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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 


FORM 10-K
 


  (Mark One)    
  

  [X]     ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
  

For the Fiscal Year Ended May 30, 2003
 
OR

  [  ]     TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF
THE EXCHANGE ACT OF 1934
  

For the transition period from ____________ to ____________

Commission File Number 0-12867

3Com Corporation
(Exact name of registrant as specified in its charter)

Delaware
                    
94-2605794
    
(State or other jurisdiction of
incorporation or organization)
                    
(I.R.S. Employer
Identification No.)
    
    
350 Campus Drive
Marlborough, Massachusetts
(Address of principal executive office)
                    
01752
(Zip Code)
    
 

Registrant’s telephone number, including area code: (508) 323-5000


 

Securities registered pursuant to Section 12(b) of the Act: NONE
 
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value; Preferred Stock Purchase Rights

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 [X]  No [  ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) 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. [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X]  No [  ]

The aggregate market value of the registrant’s Common Stock held by non-affiliates, based upon the closing price of the Common Stock on November 29, 2002, as reported by the Nasdaq National Market, was approximately $1,608,484,000. 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 25, 2003, 368,274,531 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, 2003 is incorporated by reference in Part III of this Form 10-K to the extent stated herein.


3Com Corporation
Form 10-K
For the Fiscal Year Ended May 30, 2003
Table of Contents

              Page
Part I
                                                  
Item 1.
                                   1    
Item 2.
                                   13    
Item 3.
                                   14    
Item 4.
                                   14    
                                  14    
Part II
                                                  
Item 5.
                                   15    
Item 6.
                                   16    
Item 7.
                                   17    
Item 7A.
                                   42    
Item 8.
                                   44    
Item 9.
                                   80    
Item 9A.
                                   81    
Part III
                                                  
Item 10.
                                   81    
Item 11.
                                   81    
Item 12.
                                   81    
Item 13.
                                   81    
Item 14.
                                   82    
Part IV
                                                  
Item 15.
                                   82    
                                  83    
                                  86    
                                  87    
 

3Com, the 3Com logo, Megahertz, NBX, OfficeConnect, SuperStack, and XJACK are registered trademarks and Kerbango, VCX, and XRN are trademarks of 3Com Corporation or its subsidiaries. CommWorks is a registered trademark of UTStarcom, Inc. Palm is a trademark of Palm, Inc. U.S. Robotics is a registered trademark and Courier is a trademark of U.S. Robotics Corporation. Other product and brand names may be trademarks or registered trademarks of their respective owners.


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This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements include, without limitation, predictions regarding the following aspects of our future:

•     The combination of our Enterprise Networking and Connectivity segments to form a dedicated enterprise networking operating as a single segment;

•     Our target customers;

•     Financial position and results of operations;

•     Cash position and cash requirements;

•     Sales and margins;

•     Sources, amounts, and concentration of revenue;

•     Costs and expenses;

•     Accounting estimates, including treatment of goodwill and intangible assets, doubtful accounts, inventory, restructuring, and warranty, and product returns;

•     Operations, including international operations, supply chain, quality control, and manufacturing supply, capacity, and facilities;

•     Products and services (including the exiting of product lines), price of products, product lines, and product and sales channel mix;

•     Relationship with customers, suppliers and strategic partners, including increased reliance on strategic partners;

•     Acquisition and disposition activity;

•     Credit facility and ability to raise financial capital;

•     Real estate arrangements;

•     Activities of 3Com Ventures;

•     Global economic, social, and geopolitical conditions;

•     Industry trends, including the trend toward increased siliconization, and our response to these trends;

•     Tax position and audits;

•     Our restructuring and cost-reduction efforts, including workforce reductions and the effect on employees;

•     Sources of competition;

•     Protection of intellectual property;

•     Outcome and effect of current and potential future litigation;

•     Joint venture with Huawei Technologies, Ltd.

•     Research and development efforts, including our investment in new technologies;

•     Future lease obligations and other commitments and liabilities;

•     Outsourcing of some of our functions and operations and increased reliance on contract manufacturing;

•     Change in principal location of our senior executive management team;

•     Our common stock, including trading price, dividends, and repurchases; and

•     Security of computer systems.

You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or the


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negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.

Actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Business Environment and Industry Trends. All forward-looking statements included in this document are based on our assessment of information available to us at this time. We undertake no obligation to update any forward-looking statements.

PRESENTATION OF DISCONTINUED OPERATIONS — COMMWORKS AND PALM, INC.

The following information relates to the continuing operations of 3Com Corporation and our consolidated subsidiaries (3Com).

CommWorks is accounted for as a discontinued operation as a result of our decision to sell the business on March 4, 2003 to UTStarcom, Inc. The sale of CommWorks was completed on May 23, 2003. As such, CommWorks’ operations ceased to be part of our operations and reported results.

Palm, Inc. is also accounted for as a discontinued operation as a result of our decision to distribute the Palm common stock we owned to 3Com stockholders in the form of a stock dividend. Subsequent to the distribution to our stockholders on July 27, 2000, Palm’s operations ceased to be part of our operations and reported results.


PART I

ITEM 1.    Business

GENERAL

3Com was incorporated on June 4, 1979. A pioneer in the computer networking industry, 3Com provides data and voice networking products and solutions, as well as support and maintenance services, for enterprises and public sector organizations of all sizes. Our competitive strengths include our strong balance sheet, intellectual property portfolio, distributor and customer relationships, and brand identity.

