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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 28, 1999 COMMISSION FILE NO. 0-12867
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
[ ] EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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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 26,
1999, AS REPORTED BY THE NASDAQ NATIONAL MARKET, WAS APPROXIMATELY
$8,489,738,000. 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 26, 1999, 352,040,006 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 23, 1999 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 28, 1999
TABLE OF CONTENTS
PART I PAGE
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Item 1. Business....................................................................................1
Item 2. Properties..................................................................................8
Item 3. Legal Proceedings...........................................................................9
Item 4. Submission of Matters to a Vote of Security Holders.........................................11
Executive Officers of 3Com Corporation .....................................................11
PART II
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Item 5. Market for 3Com Corporation's Common Stock and Related Stockholder Matters..................14
Item 6. Selected Financial Data.....................................................................15
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations............................................................................16
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..................................33
Item 8. Financial Statements and Supplementary Data.................................................34
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure...............................................................................62
PART III
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Item 10. Directors and Executive Officers of 3Com Corporation........................................62
Item 11. Executive Compensation......................................................................62
Item 12. Security Ownership of Certain Beneficial Owners and Management..............................62
Item 13. Certain Relationships and Related Transactions..............................................62
PART IV
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Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.............................62
Exhibit Index...............................................................................63
Signatures..................................................................................65
Financial Statement Schedule................................................................S-1
3Com, CoreBuilder, DynamicACCESS, EtherLink, Graffiti, NBX, NETBuilder,
OfficeConnect, Palm Computing, Parallel Tasking, SuperStack, Total Control,
Transcend, and U.S. Robotics are registered trademarks of 3Com Corporation or
its subsidiaries. AirConnect, HomeConnect, Palm, Palm III, Palm IIIx, Palm V,
Palm VII, Palm OS, Palm.Net, PathBuilder, 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 the federal securities laws. These statements include those
concerning the following: expected price erosion; plans to make acquisitions
or strategic investments; expectations of progress toward the long-term
financial model; expectation of a shift to personal computer (PC) original
equipment manufacturer (OEM) distribution for certain products; future sales
from moderate growth and high growth/emerging markets; future financial
results; and expectations of Year 2000 readiness.
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 3Com's recent results or those projected in the
forward-looking statements include, but are not limited to, management of the
transition of our sales base from mature to higher growth markets,
significant increases or decreases in demand for our 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 manage
sales of our products through distributors, resellers and OEMs, failure to
secure supply of key component parts, loss of a significant customer,
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 3Com's business, see the "Business
Environment and Industry Trends" and "Company-Specific Trends and Risks"
sections of this Form 10-K. 3Com 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
GENERAL
3Com Corporation was founded on June 4, 1979. A pioneer in the computer
networking industry, we have evolved from a supplier of discrete networking
products to a leading provider of broad-based networking systems and services
that connect people and organizations to information across both local area
networks (LANs) and wide area networks (WANs), including the Internet. Our
products include switches, hubs, remote access systems, routers, network
management software, network interface cards (NICs), modems and handheld
computers.
We believe the future direction of our industry is being driven primarily by
three trends that we believe will create significant new opportunities for us:
- - an increasing demand for information delivered through the Internet and
corporate intranets;
- - the need for information to be accessible wherever people are - at work, in
the home, while on the move - making technologies such as wireless access
more important; and
- - a 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 data infrastructure.
To capitalize on these opportunities, our strategy is focused on the changing
networking needs of users. These include the need for simple, reliable
convergence-ready solutions that customize network access and service for
individuals. In addition, to improve the user's access to information through
the Internet or a corporate network, networking products must take into
account individual user's preferences, needs, and service requirements. We
believe that for networking to become pervasive and extend from the workplace
into other locations, networks and network access products must address these
requirements. 3Com will continue to advocate and implement network solutions
that address these needs.
We are also focused on incorporating intelligence into the network. For
convergence to be successfully implemented, equipment throughout the network
must be capable of performing in an intelligent fashion, routing network
traffic based on both pre-established priorities and the particular needs of
the individual network user. This intelligence must be concentrated at the
edge and access points of the network. For example, a network carrying voice,
video and data traffic must be able to distinguish between a telephone
handset and a desktop computer and deliver the appropriate form of
information to each.
1
Our principal competitive advantages include the depth and breadth of our
product lines, our volume manufacturing capability, brand recognition,
channels of distribution and our focus on making networking easier for users.
We believe 3Com's strong brand recognition in key markets such as NICs,
analog modems, handheld computing products, switches, hubs and remote access
concentrators is transferable to other product and technology markets, such
as home networking, wireless access products, broadband cable and digital
subscriber line (DSL) modems, and Internet appliances. Our low-cost
manufacturing, worldwide presence, strong indirect distribution channel and
comprehensive customer service and support capabilities allow us to extend
the reach, scope and performance of networking.
Since the early 1990s, 3Com has pursued a course of strategic acquisitions
and alliances to expand our technologies, product offerings and distribution
capabilities. In fiscal 1999, we acquired four companies and entered into a
joint venture to further our position in key markets and technologies:
- - The acquisition of EuPhonics, Inc. (EuPhonics) enabled us to integrate
high-quality sound capabilities in desktop and mobile modems and NICs to
leverage new communications technologies such as voice over Internet
protocol (VoIP) and streaming multimedia.
- - The acquisition of Smartcode Technologie SARL (Smartcode) added advanced
wireless communications capabilities to the Palm Computing-Registered
Trademark- platform to address the fast-growing market for mobile
information appliances such as cellular telephones, messaging devices,
data communicators and smart phones.
- - The acquisition of certain assets of ICS Networking, Inc. (ICS) added
silicon design technology and intellectual property that we can use to
significantly reduce development time and lower production costs of
semiconductor chips for a broad range of current and future products.
- - The acquisition of NBX Corporation (NBX) further accelerated our
development and deployment of converged network solutions, products and
services with Internet protocol (IP)-based telephony systems that integrate
voice and data communications over small business LANs and WANs.
- - 3Com entered into a joint venture named ADMtek, Inc. (ADMtek) to gain
access to specific silicon design technology and expertise.
During fiscal 1999, we expanded our strategic relationship with Siemens AG to
include a worldwide joint selling agreement in the large enterprise and
solutions provider markets. The strategic alliance may consider joint
development of voice-related enterprise and carrier solutions. In light of
the current strategic relationship, the two companies will not proceed with a
previously announced joint venture.
In fiscal 1999, we also formed a strategic alliance with Microsoft
Corporation to accelerate deployment of a new generation of converged
networks and solutions. Under this alliance, we are collaborating with
Microsoft to develop and market simple-to-use converged networking products
across a variety of markets for both business and personal use, including
co-developed and co-branded home networking products. The efforts will
further integrate the Microsoft Windows operating system within 3Com's
product lines, including managed network services for carriers.
INDUSTRY SEGMENT INFORMATION
3Com operates primarily in the networking industry. Our principal operating
segments within this industry are the following: Network Systems, Personal
Connectivity, and Handheld Computing.
PRODUCTS AND SERVICES
3Com offers a broad range of products, which are grouped into three general
categories: Network Systems Products, Personal Connectivity Products and
Handheld Computing products. We enhance the value of these products through
our Customer Service and Support offerings.
2
NETWORK SYSTEMS PRODUCTS
3Com's network systems products comprise the key components of a LAN and
provide access capabilities across a WAN. Our network systems products can be
categorized in the following areas:
- LAN Switches
- LAN Hubs
- Multiprotocol Routers and Tunnel Switches
- Access Routers and Remote Access Servers
- Multiservice Access Platforms (Remote Access Concentrators)
- LAN Telephony Products
- WAN Access Switches
- Network Management Products
LAN SWITCHES: In business environments where the network connects hundreds or
thousands of users, 3Com-Registered Trademark- switches create direct
connections to the server or desktop PC, enabling cost-effective, high-speed
links between multiple network segments. Switches also provide additional
bandwidth to help businesses maximize productivity and support growing
organizations. 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 such as Fast Ethernet and Gigabit Ethernet.
3Com offers a variety of switches for the requirements of any organization.
Our OfficeConnect-Registered Trademark- Ethernet/Fast Ethernet switches
combine simplicity of design, installation and operation with advanced
functionality and outstanding speed at a low cost. Our award-winning
SuperStack-Registered Trademark- 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 enterprise LAN backbone for high-density
connectivity, scalable capacity, reliability and network control, we offer
the CoreBuilder-Registered Trademark- family of high-bandwidth multi service
switches.
LAN HUBS: Hubs act as concentrators of network traffic generated from the
desktop PC 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 to
segment the network and improve overall performance.
3Com offers 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. Our SuperStack II hubs offer a range of
options for small, medium and large enterprises, including entry-level 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.
MULTIPROTOCOL ROUTERS AND TUNNEL SWITCHES: Routers are protocol-dependent
devices that connect sub-networks together. We offer a variety of backbone
and remote office routers that facilitate enterprise internetworking. For
remote offices, SuperStack II NETBuilder-Registered Trademark- and
OfficeConnect NETBuilder routers provide scalable, multi-protocol links to
remote branch offices of any size. For companies deploying extranets, we
offer product bundles, which include the SuperStack II NETBuilder routers and
bridges and the OfficeConnect NETBuilder routers; these bundles facilitate
the deployment of virtual private networks (VPNs). VPNs support large-scale
access for suppliers, partners, customers and branch offices at a substantial
cost savings over traditional WAN access because they bypass the public
switched telephone network (PSTN) and go over the Internet.
