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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED NOVEMBER 26, 1999 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 DECEMBER 24, 1999, 342,344,891 SHARES OF THE REGISTRANT'S COMMON STOCK
WERE OUTSTANDING.
THIS REPORT CONTAINS A TOTAL OF 35 PAGES OF WHICH THIS PAGE IS NUMBER 1.
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3COM CORPORATION
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Income Statements
THREE AND SIX MONTHS ENDED NOVEMBER 26, 1999 AND NOVEMBER 27, 1998 3
Condensed Consolidated Balance Sheets
NOVEMBER 26, 1999 AND MAY 28, 1999 4
Condensed Consolidated Statements of Cash Flows
SIX MONTHS ENDED NOVEMBER 26, 1999 AND NOVEMBER 27, 1998 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 29
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 30
ITEM 2. Changes in Securities and Use of Proceeds 31
ITEM 3. Defaults Upon Senior Securities 31
ITEM 4. Submission of Matters to a Vote of Security Holders 32
ITEM 5. Other Information 32
ITEM 6. Exhibits and Reports on Form 8-K 32
Signatures 35
</TABLE>
3Com, Graffiti, and CoreBuilder are registered trademarks of 3Com Corporation
or its subsidiaries. Palm is a trademark of 3Com Corporation or its
subsidiaries.
2
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
3COM CORPORATION
CONDENSED CONSOLIDATED INCOME STATEMENTS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------------ ------------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Sales $ 1,474,997 $ 1,540,537 $ 2,862,406 $ 2,946,048
Cost of sales 788,866 848,047 1,527,944 1,650,086
----------- ----------- ----------- -----------
Gross margin 686,131 692,490 1,334,462 1,295,962
----------- ----------- ----------- -----------
Operating expenses:
Sales and marketing 298,697 292,627 571,522 571,278
Research and development 162,109 156,280 324,953 303,777
General and administrative 59,918 64,588 121,158 123,994
Merger-related charges (credits)
and other - 638 (2,105) (9,580)
Business realignment costs 5,884 - 5,884 -
----------- ----------- ----------- -----------
Total operating expenses 526,608 514,133 1,021,412 989,469
----------- ----------- ----------- -----------
Operating income 159,523 178,357 313,050 306,493
Gains on sales of investments, net 71,322 - 94,873 -
Interest and other income, net 20,206 12,274 36,120 21,919
----------- ----------- ----------- -----------
Income before income taxes 251,051 190,631 444,043 328,412
Income tax provision 72,833 57,718 129,309 101,808
Equity interest in loss of
consolidated joint venture (53) - (1,028) -
Equity interest in loss of
unconsolidated investee 946 - 946 -
----------- ----------- ----------- -----------
Net income $ 177,325 $ 132,913 $ 314,816 $ 226,604
=========== =========== =========== ===========
Net income per share:
Basic $ 0.52 $ 0.37 $ 0.90 $ 0.63
Diluted $ 0.51 $ 0.36 $ 0.89 $ 0.62
Shares used in computing per share amounts:
Basic 342,889 358,302 348,066 358,418
Diluted 348,988 368,207 353,346 367,316
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
3COM CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
<TABLE>
<CAPTION>
November 26, May 28,
1999 1999
------------ -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and equivalents $ 1,095,611 $ 952,249
Short-term investments 915,892 709,365
Accounts receivable, net 730,395 925,598
Inventories, net 321,461 354,272
Deferred income taxes - 312,011
Investments and other 935,088 166,357
------------ -----------
Total current assets 3,998,447 3,419,852
Property and equipment, net 776,111 831,557
Goodwill, intangibles, deposits and other assets 205,809 243,980
------------ -----------
Total assets $ 4,980,367 $ 4,495,389
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 476,305 $ 336,503
Accrued liabilities and other 654,810 674,375
Income taxes payable 200,481 173,116
Deferred income taxes 47,783 -
Current portion of long-term debt 13,822 14,568
------------ -----------
Total current liabilities 1,393,201 1,198,562
Long-term debt 16,510 30,405
Deferred income taxes and other long-term obligations 52,324 64,492
Equity interest in consolidated joint venture - 5,475
Stockholders' equity:
Preferred stock, $.01 par value, 10,000 shares
authorized; none outstanding - -
Common stock, $.01 par value, 990,000 shares
authorized; shares outstanding: November 26, 1999,
365,825; May 28, 1999, 365,805 1,979,254 1,954,204
Treasury stock at cost, November 26, 1999, 23,902
shares; May 28, 1999, 8,190 shares (611,150) (197,064)
Unamortized restricted stock grants (5,204) (5,303)
Retained earnings 1,660,847 1,403,709
Accumulated other comprehensive income 494,585 40,909
------------ -----------
Total stockholders' equity 3,518,332 3,196,455
------------ -----------
Total liabilities and stockholders' equity $ 4,980,367 $ 4,495,389
============ ===========
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
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3COM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Six Months Ended
--------------------------------
November 26, November 27,
1999 1998
----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 314,816 $ 226,604
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 156,786 131,836
Loss on disposal of fixed assets 7,433 8,161
Gains on sales of investments, net (94,873) -
Deferred income taxes 46,122 60,830
Merger-related credits (2,105) (9,580)
Equity in loss of consolidated joint venture (1,028) -
Equity in loss of unconsolidated investee 946 -
Changes in assets and liabilities, net of effects of acquisitions:
Accounts receivable 193,714 (267,809)
Inventories 27,336 198,770
Investments and other assets 6,112 38,592
Accounts payable 140,887 50,619
Accrued liabilities and other (18,306) 11,429
Income taxes payable 48,640 37,568
----------- -----------
Net cash provided by operating activities 826,480 487,020
----------- -----------
Cash flows from investing activities:
Purchase of investments (439,189) (318,999)
Proceeds from maturities and sales of investments 319,114 120,538
Purchase of property and equipment (93,161) (126,362)
Proceeds from sale of property and equipment 6,790 14,746
Business acquired in purchase transaction - (6,258)
Other, net 1,621 (2,402)
----------- -----------
Net cash used for investing activities (204,825) (318,737)
----------- -----------
Cash flows from financing activities:
Issuance of common stock 72,623 53,147
Repurchase of common stock (540,780) (130,398)
Repayments of long-term borrowings (12,000) (12,000)
Other, net 1,864 (907)
----------- -----------
Net cash used for financing activities (478,293) (90,158)
----------- -----------
Increase in cash and equivalents 143,362 78,125
Cash and equivalents, beginning of period 952,249 528,981
----------- -----------
Cash and equivalents, end of period $ 1,095,611 $ 607,106
=========== ===========
</TABLE>
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
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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 ("3Com," "us," "we," or "our"), pursuant
to the rules of the Securities and Exchange Commission. In the opinion
of management, these unaudited condensed consolidated financial
statements include all adjustments necessary for a fair presentation of
3Com's financial position as of November 26, 1999, results of
operations for the three and six months ended November 26, 1999 and
November 27, 1998, and cash flows for the six months ended November 26,
1999 and November 27, 1998. Certain amounts from the prior year have
been reclassified to conform to the current year presentation.
Effective June 1, 1998, 3Com adopted a 52-53 week fiscal year ending on
the Friday nearest to May 31. Accordingly, fiscal 2000 will end on June
2, 2000, resulting in a 53-week fiscal 2000, rather than 52 weeks as
reported in fiscal 1999. For fiscal year 2000, the first three quarters
will contain 13 weeks, and the fourth quarter will contain 14 weeks.
This change did not have a significant effect on 3Com's condensed
consolidated financial statements for the six months ended November 26,
1999 as compared to the six months ended November 27, 1998. The results
of operations for the three and six months ended November 26, 1999 may
not be indicative of the results to be expected for the fiscal year
ending June 2, 2000. These condensed consolidated financial statements
should be read in conjunction with the consolidated financial
statements and related notes thereto included in 3Com's Annual Report
on Form 10-K for the fiscal year ended May 28, 1999.
2. Merger Related Charges
On June 12, 1997, 3Com completed a merger with U.S. Robotics, which was
accounted for as a pooling-of-interests. As a result of this merger,
3Com recorded aggregate merger-related charges of $240.1 million
through November 26, 1999, which included $196.3 million of integration
expenses and $43.8 million of direct transaction costs (consisting
primarily of investment banking and other professional fees). Remaining
cash expenditures relating to the U.S. Robotics merger charge are
estimated to be approximately $1.0 million, primarily for facilities.
The following tables display the activity and balances relating to the
U.S. Robotics merger reserve (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------ ------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Merger reserve activity-Facilities:
Revisions in estimates - 1,605 (2,091) (44)
Deductions (697) (578) (10,954) (798)
-------- -------- -------- --------
Total change in facilities reserve $ (697) $ 1,027 $(13,045) $ (842)
======== ======== ======== ========
Merger reserve activity-Long-term assets and other:
Revisions in estimates - 2,233 (14) (6,336)
Deductions (56) (6,296) (815) (17,478)
-------- -------- -------- --------
Total change in long-term assets and other reserve $ (56) $ (4,063) $ (829) $(23,814)
======== ======== ======== ========
</TABLE>
6
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<TABLE>
<CAPTION>
November 26, May 28,
1999 1999
------- -------
<S> <C> <C>
Merger reserve balance:
Facilities $ 890 $13,935
Long-term assets and other 509 1,338
------- -------
Total merger reserve balance $ 1,399 $15,273
======= =======
</TABLE>
3. Business Realignment Costs
On September 13, 1999, 3Com announced its intent to sell less than 20
percent of the common stock of its wholly-owned subsidiary, Palm
Computing, Inc. ("Palm Computing"), in an initial public offering
("IPO") early in calendar 2000. 3Com intends to distribute the balance
of the shares of Palm Computing to 3Com shareholders approximately six
months following the IPO, subject to receiving board approval and a
favorable tax ruling, as well as market conditions. As we execute the
separation of Palm Computing from 3Com, we are incurring certain
business realignment costs, which consist primarily of incremental
third party costs related to legal and accounting services, strategic
business planning, information systems separation, development of
compensation and benefits strategies, and recruiting of certain key
Palm Computing management. Internal costs incurred to separate the
operations of Palm Computing and 3Com have been excluded from business
realignment costs. Direct costs of the IPO, such as the underwriters'
commissions and legal and accounting fees, will be deducted from the
proceeds of the offering.
