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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
[X] EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MAY 31, 1998 COMMISSION FILE NO. 0-12867
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
[ ] EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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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
SANTA CLARA, CALIFORNIA 95052
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (408) 326-5000
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK, $.01
PAR VALUE.
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
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INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405
OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS
FORM 10-K. [X]
THE AGGREGATE MARKET VALUE OF THE REGISTRANT'S COMMON STOCK HELD BY
NON-AFFILIATES, BASED UPON THE CLOSING PRICE OF THE COMMON STOCK ON JULY 27,
1998, AS REPORTED BY THE NASDAQ NATIONAL MARKET, WAS APPROXIMATELY
$9,205,886,000. SHARES OF COMMON STOCK HELD BY EACH EXECUTIVE OFFICER AND
DIRECTOR AND BY EACH PERSON WHO OWNS 5% OR MORE OF THE OUTSTANDING COMMON STOCK,
BASED ON SCHEDULE 13G FILINGS, HAVE BEEN EXCLUDED SINCE SUCH PERSONS MAY BE
DEEMED AFFILIATES. THIS DETERMINATION OF AFFILIATE STATUS IS NOT NECESSARILY A
CONCLUSIVE DETERMINATION FOR OTHER PURPOSES.
AS OF JULY 27, 1998, 358,558,817 SHARES OF THE REGISTRANT'S COMMON STOCK WERE
OUTSTANDING.
THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FOR THE ANNUAL MEETING OF
STOCKHOLDERS TO BE HELD ON SEPTEMBER 24, 1998 IS INCORPORATED BY REFERENCE IN
PART III OF THIS FORM 10-K TO THE EXTENT STATED HEREIN.
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3COM CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED MAY 31, 1998
TABLE OF CONTENTS
PART I PAGE
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Item 1. Business...................................................... 1
Item 2. Properties.................................................... 10
Item 3. Legal Proceedings............................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........... 13
Executive Officers of the Registrant ......................... 13
PART II
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Item 5. Market for Registrant's Common Stock and Related
Stockholder Matters......................................... 17
Item 6. Selected Financial Data....................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 19
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.... 32
Item 8. Financial Statements and Supplementary Data................... 34
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 61
PART III
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Item 10. Directors and Executive Officers of 3Com Corporation.......... 61
Item 11. Executive Compensation........................................ 61
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 61
Item 13. Certain Relationships and Related Transactions................ 61
PART IV
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Item 14. Exhibits, Financial Statement Schedule, and Reports on
Form 8-K.................................................... 61
Exhibit Index................................................. 62
Signatures.................................................... 65
Financial Statement Schedule.................................. S-1
3Com, 3ComImpact, AccessBuilder, EtherLink, HotSync, Megahertz, NETBuilder,
OfficeConnect, Palm Computing, Parallel Tasking, SuperStack, Transcend and U.S.
Robotics are registered trademarks of 3Com Corporation or its subsidiaries.
Bigpicture, CoreBuilder, Courier, DynamicAccess, HiPer, Palm III, PalmPilot,
PathBuilder, Total Control, and x2 are trademarks of 3Com Corporation or its
subsidiaries. Other product and brand names may be trademarks or registered
trademarks of their respective owners.
i
This Annual Report on Form 10-K contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21(e) of the Securities Exchange Act of 1934, as amended. These statements
include, but are not limited to statements concerning expected price erosion,
the Company's plans to make acquisitions or strategic investments, the Company's
expectations of progress toward the long-term financial model, the Company's
expectation of increased sales to original equipment manufacturers, and the
Company's plans to improve and enhance existing products and develop new
products.
The forward-looking statements of 3Com Corporation are subject to risks and
uncertainties. Some of the factors that could cause future results to materially
differ from the Company's recent results or those projected in the
forward-looking statements include, but are not limited to, significant
increases or decreases in demand for the Company's products, increased
competition, lower prices and margins, failure to successfully develop and
market new products and technologies, competitors introducing superior products,
continued industry consolidation, failure to effectively integrate acquired
companies and products, declining industry growth rates, failure to effectively
manage sales of the Company's products through distributors, resellers and
original equipment manufacturers (OEMs), failure to manage the amount of product
in distributors' and resellers' inventory, failure to secure supply of key
component parts, instability and currency fluctuations in international markets,
failure to fulfill product orders in a timely and effective manner, product
defects, failure to secure intellectual property rights, results of litigation,
and failure to retain and recruit key employees. For a more detailed discussion
of certain risks associated with the Company's business, see the "Business
Environment and Risk Factors" section of this Form 10-K. The Company undertakes
no obligation to update forward-looking statements to reflect events or
circumstances occurring after the date of this Form 10-K.
PART I
ITEM 1. BUSINESS
3Com Corporation was founded on June 4, 1979 and pioneered the networking
industry. Over the years, 3Com and its subsidiaries ("3Com" or "the Company")
have evolved from a supplier of discrete networking products to a broad-based
supplier of local area network (LAN) and wide area network (WAN) systems. With
an emphasis on connectivity from the edge to the core of the network, 3Com
offers customers a broad range of networking solutions that include switches,
hubs, remote access systems, routers, network management software, network
interface cards (NICs), modems and handheld connected organizers. 3Com has
structured its business, products, marketing and sales to address four key
customer markets: large enterprise - typically with more than 500 users,
including the corporate, education, retail, health care and government sectors;
small/medium enterprise - those organizations with 25-500 users; consumer/small
office, home office (SOHO); and carrier/service provider - including traditional
telecommunication providers, competitive local exchange carriers and Internet
service providers.
3Com's name is derived from its focus on computer communication compatibility.
Since its inception, the Company has been a leader in defining, shaping and
promoting the growth of networking infrastructures that transmit information
across the enterprise or the Internet quickly and reliably. Currently, the
networking industry is undergoing a profound shift of emphasis from parallel
networks - separate data, voice and video infrastructures running side by side -
to converged networks that integrate all communications onto a single network
infrastructure. The Company intends to be the leading provider of converged
networking technologies and solutions. A key element of the Company's strategy
is to make networks faster, more intelligent, and fundamentally easier to
design, install, maintain and upgrade.
Since 1992, 3Com has augmented its internal growth by actively pursuing a course
of strategic acquisitions to expand its distribution capabilities, technologies
and product offerings. From fiscal years 1993 through 1997, the Company acquired
several companies to further its technological growth and market position,
primarily in enterprise networking. Of particular note, the acquisitions of
Synernetics, Inc., NiceCom, Ltd., Chipcom Corporation, AXON Networks, Inc. and
OnStream Networks, Inc. enhanced 3Com's product offerings in LAN and WAN
Asynchronous Transfer Mode (ATM), Fiber Distributed Data Interface (FDDI) and
Ethernet switching, enterprise remote access and remote network management and
monitoring (RMON2).
1
In the first quarter of fiscal 1998, the Company merged with U.S. Robotics
Corporation (U.S. Robotics), the leading supplier of products and systems for
accessing information across the wide area network, including modems and remote
access products. The merger was accounted for as a pooling-of-interests and was
valued at approximately $6.6 billion on the date the acquisition was announced.
The two companies' complementary capabilities and leadership position in their
respective areas has created a single networking company with the ability to
deliver integrated end-to-end LAN and WAN solutions to the broadest set of
customers in the industry.
In the fourth quarter of fiscal 1998, the Company acquired Lanworks
Technologies, Inc., a leading provider of PC network boot technologies and
products. PC network boot technologies are critical for remote desktop
management, which includes activities such as automated configuration of PCs
upon start-up. This acquisition was valued at $13.0 million and was accounted
for as a purchase.
The Company's acquisition strategy is consistent with the current trend of
consolidation in the networking industry. Such consolidation is expected to
continue.
During fiscal 1998 the Company announced a joint development agreement with
Siemens AG's (Siemens) Public Communications Networks Group to produce a
multi-service central office switch for carriers and service providers, as well
as the industry's first stackable voice/data networking solutions for enterprise
environments. In addition, each company will resell certain of the other
company's products. In 1998, the Company also entered into a strategic agreement
with Newbridge Networks Corporation (Newbridge) to develop and deploy
next-generation, end-to-end networks supporting converged voice, video and data
applications that employ standards-based techniques for network traffic
prioritization and policy control. The agreement with Newbridge provides 3Com
with industry-leading ATM WAN switching capabilities. In addition, 3Com's Palm
Computing(R) business unit established strategic relationships with IBM to
manufacture the WorkPad PC companion and with QUALCOMM to develop wireless
communications products that are compatible with the Palm Computing platform.
3Com's products are primarily distributed and serviced worldwide through 3Com
and systems integrators, value-added resellers (VARs), national resellers and
dealers, distributors and OEMs. Certain products, such as analog and digital
modems, NICs, handheld connected organizers, hubs, low-end switches, and the
Network Starter Kit, are also sold through electronics catalogs and retailers.
The Company also has a direct sales organization focused on large enterprise and
carrier/service provider customers worldwide.
The Company's objective is to maintain a leading market share position in the
product areas in which it competes. In fiscal 1998 the Company maintained or
extended its leadership as the number one global provider of NICs, modems,
workgroup switches, remote access concentrators, hubs and handheld connected
organizers, according to various industry sources.
In fiscal 1998 the Company announced and/or introduced a number of new products
and enhancements to refresh its traditional product lines as well as a
significant number of new offerings incorporating emerging technologies. New
products and enhancements address each of the Company's four primary markets,
and include:
Large Enterprise
+ CoreBuilder(TM) line of High-Function Layer 3 switches
+ SuperStack(R) II line of switches and hubs that support migration to
Fast Ethernet (100 megabits per second (Mbps) Ethernet) and Gigabit
Ethernet (1000 Mbps Ethernet)
+ PathBuilder(TM) ATM WAN access switches
+ A single-chip version of the 3Com Fast EtherLink(R) 10/100 Mbps NIC
+ 3Com Policy-Based Management Solution, an enterprise-wide network
traffic prioritization package based on the Company's Transcend(R)
network management and control solutions
+ Hardware and software enhancements to NETBuilder(R) routers to enable
next-generation intranets and Virtual Private Networks (VPNs)
2
Small/Medium Enterprise
+ SuperStack II hubs and switches for price-sensitive, entry-level users
+ PathBuilder ATM WAN access switches A single-chip version of the 3Com
+ Fast EtherLink 10/100 Mbps NIC
+ OfficeConnect(R) small office solutions including Fast Ethernet hubs
and switches, an Integrated Services Digital Network (ISDN) LAN modem,
low port-count LAN switches, and NETBuilder routers
Consumer/SOHO
+ New modems, including the industry's first International
Telecommunications Union (ITU) standard-based V.90 56 kilobits per
second (Kbps) modems, the OfficeConnect ISDN LAN modems and
telephone-return cable modems
+ Palm III(TM) handheld connected organizer and Network HotSync(R)
remote synchronization capabilities for the PalmPilot(TM) Professional
+ Bigpicture(TM) video phone camera and Peripheral Component
Interconnect (PCI) capture card system for high-quality video calls
over the Internet or regular telephone lines
Carrier/Service Provider
+ Cable head-end equipment
+ Additions to the Total Control(TM) product line, including the new
higher-density Total Control HiPer(TM) Access System, HiPer Arc routing
software, and next-generation application capabilities, such as Voice
over Internet Protocol (IP)
+ New VPN systems, comprised of 3Com Transcend software and multiple
3Com network hardware products
+ PathBuilder WAN ATM carrier-class switch
The Company's principal competitive advantages lie in the depth and breadth of
its product lines, its ability to recognize and quickly respond to new trends in
networking (such as converged voice, video and data networks), its focus on
making all aspects of networking easier for customers, and a strong yet flexible
business infrastructure. 3Com has strong brand recognition across most of its
key markets, including NICs, modems, handheld connected organizers, workgroup
switches and hubs and remote access concentrators, which is transferable to
other product and technology areas and markets, such as core LAN switching, and
remote office and personal office internetworking platforms. Additionally, the
Company's low-cost manufacturing, worldwide presence, strong distribution
channel and comprehensive service and support capabilities allow it to take
advantage of market trends to extend the reach, scope and performance of current
networks.
