##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 1, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to
 Commission File No. 0-12867
 3COM CORPORATION
 (Exact name of registrant as specified in its charter)
 Delaware
    
    94-2605794(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)350 Campus Drive
    
    01752Marlborough, Massachusetts
    
    (Zip Code)(Address of principal executive offices)
 508) 323-1000
 N/A
 þ o
  þ o o
 o þ




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##### 



3COM CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 1, 2006
TABLE OF CONTENTS
 PagePART I.
    
    FINANCIAL INFORMATION
    
    
    1Item 1.
    
    Financial Statements
    
    
    1Condensed Consolidated Statements of OperationsThree Months Ended August 31, 2006 and 2005
    
    
    1Condensed Consolidated Balance SheetsAugust 31 and May 31, 2006
    
    
    2Condensed Consolidated Statements of Cash FlowsThree Months Ended August 31, 2006 and 2005
    
    
    3Notes to Condensed Consolidated Financial Statements
    
    
    4Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    23Item 4.
    
    Controls and Procedures
    
    
    23PART II.
    
    OTHER INFORMATION
    
    
    23Item 1.
    
    Legal Proceedings
    
    
    23Item 1A.
    
    Risk Factors
    
    
    24Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    33Item 6.
    
    Exhibits
    
    
    34SIGNATURES
    
    
    
    
    36EXHIBITS
    
    
    
    
    37EX-10.2 STAND ALONE STOCK OPTION AGREEMENT, DATED SEPTEMBER 5, 2006EX-10.3 2003 STOCK PLAN RESTRICTED STOCK UNIT GRANT AWARD AGREEMENTEX-10.7 AGREEMENT FOR THE LEASE OF HANGZHOU REAL PROPERTYEX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEO & CFO




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 
 3COM CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months EndedAugust 31,(In thousands, except per share data)
    
    2006
    
    
    2005Sales
    
    $
    300,144
    
    
    $
    177,636Cost of
sales (including stock-based compensation expense of $319 and $9,
respectively)
    
    
    163,715
    
    
    
    107,570Gross profit
    
    
    136,429
    
    
    
    70,066Operating expenses:Sales and
marketing (including stock-based compensation expense of $1,237 and
$67, respectively)
    
    
    77,122
    
    
    
    70,118Research and
development (including stock-based compensation expense of $1,168 and
$30, respectively)
    
    
    47,793
    
    
    
    21,197General and
administrative (including stock-based compensation expense of $563
and $530, respectively)
    
    
    20,276
    
    
    
    18,213Amortization and write-down of intangible
assets
    
    
    12,181
    
    
    
    3,862Restructuring (benefit) charges
    
    
    (75
    )
    
    
    3,361Total operating expenses
    
    
    157,297
    
    
    
    116,751Operating loss
    
    
    (20,868
    )
    
    
    (46,685
    )Gain (loss) on investments, net
    
    
    2,292
    
    
    
    (414
    )Interest income, net
    
    
    10,090
    
    
    
    5,835Other income, net
    
    
    4,718
    
    
    
    154Loss before income taxes, equity interest in
loss of unconsolidated joint venture and
minority interest
    
    
    (3,768
    )
    
    
    (41,110
    )Income tax provision
    
    
    (1,358
    )
    
    
    (915
    )Equity interest in loss of unconsolidated
joint venture
    
    
    
    
    
    
    (16
    )Minority interest in income of consolidated
joint venture
    
    
    (8,942
    )
    
    
    Net loss
    
    $
    (14,068
    )
    
    $
    (42,041
    )Basic and diluted net loss per share
    
    $
    (0.04
    )
    
    $
    (0.11
    )Shares used in computing per share amounts:Basic and diluted
    
    
    391,885
    
    
    
    383,760
  1




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3COM CORPORATION  CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands, except per share data)
    
    August 31, 2006
    
    
    May 31, 2006ASSETSCurrent assets:Cash and equivalents
    
    $
    525,177
    
    
    $
    501,097Short-term investments
    
    
    390,482
    
    
    
    363,250Notes receivable
    
    
    50,935
    
    
    
    63,224Accounts receivable, less allowance for doubtful accounts of
$15,728 and $16,422, respectively
    
    
    120,848
    
    
    
    115,120Inventories
    
    
    171,366
    
    
    
    148,819Other current assets
    
    
    56,970
    
    
    
    57,835Total current assets
    
    
    1,315,778
    
    
    
    1,249,345Property and equipment, less accumulated depreciation and
amortization of $240,631 and $232,944, respectively
    
    
    80,309
    
    
    
    89,109Goodwill
    
    
    354,259
    
    
    
    354,259Intangible assets, net
    
    
    99,614
    
    
    
    111,845Deposits and other assets
    
    
    28,929
    
    
    
    56,803Total assets
    
    $
    1,878,889
    
    
    $
    1,861,361LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    148,326
    
    
    $
    153,245Accrued liabilities and other
    
    
    338,342
    
    
    
    318,036Total current liabilities
    
    
    486,668
    
    
    
    471,281Deferred revenue and long-term obligations
    
    
    13,299
    
    
    
    13,788Minority interest
    
    
    182,872
    
    
    
    173,930Stockholders equity:Preferred stock, $0.01 par value, 10,000 shares authorized;
none outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 990,000 shares authorized;
shares issued: 393,567 and 393,442, respectively
    
    
    2,301,384
    
    
    
    2,300,396Treasury stock, at cost, of 552 and zero shares, respectively
    
    
    (2,705
    )
    
    
    Unamortized stock-based compensation
    
    
    
    
    
    
    (7,565
    )Retained deficit
    
    
    (1,101,391
    )
    
    
    (1,087,512
    )Accumulated other comprehensive loss
    
    
    (1,238
    )
    