4. Comprehensive Income
The components of comprehensive income, net of tax, are as follows (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- --------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C>
Net income $ 177,325 $ 132,913 $ 314,816 $ 226,604
Other comprehensive income:
Change in net unrealized gain on investments 202,133 (213) 453,876 883
Change in accumulated translation adjustments (344) 5,801 (200) (2,293)
--------- --------- --------- ---------
Total comprehensive income $ 379,114 $ 138,501 $ 768,492 $ 225,194
========= ========= ========= =========
</TABLE>
7
<PAGE>
5. Net Income Per Share
The following table presents the calculation of basic and diluted
earnings per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- --------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income $177,325 $132,913 $314,816 $226,604
============ ============ ============ ============
Weighted average shares-Basic 342,889 358,302 348,066 358,418
Effect of dilutive securities:
Employee stock options 5,768 9,721 5,024 8,696
Restricted stock 331 184 256 202
------------ ------------ ------------ ------------
Weighted average shares-Diluted 348,988 368,207 353,346 367,316
============ ============ ============ ============
Net income per share-Basic $ 0.52 $ 0.37 $ 0.90 $ 0.63
Net income per share-Diluted $ 0.51 $ 0.36 $ 0.89 $ 0.62
</TABLE>
6. Inventories
Inventories, net, consist of (in thousands):
<TABLE>
<CAPTION>
November 26, May 28,
1999 1999
------------ --------
<S> <C> <C>
Finished goods $203,104 $237,515
Work-in-process 48,103 49,452
Raw materials 70,254 67,305
------------ --------
Total Inventory $321,461 $354,272
============ ========
</TABLE>
7. Stock Repurchase and Put Option Programs
The board of directors has authorized us to repurchase certain amounts
of our common stock in the open market from time to time. During the
second quarter of fiscal 2000 we initiated a program of selling put
options on our common stock. Each put option entitles the holder to
sell one share of our common stock to us at a specified price. During
the second quarter of fiscal 2000, we realized proceeds of $4.9 million
from the sale of put options covering 1.7 million shares of our common
stock. The put options have an average exercise price of $29.14 per
share and expire in January 2000. Under these put option arrangements,
we have the right to settle any option exercises with either physical
delivery or a net amount of common shares equal in value to the
difference between the exercise price and market value at the date of
exercise. For purposes of determining the number of shares available
for repurchase under the present board authorization, the sale of one
put option is counted as the repurchase of one share. As of November
26, 1999, the remaining number of shares authorized for repurchase was
8.0 million shares.
8
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8. Equity Interest in Consolidated Joint Venture
In January 1999, we entered into a joint venture named ADMTek, Inc.
("ADMTek"), and began consolidating the joint venture with our results,
due to our ability at that time to exercise significant influence over
operating and financial policies of the joint venture. We entered into
this joint venture to gain access to specific silicon design technology
and expertise. In September 1999, we sold a portion of our existing
interest in ADMTek to our joint venture partner. As a result of this
sale, our ownership interest was reduced to 19 percent and we no longer
have the ability to exercise significant influence over the joint
venture. During our second fiscal quarter, we began accounting for this
investment using the cost method.
9. Equity Interest in Unconsolidated Investee
In August 1999, we invested $7.5 million in OmniSky Corporation
("OmniSky") (formerly OpenSky Corporation). OmniSky intends to provide
a wireless data service that will allow mobile users to access the
Internet, corporate intranets, and other data sources. As of November
26, 1999, we owned a 41 percent interest in OmniSky. This investment is
being accounted for using the equity method.
10. Business Segment Information
The following tables display information on our reportable segments (in
thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- ---------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales
Network Systems $ 593,190 $ 672,414 $1,267,397 $1,293,225
Personal Connectivity 620,907 720,889 1,159,896 1,389,744
Handheld Computing 260,900 147,234 435,113 263,079
------------ ------------ ------------ ------------
Total Sales $1,474,997 $1,540,537 $2,862,406 $2,946,048
============ ============ ============ ============
Segment Income
Network Systems $ 6,136 $ 57,519 $ 78,461 $ 78,323
Personal Connectivity 134,286 121,103 221,774 232,536
Handheld Computing 34,133 12,417 46,529 18,597
Corporate and Other (1) 2,770 (58,126) (31,948) (102,852)
------------ ------------ ------------ ------------
Total Segment Income $ 177,325 $ 132,913 $ 314,816 $ 226,604
============ ============ ============ ============
<CAPTION>
November 26, May 28,
1999 1999
------------ -----------
<S> <C> <C>
Inventory
Network Systems $ 162,210 $ 172,577
Personal Connectivity 122,556 162,924
Handheld Computing 36,695 18,771
------------ ------------
Total Inventory $ 321,461 $ 354,272
============ ============
</TABLE>
(1) Included in the corporate and other category are the following:
bonuses based on 3Com results; corporate expenses; merger charges
(credits) and other; business realignment costs; gains on sales of
investments, net; interest and other income, net; income tax
provision; equity interest in loss of consolidated joint venture;
and equity interest in loss of unconsolidated investee.
9
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11. Subsequent Events
In our third fiscal quarter, we sold our manufacturing facility and
related assets in Salt Lake City, Utah to Manufacturers' Services Ltd.
We expect to record a gain on this transaction of approximately $20 to
$30 million. In connection with the sale, we agreed to purchase certain
products previously manufactured in the Salt Lake City facility for two
years.
In December, we acquired LANSource Technologies, Inc., a leading vendor
of data- and fax-over-Internet Protocol (IP) software applications. The
acquisition targets the multi-billion dollar worldwide IP fax and
unified messaging services markets. The transaction is valued at
approximately $26 million and was accounted for as a purchase.
Additionally, in December we acquired Interactive Web Concepts Inc., a
privately held Internet business consulting, creative design, and
software engineering firm. The acquisition expands our capabilities to
provide total, turnkey e-business solutions for customers worldwide.
The transaction was accounted for as a purchase.
In December, we announced the formation of a strategic global alliance
with USWeb/CKS to develop, market, and deliver wireless applications
for the mobile workplace and converged voice, video, and data
solutions. Under the alliance, 3Com will contribute up to $100 million
in a combination of funded development and an equity investment in
USWeb/CKS. The equity investment portion is expected to be up to $40
million.
12. Litigation
We are a party to lawsuits in the normal course of our business.
Litigation in general, and intellectual property and securities
litigation in particular, can be expensive and disruptive to normal
business operations. Moreover, the results of complex legal proceedings
are difficult to predict. We believe that we have defenses in each of
the cases set forth below and are vigorously contesting each of these
matters. An unfavorable resolution of one or more of the following
lawsuits could adversely affect our business, results of operations, or
financial condition.
SECURITIES LITIGATION
On March 24 and May 5, 1997, 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 3Com 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 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 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
plaintiffs have filed an amended complaint. 3Com has filed an answer to
the amended complaint. The trial is scheduled for October 2000.
10
<PAGE>
In December 1997, a 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. Several similar actions have been consolidated into this
action, including FLORIDA STATE BOARD OF ADMINISTRATION AND TEACHERS
RETIREMENT SYSTEM OF LOUISIANA V. 3COM CORPORATION, ET AL., Civil
Action No. C-98-1355. On August 17, 1998, the plaintiffs filed a
consolidated amended complaint which alleges violations of the federal
securities laws, specifically Sections 10(b) and 20(a) of the
Securities and Exchange Act of 1934, and which seeks unspecified
damages on behalf of a purported class of purchasers of 3Com common
stock during the period from April 23, 1997 through November 5, 1997.
In July 1999, the court dismissed the complaint and granted the
plaintiffs the right to file an amended complaint. Plaintiffs have
filed an amended complaint, and defendants have filed a motion to
dismiss.
In October 1998, a securities class action lawsuit, captioned ADLER V.
3COM CORPORATION, ET AL., Civil Action No. CV777368 (ADLER), was filed
against 3Com and certain of its officers and directors in the
California Superior Court, Santa Clara County, asserting the same class
period and factual allegations as the REIVER action. The complaint
alleges violations of Sections 25400 and 25500 of the California
Corporations Code and seeks unspecified damages. The action is in
discovery. No trial date has been set.
In October 1998, two shareholder derivative actions purportedly on
behalf of 3Com, captioned SHAEV V. BARKSDALE, ET AL., Civil Action No.
16721-NC, and BLUM V. BARKSDALE, ET AL., Civil Action No. 16733-NC,
were filed in Delaware Chancery Court. The complaints allege that
3Com's directors breached their fiduciary duties to 3Com through the
issuance of and disclosures concerning director stock options. 3Com is
named solely as a nominal defendant, against whom the plaintiffs seek
no recovery. 3Com and the individual defendants filed a motion to
dismiss, and on October 25, 1999, the Court issued an order dismissing
these actions.
On May 11, 1999, a securities class action, captioned GAYLINN V. 3COM
CORPORATION, ET AL., Civil Action No. C-99-2185 MMC (GAYLINN), 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. Several similar actions have been consolidated into the
GAYLINN action. On September 10, 1999, the plaintiffs filed a
consolidated complaint which 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 September 22, 1998 through March 2, 1999. 3Com has
filed a motion to dismiss.
