**UNITED STATES****SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM****10-Q**

 
| **ý** |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

 

**For the quarterly period ended February 28, 2003**

 

**or**

 
| **o** |   | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|-----------------------------------------------------------------------------------------------|

 

**For the transition periodfrom           to           **

 

**Commission File No. 0-12867**

 

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**3Com Corporation**

(Exactname of registrant as specified in its character)

 

| **Delaware**                                                     |   | **94-2605794**                        |
|------------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification No.) |
|                                                             |   |                                  |
| **5500 Great America Parkway  Santa Clara, California**          |   | **95052**                             |
| (Address of principal  executive offices)                        |   | (Zip Code)                            |

 

**Registrant’stelephone number, including area code:  (408) 326-5000**

 

**Formername, former address and former fiscal year, if changed since last report:   N/A**

 

**Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.**

 

**Yes  **ý              **No**  o

 

**Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).**

 

**Yes  **ý              **No**  o

 

**As ofMarch 21, 2003, 362,314,245 shares of the Registrant’s Common Stock wereoutstanding.**

 

**Thisreport contains a total of 47 pages of which this page is number 1.**

 

 

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**3Com Corporation**

 

**Table of Contents**

 
|       |                                                                                        |                                                                                                               | **Page** |
|------------|---------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------|----------|
| PART I.    | FINANCIAL INFORMATION                                                                       |                                                                                                               |     |
|       |                                                                                        |                                                                                                               |     |
| *Item 1.*  | Financial Statements                                                                        |                                                                                                               |     |
|       |                                                                                        |                                                                                                               |
|       |                                                                                        | Condensed  Consolidated Statements of Operations*Three  and Nine Months Ended February 28, 2003 and March 1, 2002* | 3        |
|       |                                                                                        |                                                                                                               |     |
|       |                                                                                        | Condensed  Consolidated Balance Sheets*February  28, 2003 and May 31, 2002*                                        | 4        |
|       |                                                                                        |                                                                                                               |     |
|       |                                                                                        | Condensed  Consolidated Statements of Cash Flows*Nine  Months Ended February 28, 2003 and March 1, 2002*           | 5        |
|       |                                                                                        |                                                                                                               |     |
|       |                                                                                        | Notes  to Condensed Consolidated Financial Statements                                                              | 6        |
|       |                                                                                        |                                                                                                               |
| *Item  2.* | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 17                                                                                                                 |
|       |                                                                                        |                                                                                                               |     |
| *Item  3.* | Quantitative  and Qualitative Disclosures About Market Risk                                 | 40                                                                                                                 |
|       |                                                                                        |                                                                                                               |     |
| *Item 4.*  | Controls and  Procedures                                                                    |                                                                                                               | 40       |
|       |                                                                                        |                                                                                                               |     |
| PART II.   | OTHER INFORMATION                                                                           |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item  1.* | Legal Proceedings                                                                           |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item  2.* | Changes  in Securities and Use of Proceeds                                                  |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item 3.*  | Defaults Upon  Senior Securities                                                            |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item  4.* | Submission  of Matters to a Vote of Security Holders                                        |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item  5.* | Other Information                                                                           |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| *Item 6.*  | Exhibits and  Reports on Form 8-K                                                           |                                                                                                               | 41       |
|       |                                                                                        |                                                                                                               |     |
| Signatures |                                                                                        | 45                                                                                                                 |
|            |                                                                                             |                                                                                                                    |          |  |

 

 

3Com, CommWorks, and Megahertz are registered trademarks and XRN is atrademark of 3Com Corporation or its subsidiaries.  Palm is a trademark of Palm, Inc.

 

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**PARTI.   FINANCIAL INFORMATION**

 

***Item 1.*   Financial Statements**

 

**3Com Corporation**

**Condensed Consolidated Statements of Operations**

(In thousands, except pershare data)

(Unaudited)

 
|                                                                              |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                              |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Sales                                                                             |   | $                       | 244,926 |                   | $      | 355,978 |   | $ | 852,842 |   | $ | 1,139,421 |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Cost of sales                                                                     |   | 132,536                 |    | 222,506                |   | 439,109 |   | 810,184 |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Gross margin                                                                      |   | 112,390                 |    | 133,472                |   | 413,733 |   | 329,237 |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Operating  expenses:                                                              |   |                    |    |                   |   |   |   |   |   |
| Sales and  marketing                                                              |   | 68,861                  |    | 78,642                 |   | 203,503 |   | 269,893 |   |
| Research and  development                                                         |   | 39,035                  |    | 72,275                 |   | 134,561 |   | 231,376 |   |
| General and  administrative                                                       |   | 25,543                  |    | 27,417                 |   | 78,082 |   | 97,202 |   |
| Amortization and  write down of intangibles                                       |   | 1,705                   |    | 63,517                 |   | 14,205 |   | 92,885 |   |
| Restructuring  charges                                                            |   | 53,990                  |    | 64,039                 |   | 146,686 |   | 153,090 |   |
| Loss on land and  facilities, net                                                 |   | —                  |    | 1,375                  |   | 887 |   | 1,375 |   |
| Total operating  expenses                                                         |   | 189,134                 |    | 307,265                |   | 577,924 |   | 845,821 |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Operating loss                                                                    |   | (76,744                 | )       | (173,793               | )      | (164,191 | ) | (516,584 | ) |
| Loss on  investments, net                                                         |   | (14,570                 | )       | (12,302                | )      | (33,122 | ) | (19,572 | ) |
| Interest and  other income, net                                                   |   | 5,177                   |    | 9,302                  |   | 18,683 |   | 55,100 |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Loss before  income taxes and cumulative effect of change in accounting principle |   | (86,137                 | )       | (176,793               | )      | (178,630 | ) | (481,056 | ) |
| Income tax  provision (benefit)                                                   |   | (6,895                  | )       | 59,341                 |   | 1,105 |   | 91,136 |   |
| Loss before  cumulative effect of change in accounting principle                  |   | (79,242                 | )       | (236,134               | )      | (179,735 | ) | (572,192 | ) |
| Cumulative  effect of change in accounting principle                              |   | —                  |    | —                 |   | (65,601 | ) | — |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Net loss                                                                          |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (245,336 | ) | $ | (572,192 | ) |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Basic and  diluted loss per share:                                                |   |                    |    |                   |   |   |   |   |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Loss before  cumulative effect of change in accounting principle                  |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.50 | ) | $ | (1.65 | ) |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Cumulative  effect of change in accounting principle                              |   | —                  |    | —                 |   | (0.18 | ) | — |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Net loss                                                                          |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.68 | ) | $ | (1.65 | ) |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Shares used in  computing per share amounts:                                      |   |                    |    |                   |   |   |   |   |   |
|                                                                              |   |                    |    |                   |   |   |   |   |   |
| Basic and  diluted                                                                |   | 361,020                 |    | 351,596                |   | 359,266 |   | 347,537 |   |

 

*Seenotes to condensed consolidated financial statements.*

 

3

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**3Com Corporation**

**Condensed Consolidated Balance Sheets**

(In thousands, except parvalue)

 
|                                                                                                       |   | **February  28,  2003** |      | **May 31,  2002** |   |
|------------------------------------------------------------------------------------------------------------|--------|-------------------------|-----------|-------------------|--------|
|                                                                                                       |   | **(Unaudited)**         |      |              |   |
| ASSETS                                                                                                     |   |                    |      |              |   |
| Current assets:                                                                                            |   |                    |      |              |   |
| Cash and  equivalents                                                                                      |   | $                       | 503,459   |              | $      | 679,055 |   |
| Short-term  investments                                                                                    |   | 937,592                 |      | 702,993           |   |
| Accounts  receivable, net                                                                                  |   | 120,152                 |      | 147,113           |   |
| Inventories                                                                                                |   | 41,328                  |      | 61,777            |   |
| Investments and  other                                                                                     |   | 49,662                  |      | 72,106            |   |
| Total current  assets                                                                                      |   | 1,652,193               |      | 1,663,044         |   |
|                                                                                                       |   |                    |      |              |   |
| Property and  equipment, net                                                                               |   | 426,162                 |      | 676,154           |   |
| Deposits and  other assets                                                                                 |   | 46,284                  |      | 87,213            |   |
| Deferred income  taxes                                                                                     |   | 6,055                   |      | 6,192             |   |
| Intangible  assets, net                                                                                    |   | 13,518                  |      | 27,689            |   |
| Goodwill                                                                                                   |   | 899                     |      | 66,500            |   |
|                                                                                                       |   |                    |      |              |   |
| Total assets                                                                                               |   | $                       | 2,145,111 |              | $      | 2,526,792 |   |
|                                                                                                       |   |                    |      |              |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                 |   |                    |      |              |   |
| Current  liabilities:                                                                                      |   |                    |      |              |   |
| Accounts payable                                                                                           |   | $                       | 118,767   |              | $      | 125,903 |   |
| Accrued  liabilities and other                                                                             |   | 222,819                 |      | 275,965           |   |
| Current portion  of debt                                                                                   |   | 31,102                  |      | 101,354           |   |
| Total current  liabilities                                                                                 |   | 372,688                 |      | 503,222           |   |
|                                                                                                       |   |                    |      |              |   |
| Long-term debt                                                                                             |   | 37,550                  |      | 68,404            |   |
| Other long-term  obligations                                                                               |   | 4,660                   |      | 4,961             |   |
|                                                                                                       |   |                    |      |              |   |
| Stockholders’  equity:                                                                                |   |                    |      |              |   |
| Preferred stock,  $.01 par value, 10,000 shares authorized; none outstanding                               |   | —                  |      | —            |   |
| Common stock, $.01 par value, 990,000 shares  authorized; shares issued: 365,739 and 365,449, respectively |   | 2,129,697               |      | 2,126,583         |   |
| Treasury stock, at cost, 3,826 and 7,743 shares,  respectively                                             |   | (96,092                 | )         | (182,341          | )      |
| Note receivable  from sale of warrants                                                                     |   | (12,631                 | )         | (21,052           | )      |
| Unamortized stock-based compensation                                                                       |   | (2,264                  | )         | (5,030            | )      |
| Retained  earnings (deficit)                                                                               |   | (284,924                | )         | 35,814            |   |
| Accumulated  other comprehensive loss                                                                      |   | (3,573                  | )         | (3,769            | )      |
| Total  stockholders’ equity                                                                           |   | 1,730,213               |      | 1,950,205         |   |
|                                                                                                       |   |                    |      |              |   |
| Total  liabilities and stockholders’ equity                                                           |   | $                       | 2,145,111 |              | $      | 2,526,792 |   |

 

*Seenotes to condensed consolidated financial statements.*

 

4

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**3Com Corporation**

**Condensed Consolidated Statements of Cash Flows**

(In thousands)

(Unaudited)

 
|                                                                                                         |   | **Nine  Months Ended**  |     |
|--------------------------------------------------------------------------------------------------------------|--------|-------------------------|----------|
|                                                                                                         |   | **February  28,  2003** |     | **March 1,  2002** |   |
| Cash flows from  operating activities:                                                                       |   |                    |     |   |   |
| Net loss                                                                                                     |   | $                       | (245,336 | ) | $ | (572,192 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities:                   |   |                    |     |   |   |
| Depreciation and  amortization                                                                               |   | 130,317                 |     | 212,634 |   |
| Loss on property  and equipment                                                                              |   | 77,758                  |     | 69,509 |   |
| Write downs of  goodwill and intangibles, including the cumulative effect of change in  accounting principle |   | 73,251                  |     | 54,422 |   |
| Loss on  investments, net                                                                                    |   | 33,122                  |     | 19,572 |   |
| Deferred income  taxes                                                                                       |   | 371                     |     | 78,420 |   |
| Stock-based  expense                                                                                         |   | 5,627                   |     | 7,380 |   |
| Changes in  current assets and liabilities:                                                                  |   |                    |     |   |   |
| Accounts  receivable                                                                                         |   | 26,962                  |     | 106,971 |   |
| Inventories                                                                                                  |   | 13,116                  |     | 116,950 |   |
| Other assets                                                                                                 |   | 23,560                  |     | 50,990 |   |
| Accounts payable                                                                                             |   | (7,137                  | )        | (104,373 | ) |
| Accrued  liabilities and other                                                                               |   | (53,213                 | )        | (289,879 | ) |
| Income taxes  payable                                                                                        |   | (243                    | )        | 87,690 |   |
|                                                                                                         |   |                    |     |   |   |
| Net cash  provided by (used in) operating activities                                                         |   | 78,155                  |     | (161,906 | ) |
|                                                                                                         |   |                    |     |   |   |
| Cash flows from  investing activities:                                                                       |   |                    |     |   |   |
| Purchase of  investments                                                                                     |   | (989,548                | )        | (567,596 | ) |
| Proceeds from  sales and maturities of investments                                                           |   | 753,663                 |     | 532,815 |   |
| Purchase of  property and equipment                                                                          |   | (17,727                 | )        | (346,807 | ) |
| Proceeds from  sale of property and equipment                                                                |   | 80,667                  |     | 15,420 |   |
|                                                                                                         |   |                    |     |   |   |
| Net cash used in  investing activities                                                                       |   | (172,945                | )        | (366,168 | ) |
|                                                                                                         |   |                    |     |   |   |
| Cash flows from  financing activities:                                                                       |   |                    |     |   |   |
| Issuance of common  stock                                                                                    |   | 12,648                  |     | 33,711 |   |
| Repurchase of  common stock                                                                                  |   | (1,548                  | )        | (3,660 | ) |
| Net proceeds  from (repayments on) revolving line of credit                                                  |   | (70,000                 | )        | 95,000 |   |
| Proceeds from  term loan                                                                                     |   | —                  |     | 105,000 |   |
| Repayments of  long-term borrowings                                                                          |   | (31,020                 | )        | (8,189 | ) |
| Collection on  note receivable from sale of warrants                                                         |   | 8,421                   |     | — |   |
| Capitalization  of deferred financing costs                                                                  |   | —                  |     | (5,165 | ) |
| Other, net                                                                                                   |   | (69                     | )        | (46 | ) |
|                                                                                                         |   |                    |     |   |   |
| Net cash  provided by (used in) financing activities                                                         |   | (81,568                 | )        | 216,651 |   |
|                                                                                                         |   |                    |     |   |   |
| Effect of currency  translation                                                                              |   | 762                     |     | 246 |   |
|                                                                                                         |   |                    |     |   |   |
| Decrease in cash  and equivalents                                                                            |   | (175,596                | )        | (311,177 | ) |
| Cash and  equivalents, beginning of period                                                                   |   | 679,055                 |     | 897,797 |   |
|                                                                                                         |   |                    |     |   |   |
| Cash and  equivalents, end of period                                                                         |   | $                       | 503,459  |   | $ | 586,620 |   |

 

*Seenotes to condensed consolidated financial statements.*

 

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**3Com Corporation**

**Notes to Condensed Consolidated Financial Statements**

**(Unaudited)**

 

1.             Basis ofPresentation

 

The unaudited condensed consolidated financial statements have beenprepared by 3Com Corporation (3Com), pursuant to the rules and regulations ofthe Securities and Exchange Commission. In the opinion of management, these unaudited condensed consolidatedfinancial statements include all adjustments (consisting solely of normalrecurring adjustments) necessary for a fair presentation of 3Com’s financialposition as of February 28, 2003, and results of operations for the three andnine months ended February 28, 2003 and March 1, 2002, and cash flows for thenine months ended February 28, 2003 and March 1, 2002.  Certain amounts from the prior period havebeen reclassified to conform to the current period presentation.  Such reclassifications had no effect on netloss as previously reported.

 

3Com uses a 52- or 53-week fiscal year ending on the Friday nearest toMay 31. The results of operations for the three and nine months ended February28, 2003 may not be indicative of the results to be expected for the fiscalyear ending May 30, 2003.  Thesecondensed consolidated financial statements should be read in conjunction withthe consolidated financial statements and related notes thereto included in3Com’s Annual Report on Form 10-K for the fiscal year ended May 31, 2002.

 

*RevenueRecognition*

 

3Com recognizes a sale when the product has been delivered and risk ofloss has passed to the customer, collection of the resulting receivable isreasonably assured, persuasive evidence of an arrangement exists, and the feeis fixed or determinable. For arrangements that involve multiple elements, suchas sales of products that include maintenance or installation, revenue isallocated to each respective element separately. For sales containingcustomer-specific acceptance requirements, no revenue is recognized untilreceipt of customer acceptance. For sales of products that contain softwarethat is marketed separately, 3Com applies the provisions of Statement ofPosition 97-2. 3Com accrues related allowances for product returns, priceprotection, warranty, other post-sales support obligations, and royaltyexpenses in the period of sale.  Alimited warranty is provided on 3Com products for periods ranging from 90 daysto the lifetime of the product, depending upon the product.  Sales of service and maintenance arerecognized upon delivery and completion of the service or, in the case ofmaintenance and support contracts, ratably over the contract term, providedthat all other revenue recognition criteria have been met. 3Com provideslimited product return and price protection rights to certain distributors andresellers.  Product return rights aregenerally limited to a percentage of sales over a one to three month period.

 

*RecentAccounting Pronouncements*

 

In June 2001, the Financial Accounting Standards Board (FASB)issued Statement of Financial Accounting Standards (SFAS) 141, “BusinessCombinations,” which addresses the financial accounting and reporting forbusiness combinations and supersedes Accounting Principles Board (APB)Opinion 16, “Business Combinations,” and SFAS 38, “Accounting forPreacquisition Contingencies of Purchased Enterprises.” SFAS 141 requires thatall business combinations be accounted for by the purchase method, modifies thecriteria for recognizing intangible assets, and expands disclosurerequirements. The provisions of SFAS 141 apply to all businesscombinations initiated after June 30, 2001.  3Com adopted SFAS 141 on June 1, 2002.  The adoption of SFAS 141 did not have a material impact on3Com’s results of operations or financial position.

 

In June 2001, the FASB issued SFAS 142, “Goodwill and OtherIntangible Assets,” which addresses financial accounting and reporting foracquired goodwill and other intangible assets and supersedes APB Opinion 17,“Intangible Assets.” SFAS 142 addresses how intangible assets that areacquired individually or with a group of other assets should be accounted forin financial statements upon their

 

6

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acquisition and after they have been initially recognized in thefinancial statements. SFAS 142 requires that goodwill and intangibleassets that have indefinite useful lives not be amortized but rather tested atleast annually for impairment, and intangible assets that have finite usefullives be amortized over their useful lives. In addition, SFAS 142 expandsthe disclosure requirements about goodwill and other intangible assets in theyears subsequent to their acquisition. Impairment losses for goodwill andindefinite-lived intangible assets that arise due to the initial application ofSFAS 142 are to be reported as a change in accounting principle.