We believe that the leading enterprise networking company of the future will be the one that offers innovative, feature-rich products and solutions that excel at lowest cost of acquisition and ownership. Further, if that company also maintains the lowest cost structure and the most efficient use of capital, it can generate superior financial returns. We intend to be that company.

In the first three quarters of fiscal 2003, we operated our company and reported our financial results in the following three principal segments:

1)     Enterprise Networking segment, which provides data and voice networking products and solutions, as well as support and maintenance services.

2)     Connectivity segment, which provides products and solutions that connect end user’s computers and other client devices to networks.

3)     CommWorks segment, which prior to being sold on May 23, 2003, was engaged in providing data communications and Voice-over-Internet Protocol (IP)-based infrastructure equipment, as well as related support, maintenance, and other professional services, to telecommunications service providers.

Additionally, results relating to products that were exited prior to fiscal 2003 have been reported as a separate segment. As a result of the CommWorks sale in the fourth quarter of fiscal 2003, CommWorks’ results are now reported as a discontinued operation. Our financial results reported through fiscal 2003 reflect continuing operations of our Enterprise Networking and Connectivity segments, as well as results of operations related to exited product lines. The discussion of operating segments below is presented as we operated and reported our financial results of continuing operations in fiscal 2003. (See Note 20 to our consolidated financial statements for historical segment information.) Effective for fiscal 2004, we are combining operations previously associated with the Enterprise Networking and Connectivity segments, and will operate solely as an enterprise networking company.

OPERATING SEGMENTS

Enterprise Networking Segment

Building on our historical success in the networking infrastructure market, 3Com is a leader in delivering innovative networking products and solutions that are feature-rich so they can support the increasingly more complex and demanding application environments in today’s businesses, while remaining easy to install, use, and operate, and yet still affordable to own.

3Com provides a broad portfolio of innovative networking solutions, encompassing data and voice products and services, which enable customers to manage business-critical information, enhance the productivity of employees, and improve the effectiveness of business relationships at an affordable price. By enriching the user experience through high performance and innovative technology, we provide practical solutions to meet the demanding real-world needs of customers.

Industry Background:

During the 1980s and 1990s, 3Com became a worldwide leader building enterprise networks and the equipment that connects computers to networks. In 1981, International Business Machines Corp. (IBM) introduced the personal computer (PC) and in 1983, 3Com introduced the first network interface card (NIC) that connected the IBM PC into Ethernet networks.


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In the enterprise networking industry, computers were first connected together in local area networks (LANs), so people in workgroups could more easily share information, such as spreadsheets, and resources, such as printers and servers. Then, network-based applications — email, for example — were developed, and these applications ignited the demand to connect workgroups together into enterprise-wide networks. Going beyond self-contained enterprise networks, the emergence of the Internet has led to the substantial growth of network-based communications and transactions between commercial enterprises and their customers and partners.

Markets and Customers:

3Com develops networking solutions for enterprises and public sector organizations. Our networking solutions are sold on a worldwide basis through our extensive relationships with distributors, value-added resellers (VARs), system integrators, and telecommunications service providers. 3Com acknowledges that networking needs vary by size of business, from industry to industry, and across the globe. 3Com therefore offers a broad product line of networking solutions to fit the demanding business needs of customers from the very small to the very large. 3Com does this by delivering rich functionality, high performance, scalability, reliability, and security in solutions that are well-suited for a variety of enterprise and public sector environments and that are easy to install, configure, use, and manage. Additionally, 3Com delivers these solutions in a way that is affordable to own and operate, which is important to our customers.

3Com has a large installed base of enterprise customers and delivers the performance, features, and flexibility demanded by these customers to meet their changing enterprise needs. 3Com also has a strong position in the small business marketplace, which stems from its understanding of the needs of small businesses and its ability to provide them with networks that are reliable, as well as easy to buy, install, and manage.

Going forward, 3Com will place special emphasis in targeting major customer groups that view their networks as mission-critical, seek convergence ready voice/data and wireless solutions that are standards based to protect their network investments, and value networking solutions that are affordable to acquire, maintain, and grow. These customers groups tend to be in vertical markets such as education, government, retail banking, healthcare, manufacturing, distribution, etc.

These customer groups not only view their networks as mission-critical tools that help them to deliver mandatory and/or valuable differentiated services to their constituents, but they also generally have procurement practices that require open bidding processes. Finally, these customers generally have lean Information Technology (IT) management staffs and tight operational budgets, and therefore value networking solutions that are easier to deploy and maintain. The combination of these conditions suggests that these customers are likely to purchase from a vendor that offers: 1) substantial customer service capabilities and a global presence, 2) innovative, feature-rich products and solutions, and 3) networking solutions that are affordable to acquire, maintain and grow. We believe we will be successful in winning business from these customers by demonstrating that we are capable of delivering on all three competitive factors. Please refer to the Competition section for further discussion of these three competitive factors.