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
captioned: 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
Xerox United States patent relating to computerized interpretation of
handwriting. The complaint seeks unspecified damages and injunctive
relief. Xerox has asserted that Graffiti-Registered Trademark- software
and certain products of Palm Computing, Inc. infringe the patent. On
June 25, 1999, the Court stayed the action pending reexamination of the
patent by the U.S. Patent and Trademark Office. On December 15, 1999,
we received a Notice of Intent to Issue Reexamination Certificate from
the United States Patent and Trademark Office stating that the
reexamination has been terminated and that a certificate will be issued
in due course. The notice stated that the certificate will indicate
that there will be no changes to the patent specification or drawings
and that all claims of the patent will be confirmed without any
changes. On December 16, 1999, both we and Xerox separately wrote the
court requesting that the stay of the action be lifted. The parties are
awaiting the scheduling of a status conference with the court.
11
<PAGE>
COMMERCIAL LITIGATION
On November 4, 1999, a lawsuit was filed against 3Com by Disney
Interactive, Inc. ("DI") in the Superior Court of the State of
California, Los Angeles County, Case No. BC219663, alleging breach of a
purported contract for the bundling of DI video products with
3Com-Registered Trademark- modems. The complaint asserts that DI is
seeking damages in excess of $15 million. The case is in discovery. No
trial date has yet been set.
13. Effects of Recent Accounting Pronouncements
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1 ("SOP 98-1"), "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." SOP
98-1 requires that entities capitalize certain costs related to
internal-use software if certain criteria are met. 3Com adopted SOP
98-1 for our fiscal year ending June 2, 2000. The adoption of SOP 98-1
did not have a significant impact on our financial results for the six
months ended November 26, 1999.
In June 1998 and June 1999, the Financial Accounting Standards Board
(FASB) issued SFAS 133, "Accounting for Derivative Instruments and
Hedging Activities" and SFAS 137, "Accounting for Derivative
Instruments and Hedging Activities-Deferral of the Effective Date of
FASB Statement No. 133." These statements require 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. These
statements will be effective for 3Com's fiscal year ending May 31,
2002. We believe that the adoption of these statements will not have a
significant impact on our financial results.
12
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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 3Com's condensed
consolidated income statements:
<TABLE>
<CAPTION>
Three months ended Six months ended
-------------------------- --------------------------
November 26, November 27, November 26, November 27,
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 53.5 55.0 53.4 56.0
----- ----- ----- -----
Gross margin 46.5 45.0 46.6 44.0
Operating expenses:
Sales and marketing 20.2 19.0 20.0 19.4
Research and development 11.0 10.2 11.4 10.3
General and administrative 4.1 4.2 4.2 4.2
Merger-related charges
(credits) and other - - (0.1) (0.3)
Business realignment costs 0.4 - 0.2 -
----- ----- ----- -----
Total operating expenses 35.7 33.4 35.7 33.6
----- ----- ----- -----
Operating income 10.8 11.6 10.9 10.4
Gains on sales of investments, net 4.8 - 3.3 -
Interest and other income, net 1.4 0.8 1.3 0.7
----- ----- ----- -----
Income before income taxes 17.0 12.4 15.5 11.1
Income tax provision 4.9 3.8 4.5 3.4
Equity interest in loss of
consolidated joint venture - - - -
Equity interest in loss of
unconsolidated investee 0.1 - - -
----- ----- ----- -----
Net income 12.0% 8.6% 11.0% 7.7%
===== ===== ===== =====
Excluding merger-related charges (credits)
and other, business realignment costs, and
gains on sales of investments, net:
Total operating expenses 35.3% 33.4% 35.5% 33.9%
Operating income 11.2 11.6 11.1 10.1
Net income 8.9 8.7 8.7 7.5
</TABLE>
13
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SALES
Sales in the second quarter of fiscal 2000 totaled $1.47 billion, an increase of
$88 million or six percent from the first quarter of fiscal 2000, and a decrease
of $66 million or four percent from the corresponding quarter one year ago.
Sales in the first six months of fiscal 2000 and fiscal 1999 both totaled $2.9
billion.
NETWORK SYSTEMS. Sales of network systems products (E.G., switches, hubs, remote
access concentrators, routers, and customer service and support) in the second
quarter of fiscal 2000 decreased 12 percent both compared to the same quarter
one year ago and sequentially from the first quarter of fiscal 2000. The
decreases were primarily due to delayed introduction of several new products,
such as our CoreBuilder-Registered Trademark- 9000 8-slot chassis, our Gigabit
Layer 3 modules, and release 3.0 of our CoreBuilder software, customer deferrals
of enterprise infrastructure purchases due to Year 2000-related buying freezes,
and increased competition. Sales of network systems products in the second
quarter of fiscal 2000 represented 40 percent of total sales compared to 44
percent in the second quarter of fiscal 1999. Sales of network systems products
in the first six months of fiscal 2000 decreased two percent from the first six
months of fiscal 1999. Sales of network systems products in the first six months
of fiscal 2000 and fiscal 1999 represented 44 percent of total sales.
PERSONAL CONNECTIVITY. Sales of personal connectivity products (E.G., desktop
network interface cards (NICs), desktop modems, and personal computer (PC) cards
for mobile computers) in the second quarter of fiscal 2000 decreased 14 percent
compared to the same quarter one year ago and increased 15 percent sequentially
from the first quarter of fiscal 2000. The decrease compared to the second
quarter of fiscal 1999 was primarily due to price declines in both analog modems
and network interface cards, partially offset by an increase in the sales of our
100 megabits per second (Mbps) Ethernet products. The sequential increase from
the first quarter of 2000 was primarily due to strong seasonal demand for these
products. Additionally, revenue from emerging high-growth markets such as
broadband access (cable and digital subscriber line (DSL)) contributed to the
increase. Sales of personal connectivity products in the second quarter of
fiscal 2000 represented 42 percent of total sales compared to 47 percent in the
second quarter of fiscal 1999.
Sales of personal connectivity products in the first six months of fiscal 2000
decreased 17 percent from the first six months of fiscal 1999. Sales of personal
connectivity products in the first six months of fiscal 2000 represented 41
percent of total sales, compared to 47 percent in the first six months of fiscal
1999. Historically, a significant portion of our sales has been derived from
desktop NICs and analog modems. Although these products experienced sequential
growth in the second quarter of fiscal 2000, sales of these products generally
have been declining over the past year primarily due to price competition and
the evolution to newer technologies such as cable and DSL. Further, our NICs and
modems are increasingly being distributed through the PC original equipment
manufacturer (OEM) channel that carries lower average selling prices. Sales of
NICs and modems are also highly correlated with sales in the PC market. While
the overall PC market continues to grow, sales of low-end PCs are growing faster
than high-end PCs. Lower priced PCs are not typically sold with high performance
NICs and modems such as those offered by 3Com.
HANDHELD COMPUTING. Sales of handheld computing products in the second quarter
of fiscal 2000 increased 50 percent sequentially and 77 percent compared to the
same quarter one year ago. The sequential increase was primarily due to strong
seasonal demand and new product introductions. The year-over-year increase was
primarily due to continued increase in market acceptance of our handheld
computing products and expansion of the market for handheld computing. Sales of
handheld computing products in the second quarter of fiscal 2000 represented 18
percent of total sales compared to nine percent in the second quarter of fiscal
1999. Sales of handheld computing products in the first six months of fiscal
2000 increased 65 percent from the first six months of fiscal 1999. Sales of
handheld computing products in the first six months of fiscal 2000 represented
15 percent of total sales, compared to nine percent in the first six months of
fiscal 1999.
14
<PAGE>
GEOGRAPHIC. In the second quarter of fiscal 2000, U.S. sales decreased 11
percent and international sales increased three percent compared to the same
period one year ago. U.S. sales in the second quarter of fiscal 2000 represented
51 percent of total sales, compared to 55 percent of total sales in the second
quarter of fiscal 1999. In the first six months of fiscal 2000, U.S. sales
decreased eight percent and international sales increased four percent compared
to the same period one year ago. U.S. sales in the first six months of fiscal
2000 represented 53 percent of total sales, compared to 56 percent of total
sales in the first six months of fiscal 1999. In the first six months of fiscal
2000, international sales reflected strong growth in Asia Pacific and Canada,
partially offset by lower sales in Europe.
SEASONALITY. Our sales are subject to seasonality, reflecting spending patterns
in different geographies and customer markets. Sales in the second quarter of
the fiscal year have historically been the strongest, due in part to seasonal
strength in international regions and holiday spending patterns. Third quarter
sales have historically been either sequentially lower or only slightly up as
compared to sales from the prior quarter.
GROSS MARGIN
Gross margin as a percentage of sales was 46.5 percent in the second quarter of
fiscal 2000, compared to 46.7 percent in the first quarter of fiscal 2000 and
45.0 percent in the second quarter of fiscal 1999. Gross margin as a percentage
of sales was 46.6 percent in the first six months of fiscal 2000, compared to
44.0 percent in the first six months of fiscal 1999. The increase in gross
margin percentage for the first six months of fiscal 2000, compared to the same
period a year ago, was primarily due to continued improvements in our inventory
management, which resulted in reduced manufacturing period costs, as well as
improvements in our operational management. The slight decrease in gross margin
percentage from the prior quarter was attributable predominately to product mix.
OPERATING EXPENSES
Operating expenses in the second quarter of fiscal 2000 were $526.6 million, or
35.7 percent of sales, compared to $494.8 million, or 35.6 percent of sales in
the first quarter of fiscal 2000 and $514.1 million, or 33.4 percent of sales in
the second quarter of fiscal 1999. Operating expenses in the second quarter of
fiscal 2000 included $5.9 million in business realignment costs. Operating
expenses in the first quarter of fiscal 2000 included merger-related credits of
$2.1 million. Operating expenses in the second quarter of fiscal 1999 included
merger-related charges of $0.6 million. Excluding these unusual items, operating
expenses for the second quarter of fiscal 2000 were $520.7 million, or 35.3
percent of sales, compared to $496.9 million, or 35.8 percent of sales in the
first quarter of fiscal 2000 and $513.5 million, or 33.4 percent of sales in the
second quarter of fiscal 1999.
