______________________________________________________________
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 August 28, 1998
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) 326-5000
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 September 25, 1998, 358,612,262 shares of the
Registrant's Common Stock were outstanding.
______________________________________________________________
3Com Corporation
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Operations
Three Months Ended August 28, 1998 and August 31, 1997
Condensed Consolidated Balance Sheets
August 28, 1998 and May 31, 1998
Condensed Consolidated Statements of Cash Flows
Three Months Ended August 28, 1998 and August 31, 1997
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities and Use of Proceeds
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, Graffiti, Palm Computing and U.S.
Robotics are registered trademarks of 3Com Corporation or its
subsidiaries. CoreBuilder, Palm III and x2 are trademarks of
3Com Corporation or its subsidiaries.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
3Com Corporation
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Three Months Ended
--------------------------
August 28, August 31,
1998 1997
---- ----
Sales $1,405,511 $1,597,516
Cost of sales 775,775 831,429
---------- ----------
Gross margin 629,736 766,087
---------- ----------
Operating expenses:
Sales and marketing 303,578 302,378
Research and development 148,834 142,798
General and administrative 59,406 62,865
Merger-related (credits) charges (10,218) 269,787
---------- ----------
Total operating expenses 501,600 777,828
---------- ----------
Operating income (loss) 128,136 (11,741)
Other income, net 9,645 2,961
---------- ----------
Income (loss) before income taxes 137,781 (8,780)
Income tax provision 44,090 42,453
---------- ----------
Net income (loss) $ 93,691 $ (51,233)
========== ==========
Net income (loss) per share:
Basic $ 0.26 $ (0.15)
Diluted $ 0.26 $ (0.15)
Shares used in computing per share amounts:
Basic 358,533 341,718
Diluted 366,425 341,718
See Notes to Condensed Consolidated Financial Statements.
3Com Corporation
Condensed Consolidated Balance Sheets
(In thousands, except par value)
August 28, May 31,
1998 1998
---------- ----------
(Unaudited)
ASSETS
Current assets:
Cash and equivalents $ 629,509 $ 528,981
Short-term investments 607,581 547,097
Accounts receivable, net 980,254 849,640
Inventories, net 501,278 644,771
Deferred income taxes 394,713 430,182
Other 113,723 134,001
---------- ----------
Total current assets 3,227,058 3,134,672
Property and equipment, net 831,556 858,779
Deposits and other assets 62,219 87,069
---------- ----------
Total assets $4,120,833 $4,080,520
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 332,070 $ 332,992
Accrued liabilities and other 647,456 673,311
Income taxes payable 193,052 177,612
---------- ----------
Total current liabilities 1,172,578 1,183,915
Long-term debt 24,000 35,878
Deferred income taxes and other
long-term obligations 49,989 53,232
Stockholders' equity:
Preferred stock, no par value,
10,000 shares authorized;
none outstanding - -
Common stock, $.01 par value,
990,000 shares authorized;
shares outstanding:
August 28, 1998,358,387;
May 31, 1998, 358,870 1,741,758 1,730,676
Treasury stock at cost,
August 28, 1998, 1,110 shares;
May 31, 1998, none (29,481) -
Unamortized restricted stock grants (5,680) (4,157)
Retained earnings 1,173,466 1,079,775
Unrealized gain on investments, net 1,923 827
Accumulated translation adjustments (7,720) 374
---------- ----------
Total stockholders' equity 2,874,266 2,807,495
---------- ----------
Total liabilities and stockholders'
equity $4,120,833 $4,080,520
========== ==========
See Notes to Condensed Consolidated Financial Statements.
3Com Corporation
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Three Months Ended
-----------------------------
August 28, August 31,
1998 1997
---- ----
Cash flows from operating activities:
Net income (loss) $ 93,691 $ (51,233)
Adjustments to reconcile net
income (loss) to net cash
provided by operating
activities:
Depreciation and amortization 66,131 57,671
Deferred income taxes 29,872 (68,955)
Adjustment to conform fiscal
year of pooled entity-U.S.
Robotics - 15,052
Merger-related (credits) charges (10,218) 269,787
Changes in assets and liabilities,
net of effects of acquisitions:
Accounts receivable (130,614) (141,529)
Inventories 141,621 58,289
Other current assets 33,330 (68,372)
Accounts payable (922) (13,174)
Accrued liabilities and
other (19,405) 99,651
Income taxes payable 18,121 60,881
--------- ----------
Net cash provided by operating activities 221,607 218,068
--------- ----------
Cash flows from investing activities:
Purchase of short-term investments (117,337) (102,973)
Proceeds from short-term investments 55,747 149,825
Purchase of property and equipment (45,417) (88,594)
Proceeds from sale of property
and equipment 14,746 -
Other, net 12,767 5,998
--------- ----------
Net cash used for investing activities (79,494) (35,744)
--------- ----------
Cash flows from financing activities:
Issuance of common stock 6,293 127,482
Repurchase of common stock (29,481) -
Repayments of short-term debt,
notes payable and capital
lease obligations - (168,066)
Repayments of long-term borrowings (12,000) (12,150)
Net proceeds from issuance of debt - 33,300
Other, net (6,397) 3,530
--------- ----------
Net cash used for financing activities (41,585) (15,904)
--------- ----------
Increase in cash and equivalents 100,528 166,420
Cash and equivalents, beginning of period 528,981 351,237
--------- ----------
Cash and equivalents, end of period $ 629,509 $ 517,657
========= ==========
See Notes to Condensed Consolidated Financial Statements.
3Com Corporation
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial
statements have been prepared by 3Com Corporation (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 condensed
consolidated financial statements include all adjustments
necessary for a fair presentation of the Company's
financial position as of August 28, 1998, and the results
of operations for the three months ended August 28, 1998
and August 31, 1997 and cash flows for the three months
ended August 28, 1998 and August 31, 1997.
On June 1, 1998, the Company adopted a 52-53 week
fiscal year ending on the Friday nearest to May 31, which
for fiscal 1999 will be May 28, 1999. This change did
not have a significant effect on the Company's condensed
consolidated financial statements for the quarter ended
August 28, 1998 as compared to the quarter ended August
31, 1997. The results of operations for the three months
ended August 28, 1998 may not necessarily be indicative
of the results to be expected for the fiscal year ending
May 28, 1999. These condensed consolidated 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, 1998.
2. U.S. Robotics Merger-Related (Credits) Charges
On June 12, 1997, the Company completed the merger with
U.S. Robotics Corporation (U.S. Robotics), the leading
supplier of products and systems for accessing
information across the wide area network (WAN), including
modems and remote access products. This merger was
accounted for as a pooling-of-interests. The Company
issued approximately 158 million shares of its common
stock in exchange for all outstanding common stock of
U.S. Robotics. The Company also assumed all options to
purchase U.S. Robotics' stock, which were converted into
options to purchase approximately 31 million shares of
the Company's common stock, pursuant to the terms of the
merger.
In connection with this merger, through August 28,
1998, the Company recorded aggregate merger-related
charges of $250.5 million, which included approximately
$206.7 million of integration expenses and $43.8 million
of direct transaction costs (consisting primarily of
investment banking and other professional fees).
