**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C.  20549**

 

**FORM 10-Q**

 

**ý****                                ****QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterlyperiod ended November 26, 2004**

 

**OR**

 

**o****                                ****TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OFTHE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from            to**

 

**CommissionFile No. 0-12867**

 

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**3Com Corporation**

(Exact name ofregistrant as specified in its charter)

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

 

Registrant’s telephonenumber, including area code:   **(508) 323-5000**

 

Former name, formeraddress and former fiscal year, if changed since last report:   **N/A**

 

**Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.**

 

**Yes   ****ý                No **o

** **

**Indicate by check mark whetherthe registrant is an accelerated filer (as defined by Rule 12b-2 of theExchange Act).**

 

**Yes   **ý**                No **o

 

**As of December 24, 2004, 380,376,591shares of the registrant’s Common Stock were outstanding.**

 

 

 

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**3ComCorporation**

 

**Table ofContents**

 
|       |   |                                                                                                                  |   | **Page** |
|------------|--------|-----------------------------------------------------------------------------------------------------------------------|--------|----------|
| PART I.    |   | FINANCIAL INFORMATION                                                                                                 |   |     |
|       |   |                                                                                                                  |   |     |
| *Item 1.*  |   | Financial Statements                                                                                                  |   |     |
|       |   |                                                                                                                  |   |     |
|       |   | Condensed  Consolidated Statements of Operations*Three and Six Months Ended November 26, 2004 and  November 28, 2003* |   | 3        |
|       |   |                                                                                                                  |   |     |
|       |   | Condensed  Consolidated Balance Sheets*November 26, 2004 and May 28, 2004*                                            |   | 4        |
|       |   |                                                                                                                  |   |     |
|       |   | Condensed  Consolidated Statements of Cash Flows*Six Months Ended November 26, 2004 and November  28, 2003*           |   | 5        |
|       |   |                                                                                                                  |   |     |
|       |   | Notes  to Condensed Consolidated Financial Statements                                                                 |   | 6        |
|       |   |                                                                                                                  |   |     |
| *Item  2.* |   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                           |   | 18       |
|       |   |                                                                                                                  |   |     |
| *Item  3.* |   | Quantitative  and Qualitative Disclosures About Market Risk                                                           |   | 44       |
|       |   |                                                                                                                  |   |     |
| *Item 4.*  |   | Controls and Procedures                                                                                               |   | 44       |
|       |   |                                                                                                                  |   |     |
| PART II.   |   | OTHER INFORMATION                                                                                                     |   |     |
|       |   |                                                                                                                  |   |     |
| *Item 1.*  |   | Legal Proceedings                                                                                                     |   | 45       |
|       |   |                                                                                                                  |   |     |
| *Item  2.* |   | Unregistered  Sales of Equity Securities and Use of Proceeds                                                          |   | 45       |
|       |   |                                                                                                                  |   |     |
| *Item 3.*  |   | Defaults Upon  Senior Securities                                                                                      |   | 45       |
|       |   |                                                                                                                  |   |     |
| *Item  4.* |   | Submission  of Matters to a Vote of Security Holders                                                                  |   | 46       |
|       |   |                                                                                                                  |   |     |
| *Item 5.*  |   | Other Information                                                                                                     |   | 46       |
|       |   |                                                                                                                  |   |     |
| *Item  6.* |   | Exhibits                                                                                                              |   | 46       |
|       |   |                                                                                                                  |   |     |
| Signatures |   |                                                                                                                  | 48     |

 

3Com is aregistered trademark and Exercise Choice is a trademark of 3Com Corporation orits subsidiaries. CommWorks is a registered trademark of UTStarcom, Inc.  Huawei is a registered trademark of HuaweiTechnologies Co. Ltd.  Palm is aregistered trademark of Palm Trademark Holding Company LLC.  Other product and brand names may betrademarks or registered trademarks of their respective owners.

 

2

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**PART I.  FINANCIAL INFORMATION**

 

***Item1.*****                            FinancialStatements**

 

**3ComCorporation**

**CondensedConsolidated Statements of Operations**

(Unaudited)

 
| ** **                                                                                                        | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| **(In  thousands, except per share data)**                                                                        | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Sales                                                                                                             |       | $                      | 151,068    |                   | $          | 181,891 |   | $ | 313,417 |   | $ | 343,770 |   |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Cost  of sales                                                                                                    |       | 98,377                 |       | 124,941                |       | 198,631 |   | 236,876 |   |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Gross  margin                                                                                                     |       | 52,691                 |       | 56,950                 |       | 114,786 |   | 106,894 |   |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Operating  expenses:                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Sales  and marketing                                                                                              |       | 59,394                 |       | 65,637                 |       | 114,493 |   | 128,244 |   |
| Research  and development                                                                                         |       | 22,164                 |       | 24,421                 |       | 44,599 |   | 51,348 |   |
| General  and administrative                                                                                       |       | 14,385                 |       | 21,784                 |       | 30,057 |   | 45,923 |   |
| Amortization  and write down of intangibles                                                                       |       | 2,175                  |       | 1,095                  |       | 3,189 |   | 4,482 |   |
| Restructuring  charges                                                                                            |       | 4,497                  |       | 58,892                 |       | 7,281 |   | 107,516 |   |
| Total  operating expenses                                                                                         |       | 102,615                |       | 171,829                |       | 199,619 |   | 337,513 |   |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Operating  loss                                                                                                   |       | (49,924                | )          | (114,879               | )          | (84,833 | ) | (230,619 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Gain  (loss) on investments, net                                                                                  |       | (351                   | )          | (12,252                | )          | 82 |   | (12,194 | ) |
| Interest  and other income, net                                                                                   |       | 4,781                  |       | 3,808                  |       | 5,814 |   | 7,752 |   |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Loss  from continuing operations before income taxes and equity interest in loss of  unconsolidated joint venture |       | (45,494                | )          | (123,323               | )          | (78,937 | ) | (235,061 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Income  tax provision (benefit)                                                                                   |       | 1,008                  |       | 1,500                  |       | 543 |   | (4,535 | ) |
| Equity  interest in loss of unconsolidated joint venture                                                          |       | (2,309                 | )          | (12,593                | )          | (4,876 | ) | (12,593 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Loss  from continuing operations                                                                                  |       | (48,811                | )          | (137,416               | )          | (84,356 | ) | (243,119 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Discontinued  operations, net of taxes                                                                            |       | —                 |       | (1,565                 | )          | — |   | (1,856 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Net  loss                                                                                                         |       | $                      | (48,811    | )                      | $          | (138,981 | ) | $ | (84,356 | ) | $ | (244,975 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Basic  and diluted loss per share:                                                                                |       |                   |       |                   |       |   |   |   |   |
| Continuing  operations                                                                                            |       | $                      | (0.13      | )                      | $          | (0.37 | ) | $ | (0.22 | ) | $ | (0.65 | ) |
| Discontinued  operations, net of taxes                                                                            |       | —                 |       | —                 |       | — |   | (0.01 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Net  loss                                                                                                         |       | $                      | (0.13      | )                      | $          | (0.37 | ) | $ | (0.22 | ) | $ | (0.66 | ) |
|                                                                                                              |       |                   |       |                   |       |   |   |   |   |
| Shares  used in computing per share amounts:                                                                      |       |                   |       |                   |       |   |   |   |   |
| Basic  and diluted                                                                                                |       | 378,694                |       | 375,332                |       | 383,140 |   | 371,606 |   |

 

*See notes to condensedconsolidated financial statements.*

 

3

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**3ComCorporation**

**CondensedConsolidated Balance Sheets**

(Unaudited)

 
| **(In  thousands, except par value)**                                                                       | ** ** | **November 26,  2004** | ** ** | **May 28,  2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-------------------|------------|
|                                                                                                        |       |                   |       |              |       |
| ASSETS                                                                                                      |       |                   |       |              |       |
| Current  assets:                                                                                            |       |                   |       |              |       |
| Cash  and equivalents                                                                                       |       | $                      | 458,669    |              | $          | 575,824 |   |
| Short-term  investments                                                                                     |       | 815,204                |       | 807,532           |       |
| Accounts  receivable, less allowance for doubtful accounts ($14,786 and $16,276,  respectively)             |       | 64,401                 |       | 66,372            |       |
| Inventories                                                                                                 |       | 22,344                 |       | 27,679            |       |
| Other  current assets                                                                                       |       | 41,317                 |       | 42,270            |       |
| Total  current assets                                                                                       |       | 1,401,935              |       | 1,519,677         |       |
|                                                                                                        |       |                   |       |              |       |
| Investment  in Huawei-3Com joint venture                                                                    |       | 138,015                |       | 142,891           |       |
| Property  and equipment, net                                                                                |       | 71,108                 |       | 72,452            |       |
| Property  and equipment held for sale                                                                       |       | 12,238                 |       | 42,147            |       |
| Deposits  and other assets                                                                                  |       | 32,718                 |       | 34,806            |       |
| Deferred  income taxes                                                                                      |       | 2,986                  |       | 2,937             |       |
| Intangible  assets, net                                                                                     |       | 1,820                  |       | 5,009             |       |
| Goodwill                                                                                                    |       | 899                    |       | 899               |       |
|                                                                                                        |       |                   |       |              |       |
| Total  assets                                                                                               |       | $                      | 1,661,719  |              | $          | 1,820,818 |   |
|                                                                                                        |       |                   |       |              |       |
| LIABILITIES  AND STOCKHOLDERS’ EQUITY                                                                  |       |                   |       |              |       |
| Current  liabilities:                                                                                       |       |                   |       |              |       |
| Accounts  payable                                                                                           |       | $                      | 75,078     |              | $          | 80,408 |   |
| Accrued  liabilities and other                                                                              |       | 222,750                |       | 226,161           |       |
|                                                                                                        |       |                   |       |              |       |
| Total  current liabilities                                                                                  |       | 297,828                |       | 306,569           |       |
|                                                                                                        |       |                   |       |              |       |
| Deferred  revenue and long-term obligations                                                                 |       | 12,466                 |       | 15,135            |       |
|                                                                                                        |       |                   |       |              |       |
| Stockholders’  equity:                                                                                 |       |                   |       |              |       |
| Preferred  stock, $.01 par value, 10,000 shares authorized; none outstanding                                |       | —                 |       | —            |       |
| Common  stock, $.01 par value, 990,000 shares authorized; shares issued: 380,366 and  392,738, respectively |       | 2,266,398              |       | 2,262,223         |       |
| Treasury  stock, at cost, 13,068  and 0 shares, respectively                                                |       | (63,986                | )          | —            |       |
| Unamortized  stock-based compensation                                                                       |       | (4,550                 | )          | (2,577            | )          |
| Retained  deficit                                                                                           |       | (841,222               | )          | (755,244          | )          |
| Accumulated  other comprehensive loss                                                                       |       | (5,215                 | )          | (5,288            | )          |
| Total  stockholders’ equity                                                                            |       | 1,351,425              |       | 1,499,114         |       |
|                                                                                                        |       |                   |       |              |       |
| Total  liabilities and stockholders’ equity                                                            |       | $                      | 1,661,719  |              | $          | 1,820,818 |   |

 

*See notesto condensed consolidated financial statements.*

 

4

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**3ComCorporation**

**CondensedConsolidated Statements of Cash Flows**

(Unaudited)

 
| ** **                                                                                         | ** ** | **Six Months Ended**     | ** ** |
|----------------------------------------------------------------------------------------------------|------------|--------------------------|------------|
| **(In thousands)**                                                                                 | ** ** | **November 26,****2004** | ** ** | **November 28,****2003** |   |
|                                                                                               |       |                     |       |   |   |
| Cash  flows from operating activities:                                                             |       |                     |       |   |   |
| Loss  from continuing operations                                                                   |       | $                        | (84,356    | ) | $ | (243,119 | ) |
| Adjustments  to reconcile loss from continuing operations to cash (used in) operating  activities: |       |                     |       |   |   |
| Loss  from discontinued operations                                                                 |       | —                   |       | (1,856 | ) |
| Depreciation  and amortization                                                                     |       | 24,731                   |       | 67,897 |   |
| Write  down of intangibles                                                                         |       | 1,161                    |       | 1,905 |   |
| (Gain)  loss on property and equipment                                                             |       | (5,021                   | )          | 29,848 |   |
| (Gain)  loss on investments, net                                                                   |       | (82                      | )          | 12,194 |   |
| Equity  interest in loss of unconsolidated joint venture                                           |       | 4,876                    |       | 12,593 |   |
| Deferred  income taxes                                                                             |       | (49                      | )          | (6 | ) |
| Purchased  in-process technology                                                                   |       | 1,675                    |       | — |   |
| Stock-based  compensation expense                                                                  |       | 865                      |       | 1,251 |   |
| Changes  in current assets and liabilities:                                                        |       |                     |       |   |   |
| Accounts  receivable                                                                               |       | 1,971                    |       | 19,385 |   |
| Inventories                                                                                        |       | (1,498                   | )          | (8,637 | ) |
| Other  assets                                                                                      |       | 2,126                    |       | 3,454 |   |
| Accounts  payable                                                                                  |       | (5,330                   | )          | (3,061 | ) |
| Accrued  liabilities and other                                                                     |       | (18,703                  | )          | 23,697 |   |
| Income  taxes                                                                                      |       | 11,726                   |       | 3,311 |   |
|                                                                                               |       |                     |       |   |   |
| Net  cash (used in) operating activities                                                           |       | (65,908                  | )          | (81,144 | ) |
|                                                                                               |       |                     |       |   |   |
| Cash  flows from investing activities:                                                             |       |                     |       |   |   |
| Investment  in Huawei-3Com joint venture                                                           |       | —                   |       | (160,000 | ) |
| Purchases  of investments                                                                          |       | (431,152                 | )          | (552,691 | ) |
| Proceeds  from maturities and sales of investments                                                 |       | 413,173                  |       | 562,550 |   |
| Purchases  of property and equipment                                                               |       | (7,464                   | )          | (8,232 | ) |
| Purchase  of technology assets                                                                     |       | (1,675                   | )          | — |   |
| Proceeds  from sale of property and equipment                                                      |       | 37,786                   |       | 99,640 |   |
|                                                                                               |       |                     |       |   |   |
| Net  cash provided by (used in) investing activities                                               |       | 10,668                   |       | (58,733 | ) |
|                                                                                               |       |                     |       |   |   |
| Cash  flows from financing activities:                                                             |       |                     |       |   |   |
| Issuances  of common stock                                                                         |       | 9,093                    |       | 59,242 |   |
| Repurchases  of common stock                                                                       |       | (73,365                  | )          | — |   |
| Collection  of note receivable issued for warrants                                                 |       | —                   |       | 8,421 |   |
| Repayments  of long-term borrowings                                                                |       | —                   |       | (346 | ) |
|                                                                                               |       |                     |       |   |   |
| Net  cash provided by (used in) financing activities                                               |       | (64,272                  | )          | 67,317 |   |
|                                                                                               |       |                     |       |   |   |
| Effect  of exchange rate changes on cash and equivalents                                           |       | 2,357                    |       | 658 |   |
|                                                                                               |       |                     |       |   |   |
| Net  decrease in cash and equivalents during period                                                |       | (117,155                 | )          | (71,902 | ) |
|                                                                                               |       |                     |       |   |   |
| Cash  and equivalents, beginning of period                                                         |       | 575,824                  |       | 515,848 |   |
|                                                                                               |       |                     |       |   |   |
| Cash  and equivalents, end of period                                                               |       | $                        | 458,669    |   | $ | 443,946 |   |

 

*See notesto condensed consolidated financial statements.*

 

5

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**3ComCorporation**

**Notes toCondensed Consolidated Financial Statements**

(Unaudited)

 

**Note 1.****                                                          Basisof Presentation**

 

The unaudited condensedconsolidated financial statements have been prepared pursuant to the rules andregulations of the Securities and Exchange Commission (SEC).  In the opinion of management, these unauditedcondensed consolidated financial statements include all adjustments necessaryfor a fair presentation of our financial position as of November 26, 2004 andMay 28, 2004, and our results of operations and cash flows for the three andsix months ended November 26, 2004 and November 28, 2003.  Certain amounts from the prior period havebeen reclassified to conform to the current period presentation.

 

We use a 52 or 53-weekfiscal year ending on the Friday nearest to May 31.  The results of operations for the three andsix months ended November 26, 2004 may not be indicative of the results to beexpected for the fiscal year ending June 3, 2005.  These condensed consolidated financialstatements should be read in conjunction with the consolidated financialstatements and related notes thereto included in our Annual Report on Form 10-Kfor the fiscal year ended May 28, 2004.

 

*Recent Accounting Pronouncements*

 

In November 2002,the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21, “RevenueArrangements with Multiple Deliverables.” EITF 00-21 addresses certain aspectsof the accounting by a vendor for arrangements under which the vendor willperform multiple revenue generating activities.  EITF 00-21 is effective for fiscal periodsbeginning after June 15, 2003; for us, EITF 00-21 became effective for thesecond quarter of fiscal 2004.  Theadoption of EITF 00-21 did not have a material effect on our financial positionor results of operations.

 

In December 2003,the SEC released Staff Accounting Bulletin No. 104, “Revenue Recognition”.  SAB 104 clarifies existing guidance regardingrevenue for contracts which contain multiple deliverables to make it consistentwith EITF No. 00-21.  The adoption of SAB104 did not have a material effect on our financial position or results ofoperations.

 

In March 2004, the FASB issued EITF Issue No. 03-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments.” EITF 03-1includes new guidance for evaluating and recording impairment losses on debtand equity investments, as well as new disclosure requirements for investmentsthat are deemed to be temporarily impaired. In September 2004, the FASB issued Staff Position EITF 03-1-1, whichdelays the effective date until additional guidance is issued for theapplication of the recognition and measurement provisions of EITF 03-1 toinvestments in securities that are impaired. We do not believe that adoption of EITF 03-1 will have a material impacton our financial position or results of operations.

 

In December 2004,the Financial Accounting Standards Board (FASB) issued Statement No. 123R, “Share-BasedPayment” (SFAS 123R), which requires companies to measure and recognizecompensation expense for all stock-based payments at fair value.  SFAS 123R is effective for all interimperiods beginning after June 15, 2005 and, thus, will be effective for usbeginning with the second quarter of fiscal 2006.  Early adoption is encouraged and retroactiveapplication of the provisions of SFAS 123R to the beginning of the fiscal yearthat includes the effective date is permitted, but not required.  We are currently evaluating the impact ofSFAS 123R on our financial position and results of operations.  See Note 3 for information related to the proforma effects on our reported net loss and net loss per share of applying thefair value recognition provisions of the previous Statement of FinancialAccounting Standards (SFAS) 123, “Accounting for Stock-Based Compensation,” tostock-based employee compensation.