Operating expenses in the first six months of fiscal 2000 and fiscal 1999 were
both $1.0 billion, corresponding to 35.7 percent of sales in the first six
months of fiscal 2000 and 33.6 percent of sales in the first six months of
fiscal 1999. Operating expenses in the first six months of fiscal 2000 included
$5.9 million of business realignment costs and $2.1 million of credits related
to the U.S Robotics merger. Operating expenses in the first six months of fiscal
1999 included a net credit of $9.6 million associated with the U.S. Robotics
merger and real estate activities. Excluding these unusual items, operating
expenses for the first six months of fiscal 2000 and fiscal 1999 were both $1.0
billion, corresponding to 35.5 percent of sales in the first six months of
fiscal 2000 and 33.9 percent of sales in the first six months of fiscal 1999.
15
<PAGE>
SALES AND MARKETING. Sales and marketing expenses in the second quarter of
fiscal 2000 increased $25.9 million or nine percent from the first quarter of
fiscal 2000, and increased to 20.2 percent of sales in the second quarter of
fiscal 2000 compared to 19.7 percent in the first quarter of fiscal 2000. The
sequential increase was due primarily to our marketing campaigns and television
advertising for our e-Networks solutions and Palm-TM- handheld computing
products. Sales and marketing expenses in the second quarter of fiscal 2000
increased $6.1 million or two percent from the second quarter of fiscal 1999,
and increased to 20.2 percent of sales in the second quarter of fiscal 2000
compared to 19.0 percent in the second quarter of fiscal 1999. The
year-over-year increase was due primarily to our marketing campaigns and
television advertising for our e-Networks solutions and Palm handheld computing
products, partially offset by reduced marketing expenditures on our analog modem
products. Sales and marketing expenses for the first six months of fiscal 2000
were comparable to the first six months of fiscal 1999.
RESEARCH AND DEVELOPMENT. Research and development expenses in the second
quarter of fiscal 2000 decreased $0.7 million from the first quarter of fiscal
2000, and decreased to 11.0 percent of sales in the second quarter of fiscal
2000 compared to 11.7 percent in the first quarter of fiscal 2000. Research and
development expenses in the second quarter of fiscal 2000 increased $5.8 million
or 3.7 percent from the second quarter of fiscal 1999, and increased to 11.0
percent of sales in the second quarter of fiscal 2000 compared to 10.2 percent
in the second quarter of fiscal 1999. This year-over-year increase was primarily
due to increased investments in new and emerging technologies and markets
including handheld computing, local area network (LAN) telephony, broadband
access, wireless access, voice over the internet protocol (VoIP), and home
networking, partially offset by decreased spending related to mature product
lines such as analog modems. Research and development expenses for the first six
months of fiscal 2000 increased by $21.2 million or 7.0 percent compared to the
first six months of fiscal 1999.
GENERAL AND ADMINISTRATIVE. General and administrative expenses in the second
quarter of fiscal 2000 decreased $1.3 million or two percent from the first
quarter of fiscal 2000, and decreased to 4.1 percent of sales in the second
quarter of fiscal 2000 compared to 4.4 percent in the first quarter of fiscal
2000. General and administrative expenses in the second quarter of fiscal 2000
decreased $4.7 million or seven percent from the second quarter of fiscal 1999,
and decreased to 4.1 percent of sales in the second quarter of fiscal 2000
compared to 4.2 percent in the second quarter of fiscal 1999. General and
administrative expenses for the first six months of fiscal 2000 decreased by
$2.8 million or two percent compared to the first six months of fiscal 1999.
General and administrative expenses have remained fairly consistent because
these costs are primarily workforce-related.
MERGER-RELATED CHARGES (CREDITS) AND OTHER. During the first six months of
fiscal 2000, we recorded a net pre-tax credit of approximately $2.1 million
related to reductions in the estimates for remaining charges associated with the
sale of a facility in Chicago. During the first six months of fiscal 1999, we
recorded a net pre-tax credit of approximately $9.6 million, associated with the
U.S. Robotics merger and real estate activities.
BUSINESS REALIGNMENT COSTS. Business realignment costs in the second quarter of
fiscal 2000 were $5.9 million, and represented incremental third party costs
related to legal and accounting services, strategic business planning,
information systems separation, development of compensation and benefits
strategies, and recruiting of certain key Palm Computing management. Internal
costs incurred to separate the operations of Palm Computing and 3Com have been
excluded from business realignment costs.
16
<PAGE>
GAINS ON SALES OF INVESTMENTS, NET
Gains on sales of investments, net in the second quarter of fiscal 2000 of $71.3
million reflected gains realized from sales of investments in equity securities,
partially offset by write-offs of certain other investments. Gains on sales of
investments in the first quarter of fiscal 2000 of $23.6 million reflected gains
realized from sales of investments in equity securities.
INTEREST AND OTHER INCOME, NET
Interest and other income, net in the second quarter of fiscal 2000 increased
$4.3 million compared to the first quarter of fiscal 2000. Interest and other
income, net in the second quarter of fiscal 2000 increased $7.9 million compared
to the same quarter a year ago. In the first six months of fiscal 2000, interest
and other income, net increased $14.2 million compared to the first six months
of fiscal 1999. The increases noted above were primarily due to higher interest
income as a result of higher cash and investment balances, as well as improved
foreign currency results.
INCOME TAX PROVISION
3Com's effective income tax rate was 29.1 percent for the first six months of
fiscal 2000, compared to 31.0 percent for the first six months of fiscal 1999.
The rate reduction compared to the same period a year ago is primarily
attributable to increased offshore manufacturing in countries with tax rates
significantly below the U.S. statutory rate.
EQUITY INTEREST IN LOSS OF CONSOLIDATED JOINT VENTURE
In January 1999, we entered into a joint venture named ADMTek, Inc. ("ADMTek"),
and began consolidating the joint venture with our results, due to our ability
to exercise significant influence over operating and financial policies of the
joint venture. In September 1999, we sold a portion of our existing interest in
ADMTek to our joint venture partner. As a result of this sale, our ownership
interest was reduced to 19 percent and we no longer have the ability to exercise
significant influence over the joint venture. During our second fiscal
quarter, we began accounting for this investment using the cost method.
EQUITY INTEREST IN LOSS OF UNCONSOLIDATED INVESTEE
In August 1999, we invested $7.5 million in OmniSky Corporation ("OmniSky")
(formerly OpenSky Corporation). As of November 26, 1999, we own a 41 percent
interest in OmniSky. This investment is being reported using the equity method.
NET INCOME AND NET INCOME PER SHARE
Net income for the second quarter of fiscal 2000 was $177.3 million, or $0.51
per share, compared to net income of $137.5 million, or $0.38 per share for the
first quarter of fiscal 2000 and net income of $132.9 million, or $0.36 per
share, for the second quarter of fiscal 1999. Excluding the business realignment
costs and net gains on sales of investments, net income was $130.9 million, or
$0.37 per share for the second quarter of fiscal 2000. Excluding the
merger-related credits and the gains on sales of investments, net income was
$119.3 million, or $0.33 per share for the first quarter of fiscal 2000.
Excluding the merger-related charge, net income was $133.4 million, or $0.36 per
share for the second quarter of fiscal 1999.
Net income for the first six months of fiscal 2000 was $314.8 million, or $0.89
per share, compared to net income of $226.6 million, or $0.62 per share for the
first six months of fiscal 1999. Excluding the merger-related credits, business
realignment costs, and net gains on sales of investments, net income was $250.1
million, or $0.71 per share for the first six months of fiscal 2000. Excluding
the net merger-related charges credits, net income was $220.1 million, or $0.60
per share for the first six months of fiscal 1999.
17
<PAGE>
BUSINESS ENVIRONMENT AND RISK FACTORS
This report on Form 10-Q contains forward-looking statements, including
statements concerning the growth of new markets within networking, the
planned initial public offering and stock distribution of Palm Computing,
effects of strategic relationships and investments, future sales of certain
products and in certain markets (including NICs, analog modems, stackable
hubs, LAN switching, remote access concentrators and wide area network (WAN)
access), and our Year 2000 readiness and expectations of the impact of Year
2000 issues. These statements are subject to certain risks and uncertainties.
Some of the factors that could cause future events or results to materially
differ from those projected in the forward-looking statements are discussed
below. The risk factors affecting Palm Computing as a separate company are
described in detail in the Registration Statement on Form S-1 filed with the
Securities and Exchange Commission on December 13, 1999.
TRANSITIONING OF SALES BASE TO HIGH-GROWTH MARKETS
We participate in many markets that are growing at varying rates.
Historically, a significant portion of our sales has been derived from
desktop NICs, analog modems, and stackable hubs, which have entered the
mature phase of their product life cycles. Although several of these products
have experienced recent sequential growth, sales of these products have been
generally declining over the past year primarily due to price competition,
increased reliance on the OEM channel and evolution to newer technologies.
