e10vk
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C.
20549
Form 10-K
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended
May 29, 2009
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OR
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to
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Commission file
number: 0-12867
3COM CORPORATION
(Exact name of registrant as
specified in its charter)
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Delaware
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94-2605794
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(State or other jurisdiction
of
incorporation or organization)
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(I.R.S. Employer
Identification No.)
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350 Campus Drive
Marlborough, Massachusetts
(Address of principal
executive offices)
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01752
(Zip Code)
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(508) 323-1000
(Registrants telephone
number, including area code)
Securities registered pursuant to Section 12(b) of the
Act:
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Title of Each Class
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Name of Each Exchange on Which Registered
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Common Stock, $0.01 par value per share
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The NASDAQ Global Select Market
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Preferred Stock Purchase Rights
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The NASDAQ Global Select Market
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Securities registered pursuant to Section 12(g) of the
Act: NONE
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes þ No o
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Exchange
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of
Regulation S-T
during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such
files). Yes o No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated filer
or a smaller reporting company. See the definitions of
large accelerated filer, accelerated
filer and smaller reporting company in
Rule 12b-2
of the Exchange Act.
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Large
accelerated
filer þ
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Accelerated
filer o
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Non-accelerated
filer o
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Smaller reporting
company o
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(Do not check if a smaller
reporting company)
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
As of November 28, 2008, the aggregate market value of the
registrants common stock held by non-affiliates of the
registrant was $769,466,763 based on the closing sale price as
reported on The NASDAQ Global Select Market.
Indicate the number of shares outstanding of each of the
issuers classes of common stock, as of the latest
practicable date.
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Class
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Outstanding at July 10, 2009
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Common Stock, $0.01 par value per share
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391,069,877 shares
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DOCUMENTS
INCORPORATED BY REFERENCE
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Document
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Parts Into Which Incorporated
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Proxy Statement for the Annual Meeting of Stockholders to be
held September 23, 2009 (Proxy Statement)
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Part III, to the extent stated herein
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3Com
Corporation
Form 10-K
Annual Report
For the Fiscal Year Ended May 29, 2009
Table of Contents
1
We use a 52 or 53 week fiscal year ending on the Friday
nearest to May 31, with each fiscal quarter ending on the
Friday generally nearest August 31, November 30 and
February 28. For presentation purposes, the periods are
shown as ending on August 31, November 30, February 28
and May 31, as applicable.
Our China-based networking equipment business, H3C, follows a
calendar year basis of reporting and therefore results are
consolidated on a two-month time lag.
3Com, the 3Com logo, H3C, Digital Vaccine, NBX, OfficeConnect,
Comware, IRF, TippingPoint, TippingPoint Technologies and VCX
are registered trademarks or trademark of 3Com Corporation or
one of its wholly owned subsidiaries. Other product and brand
names may be trademarks or registered trademarks of their
respective owners.
This Annual Report on
Form 10-K
contains forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform
Act of 1995. These forward-looking statements include, without
limitation, statements regarding the following aspects of our
business: global economic slowdown and effects and strategy;
core business strategy to leverage China and emphasize larger
enterprise business; China-based sales region strategy, growth,
dependence, expected benefits, tax rate, sales from China,
expected decline in sales to Huawei and resources needed to
comply with Sarbanes-Oxley and manage operations; impact of
recent accounting regulations; expected annual amortization
expense; environment for enterprise networking equipment;
challenges relating to sales growth; trends and goals for
segments and regions; pursuit of termination fee; supply of
components; research and development focus; execution of our
strategy; strategic product and technology development plans;
goal of sustaining profitability; short-term management of cash
during economic slowdown; intercompany dividends from China;
ability to satisfy cash requirements for at least the next
twelve months; stock repurchase program; restructuring
activities and expected charges to be incurred; expected cost
savings from restructuring activities and integration; potential
acquisitions and strategic relationships; future contractual
obligations; recovery of deferred tax assets and balance of
unrecognized tax benefits; reserves; market risk; outsourcing;
competition and pricing pressures; expectation regarding base
interest rates; impact of foreign currency fluctuations; belief
regarding meritorious defenses to litigation claims and effects
of litigation; and you can identify these and other
forward-looking statements by the use of words such as
may, can, should,
expects, plans, anticipates,
believes, estimates,
predicts, intends, continue,
or the negative of such terms, or other comparable terminology.