Integration expenses included:
- - $44.6 million related to the closure and elimination
of owned and leased facilities, primarily duplicate
corporate headquarters and domestic and European sales
offices;
- - $57.4 million for severance and outplacement costs
related to the merger, including amounts related to
termination benefits associated with employment
agreements. Employee groups impacted by the merger
included personnel involved in duplicate corporate
services, manufacturing and logistics, product
organizations and sales;
- - $40.8 million associated with certain long-term
assets, primarily including duplicate finance,
manufacturing, human resource and other management
information systems, and capitalized purchased research
and development costs related to a discontinued
product; and
- - $63.9 million primarily associated with the
elimination and phase-out of duplicate wide area
networking products (i.e., 3Com's AccessBuilder (registered
trademark) 2000, 4000, 5000 and 8000 products and U.S.
Robotics(registered trademark) TOTALswitch, ATM switch,
LANLinker and related small office, home office products),
and the discontinuance of U.S. Robotics' telephony products.
The charge primarily included inventory write-offs and
noncancelable purchase commitments.
During the first quarter of fiscal 1999, the Company
reversed approximately $10.2 million of previously
recorded merger charges primarily related to reductions
in the estimates for remaining charges associated with
duplicate facilities and employee termination benefits.
The remaining merger-related accrual at August 28,
1998 was approximately $28.4 million. Total expected
cash expenditures relating to this merger charge are
estimated to be approximately $113 million, of which
approximately $102 million was disbursed prior to August
28, 1998. Benefits paid to 869 employees terminated
through August 28, 1998 (approximately 96 percent of the
total planned severances) were approximately $55 million.
The remaining severance and outplacement amounts are
expected to be paid within the next fiscal quarter.
3. Comprehensive Income
On June 1, 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income," which requires that an enterprise
report, by major components and as a single total, the
change in net assets during the period from non-owner
sources. The reconciliation of net income (loss) to
comprehensive income (loss) is as follows (in thousands):
Three Months Ended
-------------------------
August 28, August 31,
1998 1997
---- ----
Net income (loss) $93,691 $(51,233)
Other comprehensive gain (loss):
Unrealized gain on investments,
net 1,096 84
Accumulated translation
adjustments (8,094) 3,469
------- --------
Total comprehensive income (loss) $86,693 $(47,680)
======= ========
4. Net Income (Loss) Per Share
The following table presents the calculation of basic and
diluted earnings per share as required under SFAS 128 (in
thousands, except per share data):
Three Months Ended
-------------------------
August 28, August 31,
1998 1997
---- ----
Net income (loss) $93,691 $(51,233)
======= ========
Weighted average shares-Basic 358,533 341,718
Effect of dilutive securities:
Employee stock options 7,671 -
Restricted stock 221 -
------- --------
Weighted average shares-Diluted 366,425 341,718
======= ========
Net income (loss) per share-Basic $ 0.26 $ (0.15)
Net income (loss) per share-Diluted $ 0.26 $ (0.15)
5. Inventories
Inventories, net consisted of (in thousands):
August 28, May 31,
1998 1998
---- ----
Finished goods $ 338,380 $ 457,726
Work-in-process 54,371 51,510
Raw materials 108,527 135,535
--------- ---------
Total $ 501,278 $ 644,771
========= =========
6. Litigation
The Company is a party to lawsuits in the normal course
of its business. The Company believes that it has
meritorious defenses in all lawsuits in which the Company
or its subsidiaries is a defendant. The Company notes
that (i) litigation in general, and intellectual property
and securities 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
On March 24 and May 5, 1997, putative securities class
action lawsuits, captioned Hirsch v. 3Com Corporation, et
al., Civil Action No. CV764977 (Hirsch), and Kravitz v.
3Com Corporation, et al., Civil Action No. CV765962
(Kravitz), respectively, were filed against the Company
and certain of its officers and directors in the
California Superior Court, Santa Clara County. The
complaints allege violations of Sections 25400 and 25500
of the California Corporations Code and seek unspecified
damages on behalf of a purported class of purchasers of
3Com common stock during the period from September 24,
1996 through February 10, 1997. The actions are in
discovery. No trial date has been set.
On February 10, 1998, a putative securities class action,
captioned Euredjian v. 3Com Corporation, et al., Civil
Action No. C-98-00508CRB (Euredjian), was filed against
3Com and several of its present and former officers and
directors in United States District Court for the
Northern District of California asserting the same class
period and factual allegations as the Hirsch and Kravitz
actions. The complaint alleges violations of the federal
securities laws, specifically Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, and seeks
unspecified damages. The Company has not responded to
the complaint.
The Hirsch, Kravitz and Euredjian actions were filed
after Intel Corporation sharply decreased prices on its
Fast Ethernet network interface cards, which resulted in
3Com decreasing its prices on similar products. The
Company believes it has meritorious defenses to the
claims in the Hirsch, Kravitz and Euredjian actions 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.
Several securities actions have been filed against the
Company and certain of its current and former officers
and directors following the Company's merger with U.S.
Robotics. In December 1997, a putative securities class
action, captioned Reiver v. 3Com Corporation, et al.,
Civil Action No. C-97-21083JW (Reiver), was filed in the
United States District Court for the Northern District of
California. The complaint alleges violations of the
federal securities laws, specifically Sections 10(b) and
20(a) of the Securities Exchange Act of 1934, and seeks
unspecified damages on behalf of a purported class of
purchasers of 3Com common stock during the period from
May 19, 1997 through November 6, 1997. In December 1997
and January 1998, seven similar shareholder class action
lawsuits were filed in the United States District Court
for the Northern District of Illinois and the United
States District Court for the Northern District of
California. The cases filed in the Northern District of
Illinois have been transferred to the Northern District
of California, and the cases have been consolidated in
the Reiver action. On August 17, 1998, plaintiffs filed
a consolidated amended complaint. The Company has not
responded to the complaint.
On April 3, 1998, a complaint, captioned Florida State
Board of Administration and Teachers Retirement System of
Louisiana v. 3Com Corporation, et al., Civil Action No.
C-98-1355 (Florida State Board), was filed in the United
States District Court for the Northern District of
California. The complaint alleges violations of the
federal securities laws, violations of the Florida
securities laws, common law fraud and negligent
misrepresentation based on factual allegations similar to
those asserted in the Reiver action. The Company has not
responded to the complaint.
The Company believes it has meritorious defenses to the
claims in the Reiver and Florida State Board complaints
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.
In January 1998, two purported shareholder complaints
relating to the Company's June 1997 merger with U.S.
Robotics, captioned Stanley Grossman v. 3Com Corporation,
et al., Civil Action No. CV771335, and Jason v. 3Com
Corporation, et al., Civil Action No. CV771713, were
filed in California Superior Court, Santa Clara County.
The actions allege that 3Com, several of its officers and
directors, and several former U.S. Robotics officers
violated Sections 11 and 15 of the Securities Act of 1933
by making alleged misrepresentations and omissions in a
May 8, 1997 registration statement. The complaints seek
damages in an unspecified amount on behalf of a purported
class of persons who received the Company's stock during
the merger pursuant to the registration statement. The
Company has not responded to the complaints. On
September 25, 1998, the Delaware Chancery Court issued an
injunction preventing plaintiffs from proceeding with
these actions, finding that plaintiffs' claims are barred
by a settlement in a prior action.