Future Trends:

The market for enterprise networking products has evolved rapidly over the last 20 years. The departmental workgroup networks spawned by the adoption of Ethernet and the explosion of PC use have developed into enterprise-wide client/server networks, and those networks have been extended via the Internet. Originally a research tool, the Internet has grown quickly to become a major influence on the design and deployment of networks. An entity’s networking infrastructure must provide a firm foundation to satisfy its strategic goals: acquiring and retaining customers, conducting commerce, providing a competitive advantage, improving productivity, and delivering profits. To fulfill this purpose, the network must deliver greater network performance, availability, and scalability in a cost-conscious environment. The network must become focused on supporting the needs of individual users, not solely on the delivery of raw data or generic applications.


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There are several trends that will shape the market for networking products over the next few years. These include:

•     Convergence of voice, video, and data over IP networks.

•     Intelligence at the edge of the network- In the past, traditional network design emphasized the capabilities of modular chassis switches at the core of the network capable of supporting multiple networking protocols. Relatively unintelligent workgroup switches were used to distribute access to desktops. Over time, Ethernet has emerged as the dominant LAN protocol and there is no longer a need for most IT managers to invest in expensive and complex core switches that support other protocols such as FDDI, AppleTalk, Token Ring, etc.

•     Total Cost of Ownership (TCO) becoming a more important metric for purchase decisions — Due to current economic trends, most organizations are under pressure to scale back investment in capital projects and lower operating expenses. They are looking at all possible ways to increase shareholder value and show return on their investment. From a technology perspective, this is causing a great deal of scrutiny on investments in networking and desktop equipment. As the networking industry matures and management experience becomes more pervasive, IT managers are increasingly considering TCO as they invest in their infrastructure for both data and voice. TCO encompasses not only the initial purchase price of the solution, but also the ongoing costs of operation, support, and maintenance. Traditionally, enterprises have maintained separate telephone and data networking infrastructures, along with the overhead necessary to operate and maintain the two separate infrastructures. In many cases, customers are now finding that using new networked telephony technologies to converge their voice and data traffic over one infrastructure allows them to achieve substantial cost savings — in terms of initial purchase price as well as ongoing operational costs. Furthermore, new IP-based applications are allowing companies to provide new productivity-enhancing telephony features to their employees.

•     Enterprise customers will increasingly look towards wireless infrastructure to expand connectivity. This will increase the requirements for vendors to provide “enterprise” class wireless solutions (integrated security, management, provisioning, etc.).

•     Proliferation of Gigabit Ethernet (GbE) in the wiring closet, desktop, and in groups of servers — known as server farms — as well as new applications such as grid computing, etc., will drive requirements for 10 GbE connectivity in core switching infrastructure.

•     Security — Network managers have become increasingly concerned about the integrity of corporate data and how this data, their users, and devices are secured. This problem is magnified when users are on the move and outside the controlled corporate environment. Additionally, implementations will evolve from current state of an amalgamation of “point products” to an integrated set of end-to-end solutions.

3Com addresses the above trends in the following fashion:

•     Convergence — 3Com products support convergence and are also built upon standards-based open architectures to protect customers’ investment in their networks. Additionally 3Com’s scaleable softswitch architecture for Voice-over-IP has a telecommunications service provider heritage that allows us to deliver high levels of performance at enterprise price points.

•     Intelligence at the edge — 3Com products support new application requirements such as security and quality of service for converged voice/data networks, which require that intelligence be pushed to the edge of the network.

•     TCO — 3Com’s approach for delivering network capabilities to enterprise customers is to put specific features at the point in the network where they can be most effective and where it makes most sense for them to be. Many competitors continue to design an increasing array of features into very large switching engines at the core of the LAN, thereby creating an expensive and complex pinch point through which all network traffic flows. Unlike many of our competitors, 3Com is focused on building cost-efficient, distributed intelligent networks that allows the network traffic to flow in a way that is optimal for performance, taking into account new application requirements such as security and voice/data convergence. 3Com’s approach moves the network services closer to end-users and to the applications. This approach offers more flexibility in network design by allowing IT managers to easily select and deploy the capabilities they want when and where they need them, resulting in a more cost effective, “pay-as-you-grow” implementation. By distributing these capabilities to the most effective places, the demand placed on individual network components is reduced, and the potential performance and reliability of the network is increased.


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•     Wireless — 3Com will continue to augment its broad portfolio of Wireless LAN products and add in higher performance and enterprise class features to meet the needs of enterprises for integrated security, management, etc. This higher performance will be delivered by the incorporation of technology using the Institute of Electrical and Electronics Engineers (IEEE) 802.11g wireless LAN networking specification, which is compatible with, and faster than, the IEEE 802.11b specification, commonly called wireless fidelity (Wi-Fi). Our commitment to standards-based technology in our wireless as well as other product offerings promotes manufacturers’ interoperability.

•     10 GbE — 3Com plans to leverage its joint venture relationship with Huawei Technologies, Ltd. to bring price/performance leading 10 GbE products to our customers.

•     Security — 3Com will build on its current security portfolio by augmenting its enterprise perimeter security products (i.e. embedded firewall) with security partnerships to bring broader end-to-end security solutions to market.

Product Offerings:

3Com’s Enterprise Networking segment provides the following major categories of offerings:

•     LAN Switches — Fixed-configuration (set number of ports) and modular chassis (variable port capacity) form factors for the network edge and the network core

•     Networked Telephony — Next-generation telephone systems that enable customers to run their voice traffic over their existing data networking infrastructure

•     Wireless LAN — Wireless network access points and adapter cards based on Wi-Fi technology

•     Network Jack — a four-port switch in the form of a standard wall jack

•     Network management software

•     Customer service and support

3Com also offers hubs, firewalls, webcaches, server load balancers, Internet gateway routers, and LAN modems.