 

6

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**Note 2.****                                                       DiscontinuedOperations**

 

On March 4, 2003, weentered into an agreement (Asset Purchase Agreement) to sell selected assetsand liabilities of our CommWorks division to UTStarcom, Inc. in exchange for$100 million in cash, subject to certain closing adjustments.  On May 23, 2003, we completed the salepursuant to the terms of the Asset Purchase Agreement.  As a result, we reported the CommWorksdivision as a discontinued operation beginning in the fourth quarter of fiscal2003 and restated allprior periods presented on a comparative basis. The loss from discontinued operations for the three months andsix months ended November 28, 2003 resulted from adjustments to previousestimates of liabilities related to the sale of the CommWorks division.

 

**Note 3.****                                                          Stock-BasedCompensation**

 

We have stock option plans under which employees and directors may begranted options to purchase common stock. Options generally are granted with exercise prices at not less than thefair market value at the date of the grant, vest annually over two to four years,and expire seven to ten years after the grant date.  In September 2003, our stockholders approved the 2003 Stock Plan (the NewPlan), which replaced the 1983 Stock Option Plan, the 1994 Stock Option Plan,the Director Plan, and the Restricted Stock Plan (the Prior Plans) for allstock awards granted subsequent to the approval date.  In connection with the approval of the New Plan,we cancelled all shares available for issuance under the Prior Plans (otherthan those shares underlying outstanding awards), which included approximately128 million shares at the time of approval; at the same time, 20 million shareswere reserved for issuance under the New Plan.

 

As discussed above, our 2003 Stock Plan replaced the Restricted StockPlan for the issuance of restricted stock. Restricted stock represents shares of common stock that are issued at nocost to key employees and that generally vest over a one to four-yearperiod.  Such shares are subject to ourright to reacquire those shares upon such person’s termination of employment tothe extent that such right has not lapsed. We also grant time accelerated restricted stock awards whereby shareswith a specified time-based vesting period may be accelerated if specificperformance milestones are achieved.

 

Wealso have an employee stock purchase plan (ESPP) under which eligibleemployees may authorize payroll deductions of up to ten percent of theircompensation, as defined, to purchase common stock at a price of 85 percent ofthe lower of the fair market value as of the beginning or end of the six-monthoffering period.  In September 2003, our stockholders approvedan increase of five million shares available for issuance under the ESPP.

 

As permitted under Statement of Financial Accounting Standards 123, “Accountingfor Stock-Based Compensation,” we follow Accounting Principles Board (APB)Opinion 25 and related Interpretations in accounting for stock-based awards toemployees.  Under APB Opinion 25,compensation expense associated with employee stock awards is measured as thedifference, if any, between the price to be paid by an employee and the fairvalue of the underlying common stock on the grant date, which usually is the measurementdate for accounting purposes.  Generally,we recognize no compensation expense with respect to stock-based option awardsand stock issued under the ESPP. However, to the extent that we modify an employee’s stock optionssubsequent to the grant date (for example, by extending the period of timepermitted for exercising a stock option following an employee’s involuntarytermination), we record compensation expense attributable to themodifications.  Also, we recordcompensation expense related to restricted stock over the applicable vestingperiod; such compensation expense is measured as the fair market value of therestricted stock at the date of the grant.

 

SFAS 123 requiresdisclosure of the pro forma effects on our reported net loss and net loss pershare of applying the fair value recognition provisions of SFAS 123 tostock-based employee compensation.  Thefollowing table illustrates such pro forma effects:

 

7

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| ** **                                                                                                        | ** ** | **Three Months Ended**   | ** ** | **Six Months Ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| **(in thousands, except per share amounts)**                                                                      | ** ** | **November 26,****2004** | ** ** | **November 28,****2003** | ** ** | **November 26,****2004** | ** ** | **November 28,****2003** | ** ** |
|                                                                                                              |       |                     |       |                     |       |   |   |   |   |
| Net  loss as reported                                                                                             |       | $                        | (48,811    | )                        | $          | (138,981 | ) | $ | (84,356 | ) | $ | (244,975 | ) |
| Add:  Stock-based compensation included in reported net loss                                                      |       | 213                      |       | 953                      |       | 865 |   | 1,251 |   |
| Deduct:  Total stock-based compensation determined under the fair value-based method, net  of related tax effects |       | (3,223                   | )          | (5,412                   | )          | (7,735 | ) | (10,689 | ) |
| Pro  forma net loss                                                                                               |       | $                        | (51,821    | )                        | $          | (143,440 | ) | $ | (91,226 | ) | $ | (254,413 | ) |
|                                                                                                              |       |                     |       |                     |       |   |   |   |   |
| Net  loss per share-basic and diluted:                                                                            |       |                     |       |                     |       |   |   |   |   |
| As  reported                                                                                                      |       | $                        | (0.13      | )                        | $          | (0.37 | ) | $ | (0.22 | ) | $ | (0.66 | ) |
| Pro  forma                                                                                                        |       | (0.14                    | )          | (0.38                    | )          | (0.24 | ) | (0.68 | ) |

 

For purposes ofthis pro forma disclosure, the estimated fair values of employee stock options(ESOs) are assumed to be amortized over the applicable vesting periods, and theestimated fair values of ESPP shares are assumed to be amortized over theapplicable subscription periods.

 

The fair values ofESOs and ESPP shares granted during the second quarter of fiscal 2005 andfiscal 2004 and the first six months of fiscal 2005 and 2004 have beenestimated as of the date of grant using the Black-Scholes option pricingmodel.  The assumptions used in preparingthe estimates and the resulting fair values are shown below:

 
| ** **                                                  | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|-------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                  | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                                                        |       |                   |       |                   |       |   |   |   |   |
| Volatility-ESO                                              |       | 53.0                   | %          | 66.0                   | %          | 57.0 | % | 67.0 | % |
| Volatility-ESPP                                             |       | 40.0                   | %          | 45.0                   | %          | 40.0 | % | 45.0 | % |
| Risk-free  interest rate-ESO                                |       | 3.2                    | %          | 2.7                    | %          | 3.3 | % | 2.6 | % |
| Risk-free  interest rate-ESPP                               |       | 2.2                    | %          | 1.0                    | %          | 2.2 | % | 1.0 | % |
| Dividend  yield-ESO and ESPP                                |       | 0.0                    | %          | 0.0                    | %          | 0.0 | % | 0.0 | % |
| Per-share  fair value of options granted under ESO          |       | $                      | 2.01       |                   | $          | 3.21 |   | $ | 2.21 |   | $ | 2.75 |   |
| Per-share  fair value of purchase rights granted under ESPP |       | $                      | 1.13       |                   | $          | 1.79 |   | $ | 1.13 |   | $ | 1.79 |   |

 

The Black-Scholesoption pricing model was developed for use in estimating the fair value oftraded options that have no vesting restrictions and are fully transferable.  In addition, option valuation models requirethe input of highly subjective assumptions, including the expected stock pricevolatility.

 

**Note 4.****                                                          RestructuringCharges**

 

In recent fiscal years,we have undertaken several initiatives involving significant changes in ourbusiness strategy and cost structure.  Infiscal 2001, we began a broad restructuring of our business to enhance thefocus and cost effectiveness of our business units in serving their respectivemarkets.  These efforts continued throughfiscal 2002.  We took the followingspecific actions in fiscal 2001 and 2002 (the “Fiscal 2001 and 2002 Actions”):  we organized aroundindependent businesses that utilized shared central services; we exited productlines; we outsourced the manufacturing of certain high volume server, desktopand mobile connectivity products in a contract manufacturing arrangement; weimplemented a reduction in workforce; and we consolidated our real estatefacilities and made plans to sell excess facilities.

 

As a result of furthersales declines and net losses, we took additional restructuring actions infiscal 2003

 

8

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(the “Fiscal 2003 Actions”).  We announced the integration of the supportinfrastructure of two of our business units to leverage a common infrastructurein order to drive additional costs out of the business.  Additionally, we entered into agreements tooutsource certain information technology (IT) functions, reduced our workforce,and continued to consolidate and dispose of excess facilities.

 

In response to continuing sales declines and netlosses, we took additional measures to reduce costs during fiscal 2004 (the “Fiscal2004 Actions”) and fiscal 2005 (the “Fiscal 2005 Actions”).  These actions included reductions of ourworkforce, outsourcing of our remaining manufacturing operations, andcontinuing efforts to consolidate and dispose of excess facilities.

 

Restructuring charges related to these variousinitiatives in the second quarters of fiscal 2005 and fiscal 2004 were $4.5million and $58.9 million, respectively. Such charges were net of credits of $1.0 million and $0.6 million,respectively, related primarily to revisions of previous estimates of employeeseparation expenses, lease obligation costs, and values on held for saleproperties.  Restructuring chargesrelated to these various initiatives in the first half of fiscal 2005 andfiscal 2004 were $7.3 million and $107.5 million, respectively.  Such charges were net of credits of $5.9million and $1.4 million, respectively, related primarily to revisions ofprevious estimates of employee separation expenses, lease obligation costs, andvalues on held for sale properties.

 

Accrued liabilities associated with restructuringcharges are classified as current, since we intend to satisfy such liabilitiesin cash within the next twelve months, and are included in the caption “Accruedliabilities and other” in the accompanying condensed consolidated balancesheets.

 

*Fiscal 2005 Actions*

 

The following table provides a summary of thecomponents of restructuring charges recorded in the first and second quartersof fiscal 2005 with respect to the Fiscal 2005 Actions, together with changesin the accrued amounts and the ending balances as of November 26, 2004 (inthousands):

 
| ** **                     | ** ** | **Employee  Separation  Expenses** | ** ** | **Facilities-  related  Charges** | ** ** | **Other  Restructuring  Costs** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|-----------|------------|
| Balance  at May 28, 2004       |       | $                                  | —     |                              | $          | —                          |       | $         | —     |   | $ | — |   |
| Provision                      |       | 5,439                              |       | 59                                |       | 333                             |       | 5,831     |       |
| Payments  and non-cash charges |       | (2,192                             | )          | (59                               | )          | (333                            | )          | (2,584    | )          |
| Balance  at August 27, 2004    |       | 3,247                              |       | —                            |       | —                          |       | 3,247     |       |
| Provision                      |       | 1,788                              |       | 5                                 |       | 87                              |       | 1,880     |       |
| Payments  and non-cash charges |       | (3,188                             | )          | (5                                | )          | (87                             | )          | (3,280    | )          |
| Balance  at November 26, 2004  |       | $                                  | 1,847      |                              | $          | —                          |       | $         | —     |   | $ | 1,847 |   |

 

Employeeseparation expenses include severance pay, outplacement services, and medicaland other related benefits.  Thereduction in workforce affected employees mainly in the customer service,supply chain, sales and marketing, and general and administrativefunctions.  The total reduction inworkforce associated with actions initiated during the first half of fiscal2005 includes approximately 90 employees. Separation payments associated with actions initiated during the firsthalf of fiscal 2005 totaled $5.0 million through November 26, 2004.

 

Facilities-relatedcharges include costs associated with vacating leased offices in fiscal2005.  Other restructuring costs relatemainly to payments to suppliers for restructuring-related services.

 

*Fiscal 2004 Actions*

 

The following table provides a summary of thecomponents of accrued restructuring charges related to the Fiscal 2004 Actions,together with changes in the accrued amounts during the first and secondquarters of fiscal 2005 and the ending balances of the associated accruedliabilities as of November 26, 2004 (in thousands):

 

9

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| ** **                     | ** ** | **Employee  Separation  Expenses** | ** ** | **Facilities-  related  Charges** | ** ** | **Other  Restructuring  Costs** | ** ** | **Total** | ** ** |
|--------------------------------|------------|------------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|-----------|------------|
| Balance  at May 28, 2004       |       | $                                  | 5,529      |                              | $          | 530                             |       | $         | —     |   | $ | 6,059 |   |
| Provision  (benefit)           |       | (2,208                             | )          | (2,455                            | )          | 192                             |       | (4,471    | )          |
| Payments  and non-cash changes |       | (2,596                             | )          | 2,600                             |       | (192                            | )          | (188      | )          |
| Balance  at August 27, 2004    |       | 725                                |       | 675                               |       | —                          |       | 1,400     |       |
| Provision                      |       | —                             |       | 389                               |       | 98                              |       | 487       |       |
| Payments  and non-cash changes |       | (91                                | )          | 78                                |       | (98                             | )          | (111      | )          |
| Balance  at November 26, 2004  |       | $                                  | 634        |                              | $          | 1,142                           |       | $         | —     |   | $ | 1,776 |   |

 

Employeeseparation expenses include severance pay, outplacement services, medical andother related benefits.  The reduction inworkforce mainly affected employees involved with the Dublin, Irelandmanufacturing operations, and also affected employees in sales and marketing,research and development, and general and administrative functions.  Through November 26, 2004, total separationpayments associated with the Fiscal 2004 Actions have been approximately $55.1million.

 

Facilities-relatedcharges in the first and second quarters of fiscal 2005 relating torestructuring actions initiated in fiscal 2004 were the result of revisions inestimates of lease obligation costs. Additionally, in the first quarter of fiscal 2005, we recorded a $2.6million benefit related to fair value adjustments of properties classified asheld for sale.

 

Otherrestructuring costs primarily reflected payments to suppliers forrestructuring-related services.

 

*Fiscal 2003 Actions*

 

The following table provides a summary of thecomponents of accrued restructuring charges related to the Fiscal 2003 Actions,together with changes in the accrued amounts during the first and secondquarters of fiscal 2005 and the ending balances as of November 26, 2004 (inthousands):

 
| ** **                     | ** ** | **Facilities-  related  Charges** | ** ** |
|--------------------------------|------------|-----------------------------------|------------|
| Balance  at May 28, 2004       |       | $                                 | 2,566      |   |
| Provision                      |       | 221                               |       |
| Payments  and non-cash charges |       | (360                              | )          |
| Balance  at August 27, 2004    |       | 2,427                             |       |
| Provision                      |       | 1,442                             |       |
| Payments  and non-cash charges |       | (360                              | )          |
| Balance  at November 26, 2004  |       | $                                 | 3,509      |   |

 

Additional facilities-related charges were the result of revisions inestimates of lease obligation costs.

 

10

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*Fiscal 2001 and Fiscal 2002 Actions*

 

The following table provides a summary of thecomponents of accrued restructuring charges related to the Fiscal 2001 andFiscal 2002 Actions, together with changes in the accrued amounts during thefirst and second quarters of fiscal 2005 and the ending balances as of November26, 2004 (in thousands):

 
| ** **                     | ** ** | **Facilities-  related  Charges** | ** ** | **Other  Restructuring  Costs** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-----------------------------------|------------|---------------------------------|------------|-----------|------------|
| Balance  at May 28, 2004       |       | $                                 | 6,723      |                            | $          | 82        |       | $ | 6,805 |   |
| Provision                      |       | 1,203                             |       | —                          |       | 1,203     |       |
| Payments  and non-cash charges |       | (1,320                            | )          | (31                             | )          | (1,351    | )          |
| Balance  at August 27, 2004    |       | 6,606                             |       | 51                              |       | 6,657     |       |
| Provision                      |       | 688                               |       | —                          |       | 688       |       |
| Payments  and non-cash charges |       | (461                              | )          | (17                             | )          | (478      | )          |
| Balance  at November 26, 2004  |       | $                                 | 6,833      |                            | $          | 34        |       | $ | 6,867 |   |

 

Additional facilities-related charges were the result of changes inestimates associated with various lease obligations.  Activity related to other restructuring costsprimarily reflected payments to suppliers for restructuring-related services.

 

**Note 5.****                                                          Investmentin Unconsolidated Joint Venture**

 

On November 17, 2003, we formed the Huawei-3ComJoint Venture (H-3C) with a subsidiary of Huawei Technologies, Ltd.(Huawei).  H-3C is domiciled in HongKong, and has its principal operating centers in Hangzhouand Beijing, China.

 

At the time of formation, we contributed cash,assets related to our operations in China and Japan, and licenses related tocertain intellectual property in exchange for a 49 percent ownershipinterest.  We recorded our initialinvestment in H-3C at $160.1 million, reflecting the carrying value of theassets contributed.  Huawei contributedits enterprise networking business assets – including Local Area Network (LAN) switchesand routers; engineering, sales, and marketing resources and personnel; andlicenses to its related intellectual property – in exchange for a 51 percent ownership interest.  Huawei’s contributed assets were valued at$178.2 million at the time of formation. Two years after formation of H-3C, we have the one-time option topurchase an additional two percent ownership interest from Huawei for an amountnot to exceed $28 million.  Three yearsafter formation of H-3C, we and Huawei each have the right to purchase all ofthe other partner’s ownership interest through a bid process.

 

Weaccount for our investment in H-3C by the equity method.  Under this method, we record ourproportionate share of H-3C’s net income or loss based on the most recentlyavailable financial statements.  SinceH-3C follows a calendar year basis of reporting, we report our equity in H-3C’snet income or loss based on H-3C’s financial statements for the most recentcalendar quarter, two months in arrears. In determining our share of H-3C’s net income or loss, we make certainadjustments to H-3C’s reported results. Such adjustments are made primarily to recognize the value and relatedamortization expense associated with Huawei’s contributed assets, as well as todefer H-3C’s sales and gross profit on sales of products sold to us thatremained in our inventory at the end of the accounting period.  During the second quarter of fiscal 2005, werecorded a loss of $2.3 million related to our share of H-3C’s net loss,adjusted as described above, for the quarter ended September 30, 2004; thisloss is included in the accompanying Condensed Consolidated Statement ofOperations under the caption “Equity interest in loss of unconsolidated jointventure.”  During the first half offiscal 2005, we recorded a loss of $4.9 million related to our share of H-3C’snet loss.  The carrying value of ourinvestment in H-3C as of November 26, 2004 was $138.0 million.