ACCESS ROUTERS AND REMOTE ACCESS SERVERS: 3Com's access routers and remote
access servers leverage today's leading access technologies--dial-up 56
Kilobits per second (Kbps) V.90 and integrated services digital network
(ISDN) -- to give users the most cost-effective array of connectivity
choices. OfficeConnect remote access routers and SuperStack II remote access
servers offer high-performance remote access support in a stackable form
factor that provides scalable, economical remote access connectivity with
full functionality.
MULTISERVICE ACCESS PLATFORMS: These platforms 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.
3
The Total Control-Registered Trademark- multiservice access platform is a
very high-density platform for carriers and enterprises that supports all
major analog and digital broadband technologies 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 this platform range from providing central site
or point of presence (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.
Our Total Control VoIP solutions enable service providers to migrate
traditional PSTN voice traffic onto a highly scalable, redundant, and
resilient IP-telephony network. This carrier-class platform features a
three-tier architecture comprised of gateways, gatekeepers/signaling
controllers, and back-end servers for a fully fault-tolerant, industry
standards-based solution that enables carriers and service providers to
deliver new and enhanced services quickly and cost effectively.
LAN TELEPHONY PRODUCTS: 3Com LAN telephony products give businesses the
combination of simple, single-network economy and administration, and
powerful, standards-based feature sets that make network convergence a
reality. Our NBX-Registered Trademark- 100 communication system looks and
acts like a traditional business telephone system, yet it is an integrated,
Ethernet-based product that sends voice packets through the LAN or across the
WAN with excellent audio quality and the sturdy reliability of a
self-contained, non-PC-based unit.
WAN ACCESS SWITCHES: 3Com's PathBuilder-TM- family of WAN access switches
integrate diverse traffic onto a common wide area network, lowering costs and
facilitating the migration to converged networks. PathBuilder switches
implement high-density asynchronous transfer mode (ATM) edge applications,
including data, voice and video at the edge of the service provider's network
or at the core of the enterprise network.
NETWORK MANAGEMENT PRODUCTS: To augment our product offerings, we incorporate
innovative technology into a growing line of industry leading network
management applications which deliver complete, end-to-end management of 3Com
network systems for ease of configuration, efficient troubleshooting, and
superior performance. These products are marketed under the
Transcend-Registered Trademark- and DynamicACCESS-Registered Trademark- brand
names and include tools to monitor and manage network traffic performance and
security.
PERSONAL CONNECTIVITY PRODUCTS
3Com's range of personal connectivity products enable an individual user to
connect his or her computer to a LAN, such as a corporate network, or to the
Internet. These products include:
- Desktop Network Interface Cards (NICs)
- Desktop Modems
- PC Cards
DESKTOP NETWORK INTERFACE CARDS (NICS): NICs, also known as adapters, are
small printed circuit boards that allow network servers, personal computers,
and workstations to connect to the LAN. 3Com NICs provide complete solutions
for a full range of network applications and environments. We offer NICs for
Ethernet, Fast Ethernet, Gigabit Ethernet, Token Ring, fiber distributed data
interface (FDDI) and ATM connectivity, as well as with combined connectivity
to support the networking industry's migration from Ethernet to Fast Ethernet
to Gigabit Ethernet. We also offer chipsets with this functionality to PC
OEMs.
All 3Com NICs feature patented Parallel Tasking-Registered Trademark-
architecture, which improves network performance, and DynamicACCESS software,
which provides the NIC with intelligence to help optimize overall network
performance, management and control.
DESKTOP MODEMS: Modems provide access to the Internet, enterprise LANs and a
host of communications services including fax. Our modems support today's
leading access technologies, including 56 Kbps V.90, ISDN, DSL and
data-over-cable, to give users the most cost-effective array of connectivity
choices.
PC CARDS: Today, portable laptop computers have the processing power, storage
and displays that make them the primary computer for many users. For these
devices, 3Com offers PC Cards which provide connectivity specifically for
mobile computers. PC Cards 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.
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HANDHELD COMPUTING PRODUCTS
3Com's handheld computing business consists of the Palm Computing line of
handheld devices, the Palm.Net-TM- service offering and the licensing of the
Palm Computing operating system. Palm-TM- devices work as companion products
to desktop and laptop computers, allowing information management both
remotely and on the desktop. Individuals use these devices 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
environment, these devices are used to enhance productivity. For example,
they allow mobile retrieval of critical data from corporate business
applications such as finance, manufacturing or sales automation systems. In
addition to the computing unit, Palm Computing products include a docking
cradle which is connected to the user's mobile or desktop computer to provide
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. Palm products also include character
recognition software that allows users to add and edit information with a
stylus while away from the desktop computer keyboard.
Introduced on a trial basis in May 1999 and scheduled for national roll-out
in fiscal year 2000, the Palm VII-TM- handheld computer provides wireless
communications capabilities as well as personal information management
features. With its advanced wireless technology and integrated antenna, the
Palm VII product provides wireless access to the Internet through our
innovative "Web clipping" technology. Applications for the Palm VII have been
developed by leading Internet content providers such as ABC News, ESPN,
E*Trade, The Wall Street Journal, Yahoo!, People Search, and many others. The
Palm VII device can also send and receive e-mail messages and, with the
appropriate applications and network configuration, can access data on
corporate intranets. 3Com delivers wireless Internet access service directly
to Palm VII product users for a monthly fee via the Palm.Net wireless
communication service.
The entire family of Palm handheld computers are based on the Palm Computing
operating system (OS), which is supported by over 17,000 independent software
developers producing a variety of applications, utilities and games for the
handheld products. We also license the Palm OS(TM) software to manufacturers
and developers of other handheld devices such as personal digital assistants,
bar code scanners, cellular phones and other communication devices.
NEW PRODUCTS
In fiscal 1999, we announced or delivered several new products and
enhancements to refresh our traditional product lines and to enter new
markets. These include:
NETWORK SYSTEMS PRODUCTS
- ATM, cell-based and Gigabit Ethernet, packet-based versions of our
CoreBuilder 9000 LAN core chassis switch
- VPN solutions, which incorporate our PathBuilder and NETBuilder
tunneling products and Total Control hub access products
- Total Control IP telephony system for carriers, based on a three-tier
architecture consisting of gatekeepers, back-end servers and gateways
- Total Control multi-access platform to support wireless access to
corporate VPNs for service providers running code division multiple
access (CDMA)-based data networks; as well as 64 Kbps wireless data
access speeds to service providers and their mobile subscribers
- NBX 100 Communications System for LAN telephony, combining voice and data
networks into one system
- Total Control cable modem termination system (CMTS) and network
management software for multi-service operators to use in
deploying bi-directional cable Internet access systems
- PathBuilder S400 WAN convergence switch, an all-in-one WAN system that
integrates VPNs, voice/data convergence and multi-protocol routing
- PathBuilder 200 voice access switch for adding voice to existing Frame
Relay and IP-based wide area data networks
5
PERSONAL CONNECTIVITY PRODUCTS
- U.S. Robotics-Registered Trademark- cable modem CMX, certified by
CableLabs for Data Over Cable Service Interface Specification (DOCSIS)
standards
- DSL internal and external modems marketed under the 3Com, HomeConnect-TM-
and OfficeConnect brands
- HomeConnect portable digital PC camera
- LAN connectivity products including a Mini PC card for notebook computers
and the EtherLink-Registered Trademark- 10/100 PCI NIC that offloads key
networking tasks from Windows 2000 to the NIC's integrated processor
- AirConnect-TM- 11 Megabits per second (Mbps) wireless LANs for mobile
access to corporate networks from anywhere in the enterprise
HANDHELD COMPUTING PRODUCTS
- Four handheld computers including the Palm III-TM-, Palm IIIx-TM-,
Palm V-TM-, and wireless Palm VII devices
- The Palm.Net wireless communications services for Palm VII device
CUSTOMER SERVICE AND SUPPORT
3Com offers comprehensive worldwide service and support across all 3Com
product lines. Our customer services include design, installation and
maintenance on-site, by phone or across the Internet. Additionally, we
provide 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. We also offer 3Com Knowledgebase, a web-based
customer-specific support system that gives customers and partners
up-to-the-minute technical information and networking solutions. All of our
Web services are accessible 24 hours a day, seven days a week, simplifying
the management of multiple network locations across several time zones. This
on-line support system allows customers to specify exactly what they need,
communicate directly with technical support and receive information directly
at the desktop. We support our customers internationally from more than 140
different locations, including eight technical call centers communicating
with customers in more than 15 languages.
PRODUCT DEVELOPMENT
3Com's research and development expenditures in fiscal years 1999, 1998 and
1997 were $635.8 million, $581.6 million and $502.5 million, respectively.
Our research and development expenditures span efforts to create new types of
products and classes of service as well as to expand and improve our current
product lines.