LAN Switches:

Core Switching.    3Com offers both modular chassis and fixed-configuration core solutions in its Switch 4000 series and SuperStack® 3 4900 series, delivering highly resilient (fault tolerant) and available Layer 2 and Layer 3 Fast Ethernet (100 megabits per second (Mbps)) and Gigabit Ethernet solutions for the core of the enterprise network. 3Com offers an alternative to traditional modular chassis designs through the Switch 40x0 range. The 4900 series and 4050/4060/4070 switches all support eXpandable Resilient Networking (XRN™) technology — 3Com’s core switching technology, which increases network resiliency and availability in a unique “pay-as-you-grow” way. In addition, in the first quarter of fiscal 2004 we have introduced the Switch 7700, a high-performance, Layer 3 LAN core switch based on technology developed by Huawei, with which we are forming a joint venture as discussed later.

XRN technology-capable switches can support both copper and fiber networks, using distributed resilient routing, distributed link aggregation, distributed device management, and wirespeed switching and routing to produce high network availability and performance.

Workgroup/Desktop Switching.    At the LAN workgroup/desktop, 3Com fixed-configuration switches aggregate edge switches, larger server farms, and/or servers and desktops, optimizing and controlling data flow. 3Com provides a full range of fixed-configuration switches to provide performance and flexibility at the edge of the network that includes the OfficeConnect® series and the SuperStack 3 Baseline, 4200, 4300, and 4400 series of products.

The SuperStack 3 Switch 4400PWR is an example of an intelligent edge switch for enterprises that are deploying new applications that require advanced functionality. This product supports standards-based Power-over-Ethernet (PoE), which can be used to pull power from the wiring closet to a networked telephone. The Switch 4400PWR and the other switches in the 4400 series also provide advanced, multi-layer packet classification designed to


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enhance network control, improve efficiency, and automatically identify and prioritize real-time or business-critical applications, an important feature for converged voice/data networks.

The SuperStack 3 Switch 4300 and 4200 series offer ease of configuration and robust network management software, as well as low cost of ownership. For small-to-mid-sized networks and branch offices that do not require network management capabilities, we offer the SuperStack 3 Baseline series and OfficeConnect series of switches that are cost-effective without sacrificing network performance or ease of use.

Networked Telephony:

SuperStack 3 NBX® and NBX 100 networked telephony solutions offer enterprise and small business customers significant telephony cost savings, flexibility and voice/data application integration over existing wiring, supporting up to 1,000 users per location. The NBX software enables enhanced call processing and multi-site IP networking. Also, the NBX platform supports productivity-enhancing applications through our Solutions Partner Program.

On March 19, 2003 we announced that as part of our enterprise strategy we intend to market new enterprise voice products based on technology originally developed by our CommWorks business for the telecommunications service provider market. This softswitch-based technology has carried over 16 billion minutes of live voice traffic for telecommunications service providers including AT&T Corp., MCI/Worldcom, China Unicom Ltd., and Sprint PCS with quality and reliability on a par with — and often better than — the traditional public switched telephone network. We intend to deploy this new offering — called Voice Core eXchange (VCX™) technology — as a high-end addition to our NBX product. With this new product offering, 3Com will offer customers networked telephony solutions that deliver powerful new business advantages including: reduced connectivity charges, reduced administration costs, lower costs for phone moves, adds, and changes, savings on teleconference costs, enhanced employee productivity tools, mobility solutions, and call center management. The blending of our proven NBX system and our new VCX technology offering will allow 3Com to address the full range of business communications needs — from a handful of users at a single location to hundreds of thousands of users integrated across a multi-site environment.

In addition to targeting the customer groups identified in the Markets and Customers section, we will also target the manufacturing and utilities industries with our networked telephony offerings.

Wireless LAN:

3Com builds 802.11 wireless products that enable users to stay connected to information while at their desk or while roaming within the enterprise. The productivity increase associated with this ease of information access is driving many corporations to deploy wireless networks. 3Com offers a large portfolio of standards-based wireless LAN solutions to meet a wide variety of application-specific needs.

Our Wireless LAN Access Point product line includes highly secure, scalable, and managed solutions for the large enterprise as well as affordable and easy-to-use solutions for small businesses. Our access points offer seamless integration with enterprise network security, with the option of centralized management. In addition to Wireless LAN Access Points, we offer Wireless PC Cards, Wireless LAN Workgroup Bridges, and Building-To-Building Bridges. We offer a range of Wireless PC Cards including PC cards with a convenient retractable XJACK® antenna. Our Wireless LAN Workgroup Bridge connects wired Ethernet-enabled devices to the wireless network, and is ideal for use in conference rooms and public access deployments. For cost-effective connections between hard-to-wire or temporary sites, the 3ComWireless LAN Building-To-Building Bridge provides a reliable, secure solution.

Network Jack:

As connectivity evolves, intelligent solutions at the edge of the networks are adding increasing value. 3Com offers a series of Network Jack products to capture this potential. The Network Jack is a four port Ethernet switch that mounts conveniently into any common wall outlet area. It increases the number of network ports available at the desktop — without the cost and inconvenience of running additional cables through walls and ceilings.