INDUSTRY SEGMENT INFORMATION
3Com operates in one industry segment as described above.
PRODUCTS
3Com is committed to making networking pervasive. The Company strives to make
the complexities of networks invisible to end users and make networks easier to
design, install, maintain and upgrade. As the cornerstone of its commitment,
3Com has developed Transcend networking, a unique framework that uses
distributed intelligence embedded in products throughout the network to
cost-effectively manage networks for greater performance, scalability and
reliability.
With an emphasis on connectivity from the edge to the core of the network, 3Com
offers customers a broad range of networking solutions that include switches,
hubs, remote access systems, routers, NICs, modems and handheld connected
organizers. During fiscal 1998, 3Com refreshed a majority of its product lines
by upgrading platforms, introducing new technologies and extending product
families. Additionally, the Company committed to a unifying strategy to lead the
industry's evolution towards the convergence of voice and video onto a single
data network infrastructure.
The Company reports its business by two main product categories: Systems and
Client Access. Systems products include switches, hubs, routers, and remote
access products. Client Access products include NICs and modems. Handheld
connected organizers are included in the reported results of both the Systems
and Client Access categories.
3
SYSTEMS PRODUCTS
LAN Switching Platforms: In the large enterprise environment where the network
connects hundreds or thousands of users, 3Com switches provide cost-effective,
high-speed links between multiple network segments, simplifying network design
and reducing network latency in client/server networks. Switches can also
provide direct links to either the desktop or server, providing dedicated
capacity to high-bandwidth users. In small/medium-sized enterprises, switches
provide additional bandwidth to help businesses leverage information to maximize
productivity and support growth.
The Company incorporates internally developed application specific integrated
circuits (ASICs) into its switches as a central component of its switching
product strategy and believes this enables it to dramatically improve the
performance and reliability of its switches while reducing costs. 3Com switches
are available in either chassis (one box) or stackable (i.e. additional capacity
added with additional boxes) form factors and support the industry's migration
to higher speed switching technologies.
3Com offers a variety of switches tailored to suit the requirements of any
organization. The Company's OfficeConnect Ethernet/Fast Ethernet switches
combine simplicity of design, installation and operation with advanced
functionality and outstanding speed at a low cost. The Company's award-winning
SuperStack II switches include multiple products, each with appropriate port,
media and connectivity specifications to meet the needs of the network at the
workgroup, data center or backbone level.
To meet the requirements of the large enterprise LAN network backbone for
high-density connectivity, scalable capacity, reliability and network control,
the Company offers High-Function switches in its CoreBuilder product line.
CoreBuilder switches include the CoreBuilder 3500 Layer 3 switch, the
CoreBuilder 5000 multi-technology switching platform, CoreBuilder 2500 and 6000
Ethernet to FDDI, Fast Ethernet and ATM backbone switch, CoreBuilder 7000 and
7000HD ATM switches, and the flagship CoreBuilder 9000 high-bandwidth
aggregation switch.
WAN Switching Platform: For the large enterprise, carrier or service provider,
building or extending current networks to carry voice, video and data, the
Company's PathBuilder (formerly AccessBuilder(R) 9000) line of WAN switches
provides ATM multi-services integration.
Hub Platforms: Hubs act as concentrators of network traffic generated from the
desktop and define specific network segments, relaying the traffic either within
the workgroup or onto the network backbone. Unlike switches, each desktop
connected through a hub shares the total available bandwidth of the hub with
other users. Their relatively low cost per port, manageability and ease-of-use
make hubs a popular choice for workgroup connectivity in any enterprise
environment. Multiple hubs are frequently connected to a switch, which acts as a
"hub of a hub," to segment the network and improve overall performance.
The Company designs, manufactures and markets a full range of hubs for customers
of all sizes. For the small office or branch office, OfficeConnect Ethernet and
Fast Ethernet hubs offer simple, plug and play connectivity. The Company's
SuperStack II hubs offer a range of options for small, medium and large
enterprises, including: entry-level unmanaged hubs for small and medium-sized
offices; and flexible, mixed Ethernet, Fast Ethernet, and Token Ring workgroup
hubs and Gigabit Ethernet workgroup hubs for small to large-sized LANs.
Routers: Routers are protocol-dependent devices that connect sub-networks
together. 3Com offers a variety of backbone and remote office routers that
facilitate enterprise internetworking. For remote offices, SuperStack II
NETBuilder and OfficeConnect NETBuilder routers provide scalable, multi-protocol
links to remote branch offices of any size. For companies deploying extranets,
3Com has recently begun offering product bundles, which include the SuperStack
II NETBuilder routers and bridges and the OfficeConnect NETBuilder routers;
these bundles facilitate the deployment of VPNs. VPNs support large-scale access
for suppliers, partners, customers and branch offices at a substantial cost
savings over traditional WAN access charges.
4
Remote Access Platforms: Remote access products bring the benefits of the
network to remote users, including telecommuters, Internet and on-line users,
corporate suppliers, and a host of other users that access the network from a
distance. The Company's remote access products leverage 3Com's HiPer Digital
Signaling Processing (DSP) technology, a multi-function digital signal
processing engine that integrates sophisticated functionality on a single chip.
HiPer DSP enables the Company's remote access platforms to achieve
industry-leading port densities, (particularly critical in space constrained
carrier environments). HiPer DSP also provides the ability to reprogram the
Company's remote access systems to support new applications - including
encryption, video compression, LAN telephony and Voice over IP - without costly
hardware upgrades. 3Com's remote access offerings include three product lines
for carrier-class and enterprise remote access.
The SuperStack II Remote Access 3000 and 1500 product lines offer
high-performance remote access support for mid-sized enterprises or service
providers with multiple numbers of smaller points of presence (POPs). The
stackable format provides scalable, economical remote access connectivity with
full functionality. The SuperStack II remote access products are also
hot-swappable (i.e. the ability to add or exchange modules without taking the
system out of service) and incorporate multiple system-resiliency features.
The AccessBuilder 7000 Access Concentrator is a chassis-based, high-density
platform for service providers with large dial-up networks and for enterprises
building large-scale corporate intranets. It supports high-bandwidth links to
Ethernet LANs and offers hot-swappable modules and a robust fault-tolerant
architecture.
The Total Control Remote Access Concentrator is a very high-density platform for
carriers and large enterprises that offers channelized bandwidth supporting all
major analog and digital dial up techniques in a single chassis. Designed for
applications where network downtime must be minimized and remote user
performance maximized, the Total Control system offers hot-swappable modules,
dual redundant power supplies, standby modems, and a host of other reliability
features. Uses of Total Control range from providing central site or POP access
to networks for Internet service providers, on-line information services,
interexchange carriers and corporations, to transaction processing applications
such as credit card verification.
CLIENT ACCESS PRODUCTS
3Com's Client Access Products include NICs and modems. In both categories, 3Com
is the worldwide market leader according to various industry sources.
NICs: Network interface cards, also known as adapters, are add-in printed
circuit boards that allow network servers, personal computers, laptop computers
and workstations to connect to the LAN. 3Com NICs provide complete solutions for
a full range of network applications and environments. 3Com offers NICs for
Ethernet, Fast Ethernet, Gigabit Ethernet, Token Ring, FDDI and ATM
connectivity. Many NICs are available with combined connectivity to support the
networking industry's migration from Ethernet to Fast Ethernet for increased
bandwidth.
All 3Com NICs feature patented Parallel Tasking(R) architecture, which improves
network performance, and DynamicAccess(TM) software, which provides the NIC with
intelligence to help optimize overall network performance, management and
control.
Modems: Modems provide dial-up access to the Internet, enterprise LANs and a
host of communications services including fax. 3Com provides modems for desktop
and mobile users. The Company was first to market with modems that are compliant
with the ITU V.90 standard for 56 Kbps download capabilities. The V.90 standard
applies to pulse code modulation technology permitting downloading of data over
regular analog telephone lines at speeds up to 56 Kbps per second and requires
compatible phone lines and modems at server sites. All V.90 products are capable
of 56 Kbps downloads; however, due to Federal Communications Commission (FCC)
regulations, current download speeds are limited to 53 Kbps. Actual speeds may
vary. The Company also provides software to facilitate upgrade to new
technologies and capabilities and is designed to be easy to install and easy to
use. They have received numerous awards for reliable connectivity and high
performance. 3Com's modem products are designed based upon the Company's
proprietary data pump architecture and offer reliable connections in compliance
with virtually all official and most proprietary data communications standards.
Desktop modem products include the U.S. Robotics(R), Courier(TM) and
3ComImpact(R) brands.
5
Today, portable laptop and notebook computers have the processing power, storage
and displays that make them the primary computer for many users. For these
devices, 3Com offers smaller form-factor PC cards, which are available in
configurations for LAN access (NICs), WAN access (modems) and combined LAN+WAN
access (NIC and modem), as well as for wireless and ISDN connectivity. 3Com's
portable LAN and WAN PC card products are sold under the 3Com Megahertz(R)
brand.
HANDHELD CONNECTED ORGANIZERS
3Com's handheld connected organizers are a new category of computing: handheld
devices designed to work as companion products to desktop and laptop computers,
allowing information management both remotely and on the desktop. Individuals
may utilize the organizers to track a variety of information from appointments
and phone numbers to more specialized data, such as patient records or
construction specifications. In the enterprise setting, the organizers can be
used to enhance productivity, for example by providing mobile retrieval of key
data from corporate business applications such as finance, manufacturing or
sales automation systems. In addition, with add-on components such as a wireless
modem, these devices can be used by both consumer and enterprise users to access
information on the Internet.
The organizers include a docking cradle, which is connected to the user's mobile
or desktop computer, providing automatic back-up and seamless synchronization of
information between the handheld device and the larger computer, thus ensuring
that both systems have the most current information. The products also include
character recognition software that allows users to add and edit information
with a stylus, while away from the desktop.
The Company's market-leading handheld connected organizers include the PalmPilot
and Palm III models. Both the PalmPilot and the Palm III products are based upon
the Palm Computing operating system, which is supported by over 7,500
independent software developers producing a variety of applications, utilities
and games for the organizer products.
PRODUCT DEVELOPMENT
The Company develops its products in a manner consistent with its goal to make
networking pervasive by providing solutions that combine high performance with
ease of use. The Company's research and development expenditures were $581.6
million, $502.5 million and $337.8 million in fiscal years 1998, 1997 and 1996,
respectively.