More recently, we are focusing a higher percentage of our research and
development investments in the following high-growth or emerging areas:
- Handheld Computing
- IP and LAN Telephony (VoIP and LAN Telephony)
- Broadband Access (primarily data-over-cable and DSL)
- Wireless Access
- Home Networking
We have a strong history of incorporating proprietary application specific
integrated circuits (ASICs) into our products to provide key functions, cost
efficiency and the capacity for future upgrades. Customers can benefit from
new technologies and enhanced capabilities through inexpensive, simple
software upgrades rather than expensive, disruptive hardware replacements. In
addition, ASICs facilitate higher density platforms - critical in certain
applications, such as high-speed Layer 3 switching - and are less costly to
manufacture. We incorporate ASIC technology into many of our products,
including NICs, switches, hubs, routers and remote access equipment. For
example, our recent acquisition of certain assets of ICS provides us with
silicon design technology and intellectual property that we can use to
significantly reduce development time and lower production costs of
semiconductor chips for our broad range of current and future products.
6
MARKETS AND CUSTOMERS
Our customers range from individual consumers of personal electronics to
large global corporations to communications services providers of all forms
and sizes. Business enterprise customers include companies in a wide variety
of industries, including finance, health care, manufacturing,
telecommunications, government, education, and retail.
Around the world, we serve our customers through both direct and indirect
sales channels. Our primary method of distribution is the indirect channel,
which includes systems integrators, value-added resellers (VARs), national
resellers and dealers, distributors, OEMs, and PC OEMs. 3Com fosters these
relationships with incentive and training programs that have earned special
recognition within the industry. Certain products, such as analog and
broadband modems, NICs, handheld computers, hubs and low-end switches are
also sold through electronics catalogs and retailers. Palm handheld computing
products are also sold on-line to customers through the Internet.
Our strong indirect channel presence enables customers to purchase 3Com
solutions through their preferred supplier. Our retail and reseller
distribution channels provide ready access to the wide array of 3Com products
and solutions on a worldwide basis. We also work directly with end users in
the large enterprise and carrier markets to establish long-term customer
relationships.
Our sales strategy encourages broad market coverage by allowing our sales
personnel to create demand for 3Com's products while giving customers the
flexibility to choose the most appropriate delivery channels. For the year
ended May 28, 1999, Ingram Micro Inc. and Tech Data Corporation accounted for
17 percent and 12 percent of our total sales, respectively. For the years
ended May 31, 1998 and 1997, Ingram Micro accounted for 14 percent and 13
percent of our total sales, respectively.
INTERNATIONAL OPERATIONS
We market our products globally, primarily through subsidiaries, sales
offices and relationships with OEMs and distributors with local presence in
all significant global markets. Outside the U.S., we have significant
research and development groups in the UK, Ireland, France and Israel. We
have manufacturing facilities in Ireland and Singapore. We maintain sales
offices in 49 countries outside the U.S.
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. Orders generally may be canceled or rescheduled by the customer
without significant penalty. Accordingly, we do not maintain a substantial
backlog, and backlog as of any particular date is not indicative of 3Com's
future sales.
MANUFACTURING
We use a combination of in-house manufacturing and independent contract
manufacturers to produce our products. 3Com operates manufacturing facilities
in Santa Clara, California; Mount Prospect and Rolling Meadows, Illinois;
Marlborough, Massachusetts; Salt Lake City, Utah; Blanchardstown, Ireland;
and Changi, Republic of Singapore. Purchasing, mechanical assembly, burn-in,
testing, final assembly, and quality assurance functions are performed at all
of these facilities.
COMPETITION
3Com's competitors range from large telecommunications equipment companies
and well-capitalized computer systems and communications companies, to
start-up companies focused on certain niches of the networking market.
7
The network systems market is characterized by a few broad-based suppliers
offering multiple product lines as well as several companies with specialized
product offerings. Principal competitors in the network systems market
include Alcatel, Cisco Systems, Intel, Lucent Technologies, Motorola, Nortel
Networks and Siemens.
Competitors in the personal connectivity market include Boca Research,
Conexant Systems (formerly Rockwell), D-Link, Diamond Multimedia, Intel,
Lucent Technologies and Xircom. In addition, 3Com expects increasing
competition from companies, including Intel, who could potentially
incorporate networking, communications, and other computer processing
functions onto a single chip. In the emerging broadband cable and DSL modem
market, 3Com's competitors include Alcatel, Cisco Systems, Com21, General
Instruments, Motorola, Nortel Networks, RCA, and Sony Corporation.
In the handheld computing market, our competition includes both device
manufacturers and companies that license competing operating systems to those
manufacturers. Competitive device manufacturers in this market include Casio,
Compaq, Hewlett-Packard, Olivetti, Phillips, Psion and Sharp. Competitors who
license their operating system to hardware manufacturers of handheld
computers include Microsoft Corporation and Symbian (the joint venture of
Ericsson, Motorola, Nokia and Psion).
INTELLECTUAL PROPERTY AND RELATED MATTERS
The quality of 3Com's innovation is reflected in a substantial portfolio of
patents covering a wide variety of networking technologies. This ownership of
core networking technologies creates opportunities to leverage our
engineering investments and develop more integrated products for simpler,
more powerful and more innovative networking solutions for customers.
3Com relies on U.S. and foreign patents, copyrights, trademarks and trade
secrets, to establish and maintain proprietary rights in our technology and
products. We have an active program to file applications for and obtain
patents in the U.S. and in selected foreign countries where a potential
market for our products exists. Our general policy has been to seek patent
protection for those inventions and improvements likely to be incorporated in
our products or that we otherwise expect to be valuable. As of May 28, 1999,
we had 228 U.S. patents (including 214 utility patents and 14 design patents)
and 60 foreign patents. During fiscal 1999, 3Com filed 429 patent
applications in the U.S. Numerous patent applications are currently pending
in the U.S. and other countries that relate to our research and development.
3Com also has patent cross license agreements with other companies.
3Com has registered 98 trademarks in the U.S. 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.
EMPLOYEES
As of May 28, 1999, 3Com had 13,027 full time employees, of whom 3,184 were
employed in engineering, 4,141 in sales, marketing and customer service,
3,465 in manufacturing and 2,237 in finance and administration. Our employees
are not represented by a labor organization, and we consider our employee
relations to be satisfactory.
ITEM 2. PROPERTIES
3Com operates in a number of locations worldwide. In fiscal 1999, we had
several significant real estate activities.
During the fourth quarter of fiscal 1999, we leased a new 540,000 square foot
office complex in Marlborough, Massachusetts. The new campus consolidates
general administration, research and development and manufacturing operations
formerly conducted in five separate facilities. The site will support
expansion of approximately 660,000 square feet to accommodate future growth.
The lease expires in August 2002, with an option to extend the lease term for
two successive periods of five years each. We have 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 3Com retaining an obligation to the
owner for the difference between the sale price and $86.0 million, subject to
certain provisions of the lease.
8
During the third quarter of fiscal 1999, we leased three additional buildings
totaling approximately 300,000 square feet at our Santa Clara, California
headquarters site. The lease expires in August 2002, with an option to extend
the lease term for two successive periods of five years each. We have 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 3Com retaining an
obligation to the owner for the difference between the sale price and $83.6
million, subject to certain provisions of the lease.
During the second quarter of fiscal 1999, we recognized a gain of $4.2
million following the resolution of certain contingencies associated with the
sale of a 33 acre parcel near 3Com's Santa Clara headquarters in fiscal 1998.
This was in addition to a gain of $15.8 million recognized during the fourth
quarter of fiscal 1998. 3Com retained an adjacent 39-acre parcel of land for
future development of potentially 1.6 million square feet.
We completed the expansion of our Rolling Meadows, Illinois facility during
the first quarter of fiscal 1999 and consolidated the operations of several
Chicago area sites into this 510,000 square foot building. We purchased this
40 acre site for $38.3 million in fiscal 1998. This site can support future
development of up to 1.1 million additional square feet.
3Com's primary locations include the following:
Location Sq. Ft. Owned/Leased Primary Use
-------- ------- ------------ -----------
United States - 1,352,000 Leased Corporate headquarters, office, customer service,
San Francisco research and development, manufacturing,
Bay Area (1) distribution and computer center
120,000 Owned Office and customer service
United States - 1,149,000 Owned Office, research and development, customer service
Chicago Area and manufacturing
443,000 Owned Property vacant; held for sale
United States - 615,000 Leased Office, research and development, customer service,
Boston Area manufacturing and distribution
United States - 341,000 Owned Office, research and development and manufacturing
Salt Lake City
Asia Pacific - 333,000 Leased Office, manufacturing and distribution
Singapore
Europe - 307,000 Owned Office, research and development and manufacturing
Ireland
Europe - 230,000 Owned Office, research and development and customer
UK service
60,000 Leased Office
(1) 3Com also owns approximately 39 acres of land in the San Francisco
Bay Area for future development.
ITEM 3. LEGAL PROCEEDINGS
We are a party to lawsuits in the normal course of our business. Litigation
in general, and intellectual property and securities litigation in
particular, can be expensive and disruptive to normal business operations.