The Network Jack provides switching capability in a compact form factor that quadruples connectivity, eliminating the need for expensive cable installation. A key feature of the NJ100 Network Jack is the ability to receive PoE


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or from a local power supply. The product can also forward power to connected devices that comply with the IEEE 802.3af PoE standard. The NJ200 Network Jack adds network management features, traffic prioritization, and virtual LAN support.

Network Management Software:

3Com Network Supervisor is a powerful, yet easy-to-use management application that graphically discovers, maps, and displays network links and IP devices, including NBX telephones and some popular third-party products. It maps devices and connections for easy monitoring of stress levels, setting thresholds and alerts, viewing network events, generating reports in user-defined formats, and launching device configuration tools. The detailed reports — on inventory, ports used, and network topology — make it easier to manage a network. The software’s advanced event processing reduces the time needed to resolve network problems. Automated operations, intelligent defaults, as well as the ability to detect network misconfigurations and offer optimization suggestions give managers at all levels of experience support for robust network supervision. The 3Com Network Supervisor is included with most 3Com managed networking devices. An Advanced Package is available for increased management functionality and capacity. For customers not using the 3Com Network Supervisor, we also offer an Integration Kit, which integrates 3Com device support into HP OpenView Network Node Manager, an alternative standard network management application.

Customer Service and Support:

Our maintenance offerings cover all the aspects of support that channel partners need to deliver a top class service to their end users, including telephone support, hardware replacement, software updates, and providing spare parts and engineers on site.

3Com Professional Services make available for our partners the expertise of 3Com engineers, enabling them to be more successful in their solution delivery. This is provided through a combination of a team of dedicated solutions office engineers at a central level and large project engagement managers in the field.

Over the past year, we have increased our service and support capabilities by adding account executives and network consultants to support enterprise customers as they evaluate and install our products and solutions. Concurrently, we have been building out our channel relationships by adding high value-add partners with substantial service and support capabilities. We intend to accelerate these efforts as the joint venture with Huawei becomes operational.

Sales, Marketing, and Distribution:

3Com has a broad distribution channel, allowing both reach and depth in terms of bringing our products and solutions to our customers. We are fully committed to working with our worldwide base of resellers and channel partners. While a substantial majority of product sales are to partners in our two-tier distribution channel, we also work closely with systems integrators, major telecom service providers, and direct marketers. 3Com also maintains a field sales organization that works alongside our partners to assist them in achieving their business goals.

Our two-tier distribution channel is comprised of distributors and resellers. Distributors are the first tier of the channel providing global distribution, logistics, market development and other services. Distributors generally sell to the second tier of the channel, comprised of VARs and other channel partners.

3Com’s resellers provide value to end users’ solutions through application, technology, or industry-specific expertise, and product and/or service offerings that complement 3Com networking solutions. To support our resellers, we maintain a comprehensive partner program, the Focus Partner Program. This partner program identifies three levels of partners (Gold, Silver and Bronze) based upon different factors such as expertise in 3Com products and solutions, certifications, customer reach, ability to support pre- and post-sales services, revenue, and growth potential. This program provides the resellers with varying benefits and services including marketing, training, sales support, service and support, and project help desks.

3Com’s worldwide sales team focuses on the various channels mentioned above. While the specifics can vary slightly based on geographic differences, in general they can be summarized as follows. Distributor account managers support our distributors in their business activities including sales, marketing, and supply chain


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management. Sales support for resellers includes field-based sales support for Gold or Silver partners and remote account management for Bronze partners. Field-based resources work closely with our resellers to assist them in their work with end users to generate and close sales opportunities. In certain countries, specific sales resources focus on supporting targeted service providers and systems integrators.

In addition, 3Com’s marketing efforts focus on increasing 3Com awareness, consideration, and preference with our target enterprise and public sector customers to create demand for 3Com products with our channel partners. The marketing group supports activities to attract, retain and develop partner channels to ensure we have the right channel partners to support our business and to help their businesses to be successful. These activities include advertising and direct marketing activities, sales tools, collateral and training, and promotions and incentives.

Competition:

3Com competes in the enterprise network infrastructure market providing a broad portfolio of voice and data products and solutions. 3Com’s principal competitors in the enterprise networking market today include Allied Telesyn, Inc., Avaya, Inc., Cisco Systems, Inc., D-Link Systems, Inc., Dell Computer Corp., Enterasys Networks, Inc., Extreme Networks, Inc., Foundry Networks, Inc., Hewlett-Packard Company, Huawei, Mitel Networks Corp., Nortel Networks Corp., and NetGear, Inc.

The primary competitive factors in the market in which we compete are as follows:

•     Tier-One capability and presence, which we define as encompassing:

—  
   Ability to deliver a broad line of networking solutions, including data, voice, security, and wireless solutions

—  
   Broad distribution channels

—  
   Financial strength

—  
   A globally recognized and preferred brand

—  
   Substantial intellectual property portfolio

—  
   Strong service and support capabilities

—  
   Global reach

•     Innovative, feature-rich products and solutions, including:

—  
   Ability to provide voice and data convergence solutions for large, multi-site environments

—  
   Convergence ready voice, data and wireless solutions built on an open architecture to protect network investments that support evolutionary migrations, heterogeneous networks, and ease of integration for new applications

—  
   An innovative product roadmap for GbE and 10 GbE switching, networked telephony, security, and wireless technologies

•     Networking solutions that are affordable to acquire, maintain and grow, including:

—  
   Ability to price lower than the competition by leveraging industry standards and an innovative, cost-efficient business model

—  
   Ease of setup, network and application management through product and network management software design, including auto-configuration and auto-diagnostic capabilities

—  
   Lower TCO

In addition to delivering the performance, availability and functionality required of today’s networks, 3Com is relentlessly focused on ensuring its solutions are easy to install, use and operate, as well as affordable to own.