Forward-looking statements also include the assumptions
underlying or relating to any forward-looking statements.
Actual results could differ materially from those anticipated in
these forward-looking statements as a result of various factors,
including those set forth under Part I Item 1A Risk
Factors. All forward-looking statements included in this
document are based on our assessment of information available to
us at the time this report is filed. We do not intend, and
disclaim any obligation, to update any forward-looking
statements.
In this
Form 10-K
we refer to the Peoples Republic of China as China or the
PRC.
2
PART I
GENERAL
3Com Corporation (3Com or the Company) is a global enterprise
networking solutions provider. 3Com has three global product and
solutions brands H3C, 3Com, and
TippingPoint that offer high-performance networking
and security solutions to enterprises large and small. The
H3C®
enterprise networking portfolio one of the leading
enterprise networking equipment brands in China
includes products that span from the data center to the edge of
the network and is targeted at large enterprises. The
3Com®
family of products offers a strong price/performance value
proposition for the small and medium-size businesses. Our
security brand,
TippingPoint®,
features network-based intrusion prevention systems (IPS) and
network access control (NAC) solutions that deliver in-depth,
no-compromise application, infrastructure and performance
protection.
We are implementing a China Out business strategy
designed to bring the H3C product portfolio to the global
marketplace. This strategy is designed to leverage a strong
local home market position built on the design,
manufacture and sales of large-scale, high-volume deployments in
China. 3Com, through our H3C brand, is now one of the leaders in
the enterprise networking market in China.
3Com has been a major contributor to the development of
enterprise networking since the invention of Ethernet in the
1970s by 3Coms founder, Bob Metcalfe. Based in
Massachusetts, U.S.A., 3Com prides itself on its continuing
commitment to innovation that improves the security, ease-of-use
and performance of networks around the world. The Company
leverages more than 2,400 world-class engineers to develop
industry-leading networking solutions. 3Com has more than 1,400
U.S. and over 400 Chinese-issued patents, more than 1,300
pending Chinese applications as well as pending applications for
56 separate inventions outside of China that cover a wide range
of networking technologies.
Our portfolio of products and services enable customers to
deploy and manage business-critical data, voice, video and other
advanced networking technologies in a secure, scalable, reliable
and efficient network environment. Since the companys
inception, 3Com has consistently offered customer-driven
technology solutions that help enterprises optimize their
budgets and resources, increase productivity, and realize their
business goals. 3Com designs its solutions to offer customers a
unique value proposition: lower total cost of ownership (TCO)
and expert, responsive service. Our data center-to-edge
enterprise networking solutions offer a common operating system
to streamline system management, and are based on open standards
to enable the use of best-of-breed applications from other
vendors. We believe we offer a broad, fresh portfolio of
products and solutions that disrupt the industry status quo and
deliver true no-compromise networking.
As disclosed above, 3Com Corporation currently maintains three
principal brands H3C for large enterprise networking
customers, 3Com for small and medium-size businesses and
TippingPoint for security solutions. We manage our networking
equipment business based on geographic regions as follows: our
China-based sales region (which includes China, Hong Kong and
Japan) and our Rest of World sales region (which covers all
other geographies). We also maintain TippingPoint as a separate
segment. Our China-based sales region is primarily comprised of
our H3C subsidiary based in Hangzhou, China, and maintains a
calendar fiscal year which results in a two-month lag in
reporting its results within 3Coms consolidated results.