Consequently, we believe that sales derived from these products will decline
as a percent of our total sales. Moderate growth markets in which we
participate include LAN switching, remote access concentrators, and WAN
access. We expect these markets will continue to grow and account for a
significant portion of our sales. However, in the second quarter of fiscal
2000, sales in our network systems segment declined 12 percent sequentially
and year-over-year, primarily due to lower than expected sales of LAN
switches and hubs. If sales in this segment continue to decline, our
consolidated financial results may be adversely affected. Finally, we are
increasing our investments in several high-growth and emerging markets that
are forecasted to grow at a significantly higher rate than the networking
industry average. We expect these businesses to account for a higher
percentage of our sales over time. In addition to handheld computing, we are
focused on the following high-growth and emerging markets:
- Voice over the Internet Protocol (VoIP)
- LAN Telephony
- Broadband Access (primarily cable and DSL)
- Wireless Access
- Home Networking
The transition of our sales base to these new markets may cause disruption in
historical relationships between our sales, research and development efforts,
and manufacturing operations. We cannot be certain that these emerging
markets will materialize in the timeframes that we expect, that we will
introduce products for these markets in a timely manner, that the market will
accept these products, or that we will successfully generate significant
sales and profitability from these markets. In addition, sales from our
mature product lines may decline more rapidly than sales grow in emerging
product lines, and therefore, our results could be adversely impacted.
18
<PAGE>
CONSOLIDATION IN OUR INDUSTRY
There have been many mergers and acquisitions in the networking industry in
the past several years. More recently, there have also been mergers between
telecommunications equipment providers and networking companies, as well as
between networking companies and computer component suppliers. Examples
during calendar 1999 include:
- 3Com acquired Smartcode, NBX, Interactive Web Concepts,
LANSource Technologies, and certain assets of ICS;
- Lucent Technologies, a telecommunications company, acquired 14
companies, including networking equipment supplier Ascend
Communications;
- Cisco Systems, a networking equipment supplier, acquired 18
companies, including the data networking business of IBM
Corporation;
- Nortel Networks, a telecommunications company, acquired three
companies and integrated the operations of previously acquired
Bay Networks, a networking equipment supplier;
- Alcatel, a telecommunications company, acquired four
companies, including Xylan, a networking equipment supplier;
- Siemens A.G., a telecommunications company, acquired three
networking firms;
- General Electric Company, a UK-based engineering firm,
acquired Fore, a networking equipment supplier;
- Intel Corporation, a computer component manufacturer, acquired
eight companies with networking technology.
Future business combinations in the networking industry may result in more
companies with greater resources and stronger competitive positions and
products than 3Com. Continued industry consolidation may adversely affect our
operating results or financial condition.
COMPETITION AND PRICING PRESSURE
We participate in a highly volatile industry characterized by vigorous
competition for market share as well as rapid product and technology
development and maturation. In addition, both 3Com and our competitors
sometimes lower product prices in order to gain market share or create more
demand for our products. For example, in the second quarter of fiscal 2000 we
experienced pricing competition in our distribution channel, particularly for
price-sensitive products sold through catalogs and certain workgroup systems
products. Intense pricing competition in our industry may adversely affect
our business, operating results, or financial condition.
Our competition historically has come from start-up companies,
well-capitalized computer systems and communications companies, and other
technology companies focusing on data networking. However, our industry is
changing, resulting in new and other potential competitors who have greater
financial, marketing, and technical resources than 3Com. For example,
technology innovations are driving the convergence of voice, video, and data
traffic onto a single network infrastructure, and we now compete with much
larger telecommunications equipment companies such as Cisco Systems, Lucent
Technologies, and Nortel Networks.
19
<PAGE>
We are also selling products into new markets where we compete with different
companies than in the past. This is especially true in our high-growth
emerging markets. For example, our Palm handheld computing products compete
in the handheld device, operating system software and Internet services
markets. The markets for these products and services are highly competitive
and we expect competition to increase in the future. Some of our competitors
or potential competitors have significantly greater financial, technical and
marketing resources than we do. Our principal competitors include Casio,
Compaq, Hewlett-Packard, Microsoft, Psion, Sharp and Palm platform licensees
such as TRG and Handspring, which was formed by two of the original founders
of Palm Computing. These competitors may be able to respond more rapidly than
we may to new or emerging technologies or changes in customer requirements.
They may also devote greater resources to the development, promotion and sale
of their products than we do. Our failure to compete successfully against
current or future competitors could seriously harm our business, financial
condition and results of operations.
BUSINESS REALIGNMENT
On September 13, 1999, we announced plans to create two distinct companies by
separating the operations of our Palm Computing subsidiary and making it an
independent company. Planning and implementing the separation of Palm
Computing from 3Com has and will require the dedication of management
resources, and we expect to incur certain incremental expenses in future
periods related to the separation. Efforts required to separate the
operations of Palm Computing may disrupt our ongoing business activities.
These factors could have an adverse affect on our results of operations or
financial condition. In addition, a significant portion of our operational
and administrative infrastructure represents costs that are fixed.
Accordingly, these costs may represent a greater percentage of sales after
the separation and thus could adversely affect our results of operations.
It is anticipated that 3Com will provide transitional services to support the
ongoing Palm Computing operations. These transitional services relate to
information technology systems, supply chain management, human resources
administration, product order administration, customer service, buildings and
facilities, treasury management, and legal, finance, and accounting. If 3Com
does not provide these services at an adequate level, we may be held liable
for losses suffered as a result by Palm Computing. The transitional service
agreements generally have terms of less than two years following the
separation. After the expiration of these various arrangements, 3Com may not
be able to effectively re-deploy the employees performing these services in a
timely manner, and our financial results could be adversely affected.
On December 13, 1999, we filed a registration statement with the Securities
and Exchange Commission for the IPO of the common stock of Palm Computing.
Although the registration statement has been filed, it has not yet become
effective. Palm Computing common stock may not be sold nor may offers to buy
be accepted prior to the time the registration statement becomes effective.
The risk factors affecting Palm Computing as a separate company are described
in detail in the Registration Statement on Form S-1 filed with the Securities
and Exchange Commission on December 13, 1999.
The Palm Computing IPO is expected to be completed in early calendar 2000,
and will be for less than 20 percent of the Palm Computing shares.
Approximately six months following the IPO, 3Com intends to distribute its
remaining shares of Palm Computing (more than 80 percent) to 3Com
shareholders, subject to receiving board approval and a favorable tax ruling,
as well as market conditions. If 3Com does not receive a favorable tax
ruling, it is unlikely that we will make the distribution in the expected
time frame, if at all. If the distribution is delayed or is not completed at
all, our stock price could be negatively impacted. After the IPO and before
the final distribution of the remaining stock to 3Com shareholders, 3Com will
own 80 percent or more of the common stock of Palm Computing. Thus, the
market price of 3Com common stock could be subject to a period of volatility
based on the value of Palm Computing's stock after it becomes publicly
traded. Furthermore, after 3Com makes the final distribution of Palm
Computing shares, 3Com's share price may experience a significant adjustment,
as investors determine the stock price for our company as a separate company
from Palm Computing.
20
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MANAGEMENT OF STRATEGIC RELATIONSHIPS AND INVESTMENTS
In addition to mergers and acquisitions, technology companies are continually
entering into strategic relationships. For example, during calendar 1999,
3Com or its Palm Computing subsidiary announced or expanded strategic
relationships with several companies including the following:
- America Online
- Dell Computer
- Gateway
- Hewlett-Packard
- Hitachi
- IBM
- Microsoft Corporation
- Motorola
- Nokia
- Siemens A.G.
- Sony
- Sun Microsystems
- Unisys
- USWeb/CKS
The strategic relationships with America Online, Motorola, and Nokia include
opportunities for these companies to make significant investments in the Palm
Computing IPO. We believe all of the strategic relationships and investments
will benefit 3Com and Palm Computing. However, our results of operations or
financial condition could be adversely impacted if we experience difficulties
managing relationships with our partners or if projects with partners are
unsuccessful. In addition, if our competitors enter into successful strategic
relationships, they could increase the competition that we face.
We have also made strategic investments in several other networking
companies. Some of these investments have significantly appreciated in value
since the companies became publicly traded. Our results of operations or
financial condition could be adversely impacted if the market value of our
investments declines.
RELIANCE ON DISTRIBUTORS, RESELLERS, AND PC OEMS
We distribute many of our products through indirect distribution channels
that include distributors, systems integrators, value-added resellers, and
retailers. We also sell our products through the PC OEM channel. Our future
results and financial condition are partially dependent on a number of
factors relating to this distribution model, including issues associated with
competition among and within our channels, selling to PC OEMs, and inventory
and customer concentration.
We believe our indirect distribution channels are experiencing heightened
competition from Internet-based suppliers and PC OEMs that distribute
directly to end-user customers. Further, 3Com is building in-house
capabilities to sell directly to end-user customers and distribution partners
over the Internet (e-business). If this initiative is successful, it could
cause conflict with our current indirect channels of distribution. If we are
unsuccessful in selling through our e-business channel, we could lose market
share to competitors who have more successfully developed these capabilities.
These changes in the pattern of distribution of networking products could
have a material adverse affect on our sales and financial results.
Our distributors and resellers maintain significant levels of our products in
their inventories. As part of our efforts to optimize our supply chain, we
are reducing the number of distributors through whom we sell our products. We
work closely with distributors and resellers to monitor inventory levels and
ensure that appropriate levels of products are available to end-users. If
channel partners attempt to reduce their levels of inventory or if they do
not maintain sufficient levels to meet customer demand, our sales could be
negatively impacted.
21
<PAGE>
PC-related networking products such as modems and NICs are increasingly being
sold through the PC OEM channel rather than the distribution channel. We
derive a significant portion of our personal connectivity product sales from
PC OEMs such as Dell Computer, Toshiba, Gateway, Hewlett-Packard, and IBM,
manufacturers that incorporate our NICs, analog modems, or chipsets into
their products. While sales to PC OEMs are important, products sold through
the PC OEM channel typically have a lower average selling price than those
sold through other channels. Therefore, our sales and margins may be
adversely impacted if sales to PC OEMs continue to become a larger percentage
of our business. In addition, PC OEMs sometime elect to integrate NIC and
modem functions onto the PC motherboard. Competitors such as large
semiconductor companies who can integrate networking and other computer
processing functions onto a single chip might offer PC OEMs a cheaper
alternative to our solutions. If the integration of networking and computer
processing functionality on a reduced number of components increases, our
future sales growth and profitability could be adversely affected.