 

Summarized condensed unaudited financial information for H-3C, adjustedas described above, is as follows (in thousands):

 

Balance Sheet:

 
| ** **               | ** ** | **September 30,  2004** | ** ** | **March 31,  2004** | ** ** |
|--------------------------|------------|-------------------------|------------|---------------------|------------|
|                     |       |                    |       |                |       |
| Current  assets          |       | $                       | 243,718    |                | $          | 242,904 |   |
| Non-current  assets      |       | 156,609                 |       | 208,471             |       |
| Current  liabilities     |       | 91,203                  |       | 86,825              |       |
| Non-current  liabilities |       | 8,866                   |       | 8,866               |       |
|                          |            |                         |            |                     |            |  |  |

 

 

11

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Statements of Operations:

 
| ** **            | ** ** | **Three  Months-Ended  September 30,  2004** | ** ** | **Six  Months-Ended  September 30,  2004** | ** ** |
|-----------------------|------------|----------------------------------------------|------------|--------------------------------------------|------------|
|                  |       |                                         |       |                                       |       |
| Sales                 |       | $                                            | 65,880     |                                       | $          | 128,580 |   |
| Gross  margin         |       | 26,178                                       |       | 50,768                                     |       |
| Loss  from operations |       | 5,393                                        |       | 11,127                                     |       |
| Net  loss             |       | 4,712                                        |       | 9,951                                      |       |
|                       |            |                                              |            |                                            |            |  |  |

 

We and H-3C are parties to agreements providing for the sale of certainproducts between the two companies.  Duringthe second quarter of fiscal 2005, we made sales of products to H-3C of $3.5million and made purchases of products from H-3C of $3.9 million.  During the first half of fiscal 2005, we madesales of products to H-3C of $7.1 million and made purchases of products fromH-3C of $7.1 million.  As of November 26,2004, our accounts receivable and accounts payable included $1.1 million and$0.7 million, respectively, related to transactions with H-3C.  Also, as of November 26, 2004, we haddeferred approximately $0.3 million related to sales of products to H-3C thathad not yet been shipped to H-3C’s end customers.

 

**Note 6.****                                                          ComprehensiveLoss**

 

The components ofcomprehensive loss, net of tax, are as follows (in thousands):

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                     | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                                           |       |                   |       |                   |       |   |   |   |   |
| Net  loss                                      |       | $                      | (48,811    | )                      | $          | (138,981 | ) | $ | (84,356 | ) | $ | (244,975 | ) |
|                                           |       |                   |       |                   |       |   |   |   |   |
| Other  comprehensive income (loss):            |       |                   |       |                   |       |   |   |   |   |
| Net  unrealized (loss) on investments          |       | (1,590                 | )          | (310                   | )          | (1,326 | ) | (1,333 | ) |
| Net  unrealized (loss) on cash flow hedges     |       | (1,247                 | )          | —                 |       | (959 | ) | — |   |
| Change  in accumulated translation adjustments |       | 2,518                  |       | 641                    |       | 2,358 |   | 658 |   |
|                                           |       |                   |       |                   |       |   |   |   |   |
| Total  comprehensive loss                      |       | $                      | (49,130    | )                      | $          | (138,650 | ) | $ | (84,283 | ) | $ | (245,650 | ) |

 

**Note 7.****                                                          NetLoss per Share**

 

The followingtable presents the calculation of basic and diluted net loss per share (inthousands, except per share data):

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended**   | ** ** |
|----------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                             | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                                   |       |                   |       |                   |       |   |   |   |   |
| Loss  from continuing operations       |       | $                      | (48,811    | )                      | $          | (137,416 | ) | $ | (84,356 | ) | $ | (243,119 | ) |
| Loss  from discontinued operations     |       | —                 |       | (1,565                 | )          | — |   | (1,856 | ) |
| Net  loss                              |       | $                      | (48,811    | )                      | $          | (138,981 | ) | $ | (84,356 | ) | $ | (244,975 | ) |
|                                   |       |                   |       |                   |       |   |   |   |   |
| Weighted  average shares-basic         |       | 378,694                |       | 375,332                |       | 383,140 |   | 371,606 |   |
| Effect  of dilutive securities:        |       |                   |       |                   |       |   |   |   |   |
| Employee  stock options                |       | —                 |       | —                 |       | — |   | — |   |
| Restricted  stock                      |       | —                 |       | —                 |       | — |   | — |   |
| Weighted  average shares-diluted       |       | 378,694                |       | 375,332                |       | 383,140 |   | 371,606 |   |
|                                   |       |                   |       |                   |       |   |   |   |   |
| Net  loss per share-basic and diluted: |       |                   |       |                   |       |   |   |   |   |
| Continuing  operations                 |       | $                      | (0.13      | )                      | $          | (0.37 | ) | $ | (0.22 | ) | $ | (0.65 | ) |
| Discontinued  operations               |       | —                 |       | —                 |       | — |   | (0.01 | ) |
| Net  loss                              |       | $                      | (0.13      | )                      | $          | (0.37 | ) | $ | (0.22 | ) | $ | (0.66 | ) |

 

12

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Employee stockoptions and restricted stock totaling 1.3 million shares and 8.9 million sharesfor the three months ended November 26, 2004 and November 28, 2003,respectively, and 2.5 million shares and 2.8 million shares for the six monthsended November 26, 2004 and November 28, 2003, respectively, were not includedin the diluted weighted average shares calculation as the effects of thesesecurities were anti-dilutive.

 

**Note 8.****                                                       Inventories**

 

Inventories consist of(in thousands):

 
| ** **      | ** ** | **November 26,  2004** | ** ** | **May 28,  2004** | ** ** |
|-----------------|------------|------------------------|------------|-------------------|------------|
|            |       |                   |       |              |       |
| Finished  goods |       | $                      | 20,636     |              | $          | 25,869 |   |
| Work-in-process |       | 632                    |       | 485               |       |
| Raw  materials  |       | 1,076                  |       | 1,325             |       |
|            |       |                   |       |              |       |
| Total           |       | $                      | 22,344     |              | $          | 27,679 |   |

 

**Note 9.****                                                          Propertyand Equipment**

 

Property and equipment,net, consist of (in thousands):

 
| ** **                                 | ** ** | **November 26,  2004** | ** ** | **May 28,  2004** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-------------------|------------|
|                                       |       |                   |       |              |       |
| Land                                       |       | $                      | 6,999      |              | $          | 8,724 |   |
| Building  and improvements                 |       | 38,325                 |       | 38,325            |       |
| Machinery  and equipment                   |       | 168,665                |       | 206,099           |       |
| Software                                   |       | 105,119                |       | 105,943           |       |
| Furniture  and fixtures                    |       | 24,347                 |       | 26,880            |       |
| Leasehold  improvements                    |       | 9,708                  |       | 10,274            |       |
| Construction  in progress                  |       | 1,621                  |       | 1,664             |       |
| Total,  gross                              |       | 354,784                |       | 397,909           |       |
|                                       |       |                   |       |              |       |
| Accumulated  depreciation and amortization |       | (283,676               | )          | (325,457          | )          |
|                                       |       |                   |       |              |       |
| Total,  net                                |       | $                      | 71,108     |              | $          | 72,452 |   |

 

Property and equipment held for sale of $12.2 millionas of November 26, 2004 included land, building and equipment in the U.K.  Property and equipment held for sale of $42.1million as of May 28, 2004 included land, buildings and equipment in Irelandand the U.K.

 

In November 2004, we completed the sale of ourproperty in Dublin that was classified as held for sale.  This property, consisting of approximately468,000 square feet of office and manufacturing space, previously had been usedin our administrative, research and development, and manufacturing activities.

 

13

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Net proceeds from the sale resulted in a gain on the sale of $0.5million that was recorded in restructuring charges in the second quarter offiscal 2005.

 

In November 2003, wecompleted the sale of certain properties in Santa Clara, California that wereclassified as held for sale.  Theseproperties, consisting of approximately 876,000 square feet of office andmanufacturing space and related furniture and fixtures, previously had beenused in our administrative, customer service, research and development, andmanufacturing activities.  Net proceedsfrom the sale resulted in a loss on the sale of $1.4 million that was recordedin restructuring charges in the second quarter of fiscal 2004.

 

In July 2003, wecompleted the sale of our 511,000 square foot office and research anddevelopment facility in Rolling Meadows, Illinois.  Net proceeds from the sale resulted in a losson the sale of $1.1 million that was recorded in restructuring charges in thefirst quarter of fiscal 2004.  As part ofthe terms of the transaction, we entered into an agreement to lease back approximately43,000 square feet of space at then prevailing market rates.

 

**Note 10.****                                                   IntangibleAssets, Net**

 

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

 
| ** **                | ** ** | **November 26,  2004** | ** ** | **May 28,  2004** | ** ** |
|---------------------------|------------|-----------------------------|------------|-------------------|------------|
|                      |       |                        |       |              |       |
| Total,  gross             |       | $                           | 35,995     |              | $          | 37,156 |   |
| Accumulated  amortization |       | (34,175                     | )          | (32,147           | )          |
|                      |       |                        |       |              |       |
| Total,  net               |       | $                           | 1,820      |              | $          | 5,009 |   |

 

In the second quarter of2005, we recorded an impairment of intangible assets, consisting mainly ofdeveloped technology associated with our acquisition of NBX Corporation infiscal 1999.  We determined the amount ofthe impairment by comparing the carrying value of the intangible asset with thefair value, which was estimated as the present value of expected future netcash flows at a discount rate of ten percent per year.  The impairment resulted primarily fromreduced revenue projections, as well as a lower percentage of projected revenuecoming from the existing technology.  Asa result of the impairment analysis, we recorded a write down of $1.2 million,which is included in the caption “Amortization and write down of intangibles”in the condensed consolidated statements of operations for the six months endedNovember 26, 2004.

 

In the first quarter offiscal 2004, we recorded an impairment of intangible assets, consisting mainlyof developed and core technology associated with our acquisition of the GigabitEthernet network interface card business of Alteon Websystems in fiscal2001.  We determined the amount of theimpairment by comparing the carrying value of the intangible assets against thefair value, which was estimated as the present value of expected future netcash flows discounted at a rate of ten percent per year.  The impairment resulted from reduced revenueand gross margin projections as compared to the initial projections at the timeof the acquisition, due to the earlier-than-expected end of life of an acquiredproduct.  As a result of the impairmentanalysis, we recorded a write down of $1.9 million, which is included in thecaption “Amortization and write down of intangibles” in the condensedconsolidated statements of operations for the six months endedNovember 28, 2003.

 

Based on the carryingvalue of our intangible assets as of November 26, 2004, amortizationexpense is expected to be $0.8 million for the second half of fiscal 2005 and$1.0 million for fiscal 2006.

 

**Note 11.****                                                   AccruedLiabilities and Other**

 

Accrued liabilities andother consist of (in thousands):

 

14

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| ** **                            | ** ** | **November 26,  2004** | ** ** | **May 28,  2004** | ** ** |
|---------------------------------------|------------|-----------------------------|------------|-------------------|------------|
|                                  |       |                        |       |              |       |
| Accrued  payroll and related expenses |       | $                           | 32,870     |              | $          | 37,995 |   |
| Accrued  product warranty             |       | 40,865                      |       | 43,825            |       |
| Accrued  rebates                      |       | 25,954                      |       | 29,536            |       |
| Income  and other taxes payable       |       | 48,349                      |       | 34,184            |       |
| Deferred  revenue                     |       | 23,675                      |       | 25,942            |       |
| Other                                 |       | 51,037                      |       | 54,679            |       |
|                                  |       |                        |       |              |       |
| Total                                 |       | $                           | 222,750    |              | $          | 226,161 |   |

 

**Note 12.****                                                   AccruedWarranty and Other Guarantees**

 

Products are sold withvarying lengths of warranty ranging from 90 days to the lifetime of theproducts.  Allowances for estimatedwarranty costs are recorded in the period of sale, based on historical experiencerelated to product failure rates and actual warranty costs incurred during theapplicable warranty period.  Also, on anongoing basis, we assess the adequacy of our allowances related to warrantyobligations recorded in previous periods and may adjust the balances to reflectactual experience or changes in future expectations.

 

The following tablesummarizes the activity in the allowance for estimated warranty costs for thesix months ended November 26, 2004 and November 28, 2003 (inthousands):

 
| ** **                                                           | ** ** | **First six  months of  fiscal 2005** | ** ** | **First six  months of  fiscal 2004** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
|                                                                 |       |                                  |       |                                  |       |
| Accrued  warranty, beginning of period                               |       | $                                     | 43,825     |                                  | $          | 44,775 |   |
| Cost  of warranty claims processed during the period                 |       | (16,751                               | )          | (17,494                               | )          |
| Provision  for warranties related to products sold during the period |       | 13,791                                |       | 17,481                                |       |
| Adjustments  to preexisting warranties                               |       | —                                |       | (23                                   | )          |
|                                                                 |       |                                  |       |                                  |       |
| Accrued  warranty, end of period                                     |       | $                                     | 40,865     |                                  | $          | 44,739 |   |

 

In prior years, weentered into several agreements whereby we sold products to resellers who, inturn, sold the products to others, and we guaranteed the payments of the endusers.  If all end users under theseagreements were to default on their remaining obligations outstanding as ofNovember 26, 2004, we would be required to pay approximately $1.5 million.  However, since deferred revenue and otherassociated accruals related to such sales approximate the guaranteed amounts,any payments resulting from end user defaults would not have a material impacton our results of operations.

 

In connection with thedevelopment of our facility in Rolling Meadows, we guaranteed a municipal bondin the amount of $2.5 million for site improvements.  Our obligation pursuant to the guarantee hadbeen accrued as of May 28, 2004.  Inconnection with the completion of the sale of the Rolling Meadows facility inthe first quarter of fiscal 2004 as discussed in Note 4, we repaid the $2.5million municipal bond.

 

**Note 13.****                                                   Stockholders’Equity**

 

In the first quarter offiscal 2005, we repurchased approximately 15.0 million shares of our commonstock at a total cost of $73.4 million. These repurchases were made pursuant to the stock repurchase programthat was approved by our Board of Directors in March 2003, and thatauthorizes expenditures

 

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of up to $100.0 millionduring a two-year period through March 2005.  We did not repurchase any shares during thesecond quarter of fiscal 2005.  AtNovember 26, 2004, approximately $26.6 million of the authorizationremains available for future repurchases.

 

**Note 14.****                                                   BusinessSegment Information**

 

Effective for fiscal2004, we streamlined our management and operating structure and merged ourprevious multiple operating segments into a single, integrated enterprisenetworking business.  As a result,effective for fiscal 2004, we present financial information related to ourbusiness on the basis of a single segment.

 

Sales by geographicregion is reported based on the customer’s designated delivery point and are asfollows (in thousands):

 
| ** **                         | ** ** | **Three Months Ended**      | ** ** | **Six Months Ended**        | ** ** |
|------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                               |       |                        |       |                        |       |   |   |   |   |
| Americas                           |       | $                           | 59,030     |                        | $          | 60,924 |   | $ | 132,854 |   | $ | 129,527 |   |
| Europe,  Middle East, & Africa |       | 72,945                      |       | 87,979                      |       | 140,327 |   | 151,798 |   |
| Asia  Pacific Rim                  |       | 19,093                      |       | 32,988                      |       | 40,236 |   | 62,445 |   |
|                               |       | $                           | 151,068    |                        | $          | 181,891 |   | $ | 313,417 |   | $ | 343,770 |   |

 

**Note 15.****                                                   Litigation**

 

We are party to lawsuitsin the normal course of our business. Litigation can be expensive and disruptive to normal businessoperations.  Moreover, the results ofcomplex legal proceedings are difficult to predict.  We believe that we have meritorious defensesin each of the cases set forth below in which we are named as a defendant andwe are vigorously contesting each of these matters.  An unfavorable resolution of one or more ofthese lawsuits could adversely affect our business, financial position, orresults of operations.  We cannotestimate the loss or range of loss that may be reasonably possible for any ofthe contingencies described and, accordingly, we have not recorded anyassociated liabilities in our consolidated balance sheets.

 

On March 4, 2003,3Com filed suit against PCTEL, Inc. (PCTEL) in the United States District Courtfor the Northern District of Illinois, Civil Action Number 03C 1582, alleginginfringement of certain of its United States Patents (the “3Com Patents”).  On March 5, 2003, PCTEL filed suitagainst 3Com in the United States District Court for the Northern District ofCalifornia, Civil Action Number C 03 0982, alleging infringement of a UnitedStates Patent held by PCTEL, seeking damages and injunctive relief,****and further seeking a declaration thatPCTEL does not infringe the 3Com Patents and that such patents are void andinvalid.  The action which 3Com initiatedin the District Court for the Northern District of Illinois was transferred tothe District Court for the Northern District of California on June 11,2003 and assigned Civil Action Number C 03 2710.  On August 18, 2003, that action was consolidatedfor certain purposes with the action PCTEL initiated against 3Com in theDistrict Court for the Northern District of California.  In November 2004, we entered into asettlement agreement with PCTEL pursuant to which both 3Com and PCTEL agreed todismiss their respective lawsuits in exchange for a cross license of certaintechnology.  In addition, we have agreedto certain business arrangements with PCTEL regarding wireless software andantennas.

 

On April 28, 1997,Xerox Corporation (Xerox) filed suit against U.S. Robotics Corporation and U.S.Robotics Access Corporation in the United States District Court for the WesternDistrict of New York.  3Com completed itsacquisition of these defendant companies on June 12, 1997.  The case is now captioned *Xerox Corporation v. 3Com Corporation, U.S. RoboticsCorporation, U.S. Robotics Access Corporation, Palm Computing, Inc., and Palm,Inc.* (Civil Action Number 97-CV-6182T).  Xerox

 

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alleged willful infringementof one of its United States patents. Xerox sought to recover damages and to permanently enjoin the defendantsfrom infringing the patent in the future. In 2000, the District Court dismissed the case, ruling that there was noinfringement.  On appeal, the Court ofAppeals for the Federal Circuit affirmed-in-part, reversed-in-part and remandedthe case to the District Court for further action.  On December 20, 2001, the District Courtgranted Xerox’s motion for summary judgment that the patent is valid,enforceable, and infringed.  Thedefendants then filed a Notice of Appeal. On February 22, 2002, the District Court denied Xerox’s motion foran injunction prohibiting further alleged infringement during the appeal andordered the defendants to post a bond in the amount of $50 million.  Xerox then appealed the denial of theinjunction.  On February 20, 2003,the Court of Appeals issued its decision affirming in part and reversing inpart the order of the trial court.  TheCourt of Appeals affirmed the grant of summary judgment of infringement,reversed the grant of summary judgment of validity and remanded the case to thetrial court to conduct a complete validity analysis.  In connection with the separation of Palmfrom 3Com, pursuant to the terms of the Indemnification and Insurance MattersAgreement dated February 26, 2000 between 3Com and Palm, Palm agreed toindemnify and hold 3Com harmless for any damages or losses that might arise outof the Xerox litigation.  On May 21,2004, the District Court awarded summary judgment to the defendants, holdingthat Xerox’s patent was invalid, and dismissed the remaining claims.  Xerox has appealed the decision.

 

**Note 16.****                                                   SubsequentEvent**

 

On December 13,2004, we entered into a definitive agreement to acquire TippingPointTechnologies, Inc., (TippingPoint) a leading provider of networked-basedintrusion prevention systems (IPS).  Thepurchase price is $47.00 in cash per outstanding TippingPoint share.  The total purchase price is currentlyestimated to be approximately $430 million including acquisition costs andassumed stock options.