    
    (2,957
    )Total stockholders equity
    
    
    1,196,050
    
    
    
    1,202,362Total liabilities and stockholders equity
    
    $
    1,878,889
    
    
    $
    1,861,361
  2




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3COM CORPORATION  CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months EndedAugust 31,(In thousands)
    
    2006
    
    
    2005Cash flows from operating activities:Net loss
    
    $
    (14,068
    )
    
    $
    (42,041
    )Adjustments to reconcile net loss to cash provided by
(used in) operating activities:Depreciation and amortization
    
    
    20,095
    
    
    
    13,129Stock-based compensation charges
    
    
    3,287
    
    
    
    1,115Gain on property and equipment disposals
    
    
    (7,605
    )
    
    
    (421
    )(Gain) loss on investments, net
    
    
    (2,422
    )
    
    
    414Minority interest in income of consolidated joint venture
    
    
    8,942
    
    
    
    Equity interest in loss of unconsolidated joint venture
    
    
    
    
    
    
    16Deferred income taxes
    
    
    (3,716
    )
    
    
    (143
    )Changes in assets and liabilities:Accounts receivable
    
    
    (5,838
    )
    
    
    (12,695
    )Inventories
    
    
    (21,662
    )
    
    
    (7,497
    )Other assets
    
    
    14,314
    
    
    
    (141
    )Accounts payable
    
    
    (6,623
    )
    
    
    (7,546
    )Other liabilities
    
    
    18,582
    
    
    
    82Net cash provided by (used in) operating activities
    
    
    3,286
    
    
    
    (55,728
    )Cash flows from investing activities:Purchases of investments
    
    
    (190,310
    )
    
    
    (211,421
    )Proceeds from maturities and sales of investments
    
    
    180,524
    
    
    
    170,964Purchases of property and equipment
    
    
    (6,012
    )
    
    
    (4,288
    )Proceeds from sale of property and equipment
    
    
    33,108
    
    
    
    Net cash provided by (used in) investing activities
    
    
    17,310
    
    
    
    (44,745
    )Cash flows from financing activities:Issuances of common stock
    
    
    2,934
    
    
    
    655Repurchases of common stock
    
    
    (187
    )
    
    
    (672
    )Net cash provided by (used in) financing activities
    
    
    2,747
    
    
    
    (17
    )Effect of exchange rate changes on cash and equivalents
    
    
    737
    
    
    
    454Net change in cash and equivalents during period
    
    
    24,080
    
    
    
    (100,036
    )Cash and equivalents, beginning of period
    
    
    501,097
    
    
    
    268,535Cash and equivalents, end of period
    
    $
    525,177
    
    
    $
    168,499
  3




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3COM CORPORATION  NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1. BASIS OF PRESENTATION
    Recently issued accounting pronouncements
   NOTE 2. STOCK-BASED COMPENSATION
  4




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Three Months EndedAugust 31,(In thousands, except per share data)
    
    2006
    
    
    2005Cost of sales
    
    $
    313
    
    
    $
    Sales and marketing
    
    
    1,039
    
    
    
    Research and development
    
    
    584
    
    
    
    General and administrative
    
    
    684
    
    
    
    Sare-based compensation effect of SFAS No.
123R on net loss
    
    $
    2,620
    
    
    $
    Share-based compensation effect of SFAS No.
123R on basic and diluted net loss per share
    
    $
    (0.01
    )
    
    $
    Share-based compensation effect of SFAS No.
123R on cash flow from operations
    
    $
    2,620
    
    
    $
    
  5




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##### Table of Contents



Three Months Ended(In thousands, except per share amounts)
    
    August 31, 2005Net loss as reported
    
    $
    (42,041
    )Add: Stock-based compensation included in
reported net loss
    
    
    1,115Deduct: Total stock-based compensation
determined under the fair value-based method,
net of related tax effects
    
    
    (3,644
    )Adjusted net loss
    
    $
    (44,570
    )Net loss per share-basic and diluted:As reported
    
    $
    (0.11
    )Adjusted
    
    $
    (0.12
    )
   Three Months EndedAugust 31,2006
    
    20051Employee stock options:Volatility
    
    
    42.8
    %
    
    
    46.0
    %Risk-free interest rate
    
    
    5.0
    %
    
    
    3.9
    %Dividend yield
    
    
    0.0
    %
    
    
    0.0
    %Expected life (years)
    
    
    4.0
    
    
    
    4.0Fair value per share
    
    $
    1.84
    
    
    $
    1.42
 
 1
    
    Assumptions used in the calculation of fair value according to the provisions of SFAS No. 123. 6




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Number of
    
    
    Weighted averageshares
    
    
    exercise priceOutstanding June 1, 2006
    
    
    61,421
    
    
    $
    5.71Granted
    
    
    493
    
    
    
    4.62Exercised
    
    
    (840
    )
    
    
    3.49Cancelled
    
    
    (15,702
    )
    
    
    5.32Outstanding August 31, 2006
    
    
    45,372
    
    
    $
    5.87Exercisable
    
    
    31,549
    
    
    $
    6.81Weighted average grant-date
fair value of options granted
    
    
    
    
    
    $
    1.84
    Weighted AverageWeighted average
    
    Remaining
    
    AggregateNumber of
    
    Grant-Date Fair
    
    Contractual Life
    
    Intrinsic Valueshares
    
    Value
    
    (in years)
    
    (in thousands)Vested and
expected to vest at
August 31, 2006
    
    
    40,756,529
    
    
    $
    6.09
    
    
    
    0.3
    
    
    $
    17,980
  Number of
    
    
    Weighted averageShares (unvested)
    
    
    Grant-Date Fair ValueOutstanding June 1, 2006
    
    
    2,117
    
    
    $
    4.07Granted
    
    
    40
    
    
    
    4.71Vested
    
    
    (131
    )
    