Moreover, the results of complex legal proceedings are difficult to predict.
We believe that we have defenses in each of the cases set forth below and are
vigorously contesting each of these matters. An unfavorable resolution of one
or more of the following lawsuits could adversely affect our business,
results of operations or financial condition.
9
SECURITIES LITIGATION
On March 24 and May 5, 1997, securities class action lawsuits, captioned
HIRSCH V. 3COM CORPORATION, ET AL., Civil Action No. CV764977 (HIRSCH), and
KRAVITZ V. 3COM CORPORATION, ET AL., Civil Action No. CV765962 (KRAVITZ),
respectively, were filed against 3Com and certain of its officers and
directors in the California Superior Court, Santa Clara County. The
complaints allege violations of Sections 25400 and 25500 of the California
Corporations Code and seek unspecified damages on behalf of a purported class
of purchasers of 3Com common stock during the period from September 24, 1996
through February 10, 1997. The actions are in discovery. No trial date has
been set.
On February 10, 1998, a securities class action, captioned EUREDJIAN V. 3COM
CORPORATION, ET AL., Civil Action No. C-98-00508CRB (EUREDJIAN), was filed
against 3Com and several of its present and former officers and directors in
United States District Court for the Northern District of California
asserting the same class period and factual allegations as the HIRSCH and
KRAVITZ actions. The complaint alleges violations of the federal securities
laws, specifically Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, and seeks unspecified damages. The plaintiffs have filed an amended
complaint. 3Com has filed an answer to the amended complaint. No trial date
has been set.
In December 1997, a securities class action, captioned REIVER V. 3COM
CORPORATION, ET AL., Civil Action No. C-97-21083JW (REIVER), was filed in the
United States District Court for the Northern District of California. Several
similar actions have been consolidated into this action, including FLORIDA
STATE BOARD OF ADMINISTRATION AND TEACHERS RETIREMENT SYSTEM OF LOUISIANA V.
3COM CORPORATION, ET AL., Civil Action No. C-98-1355. On August 17, 1998, the
plaintiffs filed a consolidated amended complaint which alleges violations of
the federal securities laws, specifically Sections 10(b) and 20(a) of the
Securities and Exchange Act of 1934, and which seeks unspecified damages on
behalf of a purported class of purchasers of 3Com common stock during the
period from April 23, 1997 through November 5, 1997. In July 1999, the court
dismissed the complaint and granted the plaintiffs the right to file an
amended complaint.
In October 1998, a securities class action lawsuit, captioned ADLER V. 3COM
CORPORATION, ET AL., Civil Action No. CV777368 (ADLER), was filed against
3Com and certain of its officers and directors in the California Superior
Court, Santa Clara County, asserting the same class period and factual
allegations as the REIVER action. The complaint alleges violations of
Sections 25400 and 25500 of the California Corporations Code and seeks
unspecified damages. The action is in discovery. No trial date has been set.
In January 1998, two purported shareholder complaints relating to 3Com'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 alleged 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 sought damages in an unspecified amount on behalf of a purported
class of persons who received 3Com stock during the merger pursuant to the
registration statement. On September 25, 1998, the Delaware Chancery Court
issued an injunction preventing the plaintiffs from proceeding with these
actions, finding that the plaintiffs' claims are barred by a settlement in a
prior action. On March 15, 1999, the Delaware Chancery Court issued an order
denying a motion by the plaintiffs to set aside the settlement in the prior
action. Pursuant to these rulings, these actions have been dismissed by the
California court.
In February 1998, a shareholder derivative action purportedly on behalf of
3Com, captioned, WASSERMAN V. BENHAMOU, ET AL., Civil Action No. 16200-NC,
was filed in Delaware Chancery Court. The complaint alleged that 3Com's
directors breached their fiduciary duties to 3Com by engaging in alleged
wrongful conduct from mid-1996 through November 1997, including the conduct
complained of in the securities litigation described above. 3Com was named
solely as a nominal defendant, against whom the plaintiff sought no recovery.
This action has been dismissed by the court.
In October 1998, two shareholder derivative actions purportedly on behalf of
3Com, captioned SHAEV V. BARKSDALE, ET AL., Civil Action No. 16721-NC, and
BLUM V. BARKSDALE, ET AL., Civil Action No. 16733-NC, were filed in Delaware
Chancery Court. The complaints allege that 3Com's directors breached their
fiduciary duties to 3Com through the issuance of and disclosures concerning
director stock options. 3Com is named solely as a nominal defendant, against
whom the plaintiffs seek no recovery. 3Com and the individual defendants have
filed a motion to dismiss these actions.
10
On May 11, 1999, a securities class action, captioned GAYLINN V. 3COM
CORPORATION, ET AL., Civil Action No. C-99-2185 MMC (GAYLINN), was filed
against 3Com and several of its present and former officers and directors in
United States District Court for the Northern District of California. Soon
thereafter, a number of additional complaints were filed in the Northern
District of California containing factual allegations similar to that in
GAYLINN. The GAYLINN 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 September 22, 1998
through March 2, 1999. The actions are in the process of being consolidated.
INTELLECTUAL PROPERTY LITIGATION
On April 28, 1997, Xerox Corporation filed suit against U.S. Robotics
Corporation and U.S. Robotics Access Corp. in the United States District
Court for the Western District of New York. The case is now captioned:
XEROX CORPORATION V. U.S. ROBOTICS CORPORATION, U.S. ROBOTICS ACCESS CORP.,
PALM COMPUTING, INC. AND 3COM CORPORATION, Civil Action No. 97-CV-6182T. The
complaint alleges willful infringement of a United States patent relating to
computerized interpretation of handwriting. The complaint further seeks for
unspecified damages and injunctive relief. Xerox has asserted that
Graffiti-Registered Trademark- software and certain products of Palm
Computing, Inc. infringe the patent. On June 25, 1999, the Court stayed the
action pending reexamination of the patent by the U.S. Patent and Trademark
Office.
CONSUMER LITIGATION
A consumer class action pending against 3Com and U.S. Robotics in the
California Superior Court, Marin County, BENDALL, ET AL. V. U.S. ROBOTICS
CORPORATION, ET AL., Civil Action No. 170441, arising out of the purchase of
x2-TM- products and products upgradeable to x2 technology, 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. The Coordination Proceeding (Case number CV769903) is
pending in the California Superior Court, Santa Clara County. Two consumer
class action lawsuits pending against 3Com and U.S. Robotics in Cook County,
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. On July 27, 1999, the Santa Clara County Superior Court
granted final approval of a settlement agreement in the California
Coordination Proceeding. The cost of this settlement was immaterial to our
consolidated financial statements. The BENDALL and INTERVENTION actions were
dismissed with prejudice on July 27, 1999. Under the terms of the
Coordination Proceeding settlement agreement, the plaintiffs in the LIPPMAN
and MICHAELS actions are to voluntarily dismiss their cases on or before
August 26, 1999.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF 3COM CORPORATION
The following table lists the names, ages and positions held by all executive
officers of 3Com. There are no family relationships between any director or
executive officer and any other director or executive officer of 3Com.
Executive officers serve at the discretion of the board of directors.
NAME AGE POSITION
---- --- --------
Eric A. Benhamou 43 Chairman and Chief Executive Officer
Bruce L. Claflin 47 President and Chief Operating Officer
Irfan Ali 35 Senior Vice President and General Manager, Carrier Systems
Group
Ralph B. Godfrey 59 Senior Vice President, e-Commerce
Jef Graham 43 Senior Vice President and General Manager, Personal Connectivity
Business Unit
John H. Hart 53 Senior Vice President, Chief Technical Officer
11
NAME AGE POSITION
---- --- --------
Randy R. Heffner 49 Senior Vice President, Manufacturing Operations
Richard W. Joyce 43 Senior Vice President, Worldwide Sales
Alan J. Kessler 41 President, Palm Computing
Edgar Masri 41 Senior Vice President and General Manager,
Network Systems Business Unit
John McClelland 54 Senior Vice President, Supply Chain Operations
Mark D. Michael 48 Senior Vice President-Legal and Government Relations, General
Counsel and Secretary
Eileen Nelson 52 Senior Vice President, Corporate Services
Christopher B. Paisley 47 Senior Vice President, Finance and Chief
Financial Officer
Janice M. Roberts 43 Senior Vice President, Marketing
and Business Development
Steve Rowley 40 Senior Vice President, Americas Sales
David H. Starr 47 Senior Vice President and Chief Information Officer
Eric A. Benhamou has been our Chief Executive Officer since September 1990
and served as our President from April 1990 through August 1998. Mr. Benhamou
became our Chairman of the board of directors in July 1994. Mr. Benhamou
served as our Chief Operating Officer from April 1990 through September 1990.
From October 1987 through April 1990, Mr. Benhamou held various general
management positions within 3Com. Mr. Benhamou serves as Chairman of the
board of directors of Cypress Semiconductor, Inc. and as a director of Legato
Systems, Inc. Mr. Benhamou is a member of President Clinton's Information
Technology Advisory Council.