 

The transaction has beenapproved by both companies’ boards of directors and is subject to the approvalof TippingPoint’s stockholders, regulatory approvals and other customary closingconditions.  Stockholders beneficiallyowning a majority of TippingPoint’s shares have executed voting agreementspursuant to which they have agreed to vote in favor of the transaction.  We expect that the acquisition will becompleted during the second half of fiscal 2005.

 

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***Item 2.*****                            Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

The following discussionshould be read in conjunction with the condensed consolidated financialstatements and the related notes that appear elsewhere in this document.

 

This quarterly report onForm 10-Q contains forward-looking statements. These forward-looking statements include, without limitation,predictions regarding the following aspects of our future:

 

•                  Resultsof operations, including reduced expenses;

•                  Ourprospects and opportunities for future growth and profitability;

•                  Improvementsin net cash flows from operations and our ability to satisfy anticipated cashrequirements for the next twelve months;

•                  Expectedbenefits of the pending acquisition of TippingPoint and the anticipated timingfor the completion of the TippingPoint acquisition;

•                  Expectedbenefits of the Huawei-3Com joint venture;

•                  Selectivehiring;

•                  Relationshipswith key distributors and strategic partners, including the continuedsignificance of certain distributors and increased reliance on strategicrelationships;

•                  Expansionof our product portfolio and solutions and the results thereof, our sourcing ofproducts from original equipment manufacturers and the Huawei-3Com jointventure, and our product mix, including the declining sales of our desktop,mobile and server connectivity products;

•                  Activitiesof 3Com Ventures, including estimated capital call payments over the next 12months to certain venture capital funds;

•                  Expandedoutsourcing activities, including with respect to customer service operations;

•                  Expectedrestructuring charges and the effects of our recent and expected restructuringactivities;

•                  Ourability to compete with Huawei in the enterprise networking market;

•                  Prospectsregarding certain litigation matters;

•                  Cashobligations related to leases, royalty and patent licensing arrangements, IToutsourcing agreements and customer service agreements;

•                  Channelinventory levels; and

•                  Salesgrowth, increases in our direct field sales organization and enhancement of ourservice and support capabilities.

 

You can identify theseand other forward-looking statements by the use of words such as “may,” “can,” “will,”“should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”“intends,” “continue,” or the negative of such terms, or other comparableterminology.  Forward-looking statementsalso include the assumptions underlying or relating to any of the foregoingstatements.

 

Actual results coulddiffer materially from those anticipated in these forward-looking statements asa result of various factors, including those set forth under BusinessEnvironment and Industry Trends.  All forward-lookingstatements included in this document are based on our assessment of informationavailable to us at the time this report is filed.  We undertake no obligation to update anyforward-looking statements.

 

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**BASIS OFPRESENTATION**

 

The following informationrelates to the continuing operations of 3Com Corporation and our consolidatedsubsidiaries (3Com).

 

On May 23, 2003, wecompleted the sale of the CommWorks division and transferred certain assets andliabilities to UTStarcom, Inc. pursuant to the terms of the Asset PurchaseAgreement.  As a result of the sale, wereported the CommWorks division as a discontinued operation beginning in thefourth quarter of fiscal 2003. Accordingly, the condensed consolidated financial statements and therelated notes that appear elsewhere in this document reflect the CommWorksdivision as a discontinued operation for all periods presented.  Unless otherwise indicated, the followingdiscussion relates to our continuing operations.

 

**BUSINESSOVERVIEW**

 

We provide innovative,practical and high-value data and voice networking products, services andsolutions for business enterprises of all sizes and public sectororganizations.  We are a company with aglobal presence, strong brand identity, large intellectual property portfolioand strong balance sheet.  We believethat our relationships with strategic partners, broad product portfolio andsignificant distribution channels provide us with a strong foundation forfuture growth.

 

We generally sell ourproducts through a two-tier distribution channel comprised of distributors andresellers.  Distributors are the firsttier of the channel providing global distribution, logistics, market developmentand other services.  Distributorsgenerally sell to the second tier of the channel, comprising value addedresellers (VARs) and other channel partners. Although a majority of our sales are made through our two-tierdistribution channel, we also work closely with systems integrators, majortelecommunications service providers, and direct marketers.  We also maintain a field sales organizationthat works alongside our channel partners to assist them in achieving theirsales goals.

 

A substantial portion ofour sales is derived from a limited number of distributors, the largest ofwhich are Ingram Micro Inc. and Tech Data Corporation.  We expect that these distributors willcontinue to represent a significant percentage of our sales for the foreseeablefuture.  The table below sets forth thepercentage of sales derived from these major distributors during the secondquarter and first half of fiscal 2005 and 2004.

 
| ** **             | ** ** | **Three Months Ended**      | ** ** | **Six Months Ended**        | ** ** |
|------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **             | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** | **November 26,  2004** | ** ** | **November 28,  2003** | ** ** |
|                   |       |                        |       |                        |       |   |   |   |   |
| Ingram  Micro, Inc.    |       | 21                          | %          | 18                          | %          | 22 | % | 20 | % |
| Tech  Data Corporation |       | 16                          |       | 11                          |       | 15 |   | 12 |   |
| Total                  |       | 37                          | %          | 29                          | %          | 37 | % | 32 | % |

 

We have undergonesignificant changes in recent years, including:

 

•                  exitingproduct lines that were not expected to yield a satisfactory return oninvestment;

•                  significantheadcount reductions;

•                  outsourcingof certain information technology functions (IT) and other functions;

•                  significantchanges to our executive leadership;

•                  outsourcingof all manufacturing activity;

•                  sellingexcess facilities;

•                  formingthe Huawei-3Com Joint Venture (H-3C);

•                  introducingnew product lines targeted at mid- to large-sized enterprises; and

•                  realigningour sales and marketing channels and expenditures.

 

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We believe an overview ofsome of these significant changes is helpful to an understanding of ouroperating results.

 

*SignificantEvents*

 

In the fourth quarter offiscal 2001, we undertook several broad initiatives in an attempt to return usto profitability.  These initiativesincluded exiting certain product lines that were not expected to yield asatisfactory return on investment. During fiscal 2002, we continued to experience declining sales.  In response to this decline, we undertookadditional measures to further reduce costs, including headcount reductions,long term asset retirements, and outsourcing manufacturing operations.  During fiscal 2003, as our sales and overallfinancial performance continued to decline, we undertook several additionalbroad initiatives to achieve further cost savings.  The first of these initiatives involved theintegration of certain central functions of our business units in order toachieve cost savings.  Other actionsincluded headcount reductions, outsourcing of certain IT functions, andcontinuing efforts to consolidate and sell excess facilities.  These actions generated restructuringcharges, but also resulted in reductions in sales and marketing, research anddevelopment, and general and administrative expenses.

 

During fiscal 2004, weundertook a number of actions, affecting both sales and expenses.  We expanded our product portfolio to includemore Layer 3-plus and higher-end products, additional modular switches androuters, and a higher-end Voice-over-Internet Protocol (VoIP) offering.  We believe that such an expanded productportfolio will allow us to deliver converged data and voice networkingsolutions not only to our traditional customers but also to larger andmulti-site enterprises.  We consolidatedour company’s operations into a single integrated business organized alongfunctional lines, and we relocated headquarters and key management positionsand functions from our Santa Clara, California location to our Marlborough,Massachusetts location as a more effective way to run this simplified businessmodel.  Also, we consolidated ouroperations into fewer facilities, disposed of excess real estate, relocatedtransaction processing activities to lower cost locations, outsourced ourDublin, Ireland manufacturing operations to our contract manufacturers, andupgraded and modified our IT infrastructure and systems to more cost-effectivealternatives.  In connection with thesevarious actions, we reduced our overall workforce by approximately forty percent.

 

On November 17,2003, we formed our joint venture, Huawei-3Com (H-3C), which is domiciled inHong Kong and has its principal operating centers in Hangzhou and Beijing,China.  We contributed $160 million incash, assets related to our operations in China and Japan, and licenses torelated intellectual property in exchange for a 49 percent ownership interestof the joint venture.  In the firstquarter of fiscal 2005, we expanded the joint venture’s market to include HongKong in addition to China and Japan.  Weexpect this venture to provide three key benefits to us – an expanded productline, access to low cost and highly effective engineering talent, and asignificant presence in the China, Japan and Hong Kong markets.

 

During the first half offiscal 2005, we undertook several additional actions that we believe willenhance our competitiveness, execution and profitability over the longerterm.  These actions included thefollowing:

 

•                  Weintroduced multiple new products that are targeted at markets we expect willgrow in the future and that are designed to meet the needs of enterprises ofall sizes.  These products includemodular routers and switches sourced from H-3C, including the new 8800 modularswitching family providing 10 Gigabit capability, as well as voice, securityand wireless solutions.

 

•                  Weincreased our focus on our “customer facing” capabilities in the areas ofsales, marketing and service.  We areadding sales and technical support people across our geographies and areincreasing our marketing investments as well. In the second quarter of the fiscal year, we entered an agreement withSiemens Business Services to provide service offerings on a global basis forenterprise customers.  With this newagreement, we can offer a range of support choices for our customers includingtwo and four hour same business day hardware replacement with on siteassistance, as well as expand our foreign language capability and hours ofcoverage for technical support.

 

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•                  Tofurther lower our costs and expenses, we reduced our total workforce byapproximately six percent.  Some of thesereductions in our workforce will be backfilled in the future in connection withselective hiring consistent with our strategy and focus – for example, byincreases in our direct field sales organization targeting mid- to large-sizedbusinesses.

 

On December 13,2004, we entered into a definitive agreement to acquire TippingPointTechnologies, Inc., a leading provider in network-based intrusion preventionsystems (IPS).  If the acquisition iscompleted, we expect TippingPoint will bring a number of benefits to us.  We believe IPS is one of the fastest growingsegments of the security market.  Also,we plan to cross sell into TippingPoint’s customer base; many of theircustomers are target customers for our growing enterprise product line.  We believe TippingPoint’s technologies areuniquely qualified to sell into a converged voice and data environment,allowing us to design reliable VOIP and security solution for enterprisecustomers.  We believe that there arefew, if any, other vendors that could make this claim.

 

*Summary of Financial Performance for the Second Quarter ofFiscal 2005*

 

•                  Oursales for the second quarter of fiscal 2005 were $151.1 million, a decrease of$30.8 million, or 17 percent compared to sales for the second quarter of fiscal2004 of $181.9 million.

 

•                  Ourgross margin increased to 34.9% for the second quarter of fiscal 2005 from31.3% for the second quarter of fiscal 2004.

 

•                  Ouroperating expenses for the second quarter of fiscal 2005 were $102.6 million,compared to $171.8 million for the second quarter of fiscal 2004, a netdecrease of $69.2 million or 40.3 percent. Operating expenses for the second quarter of fiscal 2005 and fiscal 2004included restructuring charges of $4.5 million and $58.9 million, respectively.

 

•                  Ournet loss for the second quarter of fiscal 2005 was $48.8 million compared to anet loss for the second quarter of fiscal 2004 of $139.0 million, animprovement of $90.2 million.

 

•                  Ourbalance sheet remains strong with cash and equivalents and short-terminvestment balances at the end of the second quarter of fiscal 2005 of $1,273.9million, compared to cash and equivalents and short-term investment balances of$1,263.6 million at the end of the first quarter of fiscal 2005.

 

*Business Environment and Future Trends*

 

Networking industryanalysts and participants differ widely in their assessments concerning theprospects for near-term industry growth. We have observed signs of growth in certain industry segments over thepast few months, but such growth has been modest and may not be sustained inthe months ahead.

 

Other industry factorsand trends also present significant challenges in the short term with respectto our goals for sales growth, gross margin expansion and profitability.  Such factors and trends include:

 

•                  Theimpact of the uncertain industry environment on component suppliers andcontract manufacturers, and the related issues of component and capacityavailability and costs;

 

•                  Intensecompetition in the market for higher end, enterprise core routing and switchingproducts;

 

•                  Aggressiveproduct pricing by competitors targeted at gaining share in market segmentswhere we have had a strong position historically, such as the small tomedium-sized enterprise market; and

 

•                  Theadvanced nature and ready availability of merchant silicon, which allowslow-end competitors to deliver feature rich products and makes it increasinglydifficult for us to differentiate our products.

 

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Based on our currentprojections for the third quarter of fiscal 2005 — sales approximately flatsequentially and gross margins to be approximately 35 percent — we expect thatwe will incur a net loss and negative cash flow from operations for thequarter.  Accordingly, although there aresigns of progress with our enterprise networking strategy, we must acceleratethe pace of improvement.  Our key focusfor the remainder of fiscal 2005 is on execution of our business plan to growsales.  Our future success is highlydependent on increased sales of our enterprise networking products, and ourlargest growth opportunities continue to be linked to the expansion of ourproduct lines targeting mid- to large-sized enterprise customers.  As our portfolio of products and solutionshas filled in, our focus increasingly turns to our “customer facing”capabilities—sales, marketing and service.

 

We are committed to ourstrategy of being a leading provider of secure, converged network solutions forsmall, medium and large enterprises.  Webelieve that, through our expanding portfolio of products and solutions, we canoffer enterprise customers a number of advantages, including the following:

 

•                  Withinthe industry, there is a trend towards increased standardization of routing andswitching technology.  Our products andsolutions are based on open technology standards, and are designed andengineered to reduce reliance on proprietary systems, complexity and total costof ownership.

 

•                  Traditionally,enterprises have deployed separate data networking and telephoneinfrastructures, with the attendant costs to install, operate and maintain theseparate infrastructures.  However, the continuedevolution of networking technology is enabling convergence of data, voice andvideo over Internet Protocol (IP) networks. Now, enterprises are finding that new IP telephony networking technologycan enable them to converge their traffic over a single infrastructure andachieve substantial cost savings – in terms of initial purchase price as wellas ongoing costs of operation and maintenance – and provide newproductivity-enhancing telephony features to their employees.  Similarly, the evolution of networkingtechnology is now enabling enterprise-class wireless solutions as well asenhanced security solutions for both wired and wireless environments.  Our convergence-ready data, voice andwireless solutions are built on an open architecture to protect networkinvestments that support evolutionary migrations, heterogeneous networks, andease of integration for new applications.

 

We believe that ourrecent initiatives and our business strategy are consistent with our goals ofgrowth and profitability over the longer term. However, in light of our results of operations and cash flows for thefirst half of fiscal 2005, we may need to restructure our business or realignour resources further to promote growth in sales and achieve additional costand expense savings.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our significantaccounting policies are described in Note 2 to the Consolidated FinancialStatements, which are included in our Annual Report on Form 10-K for the fiscalyear ended May 28, 2004.  Some of thoseaccounting policies require us to make assumptions and estimates that affectthe amounts reflected in our financial statements.  The following accounting policies are thosewhich often require significant judgment and 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 whetherthe fee is fixed or determinable involves consideration of whether asignificant portion of the fee is due after our normal payment terms.  If we determine that the fee is not fixed ordeterminable, we recognize revenue at the time the fee becomes due, providedthat all other revenue recognition criteria have been met.  Also, sales arrangements may containcustomer-specific acceptance requirements for both products and services.  In such cases, revenue is deferred at thetime of delivery of the product or service and is recognized upon receipt ofcustomer acceptance.

 

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For arrangements thatinvolve multiple elements, such as sales of products that include maintenanceor installation services, revenue is allocated to each respective element basedon its relative fair value and recognized when revenue recognition criteria foreach element have been met.  We use theresidual method to recognize revenue when an arrangement includes one or moreelements to be delivered at a future date and vendor-specific objectiveevidence of the fair value of all the undelivered elements exists.  Under the residual method, the fair value ofthe undelivered elements is deferred and the remaining portion of the arrangementfee is recognized as revenue.  Ifevidence of fair value of one or more undelivered elements does not exist,revenue is deferred and recognized when delivery of those elements occurs orwhen fair value can be established.

 

We assess collectibilitybased on a number of factors, including general economic and market conditions,past transaction history with the customer, and the creditworthiness of thecustomer.  If we determine thatcollection of the fee is not reasonably assured, then we defer the fee andrecognize revenue upon receipt of payment. We typically do not request collateral from our customers.

 

A significant portion ofour sales is made to distributors and VARs. Revenue is generally recognized when title and risk of loss pass to thecustomer, assuming all other revenue recognition criteria have been met.  Sales to these customers are recorded net ofappropriate allowances, including estimates for product returns, priceprotection, and excess channel inventory levels.

 

For sales of productsthat contain software that is marketed separately, we apply the provisions ofAICPA Statement of Position 97-2, “Software Revenue Recognition” asamended.  Sales of services, includingprofessional services, system integration, project management and training, arerecognized upon delivery and completion of performance.  Other service revenue, such as that relatedto maintenance and support contracts, is recognized ratably over the contractterm, provided that all other revenue recognition criteria have been met.  Royalty revenue from licensing is recognizedas earned.

 

*Allowancefor doubtful accounts: *Wecontinuously monitor payments from our customers and maintain allowances fordoubtful accounts for estimated losses resulting from the inability of ourcustomers to make required payments. When we evaluate the adequacy of our allowances for doubtful accounts,we take into account various factors including our accounts receivable aging,customer creditworthiness, historical bad debts, and geographic and politicalrisk.  If the financial condition of ourcustomers were to deteriorate, resulting in an impairment of their ability tomake payments, additional allowances might be required.  As of November 26, 2004, our netaccounts receivable balance was $64.4 million.

 

*Inventory:*  Inventory is stated at the lower of standardcost, which approximates cost, or net realizable value.  Cost is determined on a first-in, first-outbasis.  We perform detailed reviewsrelated to the net realizable value of inventory on an ongoing basis, for bothinventory on hand and inventory that we are committed to purchase, givingconsideration 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 might be required; alternatively,we might realize benefits through cost of sales for sale or disposition ofinventory that had been previously written off. As of November 26, 2004, our net inventory balance was $22.3million.

 

*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.  As of November 26, 2004, we had $1.8million of net intangible assets and $0.9 million of goodwill remaining on thebalance sheet, which we believe to be realizable based on the estimated futurecash flows of the associated products and technology.  However, it is possible that the estimatesand assumptions used in assessing the carrying value of these assets, such asfuture sales and expense levels, may need to be reevaluated in the case ofcontinued market deterioration, which could result in further impairment ofthese assets.