 

3Com adopted SFAS 142 on June 1, 2002 and ceased amortization of netgoodwill totaling $66.5 million, which included $0.7 million of acquiredworkforce intangible assets previously classified as purchased intangibleassets; amortization continues on net finite-lived intangible assets withremaining useful lives of generally two to three years and totaling $13.5million as of February 28, 2003 as discussed in Note 7. In the firstquarter of fiscal 2003, 3Com completed the first phase of the SFAS 142analysis, which indicated that an impairment might have existed for goodwillassociated with the Company’s Enterprise Networking and CommWorks segments. Inthe second quarter of fiscal 2003, 3Com completed the transitional goodwillimpairment evaluation and recorded a charge totaling $65.6 million as a changein accounting principle effective June 1, 2002 to write off goodwill of $45.4million in the Enterprise Networking segment and $20.2 million in the CommWorkssegment. The remaining recorded goodwill for 3Com after this impairment chargewas $0.9 million, and related solely to the Connectivity segment. Areconciliation of previously reported net loss and net loss per share to theamounts adjusted for the exclusion of goodwill and acquired workforceamortization follows (in thousands, except per share amounts):

 

 
|                                                   |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|--------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                   |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
|                                                   |   |                    |    |                   |   |   |   |   |   |
| Reported net  loss                                     |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (245,336 | ) | $ | (572,192 | ) |
| Add back  goodwill and acquired workforce amortization |   | —                  |    | 8,975                  |   | — |   | 26,937 |   |
| Adjusted net  loss                                     |   | $                       | (79,242 | )                      | $      | (227,159 | ) | $ | (245,336 | ) | $ | (545,255 | ) |
|                                                   |   |                    |    |                   |   |   |   |   |   |
| Reported net  loss per share-Basic and Diluted:        |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.68 | ) | $ | (1.65 | ) |
| Add back  goodwill and acquired workforce amortization |   | —                  |    | 0.02                   |   | — |   | 0.08 |   |
| Adjusted net  loss-Basic and Diluted                   |   | $                       | (0.22   | )                      | $      | (0.65 | ) | $ | (0.68 | ) | $ | (1.57 | ) |

 

In August 2001, the FASB issued SFAS 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS 144 addresses financial accounting and reporting for the impairmentor disposal of long-lived assets. 3Com adopted SFAS 144 on June 1, 2002.  The adoption of SFAS 144 did not have amaterial impact on the Company’s results of operations or financial position.

 

In June 2002, the FASB issued SFAS 146, “Accounting for CostsAssociated with Exit or Disposal Activities,” which addresses financialaccounting and reporting for costs associated with exit or disposal activitiesand supersedes Emerging Issues Task Force (EITF) Issue 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).”  SFAS 146 requires that a liability for acost associated with an exit or disposal activity be recognized when theliability is incurred.  Under EITF 94-3,a liability for an exit cost as defined in EITF 94-3 was recognized at thedate of an entity’s commitment to an exit plan.  SFAS 146 also establishes that the liability initially should bemeasured and recorded at fair value. 3Com adopted the provisions of SFAS 146 for exit or disposal activitiesthat were initiated after

 

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December 31, 2002. The adoption of SFAS 146 did not have amaterial impact on the Company’s results of operations or financial position.

 

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.” FIN 45 requires that uponissuance of a guarantee, the guarantor must recognize a liability for the fairvalue of the obligation it assumes under that guarantee. The provisions forinitial recognition and measurement are effective on a prospective basis forguarantees that are issued or modified after December 31, 2002, irrespective ofa guarantor’s year-end. The disclosure requirements of FIN 45 are effective forinterim and annual periods ending after December 15, 2002, and areapplicable to 3Com’s product warranty liability and other guarantees. 3Comadopted the provisions of FIN 45 for guarantees issued or modified afterDecember 31, 2002, and the adoption of FIN 45 did not have a material impact onthe Company’s results of operations or financial position.

 

In November 2002, the EITF reached a consensus on Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses certainaspects of the accounting by a vendor for arrangements under which the vendorwill perform multiple revenue generating activities. The EITF will be effectivefor fiscal years beginning after June 15, 2003. 3Com has not yet determined theimpact of the adoption of EITF 00-21 on the Company’s results of operations orfinancial position.

 

In December 2002, the FASB issued SFAS 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure,” which amends SFAS 123, “Accounting forStock-Based Compensation.” SFAS 148 provides alternative methods of transitionfor an entity that voluntarily changes to the fair value based method ofaccounting for stock-based employee compensation.  It also amends thedisclosure provisions of SFAS 123 to require prominent disclosure about theeffects an entity’s accounting policy decisions with respect to stock-basedemployee compensation on reported net income in both annual and interimperiods. SFAS 148 is effective for annual periods ending afterDecember 15, 2002 and interim periods beginning after December 15,2002.  3Com has not yet determined theimpact of the adoption of SFAS 148 on the Company’s results of operations orfinancial position.

 

2.             RestructuringCharges

 

In fiscal 2001, 3Com began the restructuring of its business to enhancethe focus and cost effectiveness of its business units in serving theirrespective markets. 3Com implemented a reduction in workforce and other actionsaimed at reducing costs, expenses and assets; exited its consumer Internetappliance and cable and digital subscriber line (DSL) modem product lines; andoutsourced the manufacturing of certain high volume server, desktop and mobileconnectivity products in a contract manufacturing arrangement as part of thisrestructuring effort.

 

In the first quarter of fiscal 2003, 3Com announced it would integrateits Business Connectivity Company (BCC) into its Business Networks Company(BNC) to leverage common infrastructure in order to drive additional cost outof the business, while retaining a structure consisting of three ongoingoperating segments as was implemented at the beginning of this restructuringprogram. The three operating segments are listed in Note 10—EnterpriseNetworking, Connectivity, and CommWorks. Additionally, the Company entered intoan agreement to outsource certain information technology functions, andcontinued its efforts to consolidate its real estate portfolio. Accruedliabilities associated with restructuring charges are classified as current, as3Com intends to satisfy such liabilities within the next year. Components ofaccrued restructuring charges, which are included in accrued liabilities andother in the accompanying balance sheet, and changes in accrued amounts relatedto this restructuring program as of February 28, 2003 were as follows (inthousands):

 

8

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|                               |   | **Employee  Separation  Expenses** |   | **Long-term  Asset  Write downs** |   | **Facilities-  related  Charges** |   | **Other  Restructuring  Costs** |   | **Total** |   |
|------------------------------------|--------|------------------------------------|--------|-----------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|-----------|--------|
|                               |   |                               |   |                              |   |                              |
|                               |   |                               |   |                              |   |                              |
| Balance at May  31, 2002           |   | **$**                              | 4,953  |                              | $      | —                            |   | $                               | 5,354  |      | $      | 3,447 |   | $ | 13,754 |   |
| Provision                          |   | 14,427                             |   | 1,894                             |   | 6,196                             |   | 640                             |   | 23,157    |   |
| Payments and  asset write downs    |   | (9,859                             | )      | (1,894                            | )      | (6,217                            | )      | (859                            | )      | (18,829   | )      |
|                               |   |                               |   |                              |   |                              |   |                            |   |      |   |
| Balance at  August 30, 2002        |   | 9,521                              |   | —                            |   | 5,333                             |   | 3,228                           |   | 18,082    |   |
| Provision  (benefit)               |   | 10,570                             |   | 3,064                             |   | 56,410                            |   | (505                            | )      | 69,539    |   |
| Payments and  asset write downs    |   | (13,091                            | )      | (3,064                            | )      | (57,240                           | )      | (330                            | )      | (73,725   | )      |
|                               |   |                               |   |                              |   |                              |   |                            |   |      |   |
| Balance at  November 29, 2002      |   | 7,000                              |   | —                            |   | 4,503                             |   | 2,393                           |   | 13,896    |   |
| Provision                          |   | 5,100                              |   | 1,323                             |   | 47,306                            |   | 261                             |   | 53,990    |   |
| Payments and  asset write downs    |   | (7,911                             | )      | (1,323                            | )      | (43,024                           | )      | (1,410                          | )      | (53,668   | )      |
|                               |   |                               |   |                              |   |                              |   |                            |   |      |   |
| Balance at  February 28, 2003      |   | $                                  | 4,189  |                              | $      | —                            |   | $                               | 8,785  |      | $      | 1,244 |   | $ | 14,218 |   |
|                               |   |                               |   |                              |   |                              |   |                            |   |      |   |
| Estimated  remaining cash payments |   | $                                  | 4,189  |                              | $      | —                            |   | $                               | 8,785  |      | $      | 1,244 |   | $ | 14,218 |   |

 

Employee separation expenses are comprised of severance pay,outplacement services, medical and other related benefits.  Affected employee groups include corporateservices, manufacturing and logistics, product organizations, research anddevelopment, sales, customer support and administrative positions. The totalreduction in workforce since the inception of this restructuring programthrough February 28, 2003 includes approximately 6,300 employees who have beenseparated or were in the separation process. Substantially all those employeeshad worked their last day at the Company. Included in the $5.1 millionprovision in the third quarter of fiscal 2003 were credits of approximately$0.3 million relating to revisions of previous estimates. Since the inceptionof this restructuring program, $165.3 million of separation payments have beenmade.

 

Long-term asset write downs include items identified as no longerneeded to support ongoing operations for 3Com. During the third quarter of fiscal 2003, 3Com recorded a charge of $1.3million, primarily for leasehold improvements in vacated office space.

 

Facilities-related charges include write downs of land and buildingsheld for sale and lease terminations. In the third quarter of fiscal 2003, 3Comrecorded $47.3 million in facilities-related charges, including $41.4 millionof accelerated depreciation and write downs of certain facilities in SantaClara, California, all of which were classified as held for sale as of February28, 2003. The accelerated depreciation charge resulted from the fact that thelife of the long-lived asset was significantly shortened due to 3Com’s decisionto vacate the buildings as part of its restructuring efforts. Also included inthe $47.3 million provision in the third quarter of fiscal 2003 were credits ofapproximately $0.5 million relating to revisions of previous estimates.

 

Other restructuring costs include expenses associated with terminatingother contractual arrangements.

 

3.                                       ComprehensiveLoss

 

The components of comprehensive loss, net of tax, are as follows (inthousands):

 
|                                           |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                           |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
|                                           |   |                    |    |                   |   |   |   |   |   |
| Net loss                                       |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (245,336 | ) | $ | (572,192 | ) |
|                                           |   |                    |    |                   |   |   |   |   |   |
| Other  comprehensive income (loss):            |   |                    |    |                   |   |   |   |   |   |
| Change in net  unrealized gain on investments  |   | (546                    | )       | (2,278                 | )      | (55 | ) | (4,675 | ) |
| Change in  accumulated translation adjustments |   | (224                    | )       | 299                    |   | 650 |   | 63 |   |
| Total  comprehensive loss                      |   | $                       | (80,012 | )                      | $      | (238,113 | ) | $ | (244,741 | ) | $ | (576,804 | ) |

 

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4.                                       NetLoss Per Share

 

The following table presents the calculation of basic and diluted lossper share (in thousands, except per share data):

 
|                                                             |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                             |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
|                                                             |   |                    |    |                   |   |   |   |   |   |
| Loss before  cumulative effect of change in accounting principle |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (179,735 | ) | $ | (572,192 | ) |
| Cumulative  effect of change in accounting principle             |   | —                  |    | —                 |   | (65,601 | ) | — |   |
| Net loss                                                         |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (245,336 | ) | $ | (572,192 | ) |
|                                                             |   |                    |    |                   |   |   |   |   |   |
| Weighted average  shares-basic                                   |   | 361,020                 |    | 351,596                |   | 359,266 |   | 347,537 |   |
| Effect of  dilutive securities:                                  |   |                    |    |                   |   |   |   |   |   |
| Employee stock  options                                          |   | —                  |    | —                 |   | — |   | — |   |
| Restricted stock                                                 |   | —                  |    | —                 |   | — |   | — |   |
| Weighted average  shares-diluted                                 |   | 361,020                 |    | 351,596                |   | 359,266 |   | 347,537 |   |
|                                                             |   |                    |    |                   |   |   |   |   |   |
| Net loss per  share-basic and diluted:                           |   |                    |    |                   |   |   |   |   |   |
| Loss before cumulative  effect of change in accounting principle |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.50 | ) | $ | (1.65 | ) |
| Cumulative  effect of change in accounting principle             |   | —                  |    | —                 |   | (0.18 | ) | — |   |
| Net loss                                                         |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.68 | ) | $ | (1.65 | ) |

 

Employee stock options and restricted stock totaling 2.4 millionshares, 9.7 million shares, 2.8 million shares, and 6.6 million shares for thethree months ended February 28, 2003 and March 1, 2002, and the nine monthsended February 28, 2003 and March 1, 2002, respectively, were notincluded in the diluted weighted average shares calculation as the effects ofthese securities were antidilutive.

 

5.                                       Inventories

 

Inventories consist of (in thousands):

 
|            |   | **February  28,  2003** |   | **May 31,  2002** |   |
|-----------------|--------|-------------------------|--------|-------------------|--------|
|            |   |                    |   |
|            |   |                    |   |              |   |
| Finished goods  |   | $                       | 19,511 |              | $      | 29,730 |   |
| Work-in-process |   | 7,413                   |   | 15,458            |   |
| Raw materials   |   | 14,404                  |   | 16,589            |   |
|            |   |                    |   |              |   |
| Total inventory |   | $                       | 41,328 |              | $      | 61,777 |   |

 

6.             Sale of Facilities

 

In July 2002, 3Com sold its 639,000 square foot manufacturing andoffice facility in Mount Prospect, Illinois that was classified as held forsale as of May 31, 2002. The estimated net realizable value of this

 

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property as of May 31, 2002 was $17.4 million. Net proceeds from thesale were $17.8 million, resulting in a $0.4 million credit that was recordedagainst restructuring charges in the first quarter of fiscal 2003.Additionally, as a portion of 3Com’s term loan was collateralized by the MountProspect facility, 3Com repaid approximately $7.5 million of the term loanbalance with the proceeds of this sale as was required under the terms of thefinancing agreement.

 

In October 2002, 3Com sold its 185,000 square foot office and researchand development facility in Salt Lake City, Utah that was classified as held forsale prior to the inception of its restructuring programs. Net proceeds fromthe sale were $4.2 million, resulting in a gain of approximately $0.3 millionthat was recorded in loss on land and facilities, net, in the second quarter offiscal 2003, resulting in a net loss of $0.9 million for the nine months endedFebruary 28, 2003 related to this property.

 

In November 2002, 3Com sold its 550,000 square foot Marlborough,Massachusetts property, and will lease back approximately 168,000 square feetof the property at prevailing market rates. Net proceeds from the sale were$56.6 million, resulting in a loss of $31.2 million that was recorded inrestructuring charges in the second quarter of fiscal 2003.

 

7.             IntangibleAssets, Net

 

Intangible assets, net, consist of (in thousands):

 
|                                  |   | **As of  February 28, 2003** |   |
|---------------------------------------|--------|------------------------------|--------|
| Segments:                             |   | **Enterprise  Networking**   |   | **Connectivity** |   | **CommWorks** |   | **Total** |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Developed and  core technology, gross |   | $                            | 21,582 |   | $ | 20,992 |   | $ | — |   | $ | 42,574 |   |
| Accumulated  amortization             |   | (13,874                      | )      | (15,300 | ) | — |   | (29,174 | ) |
| Developed and  core technology, net   |   | 7,708                        |   | 5,692 |   | — |   | 13,400 |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Customer  relationships, gross        |   | 420                          |   | 56 |   | — |   | 476 |   |
| Accumulated  amortization             |   | (327                         | )      | (31 | ) | — |   | (358 | ) |
| Customer  relationships, net          |   | 93                           |   | 25 |   | — |   | 118 |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Total net  intangible assets          |   | $                            | 7,801  |   | $ | 5,717 |   | $ | — |   | $ | 13,518 |   |
|                                  |   |                         |   |   |   |   |   |   |   |
|                                  |   | **As of May 31, 2002**       |   |
| Segments:                             |   | **Enterprise  Networking**   |   | **Connectivity** |   | **CommWorks** |   | **Total** |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Developed and  core technology, gross |   | $                            | 24,780 |   | $ | 20,992 |   | $ | 14,041 |   | $ | 59,813 |   |
| Accumulated  amortization             |   | (11,449                      | )      | (12,236 | ) | (9,934 | ) | (33,619 | ) |
| Developed and  core technology, net   |   | 13,331                       |   | 8,756 |   | 4,107 |   | 26,194 |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Customer  relationships, gross        |   | 420                          |   | 56 |   | 4,864 |   | 5,340 |   |
| Accumulated  amortization             |   | (221                         | )      | (20 | ) | (3,604 | ) | (3,845 | ) |
| Customer  relationships, net          |   | 199                          |   | 36 |   | 1,260 |   | 1,495 |   |
|                                  |   |                         |   |   |   |   |   |   |   |
| Total net  intangible assets          |   | $                            | 13,530 |   | $ | 8,792 |   | $ | 5,367 |   | $ | 27,689 |   |

 

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In the second quarter of fiscal 2003, 3Comrecorded an impairment of intangible assets associated with its EnterpriseNetworking and CommWorks segments. For each segment, 3Com determined the amountof the impairments by comparing the carrying value against the fair value, whichwas estimated using discounted cash flows. For the intangible assetsrelated to the acquisition of NBX Corporation, the core and developedtechnology intangible assets were written down to the net present value ofexpected cash flows discounted at a rate of 14 percent per year. This writedown resulted from significantly reduced revenue projections as compared to theinitial projections that existed at the date of acquisition. The revisions in revenue projections includedlower projected market growth and a lower percentage of projected NBX revenuescoming from existing technology. Asa result of this analysis, 3Com recorded a write down of $3.2 million for theEnterprise Networking segment.

 

The intangible assets related to the Call Technologies, Inc. (CTI) and LANSource Technologies, Inc. (LANSource) acquisitionsconsisted of core and existing technology and customer relationships. Theseintangible assets were written off completely as estimated future net cashflows were forecasted to be negative for the related product lines. These writeoffs were the result of significantly reduced revenue projections as comparedto the initial projections that existed at the date of acquisition dueprimarily to the overall economic downturn in the telecommunications sector. Asa result of its analyses, 3Com wrote off $4.4million and $0.1 million for the CommWorks segment relating to the CTI andLANSource acquisitions, respectively.

 

All of these impairments were recorded inamortization and write down of intangibles and are components of contributionmargin in the nine months ended February 28, 2003, as reported in Note 10.

 

Based on the carrying value of 3Com’s intangibleassets as of February 28, 2003, remaining amortization is expected to be $1.5million for the remainder of fiscal 2003, $5.8 million in fiscal 2004, $4.3million in fiscal 2005, and $1.9 million in fiscal 2006.

 

8.             Accrued Warrantyand Other Guarantees

 

Products are sold with varying lengths ofwarranty ranging from 90 days to the lifetime of the products.  Reserve requirements are recorded in theperiod of sale and are based on an assessment of the products sold with awarranty and historical warranty costs incurred. The Company also assesses itspreexisting warranty obligations and may adjust the amounts based on actualexperience or changes in future expectations.