Moreover, significant portions of our sales are made to a few customers. In
the second quarter of fiscal 2000, Ingram Micro Inc. represented
approximately 19 percent of our total sales and Tech Data Corporation
represented approximately 13 percent of our total sales. Ingram Micro Inc.
and Tech Data Corporation are both distributors of our products. We cannot be
certain that these customers will continue to purchase our products at
current levels. We typically do not enter into contracts with our customers
that require them to purchase minimum quantities of our products, and our
customers have some rights to extend or delay the shipment of their orders.
Additionally, consolidation among distributors is reducing the number of
distributors in the North American market. Because our sales are becoming
more concentrated among a smaller number of customers, our results of
operations, financial condition, or market share could be adversely affected
if our customers:
- stopped purchasing our products or focused more on selling our
competitors' products;
- reduced, delayed, or canceled their orders;
- were unable to sell our products because we did not timely
ship the products to them; or
- experience competitive, operational, or financial difficulties
resulting in less demand from them for our products or
impairing our ability to collect payments from them.
3COM FINANCIAL MODEL
In managing our business, we periodically establish and revise 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. Instead, our management uses it in making decisions about
the allocation of resources and investments. The current model is as follows:
<TABLE>
<S> <C>
Gross margin 44.5 - 46.0%
Operating expenses 28.0 - 29.5%
Operating income 15.0 - 18.0%
</TABLE>
We intend to revisit and communicate an updated model as 3Com enters the next
fiscal year, when the Palm Computing distribution is expected to be near
completion.
UNCERTAINTIES OF INTERNATIONAL MARKETS
We operate internationally and expect that international markets will
continue to account for a significant percentage of our sales. Some
international markets are characterized by economic and political instability
and currency fluctuations that can adversely affect our operating results or
financial condition. Our results of operations in the past have been
adversely impacted by economic instability in the Asia Pacific and Latin
American regions.
22
<PAGE>
ABILITY TO DEVELOP AND INTRODUCE NEW PRODUCTS
Products in the markets in which we compete have short life cycles.
Therefore, 3Com's success depends on our ability to identify new market and
product opportunities, to timely develop and introduce new products, and to
gain market acceptance of new products, particularly in the emerging markets
described above. For example, the timely introduction and delivery of a next
generation multi-service access platform will be important for our long-term
success in the Carrier/Network Service Provider market. Any delay in new
product introductions or lower than anticipated demand for our new products
could have an adverse affect on our operating results or financial condition,
particularly in those product markets we have identified as emerging
high-growth opportunities.
INDUSTRY STANDARDS AND REGULATIONS
3Com's success also depends on:
- the timely adoption of industry standards;
- resolution of conflicting U.S. and international standards
requirements created by the convergence of technology such as
voice onto data networks;
- the timely introduction of new standards-compliant products; and
- a favorable regulatory environment.
Slow market acceptance of new technologies and industry standards could
adversely affect our results of operations or financial condition. In
addition, if we fail to achieve timely certification of compliance to
industry standards for our products, our sales of such products and our
results of operations or financial condition could be adversely affected.
Further, a number of new product initiatives, particularly in the area of
VoIP and LAN Telephony, could be impacted by new or revised regulations,
which in turn could adversely affect our results of operations or financial
condition.
CUSTOMER ORDER FULFILLMENT
The timing and amount of our sales depend on a number of factors that make
estimating operating results prior to the end of any period uncertain. For
example, we do not typically maintain a significant backlog and sales are
dependent on our ability to appropriately forecast product demand. In
addition, our customers historically request fulfillment of orders in a short
period of time, resulting in limited visibility to sales trends. As a result,
our operating results depend on the volume and timing of orders and our
ability to fulfill the orders in a timely manner. Historically, sales in the
third month of the quarter have been higher than sales in each of the first
two months of the quarter, particularly in the third fiscal quarter.
Non-linear sales patterns make business planning difficult, and increase the
risk that our quarterly results will fluctuate due to disruptions in
functions such as manufacturing, order management, information systems, and
shipping.
WARRANTIES AND INTERNATIONAL REQUIREMENTS
Because 3Com products are often covered by warranties, we may be subject to
contractual and/or legal commitments to perform under such warranties. If our
products fail to perform as warranted and we do not resolve product quality
or performance issues in a timely manner, our operating results or financial
condition could be adversely affected. Likewise, if we fail to meet
commitments related to the installation of networks, we could be subject to
claims for business disruption or consequential damages if a network
implementation is not successfully or timely completed.
Our products are sold and marketed in many countries, and as such, our
products must function in and meet the requirements of many different
telecommunications environments and be compatible with various
telecommunications systems and products. If our products fail to meet the
requirements of international telecommunication environments, our sales could
be negatively impacted.
23
<PAGE>
SUPPLY CHAIN MANAGEMENT
Some key components of our products are currently available only from single
or limited sources. Likewise, some services on which we rely are furnished
from single or limited service providers. In addition, some of our suppliers
are also competitors. While we generally have been able to obtain adequate
supplies of components from existing sources, we cannot be certain that in
the future our suppliers will be able to meet our demand for components in a
timely and cost-effective manner. For example, within the electronics
industry, we are experiencing a shortage in the availability of certain
components. Our operating results, financial condition, or customer
relationships could be adversely affected by these shortages. These adverse
effects could result from an inability to fulfill customer demand or
increased costs to acquire key components or services.
We are working to significantly reduce our supply chain cycle time, from
ordering raw materials, to manufacturing products and delivering the products
to customers. For example, in our continual effort to streamline supply chain
operations, we sold our Salt Lake City, Utah manufacturing facility in
November 1999 to Manufacturers' Services Ltd. ("MSL"). Palm handheld
computing products and our mobile connectivity products are manufactured in
this facility. MSL will now manufacture these products for 3Com. We have a
limited operating history with MSL. The cost, quality, and availability of
third-party manufacturing operations are essential to the successful
production and sale of many of 3Com's products. The inability of any third
party manufacturer to meet our cost, quality, and availability standards
could adversely impact 3Com's financial condition or results of operations.
Changes to our supply chain processes may cause us to experience temporary
disruptions in our ability to ship products timely to our customers, and our
financial condition or results of operations may be negatively impacted as a
result.
COMMERCIAL COMMITMENTS
We sometimes enter into minimum quantity or other non-cancelable commitments.
If sales volumes fluctuate significantly, our obligation to meet commitments
could adversely affect our results of operations or financial condition.
INTELLECTUAL PROPERTY RIGHTS
Many of 3Com's competitors, such as telecommunications and computer equipment
manufacturers, have large intellectual property portfolios, including patents
that may cover technologies that are relevant to our business. In addition,
many smaller companies, universities, and individual inventors have obtained
or applied for patents in areas of technology that may relate to our
business. The industry is moving towards aggressive assertion, licensing, and
litigation of patents and other intellectual property rights.
In the course of our business, we frequently receive claims of infringement
or otherwise become aware of potentially relevant patents or other
intellectual property rights held by other parties. We evaluate the validity
and applicability of these intellectual property rights, and determine in
each case whether we must negotiate licenses or cross-licenses to incorporate
or use the proprietary technologies, protocols, or specifications in our
products. If we are unable to obtain and maintain licenses on favorable terms
for intellectual property rights required for the manufacture, sale, and use
of our products, particularly those which must comply with industry standard
protocols and specifications to be commercially viable, our business, results
of operations, or financial condition could be adversely impacted.
24
<PAGE>
In addition to disputes relating to the validity or alleged infringement of
other parties' rights, we may become involved in disputes relating to our
assertion of our intellectual property rights. Whether we are defending the
assertion of intellectual property rights against us or asserting our
intellectual property rights against others, intellectual property litigation
can be complex, costly, protracted, and 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 this litigation could subject us to
significant liabilities and costs. In addition, if we are the alleged
infringer, we could be required to seek licenses from others or be prevented
from manufacturing or selling our products, which could cause disruptions to
our operations or the markets in which we compete. If we are asserting our
intellectual property rights, we could be prevented from stopping others from
manufacturing or selling competitive products. Any one of these factors could
adversely affect our results of operations or financial condition.
PROPOSED CHANGES IN ACCOUNTING FOR BUSINESS COMBINATIONS AND INTANGIBLE ASSETS
The Financial Accounting Standards Board (FASB) began deliberation of
revisions to the rules for business combinations and intangible assets in
1996. Some of these deliberations have included accounting rule-making bodies
from other nations as the financial communities attempt to develop global
consistency where possible. Business combination rules govern the accounting
for mergers and acquisitions used in either a purchase or a
pooling-of-interests combination. Business combinations may generate
intangible assets (including goodwill) which represent the excess purchase
price of an acquired enterprise over net identifiable assets.
Tentative conclusions of the FASB will prohibit the use of
pooling-of-interests and will establish new accounting standards and
financial presentation for intangible assets resulting from business
combinations. The FASB expects to issue a final standard by the end of
calendar year 2000. Changes to the current accounting rules for business
combinations and intangible assets will not preclude mergers or acquisitions
but may increase the earnings dilution associated with future transactions.
In addition, if pooling-of-interests accounting is no longer available, we
may use cash more often than our common stock to pay for acquisitions of
other companies.
FLUCTUATIONS IN QUARTERLY RESULTS
3Com's quarterly operating results are difficult to predict and may fluctuate
significantly. A wide variety of factors can cause these fluctuations,
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;
- industry consolidation, acquisitions, or litigation;
- disruption in the distribution channel; and
- timing of orders received within the quarter.
In recent years, as the consumer mix of our business has grown, our third
fiscal quarter has been a seasonally weaker period characterized by
sequentially lower sales. We expect this pattern to continue in fiscal 2000.