 

*Equitysecurities and other investments:*  As of November 26, 2004, we had $154.1million of equity securities and other investments, including $138.0 millionrelated to our investment in H-3C.  We

 

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account fornon-marketable equity securities and other investments at historical cost or,if we have the ability to exert significant influence over the investee, by theequity method.  Investments accounted forby the equity method include investments in limited partnership venture capitalfunds and our investment in H-3C.  Inaccounting for these investments by the equity method, we record ourproportionate share of the fund’s net income or loss, or H-3C’s net income orloss, based on the most recently available quarterly financial statements.  Since H-3C has adopted a calendar year basisof reporting, we report our equity in H-3C’s net income or loss based on H-3C’smost recent quarterly financial statements, two months in arrears.

 

We review all of ourinvestments for impairment whenever events or changes in business circumstancesindicate that the carrying amount of the investment may not be fullyrecoverable.  The impairment reviewrequires significant judgment to identify events or circumstances that wouldlikely have a significant adverse effect on the fair value of the investment.  Investments identified as having an indicationof impairment are subject to further analysis to determine if the impairment isother than temporary; in the event that the indicated impairment is other thantemporary, we write the investment down to its impaired value.

 

*Restructuringcharges:*  Over the lastseveral years we have undertaken significant restructuring initiatives.  These initiatives have required us to recordrestructuring charges related to severance and outplacement costs, leasecancellations, accelerated depreciation and write-downs of held for saleproperties, write-downs of other long-term assets, and other restructuringcosts.  Given the significance of ourrestructuring activities and the time required for execution and completion ofsuch activities, the process of estimating restructuring charges is complex andinvolves periodic reassessments of estimates made at the time the originaldecisions were made.  The accounting forrestructuring costs and asset impairments requires us to record charges when wehave taken actions or have the appropriate approval for taking action, and whena liability is incurred.  Our policiesrequire us to continually evaluate the adequacy of the remaining liabilitiesunder our restructuring initiatives.  Aswe continue to evaluate our business, we might be required to record additionalcharges for new restructuring activities as well as changes in estimates toamounts previously recorded.

 

*Warranty:*  We provide a limited warranty on our productsfor periods ranging from 90 days to the lifetime of the product, depending uponthe product, and we record allowances for estimated warranty costs during theperiod of sale.  The determination ofsuch allowances requires us to make estimates of product return rates and expectedcosts to repair or replace the products under warranty.  If actual return rates or repair andreplacement costs differ significantly from our estimates, adjustments torecognize additional cost of sales might be required.

 

*Incometaxes: *We are subjectto income tax in a number of jurisdictions. A certain degree of estimation is required in recording the assets andliabilities related to income taxes, and it is reasonably possible that suchassets may not be recovered and that such liabilities may not be paid or thatpayments in excess of amounts initially estimated and accrued may berequired.  We assess the likelihood thatour deferred tax assets will be recovered from our future taxable income and,to the extent we believe that recovery is not likely, we establish a valuationallowance.  We consider historicaltaxable income, estimates of future taxable income, and ongoing prudent andfeasible tax planning strategies in assessing the amount of the valuationallowance.  Based on various factors,including our recent losses and estimates of future profitability, we haveconcluded that future taxable income will, more likely than not, beinsufficient to recover our U.S. net deferred tax assets as ofNovember 26, 2004.  Accordingly, wehave established an appropriate valuation allowance to offset such deferred taxassets.  Adjustments could be required inthe future if we determine that the amount to be realized is greater or lessthan the valuation allowance we have recorded.

 

**Effectsof Recent Accounting Pronouncements**

 

In November 2002,the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21, “RevenueArrangements with Multiple Deliverables.” EITF 00-21 addresses certain aspectsof the accounting by a vendor for arrangements under which the vendor willperform multiple revenue

 

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generatingactivities.  EITF 00-21 is effective forfiscal periods beginning after June 15, 2003; for us, EITF 00-21 becameeffective for the second quarter of fiscal 2004.  The adoption of EITF 00-21 did not have amaterial effect on our financial position or results of operations.

 

In December 2003,the SEC released Staff Accounting Bulletin No. 104, “Revenue Recognition”.  SAB 104 clarifies existing guidance regardingrevenue for contracts which contain multiple deliverables to make it consistentwith EITF No. 00-21.  The adoption of SAB104 did not have a material effect on our financial position or results ofoperations.

 

In March 2004, theFASB issued EITF Issue No. 03-1, “The Meaning of Other-Than-TemporaryImpairment and Its Application to Certain Investments.” EITF 03-1 includes newguidance for evaluating and recording impairment losses on debt and equityinvestments, as well as new disclosure requirements for investments that aredeemed to be temporarily impaired. In September 2004, the FASB issuedStaff Position EITF 03-1-1, which delays the effective date until additionalguidance is issued for the application of the recognition and measurementprovisions of EITF 03-1 to investments in securities that are impaired.  We do not believe that adoption of EITF 03-1will have a material impact on our financial position or results of operations.

 

In December 2004,the Financial Accounting Standards Board (FASB) issued Statement No. 123R, “Share-BasedPayment” (SFAS 123R), which requires companies to measure and recognizecompensation expense for all stock-based payments at fair value.  SFAS 123R is effective for all interimperiods beginning after June 15, 2005 and, thus, will be effective for usbeginning with the second quarter of fiscal 2006.  Early adoption is encouraged and retroactiveapplication of the provisions of SFAS 123R to the beginning of the fiscal yearthat includes the effective date is permitted, but not required.  We are currently evaluating the impact ofSFAS 123R on our financial position and results of operations.  See Note 3 of notes to condensed consolidatedfinancial statements included in Part I, Item 1 of this report for informationrelated to the pro forma effects on our reported net loss and net loss pershare of applying the fair value recognition provisions of the previousStatement of Financial Accounting Standards (SFAS) 123, “Accounting forStock-Based Compensation,” to stock-based employee compensation.

 

25

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**Results of Operations**

 

The following table setsforth, for the periods indicated, the percentage of total sales represented bythe line items reflected in our condensed consolidated income statements:

 
| ** **                                                                                                        | ** ** | **Three months ended** | ** ** | **Six months ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                                                        | ** ** | **November 26,**       | ** ** | **November 28,**     | ** ** | **November 26,** | ** ** | **November 28,** | ** ** |
| ** **                                                                                                        | ** ** | **2004**               | ** ** | **2003**             | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Sales                                                                                                             |       | 100.0                  | %          | 100.0                | %          | 100.0 | % | 100.0 | % |
| Cost of sales                                                                                                     |       | 65.1                   |       | 68.7                 |       | 63.4 |   | 68.9 |   |
| Gross margin                                                                                                      |       | 34.9                   |       | 31.3                 |       | 36.6 |   | 31.1 |   |
| Operating  expenses:                                                                                              |       |                   |       |                 |       |   |   |   |   |
| Sales and  marketing                                                                                              |       | 39.3                   |       | 36.1                 |       | 36.5 |   | 37.3 |   |
| Research and  development                                                                                         |       | 14.7                   |       | 13.4                 |       | 14.2 |   | 14.9 |   |
| General and  administrative                                                                                       |       | 9.5                    |       | 12.0                 |       | 9.6 |   | 13.4 |   |
| Amortization and  write down of intangibles                                                                       |       | 1.4                    |       | 0.6                  |       | 1.0 |   | 1.3 |   |
| Restructuring  charges                                                                                            |       | 3.0                    |       | 32.4                 |       | 2.3 |   | 31.3 |   |
| Total operating  expenses                                                                                         |       | 67.9                   |       | 94.5                 |       | 63.7 |   | 98.3 |   |
| Operating loss                                                                                                    |       | (33.0                  | )          | (63.2                | )          | (27.1 | ) | (67.1 | ) |
| Gain (loss) on  investments, net                                                                                  |       | (0.2                   | )          | (6.7                 | )          | 0.0 |   | (3.5 | ) |
| Interest and  other income, net                                                                                   |       | 3.2                    |       | 2.1                  |       | 1.9 |   | 2.2 |   |
| Loss from  continuing operations before income taxes and equity interest in loss of  unconsolidated joint venture |       | (30.1                  | )          | (67.8                | )          | (25.2 | ) | (68.5 | ) |
| Income tax  provision (benefit)                                                                                   |       | 0.7                    |       | 0.8                  |       | 0.2 |   | (1.3 | ) |
| Equity interest  in loss of unconsolidated joint venture                                                          |       | (1.5                   | )          | (6.9                 | )          | (1.6 | ) | (3.7 | ) |
| Loss from  continuing operations                                                                                  |       | (32.3                  | )          | (75.5                | )          | (26.9 | ) | (70.8 | ) |
| Discontinued  operations, net of taxes                                                                            |       | —                 |       | (0.9                 | )          | — |   | (0.5 | ) |
| Net loss                                                                                                          |       | (32.3                  | )%         | (76.4                | )%         | (26.9 | )% | (71.3 | )% |

 

Sales 

 

Sales in the secondquarter of fiscal 2005 totaled $151.1 million, a decrease of $30.8 million, or17 percent, compared to the same quarter one year ago.  Sales in the first six months of fiscal 2005totaled $313.4 million, a decrease of $30.4 million, or 9 percent, compared tothe same period one year ago.

 

The decrease in sales was due primarily to a decline in sales of ourdesktop, mobile, and server connectivity products and our 10/100 Mbps productsas the result of increased competitive pressures.  Partially offsetting this decrease was anincrease in our Gigabit products, reflecting a shift in technology within theindustry from 10/100 switching solutions towards Gigabit switchingsolutions.  Additionally, there was anincrease in voice product sales, reflecting the continued acceptance of ourvoice solutions and the trend towards convergence in the market.  Enterprise networking productsrepresented 91 percent of total sales in the first six months of fiscal 2005compared to 83 percent in the same period one year ago.

 

Sales of our desktop, mobile, and server connectivity products in thesecond quarter and first six months of fiscal 2005 decreased $14.0 million and $29.7 million, respectively,compared to the same periods one year ago. The decrease in sales of connectivity products as compared to the same periodsone year ago is the result of lower unit demand for these products,reflecting the continued shift in technology from traditional network interfacecard (NIC), personal computer (PC) card, and mini-peripheral componentinterconnect (Mini-PCI) form factors to PC chipsets with embedded networkingtechnology, as well as lower average selling prices (ASPs).  Weanticipate that sales of our desktop, mobile, and server connectivity productswill decline sequentially between 15 and 25 percent in the third quarter offiscal 2005 due to both reduced demand for our product offerings and continuedpricing pressures.

 

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*By Geography*:  U.S. sales in the second quarter and first six months of fiscal 2005decreased 12 percent and 2 percent, respectively, when compared to the sameperiods one year ago.  For the secondquarter and the first six months of 2005, the decline in sales of 10/100 Mbpsand connectivity products were offset by increased sales of Gigabit and voiceproducts.  U.S. sales in the secondquarter of fiscal 2005 represented approximately 27 percent of total salescompared to approximately 26 percent of total sales in the second quarter offiscal 2004.  U.S. sales in the first sixmonths of fiscal 2005 represented approximately 32 percent of total salescompared to approximately 30 percent of total sales in the same periodone year ago.

 

International sales in the second quarter andfirst six months of fiscal 2005 decreased 19 percent and 12 percent,respectively, compared to the same periods one year ago.  The decline in international sales, ascompared to the same periods one year ago, was primarily the result of adecline in sales of 10/100 Mbps and connectivity products, which were partiallyoffset by increased sales of Gigabit, voice, and routers sourced from the H-3C.

 

Gross Margin

Gross margin as apercentage of sales improved 3.6 percentage points from 31.3 percent in thesecond quarter of fiscal 2004 to 34.9 percent in the second quarter of fiscal2005.  Gross margin as a percentage ofsales improved 5.5 percentage points from 31.1 percent in the first six monthsof fiscal 2004 to 36.6 percent of sales in the first six months of fiscal 2005.  Significant components of the improvement ingross margins were as follows:

 

| ** **                                     | ** ** | **Second Quarter** | ** ** | **First Six Months** | ** ** |
|------------------------------------------------|------------|--------------------|------------|----------------------|------------|
| Outsourced  manufacturing and facility closure |       | 3.0                | %          | 3.1                  | %          |
| IT and  facilities-related expenses            |       | 1.9                |       | 2.1                  |       |
| Standard-related  margin                       |       | 1.3                |       | 1.0                  |       |
| Warranty  provision                            |       | 1.1                |       | 1.0                  |       |
| Volume-related  impacts                        |       | (4.0               | )          | (2.9                 | )          |
| Customer service  agreement                    |       | (1.3               | )          | (0.6                 | )          |
| Other                                          |       | 1.6                |       | 1.8                  |       |
| Total                                          |       | 3.6                | %          | 5.5                  | %          |

 

•                  Gross margin benefited compared tothe prior year periods due to effects associated with our decision to outsourceour remaining manufacturing operations in Dublin during fiscal 2004.  Such effects include lower operating costsand the absence of impairment and transition costs incurred in the prior yearperiods.

 

•                  We allocate and report both IT andfacilities-related expenses as a component of cost of sales and operatingexpenses.  The portion of such expensesallocated to cost of sales decreased by $3.4 million and $7.1 million in thesecond quarter and the first six months of fiscal 2005, respectively.

 

•                  Standard-related margin is a measureof product selling prices less direct manufacturing costs.  The increase in standard-related margin ascompared to the same periods one year ago was primarily related to product costreductions.

 

•                  Warranty costs decreased in the threeand six month periods of fiscal 2005 compared to the same periods one year agoprimarily due to improvements in the quality of our products and the cost ofservices.

 

•                  Volume-related impacts include higherpost-sale technical support costs, manufacturing overhead costs, and royaltyfees as a percentage of sales.  Since aportion of these costs is not directly variable with sales, these costs did notdecline at the same rate as sales.

 

•                  In the second quarter of fiscal 2005we entered into an agreement with SiemensBusiness Services to outsource and enhance our customer service offerings.  This agreement resulted in

 

27

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transition costs that were not incurred in previousquarters.

 

Operating Expenses

Total operating expensesin the second quarter of fiscal 2005 were $102.6 million compared to $171.8million in the second quarter of fiscal 2004, a net decrease of $69.2million.  In aggregate, sales andmarketing, research and development and general and administrative expensesdecreased by $15.9 million.  Restructuringcharges decreased by $54.4 million. Partially offsetting these decreases was an increase in amortization andwrite down of intangibles in the second quarter of fiscal 2005 of $1.1 millioncompared to the prior year quarter.

 

As a percent of sales,total operating expenses in the second quarter of fiscal 2005 were 67.9percent, compared to 94.5 percent in the second quarter of fiscal 2004.  In aggregate, sales and marketing, researchand development and general and administrative expenses were 63.5 percent ofsales in the second quarter of fiscal 2005, compared to 61.5 percent in thesecond quarter of fiscal 2004.  To asignificant degree, these expenses are controllable and discretionary overtime, but they are not directly variable with sales levels within a particularperiod.  Amortization and write down ofintangibles and restructuring costs were 1.4 percent and 3.0 percent of sales,respectively, in the second quarter of fiscal 2005, compared to 0.6 percent and32.4 percent, respectively, in the second quarter of fiscal 2004.

 

Total operating expensesin the first six months of fiscal 2005 were $199.6 million compared to $337.5million in the first six months of fiscal 2004, a net decrease of $137.9million.  In aggregate, sales andmarketing, research and development and general and administrative expensesdecreased by $36.4 million from the prior year first half.  In addition, amortization and write down ofintangibles and restructuring charges in the first half of fiscal 2005decreased by $1.3 million and $100.2 million, respectively, from the first halfof fiscal 2004.

 

As a percent of sales,total operating expenses in the first six months of fiscal 2005 were 63.7percent, compared to 98.3 percent in the first six months of fiscal 2004.  In aggregate, sales and marketing, researchand development and general and administrative expenses were 60.4 percent ofsales in the first six months of fiscal 2005, compared to 65.6 percent in thefirst six months of fiscal 2004.  To asignificant degree, these expenses are controllable and discretionary overtime, but they are not directly variable with sales levels within a particularperiod.  Amortization and write down ofintangibles and restructuring costs were 1.0 percent and 2.3 percent of sales,respectively, in the first six months of fiscal 2005, compared to 1.3 percentand 31.3 percent, respectively, in the first six months of fiscal 2004.

 

We allocate and reportIT-related and facilities-related expenses as a component of cost of sales andoperating expenses.  On an overall basis,total operating expenses for the second quarter and first half of 2005reflected a decrease in IT and facilities-related expenses, as compared to thesame three and six-month periods one year ago, largely as a result of employeereductions and other costs associated with our IT outsourcing initiatives.

 

A more detaileddiscussion of the factors affecting each major component of total operatingexpenses is provided below.

 

*Sales andMarketing. *Sales andmarketing expenses in the second quarter of fiscal 2005 decreased $6.2 millionas compared to the second quarter of fiscal 2004, primarily due to reducedworkforce-related expenses, reflecting the reduction of direct-touch salesrepresentatives.  Additionally, reducedIT and facilities-related expenses contributed to the decreased sales andmarketing expenses.  Sales and marketingexpenses in the first six months of fiscal 2005 decreased $13.8 million ascompared to the comparable period of fiscal 2004, primarily due to decreasedworkforce-related and reduced IT and facilities-related expenses as discussedabove.

 

*Researchand Development. *Researchand development expenses in the second quarter of fiscal 2005 decreased $2.3million as compared to the second quarter of fiscal 2004 due to reduced IT andfacilities-related expenses and lower employee-related expenses resulting fromreduced headcount.  Research anddevelopment expenses in the first six months of fiscal 2005 decreased $6.7million as compared to the

 

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first six months offiscal 2004 due to reduced IT and facilities-related expenses, as well as loweremployee related expenses.  Thesedecreases were offset to some degree by a charge of approximately $1.7 recordedduring the first quarter of fiscal 2005 with respect to purchased in-processtechnology.

 

G*eneral andAdministrative. *General andadministrative expenses in the second quarter and first six months of fiscal2005 decreased $7.4 million and $15.9 million, respectively, from thecomparable prior periods of fiscal 2004. Factors contributing to the decreases included reduced workforce-relatedexpenses resulting from lower headcount, reduced fees for professional servicesrelated to completing the establishment of H-3C, and reduced IT and legalexpenses.

 

*Amortizationand Write Down of Intangibles.** *Amortization and write down ofintangibles increased $1.1 million in the second quarter of fiscal 2005 ascompared to the second quarter of fiscal 2004. This increase was due to an impairment charge of $1.2 million related todeveloped technology associated with the acquisition of assets from NBXCorporation in fiscal 1999.  Amortizationand write down of intangibles decreased $1.3 million in the first six months offiscal 2005 as compared to the first six months of fiscal 2004 due to reducedimpairment charges as well as reduced amortization expenses reflecting a lowerbase of intangible assets.  In the firstsix months of fiscal 2004, there was an impairment charge of $1.9 millionrelated to developed and core technology associated with the acquisition ofassets from Alteon Websystems in fiscal 2001.