3Com's ownership of core networking technologies creates opportunities to
leverage its engineering investments and develop more integrated products for
simpler, more powerful and more innovative networking solutions for customers in
each of its target markets: large enterprise, small/medium enterprise,
consumer/SOHO, and carrier/service provider. The Company plans to invest in
emerging technologies for use in existing and future products, as well as to
improve and enhance existing products to extend their useful lives, reduce
manufacturing costs and increase functionality.
The Company has a strong history of incorporating ASICs into its products to
provide key functions and the capacity for future upgrades. Customers are
thereby able to realize the benefits of new technologies and enhanced
capabilities through inexpensive, simple software upgrades rather than
expensive, disruptive hardware replacement. In addition, ASICs facilitate higher
density platforms - critical in certain applications, such as high-speed Layer 3
switching - and are less costly to manufacture. The Company incorporates ASIC
technology into many of its products, including NICs, switches, hubs, routers
and remote access equipment.
In addition to the development of custom ASICs to improve performance, increase
reliability and reduce costs, the Company is investing in the following key
areas: network management; Fast Ethernet, Gigabit Ethernet, ATM, Layer 3
switching and other high-speed networking technologies; virtual local area
network (VLAN) capabilities; convergence solutions such as Voice over IP and LAN
telephony; WAN access, ISDN and other remote-access technologies; enhanced
connectivity in major operating environments, including Windows and Windows NT;
and remote access for single and mobile users (including data-over-cable and
Asymmetric Digital Subscriber Line (ADSL) technologies).
The Company's modem and remote access products are designed using software
programs that run on digital signal processors and microprocessors. These
designs allow for rapid modification or addition of product features through
simple software downloads. As a result, the Company believes it is
well-positioned to exploit advances in technology and pass the benefits on to
customers quickly, introducing new features and improving performance faster and
at a lower cost than many of its competitors.
6
MARKETS AND CUSTOMERS
3Com's customers range from individual consumers of personal electronics to
large global corporations, and encompass companies in a wide variety of
industries, including finance, health care, manufacturing, telecommunications,
government, education, and retail. The Company's merger with U.S. Robotics gave
3Com a broader reach and more leverage across its four target markets: large
enterprise, small/medium enterprise, consumer/SOHO, and carrier/service
provider.
The Company's strong channel presence enables customers to gain access to 3Com
solutions through their supplier of choice. The Company's unparalleled retail
and reseller distribution channels provide ready access to the wide array of
3Com products and solutions on a worldwide basis. 3Com also works directly with
end users to establish long-term customer relationships.
Around the world, 3Com serves its customers through a variety of sales channels
including direct and indirect channels. Indirect channels include systems
integrators, VARs, distributors, national dealers and resellers, OEMs and retail
stores. 3Com nurtures these relationships with incentive and training programs
that have earned special recognition from the industry. The Company's
multi-channel sales strategy encourages broad market coverage by allowing 3Com
sales personnel to create demand for the Company's products while giving
customers the flexibility to choose the most appropriate delivery channels. As
of and for the year ended May 31, 1998, the Company had one customer which
accounted for 14 percent of total sales and 14 percent of total accounts
receivable. The same customer accounted for 13 percent and 12 percent of total
sales for the fiscal years ended May 31, 1997 and 1996, respectively.
International Operations: 3Com distinguishes itself from many of its competitors
with its dedicated research and development, manufacturing, sales and service
organizations outside the United States. During fiscal 1998, the Company
increased off-shore manufacturing capacity by opening a new plant in Singapore
and installing additional manufacturing lines in its Ireland facility. The
Company maintains approximately 190 sales offices in 48 countries. The Company
markets its products internationally primarily through subsidiaries, sales
offices and relationships with OEMs and distributors with local presence in
Europe, Canada, Asia Pacific and Latin America (see Note 15 of the Notes to
Consolidated Financial Statements).
Customer Service: Since global networking infrastructures are becoming
increasingly complex, customers require vendors to help them manage and support
their networks as well as design and build them. Additionally, as customers'
networking purchases transition from point-product to connectivity systems, a
more solutions-oriented approach to service and support is required. The Company
recognized these trends early and has invested in a comprehensive worldwide
service and support organization capable of providing 7-by-24 customer support.
3Com customer services include design, installation and maintenance on-site, by
phone, or across the Internet. The Company also offers web-based
customer-specific support. Additionally, the Company provides a wide variety of
training services, including on-site training and computer-based courses that
allow customers to learn networking technologies at their own pace. The Company
supports its customers internationally from more than 140 different locations,
including eight technical call centers communicating with customers in more than
15 languages.
BACKLOG
3Com manufactures its products based upon its forecast of worldwide customer
demand and builds finished products in advance of receiving firm orders from its
customers. Orders are generally placed by the customer on an as-needed basis and
products are usually shipped within one to four weeks after receipt of an order.
Such orders generally may be canceled or rescheduled by the customer without
significant penalty. Accordingly, the Company does not maintain a substantial
backlog, and backlog as of any particular date is not indicative of 3Com's
future sales.
7
MANUFACTURING
3Com has manufacturing facilities in Santa Clara, California; Mount Prospect and
Morton Grove, Illinois; Boxborough and Southborough, Massachusetts; Salt Lake
City, Utah; Blanchardstown, Ireland; and Changi, Republic of Singapore. The
Singapore manufacturing facility began operations in fiscal 1998 and is 3Com's
first production site in the Asia Pacific region. The plant is the first in
Singapore to manufacture networking equipment and will produce 3Com's full range
of high-volume products from NICs and modems to sophisticated enterprise
systems. Purchasing, mechanical assembly, burn-in, testing, final assembly, and
quality assurance functions are performed at all of these facilities. The
Company also procures certain products and subassemblies through subcontractors.
Over the past several years, the Company has been investing in automating its
manufacturing capabilities, decreasing the costs and increasing the quality of
both manufacturing design and production. In fiscal 1997, the Company commenced
construction of an additional 170,000 square feet of office, manufacturing, and
research and development space in Ireland, and commenced construction of the
first phase of development of the new manufacturing facility in Singapore. Both
facilities were completed and occupied during fiscal 1998. In fiscal 1998, the
Company commenced construction of a 525,000 square foot research and development
and manufacturing facility in Marlborough, Massachusetts, which will replace
several existing facilities, and is expected to be occupied in the fourth
quarter of fiscal 1999. The Company also began consolidation of two
manufacturing plants in the Chicago area into one facility.
COMPETITION
Networking is a fast-paced market within the information systems industry
encompassing both LAN and WAN technologies that enable communications and access
to information over data and voice network infrastructures. The Company
participates primarily in designing, manufacturing and marketing both LAN/WAN
products and systems. The evolution of high-speed network technologies including
Fast Ethernet, Gigabit Ethernet, ATM, xDSL, cable and Layer 3 switching has
changed the competitive landscape and resulted in shorter product life cycles,
as well as the creation of new standards and competitors. 3Com's competitors
typically compete in one or more segments of the LAN/WAN sector of the
networking market. These companies are using their resources and technical
expertise to improve and expand their product lines in an effort to gain market
share. Several competitors are extending their product offerings beyond a single
market segment and are pursuing strategies more closely resembling 3Com's global
networking strategy. The industry continues to witness a wave of merger and
strategic partnering activity as companies seek to provide broader networking
solutions.
Large Enterprise Market: Competition in the large enterprise market is centered
primarily around three areas: network interface, LAN systems and high-speed,
broadband networking.
The market for NICs is highly competitive, with companies offering products that
support a range of Ethernet, Fast Ethernet, Token Ring, ATM and FDDI media.
Traditional competitors in the NIC market include Intel, IBM, Standard
Microsystems and Xircom. However, as the trend from Ethernet to Fast Ethernet to
Gigabit Ethernet accelerates, the competitive landscape is changing to favor
companies that have a strong position in these faster technologies, namely 3Com
and Intel.
The LAN systems market is characterized by a few broad-based suppliers offering
multiple product lines. This has been achieved through mergers and acquisitions,
through joint marketing agreements, and through internally developed products.
This industry consolidation, and the convergence of hub, switching and routing
technologies on single platforms, will likely continue, thus intensifying
competition, as reflected by the emergence of new entrants including Lucent
Technologies and Northern Telecom. Principal competitors in the network systems
large enterprise market include Bay Networks, Cabletron and Cisco Systems.
The market for high-speed, broadband networking products has grown rapidly,
driven by companies' implementations of bandwidth-intensive applications. As the
need for high-speed wide-area communications continues to grow, many carriers
and enterprises are looking to vendors to provide a new generation of equipment
which permits increases in performance both in terms of speed and number of
connections supported by the network. Other companies, including Ascend
Communications, Cisco Systems and Lucent Technologies have network access
switching products that are competitive with 3Com.
8
Small/Medium Enterprise Market: Competition in the small/medium enterprise
market is characterized by a large number of suppliers, ranging from small firms
with a limited number of products to very large firms from other industries with
only a few networking product offerings. The market for small/medium-sized
organizations encompasses products ranging from NICs to workgroup hubs to
high-density switches. Principal competitors of the Company in the small/medium
enterprise market include Bay Networks, Cisco Systems, Dlink, Hewlett-Packard
and Intel.
Consumer/SOHO Market: The consumer/SOHO market is characterized by a large
number of suppliers and a dependence on brand awareness. Products sold into the
consumer and SOHO areas include modems, entry-level hubs and switches and
handheld connected organizers.
The Company's primary competitors with respect to desktop modems include Boca
Research, Hayes Microcomputer Products and Zoom. The Company was the first to
begin commercial volume shipments of V.90 standard 56 Kbps technology products
in February 1998. 3Com anticipates vigorous competition from many of the
significant modem and remote access equipment manufacturers, most of which have
begun shipment of, or announced their intentions to, bring products featuring
the V.90 56 Kbps technology to market. The majority of these manufacturers have
implemented or intend to implement this high-speed technology with chipsets
provided by Lucent Technologies or Rockwell International.
In the emerging high-speed modem markets, the Company's primary competitors
include: Alcatel/Hayes, Cisco Systems, Efficient, and Flowpoint for xDSL modems,
and Bay Networks, General Instruments, Motorola, RCA, and Sony for cable modems.
Handheld connected organizers are an emerging product area. The Company's
competitors in this arena include Casio, Hewlett-Packard, Phillips, Psion and
Sharp. During fiscal 1998, Microsoft Corporation entered the handheld connected
organizer market as a licensor of the Windows CE operating system.
Carrier/Service Provider Market: The carrier/service provider market is
characterized by intense competition to sell remote access concentrators that
handle both digital and analog signals for POP connectivity. 3Com competes
against various manufacturers of integrated remote access concentrators,
including Ascend Communications, Bay Networks, Cisco Systems and Lucent
Technologies.
The carrier/service provider market is also characterized by competition to sell
head-end equipment for emerging high-speed xDSL and cable technologies. The
Company's competitors for xDSL head-end equipment include: Alcatel, Cisco
Systems, Fujitsu/Orkit, Lucent Technologies and Northern Telecom. For cable
head-end equipment, competitors include: Bay Networks, Cisco Systems, Com21 and
Motorola.
