per share. SFAS 128 will be effective
for the Company's third quarter of fiscal 1998, and requires
restatement of all previously reported earnings per share data
that are presented. Early adoption of this Statement is not
permitted. SFAS 128 replaces primary and fully diluted
earnings per share with basic and diluted earnings per share.
The Company expects that basic earnings per share amounts will
be accretive compared to the Company's primary earnings per
share amounts, and diluted earnings per share amounts will not
be materially different from the Company's fully diluted
earnings per share amounts.
In June 1997, the FASB issued SFAS 130, "Reporting
Comprehensive Income." This statement establishes standards
for the reporting and display of comprehensive income and its
components. SFAS 130 will be effective for the Company's
fiscal year 1999 and requires reclassification of financial
statements for earlier periods for comparative purposes.
In June 1997, the FASB issued SFAS 131, "Disclosures
About Segments of an Enterprise and Related Information." This
statement requires that financial information be reported on
the basis used internally for evaluating segment performance
and deciding how to allocate resources to segments. SFAS 131
is effective for the Company's fiscal year 1999 and requires
restatement of all previously reported information for
comparative purposes.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to lawsuits in the normal course
of its business. The Company notes that (i) litigation in
general and patent litigation in particular can be expensive
and disruptive to normal business operations and (ii) the
results of complex legal proceedings can be very difficult to
predict with any certainty.
Securities Litigation
In December 1997 and January 1998, several putative
shareholder class action lawsuits were filed against the
Company and certain of its officers and directors in the
United States District Court for the Northern District of
Illinois and in the United States District Court for the
Northern District of California. The complaints allege
violations of the federal securities laws, specifically
Sections 10(b) and 20(a) of the Securities and Exchange Act of
1934. The complaints allege class periods between May 19,
1997 and November 14, 1997 and do not specify the damages
sought. The Company believes it has meritorious defenses to
the claims and intends to contest the lawsuits vigorously. An
unfavorable resolution of the actions could have a material
adverse effect on the business, results of operations or
financial condition of the Company.
U.S. Robotics, certain of its directors, and the Company
were named as defendants in shareholder class actions relating
to the merger between the Company and U.S. Robotics. (In re:
U.S. Robotics Corporation Shareholders Litigation, Delaware
Chancery Court Consolidated Civil Action No. 15580). On
October 7, 1997, all claims related to such suits were settled
pursuant to a settlement approved by the Delaware Chancery
Court. Results of the settlement did not have a material
effect on the Company's results of operations or financial
condition.
On March 24, and May 5, 1997, putative shareholder class
action lawsuits, entitled Hirsch v. 3Com Corporation, et al.,
Civil Action No. CV764977, and Kravitz v. 3Com Corporation, et
al., Civil Action No. CV765962, respectively, were filed
against the Company and certain of its officers and directors
in the California Superior Court, Santa Clara County (the
Superior Court). Following resolution of a demurrer filed by
the Company, the remaining causes of action in the complaints
allege violations of the state securities laws, specifically
sections 25400 and 25500 of the California Corporations Code.
The complaints, which cover a putative period of September 24,
1996 through February 10, 1997, do not specify the damages
sought. The Company believes it has meritorious defenses to
the claims and intends to contest the lawsuits vigorously. An
unfavorable resolution of the actions could have a material
adverse effect on the business, results of operations or
financial condition of the Company.
Intellectual Property Litigation
In September 1997, Livingston Enterprises, Inc.
(Livingston) filed suit against U.S. Robotics in the United
States District Court for the Northern District of California
(Livingston Enterprises, Inc. v. U.S. Robotics Access
Corporation, Case No. C-97-3551(CRB)), claiming copyright
infringement, misappropriation of trade secrets, breach of
contract and unfair competition with respect to certain
software code previously licensed to U.S. Robotics for
incorporation in certain of its remote access server and
concentrator products. Livingston seeks injunctive relief and
damages that are not specified as to amount. The Company
believes it has meritorious defenses to Livingston's claims
and intends to contest the lawsuit vigorously. In September
1997, Livingston filed a separate action in the same federal
court (Livingston Enterprises, Inc. v. U.S. Robotics Access
Corporation, Case No. C-97-3487 (CRB)) seeking a declaratory
judgment to the effect that one of U.S. Robotics' U.S. patent
is invalid and not infringed by Livingston's products, as well
as unspecified damages. U.S. Robotics has answered this
complaint and filed counterclaims alleging infringement of
such patent by Livingston. An unfavorable resolution of the
action could have a material adverse effect on the business,
results of operations or financial condition of the Company.