    
    3.96Forfeited
    
    
    (717
    )
    
    
    4.33Outstanding August 31, 2006
    
    
    1,309
    
    
    $
    3.97
  7




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NOTE 3. ACQUISITIONS
     Three Months EndedAugust 31, 2005Net sales
    
    $
    259.6Net loss
    
    
    (42.6
    )Basic and diluted net loss per share
    
    $
    (0.11
    )
 NOTE 4. RESTRUCTURING CHARGES
    8




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
    
    further reductions in workforce; and
    
    continued efforts to consolidate and dispose of excess facilities.
   Fiscal 2007 Actions
  Employee
    
    
    Facilities-
    
    
    OtherSeparation
    
    
    related
    
    
    RestructuringExpense
    
    
    Sales
    
    
    Costs
    
    
    TotalBalance as of June 1, 2006
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Provisions (benefits)
    
    
    7,619
    
    
    
    (7,965
    )
    
    
    85
    
    
    
    (261
    )Payments and non-cash charges
    
    
    (2,933
    )
    
    
    7,965
    
    
    
    (85
    )
    
    
    4,947Balance as of August 31, 2006
    
    $
    4,686
    
    
    $
    
    
    
    $
    
    
    
    $
    4,686
    Fiscal 2006 Actions
  Employee
    
    
    Facilities-Separation
    
    
    relatedExpense
    
    
    Charges
    
    
    TotalBalance as of June 1, 2006
    
    $
    4,877
    
    
    $
    891
    
    
    $
    5,768Provisions (benefits)
    
    
    (10
    )
    
    
    (13
    )
    
    
    (23
    )Payments and non-cash charges
    
    
    (2,902
    )
    
    
    (60
    )
    
    
    (2,962
    )Balance as of August 31, 2006
    
    $
    1,965
    
    
    $
    818
    
    
    $
    2,783
  9




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Fiscal 2005 Actions
  Employee
    
    
    Long-term
    
    
    Facilities-
    
    
    OtherSeparation
    
    
    Asset
    
    
    related
    
    
    RestructuringExpense
    
    
    Write-downs
    
    
    Charges
    
    
    Costs
    
    
    TotalBalance as of June 1, 2006
    
    $
    1,843
    
    
    $
    255
    
    
    $
    
    
    
    $
    13
    
    
    $
    2,111Provisions (benefits)
    
    
    (11
    )
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    3Payments and non-cash charges
    
    
    (145
    )
    
    
    
    
    
    
    (14
    )
    
    
    
    
    
    
    (159
    )Balance as of August 31, 2006
    
    $
    1,687
    
    
    $
    255
    
    
    $
    
    
    
    $
    13
    
    
    $
    1,955
   Fiscal 2001, 2002, 2003 and 2004 Actions
  Facilities-
    
    
    Otherrelated
    
    
    RestructuringCharges
    
    
    Costs
    
    
    TotalBalance as of June 1, 2006
    
    $
    5,641
    
    
    $
    5
    
    
    $
    5,646Provisions
    
    
    205
    
    
    
    
    
    
    
    205Payments and non-cash charges
    
    
    (921
    )
    
    
    
    
    
    
    (921
    )Balance as of August 31, 2006
    
    $
    4,925
    
    
    $
    5
    
    
    $
    4,930
  NOTE 5. INVESTMENT IN UNCONSOLIDATED JOINT VENTURE
   10




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Three months endedJune 30, 2005Statement
of Operations:Sales
    
    $
    95,772Gross profit
    
    
    40,450Net loss
    
    
    (33
    )
   NOTE 6. COMPREHENSIVE LOSS
  Three Months EndedAugust 31,2006
    
    
    2005Net loss
    
    $
    (14,068
    )
    
    $
    (42,041
    )Other comprehensive income:Net unrealized gain on investments
    
    
    1,039
    
    
    
    419Change in accumulated translation
adjustments
    
    
    682
    
    
    
    436Total comprehensive loss
    
    $
    (12,347
    )
    
    $
    (41,186
    )
 NOTE 7. NET LOSS PER SHARE
  NOTE 8. INVENTORIES
  August 31,
    
    
    May 31,2006
    
    
    2006Finished goods
    
    $
    98,472
    
    
    $
    69,386Work-in-process
    
    
    15,851
    
    
    
    12,777Raw materials
    
    
    57,043
    
    
    
    66,656Total
    
    $
    171,366
    
    
    $
    148,819
 11




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NOTE 9. INTANGIBLE ASSETS, NET
  August 31, 2006
    
    
    May 31, 2006Accumulated
    
    
    
    
    
    
    
    
    
    
    AccumulatedGross
    
    
    Amortization
    
    
    Net
    
    
    Gross
    
    
    Amortization
    
    
    NetExisting technology
    
    $
    203,946
    
    
    $
    (124,344
    )
    
    $
    79,602
    
    
    $
    203,946
    
    
    $
    (114,235
    )
    
    $
    89,711Maintenance contracts
    
    
    19,000
    
    
    
    (5,014
    )
    
    
    13,986
    
    
    
    19,000
    
    
    
    (4,222
    )
    
    
    14,778Other
    
    
    15,301
    
    
    
    (9,275
    )
    
    
    6,026
    
    
    
    15,301
    
    
    
    (7,945
    )
    
    
    7,356Total
    
    $
    238,247
    
    
    $
    (138,633
    )
    
    $
    99,614
    
    
    $
    238,247
    
    
    $
    (126,402
    )
    
    $
    111,845
 NOTE 10. ACCRUED WARRANTY
   Three Months EndedAugust 31,2006
    
    
    2005Accrued warranty, beginning of period
    
    $
    41,791
    
    
    $
    41,782Cost of warranty claims processed during the period
    
    
    (11,592
    )
    