In February 1998, a shareholder derivative action
purportedly on behalf of the Company, captioned,
Wasserman v. Benhamou, et al., Civil Action No. 16200-NC,
was filed in Delaware Chancery Court. The complaint
alleges that the Company's directors breached their
fiduciary duties to the Company by engaging in alleged
wrongful conduct from mid-1996 through November 1997,
including the conduct complained of in the securities
litigation described above. The Company is named solely
as a nominal defendant, against whom the plaintiff seeks
no recovery. The Company and the individual defendants
have filed a motion to dismiss the complaint. 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
On April 28, 1997, Xerox Corporation filed suit against
U.S. Robotics Corporation and U.S. Robotics Access Corp.
in the United States District Court for the Western
District of New York. The case is now entitled: Xerox
Corporation v. U.S. Robotics Corporation, U.S. Robotics
Access Corp., Palm Computing, Inc. and 3Com Corporation,
Civil Action No. 97-CV-6182T. The complaint alleges
willful infringement of a United States patent relating
to computerized interpretation of handwriting. The
complaint further prays for unspecified damages and
injunctive relief. Xerox has asserted that Graffiti
(registered trademark) software and certain products of
Palm Computing, Inc. infringe the patent. The Company
believes it has meritorious defenses to the claims and
is contesting 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
A putative consumer class action pending against the
Company and U.S. Robotics in the California Superior
Court, Marin County, Bendall, et al. v. U.S. Robotics
Corporation, et al., Civil Action No. 170441, arising out
of the purchase of x2TM products and products upgradeable
to x2, was coordinated with a previously filed individual
action in the California Superior Court, San Francisco
County, Intervention Inc. v. U.S. Robotics Corporation,
Civil Action No. 984352. Two putative consumer class
action lawsuits pending against the Company and U.S.
Robotics in state court of Illinois arising out of the
same facts as those alleged in the California cases are
stayed, Lippman, et al. v. 3Com, Civil Action
No. 97 CH 09773, and Michaels, et al. v. U.S. Robotics
Access Corporation, et al., Civil Action No. 97 CH 14417.
A class has not been certified, and discovery is under
way. 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.
7. Effects of Recent Accounting Pronouncements
In June 1997, the Financial Accounting Standards Board
(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 will be effective for the Company's fiscal year ended
May 28, 1999 and requires disclosure of historical
information for comparative purposes. Management of the
Company is currently evaluating the effects of this
Statement on its reporting of segment information.
In June 1998, the FASB issued SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." This
Statement requires companies to record derivatives on the
balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the
values of those derivatives would be accounted for
depending on the use of the derivative and whether it
qualifies for hedge accounting. SFAS 133 will be
effective for the Company's fiscal year 2001. Management
believes that this Statement will not have a significant
impact on the Company.
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 condensed consolidated statements
of operations:
Three Months Ended
------------------
August 28, May 31, August 31,
1998 1998 1997
---- ---- ----
Sales.............................. 100.0 % 100.0 % 100.0 %
Cost of sales ..................... 55.2 56.5 52.0
----- ----- -----
Gross margin....................... 44.8 43.5 48.0
----- ----- -----
Operating expenses:
Sales and marketing.............. 21.6 21.2 18.9
Research and development......... 10.6 10.9 8.9
General and administrative....... 4.2 4.8 4.0
Non-recurring (credits) charges:
Purchased in-process technology. - 0.7 -
Merger-related (credits) charges (0.7) (0.4) 16.9
----- ----- -----
Total operating expenses........... 35.7 37.2 48.7
----- ----- -----
Operating income (loss) ........... 9.1 6.3 (0.7)
Other income, net.................. 0.7 0.8 0.2
----- ----- -----
Income (loss) before income taxes.. 9.8 7.1 (0.5)
Income tax provision............... 3.1 2.5 2.7
----- ----- -----
Net income (loss).................. 6.7 % 4.6 % (3.2) %
===== ===== =====
Excluding non-recurring (credits)
charges:
Total operating expenses........ 36.4 % 36.9 % 31.8 %
Operating income................ 8.4 6.6 16.2
Net income...................... 6.2 4.8 10.6
Sales
Sales in the first quarter of fiscal 1999 totaled $1.41
billion, an increase of $30.0 million or two percent from the
fourth quarter of fiscal 1998, and a decrease of $192.0
million or 12 percent from the corresponding quarter a year
ago.
Client Access. Sales of client access products (e.g., modems
and network interface cards (NICs)) in the first quarter of
fiscal 1999 increased three percent from the fourth quarter of
fiscal 1998, and decreased 19 percent from the same quarter a
year ago. Sales of client access products in the first quarter
of fiscal 1999 and the fourth quarter of fiscal 1998
represented 51 percent of total sales compared to 56 percent
in the first quarter of fiscal 1998. Excluding sales of
connected organizer products, which are proportionally
allocated into both the client access and systems categories,
sales for client access products were flat when compared to
the fourth quarter of fiscal 1998.
Systems. Sales of network systems products (e.g., switches,
routers, hubs, and remote access concentrators) in the first
quarter of fiscal 1999 increased two percent compared to the
fourth quarter of fiscal 1998 and decreased four percent
compared to the same quarter one year ago. Sales of network
systems products represented 49 percent of total sales in the
first quarter of fiscal 1999 and the fourth quarter of fiscal
1998, compared to 44 percent in the year-ago quarter.
Excluding sales of connected organizer products, which are
proportionally allocated into both the client access and
systems categories, sales of systems products were flat when
compared to the fourth quarter of fiscal 1998.
Geographic. Sales in the U.S. represented 57 percent of total
sales for the first quarter of fiscal 1999. Domestic sales
increased 13 percent sequentially and decreased nine percent
compared to the same period a year ago. International sales
decreased 10 percent sequentially and 16 percent year-over-
year.
Sales for the first quarter of fiscal 1999 were affected by
the following factors:
Industry Growth Rates. Networking industry growth rates have
slowed since the beginning of calendar 1997 and into calendar
1998. While the industry had grown at rates in excess of 30
percent in prior years, recent reports indicate that the
networking industry worldwide grew by less than 20 percent
during 1997, and this pattern continued into 1998.
Global Economic Turmoil. During fiscal 1998 and the first
quarter of fiscal 1999, the Asia Pacific and most recently,
Latin American and Russian regions experienced a weakening of
their local currencies and turmoil in their financial markets
and institutions. Historically, the Asia Pacific and Latin
American regions had been high growth regions for the
networking industry and the Company. The Company believes
this economic turmoil adversely affected financial results
during the first quarter fiscal 1999.
Pricing and Competition. The pricing environment has been
very competitive. For example, during the first quarter of
fiscal 1999, the Company decreased prices on certain 56
kilobits per second (Kbps) modems in North America retail by
approximately 20 percent. More recently, Intel Corporation
reduced prices up to 49 percent on a range of its low-end hubs
and switches.
Sales of modem products decreased compared to the first
quarter of fiscal 1998, in part due to substantial reductions
in average selling prices for modems. The decrease in modem
sales was also impacted by a general slowdown in the modem
market, in part attributable to the transition to the V.90
standard for 56 Kbps technology, which was ratified by the
International Telecommunications Union (ITU) in September
1998. Sales of remote access concentrators decreased compared
to the first quarter of fiscal 1998. Factors affecting this
decrease included aggressive price competition, including the
introduction of new higher-density products at prices similar
to the older lower-density products. 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.