On April 26, 1997, Xerox Corporation filed suit against
U.S. Robotics in the United States District Court for the
Western District of New York (Xerox Corporation v. U.S.
Robotics Corporation and U.S. Robotics Access Corporation, No.
97-CV-6182T), claiming infringement of one United States
Patent related to handwriting recognition. The complaint
alleges willful infringement and prays for unspecified damages
and injunctive relief. The Company believes it has
meritorious defenses to the claims and intends to contest the
lawsuit vigorously. An unfavorable resolution of the action
could have a material adverse effect on the business, results
of operations or financial condition of the Company.
On February 13, 1997, Motorola, Inc. filed suit against
U.S. Robotics in the United States District Court for the
District of Massachusetts (Motorola, Inc. v. U.S. Robotics
Corporation, et al., Civil Action No. 97-10339RCL), claiming
infringement of eight United States patents. The complaint
alleges willful infringement and prays for unspecified damages
and injunctive relief. U.S. Robotics has filed an answer to
Motorola's claims setting forth its defenses and asserting
counterclaims which allege infringement of a U.S. Robotics
patent, violation of antitrust laws, promissory estoppel and
unfair competition. The Company believes it has meritorious
defenses to the claims and intends to contest the lawsuit
vigorously. An unfavorable resolution of the action could
have a material adverse effect on the business, results of
operations or financial condition of the Company.
Consumer Litigation
During 1997, three putative class action lawsuits
were filed against the Company or its subsidiary, U.S.
Robotics in the state courts of California and Illinois. Each
of the actions seeks damages as a result of alleged
misrepresentations by the Company or U.S. Robotics in
connection with the sale of its new x2TM products and products
upgradeable to x2 under various California and Illinois
consumer fraud statutes and under common law theories
including fraud and negligent misrepresentation. Plaintiffs
in Bendall, et al. v. U.S. Robotics Corporation, et al., (No.
170441, Superior Court of Marin County, California), Lippman,
et al v. 3Com, (No. 97 CH 09773, Circuit Court of Cook County,
Illinois), and Michaels, et al. v. U.S. Robotics Access
Corporation et al., (No. 94 CH 14417, Circuit Court of Cook
County, Illinois) seek certification respectively of
nationwide classes of purchasers of x2 technology during the
approximate period November 1996 through at least May 1997.
U.S. Robotics' motion to dismiss the Bendall action is
presently pending; the Lippman action presently is stayed, and
a responsive pleading is not yet due in the Michaels action.
The complaints seek injunctive relief and an unspecified
amount of damages. Two other actions purporting to be brought
in the public interest have also been filed against U.S.
Robotics in state court in California under California
statutes arising out of U.S. Robotics alleged
misrepresentation in connection with the sale of the x2
products. Levy v. U.S. Robotics Corporation, (No. 170968,
Superior Court of Marin County, California) and Intervention
Inc. v. U.S. Robotics Corporation, (No. 984352, Superior Court
of San Francisco, California) seek injunctive and unspecified
monetary relief. The Company believes it has meritorious
defenses to these lawsuits and intends to contest the lawsuits
vigorously. An unfavorable resolution of the actions could
have a material adverse effect on the business, results of
operations or financial condition of the Company.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The Annual Meeting of Shareholders was held on
October 7, 1997.
(b) Each of the persons named in the Proxy Statement as
a nominee for director was elected and the proposals listed
below were approved. The following are the voting results
of the proposals:
Proposal I In Favor Instructed Withheld
Election of Directors 294,476,345 57,881 1,516,491
Proposal II In Favor Opposed Abstain
To approve an increase in the 255,933,552 38,672,866 1,444,299
share reserve under the Company's
1983 Stock Option Plan by
7,000,000 shares.