Research and Development:

3Com’s research and development approach focuses internal investments upon those core activities that are necessary to deliver differentiated products and drive product cost reductions. This is particularly true for newer technologies where it is important to develop internal intellectual property or platforms for future product offerings.


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Areas of focus include potential high growth areas such as voice and data convergence, network security, 10 GbE, XRN technology for distributed LAN cores, and wireless networking. For non-core activities that may include mature technologies or widely available components, we leverage third parties for sourcing or contract work for that portion of the product development. This two-part approach increases our ability to bring products to market in a timely and low cost manner and ensures that we are focused upon those product attributes that matter most to our customers.

Research and development investments in application specific integrated circuits (ASICs) and value-added software remain a high priority for 3Com. ASICs provide higher performance, innovative features, as well as cost benefits. Gigabit switching ASICs such as the ones developed for our XRN technology deliver high, non-blocking performance as well as unique combinations of capabilities such as Distributed Resilient Routing, Distributed Device Management, and Link Aggregation Clustering. ASICs used in our networked telephony solutions enable powerful features and provide key cost advantages. Along with our ASICs, value added software provides differentiation across our product lines. In many cases, sophisticated software underlies the reliability and ease of use that our customers have grown to associate with 3Com products. Examples include self-configuration capabilities in our wireless LAN access points and switches to automatic prioritization of networked telephony traffic traversing our Switch 4400.

Connectivity Segment

3Com is a leading provider of easy-to-use, reliable, high-performance connectivity solutions at the edge of the network that enable users to access information. We develop and sell a full portfolio of connectivity solutions that provide LAN connectivity at the edge of the network for notebook, desktop, and server systems. The technologies supported by our products include 10/100/1000 Mbps Ethernet and LAN/Modem combination products. We offer these technologies in all of the common user configurations and form factors.

Please note that our wireless LAN client products are part of our Enterprise Networking segment. Please see the Enterprise Networking section for a description of our wireless LAN offerings.

Industry Background:

As discussed in the Enterprise Networking section, during the 1980s and 1990s, 3Com became a worldwide leader building enterprise networks and the equipment that connects computers to networks and a preferred supplier of Ethernet connectivity products to the Fortune 1000. As the Ethernet connectivity industry evolved and matured, niche competitors entered the market and, over time, attempted to become mainstream players. Companies, including Western Digital Corp., Lannet Company, Inc., SMC Networks, Inc., Cogent Communications Group, Inc., Xircom, Inc., and Proteon, have either sold their business to one of the remaining players or have left the market entirely. Today, the market is composed of Taiwan-based manufacturers that generally focus on the consumer market and U.S.-based semiconductor chip manufacturers that generally focus on the corporate market.

Markets and Customers:

Our Ethernet connectivity solutions are targeted for worldwide distribution to enterprise customers via PC Original Equipment Manufacturers (OEMs) and VARs. We sell directly to PC OEMs, which integrate our connectivity products primarily into their commercial PC product offerings. Our 3Com-branded products are sold primarily through our two-tier distribution channel, which leverages the capabilities of our resellers and channel partners.

Future Trends:

As the market for Ethernet connectivity products has evolved, there has been a transition from higher priced NICs to lower priced ASICs that are installed on the PC motherboard, which contains the PC’s basic circuitry and components, in a LAN-on-motherboard (LOM) configuration. Looking forward, connectivity products will increasingly reside in smaller and lower priced form factors, designed in coordination with the PC motherboard itself. As this trend continues, this configuration will become the form factor of choice for connectivity products, significantly impacting and eroding the market for NICs. Intel is well positioned in the Ethernet connectivity market due to the trend towards the use of integrated silicon products. In addition to changing form factors, users are


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beginning to implement higher speed connectivity products. 3Com anticipates that a growing number of connectivity products will be based on GbE (10/100/1000 Mbps) line speed. 3Com is partnering with Marvell Semiconductor, Inc., a major silicon provider, to develop and market Gigabit Ethernet products.

Going forward, 3Com will utilize its strong brand, installed base and market share positions, as well as its intellectual property portfolio, to maximize the profitability of its Ethernet connectivity products. We will leverage alliances, which provide cost effective product development and manufacturing, allowing for the effective extension of connectivity products. 3Com is well positioned to license its strong intellectual property portfolio in connectivity, with the potential to provide the company with future royalty streams, with minimal overhead investment. Ultimately, we will focus on yielding the greatest possible cash generation through the extension of our Ethernet connectivity products.

Product Offerings:

3Com’s Ethernet connectivity products enable computers as well as non-PC devices to connect to Ethernet networks. Building on proprietary ASICs, hardware, and software, 3Com is one of the world leaders in providing 10/100/1000 Mbps Ethernet connectivity. A major factor in 3Com’s success has been our focus on ease of use, reliability, and performance. Our customers expect a 3Com product to install easily and to operate reliably over the life of the system. Further, they expect a 3Com solution will provide excellent performance, which will enhance their productivity, by providing timely access to information on the network.