 

*RestructuringCharges.*Restructuring charges in the second quarter and first six months of fiscal 2005were $4.5 million and $7.3 million, respectively.  Restructuring charges in the secondquarter of fiscal 2005 included $2.5 million for facilities-related costs,reflecting additional charges of $3.2 million related to revisions in estimatesof lease obligation costs offset by a $0.7 million benefit related to fairvalue adjustments of properties classified as held for sale.  Restructuring charges in the second quarterof fiscal 2005 also included charges of $1.8 million for severance andoutplacement costs and $0.2 million for other restructuring costs, primarilycosts associated with the termination of service agreements.  Restructuring charges in the first six monthsof fiscal 2005 included $1.6 million for facilities-related costs, reflectingadditional charges of $4.8 million related to revisions in estimates of leaseobligation costs offset by a $3.3 million benefit related to fair valueadjustments of properties classified as held for sale.  Restructuring charges in the first half offiscal 2005 also included charges of $5.0 million for severance andoutplacement costs and $0.7 million for other restructuring costs, primarilycosts associated with the termination of service agreements.  Additional restructuring charges are expectedto be recorded in the second half of fiscal 2005 in connection with the ongoingtransition of our customer service operations to a third-party provider.

 

Restructuringcharges in the second quarter and first six months of fiscal 2004 were $58.9million and $107.5 million, respectively. Restructuring charges in the second quarter of fiscal 2004 included $32.9million in facilities-related charges, including $20.9 million for accelerateddepreciation of a Santa Clara facility, $4.6 million of accelerateddepreciation of our Dublin manufacturing facility, a $1.4 million loss on thesale of certain Santa Clara properties, $1.4 million of fair value adjustmentsrelated to properties held for sale in Hemel Hempstead, U.K. and Dublin, and$4.6 million of other charges related to revisions in estimates of leaseobligation costs.  Restructuring charges in the second quarterof fiscal 2004 also included $23.5 million in severance related charges and$2.5 million related to other restructuring costs, primarily relating tolong-term asset write downs. Restructuring charges in the first six months of fiscal 2004 included $68.8million in facilities-related charges, including $26.4 million of accelerateddepreciation of a Santa Clara facility, $22.1 million for an impairment andaccelerated depreciation of our Dublin manufacturing facility, $12.6 million incharges for the write down and sale of certain Santa Clara properties, a lossof $1.1 million related to the sale of our Rolling Meadows, Illinois facility,$1.1 million of fair value adjustments related to properties held for sale inHemel Hempstead and Dublin, and $5.5 million of other facilities-relatedcharges.  Restructuring charges in the first six months of fiscal 2004 alsoincluded $31.0 million in severance related charges and $7.7 million related toother restructuring costs, primarily relating to the outsourcing of ourmanufacturing operations.  Thesecharges were primarily the result of cost reduction efforts initiated in fiscal2004.

 

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Gain (Loss) onInvestments, Net

 

Net loss on investmentsin the second quarter and first six months of fiscal 2005 was mainly the resultof write downs of long term equity investments. Net loss on investments in the second quarter of fiscal 2004 was dueprimarily to market value adjustments of limited partner venture funds andwrite downs of long term equity investments. Net loss on investments in the first half of fiscal 2004 was dueprimarily to market value adjustments and sale of investments in limitedpartner venture funds.

 

Interest and Other Income, Net

 

Interest and otherincome, net, of $4.8 million in the second quarter of fiscal 2005 increased$1.0 million compared to the second quarter of fiscal 2004.  The increase was primarily driven by anincrease in interest income that resulted from higher market interest rates.

 

Interest and otherincome, net, in the first six months of fiscal 2005 decreased $1.9 million ascompared to the first six months of fiscal 2004. The reduction reflected aprovision for unrecoverable value added tax for prior years that was recordedin the first half of fiscal 2005 as a result of an unfavorable tax authorityruling ($2.4 million), partially offset by a reduction in interest expense.

 

Income Tax Provision (Benefit) 

 

Our tax provision in thesecond quarter of fiscal 2005 and fiscal 2004 was the result of providing fortaxes in certain state and foreign jurisdictions.  Our income tax provision for the first sixmonths of fiscal 2005 was the result of providing for taxes in certain stateand foreign jurisdictions, partially offset by the favorable resolution of anincome tax audit in a foreign jurisdiction. Our income tax benefit for the first six months of fiscal 2004 includedthe benefit of a foreign net operating loss carryback of $8.5 million,partially offset by a provision of $4.0 million for taxes in certain state andforeign jurisdictions.

 

Equity Interest in Loss of Unconsolidated JointVenture

 

As discussed above, weaccount for our investment in H-3C under the equity method.  Under this method, we record our proportionate share of H-3C’s netincome or loss based on the most recently available financial statements.  Since H-3C follows a calendar year basis ofreporting, we report our equity in H-3C’s net income or loss based on H-3C’sfinancial statements for the most recent calendar quarter, two months inarrears. During the second quarter of fiscal 2005, we recorded a chargeof $2.3 million representing our ownership share of the net loss from operationsincurred by H-3C for the quarter ended September 30, 2004.

 

H-3C was formed duringour second quarter of fiscal 2004.  Atthat time, we recorded a charge of $12.6 million representing our ownershipshare of the value attributed to in-process technology contributed to H-3C byHuawei that had not yet reached technological feasibility and had noalternative future use.

 

DiscontinuedOperations

 

Discontinued operationsrelate to our CommWorks business unit that was sold in the fourth quarter offiscal 2003.  We recorded a loss of $1.6million and $1.9 million in the second quarter and first six months of fiscal2004, respectively, due to adjustments to previous estimates of liabilitiesrelated to the sale of CommWorks.

 

**Liquidity andCapital Resources**

** **

Cash and equivalents and short-term investments at November 26, 2004were $1,273.9 million, a decrease of approximately $109.5 million compared tothe balance as of May 28, 2004 of $1,383.4 million.

 

Net cash used inoperating activities was $65.9 million in the first six months of fiscal 2005,primarily

 

30

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reflecting our loss fromcontinuing operations of $84.4 million. We expect that cash flows from operating activities will be negativeduring third quarter of fiscal 2005, and probably longer, due to projectedcontinuing net losses.  There are noassurances that we can reduce our net losses and negative cash flow in theforeseeable future, or that we can raise additional capital if needed to fundour operations on an ongoing basis. However, based on current business conditions and our current operatingand financial plans, but subject to the discussion in Business Environment andIndustry Trends below, we believe that our existing cash and equivalents and short-terminvestments will be sufficient to satisfy our anticipated cash requirements forat least the next twelve months.  As aresult of the aforementioned fiscal 2005 restructuring actions and relatedcharges, and based on our current projections for sales, costs and expenses,which are subject to significant uncertainty, we expect net cash flow fromoperations to be improved by approximately $1 million per quarter from thelevel reported for the second quarter of fiscal 2005.  This improvement excludes the impact of cashdisbursements to be made in settlement of liabilities accrued as of November26, 2004 and is not expected to be fully realized until the fourth quarter offiscal 2005.

 

Significant commitmentsthat will require the use of cash in future periods include the pendingacquisition of TippingPoint, as well as obligations under lease, contractmanufacturing, royalty and patent licensing arrangements, IT outsourcingagreements, customer service agreements and guarantee agreements.  Total future lease obligations as of November26, 2004 were $50.8 million, of which $19.4 million will be paid over the nexttwelve months.  Obligations under royaltyand patent licensing arrangements as of November 26, 2004 were approximately$12.0 million, all of which is expected to be paid over the next twelvemonths.  Under our IT outsourcingagreements, we are subject to minimum annual payments that vary depending onthe service level we choose.  Based uponcurrent service levels, we would owe approximately $37.9 million throughDecember 2013, of which $4.7 million will be paid over the next twelve months.  Termination of such agreements prior to December2013 would result in early termination penalties that decline over time.  If we were to terminate the agreements at thebeginning of the third quarter of fiscal 2005, such penalties are estimated tobe approximately $2.8 million.  Under ourcustomer service agreements, we are subject to minimum annual payments thatvary depending on the volume of service provided.  Based upon our estimated service volumes, wewould owe approximately $122.3 million through the next seven years, of which$13.1 million will be paid over the next twelve months.   Termination of such agreements prior to thisdate would result in early termination fees.

 

Net cash provided byinvesting activities was $10.7 million for the first six months of fiscal 2005,including approximately $37.8 million from the sale of property and equipment,primarily our Dublin facility.  Theseproceeds were offset by $17.9 million of net outflows related to purchases,sales and maturities of debt and equity securities, $7.5 million of outflowsrelated to the purchase of property and equipment, and expenditures of $1.7million related to the purchase of technology assets.  As of November 26, 2004, capital expenditurecommitments outstanding were not material.

 

Our investments in equitysecurities include the activities of 3Com Ventures.  3Com Ventures selectively makes strategicinvestments in privately-held companies and in limited partnership venturecapital funds, which in turn invest in privately-held companies.  These investment activities may include astrategic commercial or technology relationship, such as a component supplyagreement or technology license arrangement, and are entered into with theintention of complementing our business strategies and research and developmentefforts.  3Com Ventures made additionalinvestments of $0.9 million in the first six months of fiscal 2005 with respectto investments initially made in prior periods; also, at November 26, 2004,3Com Ventures was contractually obligated to make additional capitalcontributions totaling $8.1 million to certain venture capital funds.  The expiration dates for such capital callsare generally five to eight years from the inception of the fund, and theamounts and timing of such calls during that period are made at the discretionof the funds’ general partners.  Weestimate that we will pay approximately $3.4 million over the next twelvemonths as capital calls are made.

 

Net cash used infinancing activities was $64.3 million in the first six months of fiscal2005.  There were no borrowings orrepayments under our revolving line of credit during the first six months offiscal 2005.  During November 2004, our revolving line ofcredit agreement expired according to its terms.

 

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Effective November 29, 2004, we entered a new credit agreementfacilitating the issuance of standby letters of credit and bank guaranteesrequired in the normal course of business.

 

In the firstquarter of fiscal 2005, we repurchased approximately 15.0 million shares of ourcommon stock at a total cost of $73.4 million. These repurchases were made pursuant to the stock repurchase programthat was approved by our Board of Directors in March 2003, and that authorizesexpenditures of up to $100.0 million during a two-year period through March2005.  There were no repurchases duringthe second quarter of fiscal 2005. At November 26, 2004, approximately $26.6million of the authorization remained available for future repurchases.

 

In the first six monthsof fiscal 2005, we issued 2.1 million shares of stock under our employee stockplans and collected $9.1 million related to such issuances.

 

As of November 26, 2004,our outstanding stock options as a percentage of outstanding shares were 15percent.  Stock option activity duringthe first six months of fiscal 2005 and stock option detail as of November 26,2004, were as follows:

 
| ** **                      | ** ** | **Number**         | ** ** | **Weighted average** | ** ** |
|---------------------------------|------------|--------------------|------------|----------------------|------------|
| ** **                      | ** ** | **of shares**      | ** ** | **exercise price**   | ** ** |
| ** **                      | ** ** | **(in thousands)** | ** ** | ** **           | ** ** |
| Outstanding, May  28, 2004      |       | 56,885             |       | $                    | 7.18       |   |
| Granted                         |       | 5,845              |       | 4.69                 |       |
| Exercised                       |       | (1,103             | )          | 5.02                 |       |
| Canceled                        |       | (6,002             | )          | 7.18                 |       |
| Outstanding,  November 26, 2004 |       | 55,625             |       | $                    | 6.96       |   |

 
| ** **          | ** ** | ** **    | ** ** | **Outstanding options  as of November 26, 2004** | ** ** | **Exercisable at November 26, 2004** | ** ** |
|---------------------|------------|---------------|------------|--------------------------------------------------|------------|--------------------------------------|------------|
| **Range of**        | ** ** | **Number**    | ** ** | **Weighted average**                             | ** ** | **Number**                           | ** ** | **Weighted average** | ** ** |
| **exercise prices** | ** ** | **of shares** | ** ** | **exercise price**                               | ** ** | **of shares**                        | ** ** | **exercise price** | ** ** |
| ** **          | ** ** | ** **    | ** ** | **(in thousands)**                               | ** ** | ** **                           | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $                   | 0.13       | -             | $          | 4.00                                             |       | 207                                  |       | $ | 3.28 |   | 203 |   | $ | 3.27 |   |
| 4.01                | -          | 5.00          |       | 15,585                                           |       | 4.60                                 |       | 6,863 |   | 4.63 |   |
| 5.01                | -          | 6.00          |       | 17,800                                           |       | 5.56                                 |       | 13,962 |   | 5.63 |   |
| 6.01                | -          | 7.00          |       | 4,064                                            |       | 6.22                                 |       | 3,159 |   | 6.20 |   |
| 7.01                | -          | 8.00          |       | 3,796                                            |       | 7.51                                 |       | 3,086 |   | 7.48 |   |
| 8.01                | -          | 21.57         |       | 14,173                                           |       | 11.43                                |       | 13,634 |   | 11.55 |   |
| Total               |       | 55,625        |       | $                                                | 6.96       |                                 | 40,907     |   | $ | 7.61 |   |
|                     |            |               |            |                                                  |            |                                      |            |  |  |  |  |  |  |  |  |

 

The following table summarizes our equity compensation plans as ofNovember 26, 2004:

 
| ** **                                              | ** ** | **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)**                                 | ** ** |
| ** **                                              | ** ** | **(in  thousands)**                                               | ** ** | ** **                                                    | ** ** | **(in  thousands)**                                                                                                         | ** ** |
|                                                    |       |                                                              |       |                                                          |       |                                                                                                                        |       |
| Equity compensation plans approved by stockholders      |       | 26,762                                                            |       | $                                                             | 7.17       |                                                                                                                        | 19,706     |   |
| Equity compensation plans not approved by stockholders* |       | 28,630                                                            |       | 6.77                                                          |       | —                                                                                                                      |       |
| Total                                                   |       | 55,392                                                            |       | $                                                             | 6.97       |                                                                                                                        | 19,706     |   |

 

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*Excludes0.2  million outstanding options with anaverage exercise price of $5.68.  Theseoptions were assumed in connection with acquisitions and no additional optionsare available for future issuance under such plans.

 

Options issued outside of the stockholder-approved planswere issued under our broad-based 1994 Stock Option Plan, as amended.  Options granted from this plan were grantedat fair value, vest over two to four years, and expire ten years after the dateof grant.  Effective September 2003, the2003 Stock Plan was approved by stockholders and has replaced the 1994 StockOption Plan for all grants subsequent to the approval date.  Also, in September 2003, stockholders approved a five million shareincrease in the number shares available for issuance under the Employee StockPurchase Plan.

 

**Business Environment and Industry Trends**

 

Industry trends and specific risks may affectour future business and results.  The matters discussed below could causeour future results to differ from past results or those described inforward-looking statements and could have a material adverse effect on ourbusiness, financial condition, results of operations and stock price.

 

***We have incurred significant net losses in recent fiscal periods,including $84 million for the first half of fiscal 2005, and $349 million,$284 million and $596 million for fiscal years 2004, 2003 and 2002,respectively, and we may not be able to return to profitability.***

 

We incurred a net loss of $84****millionfor the first half of fiscal 2005, and net losses of $349 million, $284 millionand $596 million for fiscal 2004, 2003 and 2002, respectively. Although we are taking steps designed to improve our results of operations, wecannot assure you that we will return to profitability.

 

We have faced a number of challenges thathave affected our operating results during the current and past several fiscalyears.  Specifically, we have experienced, and may continue to experience,the following:

 

•                                          declining sales due to price competition andreduced incoming order rate;

 

•                                          increased risk of excess and obsoleteinventories;

 

•                                          excess facilities;

 

•                                          operating expenses that, as a percentage ofsales, have exceeded our desired financial model; and

 

•                                          disruptions resulting from our workforcereductions and employee attrition.

 

***We focus primarily on enterprise networking, and our results ofoperations may fluctuate based on factors related entirely to conditions inthis market.***

 

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In fiscal 2004, we began operating in asingle business segment focused primarily on enterprise networking.  Thissingle enterprise networking business reflects a streamlined management andoperating structure encompassing all of our operations, including ourconnectivity business that we previously operated and reported as a separatesegment and which we expect will continue to diminish.  Our focus onenterprise networking may cause increased risk or volatility associated withdecreased diversification of our business.  There will be increasedsensitivity to the business risks associated specifically with the enterprisenetworking market and our ability to execute successfully on our strategies toprovide superior solutions for larger and multi-site enterpriseenvironments.  To be successful in the enterprise networking market, wewill need to overcome negative perceptions of our company held by certain chiefinformation officers of large enterprises, who may be skeptical of ourlong-term commitment to the high-end networking business as a result of ourwithdrawal from that business in fiscal 2000.  Also, expansion of sales tolarge enterprises may be disruptive in a variety of ways, such as adding largersystems integrators that may raise channel conflict issues with existingdistributors, or a perception of any diminished focus on the small and mediumenterprise market.

 

***We may not respond effectively to increased competition caused byindustry volatility and consolidation.***

 

Our business could be seriously harmed if wedo not compete effectively.  We face competitive challenges that arelikely to arise from a number of factors, including:

 

•                                          industry volatility resulting from rapidproduct development cycles;

 

•                                          increasing price competition due tomaturation of basic networking technologies;

 

•                                          industry consolidation resulting incompetitors with greater financial, marketing, and technical resources; and

 

•                                          the presence of existing competitors withgreater financial resources together with the potential emergence of newcompetitors with lower cost structures and more competitive offerings.

 

***We may not be able to compensate for lower sales or unexpected cashoutlays with cost reductions sufficient to generate positive net income or cashflow.***

 

Although we have implemented cost and expensereductions, if we are unable to achieve our growth objectives, we will need tofurther reduce costs which may in turn reduce our sales.  If we are notable to effectively reduce our costs and expenses, we may not be able togenerate positive net income or cash flow from operations.  If we continueto experience negative cash flow from operations over a prolonged period oftime or if we suffer unexpected cash outflows, our liquidity and ability tooperate our business effectively could be adversely affected.  Forexample, our ability to raise financial capital may be hindered due to thepossibility of continuing net losses and negative cash flow in thefuture.  An inability to raise financial capital would limit our operatingflexibility.

 

We are unable to predict the exact amount ofcost reductions required for us to generate positive net income or cash flowfrom operations because we cannot accurately predict the amount of our futuresales.  The amount of our future sales depends, in part, on futureeconomic and market conditions, which are difficult to forecastaccurately.  Although we cannot accurately predict the amount of ourfuture sales

 

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overall, we expect that sales from sales ofdesktop, mobile and server connectivity products, which representedapproximately 9****percentof total sales for the first half of fiscal 2005, will decline further due tochanging technological trends in the networking industry as well as continuingpricing pressures.