INTELLECTUAL PROPERTY AND RELATED MATTERS
The Company relies on U.S. and foreign patents, copyrights, trademarks and trade
secrets to establish and maintain proprietary rights in its technology and
products. 3Com has an active program to file applications for and obtain patents
in the U.S. and in selected foreign countries where a potential market for the
Company's products exists. The Company's general policy has been to seek patent
protection for those inventions and improvements likely to be incorporated in
its products or otherwise expected to be of value. 3Com has been issued 147 U.S.
patents (including 141 utility patents and 6 design patents) and has been issued
39 foreign patents. Numerous patent applications are currently pending in the
U.S. and other countries which relate to the Company's research and development.
There can be no assurance that any of these patents would be upheld as valid if
litigated. While the Company believes that its patents and patent applications
have value, it also believes that its competitive position depends primarily on
the innovative skills, technological expertise and management abilities of its
employees.
3Com has registered 92 trademarks in the United States and has registered 64
trademarks in one or more of 75 foreign countries. Numerous applications for
registration of domestic and foreign trademarks are currently pending.
9
EMPLOYEES
As of May 31, 1998, 3Com had approximately 12,920 full-time employees, of whom
3,165 were employed in engineering, 3,980 in sales, marketing and customer
service, 3,575 in manufacturing and 2,200 in finance and administration. None of
3Com's employees is represented by a labor organization, and the Company
considers its employee relations to be satisfactory.
ITEM 2. PROPERTIES
The Company operates in a number of locations worldwide. In fiscal 1998, the
Company entered into a number of property transactions, as follows:
During the first quarter of fiscal 1998, the Company signed a lease, which
replaced a previous land lease, for 300,000 square feet of office and research
and development space and a data center to be built on land adjacent to the
Company's headquarters site in Santa Clara, California. The lease expires in
August 2002, with an option to extend the lease term for two successive periods
of five years each. The Company has an option to purchase the property for $83.6
million, or at the end of the lease arrange for the sale of the property to a
third party with the Company retaining an obligation to the owner for the
difference between the sale price and $83.6 million, subject to certain
provisions of the lease. Construction of the buildings began in July 1997, and
the Company anticipates that it will occupy the facility and begin lease
payments in the second quarter of fiscal 1999.
During the first quarter of fiscal 1998, the Company signed a lease, which
replaced a previous land lease, for 525,000 square feet of office, research and
development and manufacturing space to be built on land in Marlborough,
Massachusetts for the consolidation and expansion of existing operations. The
lease expires in August 2002, with an option to extend the lease term for two
successive periods of five years each. The Company has an option to purchase the
property for $86.0 million, or at the end of the lease arrange for the sale of
the property to a third party with the Company retaining an obligation to the
owner for the difference between the sale price and $86.0 million, subject to
certain provisions of the lease. Construction of the buildings began in the
first quarter of fiscal 1998, and the Company anticipates that it will occupy
the facility and begin lease payments in the fourth quarter of fiscal 1999.
Adjacent to this property is a leased facility consisting of 100,000 square feet
of office space. This lease expires in December 1999.
During the fourth quarter of fiscal 1998, the Company notified the lessor of a
58-acre parcel of land near its existing headquarters in Santa Clara of its
intention to exercise its option to purchase the land for $49.5 million. On
March 26, 1998 the option was exercised, and the Company immediately sold a
portion of the land to a third party. Terms of the transaction resulted in the
Company reporting a net gain of $15.8 million on the sale of the property during
the fourth quarter of fiscal 1998. An additional gain of $4.2 million was
deferred pending the resolution of certain contingencies. The Company retained a
25-acre parcel of land for future development. This parcel of land is adjacent
to a 14-acre parcel of land previously purchased by the Company.
During the fourth quarter of fiscal 1998, the Company paid $38.3 million to
purchase property in Rolling Meadows, Illinois, which was previously under an
operating lease. The property consists of 40 acres of land and an existing
400,000 square foot facility. 3Com is expanding the building to a total of
510,000 square feet and will use the new facility to consolidate existing
operations in the Chicago area. Construction of this facility is expected to be
completed in the first quarter of fiscal 1999.
10
At the end of fiscal 1998, the Company's primary locations, including those
under construction, were as follows:
LOCATION SQ. FT. OWNED/LEASED PRIMARY USE
- -------- ------- ------------ -----------
United States - 120,000 Owned Office and customer service
San Francisco
Bay Area (1)
1,283,000 Leased Office, research and development,
data center, distribution and
manufacturing
United States - 1,800,000 Owned Office, research and development,
Chicago Area customer service and manufacturing
United States - 489,000 Owned Office, research and development,
Other(2) and manufacturing
788,000 Leased Office, research and development,
distribution and manufacturing
Europe - 307,000 Owned Office, research and development,
Ireland and manufacturing
Europe - 230,000 Owned Office, research and development
UK and customer service
73,000 Leased Office
Asia Pacific - 325,000 Leased Office, distribution and
Singapore manufacturing
(1) The Company also holds approximately 39 acres of land in the San Francisco
Bay Area for development.
(2) Includes Salt Lake City, Utah; and Boxborough, Marlborough and
Southborough, Massachusetts.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party to lawsuits in the normal course of its business. The
Company believes that it has meritorious defenses in all lawsuits in which the
Company or its subsidiaries is a defendant. The Company notes that (i)
litigation in general and intellectual property and securities litigation in
particular can be expensive and disruptive to normal business operations and
(ii) the results of complex legal proceedings can be very difficult to predict
with any certainty.
Securities Litigation
On March 24 and May 5, 1997, putative securities class action lawsuits,
captioned Hirsch v. 3Com Corporation, et al., Civil Action No. CV764977
(Hirsch), and Kravitz v. 3Com Corporation, et al., Civil Action No. CV765962
(Kravitz), respectively, were filed against the Company and certain of its
officers and directors in the California Superior Court, Santa Clara County. The
complaints allege violations of Sections 25400 and 25500 of the California
Corporations Code and seek unspecified damages on behalf of a purported class of
purchasers of 3Com common stock during the period from September 24, 1996
through February 10, 1997. The actions are in discovery. No trial date has been
set.
11
On February 10, 1998, a putative securities class action, captioned Euredjian v.
3Com Corporation, et al., Civil Action No. C-98-00508CRB (Euredjian), was filed
against 3Com and several of its present and former officers and directors in
United States District Court for the Northern District of California asserting
the same class period and factual allegations as the Hirsch and Kravitz actions.
The complaint alleges violations of the federal securities laws, specifically
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and seeks
unspecified damages. The Company has not responded to the complaint. The Hirsch,
Kravitz and Euredjian actions were filed after Intel Corporation sharply
decreased prices on its Fast Ethernet network interface cards, which resulted in
3Com decreasing its prices on similar products. The Company believes it has
meritorious defenses to the claims in the Hirsch, Kravitz and Euredjian actions
and intends to contest the lawsuits vigorously. An unfavorable resolution of the
actions could have a material adverse effect on the business, results of
operations or financial condition of the Company.
Several securities actions have been filed against the Company and certain of
its current and former officers and directors following the Company's merger
with U.S. Robotics. In December 1997, a putative securities class action,
captioned Reiver v. 3Com Corporation, et al., Civil Action No. C-97-21083JW
(Reiver), was filed in the United States District Court for the Northern
District of California. The complaint alleges violations of the federal
securities laws, specifically Sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, and seeks unspecified damages on behalf of a purported
class of purchasers of 3Com common stock during the period from May 19, 1997
through November 6, 1997. In December 1997 and January 1998, seven similar
shareholder class action lawsuits were filed in the United States District Court
for the Northern District of Illinois and the United States District Court for
the Northern District of California. The cases filed in the Northern District of
Illinois have been transferred to the Northern District of California, and the
cases have been consolidated in the Reiver action. A consolidated amended
complaint will be filed shortly.
On April 3, 1998, a complaint, captioned Florida State Board of Administration
and Teachers Retirement System of Louisiana v. 3Com Corporation, et al., Civil
Action No. C-98-1355 (Florida State Board), was filed in the United States
District Court for the Northern District of California. The complaint alleges
violations of the federal securities laws, violations of the Florida securities
laws, common law fraud and negligent misrepresentation based on factual
allegations similar to those asserted in the Reiver action. The Company has not
responded to the complaint. The Company believes it has meritorious defenses to
the claims in the Reiver and Florida State Board actions and intends to contest
the lawsuits vigorously. An unfavorable resolution of the actions could have a
material adverse effect on the business, results of operations or financial
condition of the Company.
In January 1998, two purported shareholder complaints relating to the Company's
June 1997 merger with U.S. Robotics, captioned Stanley Grossman v. 3Com
Corporation, et al., Civil Action No. CV771335, and Jason v. 3Com Corporation,
et al., Civil Action No. CV771713, were filed in California Superior Court,
Santa Clara County. The actions allege that 3Com, several of its officers and
directors, and several former U.S. Robotics officers violated Sections 11 and 15
of the Securities Act of 1933 by making alleged misrepresentations and omissions
in a May 8, 1997 registration statement. The complaints seek damages in an
unspecified amount on behalf of a purported class of persons who received the
Company's stock during the merger pursuant to the registration statement. The
Company has not responded to the complaints. The Company has filed a motion in
Delaware Chancery Court seeking an injunction preventing plaintiffs from
proceeding, on the basis that plaintiffs' claims are barred by a settlement in a
prior action. The Company believes it has meritorious defenses to the claims and
intends to contest the lawsuits vigorously. An unfavorable resolution of the
actions could have a material adverse effect on the business, results of
operations or financial condition of the Company.
In February 1998, a shareholder derivative action purportedly on behalf of the
Company, captioned, Wasserman v. Benhamou, et al., Civil Action No. 16200-NC,
was filed in Delaware Chancery Court. The complaint alleges that the Company's
directors breached their fiduciary duties to the Company by engaging in alleged
wrongful conduct from mid-1996 through November 1997, including the conduct
complained of in the securities litigation described above. The Company is named
solely as a nominal defendant, against whom the plaintiff seeks no recovery. The
Company and the individual defendants have filed a motion to dismiss the
complaint.
12
Intellectual Property Litigation
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District Court
for the Western District of New York. The case is now entitled: Xerox
Corporation v. U.S. Robotics Corporation, U.S. Robotics Access Corp., Palm
Computing, Inc. and 3Com Corporation, Civil Action No. 97-CV-6182T. The
complaint alleges willful infringement of a United States patent relating to
computerized interpretation of handwriting. The complaint further prays for
unspecified damages and injunctive relief. Xerox has asserted that "Graffiti"
software and certain products of Palm Computing, Inc. infringe the patent. The
Company believes it has meritorious defenses to the claims and is contesting the
lawsuit vigorously. An unfavorable resolution of the action could have a
material adverse effect on the business, results of operations or financial
condition of the Company.
By an agreement effective February 27, 1998, the Company and Motorola, Inc.
settled the patent lawsuit pending between Motorola, Inc. and U.S. Robotics
Corporation, U.S. Robotics Access Corp. and U.S. Robotics Mobile Communications
Corp. in the United States District Court for the District of Massachusetts,
Civil Action No. 97-10339RCL. This case was dismissed on March 31, 1998. None of
the parties admitted fault. In connection with the settlement, the Company and
Motorola, Inc. entered into a cross-license of their respective patents relating
to high-speed analog modem technologies for implementation of international
standard data communication protocols. The terms of the settlement were not
material to the business, results of operations or financial condition of the
Company.