    
    (7,919
    )Provision for warranties related to products sold during the period
    
    
    11,589
    
    
    
    6,865Accrued warranty, end of period
    
    $
    41,788
    
    
    $
    40,728
  NOTE 11. SEGMENT INFORMATION
    12




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Three Months Ended August 31, 2006SCN
    
    H-3C
    
    Eliminations1
    
    TotalRevenue
    
    $
    155,823
    
    
    $
    169,968
    
    
    $
    (25,647
    )
    
    $
    300,144Gross profit
    
    
    56,345
    
    
    
    80,084
    
    
    
    
    
    
    
    136,429Sales and marketing,
research and
development, and
general and
administrative
    
    
    85,403
    
    
    
    59,788
    
    
    
    
    
    
    
    145,191Restructuring,
amortization, and
in-process
research and
development
    
    
    3,516
    
    
    
    8,590
    
    
    
    
    
    
    
    12,106Operating income (loss)
    
    
    (32,574
    )
    
    
    11,706
    
    
    
    
    
    
    
    (20,868
    )Net income (loss)
    
    $
    (23,375
    )
    
    $
    18,249
    
    
    $
    (8,942
    )
    
    $
    (14,068
    )Assets
    
    $
    1,453,244
    
    
    $
    453,885
    
    
    $
    (28,240
    )
    
    $
    1,878,889
  1 
    
    Represents eliminations for inter-company sales as well as the recording of minority
interest related to Huaweis 49 percent ownership in the joint-venture.
  Three Months Ended August 31,2006
    
    
    2005Networking
    
    $
    244,033
    
    
    
    81.3
    %
    
    $
    127,054
    
    
    
    71.5
    %Security
    
    
    25,462
    
    
    
    8.5
    
    
    
    16,876
    
    
    
    9.5Voice
    
    
    15,949
    
    
    
    5.3
    
    
    
    15,408
    
    
    
    8.7Services
    
    
    8,351
    
    
    
    2.8
    
    
    
    7,835
    
    
    
    4.4Connectivity Products
    
    
    6,349
    
    
    
    2.1
    
    
    
    10,463
    
    
    
    5.9Total
    
    $
    300,144
    
    
    
    
    
    
    $
    177,636
  NOTE 12. GEOGRAPHIC INFORMATION
  Three Months Ended August 31,2006
    
    
    2005North America
    
    $
    58,423
    
    
    $
    68,624Latin and South America
    
    
    15,319
    
    
    
    14,117Europe, Middle East, and Africa
    
    
    69,534
    
    
    
    74,908Asia Pacific
    
    
    156,868
    
    
    
    19,987Total
    
    $
    300,144
    
    
    $
    177,636
  NOTE 13. LITIGATION
  13




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14




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##### Table of Contents



ITEM 2.
    
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 INTRODUCTION
  BUSINESS OVERVIEW
   
    
    Networking;
    
    Security;
    
    Voice;
    
    Services; and
    
    Connectivity Products.
  
    
    significant headcount reductions and consolidation of facilities;
    
    restructuring activities which included outsourcing of information
technology, all manufacturing activity in our SCN segment, and other
functions, and selling excess facilities;
    
    significant changes to our executive leadership;
    
    forming the Huawei-3Com joint venture (H-3C);
    
    acquisition of majority ownership of H-3C;
    
    acquiring TippingPoint Technologies, Inc.; and
    
    realigning our sales and marketing channels and expenditures.
  Significant Events
   15




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##### Table of Contents



Summary of Three Months Ended August 31, 2006 Financial Performance
 
    
    Our sales in the three months ended August 31, 2006 were $300.1 million, compared to
sales of $177.6 million in the three months ended
August 31, 2005, an increase of $122.5
million, or 69.0 percent.
    
    Our gross margin improved to 45.5 percent in the three months ended August 31, 2006
from 39.4 percent in the three months ended August 31, 2005.
    
    Our operating expenses in the three months ended August 31, 2006 were $157.3 million,
compared to $116.8 million in the three months ended August 31, 2005, a net increase of
$40.5 million, or 34.7 percent.
    
    Our net loss in the three months ended August 31, 2006 was $14.1 million, compared to a
net loss of $42.0 million in the three months ended August 31, 2005. In the three months
ended August 31, 2006 net loss in our SCN segment was $23.4 million which was partially
offset by net income of $18.2 million in our H-3C segment before reflecting the minority
interest to Huawei of $8.9 million.
    
    Our balance sheet remained strong with cash and equivalents and short-term investment
balances of $915.7 million as of August 31, 2006, compared to cash and equivalents and
short-term investment balances of $864.3 million at the end of fiscal 2006.
 Business Environment and Future Trends
  
    
    Intense competition in the market for higher end, enterprise core routing and switching products;
    
    Aggressive product pricing by competitors targeted at gaining share in market segments where we
have had a strong position historically, such as the small to medium-sized enterprise market;
and
    
    The advanced nature and ready availability of merchant silicon, which allows low-end competitors
to deliver competitive products and makes it increasingly difficult for us to differentiate our
products.
  16




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##### Table of Contents



CRITICAL ACCOUNTING POLICIES
  Stock-based Compensation
    17




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##### Table of Contents



RESULTS OF OPERATIONS
 THREE MONTHS ENDED AUGUST 31, 2006 AND 2005
  Three Months EndedAugust 31,2006
    
    
    2005Sales
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    54.5
    
    
    
    60.6Gross profit margin
    
    
    45.5
    
    
    
    39.4Operating expenses:Sales and marketing
    
    
    25.7
    
    
    
    39.5Research and development
    
    
    15.9
    
    
    
    11.9General and administrative
    
    
    6.8
    
    
    
    10.3Amortization and write-down of intangible assets
    
    
    4.1
    
    
    