Bruce L. Claflin has been our President and Chief Operating Officer since
August 1998. Prior to joining 3Com, Mr. Claflin worked for Digital Equipment
Corporation ("DEC") from October 1995 to June 1998. From July 1997 to June
1998, he was Senior Vice President and General Manager, Sales and Marketing
at DEC and prior to that he served as Vice President and General Manager of
DEC's Personal Computer Business Unit from October 1995 to June 1997. From
April 1973 to October 1995, Mr. Claflin held a number of senior management
and executive positions at International Business Machines Corporation
("IBM").
Irfan Ali has been the Senior Vice President and General Manager of our
Carrier Systems Group since March 1999. From October 1997 to March 1999 he
was Vice President, Worldwide Marketing of our Carrier Systems. Prior to
joining 3Com, Mr. Ali worked for Newbridge Networks, Inc., where he was Vice
President, Marketing from July 1995 to October 1997 and Assistant Vice
President, Fast Packet Networks from July 1993 to June 1995. Prior to working
at Newbridge Networks, Inc., Mr. Ali was Senior Manager, Market Development
for Strategic Technology at Northern Telecom, Inc. from July 1991 to July
1993. From August 1987 to July 1991, Mr. Ali was a Senior Member of the
Scientific Staff at Bell-Northern Research.
Ralph B. Godfrey has been our Senior Vice President, e-Commerce since June
1999. From June 1998 to June 1999 he was Senior Vice President of Sales for
the Americas. 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, U.S. Sales,
a position he held through May 1993. Mr. Godfrey serves as a director of
Rockford Corporation.
12
Jef Graham has been our Senior Vice President and General Manager of our
Personal Connectivity Business Unit since April 1999. Mr. Graham joined 3Com
in August 1995 as Vice President and General Manager of the Mobile
Communications Division. Prior to joining 3Com, he was President and Chief
Executive Officer of Trident Systems, Inc. from May 1993 to July 1995. From
July 1978 to April 1993, Mr. Graham held various general management, sales
and marketing positions around the world for Hewlett-Packard Company.
John H. Hart has been our Senior Vice President and Chief Technical Officer
since August 1996. From the time Mr. Hart joined 3Com in September 1990 until
July 1996, he was Vice President and Chief Technical Officer. Prior to
joining 3Com, Mr. Hart worked for Vitalink Communications Corporation from
June 1983 to August 1990, where his most recent position was Vice President
of Network Products.
Randy R. Heffner has been our Senior Vice President, Manufacturing Operations
since June 1997. From July 1992 through May 1997, Mr. Heffner was the Vice
President of Manufacturing for our Personal Connectivity Operations. Prior to
joining 3Com, Mr. Heffner worked for NeXT Computer, Inc. as Vice President of
Manufacturing from March 1987 to January 1992. Mr. Heffner worked for
Hewlett-Packard Company from August 1974 to February 1987 in a variety of
materials management and production control positions.
Richard W. Joyce has been our 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 President of our Palm Computing subsidiary since
July 1999. From June 1998 to June 1999, Mr. Kessler served as our Senior
Vice President, Global Customer Service. 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 our 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. Mr. Kessler
joined 3Com in October 1985.
Edgar Masri has been our Senior Vice President and General Manager, Network
Systems 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
from July 1992 to September 1995 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. Mr. Masri joined 3Com in December 1985.
John McClelland has been our Senior Vice President, Supply Chain Operations
since April 1999. Prior to joining 3Com, Mr. McClelland was Chief Industrial
Officer for the Philips Consumer Electronics division of Philips
International, B.V. from November 1998 to March 1999. Mr. McClelland was
Vice President of Manufacturing and Distribution at DEC from February 1995 to
October 1998. From October 1968 to January 1995, Mr. McClelland held various
management positions at IBM. Most recently at IBM, he held the position of
V.P. Manufacturing and Distribution, IBM PC Co. from April 1994 to January
1995.
Mark D. Michael has been our Senior Vice President-Legal and Government
Relations, General Counsel, and Secretary since May 1999. Mr. Michael served
as Senior Vice President, Legal, General Counsel and Secretary from September
1997 to April 1999. Mr. Michael joined 3Com 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 3Com, 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 our Senior Vice President, Corporate Services since
July 1998. From April 1997 to July 1998, Ms. Nelson served as our Vice
President, Enterprise Systems, Human Resources. From 1988 to April 1997, Ms.
Nelson held various Human Resources director level roles at 3Com. Prior to
joining 3Com, 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.
13
Christopher B. Paisley has been our Senior Vice President, Finance and Chief
Financial Officer since August 1996. From the time Mr. Paisley joined 3Com
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 our Senior Vice President, Marketing and Business
Development since August 1996. From June 1997 to March 1999, Ms. Roberts was
also responsible for the Palm Computing Business Unit and New Business
Initiatives. 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.
Steve Rowley has been our Senior Vice President, Americas Sales since June
1999. Mr. Rowley served as Vice President, 3Com Europe from April 1998 to
June 1999. From June 1997 to April 1998, Mr. Rowley served as Vice
President, 3Com European Enterprise Systems. From May 1996 to June 1997, Mr.
Rowley served as Vice President of Europe Sales. Before joining 3Com, Mr.
Rowley was General Manager and Marketing Director of Cellnet from 1994 to
1996. From 1984 to 1994, Mr. Rowley held various positions at IBM. Most
recently at IBM, he held the position of Director of the Personal Computer
Company.
David H. Starr has been our Senior Vice President and Chief Information
Officer (CIO) since August 2, 1999. Prior to joining 3Com, Mr. Starr was the
CIO at Knight-Ridder from June 1998 to July 1999. From June 1997 to June
1998, Mr. Starr was the CIO at Reader's Digest. Prior to Reader's Digest, Mr.
Starr was CIO for ITT Corporation from May 1994 to June 1997.
PART II
ITEM 5. MARKET FOR 3COM CORPORATION'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
Fiscal 1999 High Low Fiscal 1998 High Low
----------- ---- --- ----------- ---- ---
First Quarter $32 13/16 $22 15/16 First Quarter $59 11/16 $43 3/16
Second Quarter 42 1/8 23 1/8 Second Quarter 56 3/4 28 1/2
Third Quarter 51 1/8 30 1/16 Third Quarter 39 1/8 28 3/8
Fourth Quarter 31 1/4 20 Fourth Quarter 38 25 1/4
Our common stock has been traded in the Nasdaq stock market under the symbol
COMS since our initial public offering on March 21, 1984. The preceding table
sets forth the high and low sales prices as reported on the Nasdaq stock
market during the last two years. As of May 28, 1999, we had approximately
7,183 stockholders of record. 3Com's credit agreement permits payment of cash
dividends subject to certain limitations based on net income levels of 3Com.
However, 3Com has not paid and does not anticipate that it will pay cash
dividends on its common stock.
14
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
-------------------------------------------------------------------------------------------
(In thousands, except May 28, May 31, May 31, May 31, May 31,
per share and employee data) 1999 1998 1997 1996 1995
- ----------------------------------- ----------------- ------------------ ----------------- ----------------- ------------------
Sales $5,772,149 $5,420,367 $5,606,077 $4,284,508 $2,479,760
Net income 403,874 30,214 500,533 347,875 210,510
Net income per share:
Basic $1.12 $0.09 $1.51 $1.10 $0.72
Diluted 1.09 0.08 1.42 1.02 0.66
- ----------------------------------- ----------------- ------------------ ----------------- ----------------- ------------------
Total assets $4,495,389 $4,080,520 $3,565,841 $2,592,400 $1,734,433
Working capital 2,221,290 1,950,757 1,574,223 1,242,095 938,672
Long-term obligations 37,707 40,358 170,652 169,536 181,872
Retained earnings 1,403,709 1,079,775 1,049,561 691,850 348,647
Stockholders' equity 3,196,455 2,807,495 2,228,344 1,650,675 1,058,119
Number of employees 13,027 12,920 13,639 11,503 7,395
- ----------------------------------- ----------------- ------------------ ----------------- ----------------- ------------------
Net income for fiscal 1999 included a net pre-tax charge of approximately
$12.7 million ($0.03 per share) for purchased in-process technology and a net
pre-tax credit of approximately $21.8 million ($0.04 per share) primarily
associated with past merger activities. 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 net 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 net 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 net pre-tax charge of
approximately $68.7 million ($0.13 per share) for purchased in-process
technology, a net 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.
See notes to the consolidated financial statements for additional information
on the above transactions for fiscal years 1999, 1998, and 1997. 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
-------------------------------------------------------------------------------------------
(In thousands, May 28, May 31, May 31, May 31, May 31,
except per share data) 1999 1998 1997 1996 1995
- ----------------------------------- ----------------- ------------------ ----------------- ----------------- ------------------
Net income excluding
non-recurring items $397,746 $246,060 $543,196 $504,054 $284,699
Net income per share
excluding non-
recurring items $1.08 $0.67 $1.54 $1.47 $0.89
15
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
3Com completed the following transactions during the fiscal year ended May
28, 1999:
- - On March 5, 1999, 3Com acquired NBX Corporation (NBX). The aggregate
purchase price of $87.8 million consisted of cash of approximately $75.4
million, assumption of stock options with a fair value of approximately
$11.9 million, and $0.5 million of costs directly attributable to the
completion of the acquisition. Approximately $5.6 million of the total
purchase price represented purchased in-process technology that had not
yet reached technological feasibility, had no alternative future use and
was charged to 3Com's operations in the fourth quarter of fiscal 1999.