 

The following table summarizes the activityin the warranty reserve for the nine months ended February 28, 2003 (inthousands):

 
|                                              |   | **Warranty  Reserve** |   |
|---------------------------------------------------|--------|-----------------------|--------|
|                                              |   |                  |   |
| Accrued  warranty, May 31, 2002                   |   | $                     | 53,289 |   |
| Cost of warranty  claims                          |   | (34,138               | )      |
| Accruals for  warranties issued during the period |   | 23,207                |   |
| Adjustments to  preexisting warranties            |   | 4,175                 |   |
|                                              |   |                  |   |
| Accrued  warranty, February 28, 2003              |   | $                     | 46,533 |   |

 

Prior to fiscal 2003, 3Com entered into several agreements whereby ithad sold product to resellers who had, in turn, sold the product to others, and3Com has guaranteed the payments of the end users. If all

 

12

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end users under these agreements were to default on their payments, asof February 28, 2003 the Company would be required to pay approximately $11.9million. As deferred revenue associated with such sales approximates theguaranteed amounts and 3Com has the right to recover such products relating tothe deferred cost of goods sold in the event of default, any payments resultingfrom end user defaults would not have a material impact on 3Com’s results ofoperations.

 

In connection with 3Com’s development of its Rolling Meadows, Illinoisfacility, the Company guaranteed a municipal bond in the amount of $2.5 millionfor site improvements, and payment of principal and interest were to besatisfied by sales tax revenue generated by 3Com’s sales in that municipality,with any shortfall being 3Com’s responsibility. 3Com intends to sell itsRolling Meadows facility, and plans to repay the principal amount and accruedinterest with the proceeds from the sale of the facility. Additional amountscould also be owed to municipalities related to the sale of Rolling Meadows forthe repayment of grants and incentives, which, subject to negotiations, couldrange up to $4.0 million and may also be paid at the time of sale.

 

9.             Stock RepurchaseProgram

 

In September 2002, 3Com’s Board of Directors approved a stock repurchaseprogram providing for expenditures of up to $40.0 million and authorized atwelve-month time limit on such repurchases. In the second quarter of fiscal2003, 3Com repurchased 0.4 million shares of its own common stock for $1.5million. As discussed in Note 12, this program was superseded on March 19,2003.

 

10.           Business SegmentInformation

 

The following tables display information on 3Com’s reportable segments(in thousands):

 
|                         |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|------------------------------|--------|-------------------------|---------|------------------------|--------|
|                         |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
| Sales:                       |   |                    |    |                   |   |   |   |   |   |
| Enterprise  Networking       |   | $                       | 165,908 |                   | $      | 196,739 |   | $ | 551,891 |   | $ | 591,219 |   |
| Connectivity                 |   | 50,619                  |    | 106,111                |   | 199,840 |   | 363,463 |   |
| CommWorks                    |   | 28,423                  |    | 51,789                 |   | 94,976 |   | 175,250 |   |
| Exited Product  Lines        |   | (24                     | )       | 1,339                  |   | 6,135 |   | 9,489 |   |
|                         |   | $                       | 244,926 |                   | $      | 355,978 |   | $ | 852,842 |   | $ | 1,139,421 |   |
|                         |   |                    |    |                   |   |   |   |   |   |
| Contribution  Margin (Loss): |   |                    |    |                   |   |   |   |   |   |
| Enterprise  Networking       |   | $                       | 3,973   |                   | $      | (12,706 | ) | $ | 41,603 |   | $ | (70,034 | ) |
| Connectivity                 |   | 12,874                  |    | (34,178                | )      | 70,408 |   | (53,763 | ) |
| CommWorks                    |   | (5,125                  | )       | (12,725                | )      | (27,986 | ) | (55,443 | ) |
| Exited Product  Lines        |   | 351                     |    | (4,494                 | )      | 1,311 |   | (26,275 | ) |
|                         |   | $                       | 12,073  |                   | $      | (64,103 | ) | $ | 85,336 |   | $ | (205,515 | ) |

 

A reconciliation of the totals reported for the reportable segments tothe applicable line items in the consolidated financial statements is set forthbelow (in thousands):

 
|                                                                                  |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|---------------------------------------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                                                  |   | **February  28,  2003** |    | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
| Total  contribution margin (loss) from operating segments                             |   | $                       | 12,073  |                   | $      | (64,103 | ) | $ | 85,336 |   | $ | (205,515 | ) |
| Indirect  operating expenses (1)                                                      |   | 34,827                  |    | 44,276                 |   | 101,954 |   | 156,604 |   |
| Restructuring  charges                                                                |   | 53,990                  |    | 64,039                 |   | 146,686 |   | 153,090 |   |
| Loss on land and  facilities, net                                                     |   | —                  |    | 1,375                  |   | 887 |   | 1,375 |   |
| Total operating  loss                                                                 |   | (76,744                 | )       | (173,793               | )      | (164,191 | ) | (516,584 | ) |
| Loss on  investments, net                                                             |   | (14,570                 | )       | (12,302                | )      | (33,122 | ) | (19,572 | ) |
| Interest and  other income, net                                                       |   | 5,177                   |    | 9,302                  |   | 18,683 |   | 55,100 |   |
| Loss before  income taxes and cumulative effect of change in accounting principle (2) |   | $                       | (86,137 | )                      | $      | (176,793 | ) | $ | (178,630 | ) | $ | (481,056 | ) |

 

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(1)          Indirect operatingexpenses include expenses that are not directly attributable to a reportingsegment, such as corporate marketing and general and administrative expenses.

(2)          As discussed in Note 1,the cumulative effect of a change in accounting principle for the nine monthsended February 28, 2003 related to the transitional goodwill impairmentanalysis that resulted in a write off of $45.4 million and $20.2 million ofgoodwill in the Enterprise Networking and CommWorks segments, respectively.These impairment charges were not included as a component of contributionmargin (loss) as presented above.

 

11.           Litigation

 

3Com is a party to lawsuits in the normal course of its business.  Litigation in general, and intellectualproperty and securities litigation in particular, can be expensive anddisruptive to normal business operations. Moreover, the results of complexlegal proceedings are difficult to predict. 3Com believes that it has meritorious defenses in each of the cases setforth below in which it is named as a defendant and is vigorously contesting each of thesematters.  An unfavorable resolution ofone or more of these lawsuitscould adversely affect its business, results of operations, or financialcondition.  3Com cannot estimatethe loss or range of loss that may be reasonably possible for any of thecontingencies described.

 

In November 2000, a shareholder derivative and class action lawsuit,captioned *Shaev v. Claflin, et al.*,No. CV794039, was filed in California Superior Court. The complaint allegesthat 3Com’s directors and officers made misrepresentations and/or omissions andbreached their fiduciary duties to the Company in connection with theadjustment of employee and director stock options in connection with theseparation of 3Com and Palm Inc. (Palm). It is unclear whether the plaintiff isseeking recovery from 3Com or if 3Com was named solely as a nominal defendant,against whom the plaintiff seeks no recovery. On November 29, 2001, theSuperior Court granted the defendants’ demurrer with leave to amend.  The plaintiff filed a First AmendedComplaint to which defendants again demurred. On July 9, 2002, the Superior Court again granted the defendants’demurrer to the plaintiff’s First Amended Complaint with leave to amend.  On or about December 13, 2002, the plaintifffiled a Second Amended Complaint. 3Com’s demurrer to such Second Amended Complaint is currently pendingbefore the Court.

 

On May 26, 2000, 3Com filed suit against Xircom, Inc. (Xircom) in theUnited States District Court for the District of Utah, Civil Action No.2:00-CV-0436C alleging infringement of U.S. Patents Nos. 6,012,953, 5,532,898,5,696,660, and 5,777,836, accusing Xircom of infringement of one or more of theclaims of the patents-in-suit by reason of the manufacture, sale, and use ofthe RealPort and RealPort2 families of PC Cards, as well as a number ofXircom’s Type II PC Modem Cards.   On November 14, 2000, 3Com amended itscomplaint to assert infringement of then-newly issued U.S. Patent No.6,146,209, also asserted against Xircom’s RealPort and RealPort2 families ofproducts.  Xircom counter-claimed for adeclaratory judgment that the asserted claims of the patents-in-suit wereinvalid and/or not infringed. On July 19, 2002 the Honorable Tena Campbellgranted 3Com’s motion for a preliminary injunction on the 6,146,209 patentprohibiting Xircom from manufacturing, using, selling, offering to sell withinthe United States or importing into the United States 26 RealPort and RealPort2products as identified in the Court’s order pending the final outcome of thelawsuit. Xircom appealed this ruling to the Court of Appeals for the Federal Circuit.In the second quarter of fiscal 2003, 3Com and Xircom announced the settlementof all litigation between them. Under the terms of the settlement, 3Comreceived $15.0 million for a paid-up technology license, which was recorded asroyalty revenue; a consent judgment acknowledging the validity of 3Com patentsand infringement by Xircom products, including RealPort and RealPort2, has beenentered; cross licensing of the patents in suit has been agreed

 

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upon and the Xircom lawsuit against 3Com has been dismissed withprejudice.  3Com, Xircom and IntelCorporation, Xircom’s parent company, have also agreed upon a two-year limitedcovenant not to sue each other with respect to any patent infringement claims.

 

On September 21, 2000, Xircom filed an action against 3Com Corporationin the United  States  District Court  for the CentralDistrict  of  California,  Case  No.: 00-10198  MRP, accusing 3Com ofinfringement  of U.S. Patents Nos.5,773,332, 5,940,275, 6,115,257, and 6,095,851, accusing 3Com of infringementby reason of the manufacture, sale, and  use of the 3Com 10/100LAN+Modem CardBus Type III PC Card, the 3Com  10/100  LAN CardBus  Type  III PC Card, the 3Com MegahertzÒ 10/100 LAN  CardBus PC Card, the 3ComMegahertz 10/100 LAN+56K Global Modem CardBus  PC  Card and  the  3Com Megahertz 56K Global GSM and Cellular Modem  PC  Card.   On July 6, 2001, Xircom filed a second action against 3Com, Case No.01-05902 GAF JTLX, also filed in the United States District Court for theCentral District of California, alleging infringement of U.S.  Patent No. 6,241,550.  The 6,241,550 patent was asserted againstthe 3Com 10/100 LAN+Modem CardBus Type III PC Card and the 3Com 10/100 LANCardBus Type III PC Card products.  Thissecond action asserting the 6,241,550 patent was consolidated with the firstaction, with both cases being heard by the Honorable Mariana R. Pfaelzer.  3Com counter-claimed for declaratoryjudgment that the asserted claims of the patents-in-suit were not infringedand/or invalid and that the claims of the 5,940,275 and 6,241,550 patents wereunenforceable.  Xircom filed a motionfor preliminary injunction seeking to enjoin 3Com from the continuedmanufacture and sale of its Type III PC card products.  The motion was heard on March 26, 2001 andwas denied by the Court.  Xircomsubsequently filed a motion for preliminary injunction on the 6,241,550 patent.Xircom’s second motion was resolved by agreement between the parties.  3Com continues to sell its type III PCcards, without the light pipe, which does not adversely affect thefunctionality of the cards. As discussed above, 3Com and Xircom settled alloutstanding patent-related litigation in the second quarter of fiscal 2003.

 

On April 28, 1997, Xerox Corporation (Xerox) filed suit against U.S.Robotics Corporation and U.S. Robotics Access Corporation in the United StatesDistrict Court for the Western District of New York.  The case is now captioned *XeroxCorporation v. 3Com Corporation, U.S. Robotics Corporation, U.S. RoboticsAccess Corporation, Palm Computing, Inc., and Palm, Inc.* (CivilAction Number 97-CV-6182T).  Xeroxalleged willful infringement of United States Patent Number 5,596,656, entitled“Unistrokes for Computerized Interpretation of Handwriting.”  Xerox sought to recover damages and topermanently enjoin the defendants from infringing the patent in thefuture.  In 2000, the District Courtdismissed the case, ruling that there was no infringement.  On appeal, the Court of Appeals for theFederal Circuit affirmed-in-part, reversed-in-part and remanded the case to theDistrict Court.  On December 20, 2001,the District Court granted Xerox’s motion for summary judgment that the patentis valid, enforceable, and infringed. The defendants then filed a Notice of Appeal.  On February 22, 2002, the District Court denied Xerox’s motionfor an injunction prohibiting further alleged infringement during the appealand ordered the defendants to post a bond in the amount of $50 million.  Xerox then appealed the denial of theinjunction.  On February 20, 2003, theCourt of Appeals issued its decision affirming in part and reversing in partthe order of the trial court.  The Courtof Appeals affirmed the grant of summary judgment of infringement, reversed thegrant of summary judgment of validity and remanded the case to the trial courtto conduct a complete validity analysis. In connection with the separation of Palm from 3Com, pursuant to theterms of the Indemnification and Insurance Matters Agreement, dated February26, 2000, between 3Com and Palm, Palm agreed to indemnify and hold 3Comharmless for any damages or losses that might arise out of the Xeroxlitigation.

 

On August 14, 2001, 3Com filed suit against Broadcom Corporation (Broadcom)in California Superior Court, captioned *3ComCorporation v. Broadcom Corporation*, CV800685, seeking to recoverfrom Broadcom, pursuant to a promissory note, the principal amount of $21.1million together with interest thereon and attorney fees. On January 8, 2002,Broadcom filed its answer denying that any sums are due and asserting numerousaffirmative defenses. In the second quarter of fiscal 2003, 3Com and Broadcomsettled this suit.  Under the terms ofthe settlement agreement, Broadcom will pay 3Com $22.0 million dollars,representing principal and a portion of prior periods’ accrued interest, plusadditional interest as it accrues during the repayment period. Broadcom isrequired to make five quarterly installments, beginning in November 2002, of $4.4million, plus additional accrued interest, and as of February 28,

 

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2003, Broadcom was current in its payment of installments to satisfyits obligation.  Broadcom also agreed toentry of a stipulated judgment in 3Com’s favor for $22.0 million, plusinterest. 3Com agreed to extend the terms of the warrant held by Broadcom topurchase 7.1 million shares of 3Com common stock for an additional 12 months toDecember 4, 2003.

 

On March 4, 2003,3Com filed suit against PCTEL, Inc., (PCTEL) in the United States DistrictCourt for the Northern District of Illinois, Civil Action Number 03C 1582alleging infringement of United States Patents Numbered 5,872,836, 5,646,983, 5,724,413, 6,097,794,6,696,660, 5,532,898 and 5,777,836.  On March 5, 2003, PCTEL filedsuit against 3Com in the United States District Court for the Northern Districtof California, Civil Action Number C 03 0982 alleging infringement of UnitedStates Patent Number 4,841,561 entitled “Operating default group selectabledata communication equipment” and further seeking a declaration that PCTEL doesnot infringe 3Com Patents Numbered 5,872,836, 5,646,983, 5,724,413, 6,097,794,6,696,660, 5,532,898 and 5,777,836, and that such patents are void and invalid.

 

On September 25, 2000 Northrop Grumman Corporation (Northrop) filedsuit in the United States District Court for the Eastern District of Texas,Civil Action No. 1:00CV-652, against Intel Corporation, 3Com Corporation,Xircom, Inc., D-Link Systems, Inc. and The Linksys Group, Inc. alleginginfringement of United States Patent Number 4,453,229 which was issued in1982.  Based on the trial court’s claimconstruction after a Markman Hearing on June 8, 2001, and briefing by theparties, the trial court entered a judgment of noninfringement in favor ofdefendants 3Com and Linksys Group, Inc. from which Northrop appealed.  On March 31, 2003, the United States Courtof Appeals for the Federal Circuit issued its ruling reversing the order of thetrial court and remanding the case back to the trial court for furtherproceedings.

 

12.                                 SubsequentEvents

 

On March 4, 2003, 3Com announced it had entered into a definitiveagreement to sell its CommWorks business whereby, pending regulatory approval,the purchaser will acquire the operations and certain assets and assume certainliabilities of the CommWorks business in exchange for approximately $100million of cash, subject to certain closing adjustments. As a result of thisagreement, 3Com will account for CommWorks as a discontinued operationbeginning in the fourth quarter of fiscal 2003. 3Com will retain ownership ofor receive a license to use any intellectual property rights related to itsCommWorks business that are also used in 3Com’s other business segments.

 

At its meeting on March 13, 2003, the Board of Directors approved a newstock repurchase program providing for expenditures of up to $100.0 million andauthorized a two-year time limit on such repurchases. This was subject tocertain conditions that were met on March 19, 2003. This new stock repurchaseprogram superseded the stock repurchase program that was approved in September2002.

 

On March 19, 2003, 3Com announced an agreement to form a joint venturewith Huawei Technologies Limited that will be domiciled in Hong Kong withprincipal operations in Hangzhou, China. 3Com will contribute to the jointventure $160 million in cash, assets related to its operations in China andJapan, and licenses to its related intellectual property in exchange for 49% ownershipof the joint venture. Operations of the joint venture will relate to 3Com’sEnterprise Networking segment and are expected to begin in the first quarter offiscal 2004, pending various regulatory approvals.

 

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**3Com Corporation**

 

***Item 2.*****                            Management’sDiscussion and Analysis of Financial Condition and Results of Operations**

 

The following discussion should be read in conjunction with thecondensed consolidated financial statements and the related notes that appearelsewhere in this document.

 

This quarterly report on Form 10-Q contains forward-lookingstatements.  These forward-lookingstatements include, without limitation, predictions regarding the followingaspects of our future:

 

•                  Balance sheet,results of operations, and financial position;

•                  Cash positionand cash requirements;

•                  Sales andmargins;

•                  Sources, amountsand concentration of revenue;

•                  Costs andexpenses;

•                  Accountingestimates, including treatment of goodwill and intangible assets, doubtfulaccounts, inventory, restructuring, and warranty, and product returns;

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

•                  Products, priceof products, product lines, and product and sales channel mix;

•                  Relationshipwith customers, suppliers and strategic partners, including the formation ofjoint ventures;

•                  Acquisition anddisposition activity;

•                  Credit facilityand ability to raise financial capital;

•                  Real estatearrangements;

•                  Activities of3Com Ventures;

•                  Global economic,social, and geopolitical conditions;

•                  Ability toidentify and respond to trends, including the trend toward increasedsiliconization;

•                  Tax position;

•                  Employees;

•                  Sources of competition;

•                  Protection ofintellectual property;

•                  Outcome andeffect of current and potential future litigation;

•                  Accountingpractices, including the adoption of accounting pronouncements;

•                  Trading price ofour common stock;

•                  Effective ofgovernment regulation; and

•                  Security ofcomputer systems.

 

You can identify these and other forward-looking statements by the useof words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,”“believes,” “estimates,” “predicts,” “intends,” “potential,” “continue,” or thenegative of such terms, or other comparable terminology.  Forward-looking statements also include theassumptions underlying or relating to any of the foregoing statements.