 

***Efforts to reduce operating expenses could involve further workforcereductions and lead to reduced sales and other disruptions in our business.***

 

Our operating expenses as a percent of salescontinue to be higher than our desired long-term financial model.  We havetaken, and will continue to take, actions to reduce these expenses. Consistent with our strategy and growth goals, future actions will be focusedon resources and investments that are not associated with our “customer facing”sales and support activities.  Suchfuture actions could include further reductions in our workforce, relocation offunctions and activities to lower cost locations, changes or modifications inIT systems or applications, or process reengineering.  As a result ofthese actions, the employment of some employees with critical skills might beterminated, and other employees might leave our company voluntarily due to theuncertainties associated with our business environment and their jobsecurity.  In addition, reductions in overall staffing levels might makeit more difficult for us to achieve our growth objectives, to adhere to ourpreferred business practices and to address all of our legal and regulatoryobligations in an effective manner, which could, in turn, ultimately lead tomissed business opportunities, higher operating costs or penalties.

 

***We entered into a joint venture in China with Huawei that, if notsuccessful, could materially and adversely impact our business, businessprospects and operating results.***

 

In November 2003, we formed a jointventure for enterprise networking products with Huawei, a leading Chinesecompany.  3Com currently has a 49 percent minority interest in H-3C,which is domiciled in Hong Kong and has its principal operations in Hangzhouand Beijing, China.  Pursuant to the joint venture agreements, as amendedand supplemented in the first quarter of fiscal 2005, we have the right tomarket and support the H-3C products under the 3Com® brand in all countriesexcept China and Japan.  The joint venture sells products sourcedinternally as well as from 3Com and Huawei under H-3C’s brand as well as the3Com brand and the Huawei brand directly in China, Japan and Hong Kong.

 

The business of H-3C is subject to all of theoperational risks that normally arise for a technology company with global operationspertaining to research and development, manufacturing, sales, service,marketing, and corporate functions.  In addition, there could bedisagreements between 3Com and Huawei with respect to important strategic andoperational decisions.  A key factor in the success of H-3C is thatproduct sourced from it remains competitive over time particularly with respectto features, performance, quality and cost.  For example, one factor thatcould affect cost competitiveness is future adverse exchange rate movementsbetween H-3C’s local currency of operations and the U.S. Dollar.  Inaddition, competition in the enterprise networking market involves challengesfrom numerous, well-established companies with substantial resources andsignificant market share.

 

Our business, business prospects andoperating results have dependencies upon the success of H-3C.  Inparticular, our product development activities will become increasinglyinterdependent with those of H-3C.  If H-3C and our transactions with itare not successful, we may not introduce new products needed to broaden ourhigh-end enterprise networking product line, which may adversely affect oursales and overall results of operations.  Also, if H-3C enters into OEMagreements with companies who compete with us, we could face increasedcompetition in the markets in which we operate.

 

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***We may pursue acquisitions of other companies that, if not successful,could adversely affect our business, financial position and results ofoperations.***

 

The networking business is highlycompetitive.  As a result, our success is dependent, in part, on ourability to meet the needs of new customers and markets by enhancing existingproducts and solutions, and introducing new products and solutions, on a timelybasis.  Our efforts to enhance existing offerings and develop newofferings include:

 

•                                          internal research and development activities

 

•                                          the H-3C joint venture and other strategicrelationships; and

 

•                                          acquisitions.

 

As described elsewhere inthis report, on December 13, 2004, we announced that we have entered into adefinitive Agreement and Plan of Merger whereby we will acquire TippingPoint.In the future, we may pursue additional acquisitions of other companies withestablished market access and position or promising technology and products toenhance our existing capabilities.

 

Acquisitions involve numerous risks,including the following:

 

•                                          potential difficulties related to integratingthe technologies, products and operations of the acquired company;

 

•                                          failure to operate as a combined organizationutilizing common information and communication systems, operating procedures,financial controls and human resources practices;

 

•                                          diverting management’s attention from the normaldaily operations of the business;

 

•                                          potential difficulties in completing projectsassociated with purchased in-process research and development;

 

•                                          entering markets in which we have no orlimited direct prior experience and where competitors in such markets havestronger market positions;

 

•                                          potential loss of key employees of theacquired company; and

 

•                                          an uncertain sales and earnings stream fromthe acquired company, which may result in unexpected dilution to our earnings.

 

There can be no assurances that our pendingacquisition of TippingPoint will be completed as planned or that theacquisition of TippingPoint or other acquisitions that we might pursue will besuccessful.   If we pursue an acquisition but are not successful incompleting it, or if we complete an acquisition but are not successful inintegrating the acquired company’s technology, products or operationssuccessfully, our business, financial position or results of operations couldbe adversely affected.

 

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***We expect to utilize joint ventures and other alliances as key elementsin our strategy.  If we are notsuccessful in forming desired ventures and alliances or if such ventures andalliances are not successful, our ability to achieve our growth andprofitability goals could be adversely affected.***

 

As discussed above, in November 2003, weformed a joint venture in China for enterprise networking products.  Inaddition, we have announced alliances with third parties, such as Electronic DataSystems Corporation (EDS), Aspect Communications Corporation, CrossbeamSystems, Inc., Trapeze Networks and Siemens Business Services.  At thepresent time, these relationships are in the early stages of development andhave not yet produced the benefits that we hope to ultimately achieve.  Inthe future, we expect to evaluate other possible strategic relationships,including joint ventures and other types of alliances, and we may increase ourreliance on such strategic relationships to broaden our sales channels,complement internal development of new technologies and enhancement of existingproducts, and exploit perceived market opportunities.

 

Strategic relationships can present a numberof challenges. For example, we compete in business areas with companies withwhich we, at the same time, have strategic alliances in other businessareas.  Also, if we fail to form the number and quality of strategicrelationships that we desire, or if such strategic relationships are notsuccessful, we could suffer missed market opportunities, channel conflicts,delays in product development or delivery, or other operationaldifficulties.  Further, if third parties acquire our strategic partners orif our competitors enter into successful strategic relationships, we may faceincreased competition.  Any of these difficulties could have an adverseeffect on our future sales and results of operations.

 

***Our strategy of outsourcing functions and operations may fail to reducecost and may disrupt our operations.***

 

We continue to look for ways to decrease costand improve efficiency by contracting with other companies to perform functionsor operations that, in the past, we have performed ourselves.  Duringfiscal 2004, we completed the outsourcing of all manufacturing of our products. We now rely on outside vendors to meet all of our manufacturing needs as wellas a significant portion of our IT needs.  Additionally, in the secondquarter of fiscal 2005, we announced an initiative to expand our serviceofferings with Siemens Business Services. To achieve future cost savings or operational benefits, we may expandour outsourcing activities to cover additional services which we believe athird party may be able to provide in a more efficient or effective manner thanwe could do ourselves internally.

 

Although we believe that outsourcing willresult in lower costs and increased efficiencies, this may not be thecase.  Because these third parties may not be as responsive to our needsas we would be ourselves, outsourcing increases the risk of disruption to ouroperations.  In addition, our agreements with these third partiessometimes include substantial penalties for terminating such agreements earlyor failing to maintain minimum service levels.  Because we cannot alwayspredict how long we will need the services or how much of the services we willuse, we may have to pay these penalties or incur costs if our businessconditions change.

 

***We may not be successful at identifying and responding to new andemerging market and product opportunities, or at responding quickly enough totechnologies or markets that are in decline.***

 

The markets in which we compete arecharacterized by rapid technology transitions and short product lifecycles.  Therefore, our success depends on our ability to:

 

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•                                          identify new market and productopportunities;

 

•                                          predict which technologies and markets willsee declining demand;

 

•                                          develop and introduce new products andsolutions in a timely manner;

 

•                                          gain market acceptance of new products andsolutions, particularly in the targeted emerging markets discussed above; and

 

•                                          rapidly and efficiently transition ourcustomers from older to newer enterprise networking technologies.

 

Our financial position or results ofoperations could suffer if we are not successful in achieving these goals. For example, our business would suffer if:

 

•                                          there is a delay in introducing new products;

 

•                                          there are fewer customers interested in ourproducts than we expected;

 

•                                          our products do not satisfy customers interms of features, functionality or quality; or

 

•                                          our products cost more to produce than weexpect.

 

Our business would suffer if negative effectssuch as these were to occur.  One factor that may cause greater difficultyfor us in quickly and effectively introducing new products with the features,functionality, quality, and costs that are optimal for the market is ourreliance on relationships with strategic partners, such as original designmanufacturers (ODMs).  Because ODMs manufacture the products of othercompanies as well as ours, the timeliness of the availability of our productsdepends, in part, on their production schedules.  In addition, we arerelying on ODMs to manufacture products that meet our specifications withregard to quality and cost.  We will continue to source other productsfrom OEMs and from H-3C.  Finally, since we rely on our strategicpartners, we may not be able to independently identify current product andtechnology trends or to respond to such trends as well as if we were workingindependently.

 

***Our past and possible future decisions to exit certain product linesmay have unforeseen negative impacts to our business.***

 

We previously exited or sold some of ourbusinesses and product lines.  Our exiting of these businesses and productlines may have adversely affected our relationships with channel partners andend customers.  Many of these channel partners and customers perceived ourremaining products as not being part of a larger integrated or complementarysolution, or questioned our commitment to their markets.  Consequently,they chose to purchase products from alternative vendors.  We may considerexiting other businesses or product lines that do not meet our goal ofdelivering satisfactory financial returns.  Future decisions to exitbusinesses or product lines could result in deterioration of our channelpartner and customer relationships, increased employee costs (such asseverance, outplacement and other benefits), contract termination costs, andasset impairments.

 

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***Our investment in technologies which are unproven or for which we havenot yet demonstrated success in the marketplace may not produce the benefits weexpect.***

 

We are making significant investments invarious new technologies and product lines.  For example, we have made andcontinue to make investments in Layer 3+ switching technology, Gigabit Ethernettechnology, Internet Protocol (IP) telephony, wireless LANs, and network securitytechnology.  In addition, if consummated as expected, our pendingacquisition of TippingPoint will result in a significant investment innetwork-based intrusion-prevention technology. We expect new products and solutions based on these various technologiesto contribute to future growth in our sales.  However, the markets forsome of these products and solutions are still emerging and the marketpotential for our products and solutions based on these technologies remainsunproven.  If customer demand for our products and solutions based onthese technologies does not develop as we expect, or if our sales and marketingstrategies for these technologies are not effective, our financial resultscould be adversely affected and we might need to change our business strategy.

 

***Our reliance on industry standards, a favorable regulatory environment,technological change in the marketplace, and new product initiatives may causeour sales to fluctuate or decline.***

 

The networking industry in which we competeis characterized by rapid changes in technology and customer requirements,evolving industry standards, and complex government regulation.  As aresult, our success depends on:

 

•                                          the emergence of new technology or theconvergence of technologies such as data and voice networking or IP telephony;

 

•                                          our ability to develop new products toaddress changes in technologies and related customer requirements on a timelybasis;

 

•                                          the timely adoption and market acceptance ofindustry standards, and timely resolution of conflicting U.S. and internationalindustry standards;

 

•                                          our ability to influence the development ofemerging industry standards and to introduce new and enhanced products that arecompatible with such standards; and

 

•                                          a favorable regulatory environment.

 

Slow market acceptance of new technologies,products, or industry standards could adversely affect our sales or overallresults of operations.  In addition, if our technology is not included inan industry standard on a timely basis or if we fail to achieve timelycertification of compliance to industry standards for our products, our salesof such products or our overall results of operations could be adverselyaffected.

 

***A significant portion of our sales is derived from a small number ofpartners.  If any of these partners reduces its business with us, ourbusiness could be seriously harmed.***

 

We distribute many of our products throughtwo-tier distribution channels that include distributors, systems integratorsand VARs.  A significant portion of our sales is concentrated among a few

 

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distributors; our two largest customersaccounted for a combined 37****percent of total sales for the first half of fiscal 2005, acombined 33 percent of total sales for both fiscal 2004 and fiscal 2003and a combined 28 percent of total sales for fiscal 2002.  If eitherof these distributors reduces its business with us, our sales and overallresults of operations could be adversely affected.

 

***We depend on distributors who maintain inventories of ourproducts.  If the distributors reduce their inventories of our products,our sales could be adversely affected.***

 

Our distributors maintain inventories of ourproducts.  We work closely with our distributors to monitor channel inventorylevels and ensure that appropriate levels of products are available toresellers and end users.  We have improved certain elements of our supplychain processes so that deliveries to our channel partners can be done morerapidly, thereby enabling our channel partners to hold fewer weeks of supply ofour products in their inventory.  Our target range for channel inventorylevels is between four and five weeks supply on hand at our distributors. Channel inventory levels were within our target range at the end of November2004, and we expect to operate our business within that range for theremainder of fiscal 2005.  At this level of channel inventory, some of ourchannel partners will hold less than the average level of inventory, and otherswill be at a higher level.  Partners with a below-average inventory levelmay incur “stock outs” that would adversely impact our sales.  If ourchannel partners further reduce their levels of inventory of our products, oursales would be negatively impacted during the period of change.

 

***We are in the process of making adjustments to the manner in which wesell our products and services.  If those adjustments are unsuccessful,our sales may be negatively affected.***

 

As part of our distribution strategy, we aretargeting System Integrators (SIs), Service Providers (SPs), and enterpriseVARs (eVARs).  These resellers typically have expertise in network designand implementation, which is important when deploying end-to-end networkinginfrastructure solutions in larger enterprises.  In addition tospecialized technical expertise, SIs, SPs and eVARs typically offersophisticated services capabilities that are frequently desired by largerenterprise customers.  In order to expand our distribution channel toinclude resellers with such capabilities, we must be able to provide effectivesupport to these resellers.  If our sales, marketing or servicescapabilities are not sufficiently robust to provide effective support to suchSIs, SPs, and eVARs, we may not be successful in expanding our distributionmodel and current SI, SP, and eVAR partners may terminate their relationshipswith us, which would adversely impact our sales and overall results ofoperations.

 

***Our competition with Huawei in the enterprise networking market could havea material adverse effect on our sales and our results of operations.***

 

As Huawei expands its internationaloperations, there will be increasing instances where we compete directly withHuawei in the enterprise networking market.  We expect to be able tocompete effectively with Huawei in this market as a result of our strengths ina number of areas including our brand identity, breadth of products andsolutions offerings, and professional services capabilities.  We also arefree to engineer derivative models of products sourced from H-3C that would notbe available to Huawei or other H-3C customers.  However, as a co-ownerand OEM customer of H-3C, Huawei will have access to many of H-3C’s productsjust as we do, thereby enhancing Huawei’s current ability to compete directlywith us in markets outside of China, Hong Kong and Japan.  If this occurs,we could lose a competitive advantage in those markets, which could have amaterial adverse effect on our sales and overall results of operations. At the same time, however, to the extent that this occurs and Huawei

 

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becomes a more significant customer of H-3C,we could benefit indirectly as a result of our 49% ownership interest in H-3C.

 

***We may be unable to manage our supply chain successfully, which wouldadversely impact our sales, gross margin, and profitability.***

 

Current business conditions and operationalchallenges in managing our supply chain affect our business in a number ofways:

 

•                                          in the past, some key components have hadlimited availability;

 

•                                          there are a smaller number of suppliers andwe have narrowed our supplier base, including, in some cases, the sole sourcingof specific components from a single supplier;

 

•                                          as integration of networking features on areduced number of computer chips continues, we are increasingly facingcompetition from parties who are our suppliers;

 

•                                          our ability to accurately forecast demand isdiminished, especially in light of general economic weakness and uncertainty followingwars and terrorist events;

 

•                                          our reliance on, and long-term arrangementswith, third-party manufacturers places much of the supply chain process out ofour direct control and heightens the need for accurate forecasting and reducesour ability to transition quickly to alternative supply chain strategies; and

 

•                                          we may experience disruptions to ourlogistics.

 

Some of our suppliers are also ourcompetitors.  We cannot be certain that in the future our suppliers,particularly those who are also in active competition with us, will be able orwilling to meet our demand for components in a timely and cost-effectivemanner.

 

There has been a trend toward consolidationof vendors of electronic components.  Our reliance on a smaller number ofvendors and the inability to quickly switch vendors increase the risk oflogistics disruptions, unfavorable price fluctuations, or disruptions insupply, particularly in a supply-constrained environment.

 

More recently, supplies of certain keycomponents, such as memory, have become tighter as industry demand for suchcomponents has increased.  Also, the prices of certain other componentshave increased as the underlying prices of raw materials needed to manufacturesuch components have increased.  This is putting upward pressure on ourcosts as well as increasing the time necessary to obtain thesecomponents.  If this persists, we may experience an adverse impact togross margin as costs either increase or do not decline as fast as they had inthe past.

 

Operation of the supply chain requiresaccurate forecasting of demand.  If overall demand for our products or themix of demand for our products is significantly different from ourexpectations, we may face inadequate or excess component supply or inadequateor excess manufacturing capacity.  This

 

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would result in orders for products thatcould not be manufactured in a timely manner, or a buildup of inventory thatcould not easily be sold.  Either of these situations could adverselyaffect our market share, sales, results of operations or financial position.

 

***Our strategies to outsource all of our manufacturing requirements tocontract manufacturers, and for contract manufacturers to ship directly to ourcustomers, may not result in meeting our cost, quality or performancestandards.  The inability of any contract manufacturer to meet our cost,quality or performance standards could adversely affect our sales and overallresults from operations.***

 

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 inabilityof any contract manufacturer to meet our cost, quality, performance, andavailability standards could adversely impact our sales and overall results ofoperations.  We may not be able to provide contract manufacturers withproduct volumes that are high enough to achieve sufficient cost savings. If shipments fall below forecasted levels, we may incur increased costs or berequired to take ownership of inventory.  In addition, a significantcomponent of maintaining cost competitiveness is the ability of our contractmanufacturers to adjust their own costs and manufacturing infrastructure to compensatefor possible adverse exchange rate movements.  To the extent that thecontract manufacturers are unable to do so, and we are unable to procurealternative product supplies, then our own competitiveness and results ofoperations could be adversely impacted.

 

Also, our ability to control the quality ofproducts produced by contract manufacturers may be limited and quality issuesmay not be resolved in a timely manner, which could adversely impact our salesand overall results of operations.  We have implemented a program with ourmanufacturing partners to ship products directly from regional shipping centersto customers.  Through this program, we are relying on these partners tofill customer orders in a timely manner.  This program may not yield theefficiencies that we expect, which would negatively impact our results ofoperations.  Any disruptions to on-time delivery to customers wouldadversely impact our sales and overall results of operations.