3Com also offers IP security NIC products for server, desktop, and notebook computers, which contain a dedicated processor capable of processing operations including 3DES (Data Encryption Standard) encryption. Our IP security NIC products provide an added layer of distributed, tamper-resistant protection at the client device level, protecting servers, desktops, and notebooks against network attacks and unauthorized access — from both inside and outside the corporate perimeter.

Sales, Marketing, and Distribution:

For sales of Ethernet connectivity products, we utilize our broad two-tier distribution channel (please see the Enterprise Networking segment Sales, Marketing, and Distribution section for detailed discussion) as well as our PC OEM sales channel to reach and support enterprise customers worldwide. Our PC OEM sales group is composed of dedicated, cross-functional account teams focused on major PC manufacturers and regional OEM sales teams focused on smaller regional OEM customers. The dedicated account teams manage the business relationship and the customer. This management includes coordination of the supply chain, quality, and logistics in addition to managing pricing and demand forecasts. The coordination is a key function as many PC customers have international manufacturing locations and are increasingly using contract manufacturers like the Original Design Manufacturers (ODMs) who will design and manufacture systems to the PC vendors’ specifications. This change in design and production strategy requires close interaction within our PC OEM sales group. Since a large percentage of PCs are sold by the non-brand name PC companies, we have a separate OEM sales group focused on the smaller, regional PC companies. A dedicated sales focus is required as the regional OEM’s business tends to be very opportunistic and deal-based. Close cooperation is required to ensure our solution is appropriately positioned to support the OEM’s ability to win its bid.

Competition:

The Ethernet connectivity market is primarily composed of Taiwan-based manufacturers that generally focus on the consumer market and U.S.-based semiconductor chip manufacturers that generally focus on the corporate market. Significant competitors include D-Link, Accton Technology Corp., Intel Corp., and Broadcom Corp. In this market, the migration away from the use of stand-alone Ethernet connectivity products as discussed in the Future Trends section is expected to continue. Intel is well positioned in the Ethernet connectivity market due to the trend towards the use of integrated silicon products. Intel has used proprietary interfaces and its strength in processors to create a strong competitive position.


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Research and Development:

For Ethernet connectivity products, 3Com utilizes its engineering teams to internally develop products. Corporate customers value the stability of the software image and robustness of design as key product attributes. These features, along with the intense focus on lowering costs, require an in-depth knowledge of our products that is only available to our internal design teams. In potential growth markets for connectivity products, a limited investment methodology will be used, especially in low volume or in new technologies. In these markets we will leverage alliances to quickly bring new products to market. Our product design approach will be to utilize standardized silicon components with product differentiation provided by embedded software (drivers and firmware), product quality assurance, and support.

Joint Venture with Huawei:

On March 19, 2003, 3Com and Huawei, a major communications equipment provider in China, announced an agreement to form a joint venture (JV) domiciled in Hong Kong with principal operations in Hangzhou, China. Huawei’s contribution to the JV will be its enterprise networking business assets, which include LAN switches; routers; engineering, sales, and marketing resources; and licenses to its related intellectual property. These resources will include over 1,000 employees. 3Com’s contribution to the JV will include $160 million in cash, assets related to its enterprise networking business operations in China and Japan, and licenses to its related intellectual property.

3Com’s president and chief executive officer, Bruce Claflin, has been named chairman of the JV’s board of directors and Ren Zhengfei, president and chief executive officer of Huawei, has been appointed chief executive officer of the JV. Huawei will own 51 percent and 3Com will hold a 49 percent ownership in the JV. On the second anniversary date of the formation of the JV, provided 3Com and its affiliates collectively hold at least 49 percent of the net outstanding shares, 3Com will have the one-time option to purchase from Huawei that number of shares that is equal to two percent of the net outstanding shares. The aggregate purchase price of these shares will be subject to negotiation between the shareholders at the time of such purchase, but will not be greater than $28 million. On the third anniversary of the formation of the JV, each shareholder will have the right to purchase all of the equity equivalents held by the other shareholder and its affiliates. This process to sell or purchase will be governed by a bidding process, where each partner can accept the other partner’s price, or bid at least two percent higher. This process will continue until one partner agrees to sell.

The intent of the JV is to enable 3Com to broaden its product portfolio, offer customers a low cost of acquisition and ownership, and improve its ability to target the Chinese and Japanese markets. The JV’s product line will complement and enhance 3Com’s position in fixed-configuration products by providing 3Com with modular Layer 2 and 3, 10/100/1000 Mbps switches. The JV and Huawei will also provide 3Com a full line of enterprise routers. These products are intended to offer a rich feature set meeting a wide variety of wiring closet, core networking, and wide-area networking needs. In addition, the highly skilled and low-cost engineering team in China will provide a foundation for a lower total cost of ownership. 3Com also intends to leverage this lower cost engineering talent for new, feature rich products in future years.