 

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

 

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**Overview**

 

In the fourth quarter of fiscal 2001 weundertook several initiatives aimed at driving revenue growth and cutting costsin an attempt to return the Company to profitability. This included exitingcertain product lines that were not expected to yield a return on investment inthe near term. After exiting these products, we were organized around threebusiness units. These business units operated throughout all of fiscal2002—Business Connectivity Company (BCC), Business Networks Company (BNC), andCommWorks. During fiscal 2002, we experienced continued declining revenues,most pronounced in BCC as a result of a shift in the market to less expensive,silicon-based products, and in CommWorks as a result of the steep reduction incapital spending of telecommunications carriers and service providers. Inresponse to such conditions, we looked to drive additional costs out of thebusiness, including headcount reductions, long term asset retirements, andoutsourcing manufacturing that resulted in facilities consolidation. Werecorded $167.5 million in restructuring charges in fiscal 2002 as result ofthese actions.

 

In the first quarter of fiscal 2003, weundertook several additional initiatives to achieve further cost savings. Thefirst of these actions included the integration of BCC into BNC in order toachieve cost savings from the consolidation of certain functions, andrestructuring charges resulted from this action. This integration, however, didnot substantially change our structure that consists of three operating units.In fiscal 2002, the business units were BCC, BNC, and CommWorks. Effective forfiscal 2003, our business units are 1) Connectivity, which includes themajority of products previously managed under BCC, 2) Enterprise Networks,which includes all of the products previously managed under BNC as well ascertain wireless and security offerings that were formerly part of BCC, and 3)CommWorks.

 

In the first nine months of fiscal 2003 wesaw the continued downward trend in revenue noted in fiscal 2002. In responseto this trend, we have taken additional measures to reduce costs. We havereduced headcount, outsourced certain information technology (IT) functions,and continued our pursuit of selling excess facilities. All of these actionshave generated restructuring charges, but also have resulted in reductions insales and marketing, research and development, and general and administrativeexpenses. If market conditions continue to decline, further cost cuttingmeasures will be pursued, which may result in additional severance and leaseabandonment costs recorded in restructuring charges.

 

In addition, on March 4, 2003 we announcedour intention to sell the operations and certain net assets of our CommWorksbusiness for approximately $100 million in cash, subject to certain closingadjustments. As a result, CommWorks will be reported as a discontinued operationfor current and prior periods starting in the fourth quarter of fiscal 2003.

 

On March 19, 2003, we announced an agreement to form a joint venturewith Huawei Technologies, Limited that will be domiciled in Hong Kong withprincipal operations in Hangzhou, China. We will contribute to the jointventure $160 million in cash, assets related to our operations in China andJapan, and licenses to our related intellectual property in exchange for 49%ownership of the joint venture. Operations of the joint venture will relate toour Enterprise Networking segment and are expected to begin in the firstquarter of fiscal 2004, pending various regulatory approvals.

 

**CriticalAccounting Policies**

 

Our significant accounting policies require us to make estimates and assumptionsthat affect the amounts reported by us. The following items require the mostsignificant judgment and often involve complex estimation:

 

*Revenuerecognition:*  Werecognize a sale when the product has been delivered and risk of loss haspassed to the customer, collection of the resulting receivable is reasonablyassured, persuasive evidence of an arrangement exists, and the fee is fixed ordeterminable. The assessment of whether the fee is fixed or determinableconsiders whether a significant portion of the fee is due after our normalpayment terms. If we determine that the fee is not fixed or determinable, werecognize revenue at the time the fee

 

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becomes due, provided that all other revenue recognition criteria havebeen met. For arrangements with multiple elements, such as sales of productsthat include maintenance or installation, revenue is allocated to eachrespective element separately. Also, sales arrangements, particularly withCommWorks customers, may contain customer-specific product acceptancerequirements, and revenue is not recognized unless customer acceptance has beenreceived.

 

We assess collectibility based on a number of factors, includinggeneral economic and market conditions, past transaction history with thecustomer, and the credit-worthiness of the customer. We do not typicallyrequest collateral from our customers. If we determine that collection of thefee is not probable, then we will defer the fee and recognize revenue uponreceipt of payment.

 

A significant portion of our sales are to distributors and value-addedresellers. Revenue is generally recognized when title and risk of loss pass tothe customer, assuming all other revenue recognition criteria have been met.Sales to these customers are recorded net of appropriate allowances, includingestimates for product returns, price protection, and potentially excess channelinventory levels.

 

For sales of products that contain software that is marketedseparately, the provisions of Statement of Position 97-2 are applied. Sales ofservice and maintenance revenue are recognized upon delivery and completion ofthe service or, in the case of maintenance and support contracts, ratably overthe contract term, provided that all other revenue recognition criteria havebeen met. Royalty revenue from licensing is recognized as earned.

 

*Allowancefor doubtful accounts:*We continuously monitor payments fromour customers and maintain allowances for doubtful accounts for estimatedlosses resulting from the inability of our customers to make required payments.When we evaluate the adequacy of our allowances for doubtful accounts, we takeinto account various factors including our accounts receivable aging, customercredit-worthiness, historical bad debts, and geographic and political risk. Ifthe financial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired. As of February 28, 2003, our net accounts receivable balance was$120.2 million.

 

*Inventory:*  Inventory is stated at the lower of standardcost, which approximates cost, or net realizable value. Cost is based on afirst-in, first-out basis. We review the net realizable value of inventory,both on hand as well as for inventory that we are committed to purchase, indetail on an on-going basis, with consideration given to deterioration,obsolescence, and other factors. If actual market conditions differ from thoseprojected by management, and our estimates prove to be inaccurate, additionalwrite downs or adjustments to cost of sales may be required. Additionally, wemay realize benefits through cost of sales for sale or disposition of inventorythat had been previously written off. As of February 28, 2003, our inventorybalance was $41.3 million.

 

*Goodwilland intangible assets:* We review the value of our long-lived assets, including goodwill, forimpairment whenever events or changes in business circumstances indicate thatthe carrying amount of the assets may not be fully recoverable or that theuseful lives of these assets are no longer appropriate. During fiscal 2002, werecognized $70.1 million of write downs of goodwill and intangible assets, andin the first nine months of fiscal 2003 we recorded $7.7 million of additionalintangible asset write downs, as well as a $65.6 million write off of goodwillin our Enterprise Networking and CommWorks segments resulting from thetransitional goodwill impairment evaluation under Statement of Financial AccountingStandards (SFAS) 142. As of February 28, 2003, we had $13.5 million of netintangible assets and $0.9 million of goodwill remaining on the balance sheet,which we believe to be realizable based on the estimated future cash flows ofthe associated products and technology. However, it is possible that theestimates and assumptions used, such as future sales and expense levels, inassessing the carrying value of these assets may need to be reevaluated in thecase of continued market deterioration, which could result in furtherimpairment of these assets.

 

*Restructuringcharges:* Over the last several years we have undertakensignificant restructuring initiatives, which have required us to developformalized plans for exiting certain business activities. These plans haverequired us to utilize significant estimates related to held for saleproperties, which

 

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resulted in both accelerated depreciation charges and write downs ofthose properties. In addition, we have had to record estimated expenses forseverance and outplacement costs, lease cancellations, long-term asset writedowns, and other restructuring costs. Given the significance and the timing ofthe execution of such activities, this process is complex and involves periodicreassessments of estimates made at the time the original decisions were made.The accounting for restructuring costs and asset impairments requires us torecord provisions and charges when we have a formal and committed plan and whena liability is incurred. Our policies require us to continually evaluate theadequacy of the remaining liabilities under our restructuring initiatives. Asmanagement continues to evaluate the business, there may be additional chargesfor new restructuring activities as well as changes in estimates to amountspreviously recorded.

 

*Warranty:*A limited warranty is provided on our products for periods ranging from 90 daysto the lifetime of the product, depending upon the product, and allowances forestimated warranty costs are recorded during the period of sale. Thedetermination of such allowances requires us to make estimates of productreturn rates and expected costs to repair or replace the products underwarranty. If actual return rates and/or repair and replacement costs differsignificantly from our estimates, adjustments to recognize additional cost ofsales may be required.

 

**Resultsof Operations**

 

The following table sets forth, for the periods indicated, thepercentage of total sales represented by the line items reflected in ourcondensed consolidated statements of operations:

 
|                                                                              |   | **Three  months ended** |   | **Nine  months ended** |   |
|-----------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                              |   | **February  28,  2003** |   | **March 1,  2002**     |   | **February  28,  2003** |   | **March 1,  2002** |   |
|                                                                              |   |                    |   |                   |   |   |   |   |   |
| Sales                                                                             |   | 100.0                   | %      | 100.0                  | %      | 100.0 | % | 100.0 | % |
| Cost of sales                                                                     |   | 54.1                    |   | 62.5                   |   | 51.5 |   | 71.1 |   |
| Gross margin                                                                      |   | 45.9                    |   | 37.5                   |   | 48.5 |   | 28.9 |   |
| Operating  expenses:                                                              |   |                    |   |                   |   |   |   |   |   |
| Sales and  marketing                                                              |   | 28.1                    |   | 22.1                   |   | 23.9 |   | 23.7 |   |
| Research and  development                                                         |   | 16.0                    |   | 20.3                   |   | 15.8 |   | 20.3 |   |
| General and  administrative                                                       |   | 10.4                    |   | 7.7                    |   | 9.1 |   | 8.5 |   |
| Amortization and  write down of intangibles                                       |   | 0.7                     |   | 17.8                   |   | 1.7 |   | 8.2 |   |
| Restructuring  charges                                                            |   | 22.0                    |   | 18.0                   |   | 17.2 |   | 13.4 |   |
| Loss on land and  facilities, net                                                 |   | —                  |   | 0.4                    |   | 0.1 |   | 0.1 |   |
| Total operating  expenses                                                         |   | 77.2                    |   | 86.3                   |   | 67.8 |   | 74.2 |   |
| Operating loss                                                                    |   | (31.3                   | )      | (48.8                  | )      | (19.3 | ) | (45.3 | ) |
| Loss on  investments, net                                                         |   | (6.0                    | )      | (3.5                   | )      | (3.9 | ) | (1.7 | ) |
| Interest and  other income, net                                                   |   | 2.1                     |   | 2.6                    |   | 2.2 |   | 4.8 |   |
| Loss before  income taxes and cumulative effect of change in accounting principle |   | (35.2                   | )      | (49.7                  | )      | (21.0 | ) | (42.2 | ) |
| Income tax  provision (benefit)                                                   |   | (2.8                    | )      | 16.6                   |   | 0.1 |   | 8.0 |   |
| Loss before  cumulative effect of change in accounting principle                  |   | (32.4                   | )      | (66.3                  | )      | (21.1 | ) | (50.2 | ) |
| Cumulative  effect of change in accounting principle                              |   | —                  |   | —                 |   | (7.7 | ) | — |   |
|                                                                              |   |                    |   |                   |   |   |   |   |   |
| Net loss                                                                          |   | (32.4                   | )%     | (66.3                  | )%     | (28.8 | )% | (50.2 | )% |

 

Sales

 

Sales in the third quarter of fiscal 2003 totaled $244.9 million, adecrease of $111.1 million, or 31 percent, compared to the same quarter oneyear ago.  Sales in the first ninemonths of fiscal 2003 were

 

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$852.8 million, a decrease of $286.6 million, or 25 percent, comparedto the same period one year ago.

 

*Enterprise Networking.*Salesof Enterprise Networking products (switches,hubs, networked telephony, wireless Local Area Networks (LANs) and wirelessNetwork Interface Cards (NICs)), and professional services in the thirdquarter of fiscal 2003 were $165.9 million, a decrease of $30.8 million, or 16percent, compared to the same quarter one year ago. Sales of EnterpriseNetworking products and services in the first nine months of fiscal 2003 were$551.9 million, a decrease of $39.3 million, or seven percent, compared to thefirst nine months of fiscal 2002. Thedecline in product sales from the same quarter one year ago was primarily dueto a decline in sales of Layer 2 fixed-configuration 10/100 managed switchingof $16.8 million due mainly to average selling price (ASP) erosion, a decreasein our shared hub product lines of $10.3 million in line with a generaltechnology shift towards switching, and a decline of $6.2 million in DSLrouters due to heavy price competition in this commodity product.  We also experienced a decline in servicerevenues of $4.7 million due to fewer maintenance contract renewals. Partiallyoffsetting the third quarter declines was an increase of $5.5 million in thesales of Layer 3 fixed-configuration Gigabit switches, which benefited from newproduct introductions and an overall growing market.

 

The decline in sales for the first ninemonths of fiscal 2003 versus the same period one year ago was primarily drivenby the same factors impacting the changes in the third quarter of fiscal 2003as compared to the same period one year ago, including a decrease in the salesof our shared hub product lines of $34.8 million, a decrease in DSL routers of$22.7 million, and a decrease in service revenues of $18.4 million.  These year-to-date declines were partiallyoffset by an increase in the sales of our Layer 3 fixed-configuration Gigabitswitches of $21.1 million, and an increase of the sales of our LAN Telephonyproducts of $11.9 million, which benefited from an overall growing market.Sales of Enterprise Networking products and services in the third quarter andfirst nine months of fiscal 2003 represented 68 percent and 65 percent of totalsales, respectively, compared to 55 percent and 52 percent in the third quarterand first nine months of fiscal 2002, respectively.

 

*Connectivity. *Sales of Connectivityproducts (wired NICs, Personal Computer(PC) Cards, LAN-On-Motherboard application-specific integrated circuits, andMini-Personal Computer Interface (PCI))in the third quarter of fiscal 2003 were $50.6 million, a decrease of$55.5 million, or 52 percent, compared to the same quarter one year ago. Salesof Connectivity products in the first nine months of fiscal 2003 were $199.8million, a decrease of $163.6 million, or 45 percent, compared to the firstnine months of fiscal 2002. The decline in sales from the same periods one yearago was due largely to lower volumes. For both the third quarter and first ninemonths of fiscal 2003, unit shipments decreased 45 percent when compared to thesame periods one year ago.

 

Factors that reduced volumes were a shift in the market from NICs, PCCards and Mini-PCI form factors to alternatives that have network functionalityimbedded in PC chipsets where we have lower market share, and lower sales toour original equipment manufacturer (OEM) partners. While declining ASPsresulting from competition placed further downward pressure on revenues, thiswas partially mitigated by a favorable product mix shift, including a higherpercentage of sales to the distribution channel relative to sales to OEMs,which normally have lower ASPs, as well as increased sales of our GigabitEthernet products, which have higher ASPs. Additionally, the decline in salesin the first nine months of fiscal 2003 was partially offset by the recognitionof $15.0 million in royalty revenue from a paid-up license resulting from thesettlement of patent litigation with Xircom Inc. as discussed in Note 11 of thecondensed consolidated financial statements. Sales of Connectivity products inthe third quarter and first nine months of fiscal 2003 represented 21 percentand 23 percent of total sales, respectively, compared to 30 percent and 32percent in the third quarter and first nine months of fiscal 2002,respectively.

 

*CommWorks.*Sales of CommWorksâ products (wireline and Internet Protocol (IP)telephony solutions and wireless access solutions) and professional services inthe third quarter of fiscal 2003 were $28.4 million, a decrease of $23.4million, or 45 percent, compared to the same quarter one year ago.  ** **For the first nine months offiscal 2003, sales of CommWorks products and services were $95.0 million, a****decrease of $80.3 million, or 46 percent,compared to the first nine months of fiscal 2002. These decreases wereattributable to a decline in sales of both wireline and wireless products, aswell as in sales

 

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of professional services. Declining revenue trends continue to reflectthe overall condition of the markets in which CommWorks offers solutions.  Telecommunications carriers and serviceproviders continue to reduce and delay capital expenditures as industryconditions remain depressed. Sales of CommWorks products and services in boththe third quarter and first nine months of fiscal 2003 represented 11 percentof total sales, compared to 15 percent in both the third quarter and first ninemonths of fiscal 2002.

 

*ExitedProduct Lines.*Sales of exited product lines (analog-onlymodems and high-end LAN and Wide Area Network chassis products, internetappliances, and consumer cable and DSL modem products) were negligible in thethird quarter of both fiscal 2003 and 2002. Sales of exited products for thefirst nine months of fiscal 2003 were $6.1 million, compared to $9.5 millionfor the same period one year ago. Sales of exited product lines weresubstantially eliminated by the second quarter of fiscal 2002 resulting fromour business restructuring and change in strategic focus, and the sales in thefirst nine months of fiscal 2003 resulted mainly from the first quarterrecognition of revenue that was deferred as of May 31, 2002. Sales of exitedproducts as a percentage of total sales in the third quarter of both fiscal2003 and 2002 were nil.  Sales of exitedproducts in both the first nine months of fiscal 2003 and 2002 were one percentof total sales.

 

Geographic

In the third quarter and first nine months of fiscal 2003, U.S. salesdecreased 45 percent and 29 percent, respectively, as compared to the sameperiods one year ago. International sales for both the third quarter and firstnine months of fiscal 2003 decreased 23 percent. U.S. sales represented 30percent of total sales in the third quarter of fiscal 2003, compared to 38percent in the third quarter of fiscal 2002, and represented 38 percent and 40percent of total sales in the first nine months of fiscal 2003 and 2002,respectively. The decline in international sales spanned all major geographicregions.

 

Gross Margin

Gross margin as a percentage of sales was 45.9 percent in the third quarter of fiscal 2003,compared to 37.5 percent in the third quarter of fiscal 2002.  Gross margin improved approximately eight percentage points due largely toreductions in materials costs as a result of design changes and component costimprovements, primarily in our Enterprise Networking and Connectivity segments.Gross margin in the third quarter of fiscal 2003 benefited from duty refundstotaling approximately $1.3 million and the sale or disposition of inventorythat had previously been written off totaling $1.2 million.

 

Gross margin as a percentage of sales was 48.5 percent and 28.9 percent for the first ninemonths of fiscal 2003 and fiscal 2002, respectively. As compared to thesame period one year ago, gross margin increased 11 percentage points duelargely to reductions in materials costs resulting from design changes andcomponent cost improvements, and a mix shift towards higher margin productsprimarily in our Enterprise Networking and Connectivity segments. Included inthe mix shift of Connectivity products is an increase in the percentage ofsales through the distribution channel versus OEM customers, which generallyhave lower ASPs. Gross margin benefited approximately one percentage point inthe first nine months of fiscal 2003 due to the second quarter’s $15.0 millionof royalty revenue in the Connectivity segment. Gross margin increasedapproximately three percentage points for the reduction of underutilizedcapacity in our manufacturing plants. Gross margin increased approximatelythree percentage points due mainly to the prior period’s excess and obsolete inventoryprovisions. These prior period provisions were largely the result of reduceddemand and product transition of certain Connectivity products. Gross marginimproved approximately a combined two percentage points from duty refundstotaling approximately $9.4 million, the sale or disposition of inventory thathad previously been written off totaling $5.8 million, and lower post-salessupport expenses.