    2.2Restructuring charges
    
    
    0.0
    
    
    
    1.9Total operating expenses
    
    
    52.4
    
    
    
    65.7Operating loss
    
    
    (7.0
    )
    
    
    (26.3
    )Gain (loss) on investments, net
    
    
    0.8
    
    
    
    (0.2
    )Interest income, net
    
    
    3.3
    
    
    
    3.3Other income, net
    
    
    1.6
    
    
    
    0.1Loss before income taxes and equity interest
    
    
    (1.3
    )
    
    
    (23.1
    )Income tax provision
    
    
    (0.4
    )
    
    
    (0.5
    )Equity
interest in loss of unconsolidated
joint venture
    
    
    
    
    
    
    (0.0
    )Minority
interest in income of consolidated joint venture
    
    
    (3.0
    )
    
    
    Net loss
    
    
    (4.7
    )%
    
    
    (23.7
    )%
 18




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##### Table of Contents



Sales
   Three Months EndedAugust 31,2006
    
    
    2005Networking
    
    $
    244.0
    
    
    
    81
    %
    
    $
    127.1
    
    
    
    72
    %Security
    
    
    25.5
    
    
    
    9
    %
    
    
    16.9
    
    
    
    9
    %Voice
    
    
    15.9
    
    
    
    5
    %
    
    
    15.4
    
    
    
    9
    %Services
    
    
    8.4
    
    
    
    3
    %
    
    
    7.8
    
    
    
    4
    %Connectivity Products
    
    
    6.3
    
    
    
    2
    %
    
    
    10.4
    
    
    
    6
    %Total
    
    $
    300.1
    
    
    
    100
    %
    
    $
    177.6
    
    
    
    100
    %
   ®
   19




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##### Table of Contents



Gross Margin
  1) Consolidation of H-3C
    
    
    9.32) SCN cost improvements
    
    
    5.03) SCN product mix and selling price reductions
    
    
    (6.5
    )4) SCN volume impact
    
    
    (1.7
    )Total
    
    
    6.1
    %
 1)
    
    The increase is due to the consolidation of H-3C results in the
current period. H-3C products generally have higher gross margins.2)
    
    The increase in the SCN margin was the result of lower product and
service material and delivery costs.3)
    
    The decrease in the SCN margin was the result of lower average selling
prices and an unfavorable shift in product mix.4)
    
    The decrease in the SCN margin was the result of lower revenue on the
portion of our costs that are fixed in nature.
 Operating Expenses
 Three Months Ended(Dollars in millions)
    
    August 31,
    
    
    Change2006
    
    
    2005
    
    
    $
    
    
    %Sales and marketing
    
    $
    77.1
    
    
    $
    70.1
    
    
    $
    7.0
    
    
    
    10
    %Research and development
    
    
    47.8
    
    
    
    21.2
    
    
    
    26.6
    
    
    
    125
    %General and administrative
    
    
    20.3
    
    
    
    18.2
    
    
    
    2.1
    
    
    
    12
    %Amortization of intangible assets
    
    
    12.2
    
    
    
    3.9
    
    
    
    8.3
    
    
    
    213
    %Restructuring
    
    
    (0.1
    )
    
    
    3.4
    
    
    
    (3.5
    )
    
    *Total
    
    $
    157.3
    
    
    $
    116.8
    
    
    $
    40.5
    
    
    
    35
    %
 
 *
    
    percentage calculation not meaningful Sales and Marketing.
 Research and Development.
 General and Administrative.
 Amortization of Intangible Assets.
 20




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Restructuring Charges
    Gain (loss) on Investments, Net
  Interest Income, Net
  Other Income, Net
  Income Tax (Provision) Benefit
  Equity Interest in Loss of Unconsolidated Joint Venture
  Minority Interest of Huawei in the Income of Consolidated Huawei-3Com Joint Venture
  Net Loss
  21




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##### Table of Contents



LIQUIDITY AND CAPITAL RESOURCES
  (In millions)
    
    Three Months EndedAugust 31,2006
    
    
    2005Cash and equivalents, beginning of period
    
    $
    501.1
    
    
    $
    268.5Net cash provided by (used in) operating activities
    
    
    3.3
    
    
    
    (55.7
    )Net cash provided by (used in) investing activities
    
    
    17.3
    
    
    
    (44.8
    )Net cash provided by (used in) financing activities
    
    
    2.7
    
    
    
    (0.0
    )Other
    
    
    0.8
    
    
    
    0.5Cash and equivalents, end of period
    
    $
    525.2
    
    
    $
    168.5
        22




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##### Table of Contents



EFFECTS OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
   
 ITEM 3.
    
    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
   
 ITEM 4.
    
    CONTROLS AND PROCEDURES
    
 PART II.
    
    OTHER INFORMATION
 
 ITEM 1.
    
    LEGAL PROCEEDINGS
 23




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##### Table of Contents



ITEM 1A.
    
    RISK FACTORS
  We have incurred significant net losses in recent fiscal periods, including $14 million for the
three months ended August 31, 2006, $101 million for the year ended May 31, 2006, and $196 million
for year ended May 31, 2005, and we may not be able to return to profitability.
   
    
    declining sales due to price competition and reduced incoming order rate;
    
    risk of increased excess and obsolete inventories;
    
    excess facilities;
    
    operating expenses that, as a percentage of sales, have exceeded our desired financial model; and
    
    disruptions resulting from our workforce reductions and employee attrition.
 If we do not respond effectively to increased competition caused by industry volatility and
consolidation our business could be harmed.
  