In the past few years, our financial results in the third quarter of our
fiscal year have been disappointing. These factors, and accompanying
fluctuations in periodic operating results, could have a significant adverse
impact on the market price of our common stock.
25
<PAGE>
COMPETITION FOR KEY PERSONNEL
Our success depends to a significant extent upon a number of key employees
and management. Recently, we have experienced an increased rate of employee
turnover compared to historical levels. The loss of the services of key
employees could adversely affect our product introduction schedules, customer
relationships, operating results, or financial condition. Recruiting and
retaining skilled personnel, including engineers, is highly competitive.
There has been a dramatic increase of technology start-up companies
recruiting for the same talent that 3Com requires. If we cannot successfully
recruit and retain skilled personnel, our ability to compete may be adversely
affected. In addition, we must carefully balance the growth of our employees
commensurate with our anticipated sales growth. If our sales growth or
attrition levels vary significantly, our results of operations or financial
condition could be adversely affected. Further, 3Com's common stock price has
been, and may continue to be, extremely volatile. When the 3Com common stock
price is less than the exercise price of stock options granted to employees,
turnover is likely to increase, which could adversely affect our results of
operations or financial condition.
YEAR 2000 READINESS DISCLOSURE
As is true for most companies, 3Com faces a risk from the Year 2000 issue. We
intend for some of our disclosures and announcements concerning our products
and Year 2000 programs, including those in this report on Form 10-Q, to
constitute "Year 2000 Readiness Disclosures" as defined in the Year 2000
Information and Readiness Disclosure Act.
While not all Year 2000-date related disruption scenarios have been
experienced, and there is a possibility of disruptions in the future, through
the date of this report, the Company has experienced no material disruption
or other significant problems. We are continuing to evaluate and mitigate our
exposure in areas where appropriate. Based on currently available
information, management continues to believe that Year 2000-related
disruptions or other problems, if any, will not have a significant adverse
impact on our operational results or financial condition. However, we cannot
be certain that Year 2000 issues will not have a material adverse impact on
us, since our evaluation process is not yet complete and it is early in the
year 2000.
STATE OF READINESS AND RISKS. 3Com has identified four key exposure areas
within 3Com with respect to the Year 2000 issue, namely: key transaction
processing applications, equipment and facilities, 3Com products, and key
suppliers. As of the date of this report, the following impacts to 3Com of
the Year 2000 date rollover have been observed:
KEY TRANSACTION-PROCESSING APPLICATIONS. Key transaction processing
applications include those used to run 3Com's business, such as finance,
manufacturing, order processing and distribution. No errors were reported
immediately after or since the Year 2000 date rollover. Applications will
continue to be monitored for the next several weeks and over the Leap Year
date to confirm continued correct date processing. If we identify significant
new non-compliance issues or encounter unexpected difficulties in areas
previously considered to be Year 2000 ready, our ability to conduct our
business or record transactions could be disrupted, which could adversely
affect our results of operations or financial condition.
EQUIPMENT AND FACILITIES. To date, we have not experienced any Year
2000-related failures in critical equipment or facilities. If we encounter
any unexpected difficulties in areas previously considered being Year 2000
ready, our production, design, and shipping capabilities could be disrupted,
which could adversely affect our results of operations or financial condition.
26
<PAGE>
PRODUCTS. To date, we are not aware of any Year 2000-related date processing
errors regarding supported 3Com products. If any of our products do not
operate properly in the Year 2000, we could have increased warranty costs,
customer satisfaction issues, litigation or other material costs and
liabilities, which could adversely affect our results of operations or
financial condition.
KEY SUPPLIERS. To date, there have been no Year 2000-related failures in the
receipt of key raw materials, components, products, or services. If key
suppliers fail to adequately address the Year 2000 issue for the products or
services they provide to 3Com, critical materials, products and services may
not be delivered in a timely manner, which could adversely affect our results
of operations or financial condition.
MOST REASONABLY LIKELY WORST-CASE SCENARIO. We believe that our most
reasonably likely worst-case Year 2000 scenario would relate to problems with
the systems and services of third parties rather than with 3Com's internal
systems or products. 3Com cannot identify all possible disruption scenarios.
Contingency plans for critical business operations are in place. These plans
will continue to be validated and modified as needed, and as we learn about
disruptions, if any, caused by the Year 2000 date rollover.
COSTS TO ADDRESS YEAR 2000 ISSUES. Through November 26, 1999, we have spent
$10.6 million on the program. Although we have incurred additional costs,
primarily for increased staffing in our customer service organization to
address potential Year 2000 issues and premium pay and bonuses for employees
working during the Year 2000 date rollover period, we believe that the
majority of our Year 2000 costs have already been incurred.
We had previously estimated an additional $6 million to $15 million for
contingencies related to Year 2000 issues. While it is still early in the
year 2000, preliminary indications are that actual costs for these
contingencies will be much lower. We have not included in the total cost
estimate any costs associated with potential Year 2000 litigation exposure
since these costs are not estimable. We have adequate funds to pay for the
expected costs of Year 2000 programs. To date, we have not deferred any
significant internal information technology projects due to our Year 2000
efforts.
SALES IMPACT. Year 2000 readiness has been 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 have devoted a substantial portion of their
information systems' spending to fund such upgrades and modifications and
divert spending away from networking solutions. In addition, some companies
have deferred spending on networking solutions while they tested and ensured
the stability of their current network configurations. Such changes in
customers' spending patterns could adversely affect our sales, operating
results, or financial condition, particularly in our third fiscal quarter.
LIQUIDITY AND CAPITAL RESOURCES
Cash and equivalents and short-term investments at November 26, 1999 were
$2.0 billion, an increase of $349.9 million or 21 percent compared to the
balance of $1.7 billion at May 28, 1999.
For the six months ended November 26, 1999, net cash generated from operating
activities was $826.5 million. Accounts receivable at November 26, 1999
decreased $195.2 million from May 28, 1999 to $730.4 million. Days sales
outstanding in receivables decreased to 45 days at November 26, 1999,
compared to 59 days at May 28, 1999 primarily due to a lower percentage of
sales in the last month of the November quarter compared to the last month of
the May quarter. Inventory levels at November 26, 1999 decreased $32.8
million from May 28, 1999 to $321.5 million. Annualized inventory turnover
was 9.4 turns for the quarter ended November 26, 1999, compared to 8.2 turns
for the quarter ended May 28, 1999.
27
<PAGE>
As part of our 3Com Ventures initiative, we selectively make strategic
investments in the equity securities of privately held companies. For those
securities which have become publicly-traded, we have marked the cost basis
to market. During the six months ended November 26, 1999, 3Com's investments
in the equity securities of privately-held and publicly-traded companies
increased by $755.8 million, primarily due to market value appreciation of
our investments in publicly-traded companies.
During the six months ended November 26, 1999, 3Com made $93.2 million in
capital expenditures. Major capital expenditures included upgrades and
expansion of our facilities and purchases and upgrades of software and
computer equipment. As of November 26, 1999, we had approximately $39.9
million in capital expenditure commitments outstanding primarily associated
with the expansion of our facilities and purchases and upgrades of software
and computer equipment. In addition, we have commitments related to operating
lease arrangements in the U.S., under which we have 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, 3Com retains an obligation for the shortfall,
subject to certain provisions of the lease.
During the first six months of fiscal 2000, the board of directors authorized
the repurchase of an additional 25 million shares of 3Com's common stock. The
share authorization will be used for purchases of our common stock made in
the open market from time to time or the sale of put options on our common
stock. During the first six months of fiscal 2000, we repurchased 20.5
million shares of our common stock at a total purchase price of $540.7
million. During the second quarter of fiscal 2000 we initiated a program of
selling put options on our common stock. Each put option entitles the holder
to sell one share of our common stock to us at a specified price. During the
second quarter of fiscal 2000, we realized proceeds of $4.9 million from the
sale of put options covering 1.7 million shares of our common stock. The put
options have an average exercise price of $29.14 per share and expire in
January 2000. For purposes of determining the number of authorized shares
remaining for repurchase, the sale of one put option is counted as the
repurchase of one share. As of November 26, 1999, the remaining number of
shares authorized for repurchase was 8.0 million shares.
During the six months ended November 26, 1999, we received net cash of $50.5
million from the sale of our common stock to employees through our employee
stock purchase and option plans.
3Com had a $100 million revolving bank credit agreement, which expired
December 20, 1999 and was not replaced or renewed.
During the six months ended November 26, 1999, we repaid $12 million of
borrowings under the 7.52% Unsecured Senior Notes agreement. As of November
26, 1999, $24 million of this debt remained outstanding, of which $12 million
is classified as current.
During the first six months of fiscal 2000, we recorded a tax benefit on
stock option transactions of $21.3 million. During the same six month period
one year ago, we recorded a tax benefit on stock option transactions totaling
$19.1 million.
Based on current plans and business conditions, we believe that our existing
cash and equivalents, short-term investments, and cash generated from
operations will be sufficient to satisfy anticipated cash requirements for at
least the next twelve months.
28
<PAGE>
EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants issued
Statement of Position No. 98-1 ("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 requires
that entities capitalize certain costs related to internal-use software if
certain criteria are met. 3Com adopted SOP 98-1 for our fiscal year ending
June 2, 2000. The adoption of SOP 98-1 did not have a significant impact on
our financial results for the quarter ended November 26, 1999.
In June 1998 and June 1999, the Financial Accounting Standards Board (FASB)
issued SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities" and SFAS 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133." These
statements require 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.
These statements will be effective for 3Com's fiscal year ending May 31,
2002. We believe that the adoption of these statements will not have a
significant impact on our financial results.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
3Com holds a substantial portfolio of marketable-equity traded securities
that have a short trading history and are highly subject to market price
volatility. Equity security price fluctuations of plus or minus 15 percent
would have a $127.8 million impact on the value of these securities as of the
end of the second quarter of fiscal 2000. Equity security price fluctuations
of plus or minus 50 percent would have a $426.1 million impact on the value
of these securities as of the end of the second quarter of fiscal 2000.