 

Operating Expenses

Operating expenses in the third quarter of fiscal 2003 were $189.1million, or 77.2 percent of sales, compared to $307.3 million, or 86.3 percentof sales, in the third quarter of fiscal 2002. Operating expenses in the third quarter of fiscal 2003 includedamortization and write down of intangibles of $1.7 million and restructuring chargesof $54.0 million.  Operating expenses inthe third quarter of fiscal 2002 included amortization and write down ofintangibles of $63.5 million, restructuring charges of $64.0

 

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million, and net losses on land and facilities of $1.4 million.Excluding these items, operating expenses for the third quarter of fiscal 2003were $133.4 million, a decline of $44.9 million as compared to $178.3 millionin the third quarter of fiscal 2002. The most significant components of the$44.9 million decrease were reductions of $23.4 million of direct employee andalternative workforce expenses, $11.6 million of project and research relatedexpenses such as depreciation on engineering assets and project materials, and $7.8million of IT-related expenses. These decreases were the result of costreduction actions primarily related to our restructuring activities, whichincluded headcount reductions, and long term asset write offs, a decline in thenumber of research projects, and IT outsourcing.

 

Operating expenses in the first nine months of fiscal 2003 were $577.9million, or 67.8 percent of sales, compared to $845.8 million, or 74.2 percentof sales, in the first nine months of fiscal 2002. Operating expenses in thefirst nine months of fiscal 2003 included amortization and write down ofintangibles of $14.2 million, restructuring charges of $146.7 million, netlosses on land and facilities of $0.9 million, and $1.4 million of creditsrelating to bad debt that were recorded in general and administrative expenses.Operating expenses in the first nine months of fiscal 2002 includedamortization and write down of intangibles of $92.9 million, restructuringcharges of $153.1 million, net losses on land and facilities of $1.4 million,and $8.1 million of credits relating to bad debt that were recorded in generaland administrative expenses. Excluding these items, operating expenses for thefirst nine months of fiscal 2003 were $417.5 million, a decline ofapproximately $189.1 million compared to $606.6 million in the first ninemonths of fiscal 2002. The most significant components of the $189.1 milliondecrease were reductions of $73.7 million of direct employee and alternativeworkforce expenses, $30.2 million of IT-related expenses, $25.9 million ofproject and research related expenses such as depreciation on engineeringassets and project materials, $15.1 million of spending on marketing andadvertising, and $9.4 million in facilities-related expenses. These decreaseswere the result of cost reduction actions primarily related to ourrestructuring activities, which included headcount reductions, IT outsourcing,long term asset write offs, a decline in the number of research projects,facilities consolidations, and general spending reductions.

 

*Salesand Marketing. *Salesand marketing expenses in the third quarter of fiscal 2003 decreased $9.8million, or 12 percent, compared to the third quarter of fiscal 2002, andincreased to 28.1 percent of total sales for the third quarter of fiscal 2003,compared to 22.1 percent of total sales for the third quarter of fiscal 2002.Sales and marketing expenses in the first nine months of fiscal 2003 decreased$66.4 million, or 25 percent, compared to the first nine months of fiscal 2002.  As compared to the same quarter one yearago, almost two thirds of the spending decrease was attributable to directemployee-related expenses, with the second largest factor being the reductionin IT-related expenses, which comprised one fifth of the decrease. As comparedto the same nine-month period one year ago, approximately one third of thedecrease was attributable to direct employee-related expenses, with the secondlargest factor being the entirety of the reduction in spending on marketing andadvertising, representing almost one quarter of the decrease. The third andfourth largest contributors were IT and facilities-related expenses,respectively, contributing a combined one fifth of the decrease.

 

*Researchand Development. *Researchand development expenses in the third quarter of fiscal 2003 decreased $33.2million, or 46 percent, compared to the third quarter of fiscal 2002, anddecreased to 16.0 percent of total sales in the third quarter of fiscal 2003compared to 20.3 percent of total sales in the third quarter of fiscal2002.  Research and development expensesin the first nine months of fiscal 2003 decreased $96.8 million, or 42 percent,compared to the first nine months of fiscal 2002. As compared to the samequarter on year ago, a decline in direct employee-related expenses resulted inapproximately two fifths of the decrease, with the second largest factor beingthe decrease in project and research related expenses such as depreciation onengineering assets and project materials, representing approximately one thirdof the decrease. The third largest factor was the decrease in IT-relatedexpenses. As compared to the same nine-month period one year ago, a decline indirect employee-related expenses resulted in approximately two fifths of the decrease,with the second largest factor being the decrease in project and researchrelated expenses such as depreciation on engineering assets and projectmaterials, representing approximately one quarter of the decrease. The thirdand fourth largest contributors were in IT and facilities-related expenses,contributing almost a combined one fifth of the decrease.

 

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G*eneraland Administrative. *Generaland administrative expenses in the third quarter of fiscal 2003 decreased $1.9million, or seven percent, compared to the third quarter of fiscal 2002, andincreased to 10.4 percent of total sales as compared to 7.7 percent of totalsales in the third quarter of fiscal 2002. As compared to the same quarter oneyear ago, a decline in direct employee expenses was the largest contributor tothe decrease in general and administrative expenses, with IT-related and legalexpenses each being the next largest component. These and other decreases werepartially offset by $4.0 million in increased consulting expenses relating toadvisory services in support of the joint venture with Huawei. General andadministrative expenses in the first nine months of fiscal 2003 decreased $19.1million, or 20 percent, compared to the first nine months of fiscal 2002. Theprior nine-month period included $6.7 million of incremental credits relatingto bad debt as compared to the first nine months of fiscal 2003; excludingthese incremental prior period credits, the decrease in general andadministrative expenses was $25.8 million. As compared to the same nine-month period one year ago, a decline indirect employee-related expenses resulted in almost half of the $25.8 milliondecrease, with IT-related spending reductions contributing one quarter of thedecrease. Additional savings were realized for decreased facilities and otherexpenses.

 

*Amortizationand Write Down of Intangibles.** *Amortization and write down of intangibles in the thirdquarter and first nine months of fiscal 2003 decreased $61.8 million and $78.7million, respectively, compared to same periods one year ago. Due to theadoption of SFAS 142 on June 1, 2002, we stopped amortizing goodwill, resultingin reductions in amortization of $9.0 million and $26.9 million for the thirdquarter and first nine months of fiscal 2003, respectively. There were noimpairment charges for the third quarter of fiscal 2003, as compared to acharge of $50.9 million that was recorded in the third quarter of fiscal 2002relating to the goodwill and developed product technology associated with theacquisition of the Gigabit Ethernet NIC business of Alteon Websystems (Alteon)in the Enterprise Networking segment. Impairment charges for the first ninemonths of fiscal 2003 included write downs of $3.2 million of intangible assetsin our Enterprise Networking segment relating to the NBX Corporationacquisition, and write offs of $4.4 million and $0.1 million of intangibleassets in our CommWorks segment relating to the Call Technologies, Inc. and LANSourceTechnologies, Inc. (LANSource) acquisitions, respectively, all of which wererecorded in the second quarter of fiscal 2003. Impairment charges for the first nine months of fiscal 2002 included theAlteon impairment, as well as a $3.5 million write down of intangible assetsand associated goodwill related to the LANSource acquisition. The remainder ofthe decrease as compared to the same periods one year ago was due to loweramortization that resulted from the previously recorded impairments of intangibleassets.

 

*RestructuringCharges.* Restructuring charges in the third quarter and first nine monthsof fiscal 2003 were  $54.0 million and$146.7 million, respectively. Expenses for the third quarter of fiscal 2003were composed primarily of charges for accelerated depreciation and write downsof facilities, severance and outplacement costs, and long-term asset writedowns. The facilities charges in the third quarter of fiscal 2003 includedcharges of $41.4 million related to accelerated depreciation and impairments offacilities in Santa Clara, California. In addition to these charges, facilitiescharges in the first nine months of fiscal 2003 also included a $31.2 millionloss on the sale of our Marlborough, Massachusetts property, $9.0 millionadditional accelerated depreciation of buildings in Santa Clara, write downs ofproperties in Ireland and the U.K. of $7.5 million and $6.6 million,respectively, and a credit of $0.4 million related to the sale of our MountProspect, Illinois facility. Restructuring charges for the first nine months offiscal 2003 were the result of the consolidation of our real estate portfolio,the integration of our Business Connectivity Company and Business NetworksCompany, IT outsourcing efforts, and continued cost reduction actions.Restructuring charges in the third quarter and first nine months of fiscal 2002were $64.0 million and $153.1 million, respectively.

 

Expenses for the third quarter of fiscal 2002 included $21.3 million inwrite downs of held for sale property in Santa Clara and Mount Prospect, $14.3million for the loss on the sale of our Singapore manufacturing facility,severance and outplacement costs, and long-term asset write-downs. Expenses forthe first nine months of fiscal 2002 included these same components, plus $22.8million of accelerated depreciation on our Mt. Prospect facility. These chargeswere the result of both cost reduction actions we took to restructure ouroperations that were announced on December 21, 2000, as well as consolidationof our manufacturing facilities and the discontinuation of our consumer cableand

 

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DSL modem product lines as announced during June 2001. Additional costreduction efforts that could likely occur in future periods include employeeseverance charges if our business activity continues to decline and additionalcost reduction efforts are necessary. In addition, a number of our facilitiesare classified as held for sale as a result of our restructuring program, particularlyin Santa Clara where real estate market values have been declining. Additionalwrite downs could result from changes in the market values of those properties,as well as from properties that are classified as held for sale in futureperiods, such as our Rolling Meadows facility, which houses our CommWorksbusiness.  Once the Commworks salecloses, the Rolling Meadows facility will be classified as an asset held forsale, and the Company would take an approximate loss on this facility in therange of $40 million to $60 million, subject to a final appraisal on thebuilding.

 

*Loss on Land and Facilities, Net.*  The net loss on land and facilities in thefirst nine months of fiscal 2003 and 2002 was $0.9 million and $1.4 millionrespectively. Charges in both periods related to the write down of our SaltLake City, Utah facility, which was sold in the second quarter of fiscal 2003.This facility was classified as held for sale prior to the inception of ourrestructuring programs and therefore the net losses associated with it were notthe result of restructuring actions and were not recorded as a part ofrestructuring charges.

 

Loss on Investments, Net

Net loss on investments in the third quarter of fiscal 2003 was $14.6million, due primarily to market value adjustments of limited partner venturefunds and write downs of long term equity investments. Net loss on investmentsin the third quarter of fiscal 2002 was $12.3 million, due primarily to salesof marketable equity securities and declines in the value of publicly-tradedequity securities determined to be other-than-temporary. Net loss oninvestments in the first nine months of fiscal 2003 was $33.1 million, dueprimarily to market value adjustments in limited partner venture funds, writedowns of long term equity investments, and sale of investments in limitedpartner venture funds. Net loss on investments in the first nine months offiscal 2002 was $19.6 million, due primarily to losses on the sales ofmarketable equity securities and declines in the value of publicly-tradedequity securities determined to be other-than-temporary and in limitedpartnership venture capital funds.

 

Interest and OtherIncome, Net

Interest and other income, net, in the third quarter of fiscal 2003 was$5.2 million, a decrease of $4.1 million compared to the third quarter offiscal 2002. The decrease in interest and other income, net, compared to thesame quarter one year ago was due primarily to lower interest income as aresult of lower interest rates. In the first nine months of fiscal 2003,interest and other income, net, was $18.7 million, a decrease of $36.4 millioncompared to the first nine months of fiscal 2002.  The decrease in interest and other income, net, as compared tothe same period one year ago was due to the decline in interest rates,increased borrowing costs associated with our term loan and revolving line ofcredit, and the receipt of $12 million of interest income on the tax refundreceived in the second quarter of fiscal 2002. These declines were partiallyoffset by the collection in the first quarter of fiscal 2003 of approximately$5.1 million of additional interest income that primarily related to the fiscal2002 tax refund.

 

Income Tax Provision 

We recorded an income tax benefit of $6.9million for the third quarter of fiscal 2003 and an income tax expense of $1.1million for the first nine months of fiscal 2003, compared to expense of $59.3million for the third quarter of fiscal 2002 and expense of $91.1 million forthe first nine months of fiscal 2002. The tax benefit in the third quarter wasthe result of a $17.7 million benefit of a net operating loss carryback madepossible by the Job Creation and Worker Assistance Act of 2002, offset by $10.8 million to provide fortaxes in foreign and state jurisdictions. The tax expense in the first ninemonths of fiscal 2003 was the result of an $18.8 million charge to provide fortaxes in foreign and state jurisdictions, offset by a $17.7 million benefit ofa net operating loss carryback made possible by the Job Creation andWorker Assistance Act of 2002. The taxexpense in the third quarter and first nine months of fiscal 2002 was theresult of a write down of a deferred tax asset that previously had beensupported by the appreciation in our real estate portfolio and providing fortaxes in foreign and state jurisdictions.

 

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Cumulative Effect of Change in Accounting Principle

We adopted SFAS 142 effective June 1, 2002. In accordance with SFAS142, we conducted a transitional goodwill impairment evaluation of the $66.5million of goodwill recorded as of May 31, 2002. In the first quarter of fiscal2003, we completed the first phase of the SFAS 142 analysis, which indicatedthat an impairment might have existed for the goodwill associated with ourEnterprise Networking and CommWorks segments. In the second quarter of fiscal2003, we completed the evaluation and recorded a charge totaling $65.6 millionas a change in accounting principle effective June 1, 2002 to write offgoodwill of $45.4 million in the Enterprise Networking segment and $20.2million in the CommWorks segment.

 

**Liquidityand Capital Resources**

 

Cash and equivalents and short-term investments at February 28, 2003were $1,441.1 million, an increase of approximately $59.0 million compared tothe balance of $1,382.0 million at May 31, 2002.

 

For the nine months ended February 28, 2003, net cash provided byoperating activities was $78.2 million. Accounts receivable at February 28, 2003 decreased $27.0 million fromMay 31, 2002 to $120.2 million.  Dayssales outstanding in receivables increased to 44 days at February 28, 2003,compared to 39 days at May 31, 2002 primarily due to an increase in thepercentage of quarterly sales made towards the end of the third quarter offiscal 2003 as compared to the fourth quarter of fiscal 2002.** **Inventory at February 28, 2003decreased $13.1 million from May 31, 2002 to $41.3 million.  Annualized inventory turnover was 12.4 turnsfor the quarter ended February 28, 2003, compared to 11.3 turns for the quarterended May 31, 2002.  Other assets atFebruary 28, 2003 decreased $23.6 million from May 31, 2002, primarily due tocollections of non-trade receivables. Accounts payable and accrued liabilitiesand other at February 28, 2003 decreased $60.4 million from May 31, 2002, andincludes the final payment related to****excess manufacturing capacity.  Income taxes payable, net, remained flat duemainly to payments of local taxes being offset by the receipt of a $5.0 millionfederal income tax refund.

 

3Com Ventures selectively makes strategic investments in privately-heldcompanies and in limited partnership venture capital funds, which in turninvest in privately-held companies. This may include a strategic commercial ortechnology relationship, such as a component supply agreement or technologylicense arrangement, with these privately-held companies. These investmentswere entered into with the intention of complementing our business strategiesand research and development efforts. In the first nine months of fiscal 2003we sold our interest in several limited partnership venture capital funds. Wecollected proceeds of $4.4 million associated with the sale of these funds,recorded a $5.4 million loss on the sale and, as part of the terms of thetransaction, with the approval of the funds’ general partners transferred theobligations of future capital calls associated with such funds. 3Com Ventureshas made strategic investments of $2.7 million over the last nine months andhas committed to make additional capital contributions to certain venturecapital funds totaling $14.4 million. We are contractually obligated to providefunding upon calls for capital. The expiration dates for such capital calls aregenerally five to eight years from the inception of the fund, and the amountsand timing of such calls during that period are entirely at the discretion ofthe funds’ general partners. We estimate that we will pay approximately $3.6million over the next twelve months as capital calls are made.

 

During the nine months ended February 28, 2003, we made $17.7 millionin capital expenditures, primarily for projects relating to facilitiesconsolidation projects, information systems, and new product introductions.Additionally, we collected $80.7 million from sales of property and equipment,including facilities in Marlborough, Mount Prospect, and Salt Lake City for netproceeds of $56.6 million, $17.8 million, and $4.2 million, respectively. As ofFebruary 28, 2003, capital expenditure commitments outstanding were notmaterial. Additionally, we have commitments relating to royalty and patentlicenses, the technologies of which are incorporated into our products thatextend through May 2005. As of February 28, 2003, these commitments were approximately$31.7 million, $9.5 million of which are expected to be paid over the next 12months.

 

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We have several agreements whereby we have sold product to resellerswho have, in turn, sold the product to end users, and we have guaranteed thepayments of the end users to our customers. If all end users under theseagreements were to default on their payments, as of February 28, 2003 we wouldbe required to pay approximately $11.9 million. As deferred revenue associatedwith such sales approximates the guaranteed amounts and we have the right torecover such products relating to the deferred cost of goods sold in the eventof default, any payments resulting from end user defaults would not have amaterial impact on our results of operations.

 

As of February 28, 2003, we had $67.6 million outstanding on our termloan and no cash advances drawn on our revolving line of credit. During thefirst nine months of fiscal 2003 we repaid the entire $70.0 million line ofcredit balance and $30.0 million on our term loan. Included in the term loanrepayments are three quarterly repayments of $7.5 million each, plus anadditional $7.5 million due to the sale of our Mount Prospect facility as wasrequired under the terms of the financing agreement.

 

During the nine months ended February 28, 2003, we collected $8.4million plus interest on the note receivable from the sale of warrants toBroadcom Corporation (Broadcom). This note was previously the subject oflitigation between us and Broadcom, which was settled in the second quarter offiscal 2003, as discussed in Note 11 of the condensed consolidated financialstatements.

 

During the nine months ended February 28, 2003, we repurchased 0.4million shares of common stock for $1.5 million, and received net cash of $12.6million from the sale of approximately 4.4 million shares of common stock toemployees through our employee stock purchase and option plans. Our stockoption program is a broad-based, long-term retention program that is intendedto attract and retain talented employees and align stockholder and employeeinterests. We consider our option program critical to our operation andproductivity; essentially all of our employees participate. The programconsists of three plans: one under which officers and employees may be grantedoptions to purchase shares of our stock, one under which non-employee directorsare granted options, and a broad-based plan under which options may be grantedto all employees other than officers and directors.

 

As of February 28, 2003, our outstanding stock options as a percentageof outstanding shares was 27 percent. This potential dilutive effect of stockoptions to existing stockholders is an area of attention of senior managementand is mainly the result of the effect of our distribution of Palm, Inc. commonstock in the first quarter of fiscal 2001. As a result of the distribution, thenumber of shares subject to option grants was adjusted to preserve theintrinsic value of the stock options, resulting in an increase of 134 millionoptions, and bringing the total option shares outstanding to 169 million at thetime of the distribution. As a result of employee reductions and management ofnew grants, we have been able to reduce the number of outstanding options 43percent since the Palm distribution.