    
    industry volatility resulting from rapid product development cycles;
    
    increasing price competition due to maturation of basic networking technologies;
    
    industry consolidation resulting in competitors with greater financial,
marketing, and technical resources; and
    
    the presence of existing competitors with greater financial resources together
with the potential emergence of new competitors with lower cost structures and
more competitive offerings.
 We may not be able to compensate for lower sales or unexpected cash outlays with cost reductions
sufficient to generate positive net income or cash flow.
   Efforts to reduce operating expenses have involved, and could involve further, workforce
reductions, closure of offices and sales or discontinuation of businesses, leading to reduced sales
and other disruptions in our business.
 24




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##### Table of Contents



We are significantly dependent on our H-3C joint venture in China and if H-3C is not successful,
it could materially and adversely impact our business, business prospects and operating results.
   Sales from our H-3C joint venture and therefore China constitute a material portion of our total
sales, and our business, financial condition and results of operations will to a significant degree
be subject to economic, political and social events in China.
  Our China joint venture, H-3C, is dependent on Huawei, our co-owner in this venture, in several
material respects, including as an important customer; should Huawei reduce its business with or
operational assistance to H-3C, our business could be materially affected.
  If we fail to adequately evolve our financial and managerial control and reporting systems and
processes, including the management of our H-3C segment, our ability to manage and grow our
business will be negatively affected.
  25




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##### Table of Contents



We may not be able to complete or finance a transaction with Huawei to purchase additional interest
in our joint venture, H-3C, on favorable terms or at all; if we cannot complete a transaction, our
strategy to further invest in H-3C may not occur, we will be subject to the risks of the bid
process described below and our business may suffer.
  We, and our joint venture partner, Huawei, each have the right, starting in November 2006, to
initiate a bid process to buy the other out of our China joint venture, H-3C; if Huawei wins the
bid process, we will no longer be able to consolidate H-3Cs results and may, over time, lose the
right to source and resell H-3Cs products.
  We may not be successful at identifying and responding to new and emerging market and product
opportunities, or at responding quickly enough to technologies or markets that are in decline.
  
    
    identify new market and product opportunities;
    
    predict which technologies and markets will see declining demand;
    
    develop and introduce new products and solutions in a timely manner;
    
    gain market acceptance of new products and solutions, particularly in targeted emerging markets; and
    
    rapidly and efficiently transition our customers from older to newer enterprise networking technologies.
  
    
    there is a delay in introducing new products;
    
    we lose certain channels of distribution or key partners;
    
    our products do not satisfy customers in terms of features, functionality or quality; or
    
    our products cost more to produce than we expect.
  26




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##### Table of Contents



Our success is dependent on continuing to hire and retain qualified managers and other personnel;
if we are not successful in attracting and retaining these personnel, our business will suffer.
  We expect to utilize strategic relationships and other alliances as key elements in our strategy.
If we are not successful in forming desired ventures and alliances or if such ventures and
alliances are not successful, our ability to achieve our growth and profitability goals could be
adversely affected.
   Our strategy of outsourcing functions and operations may fail to reduce cost and may disrupt our
operations.
   Our reliance on industry standards, technological change in the marketplace, and new product
initiatives may cause our sales to fluctuate or decline.
  
    
    the convergence of technologies, such as voice, data and video on
single, secure networks;
    
    the timely adoption and market acceptance of industry standards, and
timely resolution of conflicting U.S. and international industry
standards; and
 27




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##### Table of Contents




    
    our ability to influence the development of emerging industry
standards and to introduce new and enhanced products that are
compatible with such standards.
  We focus on enterprise networking, and our results of operations may fluctuate based on factors
related entirely to conditions in this market.
  A significant portion of our SCN sales is derived from a small number of resellers. If any of
these partners reduces its business with us, our business could be seriously harmed.
  We depend on distributors who maintain inventories of our products. If the distributors reduce
their inventories of our products, our sales could be adversely affected.
  If we are unable to successfully develop relationships with system integrators, service providers,
and enterprise VARs, our sales may be negatively affected.
  The members of the board of our China joint venture designated by our co-owner, Huawei, have
protective rights over the approval of certain matters; accordingly if Huawei does not agree with
us on these matters, these rights could harm 3Coms business by preventing us from taking desired
actions.
  28




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##### Table of Contents




    
    any amendment to the Articles or charter documents;
    
    any voluntary bankruptcy, liquidation, dissolution or winding up;
    
    changes in authorized capital stock or the issuance of capital stock (or rights to
acquire capital stock);
    
    any significant merger, acquisition, disposition or other corporate reorganization;
    
    determining the amount of dividends to pay and whether to pay special dividends
not required by the dividend policy;
    
    related party transactions, including loans and capital contributions;
    
    incurrence of debt over a specified amount that falls outside of the approved
budget; and
    
    any sale, exclusive license or other transfer or disposition of any significant
technology or intellectual property.
  Our competition with Huawei in the enterprise networking market could have a material adverse
effect on our sales and our results of operations.
  We may pursue acquisitions of other companies that, if not successful, could adversely affect our
business, financial position and results of operations.
  We may be unable to manage our supply chain successfully, which would adversely impact our sales,
gross margin and profitability.
  
    
    in the past, some key components have had limited availability;
    
    as integration of networking features on a reduced number of computer
chips continues, we are increasingly facing competition from parties
who are our suppliers;
    
    our ability to accurately forecast demand is diminished;
    
    our reliance on, and long-term arrangements with, third-party
manufacturers places much of the supply chain process out of our
direct control and heightens the need for accurate forecasting and
reduces our ability to transition quickly to alternative supply chain
strategies; and
    
    we may experience disruptions to our logistics.
  29




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##### Table of Contents



Our strategies to outsource the majority of our manufacturing requirements to contract
manufacturers may not result in meeting our cost, quality or performance standards. The inability
of any contract manufacturer to meet our cost, quality or performance standards could adversely
affect our sales and overall results from operations.
   Chinas governmental and regulatory reforms and changing economic environment may impact our
ability to do business in China.
  