Connected Organizers and Switching Products. Sales of
connected organizer products more than doubled compared to the
first quarter fiscal 1998, and according to recent industry
reports, 3Com gained share in this market segment. Growth
rates and market share gains in the connected organizer market
may not be sustainable in the face of increasing competition
from new entrants to the market. The Company's workgroup
switching products also experienced significant unit volume
growth in the first quarter of fiscal year 1999 compared to
the first quarter of fiscal 1998. Sales for these products
increased on a year-over-year basis despite significant
declines in average selling prices.
Seasonality. Sales in the first quarter of fiscal 1999
increased two percent compared to the fourth
quarter of fiscal 1998. The first quarter of the fiscal year
has traditionally been the Company's lowest sales quarter, as
it includes the three summer months of June, July and August.
The Company experienced a sequential decrease of 10 percent
from the fourth quarter of fiscal 1998 in international sales,
primarily attributable to the typical summer seasonal slowdown
in Europe, as well as the economic turmoil in Latin America,
Asia and Russia.
Gross Margin
Gross margin as a percentage of sales was 44.8 percent in the
first quarter of fiscal 1999, compared to 43.5 percent in the
fourth quarter of fiscal 1998 and 48.0 percent in the first
quarter of fiscal 1998. The gross margin improvement from the
fourth quarter of fiscal 1998 is primarily due to improving
manufacturing capacity utilization, product cost declines
greater than reductions in average selling prices, and the
favorable impact of product mix, including new products. The
gross margin decline from the same quarter a year ago is
primarily due to a decline in average selling prices due to
competitive pricing pressures, particularly in workgroup
switching products and remote access concentrators.
Operating Expenses
Operating expenses in the first quarter of fiscal 1999 were
$501.6 million, or 35.7 percent of sales, compared to $511.2
million, or 37.2 percent of sales in the fourth quarter of
fiscal 1998 and $777.8 million, or 48.7 percent of sales in
the first quarter of fiscal 1998. Excluding the pre-tax
credit of $10.2 million related to the merger with U.S.
Robotics, total operating expenses for the first quarter of
fiscal 1999 were $511.8 million, or 36.4 percent of sales.
Excluding the pre-tax purchased in-process technology charge
of $8.4 million related to the Lanworks Technologies, Inc.
(Lanworks) acquisition and the pre-tax credit of $4.9 million
related to past merger activities and disposition of real
estate, total operating expenses for the fourth quarter of
fiscal 1998 were $507.7 million, or 36.9 percent of sales.
Excluding the pre-tax charge of $269.8 million related to the
merger with U.S. Robotics, total operating expenses for the
first quarter of fiscal 1998 were $508.0 million, or 31.8
percent of sales. The Company's objective is to reduce
expenses as a percentage of sales in future quarters. See
Business Environment and Risk Factors - Financial Model.
Sales and Marketing. Sales and marketing expenses in the
first quarter of fiscal 1999 increased $11.7 million or four
percent from the fourth quarter of fiscal 1998 and increased
as a percentage of sales to 21.6 percent of sales in the first
quarter of fiscal 1999, from 21.2 percent in the fourth
quarter of fiscal 1998. The sequential increase in sales and
marketing expenses was related, in part, to increased
international expenses, as well as higher selling and
marketing costs of connected organizer products. These
expenses were relatively flat compared to the first quarter of
fiscal 1998 but increased to 21.6 percent of sales from 18.9
percent in the corresponding fiscal 1998 period as a result of
the year-over-year decrease in sales.
Research and Development. Research and development expenses
in the first quarter of fiscal 1999 were flat when compared to
the fourth quarter of fiscal 1998 and decreased to 10.6
percent of sales from 10.9 percent of sales in the fourth
quarter of fiscal 1998. Research and development expenses
increased $6.0 million or four percent from the year-ago
period, and increased to 10.6 percent of total sales in the
first quarter of fiscal 1999, compared to 8.9 percent in first
quarter of fiscal 1998. The year-over-year increase in
research and development expenses in absolute dollars was
primarily attributable to the cost of developing the Company's
new products in connected organizers and the small and medium
enterprise market. The Company believes the timely
introduction of new technologies and products is crucial to
its success. In addition to its own internal development, the
Company will, from time to time, make acquisitions or
strategic investments to accelerate time to market where
appropriate.
General and Administrative. General and administrative
expenses in the first quarter of fiscal 1999 decreased $6.8
million or 10 percent from the fourth quarter of fiscal 1998
and decreased to 4.2 percent of total sales in the first
quarter of fiscal 1999 from 4.8 percent in the fourth quarter
of fiscal 1998. General and administrative expenses in the
first quarter of fiscal 1999 decreased $3.5 million or six
percent from the same period a year ago, and increased to 4.2
percent of total sales in the first quarter of fiscal 1999,
compared to 4.0 percent in the first quarter of fiscal 1998.
Merger-Related (Credits) Charges. During the first quarter of
fiscal 1999, the Company reversed approximately $10.2 million
of previously recorded merger charges primarily related to
reductions in the estimates for remaining charges associated
with duplicate facilities and employee termination benefits.
Other Income, Net
Other income, net decreased $1.1 million compared to the
fourth quarter of fiscal 1998 primarily due to increased
foreign currency losses. Other income, net increased $6.7
million compared to the first quarter of fiscal 1998,
primarily due to reduced interest expense, as a result of
lower debt balances, and improved foreign currency results.
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.
Income Tax Provision
The Company's income tax rate was 32.0 percent in the first
quarter of fiscal 1999 compared to 35.0 percent in the fourth
quarter of fiscal 1998. This rate reduction is primarily
attributable to increased offshore manufacturing in countries
with tax rates significantly below the U.S. statutory rate.
The Company recorded a tax provision of $44.1 million for the
first quarter of fiscal 1999, compared to $42.5 million for
the first quarter of fiscal 1998. The provision in the first
quarter of fiscal 1998 reflected the non-deductibility of
certain costs associated with the merger.
Net Income (Loss) and Net Income (Loss) Per Share
Net income for the first quarter of fiscal 1999 was $93.7
million, or $0.26 per share, compared to net income of $63.6
million, or $0.17 per share for the fourth quarter of fiscal
1998 and a net loss of $51.2 million, or $0.15 per share, for
the first quarter of fiscal 1998. Excluding the pre-tax
merger-related credit, net income was $86.7 million, or $0.24
per share for the first quarter of fiscal 1999. Excluding the
pre-tax charge for purchased in-process technology and the
pre-tax credit for merger-related activities, net income was
$65.9 million, or $0.18 per share for the fourth quarter of
fiscal 1998. Excluding the pre-tax merger-related charge, net
income was $169.6 million, or $0.47 per share for the first
quarter of fiscal 1998.
Business Environment and Risk Factors
This report may contain forward-looking statements. Actual
results could vary materially based on a number of factors,
including but not limited to the risk factors set forth below.
Financial Model. In managing its business, the Company
annually establishes a long-term financial model based on
observed and anticipated trends in technology and the
marketplace. The model, which includes ranges for gross
margin, operating expenses and operating income, is not
intended to be a prediction of future financial results,
rather, it is used to assist the Company's management in
making decisions about the allocation of resources and
investments. The current model is as follows:
Gross margin 45.5 - 47.5%
Operating expenses 27.5 - 29.5%
Operating income 16.0 - 20.0%
The gross margin and operating expenses ranges of the model
were reduced during fiscal 1998 to reflect, in part,
increasing sales attributable to PC original equipment
manufacturers (OEMs), the emerging importance of the consumer
and small enterprise market segment and increased price
competition. The Company currently is not operating within
the ranges of the model. While the Company made progress
towards these ranges in the first quarter fiscal 1999, there
can be no assurance that the Company will achieve one or more
of the ranges within fiscal 1999 or that actual results in any
particular period will fall within the ranges stated in the
long-term model above.