 

Stock option activity during the first nine months of fiscal 2003 andstock option detail as of February 28, 2003, were as follows:

 

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| **(Shares in  thousands)**      |   | **Number  of shares** |   | **Weighted  average  exercise price** |   |
|---------------------------------|--------|-----------------------|--------|---------------------------------------|--------|
| Outstanding, May  31, 2002      |   | 111,102               |   | $                                     | 7.25   |   |
|                            |   |                  |   |                                  |   |
| Granted                         |   | 12,591                |   | 4.48                                  |   |
| Exercised                       |   | (2,197                | )      | 2.97                                  |   |
| Canceled                        |   | (24,744               | )      | 7.51                                  |   |
| Outstanding,  February 28, 2003 |   | 96,752                |   | $                                     | 6.92   |   |

 

 
|                          |   |                  |   |                                  | **Outstanding  options  as of February 28, 2003** |                  | **Exercisable  options  as of  February 28, 2003** |                                  |
|-------------------------------|--------|-----------------------|--------|---------------------------------------|---------------------------------------------------|-----------------------|---------------------------------------------------------|---------------------------------------|
| **Range of  exercise prices** |   | **Number  of shares** |   | **Weighted  average  exercise price** |                                              | **Number  of shares** |                                                    | **Weighted  average  exercise price** |   |
|                          |   |                  |   |                                  | **(in  thousands)**                               |                  |                                                    |                                  | **(in thousands)** |   |   |   |
|                          |   |                  |   |                                  |                                              |                  |                                                    |                                  |   |   |   |   |
| $                             | 0.13   | -                     | $      | 4.80                                  |                                              |                  | 27,299                                                  |                                  | $ | 4.27 |   | 12,241 |   | $ | 4.02 |   |
| 4.81                          | -      | 5.54                  |   |                                  | 19,095                                            |                  | 5.37                                                    |                                  | 13,598 |   | 5.39 |   |
| 5.55                          | -      | 6.68                  |   |                                  | 19,521                                            |                  | 5.96                                                    |                                  | 17,589 |   | 5.97 |   |
| 6.71                          | -      | 11.73                 |   |                                  | 18,505                                            |                  | 8.78                                                    |                                  | 13,308 |   | 8.69 |   |
| 11.76                         | -      | 21.57                 |   |                                  | 12,332                                            |                  | 13.94                                                   |                                  | 7,354 |   | 13.95 |   |
| Total                         |   |                  |   |                                  | 96,752                                            |                  | $                                                       | 6.92                                  |   | 64,090 |   | $ | 6.96 |   |
|                               |        |                       |        |                                       |                                                   |                       |                                                         |                                       |  |  |  |  |  |  |  |  |

 

 

The following table summarizes our equity compensation plans as ofFebruary 28, 2003

 
| **(Shares in thousands)**                               |   | **Number of securities to  be issued upon  exercise of options** |   | **Weighted average  exercise price of  outstanding options** |   | **Number of  securities  remaining available for  future issuance under equity  compensation plans  (excluding securities  reflected in 1st column)** |    |
|---------------------------------------------------------|--------|------------------------------------------------------------------|--------|--------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------|---------|
|                                                    |   |                                                             |   |                                                         |   |                                                                                                                                                  |    |
| Equity compensation plans approved by stockholders      |   | 26,127                                                           |   | $                                                            | 7.50   |                                                                                                                                                  | 45,787  |   |
| Equity compensation plans not approved by stockholders* |   | 68,418                                                           |   | 6.81                                                         |   | 84,117                                                                                                                                                |    |
|                                                    |   |                                                             |   |                                                         |   |                                                                                                                                                  |    |
| Total                                                   |   | 94,545                                                           |   | $                                                            | 7.00   |                                                                                                                                                  | 129,904 |   |

 

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*Excludes2.2 million outstanding options with an average exercise price of $3.66. Theseoptions were assumed in connection with acquisitions and no additional optionsare available for future issuance under such plans.

 

Options issued and availablefor future issuance outside of the stockholder-approved plans have been issuedunder our broad based plan, which is the 1994 Stock Option Plan, as amended.Options granted from this plan are granted at fair value, vest over two to fouryears, and expire ten years after the date of grant.

 

There are no assurances that we can reduce losses from operations and avoidfuture negative cash flow or raise capital as needed to fund the operations of3Com. However, based on current plans and business conditions, but subject tothe discussion in the Business Environment and Industry Trends, we believe thatour existing cash and equivalents, short-term investments, revolving line ofcredit, and cash generated from operations will be sufficient to satisfyanticipated cash requirements for at least the next twelve months.

 

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**Effects of Recent AccountingPronouncements**

 

In June 2001, the Financial Accounting Standards Board (FASB) issuedSFAS 141, “Business Combinations” which addresses the financial accounting andreporting for business combinations and supersedes Accounting Principles Board(APB) Opinion 16, “Business Combinations,” and SFAS 38, “Accounting forPreacquisition Contingencies of Purchased Enterprises.” SFAS 141 requires thatall business combinations be accounted for by the purchase method, modifies thecriteria for recognizing intangible assets, and expands disclosurerequirements. The provisions of SFAS 141 apply to all business combinationsinitiated after June 30, 2001. We adopted SFAS 141 on June 1, 2002. Theadoption of SFAS 141 did not have a material impact on our results ofoperations or statements of financial position.

 

In June 2001, the FASB issued SFAS 142, “Goodwill and Other IntangibleAssets,” which addresses financial accounting and reporting for acquiredgoodwill and other intangible assets and supersedes APB Opinion 17, “IntangibleAssets.” SFAS 142 addresses how intangible assets that are acquiredindividually or with a group of other assets should be accounted for infinancial statements upon their acquisition and after they have been initiallyrecognized in the financial statements. SFAS 142 requires that goodwill andintangible assets that have indefinite useful lives not be amortized but rathertested at least annually for impairment, and intangible assets that have finiteuseful lives be amortized over their useful lives. In addition, SFAS 142expands the disclosure requirements about goodwill and other intangible assetsin the years subsequent to their acquisition. Impairment losses for goodwilland indefinite-lived intangible assets that arise due to the initialapplication of SFAS 142 are to be reported as a change in accounting principle.

 

We adopted SFAS 142 on June 1, 2002 and ceased amortization of netgoodwill totaling $66.5 million, which included $0.7 million of acquiredworkforce intangible assets previously classified as purchased intangibleassets; amortization continues on net finite-lived intangible assets, withremaining useful lives of generally two to three years and totaling $13.5million as of February 28, 2003 as discussed in Note 7 of the condensedconsolidated financial statements. In the first quarter of fiscal 2003, wecompleted the first phase of the SFAS 142 analysis, which indicated that animpairment might have existed for the goodwill associated with our Enterprise Networkingand CommWorks segments. In the second quarter of fiscal 2003, we completed thetransitional goodwill impairment evaluation and recorded a charge totaling$65.6 million as a change in accounting principle effective June 1, 2002 towrite off goodwill of $45.4 million in the Enterprise Networking segment and$20.2 million in the CommWorks segment. The remaining recorded goodwill afterthis impairment charge was $0.9 million, and related solely to the Connectivitysegment. A reconciliation of previously reported net loss and net loss pershare to the amounts adjusted for the exclusion of goodwill and acquiredworkforce amortization follows (in thousands, except per share amounts):

 
|                                                   |   | **Three  Months Ended** |    | **Nine  Months Ended** |   |
|--------------------------------------------------------|--------|-------------------------|---------|------------------------|--------|
|                                                   |   | **February  28,2003**   |    | **March 1,2002**       |   | **February  28,2003** |   | **March 1,2002** |   |
|                                                   |   |                    |    |                   |   |   |   |   |   |
| Reported net  loss                                     |   | $                       | (79,242 | )                      | $      | (236,134 | ) | $ | (245,336 | ) | $ | (572,192 | ) |
| Add back  goodwill and acquired workforce amortization |   | —                  |    | 8,975                  |   | — |   | 26,937 |   |
| Adjusted net  loss                                     |   | $                       | (79,242 | )                      | $      | (227,159 | ) | $ | (245,336 | ) | $ | (545,255 | ) |
|                                                   |   |                    |    |                   |   |   |   |   |   |
| Reported net  loss per share-Basic and Diluted:        |   | $                       | (0.22   | )                      | $      | (0.67 | ) | $ | (0.68 | ) | $ | (1.65 | ) |
| Add back  goodwill and acquired workforce amortization |   | —                  |    | 0.02                   |   | — |   | 0.08 |   |
| Adjusted net  loss-Basic and Diluted                   |   | $                       | (0.22   | )                      | $      | (0.65 | ) | $ | (0.68 | ) | $ | (1.57 | ) |

 

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In August 2001, the FASB issued SFAS 144, “Accounting for theImpairment or Disposal of Long-Lived Assets.” SFAS 144 addresses financial accounting and reporting for the impairmentor disposal of long-lived assets. We adopted SFAS 144 on June 1, 2002.  The adoption of SFAS 144 did not have amaterial impact on our results of operations or financial position.

 

In June 2002, the FASB issued SFAS 146, “Accounting for CostsAssociated with Exit or Disposal Activities,” which addresses financialaccounting and reporting for costs associated with exit or disposal activitiesand supersedes Emerging Issues Task Force (EITF) Issue 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other Costs to Exitan Activity (including Certain Costs Incurred in a Restructuring).”  SFAS 146 requires that a liability for acost associated with an exit or disposal activity be recognized when theliability is incurred.  Under EITF 94-3,a liability for an exit cost as defined in EITF 94-3 was recognized at thedate of an entity’s commitment to an exit plan.  SFAS 146 also establishes that the liability should initially bemeasured and recorded at fair value.  Weadopted the provisions of SFAS 146 for exit or disposal activities that wereinitiated after December 31, 2002. The adoption of SFAS 146 did not have amaterial impact on our results of operations or financial position.

 

In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),“Guarantor’s Accounting and Disclosure Requirements for Guarantees, IncludingIndirect Guarantees of Indebtedness of Others.” FIN 45 requires that uponissuance of a guarantee, the guarantor must recognize a liability for the fairvalue of the obligation it assumes under that guarantee. The provisions forinitial recognition and measurement are effective on a prospective basis forguarantees that are issued or modified after December 31, 2002, irrespective ofa guarantor’s year-end. The disclosure requirements of FIN 45 are effective forinterim and annual periods ending after December 15, 2002, and areapplicable to our product warranty liability and other guarantees. We adoptedthe provisions of FIN 45 for guarantees issued or modified after December 31,2002, and the adoption of FIN 45 did not have a material impact on our resultsof operations or financial position.

 

In November 2002, the EITF reached a consensus on Issue No. 00-21,“Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses certainaspects of the accounting by a vendor for arrangements under which the vendorwill perform multiple revenue generating activities. The EITF will be effectivefor fiscal years beginning after June 15, 2003. We have not yet determined theimpact of the adoption of EITF 00-21 on our results of operations or financialposition.

 

In December 2002, the FASB issued SFAS 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure,” which amends SFAS 123, “Accounting forStock-Based Compensation.” SFAS 148 provides alternative methods of transitionfor an entity that voluntarily changes to the fair value based method ofaccounting for stock-based employee compensation.  It also amends thedisclosure provisions of SFAS 123 to require prominent disclosure about theeffects an entity’s accounting policy decisions with respect to stock-basedemployee compensation on reported net income in both annual and interimperiods. SFAS 148 is effective for annual periods ending after December 15,2002 and interim periods beginning after December 15, 2002.  We have not yet determined the impact of theadoption of SFAS 148 on our results of operations or financial position.

 

**BusinessEnvironment and Industry Trends**

 

Industry trends and specific risks may affect our future business andresults in our business.  The mattersdiscussed below could cause our future results to differ from past results orthose described in forward-looking statements.

 

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***Global economic, political, and socialconditions beyond our control may adversely affect our ability to operateprofitably or to increase revenues.***

 

Adverse economic conditions worldwide have contributed to a technologyindustry slowdown and impacted our business resulting in:

 

•                  reduced demandfor most of our products;

•                  increased pricecompetition for our products;

•                  increased riskof excess and obsolete inventories;

•                  excessfacilities and manufacturing capacity; and

•                  higher generaland administrative costs, as a percentage of revenues.

 

Recent geopolitical and social turmoil in many parts of the world,including actual incidents and potential future acts of terrorism and war, maycontinue to put pressure on global economic conditions.  These geopolitical, social and economicconditions and uncertainties make it extremely difficult for 3Com, ourcustomers and our vendors to accurately forecast and plan future businessactivities.  This reduced predictabilitychallenges our ability to operate profitably or to increase revenues.  In particular, it is difficult to developand implement strategies, sustainable business models and efficient operations,and effectively manage outsourced relationships for certain contractmanufacturing and information technology services.  If the current economic or market conditions continue or furtherdeteriorate, there could be additional material adverse impact on our financialposition, revenues, results of operations and cash flow.

 

***Our strategy of outsourcing certain functionsand operations may not be successful in reducing costs and may disrupt  our operations.***

 

We are continuing to evaluate the potential for outsourcing certainfunctions or operations that do not differentiate 3Com or create a competitiveadvantage for our company supporting profitable growth.  This strategy has included outsourcingcertain software development for IT applications and outsourcing a substantialportion of 3Com’s IT infrastructure. Implementation of such outsourcing may not result in reduction of actualcosts associated with such services or functions.  No final decisions have been made about outsourcing othersignificant functions.  Outsourcing mayalso increase the risk of disruption to our operations in that we will berelying upon third parties to meet our needs, and these third parties may notbe as responsive to our needs as we would be ourselves.  Moreover, future events are unpredictableand there may be substantial penalties for terminating agreements early orfailing to maintain minimum service levels.

 

***The pending sale of assets related to ourCommWorks business is subject to contingencies and regulatory approval. If the closing of thistransaction is delayed or the transaction is not completed, it may adversely affectour results.***

 

We have entered into an agreement to sell certain assets and transfercertain liabilities related to our CommWorks business. This transaction is notscheduled to be consummated until regulatory approval has been received andconditions are met related to a pro forma audit of assets being sold andliabilities being transferred, assignment of certain contracts, and the absenceof any material adverse change.  We planto account for our CommWorks segment as discontinued operations beginning inthe fourth quarter of fiscal 2003.  Thistransaction creates risks to the normal operations of our CommWorks businessincluding uncertainties for employees who may or may not be offered employmentor accept employment with the buyer, the assignment of contracts with customersand resellers, and disruption of the operating results of this business.  If the transaction fails to close as aresult of the buyer’s failure to meet its obligations, we may receive atermination fee.  However, the failureto complete this transaction would adversely affect our results.

 

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***Our efforts to reduce costs may not beeffective.  If we fail to reduce costseffectively, we may not maintain positive cash flow or return to profitable operations.***

 

We believe strict costcontainment and expense reductions are essential to maintaining positive cashflow from operations in future quarters and returning to profitability.  If we are not able to effectively reduce ourcosts and achieve an expense structure commensurate with our businessactivities and revenues, we may not be able to maintain positive cash flow.This would adversely impact our efforts to operate our businessprofitably.  A number of factors couldpreclude us from successfully bringing costs and expenses in line with ourrevenues, such as our inability to accurately forecast business activities, afurther deterioration of our revenues, and our inability to reduce our generaland administrative expenses commensurate with, and at the same pace as, anyfurther deterioration in our revenues.

 

***We face increasedcompetition due to industry volatility and consolidation, weakening economicconditions, excess inventories and capacity in the telecommunications market,and greater integration of functions on a reduced number of components.  If we do not compete effectively, ourbusiness could be seriously harmed.***

 

Our business could beseriously harmed if we do not compete effectively.  We face competitive challenges that are likely to arise from anumber of factors, including:

 

•                  industryvolatility resulting from rapid development and maturation of technologies;

•                  industryconsolidation resulting in competitors with greater financial, marketing andtechnical resources;

•                  greatercompetition for fewer customers as a result of consolidation in the resellerand distribution channels; potential consolidation among networking equipmentproviders; as well as consolidation in the telecommunications service providermarket due to excess capacity and the financial difficulties being experiencedby some service providers; and the potential emergence of new competitors withlower cost structures and more competitive offerings; and

•                  increasing pricecompetition in the face of weakening economic conditions, excess inventoriesand excess capacity in the telecommunications service provider market.

 

***The increased integration of networking, communications, andcomputer processing functions on a reduced number of semiconductor componentsmay adversely affect our future sales growth and operating results.***

 

The integration of networking, communications and computer processingfunctions on a reduced number of semiconductor components has become an industry trend.  This trend is sometimes referred to as “siliconization.”  Because the improved features, increasedperformance and lower cost of such semiconductor components may render certainof our products obsolete, increased siliconization may adversely affect ourfuture sales growth and operating results. For example, we derive a significant portion of our sales ofconnectivity products from PC manufacturers such as Dell, Gateway,Hewlett-Packard and IBM, all of which are manufacturers that incorporate ourconnectivity products into their products. These companies also have begun utilizing chipsets from other vendorsthat contain integrated connectivity solutions into their products.  As this integrated connectivity technologycontinues to mature, we have seen the incorporation of our connectivity productfeatures into lower-priced form factors and integrated into the chipsets on themotherboard.  Certain competitors thathave a significant share of the PC chipset market may be bundling such PCchipsets with integrated connectivity at little or no price premium to PC chipsetswithout connectivity.  This bundling ofPC chipsets and connectivity will have an adverse impact on competition in theconnectivity market, including a significant negative impact on our ability tosell our connectivity solutions to our existing PC manufacturing and designcustomers.  We expect that PCmanufacturers and designers increasingly will purchase the lower-priced formfactors of connectivity products.  If wecannot lower the costs of our products or transition customers to products withhigher average selling prices, then our margins will be reduced and ourfinancial results will be adversely impacted. In addition, as networking functions become more embedded on themotherboard, we are increasingly facing competition from parties who are alsoour current suppliers of products.  Ourfailure to compete successfully against current or future competitors couldharm our business, operating results or financial condition.