    
    the promulgation of new laws and regulations and the interpretation of those
laws and regulations;
    
    enforcement and application of rules and regulations by the Chinese government;
    
    the introduction of measures to control inflation or stimulate growth; or
    
    any actions that limit our ability to develop, manufacture, import or sell our
products in China, or to finance and operate our business in China.
  Uncertainties with respect to the Chinese legal system may adversely affect us.
 30




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##### Table of Contents



If tax benefits available to our China joint venture, H-3C, are reduced or repealed, our business
could suffer.
  H-3C is subject to restrictions on paying dividends and making other payments to us.
  If we fail to maintain an effective system of internal control over financial reporting that
includes our China joint venture, H-3C, we may not be able to accurately report our financial
results or prevent fraud.
  We are subject to risks relating to currency rate fluctuations and exchange controls and we do not
hedge this risk in China.
   31




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##### Table of Contents



We may need to engage in complex and costly litigation in order to protect, maintain or enforce our
intellectual property rights; in some jurisdictions, such as China, our rights may not be as strong
as the rights we enjoy in the U.S.
   We may not be able to defend ourselves successfully against claims that we are infringing the
intellectual property rights of others.
   Fluctuations in our operating results and other factors may contribute to volatility in the market
price of our stock.
  
    
    fluctuations in our quarterly results of operations and cash flow;
    
    changes in our cash and equivalents and short term investment balances;
    
    variations between our actual financial results and published analysts expectations; and
    
    announcements by our competitors.
  32




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##### Table of Contents



ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  Total Number of
    
    
    DollarShares Purchased as
    
    
    Value of SharesTotal Number
    
    
    Average
    
    
    Part of Publicly
    
    
    that May Yet Beof Shares
    
    
    Price Paid
    
    
    Announced Plans or
    
    
    Purchased Under thePeriod
    
    Purchased
    
    
    per Share
    
    
    Programs(1)
    
    
    Plans or ProgramsJune 3, 2006 through June 30, 2006
    
    
    1,223
    (2)
    
    $
    4.56
    
    
    
    
    
    
    $
    100,000,000July 1, 2006 through July 28, 2006
    
    
    34,127
    (2)
    
    
    5.04
    
    
    
    
    
    
    $
    100,000,000July 29, 2006 through September 1, 2006
    
    
    2,093
    (2)
    
    
    4.41
    
    
    
    
    
    
    $
    100,000,000Total
    
    
    37,443
    
    
    $
    4.99
    
    
    
    
    
    
    $
    100,000,000
 
 (1)
    
    On March 23, 2005, our Board of Directors approved a new stock repurchase program providing
for expenditures of up to $100.0 million through March 31, 2007, provided that all repurchases
are pre-approved by the Audit and Finance Committee of the Board of Directors. We did not
repurchase shares of our common stock pursuant to this authorization in the three months ended
August 31, 2006. However, we may use cash to repurchase shares in future periods. Our last
open market purchase was made in August, 2004 for 10,700,041 shares.(2)
    
    Represents shares returned to us to satisfy tax withholding obligations that arose upon the
vesting of restricted stock awards. 33




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##### Table of Contents



ITEM 6.
    
    EXHIBITS
 Exhibit
    
    
    
    Incorporated by Reference
    
    FiledNumber
    
    Exhibit Description
    
    Form
    
    File No.
    
    Exhibit
    
    Filing Date
    
    Herewith2.1
    
    Master Separation and Distribution
Agreement between the Registrant and Palm,
Inc. effective as of December 13, 1999
    
    10-Q
    
    002-92053
    
    2.1
    
    4/4/002.2
    
    Indemnification and Insurance Matters
Agreement between the Registrant and Palm,
Inc.
    
    10-Q
    
    002-92053
    
    2.11
    
    4/4/002.3
    
    Asset Purchase Agreement by and between the
Registrant and UTStarcom, Inc. dated March
4, 2003
    
    8-K
    
    000-12867
    
    10.1
    
    6/9/032.4
    
    Agreement and Plan of Merger, dated
December 13, 2004, by and among the
Registrant, Topaz Acquisition Corporation
and TippingPoint Technologies, Inc.
    
    8-K
    
    000-12867
    
    2.1
    
    12/16/042.5
    
    Securities Purchase Agreement by and among
3Com Corporation, 3Com Technologies, Huawei
Technologies Co., Ltd. and Shenzen Huawei
Investment & Holding Co., Ltd., dated as of
October 28, 2005
    
    8-K/A
    
    000-12867
    
    2.1
    
    3/30/063.1
    
    Corrected Certificate of Merger filed to
correct an error in the Certificate of
Merger
    
    10-Q
    
    002-92053
    
    3.4
    
    10/8/993.2
    
    Registrants Bylaws, as amended on March
23, 2005
    
    8-K
    
    000-12867
    
    3.1
    
    3/28/053.3
    
    Certificate of Designation of Rights,
Preferences and Privileges of Series A
Participating Preferred Stock
    
    10-Q
    
    000-12867
    
    3.6
    
    10/11/014.1
    
    Third Amended and Restated Preferred Shares
Rights Agreement, dated as of November 4,
2002
    
    8-A/A
    
    000-12867
    
    4.1
    
    11/27/0210.1
    
    3Com Corporation Employment Agreement,
dated as of August 8, 2006 between the
registrant and Edgar Masri *
    
    8-K
    
    000-12867
    
    10.1
    
    8/9/0610.2
    
    3Com Corporation Stand Alone Stock Option
Agreement dated September 5, 2006 by and
between Edgar Masri and 3Com Corporation *
    
    
    
    
    
    
    
    
    
    X10.3
    
    Form of 3Com Corporation 2003 Stock Plan
Restricted Stock Unit Grant Award
Agreement*
    
    
    
    
    
    
    
    
    
    X10.4
    
    Executive Officer Fiscal 2007 Compensation*
    
    8-K
    
    000-12867
    
    Text of Item 1.01
    
    6/26/0610.5
    
    3Com Corporation Consultant Services
Agreement made as of August 8, 2006 by and
between 3Com Corporation and Anik Bose
    
    8-K
    
    000-12867
    
    10.1
    
    8/11/0610.6
    
    Purchase and Sale Agreement made as of July
24, 2006 by and between 3Com Corporation
and SSC II, L.P.
    