Competition and Pricing. The Company participates in a highly
volatile industry characterized by vigorous competition for
market share, rapid product and technology development,
uncertainty over adoption of industry standards and declining
prices. The Company's competition comes from start-up
companies, well-capitalized computer systems and
communications companies, and other technology companies.
Many of the Company's current and potential competitors have
greater financial, marketing and technical resources than the
Company. In addition with the highly competitive nature of
the Company's industry, new products are routinely introduced
by competitors. For example, Microsoft Corporation and its
licensees recently entered the connected organizer market to
compete with the Palm Computing (registered trademark) platform,
the Company's fastest growing product category. The Company's
business may be adversely impacted by the development by
competitors of products and technologies that render certain
of the Company's products obsolete or noncompetitive.
The effects of intense competition in the Company's industry
include aggressive pricing practices and declining product
prices, which have directly impacted the Company's operating
results. For example, during the first quarter of fiscal
1999, the Company decreased prices on certain 56 Kbps modems
in North America retail by approximately 20 percent. More
recently, Intel Corporation reduced prices up to 49 percent on
a range of its low-end hubs and switches. Significant
competition and decreasing prices have also impacted other
product lines in recent periods, including switches, hubs and
remote access concentrators.
There can be no assurance that intense competition in the
industry and particular actions of the Company's competitors
will not have an adverse effect on the Company's business,
operating results and financial condition. In particular, the
Company expects that prices on many of its products will
continue to decrease in the future and that the pace and
magnitude of such price decreases may have an adverse impact
on the results of operations or financial condition of the
Company.
International Markets. The Company operates internationally
and expects that international markets will continue to
account for a significant percentage of the Company's sales.
Many international markets are characterized by economic and
political instability and currency fluctuations that can
adversely affect the Company's operating results or financial
condition.
During the first quarter of fiscal year 1999, the Company
experienced sequentially lower sales in the Russian and Latin
American regions, due in large part to economic and political
instability and currency fluctuations. In addition, the
instability in the Asian financial markets has continued to
negatively impact the Company's sales in those markets by,
among other things, decreasing end-user purchases, increasing
competition from local competitors offering sales terms in
local currencies, and reducing access to sources of capital
needed by customers to make purchases. In addition to
reducing sales, difficulties in all these regions have
subjected the Company's resellers to financial difficulties
and may increase the Company's credit risk, as customers
become insolvent or otherwise have their ability to meet
obligations impaired. Should the economic environment in
these regions fail to improve, the Company may consider
continuing to expand its exposure to foreign currencies to
preserve long-term customer relationships. There can be no
assurance that the instability in Asia, Russia, and Latin
America will not continue to have an adverse effect on the
Company's operating results. In addition, there is no
assurance that similar situations in other markets will not
occur and adversely impact the Company. In particular,
significant fluctuations in foreign currency could have an
adverse impact on the Company's sales, credit and/or foreign
currency exchange exposures.
Development and Introduction of New Products. The Company is
actively engaged in the research and development of new
technologies and products. The Company's success depends, in
substantial part, on the identification of new market and
product opportunities and the development and market
acceptance of new products. This includes the recently
introduced CoreBuilderTM 9000 switch, as well as the Company's
next generation products under development in the areas of
connected organizers and remote access concentrators. The
Company's operating results or financial condition may be
adversely affected by a change in one or more of the
technologies affecting network communications, a change in
market demand for products based on a particular technology, a
failure to develop new products, delays in manufacturing and
shipment of new products, or technical problems with new
products.
The Company's success also depends, in part, on the adoption
of industry standards, the timely introduction of new
standards-compliant products, and market acceptance of these
products. For example, the V.90 (56 Kbps) standard was
determined in January 1998 and ratified in September 1998.
The Company's results have been and will continue to be
affected by the extent to which the V.90 technology is
deployed by Internet service providers and adopted by Internet
and other modem users. Slow market acceptance of new
technologies and industry standards, such as the V.90
technology, could have an adverse impact on the Company's
results of operations or financial condition.
Industry Consolidation. The networking industry is in a
period of significant consolidation. For example, during
calendar year 1998, the Company acquired Lanworks; Lucent
Technologies acquired ten companies; Cisco Systems acquired
seven companies; and Northern Telecom acquired four companies,
including Bay Networks. The Company expects that networking
industry consolidation will continue, including combinations
between traditional suppliers of telecommunications or voice
networking and data networking companies. Future business
combinations may result in companies with strong competitive
positions and products. Continued consolidation may have a
material adverse effect on the Company's operating results or
financial condition.
Declining Industry Growth Rates. The Company's success is
dependent, in part, on the overall growth rate of the
networking industry. In 1997 and continuing through the first
half of 1998, industry growth has been below historical rates.
There can be no assurance that the networking industry will
continue to grow or that it will again achieve higher growth
rates. The Company's business, operating results or financial
condition may be adversely affected by any further decrease in
industry growth. In addition, there can also be no assurance
that the Company's results in any particular period will fall
within the ranges for growth forecast by market researchers.
Reliance on Distributors, Resellers and OEMs. The Company
sells a significant portion of its products to distributors,
resellers and OEMs. In recent years, the percentage of
products sold through these channels has increased. The
Company's reliance on distributors, resellers and OEMs
subjects the Company to many risks, including inventory,
credit and business concentration.
The Company's distributors and resellers maintain significant
levels of the Company's products in their inventories. The
Company attempts to ensure that appropriate levels of products
are available to end users by working closely with
distributors and resellers to manage inventory levels. There
can be no assurance that the Company will be successful in
efforts to manage the inventory levels of its distributors and
resellers or that the Company will be able to successfully
operate its business within its desired channel inventory
business model. Any failure by the Company to do so could
adversely affect the Company's operating results or financial
condition.
The distribution and reseller channels utilized by the Company
have undergone a significant level of consolidation. As a
result, the Company has an increased concentration of credit
risk. While the Company monitors and attempts to manage this
risk, financial difficulties on the part of one or more of the
Company's distributors or resellers may have a material
adverse effect on the Company's results of operations or
financial condition.
The Company derives an increasing portion of its sales from
OEMs, including PC companies that bundle 3Com (registered trademark)
NICs and modems, and incorporate 3Com chipsets into their products.
The Company expects that the trend toward increasing OEM sales
will continue. As a result, the Company's future operating
results are dependent, in part, on the Company's ability to
establish, maintain and strengthen relationships with OEMs.
Because sales to OEMs are typically at lower prices and result
in lower margins to the Company, the Company's sales and gross
margins may be adversely impacted if, as the Company expects,
OEMs continue to become a larger percentage of the business.
Product Integration. Certain OEMs in the PC industry have,
from time to time, chosen to integrate networking and modem
functions on the PC motherboard. For example, the Company
currently sells networking chipsets to Dell Computer which are
integrated directly onto the PC motherboard of Dell's high-end
Optiplex line of PCs. While no clear long-term trend has
emerged, should integration become a trend, the Company's
future sales growth and profitability could be adversely
impacted.