For interest rate sensitivity and foreign currency exchange risk, reference
is made to Part II, Item 7A, Quantitative and Qualitative Disclosures About
Market Risk, in our Annual Report on Form 10-K for the year ended May 28,
1999.
29
<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are a party to lawsuits in the normal course of our business. Litigation
in general, and intellectual property and securities litigation in
particular, can be expensive and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult to predict.
We believe that we have defenses in each of the cases set forth below and are
vigorously contesting each of these matters. An unfavorable resolution of one
or more of the following lawsuits could adversely affect our business,
results of operations, or financial condition.
SECURITIES LITIGATION
On March 24 and May 5, 1997, 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 3Com 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 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 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 plaintiffs have filed an amended complaint. 3Com has
filed an answer to the amended complaint. The trial is scheduled for October
2000.
In December 1997, a 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. Several
similar actions have been consolidated into this action, including FLORIDA STATE
BOARD OF ADMINISTRATION AND TEACHERS RETIREMENT SYSTEM OF LOUISIANA V. 3COM
CORPORATION, ET AL., Civil Action No. C-98-1355. On August 17, 1998, the
plaintiffs filed a consolidated amended complaint which alleges violations of
the federal securities laws, specifically Sections 10(b) and 20(a) of the
Securities and Exchange Act of 1934, and which seeks unspecified damages on
behalf of a purported class of purchasers of 3Com common stock during the period
from April 23, 1997 through November 5, 1997. In July 1999, the court dismissed
the complaint and granted the plaintiffs the right to file an amended complaint.
Plaintiffs have filed an amended complaint, and defendants have filed a motion
to dismiss.
In October 1998, a securities class action lawsuit, captioned ADLER V. 3COM
CORPORATION, ET AL., Civil Action No. CV777368 (ADLER), was filed against 3Com
and certain of its officers and directors in the California Superior Court,
Santa Clara County, asserting the same class period and factual allegations as
the REIVER action. The complaint alleges violations of Sections 25400 and 25500
of the California Corporations Code and seeks unspecified damages. The action is
in discovery. No trial date has been set.
In October 1998, two shareholder derivative actions purportedly on behalf of
3Com, captioned SHAEV V. BARKSDALE, ET AL., Civil Action No. 16721-NC, and BLUM
V. BARKSDALE, ET AL., Civil Action No. 16733-NC, were filed in Delaware Chancery
Court. The complaints allege that 3Com's directors breached their fiduciary
duties to 3Com through the issuance of and disclosures concerning director stock
options. 3Com is named solely as a nominal defendant, against whom the
plaintiffs seek no recovery. 3Com and the individual defendants filed a motion
to dismiss, and on October 25, 1999, the Court issued an order dismissing these
actions.
30
<PAGE>
On May 11, 1999, a securities class action, captioned GAYLINN V. 3COM
CORPORATION, ET AL., Civil Action No. C-99-2185 MMC (GAYLINN), 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. Several similar
actions have been consolidated into the GAYLINN action. On September 10, 1999,
the plaintiffs filed a consolidated complaint which 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 September 22,
1998 through March 2, 1999. 3Com has filed a motion to dismiss.
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 captioned: 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 Xerox United States patent relating
to computerized interpretation of handwriting. The complaint seeks unspecified
damages and injunctive relief. Xerox has asserted that Graffiti-Registered
Trademark- software and certain products of Palm Computing, Inc. infringe the
patent. On June 25, 1999, the Court stayed the action pending reexamination of
the patent by the U.S. Patent and Trademark Office. On December 15, 1999, we
received a Notice of Intent to Issue Reexamination Certificate from the United
States Patent and Trademark Office stating that the reexamination has been
terminated and that a certificate will be issued in due course. The notice
stated that the certificate will indicate that there will be no changes to the
patent specification or drawings and that all claims of the patent will be
confirmed without any changes. On December 16, 1999, both we and Xerox
separately wrote the court requesting that the stay of the action be lifted. The
parties are awaiting the scheduling of a status conference with the court.
COMMERCIAL LITIGATION
On November 4, 1999, a lawsuit was filed against 3Com by Disney Interactive,
Inc. ("DI") in the Superior Court of the State of California, Los Angeles
County, Case No. BC219663, alleging breach of a purported contract for the
bundling of DI video products with 3Com modems. The complaint asserts that DI is
seeking damages in excess of $15 million. The case is in discovery. No trial
date has yet been set.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The Annual Meeting of Shareholders was held on September 23,
1999.
(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:
<TABLE>
<CAPTION>
<S> <C> <C> <C>
PROPOSAL I FOR WITHHELD BROKER NON-VOTES
Election of Directors:
Casey G. Cowell 308,896,702 6,574,318 0
David W. Dorman 309,124,492 6,346,528 0
Jean-Louis Gassee 309,123,028 6,347,992 0
Paul G. Yovovich 309,086,251 6,384,769 0
William F. Zuendt 309,159,762 6,311,258 0
</TABLE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
PROPOSAL II FOR AGAINST ABSTAIN BROKER NON-VOTES
To ratify the appointment of Deloitte
& Touche LLP as the Company's
independent public accountants for
the fiscal year ending June 2, 2000: 311,318,844 2,730,899 1,421,277 0
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
<TABLE>
<CAPTION>
(a) Exhibits
Exhibit
Number Description
------- -----------
<S> <C>
3.1 Certificate of Incorporation (11)
3.2 Certificate of Correction Filed to Correct a Certain Error in
the Certificate of Incorporation (11)
3.3 Certificate of Merger (11)
3.4 Corrected Certificate of Merger (14)
3.5 Bylaws of 3Com Corporation, As Amended (12)
4.1 Amended and Restated Rights Agreement dated December 31, 1994
(Exhibit 10.27 to Form 10-Q) (4)
4.2 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 (5)
4.3 Amendment to amended and restated note agreements between 3Com
Corporation, Metropolitan Life Insurance Company, The
Northwestern Mutual Life Insurance Company, and Metropolitan
Property and Casualty Insurance Company (13)
4.4 Second amendment to amended and restated note agreements
between 3Com Corporation, Metropolitan Life Insurance Company,
The Northwestern Mutual Life Insurance Company, and
Metropolitan Property and Casualty Insurance Company (14)
10.1 1983 Stock Option Plan, as amended (14)*
10.2 Amended and Restated Incentive Stock Option Plan (2)*
32
<PAGE>
<S> <C>
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) (6)*
10.5 3Com Corporation Director Stock Option Plan, as amended
(Exhibit 19.3 to Form 10-Q) (3)*
10.6 Amended 3Com Corporation Director Stock Option Plan (Exhibit
10.8 to Form 10-Q) (6)*
10.7 3Com Corporation Restricted Stock Plan, as amended (Exhibit
10.17 to Form 10-Q) (6)*
10.8 1994 Stock Option Plan, as amended (14)*
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) (8)
10.10 Purchase Agreement between BNP Leasing Corporation, and 3Com
Corporation, effective as of November 20, 1996 (Exhibit 10.38
to Form 10-Q) (8)
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) (7)
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) (10)
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)
(10)
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) (10)
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 (9)
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 (11)
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 (11)
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 (11)
10.19 Purchase agreement between BNP Leasing Corporation and 3Com
Corporation, effective as of July 29, 1997 for the Marlborough
site (11)
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 (11)
10.21 Purchase Agreement between BNP Leasing Corporation, and 3Com
Corporation, effective as of August 11, 1997 for the Rolling
Meadows site (11)
10.22 First Amendment to Credit Agreement (11)
27.1 Financial Data Schedule
- -------------------------------------------------------------------------------
* Indicates a management contract or compensatory plan.
</TABLE>
33
<PAGE>
(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-Q filed on January 10, 1992
(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 on January 13, 1995
(File No. 0-12867)
(5) 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)
(6) 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)
(7) 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 October 11, 1996 (File No. 333-13993)
(8) 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)
(9) 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)
(10) 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)
(11) 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)
(12) Incorporated by reference to the Exhibit identified
in parentheses previously filed as an Exhibit to
Registrant's Form 10-Q filed on January 11, 1999
(File No. 0-12867)
(13) Incorporated by reference to the Exhibit identified
in parentheses previously filed as an Exhibit to
Registrant's Form 10-K filed on August 17, 1999 (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 8, 1999 (File
No. 0-12867)
(b) Reports on Form 8-K
None.
34
<PAGE>
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 10, 2000 By: /s/ Christopher B. Paisley
---------------------- -----------------------------------------
Christopher B. Paisley
Senior Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer)
35
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-02-2000
<PERIOD-END> NOV-26-1999
<CASH> 1,095,611
<SECURITIES> 915,892
<RECEIVABLES> 730,395
<ALLOWANCES> 106,514
<INVENTORY> 321,461
<CURRENT-ASSETS> 3,998,447
<PP&E> 1,577,222
<DEPRECIATION> 801,111
<TOTAL-ASSETS> 4,980,367
<CURRENT-LIABILITIES> 1,393,201
<BONDS> 0
0
0
<COMMON> 1,368,104
<OTHER-SE> 2,150,228
<TOTAL-LIABILITY-AND-EQUITY> 4,980,367
<SALES> 2,862,406
<TOTAL-REVENUES> 2,862,406
<CGS> 1,527,944
<TOTAL-COSTS> 2,148,744
<OTHER-EXPENSES> 311,875
<LOSS-PROVISION> 6,000
<INTEREST-EXPENSE> 1,022
<INCOME-PRETAX> 444,043
<INCOME-TAX> 129,309
<INCOME-CONTINUING> 314,816
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 314,816
<EPS-BASIC> 0.90
<EPS-DILUTED> 0.89
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