During February 1998 the Company and Livingston Enterprises, Inc. (Livingston)
agreed to settle the cases pending between Livingston and U.S. Robotics in the
United States District Court for the Northern District of California, Civil
Action Nos. C-97-3551CRB and C-97-3487CRB. These actions were dismissed on March
4, 1998. Neither party admitted fault in the settlement. The terms of the
settlement, which were not disclosed, were not material to the business, results
of operations, or financial condition of the Company.
Consumer Litigation
A putative consumer class action pending against the Company and U.S. Robotics
in the California Superior Court, Marin County, Bendall, et al. v. U.S. Robotics
Corporation, et al., Civil Action No. 170441 (Bendall), arising out of the
purchase of x2TM products and products upgradeable to x2, was coordinated with a
previously filed individual action in the California Superior Court, San
Francisco County, Intervention Inc. v. U.S. Robotics Corporation, Civil Action
No. 984352. Two putative consumer class action lawsuits pending against the
Company and U.S. Robotics in state court of Illinois arising out of the same
facts as those alleged in the California cases are stayed. Lippman, et al. v.
3Com, Civil Action No. 97 CH 09773, and Michaels, et al. v. U.S. Robotics Access
Corporation, et al., Civil Action No. 97 CH 14417. In June, 1998, the Company
filed a demurrer to the First Amended Complaint filed in Bendall. The Company
believes it has meritorious defenses to these lawsuits and intends to contest
the lawsuits vigorously. An unfavorable resolution of the actions could have a
material adverse effect on the business, results of operations or financial
condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held with the Registrant
of all executive officers of the Registrant. There are no family relationships
between any director or executive officer and any other director or executive
officer of the Registrant. Executive officers serve at the discretion of the
Board of Directors.
NAME AGE POSITION
---- --- --------
Eric A. Benhamou 42 Chairman and Chief Executive Officer
Bruce L. Claflin 46 President and Chief Operating Officer
Richard L. Edson 44 Senior Vice President, New Business Initiatives
13
NAME AGE POSITION
---- --- --------
Debra J. Engel 46 Senior Vice President, Corporate Services
Ralph B. Godfrey 58 Senior Vice President, Sales for the Americas
John H. Hart 52 Senior Vice President and Chief Technical Officer
Randy R. Heffner 48 Senior Vice President, Operations
Richard W. Joyce 42 Senior Vice President, Worldwide Sales
Alan J. Kessler 41 Senior Vice President, Global Customer Service
Ross W. Manire 46 Senior Vice President, Carrier Systems
Business Unit
Edgar Masri 40 Senior Vice President and General Manager,
Small to Medium Enterprise Business Unit
Mark D. Michael 47 Senior Vice President, General Counsel
and Secretary
Eileen Nelson 51 Senior Vice President, Human Resources
Christopher B. Paisley 46 Senior Vice President, Finance and Chief
Financial Officer
Janice M. Roberts 42 Senior Vice President, Global Marketing
and Business Development
Ronald A. Sege 41 Senior Vice President, Enterprise Systems
Business Unit
Douglas C. Spreng 54 Senior Vice President, Client Access
Business Unit
Thomas L. Thomas 49 Senior Vice President, Global Information
Systems and Chief Information Officer
Eric A. Benhamou has been the Company's Chief Executive Officer since September
1990 and served as the Company's President from April 1990 through July 1998.
Mr. Benhamou became Chairman of the Board of Directors of the Company in July
1994. Mr. Benhamou served as the Company's Chief Operating Officer from April
1990 through September 1990. From October 1987 through April 1990, Mr. Benhamou
held various general management positions within the Company. Mr. Benhamou
serves as Chairman of the Board of Directors of Cypress Semiconductor, Inc. and
as a director of Legato Systems, Inc. and Netscape Communications Corporation.
Bruce L. Claflin has been President and Chief Operating Officer of 3Com since
August 1998. Prior to joining the Company, Mr. Claflin worked for Digital
Equipment Corporation beginning in November 1995, most recently as Senior Vice
President and General Manager, Sales and Marketing and prior to that as Vice
President and General Manager of Digital Equipment Corporation's Personal
Computer Business Unit. For 22 years prior to working at Digital Equipment
Corporation, Mr. Claflin held a number of senior management and executive
positions at International Business Machines Corporation.
14
Richard L. Edson has been Senior Vice President, New Business Initiatives since
June 1997. Prior to joining the Company, Mr. Edson worked for U.S. Robotics as
Vice President and General Manager, Manufacturing beginning in July 1995. From
1987 to 1995, Mr. Edson worked for Thinking Machines Corporation, where he held
the position of Chief Operating Officer from 1994 to 1995, and other management
positions, including Vice President of Core Products, Vice President of
Manufacturing, and Director of Manufacturing from 1987 to 1993.
Debra J. Engel has been Senior Vice President, Corporate Services since August
1996. From March 1990 through July 1996, Ms. Engel was Vice President, Corporate
Services. From the time Ms. Engel joined the Company in November 1983 until
March 1990, she was Vice President, Human Resources. Ms. Engel serves as a
director of Aspect Telecommunications.
Ralph B. Godfrey has been Senior Vice President, Sales for the Americas since
June 1998. From June 1997 to June 1998, Mr. Godfrey was Senior Vice President,
Client Access Products, Americas Sales. Mr. Godfrey was Senior Vice President,
Global Channel Sales from August 1996 to May 1997. From June 1993 to July 1996,
Mr. Godfrey was Vice President, Channel Sales - North America. Mr. Godfrey
joined 3Com in June 1990 as Vice President of 3Com USA, a position he held
through May 1993. Mr. Godfrey serves as a director of Interlink Computer
Sciences, Inc.
John H. Hart has been Senior Vice President and Chief Technical Officer since
August 1996. From the time Mr. Hart joined the Company in September 1990 until
July 1996, he was Vice President and Chief Technical Officer. Prior to joining
the Company, Mr. Hart worked for Vitalink Communications Corporation for seven
years, where his most recent position was Vice President of Network Products.
Randy R. Heffner has been Senior Vice President, Operations since June 1997.
From July 1992 through May 1997, Mr. Heffner was the Vice President of
Manufacturing for 3Com's Personal Connectivity Operations. Prior to joining the
Company, Mr. Heffner worked for NeXT Computer Inc. as Vice President of
Manufacturing for five years. Mr. Heffner also worked for Hewlett-Packard
Company for thirteen years in a variety of Materials Management and Production
Control positions.
Richard W. Joyce has been Senior Vice President, Worldwide Sales since June
1998. Previously, Mr. Joyce had been Senior Vice President, Remote Access
Products Division since June 1997. Mr. Joyce was Senior Vice President, New
Business Operations from August 1996 to June 1997. From June 1995 through July
1996, Mr. Joyce was Vice President, New Business Operations. From June 1993 to
June 1995, Mr. Joyce served as Vice President, Sales Europe and Asia Pacific
Rim. From January 1990 to June 1995, Mr. Joyce served as President, 3Com Europe
Limited.
Alan J. Kessler has been Senior Vice President, Global Customer Service since
June 1998. From June 1997 to June 1998, Mr. Kessler was Senior Vice President,
Enterprise Systems Business Unit, Global Sales and Service. From August 1996 to
May 1997, Mr. Kessler was Senior Vice President of the Company's Global Systems
Sales and Services. From June 1995 to July 1996, Mr. Kessler served as Vice
President, Customer Service Operations. From June 1993 to June 1995, Mr. Kessler
served as Vice President, Systems Sales - North America. From May 1991 through
May 1993, Mr. Kessler served as Vice President and General Manager, Network
Systems Division.
Ross W. Manire has been Senior Vice President, Carrier Systems Business Unit
since June 1997. Prior to joining the Company, Mr. Manire worked for U.S.
Robotics in a variety of management roles, most recently as General Manager,
Network Systems from April 1995 until June 1997, and as Senior Vice President,
Operations from August 1992 through March 1995. He also served as Vice
President, Finance beginning in August 1991 until he was named Chief Financial
Officer in March 1992, a position he held until March 1995. Mr. Manire also
served as Secretary of U.S. Robotics from March 1993 to February 1994. From 1989
to 1991, Mr. Manire was Vice President of Ridge Capital Corporation, a private
equity investment firm. Mr. Manire serves as a director of Cerion Technologies,
Inc. and EA Industries, Inc.
Edgar Masri has been Senior Vice President and General Manager, Small to Medium
Enterprise Business Unit since June 1998. From September 1995 to May 1998, Mr.
Masri served as Vice President and General Manager, Premises Distribution
Division. Mr. Masri was Director of Marketing, Premises Distribution Division
for two years prior to becoming General Manager. He has held several marketing
director positions for 3Com product lines and management roles in the fields of
business development, engineering and project management.
15
Mark D. Michael has been the Company's Senior Vice President, General Counsel
and Secretary since September 1997. Mr. Michael joined the Company in 1984 as
Counsel, was named Assistant Secretary in 1985, and General Counsel in 1986. In
1989, Mr. Michael was named Corporate Secretary, and became a Vice President in
1991. Prior to joining the Company, Mr. Michael was engaged in the private
practice of law with law firms in Honolulu, Hawaii from 1977 to 1981 and in San
Francisco, California from 1981 to 1984.
Eileen Nelson has been Senior Vice President, Human Resources since July 1998.
From April 1997 until July 1998, Ms. Nelson served as the Company's Vice
President, Enterprise Systems, Human Resources. From 1988 until April 1997, Ms.
Nelson held various Human Resources director level roles at the Company. Prior
to joining the Company, Ms. Nelson served as Director, Human Resources for
Tandon Corporation from 1985 to 1988. From 1983 to 1985, Ms. Nelson was the Vice
President, Human Resources and Administration at Davong Systems.
Christopher B. Paisley has served as the Company's Senior Vice President,
Finance and Chief Financial Officer since August 1996. From the time Mr. Paisley
joined the Company in 1985 until July 1996, he was Vice President, Finance and
Chief Financial Officer. From 1982 to 1985, Mr. Paisley was Vice President of
Finance of Ridge Computers. From 1977 to 1982, Mr. Paisley held a variety of
finance and accounting positions at Hewlett-Packard Company. Mr. Paisley serves
as a director of Applied Digital Access, Inc.
Janice M. Roberts has been Senior Vice President, Global Marketing and Business
Development since August 1996. From June 1992 through July 1996, Ms. Roberts was
Vice President, Marketing. From February 1994 to June 1995, Ms. Roberts also
served as General Manager, Personal Office Division. From February 1992 until
June 1992, Ms. Roberts was Vice President and General Manager, Premises
Distribution Division. During the period January 1989 to February 1992, Ms.
Roberts served as Director of BICC Technologies Limited and President of BICC
Technologies, Inc. and BICC Communications, Inc. She was also Chairman and
Managing Director of BICC Data Networks Limited.
Ronald A. Sege has been 3Com's Senior Vice President, Enterprise Systems
Business Unit since June 1997. From October 1996 to June 1997, Mr. Sege served
as Senior Vice President, LAN Operations. Mr. Sege served as Vice President and
General Manager, Integrated Systems Division from October 1995 to October 1996.