Proposal III In Favor Opposed Abstain
To ratify the appointment of 294,752,931 510,203 787,583
Deloitte & Touche LLP as the
Company's independent public
accountants for the fiscal year
ending May 31, 1998.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Certificate of Incorporation (13)
3.2 Certificate of Correction Filed
to Correct a Certain Error in the Certificate of Incorporation (13)
3.3 Certificate of Merger (13)
3.4 Bylaws of 3Com Corporation, As Amended (13)
4.1 Indenture Agreement between 3Com Corporation and The First
National Bank of Boston for the private placement of convertible subordinated
notes dated as of November 1, 1994 (Exhibit 5.2 to Form 8-K) (6)
4.2 Placement Agreement for the private placement of convertible
subordinated notes dated November 8, 1994 (Exhibit 5.1 to Form 8-K) (6)
4.3 Amended and Restated Rights Agreement dated December 31, 1994
(Exhibit 10.27 to Form 10-Q) (7)
10.1 1983 Stock Option Plan, as amended (Exhibit 10.1 to Form 10-K)
(3)*
10.2 Amended and Restated Incentive Stock Option Plan (2)*
10.3 License Agreement dated March 19, 1981 (1)
10.4 First Amended and Restated 1984 Employee Stock Purchase Plan,
as amended (Exhibit 19.1 to Form 10-Q) (4)*
10.5 Second Amended and Restated 1984 Employee Stock Purchase Plan
(Exhibit 10.5 to Form 10-Q)(8)*
10.6 3Com Corporation Director Stock Option Plan, as amended
(Exhibit 19.3 to Form 10-Q) (4)*
10.7 Amended 3Com Corporation Director Stock Option Plan
(Exhibit 10.8 to Form 10-Q)(8)*
Item 6. Exhibits and Reports on Form 8-K (Continued)
10.8 3Com Corporation Restricted
Stock Plan, as Amended (Exhibit 10.17 to
Form 10-Q)(8)*
10.9 1994 Stock Option Plan (Exhibit
10.22 to Form 10-K) (5)*
10.10 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
November 20, 1996 (Exhibit 10.37 to Form
10-Q) (10)
10.11 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of November 20,
1996 (Exhibit 10.38 to Form 10-Q) (10)
10.12 Agreement and Plan of
Reorganization among 3Com Corporation,
OnStream Acquisition Corporation and
OnStream Networks, Inc. dated as of
October 5, 1996 (Exhibit 2.1 to Form S-4)
(9)
10.13 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
February 3, 1997 for the Combined Great
America Headquarters site (Exhibit 10.19
to Form 10-Q) (12)
10.14 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of February 3,
1997 for the Combined Great America
Headquarters site (Exhibit 10.20 to Form
10-Q) (12)
10.15 Credit Agreement dated as
of December 20, 1996 among 3Com
Corporation, Bank of America National
Trust and Savings Association, as Agent,
and the Other Financial Institutions Party
Hereto Arranged by BA Securities, Inc.
(Exhibit 10.21 to Form 10-Q) (12)
10.16 Amended and Restated
Agreement and Plan of Merger by and among
3Com Corporation, TR Acquisitions
Corporation, 3Com (Delaware) Corporation,
and U.S. Robotics Corporation, dated as of
February 26, 1997 and amended as of March
14, 1997(11)
10.17 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
July 25, 1997 for the Great America Phase
III (PAL) site (13)
10.18 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of July 25, 1997
for the Great America Phase III (PAL) site
(13)
10.19 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
July 29, 1997 for the Marlborough site
(13)
10.20 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of July 29, 1997
for the Marlborough site (13)
10.21 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
August 11, 1997 for the Rolling Meadows
site (13)
10.22 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of August 11,
1997 for the Rolling Meadows site
10.23 First Amendment to Credit
Agreement (13)
* Indicates a management contract
or compensatory plan.
(1) Incorporated by reference to the
corresponding Exhibit previously filed as
an Exhibit to Registrant's Registration
Statement on Form S-1 filed January 25,
1984 (File No. 2-89045)
(2) Incorporated by reference to
Exhibit 10.2 to Registrant's Registration
Statement on Form S-4 filed on August 31,
1987 (File No. 33-16850)
(3) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-K filed on August 27,
1991 (File No. 0-12867)
(4) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q filed January 10,
1992 (File No. 0-12867)
(5) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-K filed on August 31,
1994 (File No. 0-12867)
(6) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 8-K filed on November
16, 1994 (File No. 0-12867)
(7) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q filed on January
13, 1995 (File No. 0-12867)
(8) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q, filed on January
15, 1996 (File No. 0-12867)
(9) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Registration Statement on
Form S-4, originally filed on October 11,
1996 (File No. 333-13993)
(10) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q filed on January
13, 1997 (File No. 0-12867)
(11) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Registration Statement on
Form S-4, filed on March 17, 1997 (File
No. 333-23465)
(12) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q, filed on April 11,
1997 (File No. 0-12867)
(13) Incorporated by reference to the
Exhibit identified in parentheses
previously filed as an Exhibit to
Registrant's Form 10-Q, filed on October
14, 1997 (File No. 0-12867)
(b) Reports on Form 8-K
None.
Signatures
Pursuant to the requirements 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.
3Com Corporation
(Registrant)
Dated: January 12, 1998 By: /s/ Christopher B. Paisley
-------------------- ---------------------------
Christopher B. Paisley
Senior Vice President, Finance
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
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