    8-K
    
    000-12867
    
    10.1
    
    7/26/0610.7
    
    Agreement for the Lease of Hangzhou Real
Property between Huawei Technologies Co.
Ltd. and Hangzhou Huawei-3Com
    
    
    
    
    
    
    
    
    
    X
 34




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##### Table of Contents



Exhibit
    
    
    
    Incorporated by Reference
    
    FiledNumber
    
    Exhibit Description
    
    Form
    
    File No.
    
    Exhibit
    
    Filing Date
    
    HerewithTechnology Co., Ltd. dated January 1, 200431.1
    
    Certification of Principal Executive Officer
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification of Principal Financial Officer
    
    
    
    
    
    
    
    
    
    X32.1
    
    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
 
 *
    
    Indicates a management contract or compensatory plan 35




---



##### Table of Contents



3Com Corporation
(Registrant)Dated: October 10, 2006
    By:
    /s/     DONALD M. HALSTED, IIIDonald M. Halsted, IIIExecutive Vice President, Finance and
Chief Financial Officer
(Principal Financial and
Accounting Officer and a duly authorized
officer of the registrant) 36




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##### Table of Contents



EXHIBIT INDEX
 Incorporated by ReferenceExhibit Number
    
    Exhibit Description
    
    Form
    
    File No.
    
    Exhibit
    
    Filing Date
    
    Filed Herewith2.1
    
    Master Separation and Distribution
Agreement between the Registrant and Palm,
Inc. effective as of December 13, 1999
    
    10-Q
    
    002-92053
    
    
    2.1
    
    
    4/4/002.2
    
    Indemnification and Insurance Matters
Agreement between the Registrant and Palm,
Inc.
    
    10-Q
    
    002-92053
    
    
    2.11
    
    
    4/4/002.3
    
    Asset Purchase Agreement by and between the
Registrant and UTStarcom, Inc. dated March
4, 2003
    
    8-K
    
    000-12867
    
    
    10.1
    
    
    6/9/032.4
    
    Agreement and Plan of Merger, dated
December 13, 2004, by and among the
Registrant, Topaz Acquisition Corporation
and TippingPoint Technologies, Inc.
    
    8-K
    
    000-12867
    
    
    2.1
    
    
    12/16/042.5
    
    Securities Purchase Agreement by and among
3Com Corporation, 3Com Technologies, Huawei
Technologies Co., Ltd. and Shenzen Huawei
Investment & Holding Co., Ltd., dated as of
October 28, 2005
    
    8-K/A
    
    000-12867
    
    
    2.1
    
    
    3/30/063.1
    
    Corrected Certificate of Merger filed to
correct an error in the Certificate of
Merger
    
    10-Q
    
    002-92053
    
    
    3.4
    
    
    10/8/993.2
    
    Registrants Bylaws, as amended on March
23, 2005
    
    8-K
    
    000-12867
    
    
    3.1
    
    
    3/28/053.3
    
    Certificate of Designation of Rights,
Preferences and Privileges of Series A
Participating Preferred Stock
    
    10-Q
    
    000-12867
    
    
    3.6
    
    
    10/11/014.1
    
    Third Amended and Restated Preferred Shares
Rights Agreement, dated as of November 4,
2002
    
    8-A/A
    
    000-12867
    
    
    4.1
    
    
    11/27/0210.1
    
    3Com Corporation Employment Agreement,
dated as of August 8, 2006 between the
registrant and Edgar Masri *
    
    8-K
    
    000-12867
    
    
    10.1
    
    
    8/9/0610.2
    
    3Com Corporation Stand Alone Stock Option
Agreement dated September 5, 2006 by and
between Edgar Masri and 3Com Corporation *
    
    
    
    
    
    
    
    
    
    
    
    X10.3
    
    Form of 3Com Corporation 2003 Stock Plan
Restricted Stock Unit Grant Award
Agreement*
    
    
    
    
    
    
    
    
    
    
    
    X10.4
    
    Executive Officer Fiscal 2007 Compensation*
    
    8-K
    
    000-12867
    
    Text of Item 1.01
    
    6/26/0610.5
    
    3Com Corporation Consultant Services
Agreement made as of August 8, 2006 by and
between 3Com Corporation and Anik Bose
    
    8-K
    
    000-12867
    
    
    10.1
    
    
    8/11/0610.6
    
    Purchase and Sale Agreement made as of July
24, 2006 by and between 3Com Corporation
and SSC II, L.P.
    
    8-K
    
    000-12867
    
    
    10.1
    
    
    7/26/0610.7
    
    Agreement for the Lease of Hangzhou Real
Property between Huawei Technologies Co.
Ltd. and Hangzhou Huawei-3Com
    
    
    
    
    
    
    
    
    
    
    
    X
 37




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##### Table of Contents



Incorporated by ReferenceExhibit Number
    
    Exhibit Description
    
    Form
    
    File No.
    
    Exhibit
    
    Filing Date
    
    Filed HerewithTechnology
Co., Ltd. dated January 1, 200431.1
    
    Certification of Principal Executive Officer
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification of Principal Financial Officer
    
    
    
    
    
    
    
    
    
    X32.1
    
    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
 
 *
    
    Indicates a management contract or compensatory plan 38