After reflecting tax basis adjustments, this purchase resulted in
approximately $94.4 million of goodwill and other intangible assets that
are being amortized over estimated useful lives of two to seven years.
- - On February 18, 1999, 3Com acquired certain assets of ICS Networking,
Inc. (ICS), a wholly-owned subsidiary of Integrated Circuit Systems,
Inc. for an aggregate purchase price of $16.1 million in cash including
$0.1 million of costs directly attributable to the completion of the
acquisition. Approximately $5.0 million of the total purchase price
represented purchased in-process technology that had not yet reached
technological feasibility, had no alternative future use and was charged
to 3Com's operations in the third quarter of fiscal 1999. This purchase
resulted in approximately $6.9 million of goodwill and other intangible
assets that are being amortized over estimated useful lives of three to
seven years.
- - On February 8, 1999, 3Com acquired Smartcode Technologie SARL
(Smartcode) for an aggregate purchase price of $17.4 million in cash
including $0.2 million of costs directly attributable to the completion
of the acquisition. Approximately $2.1 million of the total purchase
price represented purchased in-process technology that had not yet
reached technological feasibility, had no alternative future use and was
charged to 3Com's operations in the third quarter of fiscal 1999. This
purchase resulted in approximately $14.4 million of goodwill and other
intangible assets that are being amortized over estimated useful lives
of two to six years.
- - On January 25, 1999, 3Com entered into a joint venture named ADMtek,
Inc. (ADMtek). 3Com contributed approximately $5.3 million in cash for a
44 percent interest in the joint venture. Under the terms of the joint
venture agreement, 3Com has certain rights to increase its ownership of
the joint venture. Due to 3Com's ability to exercise significant
influence over operating and financial policies of the joint venture, we
have consolidated this joint venture since the date of our investment by
including its full results in our consolidated balance sheet and
consolidated statement of income and then excluding the portion of the
net income/loss and equity related to the other venture partners.
- - On November 6, 1998, 3Com acquired EuPhonics, Inc. (EuPhonics). The
aggregate purchase price of $8.3 million consisted of cash of
approximately $6.6 million, assumption of stock options with a fair
value of approximately $1.5 million, and $0.2 million of costs directly
attributable to the completion of the acquisition. The charge for
purchased in-process technology associated with the acquisition was not
material, and was included in research and development expenses in the
second quarter of fiscal 1999. After reflecting tax basis adjustments,
this purchase resulted in approximately $10.8 million of goodwill and
other intangible assets that are being amortized over estimated useful
lives of four years.
3Com completed the following acquisitions during the fiscal 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. 3Com issued approximately 158
million shares of its common stock in exchange for all outstanding
common stock of U.S. Robotics. 3Com also assumed all options to purchase
U.S. Robotics' stock, which were converted into options to purchase
approximately 31 million shares of 3Com's common stock, pursuant to the
terms of the merger.
16
All financial data of 3Com 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, 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 3Com'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 1997 QUARTERLY PERIODS
----------------------------------------------------------
Q1'97 Q2'97 Q3'97 Q4'97
----- ----- ----- -----
3Com Aug `96 Nov `96 Feb `97 May `97
U.S. Robotics 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.
- - On March 2, 1998, 3Com purchased Lanworks Technologies, Inc. (Lanworks),
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, had no alternative
future use, and was charged to 3Com's operations in the fourth quarter
of fiscal 1998.
3Com completed the following acquisitions during the fiscal year ended
May 31, 1997:
- - On October 31, 1996, we acquired OnStream Networks, Inc. (OnStream), a
provider of asynchronous transfer mode (ATM) and broadband WAN and
access products. The acquisition was accounted for as a
pooling-of-interests.
- - 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.
- - On August 29, 1996, U.S. Robotics acquired Scorpio Communications, Ltd.
(Scorpio) in a purchase transaction. Scorpio was a designer,
manufacturer and marketer of scalable, fully redundant, fault tolerant
ATM switches that targeted workgroup local area network (LAN), corporate
backbone and WAN access environments.
See notes to consolidated financial statements for additional information
about these business combinations.
17
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 3Com's consolidated
statements of income:
Years Ended
----------------------------------------------------
May 28, May 31, May 31,
1999 1998 1997
--------------- ----------------- ----------------
Sales.................................................................... 100.0% 100.0% 100.0%
Cost of sales............................................................ 53.5 54.6 52.1
----- ----- -----
Gross margin............................................................. 46.5 45.4 47.9
Operating expenses:
Sales and marketing.................................................. 22.0 23.0 19.3
Research and development............................................. 11.0 10.7 9.0
General and administrative........................................... 4.5 5.0 4.4
Non-recurring charges:
Purchased in-process technology................................... 0.2 0.2 1.0
Merger-related charges (credits) and other........................ (0.4) 4.7 0.1
----- ----- -----
Total operating expenses................................................. 37.3 43.6 33.8
----- ----- -----
Operating income......................................................... 9.2 1.8 14.1
Interest and other income, net........................................... 0.9 0.3 0.2
----- ----- -----
Income before income taxes............................................... 10.1 2.1 14.3
Income tax provision..................................................... 3.1 1.6 5.4
Equity interest in loss of consolidated joint venture.................... - - -
---- ---- ----
Net income.............................................................. 7.0% 0.5% 8.9%
==== ==== ====
Excluding non-recurring charges:
Total operating expenses............................................ 37.5% 38.7% 32.7%
Operating income.................................................... 9.0 6.7 15.2
Net income.......................................................... 6.9 4.5 9.7
COMPARISON OF FISCAL YEARS ENDED MAY 28, 1999 AND MAY 31, 1998
SALES
Fiscal 1999 sales totaled $5.77 billion, an increase of six percent from fiscal
1998 sales of $5.42 billion.
NETWORK SYSTEMS. Sales of network systems products (e.g., switches, hubs, remote
access concentrators, routers and customer service and support) in fiscal 1999
were $2.61 billion, an increase of 11 percent from fiscal 1998 sales of $2.35
billion. The increase in network systems products sales when compared to fiscal
1998 was primarily due to growth in workgroup switching product sales, customer
service sales, and the introduction of our CoreBuilder 9000 enterprise switch,
partially offset by a decrease in certain other enterprise systems products.
Sales of network systems products represented 45 percent of total sales in
fiscal 1999 compared to 43 percent of total sales in fiscal 1998.
PERSONAL CONNECTIVITY. Sales of personal connectivity products (e.g., desktop
network interface cards (NICs), desktop modems, and personal computers (PC)
cards for mobile computers) in fiscal 1999 were $2.59 billion, a decrease of
eight percent from fiscal 1998 sales of $2.81 billion. The decline in personal
connectivity sales when compared to fiscal 1998 was primarily due to lower sales
of desktop analog modems. Sales of personal connectivity products represented 45
percent of total sales in fiscal 1999 compared to 52 percent of total sales in
fiscal 1998.
HANDHELD COMPUTING. Sales of handheld computing products in fiscal 1999 were
$569.9 million, an increase of 116 percent when compared to fiscal 1998 sales of
$264.4 million. The increase in handheld computing sales when compared to fiscal
1998 was due to increased market acceptance of our products and expansion of the
market for handheld computing. Sales of handheld computing products represented
10 percent of total sales in fiscal 1999 compared to five percent of total sales
in fiscal 1998.
18
3Com's sales in fiscal 1999 were primarily impacted by the transformation of our
business mix. Historically, a significant portion of our sales has been derived
from desktop NICs, analog modems, and stackable hubs, which have entered the
mature phase of their product life cycles. Sales in these product markets are
flat to declining, because these products are particularly sensitive to price
competition, are beginning to be replaced by newer technologies, and are
increasingly being distributed through the PC original equipment manufacturer
(OEM) channel which carries lower average selling prices. Further, our sales of
NICs and modems are highly correlated with sales in the PC market. While the
overall PC market continues to grow, sales of low-end PCs are growing faster
than high-end PCs. Lower priced PCs are not typically sold with high performance
NICs and modems such as those offered by 3Com. 3Com's aggregate sales increased
on a year-over-year basis primarily because of growth in handheld computing and
workgroup switching.
U.S. sales represented 53 percent of total sales in fiscal 1999 compared to 55
percent in fiscal 1998 and increased four percent when compared to fiscal 1998.
International sales in fiscal 1999 increased nine percent when compared to
fiscal 1998. Historically, the Asia Pacific and Latin American regions have been
high growth regions for the networking industry and 3Com. We believe that fiscal
1999 sales were impacted by the economic turmoil that occurred in these markets.
Fiscal 1999 sales in the Asia Pacific region increased by only one percent when
compared to fiscal 1998. In addition, sales in the Latin American region
decreased by 12 percent when compared to fiscal 1998.