Reliance on Suppliers. Some key components of the Company's
products are currently available only from single or limited
sources. In addition, certain of the Company's suppliers are
competitors of the Company. While the Company has generally
been able to obtain adequate supplies of components from
existing 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 business, operating results, financial condition
or customer relationships could be adversely affected by
either an increase in prices for, or an interruption or
reduction in supply of, key components.
Euro-currency. The Single European Currency (Euro) will be
introduced on January 1, 1999 with complete transition to this
new currency required by January 2002. The Company is
currently assessing the issues raised by the introduction of
the Euro. The Company has made and expects to continue to
make changes to its internal systems in preparation for the
initial introduction of the Euro. The Company further expects
that introduction and use of the Euro will affect the
Company's foreign exchange and hedging activities, and may
result in increased fluctuations in foreign currency hedging
results. Any delays in the Company's ability to be Euro-
compliant could have an adverse impact on the Company's
results of operations or financial condition.
Ability to Satisfy Product Orders. The timing and amount of
the Company's sales are dependent on a number of factors that
make estimating operating results prior to the end of any
period uncertain. For example, the Company does not typically
maintain a significant backlog and, as a result, product sales
in any quarter are dependent on orders booked and shipped in
that quarter. In addition, the Company's customers
historically request fulfillment of orders in a short period
of time, resulting in limited visibility to sales trends. As
a result, the Company's operating results depend on the volume
and timing of orders and the Company's ability to fulfill the
orders in a timely manner. The Company's results of
operations or financial condition would be adversely affected
if incoming order rates decline, if ordered products are not
readily available, or if the Company is not able to
immediately fill orders.
Typically, the Company ships more of its products in the third
month of a fiscal quarter than in the first or second month of
a fiscal quarter. This subjects the Company to risks
including reduced sales in the weeks following the quarter
end, and unexpected disruptions in functions including
manufacturing, order management, information systems and
shipping. Should the percentage of sales in the third month
of a quarter escalate further, or should a significant
disruption in the Company's functions occur, there could be an
adverse affect on the Company's results of operations or
financial condition.
Inventory. In recent periods, the Company's inventory has
been higher than desired levels. High levels of inventory
increase the exposure to the Company when products in
inventory become obsolete or otherwise not saleable. While
the Company has been able to reduce the level of its inventory
in the past two quarters, there can be no assurance that it
will be successful in doing so in future periods, or that
products in the Company's inventory will not become obsolete.
Failure to adequately manage the levels of inventory could
adversely impact the Company's operating results or financial
condition.
Product Warranties. The Company's products are covered by
warranties, and the Company is subject to contractual
commitments to perform under such warranties. If unexpected
circumstances arise such that products do 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 operating results or financial condition
of the Company.
Intellectual Property Rights. Many of the Company's
competitors, in particular, the large, well established
telecommunications and computer equipment manufacturers, have
large intellectual property portfolios, including patents
which may cover technologies that are relevant to the
Company's business. In addition, many smaller companies,
universities and individual inventors are actively engaged in
research and development and have obtained or applied for
patents in areas of technology that may relate to the
Company's business. There appears to be a trend in the
Company's industry toward more aggressive assertion and
litigation of patents and other intellectual property rights.
In the course of its business, the Company frequently receives
assertions of infringement and invitations to take licenses or
otherwise becomes aware of potentially relevant patents or
other intellectual property rights held by third parties. For
example, in recent periods, the Company has received a
significant increase in assertions of infringement and
invitations to take licenses. The Company evaluates the
validity and applicability of any such intellectual property
rights and the merits of any such third party claims, and
determines in each case whether it must negotiate licenses or
cross-licenses to incorporate or use the subject proprietary
technologies, protocols or specifications in the Company's
products. Any failure by the Company to obtain and maintain
licenses, on favorable terms, for intellectual property rights
required for the manufacture, sale and use of its products,
particularly those which must comply with industry standard
protocols and specifications to be commercially viable, could
have a material adverse effect on the Company's business,
results of operations or financial condition.
In connection with the enforcement of its own intellectual
property rights or in connection with disputes relating to the
validity or alleged infringement of third party rights, the
Company may be subject to complex, protracted litigation.
Intellectual property litigation is typically very costly and
can be highly disruptive to business operations by diverting
the attention and energies of management and key technical
personnel. Further, plaintiffs in intellectual property cases
often seek injunctive relief and the measures of damages in
intellectual property litigation are complex and often
subjective or uncertain. Thus, the existence of or any
adverse determinations in such litigation could subject the
Company to significant liabilities and costs, require the
Company to seek licenses from others, prevent the Company from
manufacturing or selling its products, or cause severe
disruptions to the Company's operations or the markets in
which it competes, any one of which could have a material
adverse effect on the results of operations or financial
condition of the Company.
Commercial Commitments. The Company regularly enters into
minimum purchase commitments. Should sales volumes fluctuate
significantly, the obligation to meet minimum purchase
commitments could adversely affect the Company's results of
operations or financial condition.
Electronic Commerce and Electronic Data Interchange (EDI).
Many vendors, distributors and resellers have been successful
in the direct sale of products to customers who wish to order
products on the Internet or through EDI. These trends have
enabled manufacturers to increase business volume and lower
their cost structures. There can be no assurance that the
Company will successfully implement or continue to expand such
systems in a timely manner, and a failure to do so could
adversely affect results of operations or financial condition.
Key Personnel and Recruiting. The success of the Company will
depend to a significant extent upon a number of key employees
and management. The loss of the services of key employees
could have a material adverse effect on the Company's
business, operating results or financial condition. Recruiting
and retaining skilled personnel, including engineers, is
highly competitive. If the Company cannot successfully
recruit and retain skilled personnel, the Company's financial
results may be adversely affected. In addition, the Company
must carefully manage the growth in employees commensurate
with anticipated growth in the Company. Should the Company's
revenue growth or attrition levels vary significantly, there
could be an adverse effect on results of operations or
financial condition.
Year 2000 Compliance. As is true for most companies, the Year
2000 computer issue creates a risk for 3Com. If systems do
not correctly recognize date information when the year changes
to 2000, there could be an adverse impact on the Company's
operations. The risk for 3Com exists in four areas: systems
used by the Company to run its business, systems used by the
Company's suppliers, potential warranty or other claims from
3Com customers, and the potential reduced spending by other
companies on networking solutions as a result of significant
information systems spending on Year 2000 remediation. The
Company is currently evaluating its exposure in all of these
areas.
3Com is in the process of conducting a comprehensive inventory
and evaluation of its systems, equipment and facilities. 3Com
has a number of projects underway to replace or upgrade
systems, equipment and facilities that are known to be Year
2000 non-compliant. The Company has not identified
alternative remediation plans if upgrade or replacement is not
feasible. The Company will consider the need for such
remediation plans as it continues to assess the Year 2000
risk. For the Year 2000 non-compliance issues identified to
date, the cost of upgrade or remediation is not expected to be
material to the Company's operating results. The Company
expects to conclude its estimates of cost by the end of the
calendar year. If implementation of replacement systems is
delayed, or if significant new non-compliance issues are
identified, the Company's results of operations or financial
condition could be materially adversely affected.
3Com is also in the process of contacting its critical
suppliers to determine that the suppliers' operations and the
products and services they provide are Year 2000 compliant.