From July 1993 to September 1995, Mr. Sege served as Vice President and General
Manager, Premises Distribution Division. In June 1991, Mr. Sege became 3Com's
Vice President and General Manager, Customer Services Operation, and held this
position until July 1993. Prior to joining 3Com, Mr. Sege held a variety of
service and sales positions at ROLM Corporation.
Douglas C. Spreng has been Senior Vice President, Client Access Business Unit
since June 1998. From August 1996 to May 1998, Mr. Spreng was Executive Vice
President, 3Com Interface Products. From July 1995 to July 1996, Mr. Spreng
served as Executive Vice President, Personal Connectivity Operations. Mr. Spreng
joined the Company as Vice President and General Manager, Network Adapter
Division in March 1992. Prior to joining the Company, Mr. Spreng was President
and Chief Operations Officer of Domestic Automation Company, a private
communications system start-up company. Previously, Mr. Spreng spent 23 years
with Hewlett-Packard Company in a variety of senior marketing, manufacturing and
general management positions.
Thomas L. Thomas has been Senior Vice President, Global Information Systems and
Chief Information Officer since August 1996. From September 1995 through July
1996, Mr. Thomas was Vice President, Global Information Systems and Chief
Information Officer. From 1993 to 1995, Mr. Thomas was Vice President and Chief
Information Officer of Dell Computer Corporation. From 1987 to 1993, Mr. Thomas
served as Vice President of Management Information Systems at Kraft General
Foods. Mr. Thomas serves as a director of ATL Products, Inc.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
FISCAL 1998 HIGH LOW FISCAL 1997 HIGH LOW
- ----------- ---- --- ----------- ---- ---
First Quarter $59 11/16 $43 3/16 First Quarter $50 7/8 $33 1/2
Second Quarter 56 3/4 28 1/2 Second Quarter 76 1/2 45
Third Quarter 39 1/8 28 3/8 Third Quarter 81 3/8 33
Fourth Quarter 38 25 1/4 Fourth Quarter 51 1/8 24
3Com Corporation common stock has been traded in the over-the-counter market
under the symbol COMS since the Company's initial public offering on March 21,
1984. The preceding table sets forth the high and low sales prices as reported
on the Nasdaq National Market during the last two years. As of May 31, 1998, the
Company had approximately 7,100 stockholders of record. 3Com's credit agreement
permits payment of cash dividends subject to certain limitations based on net
income levels of the Company. However, 3Com has not paid and does not anticipate
it will pay cash dividends on its common stock.
17
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial information has been derived from the audited
Consolidated Financial Statements. The information set forth below is not
necessarily indicative of results of future operations and should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the Consolidated Financial Statements and related
Notes thereto included elsewhere in this Form 10-K.
Years ended May 31,
(Dollars in thousands, except
per share and employee data)
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------
Sales $5,420,367 $5,606,077 $4,284,508 $2,479,760 $1,510,608
Net income 30,214 500,533 347,875 210,510 24,251
Net income per share:
Basic 0.09 1.51 1.10 0.72 0.09
Diluted 0.08 1.42 1.02 0.66 0.08
- --------------------------------------------------------------------------------------
Total assets $4,080,520 $3,565,841 $2,592,400 $1,734,433 $ 937,965
Working capital 1,950,757 1,574,223 1,242,095 938,672 495,940
Long-term obligations 40,358 170,652 169,536 181,872 74,106
Retained earnings 1,079,775 1,049,561 691,850 348,647 162,155
Stockholders' equity 2,807,495 2,228,344 1,650,675 1,058,119 609,839
Number of employees 12,920 13,639 11,503 7,395 4,970
- --------------------------------------------------------------------------------------
Net income for fiscal 1998 included a pre-tax charge of approximately $8.4
million ($0.02 per share) related to purchased in-process technology and a
pre-tax charge of approximately $253.7 million ($0.57 per share) for
merger-related costs and disposition of real estate. Net income for fiscal 1997
included a pre-tax charge of approximately $54.0 million ($0.15 per share) for
purchased in-process technology, a pre-tax charge of approximately $6.6 million
($0.02 per share) for merger-related costs, and a tax benefit of approximately
$17.9 million ($0.05 per share) related to an acquisition. Net income for fiscal
1996 included a pre-tax charge of approximately $106.4 million ($0.31 per share)
for purchased in-process technology, a pre-tax charge of approximately $69.0
million ($0.14 per share) for merger-related costs, and a pre-tax charge of
approximately $1.0 million (no per share impact) for a litigation settlement.
Net income for fiscal 1995 included a pre-tax charge of approximately $68.7
million ($0.13 per share) for purchased in-process technology, a pre-tax charge
of approximately $40.7 million ($0.10 per share) for merger-related costs, and a
pre-tax credit of approximately $1.1 million (no per share impact) for a
reduction in accrued restructuring costs. Net income for fiscal 1994 included a
pre-tax charge of approximately $134.5 million ($0.44 per share) for purchased
in-process technology, a pre-tax gain of approximately $17.7 million ($0.04 per
share) on the sale of an investment, and a tax benefit of approximately $1.2
million (no per share impact) resulting from tax law changes. See Notes 3 and 12
to the Consolidated Financial Statements for additional information on the above
transactions for fiscal years 1998, 1997, and 1996. Excluding the non-recurring
items noted above, net income and net income per share on a diluted basis would
have been as follows:
Years ended May 31,
(Dollars in thousands,
except per share data)
1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------------
Net income excluding
non-recurring items $246,060 $543,196 $504,054 $284,699 $139,834
Net income per share
excluding non-
recurring items $0.67 $1.54 $1.47 $0.89 $0.48
18
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes thereto.
BUSINESS COMBINATIONS
For the year ended May 31, 1998. On June 12, 1997, 3Com Corporation completed
the merger with U.S. Robotics Corporation (U.S. Robotics), the leading supplier
of products and systems for accessing information across the wide area network
(WAN), including modems and remote access products. This merger was accounted
for as a pooling-of-interests. The Company issued approximately 158 million
shares of its common stock in exchange for all outstanding common stock of U.S.
Robotics. The Company also assumed all options to purchase U.S. Robotics' stock,
which were converted into options to purchase approximately 31 million shares of
the Company's common stock, pursuant to the terms of the merger.
All financial data of 3Com Corporation and its subsidiaries ("3Com" or "the
Company") presented in this Form 10-K have been restated to include the
historical financial information of U.S. Robotics in accordance with generally
accepted accounting principles and pursuant to Regulation S-X. The 3Com
statement of income for the fiscal year ended May 31, 1996 has been combined
with the U.S. Robotics statement of income for the fiscal year ended September
29, 1996. The 3Com statement of income for the fiscal year ended May 31, 1997
has been combined with the U.S. Robotics statement of income for the period from
July 1, 1996 through May 25, 1997. This combining methodology includes the last
three reported quarters of U.S. Robotics, ended September 29, 1996, December 29,
1996, and March 30, 1997, and the months of April and May 1997. To reflect a
complete 12-month year and a three-month fourth quarter and thereby enhance
comparability of periodic reported results, U.S. Robotics' results of operations
for the month ended March 30, 1997 are included in both the three-month period
ended March 30, 1997 and the three-month period ended May 25, 1997. This
presentation has the effect of including U.S. Robotics' results of operations
for the three-month period ended September 29, 1996 in both the combined years
ended May 31, 1997 and 1996, and reflects sales of $611.4 million and net income
of $13.5 million. The aggregate of net income for the three-month period ended
September 29, 1996 of $13.5 million and the one-month period ended March 30,
1997 of $112.9 million has been reported as a decrease to the Company's fiscal
1997 retained earnings. 3Com's balance sheet as of May 31, 1997 was combined
with U.S. Robotics' balance sheet as of May 25, 1997. The combining periods are
as follows:
FISCAL 1996 FISCAL 1997 QUARTERLY PERIODS
----------- -----------------------------
YEAR ENDED Q1'97 Q2'97 Q3'97 Q4'97
---------- ----- ----- ----- -----
3Com May `96 Aug `96 Nov `96 Feb `97 May `97
U.S. Robotics Sept `96 Sept `96 Dec `96 Mar `97 May `97*
*Three-month period which includes March, April, and May.
The results of operations for the fiscal year ended May 31, 1998 contain the
combined results of both 3Com and U.S. Robotics for the entire 12 months.
During the fourth quarter of fiscal 1998, the Company purchased Lanworks
Technologies, Inc. (Lanworks), a leading provider of PC network boot
technologies and products, for approximately $13.0 million in cash.
Approximately $8.4 million of the total purchase price represented purchased
in-process technology that had not yet reached technological feasibility and had
no alternative future use. This amount was charged to the Company's operations
in the fourth quarter of fiscal 1998.
For the year ended May 31, 1997. To extend its leadership position in the
enterprise Asynchronous Transfer Mode (ATM) market, on October 31, 1996, the
Company acquired OnStream Networks, Inc. (OnStream), a provider of ATM and
broadband WAN and access products. The acquisition was accounted for as a
pooling-of-interests. In addition, to increase its market presence
internationally, U.S. Robotics acquired distributors in Korea, Japan, Australia,
and Sweden, for an aggregate purchase price of $13.4 million in cash, net of
cash acquired, and issuance of stock with a fair value of $0.1 million, all of
which were accounted for as purchases.
19
For the year ended May 31, 1996. To enhance its product offerings and accelerate
its time-to-market in new technologies, the Company acquired Chipcom Corporation
(Chipcom), a provider of computer networking multi-function platforms, including
hubs, switching, and network management products, Primary Access Corporation
(Primary Access), a provider of integrated network access systems, and AXON
Networks, Inc. (AXON), a developer and manufacturer of remote network management
and data network traffic management products. The acquisitions of Chipcom and
Primary Access were accounted for as poolings-of-interests. The acquisition of
AXON was a purchase transaction. In addition, U.S. Robotics acquired Amber Wave
Systems, Inc. (Amber Wave) in a pooling-of-interests transaction, a developer of
local area network (LAN) switching products, and acquired Scorpio
Communications, Ltd. (Scorpio) in a purchase transaction, a designer,
manufacturer and marketer of scalable, fully redundant, fault-tolerant ATM
switches that targeted workgroup LAN, corporate backbone and WAN access
environments.
The impact of merger-related charges on the Company's operating expenses, taxes
and net income are discussed below. See Notes 3 and 12 of Notes to Consolidated
Financial Statements for additional information on the above business
combinations.
SUPPLEMENTAL OPERATING INFORMATION FOR U.S. ROBOTICS
Following is supplemental information regarding U.S. Robotics' results of
operations for the three-month period ended May 25, 1997 (in thousands). Results
for these periods exclude reclassifications made to conform to the Company's
financial statement presentation.
Three
March April/May Months Ended
1997 1997 May 25, 1997
---- ---- ------------
Sales $541,662 $ 15,277 $ 556,939
Gross margin 279,411 (49,204) 230,207
Total operating expenses 97,457 187,557 285,014
-------- --------- ---------
Operating income (loss) 181,954 (236,761) (54,807)
Income (loss) before income taxes 179,647 (242,929) (63,282)
Income tax provision (benefit) 66,720 (82,625) (15,905)
-------- --------- ---------
Net income (loss) $112,927 $(160,304) $ (47,377)
======== ========= =========
U.S. Robotics' sales for the month ended March 30, 1997 (March 1997) were
approximately $541.7 million, reflecting strong market demand worldwide for
information access devices including the introduction and initial high volume
shipments of products incorporating x2TM technology (x2 products). x2 technology
increases the potential speed for downloading data from 28.8 or 33.6 Kilobits
per second (Kbps) for standard V.34 modems to 56 Kbps. Consistent with U.S.