GROSS MARGIN
Gross margin as a percentage of sales was 46.5 percent in fiscal 1999, compared
to 45.4 percent in fiscal 1998. The year-over-year gross margin improvement came
from virtually all product lines and was primarily the result of product cost
reductions, increased mix of certain higher margin network systems products,
improved inventory management and improved manufacturing capacity utilization.
OPERATING EXPENSES
Operating expenses in fiscal 1999 were $2.15 billion, or 37.3 percent of sales,
compared to $2.36 billion, or 43.6 percent of sales in fiscal 1998. Excluding a
purchased in-process technology charge of $12.7 million and a credit of $21.8
million for merger-related and other primarily associated with the U.S. Robotics
merger, operating expenses would have been $2.16 billion, or 37.5 percent of
sales for fiscal 1999. Excluding a purchased in-process technology charge of
$8.4 million and a charge of $253.7 million for merger-related and other
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. The decline
as a percentage of sales was primarily due to cost reductions as a result of
post-merger consolidation activities.
SALES AND MARKETING. Sales and marketing expenses in fiscal 1999 increased $22.8
million or two percent from fiscal 1998. Sales and marketing expenses as a
percentage of sales decreased to 22.0 percent of sales in fiscal 1999 compared
to 23.0 percent of sales in fiscal 1998. The year-over-year increase in sales
and marketing expenses in absolute dollars is attributable to increased spending
on handheld computing products and customer service programs, consistent with
sales growth in those areas. These expense increases were partially offset by
decreased spending related to mature product lines such as analog modems.
RESEARCH AND DEVELOPMENT. Research and development expenses in fiscal 1999
increased $54.2 million or nine percent compared to fiscal 1998. Research and
development expenses as a percentage of sales increased to 11.0 percent of sales
in fiscal 1999 compared to 10.7 percent of sales in fiscal 1998. The year-over-
year increase in research and development expenses is primarily attributable to
the cost of developing new products and enhancements in the areas of switching,
handheld computing, Voice Over the Internet Protocol (VoIP) and LAN telephony
(VoIP), wireless access, broadband access (primarily cable and digital
subscriber line (DSL)) and NICs. We believe the timely introduction of new
technologies and products is crucial to our success, and we plan to continue to
make acquisitions or strategic investments to accelerate time to market where
appropriate.
3Com has continued to develop technologies that were in process at NBX, ICS,
Smartcode and EuPhonics as of the dates of the acquisitions. The costs for the
projects in process are primarily labor costs for design, prototype development
and testing. As of May 28, 1999, we estimate that approximately $5.9 million
dollars will be expensed over the next 18 months in connection with completion
of such acquired research and development projects. We anticipate future
research and development spending, including costs remaining for the completion
of these purchased in-process research and development projects, will not
significantly differ from the historical trend of research and development
expenses as a percent of sales.
19
GENERAL AND ADMINISTRATIVE. General and administrative expenses in fiscal 1999
decreased $11.8 million or four percent from fiscal 1998. As a percentage of
sales, general and administrative expenses decreased to 4.5 percent of sales in
fiscal 1999 compared to 5.0 percent of sales in fiscal 1998. The year-over-year
decrease in general and administrative expenses in absolute dollars is primarily
due to the elimination of duplicate infrastructure from the U.S. Robotics
merger, partially offset by an increase in the provision for bad debts,
primarily related to receivables in certain international regions.
PURCHASED IN-PROCESS TECHNOLOGY. During fiscal 1999, 3Com recorded a charge
for purchased in-process technology of approximately $12.7 million associated
with the acquisitions of Smartcode, NBX, and certain assets of ICS. See notes
to consolidated financial statements.
MERGER-RELATED CHARGES (CREDITS) AND OTHER. During fiscal 1999, 3Com recorded
net pre-tax merger-related and other credits of approximately $21.8 million.
This net amount reflects adjustments to previously recorded merger and
restructuring charges, which totaled: a net pre-tax credit of approximately
$20.6 million; a $3.0 million charge reflecting a change in the estimated net
realizable value of closed manufacturing plants in Chicago; and a $4.2 million
net gain on the sale of land in California. See notes to consolidated financial
statements.
INTEREST AND OTHER INCOME, NET
Interest and other income, net increased $37.1 million compared to fiscal 1998,
primarily as a result of higher interest income due to higher average cash and
investment balances, improved foreign currency results, and reduced interest
expense. Interest and other income, net for fiscal 1998 included 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. In addition, in fiscal 1998, we recorded 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 convertible notes.
The majority of our sales are denominated in U.S. Dollars. Where available, we
enter into foreign exchange forward contracts to hedge significant balance sheet
exposures and intercompany balances against future movements in foreign exchange
rates.
INCOME TAX PROVISION
3Com's effective income tax rate was 31.1 percent in fiscal 1999 compared to
74.1 percent in fiscal 1998. The tax rate in fiscal 1998 reflected certain
merger-related and other costs associated with the merger with U.S. Robotics
that were not deductible. 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. The decrease in tax
rate from 1998 to 1999 was primarily due to the increase in offshore
manufacturing in countries with tax rates significantly below the U.S. statutory
rate.
EQUITY INTEREST IN LOSS OF CONSOLIDATED JOINT VENTURE
Equity interest in loss of consolidated joint venture was $1.1 million for
fiscal 1999. This amount represents the pro-rata share of the joint venture's
loss allocated to the other investors for the period between the date of
investment and the end of our fiscal year. 3Com entered into this joint venture
in the third quarter of fiscal 1999. See notes to consolidated financial
statements.
NET INCOME AND NET INCOME PER SHARE
Net income for fiscal 1999 was $403.9 million, or $1.09 per share, compared to
$30.2 million, or $0.08 per share, for fiscal 1998. Excluding the purchased
in-process technology, net pre-tax merger-related charges (credits), and other,
net income was $397.7 million, or $1.08 per share for fiscal 1999. Excluding the
net pre-tax charge for purchased in-process technology and merger-related
charges (credits) and other, net income was $246.1 million, or $0.67 per share
for fiscal 1998.
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.
NETWORK SYSTEMS. Sales of network systems products in fiscal 1998 were $2.35
billion, an increase of one percent from fiscal 1997 sales of $2.33 billion.
Sales of network systems products represented 43 percent of total sales in
fiscal 1998 compared to 42 percent of total sales in fiscal 1997.
20
PERSONAL CONNECTIVITY. Sales of personal connectivity products in fiscal 1998
were $2.81 billion, a decrease of 11 percent from fiscal 1997 sales of $3.16
billion. Sales of personal connectivity products represented 52 percent of total
sales in fiscal 1998 compared to 56 percent of total sales in fiscal 1997.
HANDHELD COMPUTING. Sales of handheld computing products in fiscal 1998 were
$264.4 million, an increase of 113 percent from fiscal 1997 sales of $124.4
million. Sales of handheld computing products represented five percent of total
sales in fiscal 1998 compared to two percent of total sales in fiscal 1997.
GEOGRAPHIC. Sales in the U.S. represented 55 percent of total sales in fiscal
1998 and fiscal 1997. 3Com experienced a decline from fiscal 1997 in domestic
and international sales of four and two percent, respectively.
3Com believes that sales in fiscal year 1998 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, market research reports indicate that the networking
industry worldwide grew by less than 20 percent during 1997, and this pattern
continued into 1998.
CHANNEL INVENTORY. In the second quarter of fiscal 1998, 3Com adopted a new
inventory business model, which generally calls for fewer weeks' supply of
inventory in the distribution channel. We transitioned to this model during the
second and third quarters of fiscal 1998. As a result, sales during these
periods were adversely affected.
MODEMS. Fiscal 1998 sales of modem products decreased compared to fiscal 1997.
In January 1998, the International Telecommunications Union (ITU) determined the
V.90 standard for 56 Kilobits per second (Kbps) technology. 3Com 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 we began shipping V.90 standard modems late in the third quarter of
fiscal 1998, we believe 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 was very competitive, and although 3Com
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, we 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.
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 3Com.
During fiscal 1998, however, several Asian countries experienced a weakening of
their local currencies and turmoil in their financial markets and institutions,
which we believe adversely affected financial results during fiscal 1998.
HANDHELD COMPUTING AND SWITCHING PRODUCTS. Fiscal 1998 sales of handheld
computing products more than doubled compared to fiscal 1997 and achieved growth
in market share, according to industry reports. Growth rates and market share
gains in the handheld computing market may not be sustainable in the face of
increasing competition from new entrants to the market. In addition, our
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.
21
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,
3Com's year-over-year gross margin decline was affected by several factors,
including product mix, increased price competition, and higher period costs.
3Com's product mix included higher sales of certain NICs and workgroup switching
products, as well as an increase in sales to 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 fiscal 1998, increased product and price
competition in this product segment resulted in a decline in gross margin
percent. Additionally, 3Com experienced aggressive pricing on 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.
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 in fiscal 1998. 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.
SALES AND MARKETING. 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 of sales 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 3Com's customer service programs. In
addition, spending on 3Com's global branding campaign during fiscal 1998
contributed to increased marketing expenses compared to the prior year.
RESEARCH AND DEVELOPMENT. 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 3Com's
new products in the areas of personal connectivity and switching, and its
expansion into new technologies and markets, such as DSL.