Where practicable, 3Com will attempt to mitigate its risks
with respect to the failure of suppliers to be Year 2000
ready. In the event that suppliers are not Year 2000
compliant, the Company will seek alternative sources of
supplies. However, such failures remain a possibility and
could have an adverse impact on the Company's results of
operations or financial condition. Additionally, litigation
may arise from situations in which the Company has minimum
purchase commitment contracts with suppliers that are not Year
2000 compliant.
The Company believes its current products are Year 2000
compliant; however, since all customer situations cannot be
anticipated, particularly those involving third party
products, 3Com may see an increase in warranty and other
claims as a result of the Year 2000 transition. In addition,
litigation regarding Year 2000 compliance issues is expected
to escalate. For these reasons, the impact of customer claims
could have a material adverse impact on the Company's results
of operations or financial condition.
Year 2000 compliance is an issue for virtually all businesses,
whose computer systems and applications may require
significant hardware and software upgrades or modifications.
Companies owning and operating such systems may plan to devote
a substantial portion of their information systems' spending
to fund such upgrades and modifications and divert spending
away from networking solutions. Such changes in customers'
spending patterns could have a material adverse impact on the
Company's sales, operating results or financial condition.
Fluctuations in Quarterly Results. The Company's operating
results for any particular quarter are difficult to predict
and may continue to be subject to significant fluctuations.
These fluctuations can be caused by a wide variety of factors,
including seasonality with respect to the volume and timing of
orders, the introduction and acceptance of new products and
technologies, price competition, general conditions and trends
in the networking industry and technology sector, disruption
in international markets, general economic conditions, and
extraordinary events such as industry consolidation,
acquisitions, or litigation. For example, the third quarter
of the fiscal year, consisting of the winter months of
December, January and February, is a seasonally slow quarter,
and has historically had either sequentially lower, or only
slightly increased sales from the prior quarter. In addition,
as the portion of the Company's consumer-related business
grows, for example with products such as the Palm IIITM
connected organizer, this seasonality will likely become more
pronounced. These factors, and accompanying fluctuations in
periodic operating results, could have a significant adverse
impact on the market price of the Company's common stock.
Liquidity and Capital Resources
Cash and equivalents and short-term investments at August 28,
1998 were $1.2 billion, an increase of $161.0 million from May
31, 1998.
For the three months ended August 28, 1998, net cash generated
from operating activities was $221.6 million. Accounts
receivable at August 28, 1998 increased $130.6 million from
May 31, 1998 to $980.3 million. Days sales outstanding in
receivables increased to 63 days at August 28, 1998, compared
to 56 days at May 31, 1998 primarily due to a higher
percentage of sales in the last month of the August quarter
compared to the last month of the May quarter. Inventory
levels at August 28, 1998 decreased $143.5 million, of which
$119.3 million was finished goods, from the prior fiscal year-
end to $501.3 million. Average inventory turnover was 5.4
turns for the quarter ended August 28, 1998, compared to 4.4
turns for the quarter ended May 31, 1998, primarily as a
result of the decrease in inventory balances.
During the three months ended August 28, 1998, the Company
made $45.4 million in capital expenditures. Major capital
expenditures included upgrades and expansion of the Company's
facilities in the U.S. and Ireland, and purchases and upgrades
of desktop systems and other equipment. Additionally, in the
first quarter of fiscal 1999, the Company sold two facilities
and equipment in the Chicago area for total net proceeds of
$14.7 million. As of August 28, 1998, the Company had
approximately $39.3 million in capital expenditure commitments
outstanding primarily associated with the expansion of
facilities. In addition, the Company has commitments related
to operating lease arrangements in the U.S., under which the
Company has an option to purchase the properties for an
aggregate of $322.2 million, or arrange for the sale of the
properties to a third party. If the properties are sold to a
third party at less than the option price, the Company retains
an obligation for the difference, subject to certain
provisions of the lease.
In June 1998, the Company's Board of Directors authorized the
repurchase of up to 10 million shares of the Company's common
stock. Such purchases are made in the open market from time
to time. During the first quarter of fiscal 1999, the Company
repurchased 1.1 million shares of common stock at a total cost
of $29.5 million. During the first three months of fiscal
1999, the Company received net cash of $6.3 million from the
sale of shares of its common stock to employees through its
employee stock purchase and option plans.
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 August 28, 1998, there were no outstanding
borrowings under the credit agreement, and the Company was in
compliance with all required covenants.
During the quarter ended August 28, 1998, the Company repaid
$12 million of borrowings under the 7.52% Unsecured Senior
Notes agreement. As of August 28, 1998, $36 million of this
debt remained outstanding, of which $12 million is classified
as current, and is included in accrued liabilities and other.
The remaining U.S. Robotics merger-related accrual at August
28, 1998 was approximately $28.4 million. Total expected cash
expenditures relating to this merger charge are estimated to
be approximately $113 million, of which approximately $102
million was disbursed prior to August 28, 1998. Benefits paid
to 869 employees terminated through August 28, 1998
(approximately 96 percent of the total planned severances)
were approximately $55 million. The remaining severance and
outplacement amounts are expected to be paid within the next
fiscal quarter.
During the first quarter of fiscal 1999, the Company recorded
a tax benefit on stock option transactions of $2.7 million.
During the same quarter a year ago, the Company recorded a
similar benefit totaling $121.1 million.
Based on current plans and business conditions, the Company
believes that its existing cash and equivalents, short-term
investments, cash generated from operations and the available
credit agreement will be sufficient to satisfy anticipated
cash requirements for at least the next twelve months.
Effects of Recent Accounting Pronouncements
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
will be effective for the Company's fiscal year ended May 28,
1999 and requires disclosure of historical information for
comparative purposes. Management of the Company is currently
evaluating the effects of this Statement on its reporting of
segment information.
In June 1998, the FASB issued SFAS 133, "Accounting for
Derivative Instruments and Hedging Activities." This
Statement requires companies to record derivatives on the
balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values
of those derivatives would be accounted for depending on the
use of the derivative and whether it qualifies for hedge
accounting. SFAS 133 will be effective for the Company's
fiscal year 2001. Management believes that this Statement will
not have a significant impact on the Company.
Item 3. Quantitative and Qualitative Disclosures About
Market Risk
Reference is made to Part II, Item 7A, Quantitative and
Qualitative Disclosures About Market Risk, in the Registrant's
Annual Report on Form 10-K for the year ended May 31, 1998.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is a party to lawsuits in the normal course of its
business. The Company believes that it has meritorious
defenses in all lawsuits in which the Company or its
subsidiaries is a defendant. The Company notes that (i)
litigation in general, and intellectual property and
securities 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
On March 24 and May 5, 1997, putative securities class action
lawsuits, captioned Hirsch v. 3Com Corporation, et al., Civil
Action No. CV764977 (Hirsch), and Kravitz v. 3Com Corporation,
et al., Civil Action No. CV765962 (Kravitz), respectively,
were filed against the Company and certain of its officers and
directors in the California Superior Court, Santa Clara
County. The complaints allege violations of Sections 25400
and 25500 of the California Corporations Code and seek
unspecified damages on behalf of a purported class of
purchasers of 3Com common stock during the period from
September 24, 1996 through February 10, 1997. The actions are
in discovery. No trial date has been set.