 

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***Our investments intechnologies for emerging product lines may not yield the benefits we expect.***

 

We are making significant investments in varioustechnologies for emerging product lines.  In the area of switching, we are investing in expandable resilientnetworking (XRNTM) technology, Layer 3+ switching, and Network Jackswitches.  In a data communicationsnetwork, a switch is a device that channels incoming data from any of multipleinput ports to the specific output port that will take the data toward itsintended destination.  In the area ofwireless technology, we are investing in code-division multiple access (CDMA)wireless networking products and services and wireless LANs.  CDMA technology is used inultra-high-frequency cellular telephone systems in the 800-MHz and 1.9-GHzbands, and a wireless LAN is one in which a mobile user can connect to a LANthrough a wireless (radio) connection. We are also making investments in Gigabit Ethernet technology, IP telephony,and network security technology (such as our embedded firewall products).  Gigabit Ethernet technology is atransmission technology based on the Ethernet frame format and protocol used inLANs that provides a data rate of 1 billion bits per second.  Gigabit Ethernet is currently being used asthe backbone in many enterprise networks. IP telephony is a general term for the technologies that use theinternet to exchange voice, fax, and other forms of information that havetraditionally been carried over the dedicated circuit-switched connections ofthe public switched telephone network. IP telephony is an important part of theconvergence of computers, telephones, and television into a single integratedinformation environment and has the advantage of avoiding the tolls charged byordinary telephone service.  Networksecurity technology is intended to protect against network attacks andunauthorized access.  Network securityhas become increasingly significant due to the volume and sensitivity ofinformation that flows through networks today.

 

We expect these product lines to account for a higherpercentage of our sales in the future, although the markets for these productsand solutions are still emerging and may not develop to our expectations.  Industry standards for some of these technologiesare yet to be widely adopted and the market potential remains unproven.  If the markets for these new technologies orproducts do not develop or grow as we expect, or if we have not adopted optimalsales and go-to-market strategies for these new technologies and products, ourfinancial results could be adversely affected and we might need to change ourbusiness strategy.

 

***We may not be successful at identifying and responding tonew and emerging market and product opportunities.***

 

Our products have shortlife cycles and rapid technology transitions in the markets in which wecompete.  Therefore, our success dependson our ability to identify new market and product opportunities, to develop andintroduce new products in a timely manner, to gain market acceptance of newproducts, particularly in our targeted emerging markets, and to rapidly andefficiently transition our customers from older to newer connectivitytechnologies.  Additionally, as weincrease our reliance on relationships with strategic partners, such asoriginal design manufacturers (ODMs), we may encounter greater difficulties inquickly and effectively introducing new products with the quality,functionality, costs and features that are optimal for the market.  This increased reliance may also limit ourability to independently identify current product and technology trends andrespond to such trends.  Any delay innew product introductions, lower than anticipated demand for our new products,failure to meet market needs for features or functionality or highermanufacturing costs could have an adverse affect on our operating results orfinancial condition, particularly in those product markets we have identifiedas emerging high-growth opportunities.

 

***Future cash requirements or restrictions on cash couldadversely impact our financial position.***

 

We incurred net losses in fiscal 2002 and in the firstnine months of fiscal 2003.  Our overallcash balance declined in fiscal 2002 and, although we generated cash in thefirst nine months of fiscal 2003, we could incur negative overall cash flow infuture quarters.  If our cash flowsignificantly deteriorates in

 

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the future, our liquidity and ability to operate ourbusiness could be adversely impacted. Additionally, our ability to raise financial capital may be hindered dueto our net losses and the possibility of future negative cash flow, thusreducing our operating flexibility.

 

The followingitems could require unexpected future cash payments, limit our ability togenerate cash or restrict our use of cash:

 

•                                          triggeringof certain payment obligations, breach of covenants or acceleration of paymentobligations under our revolving and term loan facilities;

•                                          inabilityto dispose of real estate holdings;

•                                          taxesdue upon the transfer of cash held in foreign locations; and

•                                          taxesassessed by local authorities where we conduct business.

 

***Our efforts to consolidate our real estate portfolio andsell certain real estate holdings may not generate the expected level of cashor reduce our operating costs.***

 

We are currently restructuring our manufacturingoperations and implementing cost reduction activities to reduce or eliminateexcess manufacturing capacity, including the consolidation of our real estateportfolio and facilities associated with our former manufacturing and otherbusiness operations in Santa Clara, Ireland, and the U.K.  Our ability to consolidate and liquidate ourholdings or to use our real estate to support other financial arrangements togain additional liquidity may be impaired by adverse conditions in thecommercial real estate market in the U.S. generally and in Silicon Valley inparticular.  The value of commercialreal estate in Silicon Valley has decreased substantially as a result of theslowdown in the technology sector, and many of our real estate holdings are inSilicon Valley.  Additionally, to theextent that we continue to own excess facilities and are not able to lease thefacilities, we will be adversely affected through continuing to bear theoperating costs associated with these properties and the inability to generaterental income.

 

***We may not be able to retain and recruitthe qualified employees and management personnel that are critical to oursuccess.***

 

Our success dependsupon retaining and recruiting highly qualified employees and managementpersonnel.  However, the significantdownturn in our business environment has had a negative impact on ouroperations and, as a result, we have restructured our operations to reduce ourworkforce and implement other cost reduction activities.  Although we believe these various changesand actions will improve our organizational effectiveness and competitiveness,they could lead, in the short term, to disruptions in our business, reducedemployee morale and productivity, increased attrition, problems with retainingexisting employees and recruiting future employees, and increased financialcosts.  Recruiting and retaining skilledpersonnel, including engineers, sales representatives and product marketingmanagers, continues to be difficult.  Atcertain locations where we operate the cost of living is extremely high and itmay be difficult to attract and retain key employees and management personnelat a reasonable cost.  If we cannotsuccessfully recruit and retain such persons, our product introductionschedules, customer relationships, operating results and financial conditionmay be harmed and our overall ability to compete may be adversely affected.

 

***A significant portion of our revenues isderived from sales to a small number of customers.  If any of these customers reduces its business with us, ourbusiness could be seriously harmed.***

 

We distribute manyof our enterprise networking and connectivity products through two-tier distributionchannels that include distributors, systems integrators and value-addedresellers.  We also sell to PCmanufacturers and telecommunications service providers.  For enterprise networking and connectivityproducts, a significant portion of our sales is concentrated among a fewdistributors and OEM customers.

 

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There has been arecent trend of decreased demand for connectivity products from OEM customers,such as Dell and HP, due to increased integration of networking connectionswith semiconductor components, and also to factors specific to our OEMcustomers.  Additionally, consolidationin our distribution channels and among PC manufacturers is reducing the numberof customers in our domestic and international markets.  In an effort to streamline our operations,we may increase the focus of our distribution sales resources on selecteddistribution channel customers.

 

***We depend on distributors who couldnegatively affect our operations by reducing the level of our products in theirinventory.***

 

Our distributors maintain inventories of our products.  We work closely with our distributors tomonitor channel inventory levels and ensure that appropriate levels of productsare available to resellers and end users. If our channel partners reduce their levels of inventory of our productsor if they do not maintain sufficient levels of inventory of our products tomeet customer demand, our sales could be negatively impacted.

 

***Our increasedreliance on contract manufacturing and our excess manufacturing capacity mayadversely impact our financial results and operations.***

 

We have changedour manufacturing strategy so that more of our products are being sourced fromcontract manufacturers and have reduced our excess manufacturing capacity.  We have sold manufacturing operations andfacilities associated with those products now sourced from contractmanufacturers.  Therefore, our ability toresume internal manufacturing operations for those products is severely limited.  The cost, quality, performance andavailability of contract manufacturing operations are and will be essential tothe successful production and sale of many of our products.  The inability of any contract manufacturerto meet our cost, quality, performance and availability standards couldadversely impact our financial condition or results of operations.  We may not be able to provide contractmanufacturers with product volumes that are high enough to achieve sufficientcost savings.  If shipments fall belowforecasted levels, we may incur increased costs or be required to takeownership of the inventory.  Also, ourability to control the quality of products produced by contract manufacturersmay be limited and quality issues may not be resolved in a timely manner, whichcould adversely impact our financial condition or results of operations.

 

We areimplementing a direct ship program in a phased manner with our manufacturingpartners.  Through this program, we willbe relying on such partners for fulfillment of customer demand.  This program may not yield the efficienciesthat we expect, which would negatively impact our financial performance.  Any disruptions to on-time delivery tocustomers would adversely impact our business and revenues.  Furthermore, because we have outsourcedsignificant manufacturing operations to contract manufacturers and have exiteda number of businesses, we now have excess manufacturing capacity in ourremaining facility.  In fiscal 2002 wesold our Singapore manufacturing facility and have leased back space for ourAsia Pacific region distribution center and office location for salesmanagement, information technology, training and customer service and supportoperations.  In fiscal 2003 we sold ourmanufacturing facility in Mount Prospect, our office and research anddevelopment facility in Salt Lake City, and our manufacturing, research anddevelopment, and office facility in Marlborough, a portion of which we areleasing back.  Our ability to reduce ourexcess manufacturing capacity and to consolidate facilities may be made moredifficult by further weakening of the networking industry and worsening ofgeneral economic conditions in the United States and globally.  If we are unable to reduce our excessmanufacturing capacity and facilities, this may negatively impact ouroperations, cost structure and financial performance.

 

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***Demand forecasting, increased contractmanufacturing, delivery and logistics disruptions, and historical componentshortages continue to pose major supply chain risks.***

 

Current business conditions and operational challenges in managing oursupply chain affect our business in a number of ways:

 

•                  certain keycomponents, in the past, have had limited availability;

•                  there are asmaller number of suppliers and we have narrowed our supplier base, includingin some cases the sole sourcing of certain components from a single supplier;

•                  as integrationof networking features on a reduced number of semiconductor componentscontinues, we are increasingly facing competition from parties who havetraditionally been and are currently our suppliers;

•                  our ability toaccurately forecast demand is diminished, especially in light of generaleconomic weakness and uncertainty following past terrorist events andcontinually deteriorating conditions in the telecommunications industry;

•                  oursignificantly increased reliance on and long-term arrangements with third-partymanufacturers places much of the supply chain process out of our direct controland heightens the need for accurate forecasting and reduces our ability totransition quickly to alternative supply chain strategies;

•                  our presentmanufacturing capacities exceed our current needs; and

•                  we mayexperience disruptions to our logistics, such as the lock-outs that haveoccurred in the past year in west coast ports.

 

Some of oursuppliers are also our competitors.  Wecannot be certain that in the future our suppliers, particularly those who arealso in active competition with us, will be able or willing to meet our demandfor components in a timely and cost-effective manner.

 

Increasingly, wehave been sourcing a greater number of components from a smaller number ofvendors.  Also, there has recently beena trend toward consolidation of vendors of electronic components.  This greater reliance on a smaller number ofsuppliers and the inability to quickly switch vendors increase the risk oflogistics disruptions, unfavorable price fluctuations or disruptions in supply,particularly in a supply-constrained environment.

 

Operation of thesupply chain requires accurate forecasting of demand, which has become morechallenging.  If overall demand for ourproducts, product mix and growth of these markets is significantly different fromour expectations, we may face inadequate, or excess, component supply.  This would result in orders for productsthat could not be manufactured in a timely manner, or a buildup of inventorythat could not easily be sold.  Eitherof these situations could adversely affect our revenues, financial results ormarket share.  If our demand forecastsare too high or our forecasts of product mix are inaccurate, we may experienceexcess and obsolete inventories and excess manufacturing capacity, which couldadversely affect our financial results.

 

***Our current and future decisions to exitcertain product lines may have unforeseen negative impacts to our business.***

 

In fiscal 2001 and early fiscal 2002, we exited certain business andproduct lines, including the cable modem business.  In certain cases, we continue to be responsible pursuant to theoriginal warranty obligations for these products.  Our exiting of these business and product lines may haveadversely impacted our relationships with channel partners and end customerssince many of these channel partners and customers perceived our remainingproducts as not being part of a larger integrated or complementary solution orquestioned our commitment to their markets and therefore shifted to productsfrom alternative vendors.  We mayconsider exiting other businesses that do not meet our goal of deliveringappropriate financial returns in a reasonable amount of time.  Future decisions to exit businesses couldresult in deterioration of our channel partner and customer relationships,increased employee costs (such as severance, outplacement and other benefits),contract termination costs and asset impairments.  We may also experience delays in the execution of our plan to exita business that may create disruptions in our transactions with suppliers andcustomers.

 

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***The reduced role of acquisitions in our current businessstrategy may negatively impact our growth and increase our reliance onstrategic relationships.***

 

Acquisitions have been a major part of 3Com’s strategyin the past.  However, commensurate withthe downturn in the technology sector, we have not made any acquisitions sincethe third quarter of fiscal 2001.  Weexpect that the number of acquisitions of businesses or product lines couldremain at this level.  The networkingbusiness is highly competitive, and while we continue to evaluate possibleacquisitions, our decision not to complete any such transactions in the recentpast could hamper our ability to enhance existing products and introduce newproducts on a timely basis.  Futureconsolidations in the networking industry may result in new companies withgreater resources and stronger competitive positions and products than us.  Furthermore, companies may be created thatare able to respond more rapidly to market opportunities.  Continued consolidation in our industry mayadversely affect our operating results or financial condition.

 

If industry andcompany performance stabilizes and we continue to have a strong balance sheet,we may begin to pursue acquisitions, investments, or other strategicrelationships to complement internal development of new technologies andenhancement of existing products and to exploit market potentials.  These strategic relationships can presentadditional problems since, in most cases, we must compete in some businessareas with companies with which we have strategic alliances and, at the sametime, cooperate with the same companies in other business areas.  If these companies fail to perform, or ifthese relationships fail to materialize as expected, we could suffer delays inproduct or market development or other operational difficulties.  Furthermore, our results of operations or financialcondition could be adversely impacted if we experience difficulties managingrelationships with our partners or if projects with partners areunsuccessful.  In addition, if thirdparties acquire our strategic partners or if our competitors enter intosuccessful strategic relationships, we may face increased competition.

 

***We have announcedan agreement to form a joint venture in China with Huawei Technologies, Ltd.that is subject to regulatory approval and faces many complex operationalchallenges that may adversely impact our results.***

 

We recentlyannounced an agreement to form a joint venture in China for enterprisenetworking with a leading Chinese company, Huawei Technologies, Ltd., in whichwe will initially have a 49% minority interest.  The 3Com-Huawei joint venture is expected to begin operation inthe summer of 2003 after receiving required regulatory approvals.  Formation of the joint venture andintegration of the business operations being contributed by each partner willinvolve complex activities that must be completed in a short period oftime.  The new joint venture is likelyto confront numerous challenges commencing its operations and operatingsuccessfully at its principal locations. The business of the joint venture willbe subject to operational risks that would normally arise for a technologycompany with global operations pertaining to research and development,manufacturing, sales, service, marketing, and corporate functions. Competitionin the market for enterprise networking will involve challenges from numerous,well-established companies with substantial resources and significant marketshare. The joint venture may also face risks in obtaining timely regulatoryapprovals from agencies in the U.S. and Chinese governments that may berequired for the export, import, or transfer of restricted technologies. Theremay be an adverse impact on the joint venture if the lawsuit pending in theUnited States District Court  for theEastern District of Texas between Cisco Systems and Huawei Technologies, Ltd.et al (Civil Action No. 2:03-CV-027TJW) is not resolved on terms satisfactoryto the joint venture. In addition, the joint venture will enter into anagreement with us to resell certain products of the joint venture under the3ComÒTM brand. If the joint venture and its related agreements with us are notsuccessful, this may limit our ability to introduce new products that areneeded to broaden our high-level enterprise networks product line and constrainour potential revenue growth.  Also, ifthe operating results of the joint venture are not satisfactory, this will havean adverse financial impact on 3Com.

 

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***Our reliance on industry standards, afavorable regulatory environment, technological change in the marketplace and newproduct initiatives may cause our revenues to fluctuate or decline.***

 

The networking industry in which we compete is characterized by rapidchanges in technology and customer requirements, evolving industry standardsand complex government regulation.  As aresult, our success depends on:

 

•                  the emergence ofnew technology or the convergence of technologies such as voice and datanetworking or IP telephony;

•                  our ability todevelop new products to address changes in technologies and related customerrequirements on a timely basis;

•                  the timelyadoption and market acceptance of industry standards, and timely resolution ofconflicting U.S. and international industry standards;

•                  our ability toinfluence the development of emerging industry standards and to introduce newand enhanced products that are compatible with such standards; and

•                  a favorableregulatory environment.

 

Slow marketacceptance of new technologies, products or industry standards could adverselyaffect our revenues or overall financial performance.  In addition, if our technology is not included in an industrystandard on a timely basis or if we fail to achieve timely certification ofcompliance to industry standards for our products, our revenues from sales ofsuch products or our overall financial performance could be adversely affected.

 

Thetelecommunications industry, in particular, is subject to complex governmentregulation, including regulations defined by the U.S. federal government, itsagencies such as the Federal Communications Commission, state public servicecommissions and various governmental authorities in foreign countries.  Failure to obtain all necessary regulatoryapprovals for our products or to comply with all applicable governmentregulations could adversely impact our revenues or overall financialperformance or expose us to fines or other penalties.  In addition, new or revised government regulations couldadversely affect the basic business economics for new technologies or theirrates of acceptance or adoption by potential customers; in turn, this couldadversely impact our revenues or overall financial performance.

 

***Our customer order fulfillment capabilitiesfluctuate and may negatively impact our operating results.***

 

The timing and amount of our sales depend on a number of factors thatmake estimating operating results uncertain. Throughout our business, we do not typically maintain a significantbacklog, and sales are partially dependent on our ability to appropriatelyforecast product demand.  In addition,our customers historically request fulfillment of orders in a short period,resulting in limited visibility to sales trends and potential pricingpressures.  Consequently, our operatingresults depend on the volume and timing of orders and our ability to fulfill ordersin a timely manner.  Historically, salesin the third month of the quarter have been higher than sales in each of thefirst two months of the quarter. Non-linear sales patterns make business planning difficult, and increasethe risk that our quarterly results will fluctuate due to disruptions infunctions such as manufacturing, order management, information systems, andshipping.

 

***We may not be able to defend ourselvessuccessfully against claims that we are infringing on the intellectual propertyrights of others.***

 

Many of our competitors, such as telecommunications, networking andcomputer equipment manufacturers, have large intellectual property portfolios,including patents that may cover technologies that are relevant to ourbusiness.  In addition, many smallercompanies, universities, and individual inventors have obtained or applied forpatents in areas of technology that may relate to our business.  The industry is moving towards aggressiveassertion, licensing, and litigation of patents and other intellectual propertyrights.

 

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In the course ofour business, we frequently receive claims of infringement or otherwise becomeaware of potentially relevant patents or other intellectual property rightsheld by other parties.  We evaluate thevalidity and applicability of these intellectual property rights, and determinein each case whether we must negotiate licenses or cross-licenses toincorporate or use the proprietary technologies, protocols, or specificationsin our products.  If we are unable toobtain and maintain licenses on favorable terms for intellectual propertyrights required for the manufacture, sale, and use of our products,particularly those that must comply with industry standard protocols andspecifications to be commercially viable, our results of operations orfinancial condition could be adversely impacted.  In addition, if we are the alleged infringer, we could berequired to seek licenses from others or be prevented from manufacturing orselling our products, which could cause disruptions to our operations or themarkets in which we compete.