GENERAL AND ADMINISTRATIVE. 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 of sales,
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 is attributable to the expansion of 3Com's infrastructure, including
personnel, as well as an increase in the provision for bad debts.
PURCHASED IN-PROCESS TECHNOLOGY. During the fourth quarter of fiscal 1998,
3Com recorded a charge of approximately $8.4 million for purchased in-process
technology associated with the Lanworks acquisition. See notes to
consolidated financial statements.
MERGER-RELATED CHARGES (CREDITS) AND OTHER. During fiscal 1998, we 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, we reversed approximately $10.6 million of previously recorded merger
accruals. 3Com 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, we made a decision to close a manufacturing
site in Illinois in order to consolidate two Chicago-area manufacturing
facilities into one location. We recognized a charge of approximately $19.4
million associated with this closure. See notes to consolidated financial
statements.
22
INTEREST AND OTHER INCOME, NET
Interest and 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. Interest and 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 our sales are denominated in U.S. Dollars. Where available, 3Com
enters into foreign exchange forward contracts to hedge certain balance sheet
exposures and intercompany balances against future movements in foreign exchange
rates. Fiscal 1998 interest and other income, net included 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.
INCOME TAX PROVISION
3Com'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.
NET INCOME AND NET INCOME PER SHARE
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.
BUSINESS ENVIRONMENT AND INDUSTRY TRENDS
3Com's future results may be affected by industry trends and specific risks in
our business. Some of the factors that could cause future results to materially
differ from past results or those described in forward-looking statements
include those discussed below.
SLOWER GROWTH IN OUR INDUSTRY
Our financial success is dependent on the overall growth rate of the networking
industry. In 1997 and 1998, the networking industry grew more slowly than in the
past. Industry reports indicate that the segments of the industry in which we
participate grew in aggregate by less than 20 percent during 1997 and in
aggregate by less than 15 percent during 1998. Independent market analysis
indicates that industry growth rates in our markets may continue to decline in
calendar 1999, both because the industry is maturing and because many companies
may delay equipment purchases through at least the end of the calendar year due
to costs associated with Year 2000 date conversion.
The growth of related industries such as the PC market also affects 3Com's
growth. Recent industry reports indicate that the PC market grew by 12 percent
in 1998 and is projected to grow by 16 percent in 1999. Much of the growth in
this sector is occurring in the low-end of the market. These inexpensive PCs
typically do not include high performance NICs and modems such as those offered
by 3Com. Our business, operating results or financial condition may be adversely
affected by any decreases in growth rates of networking or PC markets. In
addition, we cannot be certain that our results in any particular period will be
consistent with the future growth rate of the industry.
23
CONSOLIDATION IN OUR INDUSTRY
There have been many mergers and acquisitions in the networking industry in the
past several years. More recently, there have also been mergers between
telecommunications equipment providers and networking companies, as well as
between networking companies and computer component suppliers. Examples from
January 1998 through June 1999 include:
- - 3Com acquired Lanworks, EuPhonics, Smartcode, NBX and certain assets of ICS
and entered into a joint venture with a Taiwanese networking company;
- - Lucent Technologies, a telecommunications company, acquired 13 companies,
including networking equipment supplier Ascend Communications;
- - Cisco Systems, a networking equipment supplier, acquired 14 companies;
- - Nortel Networks, a telecommunications company, acquired five companies,
including Bay Networks, a networking equipment supplier;
- - Alcatel, a telecommunications company, acquired five companies, including
Xylan, a networking equipment supplier;
- - Siemens A.G., a telecommunications company, announced plans to acquire
three networking firms;
- - General Electric Company, an engineering firm, acquired Fore, a
networking equipment supplier;
- - Intel Corporation, a computer components manufacturer, acquired a data
networking company and a manufacturer of telecommunications computer
components.
Future business combinations in the networking industry may result in companies
with greater resources and stronger competitive positions and products than
3Com. Continued industry consolidation may adversely affect our operating
results or financial condition.
MANAGING STRATEGIC RELATIONSHIPS
In addition to mergers and acquisitions, technology companies are continually
entering into strategic relationships. For example, during fiscal 1999, we
announced or expanded strategic relationships with several companies including
the following:
- - Microsoft Corporation
- - Siemens A.G.
- - Dell Computer
- - IBM
- - Hewlett-Packard
- - Sun Microsystems
- - Motorola
- - Symbol
Our results of operations or financial condition could be adversely impacted if
we experience difficulties managing relationships with our partners or if
projects with partners are unsuccessful. In addition, if our competitors enter
into successful strategic relationships, they could increase the competition
that we face.
INCREASED COMPETITION IN OUR DISTRIBUTION CHANNELS
We distribute many of our products through indirect distribution channels that
include distributors, systems integrators, value-added resellers, and retailers.
We believe these indirect distribution channels are experiencing heightened
competition from Internet-based suppliers and PC manufacturers that distribute
directly to end user customers. These changes in the pattern of distribution of
networking products could have a material adverse affect on our sales and
financial results. Further, 3Com is building in-house capabilities to sell
directly to end-user customers over the Internet (e-business). If this
initiative is successful, it could cause conflict with our current indirect
channels of distribution. If we are unsuccessful in selling through our
e-business channel, we could lose market share to competitors who have more
successfully developed these capabilities. Either of these outcomes could have a
material adverse affect on our operating results or financial condition.
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SHIFT TO PC OEM DISTRIBUTION
PC related networking products such as modems and NICs are increasingly being
sold through the PC OEM channel rather than the distribution channel. We derive
a significant portion of our personal connectivity product sales from PC OEMs
such as Dell Computer, Toshiba, Gateway, Hewlett-Packard and IBM, who
incorporate our NICs, analog modems, or chipsets into their products. While
sales to PC OEMs are important, products sold through the PC OEM channel
typically have a lower average selling price than those sold through other
channels. Therefore, our sales and margins may be adversely impacted if sales to
PC OEMs continue to become a larger percentage of our business.
In addition, PC OEMs sometimes choose to integrate NIC and modem functions onto
the PC motherboard. For example, we currently sell networking chipsets to Dell
Computer that are integrated directly onto the PC motherboard of Dell's high-end
Optiplex line of PCs. Competitors who can integrate networking and other
computer processing functions onto a single chip might offer PC OEMs a cheaper
alternative to our solutions. If the integration of networking and computer
processing functionality on a reduced number of components increases, our future
sales growth and profitability could be adversely affected.
COMPETITION AND PRICING PRESSURE MAY AFFECT OUR BUSINESS
We participate in a highly volatile industry characterized by vigorous
competition for market share as well as rapid product and technology development
and maturation. As products mature and become less differentiated from
competitive offerings, product prices decline. In addition, both 3Com and our
competitors sometimes lower product prices in order to gain market share or
create more demand for our products. Intense pricing competition in our industry
may adversely affect our business, operating results or financial condition. For
example, the rapid decline in prices for analog modems and network interface
cards caused our sales to these markets to decline in fiscal 1999, and continued
price declines will likely result in a further decrease in our sales to these
markets.
Our competition historically has come from start-up companies, well-capitalized
computer systems and communications companies, and other technology companies
focusing on data networking. However, our industry is changing, resulting in new
and other potential competitors who have greater financial, marketing and
technical resources than 3Com. For example, technology innovations are driving
the convergence of voice, video and data traffic onto a single network
infrastructure, and we now compete with much larger telecommunications equipment
companies such as Lucent Technologies Inc. and Nortel Networks. We are also
selling products into new markets where we compete with different companies than
in the past. For example, our Palm Computing products compete with product
offerings from consumer electronics companies such as Sharp, Casio and Phillips
and could compete with other companies who license the Palm operating system
from us. Competitors may develop products and technologies that render our
products obsolete or noncompetitive, which could adversely affect our business,
operating results or financial condition.
We expect significant technology transitions to take place in the networking
industry. Although these changes will create long-term business potential for
us, it is possible that they may also create a disruptive effect on short-term
buying patterns by our customers and could potentially change the competitive
landscape in which 3Com has operated historically.
UNCERTAINTIES OF INTERNATIONAL MARKETS
We operate internationally and expect that international markets will continue
to account for a significant percentage of our sales. Some international markets
are characterized by economic and political instability and currency
fluctuations that can adversely affect our operating results or financial
condition.
For example, during fiscal 1999, 3Com had lower sales in the Latin American
region and only slightly increased sales in the Asia Pacific region compared to
fiscal 1998. The instability in the Latin American and Asia Pacific financial
markets negatively affected our sales in those markets by, among other things,
decreasing end user purchases, increasing competition from local competitors,
and reducing access to sources of capital needed by customers to make purchases.
In addition to reducing sales, difficulties in the Latin American and Asia
Pacific regions subject our resellers to financial hardships, which may increase
our credit risk if our customers become insolvent or their ability to meet
obligations is otherwise impaired.
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PROPOSED CHANGES IN ACCOUNTING FOR BUSINESS COMBINATIONS
The Financial Accounting Standards Board (FASB) began deliberation of revisions
to the rules for business combinations in 1996. Some of these deliberations have
included accounting rule-making bodies from other nations as the financial
communities attempt