Robotics' non-linear quarterly sales pattern, sales in the first two months of
the quarter were relatively low and in the third month of the quarter, which
March 1997 represents, were significantly higher.
Gross margin for March 1997 was approximately $279.4 million, or 51.6 percent of
sales. The overall gross margin reflected the initial high volume shipments of
x2 products, which generated higher gross margins due to U. S. Robotics'
temporary "first to market" advantage over competitors in the 56 Kbps modem
market. Also, to a lesser extent, the overall gross margin reflected higher
margins on the initial sales of newer generation handheld connected organizer
products introduced during the month.
20
Total operating expenses for March 1997 were approximately $97.5 million, or
18.0 percent of sales. Sales and marketing expenses reflected significant
spending related to the introduction of x2 products, other marketing programs
designed to generate continuing growth in sales and efforts to expand market
share, and continuing investments to increase the worldwide sales force with the
intent of increasing sales of network systems products. General and
administrative expenses and research and development expenses reflected
continuing investments in personnel and systems necessary to support U.S.
Robotics' expanded level of business activity and its commitment to new product
and technology development. As a percentage of sales, total operating expenses
for March 1997 were low due to the non-linear sales pattern described above.
Gross sales for the two months ended May 25, 1997 were approximately $200.3
million. Net sales after provisions, primarily for product returns of $143
million and price protection of $33 million, were approximately $15.3 million.
These results principally reflect the following factors: U.S. Robotics'
non-linear sales pattern, as described above; lower than anticipated sales out
of the channel, due in part to confusion about the new 56 Kbps technologies and
concerns regarding the absence of an industry standard for 56 Kbps modems;
efforts to reduce levels of channel inventory, including increased emphasis on
sales out of the channel via price reductions and other promotions; and product
returns from channel partners whose sales out had been lower than anticipated.
Returns during the two months ended May 25, 1997 totaled $82.3 million,
reflecting primarily desktop modems and remote access concentrators. The
majority of the desktop modem returns consisted of older generation products,
which were heavily impacted by the March 1997 introduction of U.S. Robotics' 56
Kbps modem with x2 technology. Returns of remote access concentrators were due
primarily to lower than anticipated sales out of the distribution channel. Based
on negotiations with individual customers, U.S. Robotics allowed returns during
this period in excess of customers' contractual rights due to the 56 Kbps
technology transition and the desire to reduce channel inventory. Returns during
this period exceeded the March 30, 1997 balance in the allowance for sales
returns of $48.9 million by $33.4 million.
The price protection provision of $33 million related primarily to price
reductions effective subsequent to March 30, 1997 for desktop modems and remote
access concentrator product lines.
Gross margin for this period was affected adversely by the provision for price
protection described above, a provision for potentially excess and obsolete
inventory of approximately $15.4 million, and unabsorbed manufacturing costs.
Operating expenses for the two months ended May 25, 1997 were approximately
$187.6 million. Sales and marketing expenses reflected significant spending
related to the introduction of x2 products and newer generation handheld
connected organizer products, other marketing programs designed to generate
continuing growth in sales and expand market share, and continuing investments
to increase the worldwide sales force with the intent of increasing sales of
network systems products. General and administrative expenses and research and
development expenses reflected continuing investments in personnel and systems
necessary to support U.S. Robotics' anticipated growth and its commitment to new
product and technology development. As a percentage of sales, total operating
expenses for the two months ended May 25, 1997 were high due to the non-linear
sales pattern described above.
Other expenses, net, for the two months ended May 25, 1997 were approximately
$6.2 million. Such expenses reflected higher interest expense due to increased
short-term borrowing. During these two months, U.S. Robotics increased its
short-term borrowings from approximately $61 million to approximately $135
million, comprised of $10 million under an existing $90 million short-term
borrowing arrangement and $125 million under an existing $300 million revolving
credit facility. Such borrowings were primarily necessary to fund ongoing
operating expenses, including costs associated with the launch of the new x2
technology, as well as capital expenditures. The Company repaid such short-term
borrowing shortly after the closing of the merger in June 1997 between 3Com and
U.S. Robotics, and the use of these borrowing arrangements is no longer expected
to be required.
The provision for income taxes for the two months ended May 25, 1997 was a net
benefit of approximately $82.6 million, resulting in an effective tax rate of
34.0 percent.
21
RESULTS OF OPERATIONS
The following table sets forth, for the fiscal years indicated, the percentage
of total sales represented by the line items reflected in the Company's
consolidated statements of income:
Years Ended May 31,
------------------------------
1998 1997 1996
---- ---- ----
Sales ...................................... 100.0% 100.0% 100.0%
Cost of sales .............................. 54.6 52.1 53.4
---- ---- ----
Gross margin ............................... 45.4 47.9 46.6
Operating expenses:
Sales and marketing ...................... 23.0 19.3 16.6
Research and development ................. 10.7 9.0 7.9
General and administrative ............... 5.0 4.4 4.0
Non-recurring charges:
Purchased in-process technology ....... 0.2 1.0 2.5
Merger-related charges and other ...... 4.7 0.1 1.6
---- ---- ----
Total operating expenses ................... 43.6 33.8 32.6
---- ---- ----
Operating income ........................... 1.8 14.1 14.0
Other income, net .......................... 0.3 0.2 0.2
---- ---- ----
Income before income taxes ................. 2.1 14.3 14.2
Income tax provision ....................... 1.6 5.4 6.1
---- ---- ----
Net income ................................. 0.5% 8.9% 8.1%
==== ==== ====
Excluding non-recurring charges:
Total operating expenses ................. 38.7% 32.7% 28.5%
Operating income ......................... 6.7 15.2 18.1
Net income ............................... 4.5 9.7 11.7
Comparison of fiscal years ended May 31, 1998 and 1997
SALES
Fiscal 1998 sales totaled $5.42 billion, a decline of three percent from fiscal
1997 sales of $5.61 billion. Sales of client access products (e.g., network
interface cards (NICs) and modems) in fiscal 1998 were $2.89 billion, a decrease
of eight percent from fiscal 1997 sales of $3.15 billion. Sales of client access
products represented 53 percent of total sales in fiscal 1998 compared to 56
percent in fiscal 1997. Sales of network systems products (e.g., switches,
routers, hubs, and remote access products) in fiscal 1998 were $2.53 billion, an
increase of three percent compared to fiscal 1997 sales of $2.46 billion. Sales
of network systems products represented 47 percent of total sales in fiscal
1998, compared to 44 percent a year ago. Sales in the U.S. represented 55
percent of total sales for fiscal 1998 and fiscal 1997. The Company experienced
a decline from fiscal 1997 in domestic and international sales of four and two
percent, respectively.
Fiscal 1998 sales were affected by the following factors:
Industry Growth Rates. Networking industry growth rates have slowed since the
beginning of calendar 1997. While the industry had grown at rates in excess of
30 percent in prior years, recent reports indicate that the networking industry
worldwide grew by less than 20 percent during 1997, and this pattern has
continued into 1998.
Channel Inventory. In the second quarter of fiscal 1998, the Company adopted a
new inventory business model, which generally calls for fewer weeks' supply of
inventory in the distribution channel. The Company transitioned to this model
during the second and third quarters of fiscal 1998. As a result, sales during
these periods were adversely affected.
22
Modems. Fiscal 1998 sales of modem products decreased compared to fiscal 1997.
In January 1998, the International Telecommunications Union (ITU) finally
determined the V.90 standard for 56 Kbps technology. The Company believes that
the previous lack of such a standard contributed to delays in customers'
purchasing decisions for higher-speed modems and remote access concentrators.
Although the Company began shipping V.90 standard modems late in the third
quarter of fiscal 1998, the Company believes these delays, as well as product
transitions, adversely affected sales. In addition, the delay in the V.90
standard caused aggressive pricing in older generation modem products, which in
connection with the channel inventory reduction mentioned above, contributed to
a year-over-year decrease in sales.
Pricing. The pricing environment has been very competitive, and although the
Company experienced significant year-over-year unit growth in key products such
as Fast Ethernet NICs and workgroup switches, these gains were partially offset
by declines in average selling prices. For example, in fiscal 1998, the Company
experienced price decreases between 15 and 39 percent compared to fiscal 1997 in
a number of product segments, including modems, workgroup switches, hubs and
remote access concentrators. While the trend of declining average selling prices
is expected to continue in future periods, the Company believes that price
erosion will be less than that experienced in fiscal 1998.
Remote Access Concentrators. Fiscal 1998 sales of remote access concentrators
decreased compared to fiscal 1997. Factors affecting this decrease included
aggressive price competition, including the introduction of new higher-density
products at prices similar to the older lower-density products. In addition,
sales of remote access concentrators were impacted by the channel inventory
reduction described above.
Asia Pacific Economic Turmoil. During fiscal 1998, sales in the Asia Pacific
region increased only four percent compared to fiscal 1997. Sales growth was 48
percent in fiscal 1997 compared to fiscal 1996. Historically, the Asia Pacific
region had been a high growth region for the networking industry and the
Company. During fiscal 1998, however, several Asian countries experienced a
weakening of their local currencies and turmoil in their financial markets and
institutions, which the Company believes adversely affected financial results
during fiscal 1998.
Handheld Connected Organizer and Switching Products. Fiscal 1998 sales of
handheld connected organizer products more than doubled compared to fiscal 1997
and achieved growth in market share, according to recent industry reports.
Growth rates and market share gains in the handheld connected organizer market
may not be sustainable in the face of increasing competition from new entrants
to the market. In addition, the Company's workgroup switching products
experienced significant unit volume growth and increased sales, despite
significant declines in average selling prices and the effect of the channel
inventory reduction, as described in the above paragraphs.
GROSS MARGIN
Gross margin as a percentage of sales was 45.4 percent in fiscal 1998, compared
to 47.9 percent in fiscal 1997. In addition to the factors mentioned above, the
Company's year-over-year gross margin decline was affected by several factors,
including product mix, increased price competition, and higher period costs. The
Company's product mix included higher sales of certain NICs and workgroup
switching products, as well as an increase in sales to original equipment
manufacturers (OEMs), which carry lower gross margins. The U.S. Robotics brand
modems with x2 technology were introduced in the third quarter of fiscal 1997
with significantly higher margins, reflecting first-to-market pricing. During
the past twelve months, increased product and price competition in this product
segment resulted in a decline in gross margin percent. Additionally, the Company
experienced aggressive pricing of remote access products, as described above,
which resulted in a decline in gross margin percent. Fixed manufacturing costs
and period costs were a higher percentage of sales, primarily as a result of the
decrease in sales in the second and third quarters of fiscal 1998, but also due
to excess manufacturing capacity. The Company is continuing to consolidate
manufacturing and distribution sites in fiscal 1999.