 

***We may need to engage in complex and costlylitigation in order to protect or maintain our intellectual property rights.***

 

In addition to disputes relating to the validity or allegedinfringement of other parties’ rights, we may become involved in disputesrelating to our assertion of our intellectual property rights.  Whether we are defending the assertion ofintellectual property rights against us or asserting our intellectual propertyrights against others, intellectual property litigation can be complex, costly,protracted, and highly disruptive to business operations by diverting theattention and energies of management and key technical personnel.  Further, plaintiffs in intellectual propertycases often seek injunctive relief and the measures of damages in intellectualproperty litigation are complex and often subjective or uncertain.  Thus, the existence of or any adversedeterminations in this litigation could subject us to significant liabilitiesand costs.  If we are asserting ourintellectual property rights, we could be prevented from stopping others frommanufacturing or selling competitive products. Any one of these factors could adversely affect our product margins,results of operations, financial condition, or cash flows.

 

***Our futurequarterly operating results are subject to factors that can cause fluctuationsin our stock price.***

 

Historically, ourstock price has experienced substantial price volatility.  We expect that our stock price may continueto experience volatility in the future, due to a variety of potential factorssuch as fluctuations in our quarterly operating results, changes in our cashbalances, variations between our actual financial results and the publishedanalysts’ expectations and announcements by our competitors.  In addition, over the past several quarters,the stock market has experienced extreme price and volume fluctuations thathave affected the stock prices of many technology companies.  These factors, as well as general economicand political conditions or investors’ concerns regarding the credibility ofcorporate financial statements and the accounting profession, may have amaterial adverse affect on the market price of our stock in the future.

 

***Some of ourfacilities in California are located near an earthquake fault, and anearthquake or other types of natural disasters or other crises could disruptour operations and adversely affect results.***

 

Significantportions of our operations are concentrated at a single location in the SiliconValley area of California, and we also have various functions and relatedinfrastructure to support our international operations in the U.K.  In the event of a crisis or naturaldisaster, such as terrorist incidents or an earthquake or flood, or localizedextended outages of critical utilities or transportation systems, we do nothave a formal business continuity or disaster recovery plan, and couldtherefore experience a significant business interruption.

 

***We may not be fully able to protect ourcomputer systems, including our financial systems, from breaches of security.***

 

We use computersystems, including our enterprise-wide financial system that may not includethe most advanced security features available. There is a risk of unauthorized access to computer systems,

 

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including ourfinancial systems.  While managementmakes concerted efforts to assess risks and prevent and detect such securitybreaches, including our current project to upgrade our existing enterprise-widefinancial system to a new SAP release, our financial results could be harmed ifsuch an unauthorized access were to occur and not be detected within our normalinternal control procedures.

*** ***

***Efforts to reduce general and administrative costs could bedisruptive and create risk for us.***

 

General andadministrative expenses as a percentage of revenue have been higher than ourdesired long-term financial model.  Wewill take actions to reduce these expenses. Such actions could includereductions in work force, relocation of processing activities to lower costlocations, changes or modifications in Information Technology systems orapplications, and process reengineering. There is risk that people withcritical skills could leave the business prematurely, or reductions in certainareas will create additional risk exposure to meeting reporting requirements oranalyzing the business, which could ultimately lead to higher costs orpenalties.

 

***Item 3.******                           *Quantitativeand Qualitative Disclosures About Market Risk**

 

3Com holds a portfolio of marketable equity securities that have ashort trading history and are highly subject to market price volatility.  Equity security price fluctuations of plusor minus 50 percent would not have a material impact on the value of thesesecurities as of the end of the third quarter of fiscal 2003.

 

For interest rate sensitivity and foreign currency exchange risk,reference is made to Part II, Item 7A, Quantitative and Qualitative DisclosuresAbout Market Risk, in our Annual Report on Form 10-K for the year ended May 31,2002.

 

***Item 4.******                        *Controlsand Procedures**

 

a.             Within the 90 daysprior to the date of this report, we carried out an evaluation, under thesupervision and with the participation of our management, including ourPresident and Chief Executive Officer along with our Chief Financial Officer,of the effectiveness of the design and operation of our disclosure controls andprocedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation,our President and Chief Executive Officer along with our Chief FinancialOfficer concluded that our disclosure controls and procedures are effective intimely alerting them to material information relating to 3Com (including itsconsolidated subsidiaries) required to be included in our periodic SEC filings.

 

Our review of our internal controls was made withinthe context of the relevant professional auditing standards defining “internal controls,”“reportable conditions,” and “material weaknesses.” “Internal controls” areprocesses designed to provide reasonable assurance that our transactions areproperly authorized, our assets are safeguarded against unauthorized orimproper use, and our transactions are properly recorded and reported, all topermit the preparation of our condensed consolidated financial statements inconformity with accounting principles generally accepted in the United States.“Significant deficiencies” are referred to as “reportable conditions,” orcontrol issues that could have a significant adverse effect on our ability toproperly authorize transactions, safeguard our assets, or record, process,summarize or report financial data in the condensed consolidated financialstatements. A “material weakness” is a particularly serious reportablecondition where the internal control does not reduce to a relatively low level the risk that misstatements causedby error or fraud may occur in amounts that would be material in relation tothe condensed consolidated financial statements and not be detected within atimely period by employees in the normal course of performing their assignedfunctions. As part of our internal controls procedures, we also address other,less significant control matters that we identify, and we determine whatrevision or improvement to make, if any, in accordance with our on-goingprocedures. However, the design of

 

40

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any system of controls is based in part upon certainassumptions about the likelihood of future events and there is no certaintythat any design will succeed in achieving its stated goal under all potentialfuture considerations, regardless of how remote.

 

b.              There have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date we carried outthis evaluation, nor were there any significant deficiencies or materialweaknesses in our internal controls. As a result, no corrective actions wererequired or undertaken.

 

**PARTII.             OTHER INFORMATION**

 

***Item 1.*            Legal Proceedings**

 

The material setforth in Note 11 of Part I, Item 1 of this Form 10-Q is incorporated herein byreference.

 

*** ***

***Item 2.*            Changes in Securities and Use ofProceeds**

 

None

 

***Item 3.*            Defaults Upon Senior Securities**

 

None.

 

***Item 4.*            Submission of Matters to a Vote ofSecurity Holders**

 

None

 

***Item 5.*            Other Information**

 

None.

 

***Item 6.*            Exhibits and Reports on Form 8-K**

 

(a)           Exhibits

 
| **Exhibit  Number** |   | **Description**                                                                                                                        |
|---------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------|
|                |   |                                                                                                                                   |
| 2.1                 |   | Master Separation and Distribution Agreement between  the Registrant and Palm, Inc. effective as of December 13, 1999, as amended  (6) |
| 2.2                 |   | General Assignment and Assumption Agreement between  the Registrant and Palm, Inc., as amended (6)                                     |
| 2.3                 |   | Master Technology Ownership and License Agreement  between the Registrant and Palm, Inc. (6)                                           |
| 2.4                 |   | Master Patent Ownership and License Agreement  between the Registrant and Palm, Inc. (6)                                               |
| 2.5                 |   | Master Trademark Ownership and License Agreement  between the Registrant and Palm, Inc. (6)                                            |
| 2.6                 |   | Employee Matters Agreement between the Registrant  and Palm, Inc. (6)                                                                  |
| 2.7                 |   | Tax Sharing Agreement between the Registrant and  Palm, Inc. (6)                                                                       |
| 2.8                 |   | Master Transitional Services Agreement between the  Registrant and Palm, Inc. (6)                                                      |
| 2.9                 |   | Real Estate Matters Agreement between the Registrant  and Palm, Inc. (6)                                                               |
| 2.10                |   | Master Confidential Disclosure Agreement between the  Registrant and Palm, Inc. (6)                                                    |

 

41

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| 2.11  |   | Indemnification and Insurance Matters Agreement  between the Registrant and Palm, Inc. (6)                                                                                                                                                                                                                                                      |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1   |   | Certificate of Incorporation (4)                                                                                                                                                                                                                                                                                                                |
| 3.2   |   | Certificate of Correction filed to Correct a Certain  Error in the Certificate of Incorporation (4)                                                                                                                                                                                                                                             |
| 3.3   |   | Certificate of Merger (4)                                                                                                                                                                                                                                                                                                                       |
| 3.4   |   | Corrected Certificate of Merger filed to correct an  error in the Certificate of Merger (5)                                                                                                                                                                                                                                                     |
| 3.5   |   | Registrant’s Bylaws, as amended on August 7, 2001  (11)                                                                                                                                                                                                                                                                                    |
| 3.6   |   | Certificate of Designation of Rights, Preferences  and Privileges of Series A Participating Preferred Stock (9)                                                                                                                                                                                                                                 |
| 4.1   |   | Amended and Restated Rights Agreement dated December  31, 1994 (2)                                                                                                                                                                                                                                                                              |
| 4.2   |   | Third Amended and Restated Preferred Shares Rights  Agreement, dated as of November 4, 2002 (12)                                                                                                                                                                                                                                                |
| 10.1  |   | 3Com Corporation 1983 Stock Option Plan, as amended  and restated effective September 30, 2001 (10)*                                                                                                                                                                                                                                            |
| 10.2  |   | Amended and Restated Incentive Stock Option Plan  (1)*                                                                                                                                                                                                                                                                                          |
| 10.3  |   | 3Com Corporation 1984 Employee Stock Purchase Plan,  as amended and restated as of September 20, 2001 (11)*                                                                                                                                                                                                                                     |
| 10.4  |   | 3Com Corporation Director Stock Option Plan, as  amended (10)*                                                                                                                                                                                                                                                                                  |
| 10.5  |   | 3Com Corporation Restricted Stock Plan, as amended  July 1, 2001 (11) *                                                                                                                                                                                                                                                                         |
| 10.6  |   | 3Com Corporation 1994 Stock Option Plan, as amended  and restated effective April 30, 2002 (11)*                                                                                                                                                                                                                                                |
| 10.7  |   | Amended and Restated Agreement and Plan of Merger by  and among the Registrant, TR Acquisitions Corporation, 3Com (Delaware)  Corporation, and U.S. Robotics Corporation, dated as of February 26, 1997 and  amended as of March 14, 1997 (3)                                                                                                   |
| 10.8  |   | Employment Agreement with Bruce Claflin, effective  as of January 1, 2001 (7)*                                                                                                                                                                                                                                                                  |
| 10.9  |   | Summary of Severance Plan for Section 16b Officers  (8)*                                                                                                                                                                                                                                                                                        |
| 10.10 |   | Credit Agreement dated as of November 28, 2001  between the Registrant, Bank of America, N.A., as Administrative Agent, Bank  of America Securities, LLC, as Lead Arranger and Sole Book Manager, Foothill  Capital Corporation, as Syndication Agent, and the Financial Institutions  Named Herein, as Lenders (10)                            |
| 10.11 |   | Credit Agreement dated as of November 28, 2001  between 3Com Technologies and 3Com Europe Limited, Bank of America, N.A., as  Administrative Agent, Bank of America Securities, LLC, as Lead Arranger and  Sole Book Manager, Foothill Capital Corporation, as Syndication Agent, and  the Financial Institutions Named Herein, as Lenders (10) |
| 10.12 |   | Security Agreement dated as of November 28,  2001, between the Registrant and Bank of America, N.A., in its capacity as  Agent for Lenders (10)                                                                                                                                                                                            |
| 10.13 |   | Continuing Guaranty dated as of November 28, 2001,  made by the Registrant in favor of the Lenders and Bank of America, N.A.**,**  as Agent for the Lenders (10)                                                                                                                                                                                |
| 10.14 |   | Intercompany Subordination Agreement dated as of  November 28, 2001, made among the Registrant and Bank of America, N.A.,  as Agent for itself and the Lenders (10)                                                                                                                                                                        |
| 10.15 |   | Deed of Trust, Assignment of Rents, Security  Agreement and Fixture Financing dated November 28, 2001, between the  Registrant, as Trustor, and First American Title Guaranty Company, as  Trustee, and Bank of America, N.A., as Agent, for the Santa Clara, CA, Betsy  Ross site (10)                                                         |
| 10.16 |   | Deed of Trust, Assignment of Rents, Security  Agreement and Fixture Financing dated November 28, 2001, between the  Registrant, as Trustor,                                                                                                                                                                                                     |

 

42

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|   |   | and First American Title Guaranty Company, as  Trustee, and Bank of America, N.A., as Agent, for the Santa Clara, CA, West  Campus (10)                                                                                                                                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.17  |   | Deed of Trust, Assignment of Rents, Security  Agreement and Fixture Financing dated November 28, 2001, between the  Registrant, as Trustor, and First American Title Guaranty Company, as  Trustee, and Bank of America, N.A., as Agent, for the Santa Clara, CA, East  Campus (10) |
| 10.18  |   | Mortgage, Assignment of Rents, Security Agreement  and Fixture Financing Statement dated November 28, 2001, between the  Registrant, as Mortgagor, and Bank of America, N.A., as Agent, as Mortgagee,  for the Rolling Meadows, IL site (10)                                        |
| 10.19  |   | Amendment Number One to Security Agreement dated  July 25, 2002, between the Registrant and Bank of America, N.A., as  Administrative Agent (13)                                                                                                                                    |
| 10.20  |   | Warrant to Purchase Common Stock, dated December 4,  2000, between the Registrant and Broadcom Corporation (13)                                                                                                                                                                     |
| 10.21  |   | Amendment Number One to Warrant, dated November 1,  2002, between the Registrant and Broadcom Corporation (13)                                                                                                                                                                      |
| 10.22  |   | Form of Indemnity Agreement between the Registrant  and its officers and directors (14)                                                                                                                                                                                             |
| 10.23  |   | 3Com Europe Limited Debt Forgiveness and Bonus  Agreement dated April 12, 1999 between 3Com Europe Limited and John  McClelland (14)*                                                                                                                                               |
| 10.24  |   | 3Com Europe Limited Promissory Note dated April 12,  1999 executed by John McClelland in favor of 3Com Europe Limited (14)*                                                                                                                                                    |
| 10.25  |   | Form of Management  Retention Agreement, effective as of December 16, 2002, for Bruce Claflin,  filed herewith *                                                                                                                                                                    |
| 10.26  |   | Form of Management  Retention Agreement, effective as of December 16, 2002, for Dennis Connors,  filed herewith *                                                                                                                                                                   |
| 10.27  |   | Form of Management  Retention Agreement, effective as of December 16, 2002, for Mark Slaven,  filed herewith *                                                                                                                                                                      |
| 10.28  |   | Schedule of Additional  Management Retention Agreements, effective as of December 16, 2002, for  attached list of parties, filed herewith *                                                                                                                                         |
| 99.1   |   | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section  1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,  filed herewith                                                                                    |

 

----

| *      |   | Indicates a management contract or compensatory  plan.                                                                                                                                       |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                         |
| (1)    |   | Incorporated by reference to the corresponding  exhibit to Registrant’s Registration Statement on Form S-4 filed on August  31, 1987 (File No. 33-16850)                                |
| (2)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  January 17, 1995 (File No. 000-12867)                        |
| (3)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Registration Statement  on Form S-4 filed on March 17, 1997 (File No. 333-23465) |
| (4)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  October 14, 1997 (File No. 000-12867)                        |
| (5)    |   | Incorporated by reference to the corresponding exhibit  previously filed as an exhibit to Registrant’s Form 10-Q filed on October 8,  1999 (File No. 002-92053)                         |
| (6)    |   | Incorporated by reference to the corresponding  exhibit previously filed as                                                                                                                  |

 

43

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|   |   | an exhibit to Registrant’s Form 10-Q filed on April  4, 2000 (File No. 002-92053)                                                                                  |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (7)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  January 16, 2001 (File No. 333-34726)   |
| (8)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-K filed on  August 8, 2001 (File No. 000-12867)     |
| (9)    |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  October 11, 2001 (File No. 000-12867)   |
| (10)   |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  January 11, 2002 (File No. 000-12867)   |
| (11)   |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-K filed on  August 2, 2002 (File No. 000-12867)     |
| (12)   |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 8-A/A filed on November  27, 2002 (File No. 000-12867) |
| (13)   |   | Incorporated by reference to the corresponding  exhibit previously filed as an exhibit to Registrant’s Form 10-Q filed on  January 7, 2003 (File No. 000-12867)    |
| (14)   |   | Incorporated by reference to the corresponding  exhibit to Registrant’s Registration Statement on Form S-3/A filed on April  9, 2003 (File No. 333-102591)         |

 

 

(b)           Reports on Form 8-K

 

A report on Form8-K filed March 10, 2003, reporting under Item 5 the announcement that on March7, 2003, 3Com Corporation issued a press release regarding its lowered revenueguidance for the third quarter of fiscal 2003.

 

A report on Form8-K filed March 20, 2003, reporting under Item 5 the announcement that on March19, 2003, 3Com Corporation 1) issued a press release regarding its financialresults for the third quarter of fiscal 2003 and 2) issued a joint pressrelease with Huawei Technologies Limited announcing an agreement to form ajoint venture.

 

44

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**Signatures**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|   |           |   |   |   |   |   | 3Com Corporation                              |
|--------|----------------|--------|--------|--------|--------|--------|-----------------------------------------------|
|   |           |   |   |   |   |   | (Registrant)                                  |
|   |           |   |   |   |   |   |                                          |   |   |
|   |           |   |   |   |   |   |                                          |   |   |
|   |           |   |   |   |   |   |                                          |   |   |
| Dated: | April 10, 2003 |   |   |   |   | By:    | /s/     Mark  Slaven |   |
|   |           |   |   |   |   |   | Mark Slaven                                   |
|   |           |   |   |   |   |   | Executive Vice  President, Finance, and       |
|   |           |   |   |   |   |   | Chief Financial  Officer                      |
|   |           |   |   |   |   |   | (Principal  Financial and                     |
|   |           |   |   |   |   |   | Accounting  Officer)                          |
|        |                |        |        |        |        |        |                                               |  |  |  |

 

45

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**Certification of Principal Executive Officer**

 

I, Bruce L. Claflin, certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of 3Com Corporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | April 10, 2003                        |   |
|--------|---------------------------------------|--------|
|   |
|   | /s/ Bruce L. Claflin                  |   |
|   | Bruce L. Claflin                      |   |
|   | President and Chief Executive Officer |   |
|        |                                       |        |  |  |

 

46

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**Certification of Principal Financial Officer**

 

I, Mark Slaven, certify that:

 

1.             I have reviewedthis quarterly report on Form 10-Q of 3Com Corporation;

 

2.                                       Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.                                       Theregistrant’s other certifying officers and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.                                       Theregistrant’s other certifying officers and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officers and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
| Date:  | April 10, 2003 |                                                            |   |
|--------|----------------|-----------------------------------------------------------------|--------|
|   |           |                                                            |
|   |           |                                                            |
|   |           | /s/ Mark Slaven                                                 |
|   |           | Mark Slaven                                                     |
|   |           | Executive Vice President, Finance, and Chief  Financial Officer |

 

47

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