 

***Our customer order fulfillment capabilities fluctuate and maynegatively impact our operating results.***

 

The timing and amount of our sales depend ona number of factors that make estimating future operating resultsdifficult.  Throughout our business, we do not typically maintain asignificant amount of backlog, and sales are partially dependent on our abilityto appropriately forecast product demand.  In addition, our customershistorically request fulfillment of orders in a short time period, resulting inlimited visibility to sales trends and potential pricing pressures. Consequently, our operating results depend on the volume and timing of ordersand our ability to fulfill orders in 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 businessplanning difficult, and increase the risk that our quarterly results willfluctuate due to disruptions in functions such as manufacturing, ordermanagement, information systems, and shipping.

 

***We may need to engage in complex and costly litigation in order toprotect, maintain or enforce our intellectual property rights.***

 

In addition to disputes relating to thevalidity or alleged infringement of other parties’ rights, we may becomeinvolved in disputes relating to our assertion of our intellectual propertyrights.  Whether we are

 

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defending the assertion of intellectualproperty rights against us, or asserting our intellectual property rights againstothers, intellectual property litigation can be complex, costly, protracted,and highly disruptive to business operations by diverting the attention andenergies of management and key technical personnel.  Further, plaintiffsin intellectual property cases often seek injunctive relief and the measures ofdamages in intellectual property litigation are complex and often subjective oruncertain.  Thus, the existence of this type of litigation, or any adversedeterminations related to such litigation, could subject us to significantliabilities and costs.  If any of our OEM, ODM, or joint venture partnersbecome involved in intellectual property disputes and are unable to hold usharmless, then we may incur liabilities or suffer temporary disruption of ourbusiness.  Any one of these factors could adversely affect our sales,gross margin, overall results of operations, cash flow or financial position.

 

***We may not be able to defend ourselves successfully against claims thatwe are infringing the intellectual property rights of others.***

 

Many of our competitors, such astelecommunications, networking, and computer equipment manufacturers, havelarge intellectual property portfolios, including patents that may covertechnologies that are relevant to our business.  In addition, many smallercompanies, universities, and individual inventors have obtained or applied forpatents in areas of technology that may relate to our business.  Theindustry continues to be aggressive in assertion, licensing, and litigation ofpatents and other intellectual property rights.

 

In the course of our business, we frequentlyreceive claims of infringement or otherwise become aware of potentiallyrelevant patents or other intellectual property rights held by otherparties.  We evaluate the validity and applicability of these intellectualproperty rights, and determine in each case whether we must negotiate licensesor cross-licenses to incorporate or use the proprietary technologies,protocols, or specifications in our products.  If we are unable to obtainand maintain licenses on favorable terms for intellectual property rightsrequired for the manufacture, sale, and use of our products, particularly thosethat must comply with industry standard protocols and specifications to be commerciallyviable, our financial position or results of operations could be adverselyaffected.  In addition, if we are alleged to infringe the intellectualproperty rights of others, we could be required to seek licenses from others orbe prevented from manufacturing or selling our products, which could causedisruptions to our operations or the markets in which we compete.

 

***Fluctuations in our operating results and other factors may contributeto volatility in the market price of our stock.***

 

Historically, our stock price has experiencedsubstantial volatility.  We expect that our stock price may continue toexperience volatility in the future due to a variety of potential factors suchas:

 

•                                          fluctuations in our quarterly results ofoperations and cash flow;

 

•                                          changes in our cash and equivalents and shortterm investment balances;

 

•                                          variations between our actual financialresults and the published analysts’ expectations; and

 

•                                          announcements by our competitors.

 

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In addition, over the past several years, the stock market hasexperienced significant price and volume fluctuations that have affected thestock prices of many technology companies.  These factors, as well asgeneral economic and political conditions or investors’ concerns regarding thecredibility of corporate financial statements and the accounting profession,may have a material adverse affect on the market price of our stock in thefuture.

 

***Item 3.  *Quantitative and Qualitative Disclosures About MarketRisk**

 

We hold marketable equitytraded securities that have a brief trading history and are highly subject tomarket price volatility.  Equity securityprice fluctuations of plus or minus 50 percent would not have a material impacton the value of these securities as of the end of the second quarter of fiscal2005.

 

Information related tointerest rate sensitivity and foreign currency exchange risk is contained inPart II, Item 7A, Quantitative and Qualitative Disclosures About Market Risk,in our Annual Report on Form 10-K for the year ended May 28, 2004.

 

***Item 4.*Controlsand Procedures**

 

a.               We carried out an evaluation, under the supervision and with theparticipation of our management, including our President and Chief ExecutiveOfficer and our Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures as of the end of our secondfiscal quarter pursuant to Rule 13a-15(b) under the Securities Exchange Act of1934.  Based upon that evaluation, exceptas set forth below, our President and Chief Executive Officer and our ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective in ensuring that information required to be disclosed by us inreports that we file or submit under the Securities Exchange Act of 1934 isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  During our second fiscal quarter, two filingson Form 8-K, to report the execution of severance agreements with formerexecutive officers of 3Com, were filed after the four business dayrequirement.  We have taken steps toensure that the execution or amendment of material contracts in the future isreported in a timely manner on Form 8-K, including increased communications ofthe rules governing our disclosure obligations and tighter integration of ourreporting requirements with operations of the business.

 

Our review of ourinternal controls was made within the context of the relevant professionalauditing standards defining “internal controls,” “reportable conditions,” and “materialweaknesses.” “Internal controls” are processes designed to provide reasonableassurance that our transactions are properly authorized, our assets aresafeguarded against unauthorized or improper use, and our transactions areproperly recorded and reported, all to permit the preparation of ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States. “Significant deficiencies” are control issues that could have asignificant adverse effect on our ability to properly authorize transactions,safeguard our assets, or record, process, summarize or report financial data inthe consolidated financial statements.  A“material weakness” is a particularly serious deficiency where the systems of internalcontrol do not reduce to a relatively low level the risk that misstatementscaused by error or fraud may occur in amounts that would be material inrelation to the consolidated financial statements and not be detected within atimely period by employees in the normal course of performing their assignedfunctions.  As part of our internalcontrols procedures, we also address other, less significant control mattersthat we identify, and we determine what revision or improvement to make, ifany, in accordance with our on-going procedures.

 

b.              There have been nochanges in our internal control overfinancial reporting that occurred during our second fiscal quarter that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

44

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**PART II.     OTHER INFORMATION**

 

***Item1.*   Legal Proceedings**

 

The information set forthin Note 15 of Part I, Item 1 of this Form 10-Q is incorporated herein byreference.

 

***Item 2.*   Unregistered Sales of Equity Securities andUse of Proceeds**

 

During the fourth quarter of fiscal 2003, ourBoard of Directors approved a new stock repurchase program that authorizesexpenditures of up to $100.0 million and is effective for a two-year periodthrough March 2005.  We did notrepurchase shares of our common stock pursuant to this authorization in fiscal2003 or 2004.  However, we beganrepurchasing shares of our common stock pursuant to this authorization in thefirst quarter of fiscal 2005, and we may use cash to repurchase additionalshares in future periods.  In addition,upon vesting of restricted stock awards, employees are permitted to return tous a portion of the newly vested shares to satisfy the tax withholdingobligations that arise in connection with such vesting.

 

The following table summarizes repurchases ofour stock, including shares returned to satisfy tax withholding obligations, inthe quarter ended November 26, 2004:

 
| **Period**                                   | ** ** | **Total  Number of  Shares  Purchased (1)** | ** ** | **Average  Price Paid per  Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced  Plans or Programs (2)** | ** ** | **Approximate  Dollar Value of Shares  that May Yet Be  Purchased Under the  Plans or Programs** | ** ** |
|----------------------------------------------|------------|---------------------------------------------|------------|------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
|                                         |       |                                        |       |                               |       |                                                                                                   |       |                                                                                             |       |
| August 28, 2004  through September 27, 2004  |       | 3,059                                       |       | $                                  | 4.27       |                                                                                                   | —     |                                                                                             | $          | 26,635,406 |   |
| September 28,  2004 through October 27, 2004 |       | 101,587                                     |       | 4.89                               |       | —                                                                                                 |       | 26,635,406                                                                                       |       |
| October 28, 2004  through November 26, 2004  |       | —                                      |       | —                             |       | —                                                                                                 |       | 26,635,406                                                                                       |       |
| Total                                        |       | 104,646                                     |       | $                                  | 4.87       |                                                                                                   | —     |                                                                                             |       |   |
|                                              |            |                                             |            |                                    |            |                                                                                                        |            |                                                                                                  |            |  |  |

 

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(1)          Includes4,646 shares returned to us from employees to satisfy tax withholdingobligations that arose upon the vesting of a restricted stock award and 100,000shares of restricted common stock returned to us upon the termination ofemployment of our former Executive Vice President, Worldwide Sales.

 

(2)          Our currentstock repurchase program was announced on March 19, 2003 and permitsexpenditures of up to $100.0 million through March 2005.

 

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

 

None.

 

45

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***Item 4.*   Submission of Matters to a Vote of SecurityHolders**

 

(a)           The Annual Meetingof Shareholders was held on September 22, 2004.

 

(b)                                 Eachof the persons named in the Proxy Statement as a nominee for director waselected and the proposals listed below were approved.  The following are the voting results of theproposals:

 
| **Proposal  I**         | ** ** | **For**     | ** ** | **Withheld** | ** ** | **Broker Non-Votes** | ** ** |
|-------------------------|------------|-------------|------------|--------------|------------|----------------------|------------|
| Election of  Directors: |       |        |       |         |       |                 |       |
| Eric A. Benhamou        |       | 344,828,234 |       | 6,300,536    |       | 0                    |       |
| Gary T.  DiCamillo      |       | 339,552,282 |       | 11,576,488   |       | 0                    |       |
| James R. Long           |       | 346,250,273 |       | 4,878,497    |       | 0                    |       |
| Raj Reddy               |       | 347,256,559 |       | 3,872,211    |       | 0                    |       |
| David C.  Wajsgras      |       | 346,221,717 |       | 4,907,053    |       | 0                    |       |

 

Other Directors whose term of office as a directorcontinued after the meeting were Bruce L. Claflin, Julie St. John and Paul G.Yovovich

 
| **Proposal  II**                                                                                                                        | ** ** | **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Votes** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|----------------------|------------|
| To ratify the  appointment of Deloitte & Touche LLP as our independent public  accountants for the fiscal year ending June 3, 2005: |       | 345,593,221 |       | 4,687,875   |       | 847,674     |       | 0                    |       |

 

***Item5.*   Other Information**

 

None.

 

***Item6.*   Exhibits**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                | ** ** | **Incorporated by Reference** | ** ** | **Filed**    | ** ** |
|-------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|--------------|------------|
| **Number**  | ** ** | **Exhibit Description**                                                                                                                                   | ** ** | **Form**                      | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Herewith** | ** ** |
| 2.1         |       | Master Separation and Distribution Agreement between  the Registrant and Palm, Inc. effective as of December 13, 1999                                     |       | 10-Q                          |       | 0-12867      |       | 2.1 |   | 04/04/00 |   |   |   |
| 2.2         |       | Tax Sharing Agreement between the Registrant and  Palm, Inc.                                                                                              |       | 10-Q                          |       | 0-12867      |       | 2.7 |   | 04/04/00 |   |   |   |
| 2.3         |       | Indemnification and Insurance Matters Agreement  between the Registrant and Palm, Inc.                                                                    |       | 10-Q                          |       | 0-12867      |       | 2.11 |   | 04/04/00 |   |   |   |
| 2.4         |       | Agreement and Plan of Merger, dated December 13,  2004, by and among 3Com Corporation, Topaz Acquisition Corporation and  TippingPoint Technologies, Inc. |       | 8-K                           |       | 0-12867      |       | 2.1 |   | 12/16/04 |   |   |   |
| 3.1         |       | Corrected Certificate of Merger filed to correct an  error in the Certificate of Merger                                                                   |       | 10-Q                          |       | 0-12867      |       | 3.4 |   | 10/08/99 |   |   |   |
| 3.2         |       | Registrant’s Bylaws, as amended on August 7, 2001                                                                                                    |       | 10-K                          |       | 0-12867      |       | 3.5 |   | 08/02/02 |   |   |   |
| 3.3         |       | Certificate of Designation of Rights, Preferences  and Privileges of Series A Participating Preferred Stock                                               |       | 10-Q                          |       | 0-12867      |       | 3.6 |   | 10/11/01 |   |   |   |
| 4.1         |       | Third Amended and Restated Preferred Shares Rights  Agreement, dated as of November 4, 2002                                                               |       | 8-A/A                         |       | 0-12867      |       | 4.2 |   | 11/27/02 |   |   |   |
| 10.1        |       | Severance Agreement and General Release dated as of  September 16, 2004 by and between the Registrant and Dennis Connors*                                 |       | 8-K                           |       | 0-12867      |       | 10.1 |   | 9/29/04 |   |   |   |
| 10.2        |       | Severance Agreement and General Release dated as of  October 22, 2004 by and between the Registrant and Nick Ganio*                                       |       | 8-K                           |       | 0-12867      |       | 99.1 |   | 11/5/04 |   |   |   |

 

46

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| **Exhibit** | ** ** | ** **                                                                                                                                                                      | ** ** | **Incorporated by Reference** | ** ** | **Filed**    | ** ** |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|--------------|------------|
| **Number**  | ** ** | **Exhibit Description**                                                                                                                                                         | ** ** | **Form**                      | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Herewith** | ** ** |
| 10.3        |       | Form of Stock Option Agreement*                                                                                                                                                 |       |                          |       |         |       |   |   |   |   | X |   |
| 10.4        |       | Form of Performance Accelerated Vesting Restricted  Stock Grant Agreement*                                                                                                      |       |                          |       |         |       |   |   |   |   | X |   |
| 10.5        |       | Form of  Restricted Stock Grant Agreement - Standard 4-Year Vesting*                                                                                                            |       |                          |       |         |       |   |   |   |   | X |   |
| 31.1        |       | Certification of Principal Executive Officer                                                                                                                                    |       |                          |       |         |       |   |   |   |   | X |   |
| 31.2        |       | Certification of Principal Financial Officer                                                                                                                                    |       |                          |       |         |       |   |   |   |   | X |   |
| 32.1        |       | 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 |       |                          |       |         |       |   |   |   |   | X |   |

 

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*  Indicates a managementcontract or compensatory plan.

 

47

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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: | January 4, 2005 |   | By:                                   |   |   | /s/     Donald M. Halsted,  III |   |
|   |            |   | Donald  M. Halsted, III               |
|   |            |   | Executive Vice President, Finance and |
|   |            |   | Chief Financial Officer               |
|   |            |   | (Principal Financial and              |
|   |            |   | Accounting Officer)                   |
|        |                 |        |                                       |  |  |  |  |  |

 

48

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**ExhibitIndex**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                      | ** ** | **Incorporated by Reference** | ** ** | **Filed**    | ** ** |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|--------------|------------|
| **Number**  | ** ** | **Exhibit Description**                                                                                                                                                         | ** ** | **Form**                      | ** ** | **File No.** | ** ** | **Exhibit** | ** ** | **Filing Date** | ** ** | **Herewith** | ** ** |
| 2.1         |       | Master Separation and Distribution Agreement between  the Registrant and Palm, Inc. effective as of December 13, 1999                                                           |       | 10-Q                          |       | 0-12867      |       | 2.1 |   | 04/04/00 |   |   |   |
| 2.2         |       | Tax Sharing Agreement between the Registrant and  Palm, Inc.                                                                                                                    |       | 10-Q                          |       | 0-12867      |       | 2.7 |   | 04/04/00 |   |   |   |
| 2.3         |       | Indemnification and Insurance Matters Agreement  between the Registrant and Palm, Inc.                                                                                          |       | 10-Q                          |       | 0-12867      |       | 2.11 |   | 04/04/00 |   |   |   |
| 2.4         |       | Agreement and Plan of Merger, dated December 13,  2004, by and among 3Com Corporation, Topaz Acquisition Corporation and  TippingPoint Technologies, Inc.                       |       | 8-K                           |       | 0-12867      |       | 2.1 |   | 12/16/04 |   |   |   |
| 3.1         |       | Corrected Certificate of Merger filed to correct an  error in the Certificate of Merger                                                                                         |       | 10-Q                          |       | 0-12867      |       | 3.4 |   | 10/08/99 |   |   |   |
| 3.2         |       | Registrant’s Bylaws, as amended on August 7, 2001                                                                                                                          |       | 10-K                          |       | 0-12867      |       | 3.5 |   | 08/02/02 |   |   |   |
| 3.3         |       | Certificate of Designation of Rights, Preferences  and Privileges of Series A Participating Preferred Stock                                                                     |       | 10-Q                          |       | 0-12867      |       | 3.6 |   | 10/11/01 |   |   |   |
| 4.1         |       | Third Amended and Restated Preferred Shares Rights  Agreement, dated as of November 4, 2002                                                                                     |       | 8-A/A                         |       | 0-12867      |       | 4.2 |   | 11/27/02 |   |   |   |
| 10.1        |       | Severance Agreement and General Release dated as of  September 16, 2004 by and between the Registrant and Dennis Connors*                                                       |       | 8-K                           |       | 0-12867      |       | 10.1 |   | 9/29/04 |   |   |   |
| 10.2        |       | Severance Agreement and General Release dated as of  October 22, 2004 by and between the Registrant and Nick Ganio*                                                             |       | 8-K                           |       | 0-12867      |       | 99.1 |   | 11/5/04 |   |   |   |
| 10.3        |       | Form of Stock Option Agreement*                                                                                                                                                 |       |                          |       |         |       |   |   |   |   | X |   |
| 10.4        |       | Form of Performance Accelerated Vesting Restricted  Stock Grant Agreement*                                                                                                      |       |                          |       |         |       |   |   |   |   | X |   |
| 10.5        |       | Form of Restricted  Stock Grant Agreement – Standard 4-Year Vesting*                                                                                                       |       |                          |       |         |       |   |   |   |   | X |   |
| 31.1        |       | Certification of Principal Executive Officer                                                                                                                                    |       |                          |       |         |       |   |   |   |   | X |   |
| 31.2        |       | Certification of Principal Financial Officer                                                                                                                                    |       |                          |       |         |       |   |   |   |   | X |   |
| 32.1        |       | 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 |       |                          |       |         |       |   |   |   |   | X |   |

 

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*  Indicates amanagement contract or compensatory plan.

 

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