3Com’s and Huawei’s geographical footprints are highly complementary, which will reduce Huawei’s and 3Com’s costs of expansion into new markets through the JV. 3Com has a strong presence in the Americas and Europe, while Huawei has an established sales network, strong brand name and highly-regarded reputation in China. By working with 3Com, the JV can broaden distribution more rapidly and efficiently, and can focus on developing the Japanese market. Outside China and Japan, 3Com will serve as the primary channel for the JV’s products. 3Com will leverage its expansive distribution channel, significantly extending the reach of the JV-developed products. 3Com will provide resellers access to the full line of JV networking products, which will be sold under the 3Com brand everywhere in the world except China and Japan, where the products will be sold under the JV’s brand. In China and Japan, the JV will sell the former Huawei networking product line (mid, low and high end routers and switches), as well as the existing 3Com product line through an OEM agreement between the JV and 3Com. Until the JV is established and operational, 3Com will purchase from Huawei selected products under an OEM arrangement on an interim basis. 3Com may also sell Huawei’s high-end routers outside China and Japan under an OEM agreement with Huawei.

The JV is subject to regulatory approval in China. Until the transaction is approved and actually closes, the parties are restricted from acting as if these businesses were formally combined. During this period, each business will continue to be managed independently. However, the parties will engage in planning for post-consummation activities.


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PRODUCT DEVELOPMENT

Our research and development expenditures in fiscal years 2003, 2002, and 2001 were $113.1 million, $198.0 million, and $406.9 million, respectively. Our research and development expenditures include efforts to create new types of products and classes of service as well as to expand and improve our current product lines, as discussed in the Research and Development sections of our description of our operating segments above.

SIGNIFICANT CUSTOMERS

For the fiscal year ended May 30, 2003, Ingram Micro, Inc. and Tech Data Corp. accounted for 21 percent and 12 percent of our total sales, respectively. For the fiscal years ended May 31, 2002, and June 1, 2001, Ingram Micro accounted for 18 percent of our total sales in each year, and Tech Data accounted for ten percent of our total sales in each year.

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 several research and development groups, with the most significant group being in the U.K. We have manufacturing and distribution facilities in Ireland and a distribution facility in Singapore. We maintain sales offices in 44 countries outside the U.S.

While the U.S. represents 3Com’s largest geographic marketplace, approximately 65 percent of 3Com’s net sales in fiscal 2003 came from sales to customers outside the U.S. Margins on sales of 3Com products in foreign countries, and sales of product that include components obtained from foreign suppliers, can be adversely affected by international trade regulations, including tariffs and antidumping duties, and by foreign currency exchange rate fluctuations. See Note 20 to the consolidated financial statements for further discussion on segment reporting.

BACKLOG

In many cases we manufacture our products in advance of receiving firm product orders from our customers based upon our forecasts of worldwide customer demand. Generally, orders are placed by the customer on an as-needed basis and may be canceled or rescheduled by the customer without significant penalty. Accordingly, backlog as of any particular date is not necessarily indicative of our future sales. As of May 31, 2003 and June 1, 2002, we had backlog of approximately $32.1 million and $46.7 million, respectively. We do not have backlog orders that cannot be filled within the next fiscal year.

MANUFACTURING

We use a combination of in-house manufacturing and independent contract manufacturers to produce our products. A substantial portion of Enterprise Networking products is manufactured at our Blanchardstown, Ireland facility, where purchasing, assembly, burn-in, testing, final assembly, and quality assurance functions are performed. Contract manufacturers are used to produce Connectivity products and a portion of Enterprise Networking products. We have contract manufacturing arrangements with Flextronics International for the production of Connectivity products. Based on current and forecasted demand, our in-house and independent contract manufacturing operations are expected to have an adequate supply of components required in the production of our products.

INTELLECTUAL PROPERTY AND RELATED MATTERS

Through its research and development activities over many years, 3Com has developed 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, powerful, and innovative networking solutions for customers.

We rely 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 potential markets for our products exist. Our general policy has been to seek patent protection for those inventions and improvements that we expect to incorporate in our products or


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that we otherwise expect to be valuable. As of May 30, 2003, we had 926 U.S. patents (including 896 utility patents and 30 design patents) and 300 foreign patents. During fiscal 2003, we filed 85 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. We also have patent cross license agreements with other companies, and have retained the right to use all intellectual property that transferred to UTStarcom with the sale of CommWorks. During fiscal 2003, we initiated a patent licensing program to identify potential sources of licensing revenue, including investigation of situations in which we believe that other companies may be improperly using our patented technology.

We have registered 66 trademarks in the U.S. and have registered 58 trademarks in one or more of 61 foreign countries, for a total of 780 worldwide registrations. Numerous applications for registration of domestic and foreign trademarks are currently pending.

EMPLOYEES

As of May 30, 2003, we had approximately 3,300 regular employees, of whom approximately 600 were employed in research and development, 1,000 in sales and marketing, 1,100 in manufacturing and customer services, and 600 in finance, information technology, and administration. Our employees are not represented by a labor organization, and we consider our employee relations to be satisfactory. As discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we intend to reduce our overall workforce by approximately ten percent from the level of employees as of May 30, 2003 by the end of the second quarter of fiscal 2004.

SALE OF COMMWORKS

On March 4, 2003, we entered into an agreement to sell selected assets and liabilities of our CommWorks division to UTStarcom in exchange for $100 million in cash (Asset Purchase Agreement), subject to certain closing adjustments. On May 23, 2003, we completed the sale of our CommWorks division and transferred certain assets and