OPERATING EXPENSES
Operating expenses in fiscal 1998 were $2.36 billion, or 43.6 percent of sales,
compared to $1.89 billion, or 33.8 percent of sales in fiscal 1997. Operating
expenses as a percentage of sales were higher than historical levels, in part
due to the reduced level of sales for fiscal 1998, as discussed above. Excluding
a purchased in-process technology charge of $8.4 million and merger-related and
other charges of $253.7 million primarily associated with the U.S. Robotics
merger, operating expenses would have been $2.10 billion, or 38.7 percent of
sales for fiscal 1998. Excluding a purchased in-process technology charge of
$54.0 million associated with the acquisition of Scorpio and a merger-related
charge of $6.6 million associated with the acquisition of OnStream, operating
expenses would have been $1.83 billion, or 32.7 percent of sales for fiscal
1997.
23
Sales and marketing expenses in fiscal 1998 increased $165.9 million or 15
percent from fiscal 1997. Sales and marketing expenses as a percentage of sales
increased to 23.0 percent of sales in fiscal 1998 from 19.3 percent in fiscal
1997. The year-over-year increase is attributable to the expansion of field
sales and marketing activities worldwide, primarily internationally, and
increased spending for the Company's customer service programs. In addition,
spending on the Company's global branding campaign during fiscal 1998
contributed to increased marketing expenses from the prior year.
Research and development expenses in fiscal 1998 increased $79.1 million or 16
percent compared to fiscal 1997. Research and development expenses as a
percentage of sales increased to 10.7 percent of sales compared to 9.0 percent
of sales in fiscal 1997. The year-over-year increase in research and development
expenses in absolute dollars and dollars as a percentage of sales was primarily
attributable to the cost of developing the Company's new products in the areas
of client access and switching, and its expansion into new technologies and
markets, such as xDSL. For example, during fiscal 1998, the Company developed a
fully-integrated (single-chip) Fast Ethernet NIC, the CoreBuilderTM Layer 3
Switch, the Palm IIITM handheld connected organizer, as well as many other key
new products. The Company believes the timely introduction of new technologies
and products is crucial to its success and plans to continue to make
acquisitions or strategic investments to accelerate time to market where
appropriate.
General and administrative expenses in fiscal 1998 increased $18.2 million or
seven percent from fiscal 1997. As a percentage of sales, general and
administrative expenses increased to 5.0 percent, compared to 4.4 percent in
fiscal 1997. The year-over-year increase in general and administrative expenses
in absolute dollars and dollars as a percentage of sales primarily reflected the
expansion of the Company's infrastructure, including personnel, as well as an
increased provision for bad debts.
During the fourth quarter of fiscal 1998, the Company recorded a charge of
approximately $8.4 million for purchased in-process technology associated with
the Lanworks acquisition. See Note 12 of Notes to Consolidated Financial
Statements.
During fiscal 1998, the Company recorded merger-related and other charges of
$253.7 million. These charges consisted of a merger-related charge and other
charges associated with past merger activities and disposition of real estate.
The merger-related charge of approximately $260.7 million related to the merger
with U.S. Robotics. During the fourth quarter, the Company reversed
approximately $10.6 million of previously recorded merger accruals. The Company
also sold a parcel of land near its headquarters site in Santa Clara, which
resulted in a net gain of approximately $15.8 million. Also during the fourth
quarter of fiscal 1998, the Company made a decision to close a manufacturing
site in Illinois in order to consolidate two Chicago-area manufacturing
facilities into one location. The Company recognized a charge of approximately
$19.4 million associated with this closure. See Note 12 of Notes to Consolidated
Financial Statements.
OTHER INCOME, NET
Other income, net increased $8.4 million compared to fiscal 1997, primarily as a
result of higher interest income due to higher average cash balances. Other
income, net for fiscal 1998 included a charge of approximately $4.7 million
related to an early call premium and write-off of unamortized issuance fees
associated with the redemption of $110 million of convertible notes in December
1997.
The majority of the Company's sales are denominated in U.S. Dollars. Where
available, the Company enters into foreign exchange forward contracts to hedge
certain balance sheet exposures and intercompany balances against future
movements in foreign exchange rates. Fiscal 1998 other income, net includes
foreign currency losses of approximately $12.3 million, primarily related to
Korean operations, where foreign exchange hedges were not available, or were
available only to a limited extent.
TAXES
The Company's effective income tax rate was approximately 74.1 percent in fiscal
1998 compared to 37.5 percent in fiscal 1997. Excluding the non-deductible
portion of merger-related and other charges primarily associated with the merger
with U.S. Robotics, the pro forma income tax rate was 35.0 percent for fiscal
1998. Excluding a charge for purchased in-process technology of approximately
$54.0 million and tax benefit of approximately $17.9 million associated with the
acquisition of Scorpio and the non-deductible portion of the merger-related
charge associated with the merger with OnStream, the pro forma income tax rate
was 36.9 percent for fiscal 1997.
24
NET INCOME
Net income for fiscal 1998 was $30.2 million, or $0.08 per share, compared to
net income of $500.5 million, or $1.42 per share for fiscal 1997. Excluding a
charge for purchased in-process technology and merger-related and other charges
mentioned above, net income would have been $246.1 million, or $0.67 per share
for fiscal 1998. Excluding the purchased in-process technology and tax benefit,
and the merger-related charge, net income would have been $543.2 million, or
$1.54 per share for fiscal 1997.
Comparison of fiscal years ended May 31, 1997 and 1996
SALES
Fiscal 1997 sales totaled $5.61 billion, an increase of 31 percent from fiscal
1996 sales of $4.28 billion. Sales of client access products in fiscal 1997 were
$3.15 billion, an increase of 30 percent from fiscal 1996 sales of $2.43
billion. Sales of client access products in fiscal 1997 represented 56 percent
of total sales compared to 57 percent in fiscal 1996. Sales of network systems
products in fiscal 1997 were $2.46 billion, an increase of 32 percent compared
to fiscal 1996 sales of $1.86 billion. Sales of network systems products
represented 44 percent of total sales in fiscal 1997, compared to 43 percent in
fiscal 1996. Fiscal 1997 sales growth was particularly strong in the areas of
Fast Ethernet NICs, stackable hubs and switches, modems, remote access
concentrators, ATM high-function switches and handheld connected organizers.
Sales in the U.S. represented 55 percent of total sales for fiscal 1997 compared
to 60 percent for fiscal 1996. U.S. and international sales increased 21 and 45
percent, respectively, compared to fiscal 1996. The increase in international
sales was a result of strong growth in the European and Asia Pacific regions due
to the Company's continued global expansion through the opening of new sales
offices in Asia, Latin America and Europe and the expansion of worldwide service
and support programs.
GROSS MARGIN
Gross margin as a percentage of sales was 47.9 percent in fiscal 1997 compared
to 46.6 percent in fiscal 1996. The U.S. Robotics brand modems with x2
technology were introduced in the third quarter of fiscal 1997, with
significantly higher margins, reflecting first-to-market pricing. The Company's
year-over-year gross margin increase primarily reflected an improved product
mix, specifically higher sales of certain modems, workgroup switching and hub
products and lower sales of network access concentrators and lower product
material costs of certain NICs. The increase in gross margins was partially
offset by a higher sales mix of certain lower margin NICs and increased pricing
pressures on remote access products. During the third quarter of fiscal 1997,
the Company reduced its average selling prices on Fast Ethernet NICs by
approximately 40 percent in response to increased competition, thus causing a
decline in gross margins, which was not completely reflected in fiscal 1997.
OPERATING EXPENSES
Operating expenses in fiscal 1997 were $1.89 billion, or 33.8 percent of sales,
compared to $1.39 billion, or 32.6 percent of sales in fiscal 1996. Excluding a
purchased in-process technology charge of $54.0 million associated with the
Scorpio acquisition and a merger-related charge of $6.6 million associated with
the OnStream acquisition, operating expenses would have been $1.83 billion, or
32.7 percent of sales for fiscal 1997. Excluding a purchased in-process
technology charge of $106.4 million associated with the acquisitions of Scorpio
and AXON and merger-related and other charges of $70.0 million primarily
associated with the acquisition of Chipcom, operating expenses would have been
$1.22 billion, or 28.5 percent of sales for fiscal 1996.
Sales and marketing expenses in fiscal 1997 increased $372.4 million or 53
percent from fiscal 1996. Sales and marketing expenses as a percentage of sales
increased to 19.3 percent of sales in fiscal 1997 from 16.6 percent in fiscal
1996. The year-over-year increase is attributable to the expansion of field
sales and marketing activities and personnel worldwide, as well as an increase
in spending for the Company's customer service programs. In addition, the
Company increased spending on advertising and marketing incentive programs and
promotions associated with the introduction of the x2 products.
Research and development expenses in fiscal 1997 increased $164.7 million or 49
percent compared to fiscal 1996. Research and development expenses as a
percentage of sales increased to 9.0 percent of sales compared to 7.9 percent of
sales in fiscal 1996. The year-over-year increase in research and development
expenses in absolute dollars and dollars as a percentage of sales was primarily
attributable to the cost of developing new products in the areas of client
access, switching, and network management and its expansion into new
technologies and markets.
25
General and administrative expenses in fiscal 1997 increased $79.6 million or 47
percent from fiscal 1996. As a percentage of sales, general and administrative
expenses increased to 4.4 percent, compared to 4.0 percent in fiscal 1997. The
year-over-year increase in general and administrative expenses in absolute
dollars and dollars as a percentage of sales primarily reflected the expansion
of the Company's infrastructure, including facilities, personnel, and an
increased provision for bad debts.
OTHER INCOME, NET
Other income, net was 0.2 percent of sales in both fiscal 1997 and fiscal 1996.
Other income, net for fiscal 1997 reflected increased interest income due to
higher cash and investment balances, which was offset by increased interest and
other expense due to higher levels of short-term debt. The majority of the
Company's sales are denominated in U.S. Dollars. Where available, the Company
enters into foreign exchange forward contracts to hedge certain balance sheet
exposures and intercompany balances against future movements in foreign exchange
rates. The impact of foreign exchange was not significant for fiscal 1997 or
1996.
TAXES
The Company's effective income tax rate was approximately 37.5 percent in fiscal
1997 compared to 43.0 percent in fiscal 1996. Excluding a charge for purchased
in-process technology of approximately $54.0 million and tax benefit of
approximately $17.9 million associated with the acquisition of Scorpio and the
non-deductible portion of the merger-related charge associated with the merger
with OnStream, the pro forma income tax rate was 36.9 percent for fiscal 1997.
Excluding the non-deductible purchased in-process technology charge of
approximately $106.4 million associated with the acquisitions of Scorpio and
AXON, and merger-related and other charges, primarily associated with Chipcom,
the pro forma income tax rate was 35.9 percent for fiscal 1996.
NET INCOME
Net income for fiscal 1997 was $500.5 million, or $1.42 per share, compared to
net income of $347.9 million, or $1.02 per share for fiscal 1996. Excluding the
purchased in-process technology and related tax benefit and the merger-related
charge, net income was $543.2 million, or $1.54 per share for fiscal 1997.
Excluding the purchased in-process technology and merger-related and other
charges mentioned above, net income was $504.1 million, or $1.47 per share for
fiscal 1996.
BUSINESS ENVIRONMENT AND RISK FACTORS
Financial Model. In managing its business, the Company annually establishes a