On February 10, 1998, a putative securities class action,
captioned Euredjian v. 3Com Corporation, et al., Civil Action
No. C-98-00508CRB (Euredjian), was filed against 3Com and
several of its present and former officers and directors in
United States District Court for the Northern District of
California asserting the same class period and factual
allegations as the Hirsch and Kravitz actions. The complaint
alleges violations of the federal securities laws,
specifically Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and seeks unspecified damages. The
Company has not responded to the complaint.
The Hirsch, Kravitz and Euredjian actions were filed after
Intel Corporation sharply decreased prices on its Fast
Ethernet network interface cards, which resulted in 3Com
decreasing its prices on similar products. The Company
believes it has meritorious defenses to the claims in the
Hirsch, Kravitz and Euredjian actions 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.
Several securities actions have been filed against the Company
and certain of its current and former officers and directors
following the Company's merger with U.S. Robotics. In
December 1997, a putative securities class action, captioned
Reiver v. 3Com Corporation, et al., Civil Action No. C-97-
21083JW (Reiver), was filed in the United States District
Court for the Northern District of California. The complaint
alleges violations of the federal securities laws,
specifically Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and seeks unspecified damages on behalf
of a purported class of purchasers of 3Com common stock during
the period from May 19, 1997 through November 6, 1997. In
December 1997 and January 1998, seven similar shareholder
class action lawsuits were filed in the United States District
Court for the Northern District of Illinois and the United
States District Court for the Northern District of California.
The cases filed in the Northern District of Illinois have been
transferred to the Northern District of California, and the
cases have been consolidated in the Reiver action. On August
17, 1998, plaintiffs filed a consolidated amended complaint.
The Company has not responded to the complaint.
On April 3, 1998, a complaint, captioned Florida State Board
of Administration and Teachers Retirement System of Louisiana
v. 3Com Corporation, et al., Civil Action No. C-98-1355
(Florida State Board), was filed in the United States District
Court for the Northern District of California. The complaint
alleges violations of the federal securities laws, violations
of the Florida securities laws, common law fraud and negligent
misrepresentation based on factual allegations similar to
those asserted in the Reiver action. The Company has not
responded to the complaint.
The Company believes it has meritorious defenses to the claims
in the Reiver and Florida State Board complaints 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.
In January 1998, two purported shareholder complaints relating
to the Company's June 1997 merger with U.S. Robotics,
captioned Stanley Grossman v. 3Com Corporation, et al., Civil
Action No. CV771335, and Jason v. 3Com Corporation, et al.,
Civil Action No. CV771713, were filed in California Superior
Court, Santa Clara County. The actions allege that 3Com,
several of its officers and directors, and several former U.S.
Robotics officers violated Sections 11 and 15 of the
Securities Act of 1933 by making alleged misrepresentations
and omissions in a May 8, 1997 registration statement. The
complaints seek damages in an unspecified amount on behalf of
a purported class of persons who received the Company's stock
during the merger pursuant to the registration statement. The
Company has not responded to the complaints. On September 25,
1998, the Delaware Chancery Court issued an injunction
preventing plaintiffs from proceeding with these actions,
finding that plaintiffs' claims are barred by a settlement in
a prior action.
In February 1998, a shareholder derivative action purportedly
on behalf of the Company, captioned, Wasserman v. Benhamou, et
al., Civil Action No. 16200-NC, was filed in Delaware Chancery
Court. The complaint alleges that the Company's directors
breached their fiduciary duties to the Company by engaging in
alleged wrongful conduct from mid-1996 through November 1997,
including the conduct complained of in the securities
litigation described above. The Company is named solely as a
nominal defendant, against whom the plaintiff seeks no
recovery. The Company and the individual defendants have
filed a motion to dismiss the complaint. 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
On April 28, 1997, Xerox Corporation filed suit against U.S.
Robotics Corporation and U.S. Robotics Access Corp. in the
United States District Court for the Western District of New
York. The case is now entitled: Xerox Corporation v. U.S.
Robotics Corporation, U.S. Robotics Access Corp., Palm
Computing, Inc. and 3Com Corporation, Civil Action No. 97-CV-
6182T. The complaint alleges willful infringement of a United
States patent relating to computerized interpretation of
handwriting. The complaint further prays for unspecified
damages and injunctive relief. Xerox has asserted that
Graffiti software and certain products of Palm Computing, Inc.
infringe the patent. The Company believes it has meritorious
defenses to the claims and is contesting 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
A putative consumer class action pending against the Company
and U.S. Robotics in the California Superior Court, Marin
County, Bendall, et al. v. U.S. Robotics Corporation, et al.,
Civil Action No. 170441, arising out of the purchase of x2TM
products and products upgradeable to x2, was coordinated with
a previously filed individual action in the California
Superior Court, San Francisco County, Intervention Inc. v.
U.S. Robotics Corporation, Civil Action No. 984352. Two
putative consumer class action lawsuits pending against the
Company and U.S. Robotics in state court of Illinois arising
out of the same facts as those alleged in the California cases
are stayed, Lippman, et al. v. 3Com, Civil Action
No. 97 CH 09773, and Michaels, et al. v. U.S. Robotics Access
Corporation, et al., Civil Action No. 97 CH 14417. A class
has not been certified, and discovery is under way. 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 and Use of Proceeds
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit
Number Description
------- -----------
3.1 Certificate of Incorporation(14)
3.2 Certificate of Correction Filed
to Correct a Certain Error in the
Certificate of Incorporation (14)
3.3 Certificate of Merger (14)
3.4 Bylaws of 3Com Corporation, As
Amended (14)
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)
4.4 Amended and Restated Senior Notes
Agreement between U.S. Robotics
Corporation, Metropolitan Life Insurance
Company, The Northwestern Mutual Life
Insurance Company, and Metropolitan
Property and Casualty Insurance Company (8)
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 Second Amended and Restated 1984
Employee Stock Purchase Plan (Exhibit 10.5
to Form 10-Q) (9)*
10.5 3Com Corporation Director Stock
Option Plan, as amended (Exhibit 19.3 to
Form 10-Q) (4)*
10.6 Amended 3Com Corporation
Director Stock Option Plan (Exhibit 10.8
to Form 10-Q)(9)*
10.7 3Com Corporation Restricted
Stock Plan, as amended (Exhibit 10.17 to
Form 10-Q)(9)*
10.8 1994 Stock Option Plan (Exhibit
10.22 to Form 10-K) (5)*
10.9 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) (11)
10.10 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of November 20,
1996 (Exhibit 10.38 to Form 10-Q) (11)
10.11 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)(10)
10.12 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) (13)
10.13 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) (13)
10.14 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) (13)
10.15 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 (12)
10.16 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 (14)
10.17 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of July 25, 1997
for the Great America Phase III (PAL) site(14)
10.18 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
July 29, 1997 for the Marlborough site(14)
10.19 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of July 29, 1997
for the Marlborough site (14)
10.20 Lease Agreement between BNP
Leasing Corporation, as Landlord, and 3Com
Corporation, as Tenant, effective as of
August 11, 1997 for the Rolling Meadows
site (14)
10.21 Purchase Agreement between
BNP Leasing Corporation and 3Com
Corporation, effective as of August 11,
1997 for the Rolling Meadows
site (14)
10.22 First Amendment to Credit Agreement (14)
* 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 on 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 May 16,
1995 (File No. 0-19550)
(9) 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)
(10) 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)
(11) 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)
(12) 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)
(13) 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)
(14) 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: October 9, 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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