3Com was incorporated in California on June 4, 1979, and
reincorporated in Delaware on June 12, 1997. Our corporate
headquarters are currently located in Marlborough,
Massachusetts. We have offices and sales capabilities in 35
countries and 60 locations worldwide. Our Web address is
www.3Com.com. Available on our Web site, free of charge, are our
SEC filings (including our Annual Report on
Form 10-K,
proxy statements on Schedule 14A, quarterly reports on
Form 10-Q,
current reports on
Form 8-K,
Section 16 filings on Forms 3, 4 and 5, and any
amendments to those reports) as soon as reasonably practicable
after we electronically file with or furnish such material to
the Securities and Exchange Commission (SEC). The information
contained on our Web site is not incorporated by reference in
this Annual Report on
Form 10-K.
Furthermore, a copy of this Annual Report on
Form 10-K
is located at the SECs Public Reference Room at
100 F Street, NE, Washington, D.C., 20549.
Information on the operation of the Public Reference Room can
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be obtained by calling the SEC at
1-800-SEC-0330.
The SEC maintains an Internet site that contains reports, proxy
and information statements and other information regarding our
filings at
http://www.sec.gov.
MARKETS
AND CUSTOMERS
3Com designs cost-effective, no-compromise networking solutions
that deliver superior performance for enterprises around the
world. H3C, TippingPoint and 3Com products and services help
organizations realize their potential and prepare for the
future. Our product and solutions portfolios address the needs
of enterprises of all sizes in a number of vertical industries,
including education, finance, government, health care, insurance
and manufacturing. These product portfolios will continue to
evolve around our goal of offering flexible, scalable,
standards-based wired or wireless data/voice networks that
deliver secure anywhere, anytime access.
Our products are built around the awareness that CIOs and IT
departments are constantly under pressure to optimize the return
on investment (ROI) from their data infrastructure purchases. We
believe we deliver high-quality, high-performance converged
networking solutions that provide exceptional business value and
help customers address the following fundamental challenges:
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Performance Bandwidth demands have increased along
with the number of users and applications IP
telephony, videoconferencing, streaming multimedia and
others on enterprise networks, yet performance
requirements never abate. 3Com routers, switches and security
devices provide robust throughput and traffic optimization
applications to ensure high-quality networking even in the most
challenging enterprise network environments.
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Cost effectiveness Todays enterprise customers
are seeking cost-effective solutions that optimize the value of
their network infrastructure investment. 3Com products are
designed to be cost-effective, competitively priced and energy
efficient. 3Coms single-pane, intuitive network management
platform minimizes time spent training IT staff and network
administrators, helping to further reduce overall TCO.
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Security Todays enterprises need to protect
themselves from a constantly evolving spectrum of internal and
external threats to ensure the safety of their mission-critical
information. 3Coms pervasive network solutions provide
granular oversight, control access, quarantine malicious
programs and files, and restore data.
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We believe that open standards-based technology delivers the
best value to our customers by providing them with the widest
selection of the most recently developed enterprise network
applications. Our standards-based technology works in tandem
with other industry leaders to deliver the best solutions to
address constantly evolving business needs, delivering the
flexibility our customers require to adopt the
best-in-class
applications that address their specific business requirements.
This interoperability ensures the longevity of an
enterprises network and its ability to evolve with the
organization.
Our products are sold on a worldwide basis through a combination
of value added resellers, systems integrators, distributors and
direct-touch sales representatives. We have invested in a global
network of sales, implementation and support teams to support
customers around the world, and have five directly operated
global enterprise support centers staffed by employees to
service our customers in 13 different languages.
PRODUCTS
AND SERVICES
3Coms product strategy involves delivering differentiation
in all three critical buying criteria categories: cost, service
and technology. By applying our unique business and services
model, 3Com designs its solutions to provide a low total cost of
ownership, through solutions that are less expensive to acquire,
power and operationally manage. 3Com also seeks to provide a new
level of customer intimacy through a direct-touch customer
relationship model and H3C-branded invitation-only reseller
program that treats each enterprise client with a personal touch
and a focus on solutions versus commodity delivery. Finally,
3Com has built a modern and innovative solutions architecture
that helps companies succeed today and prepare for tomorrow
through key design decisions, such as the use of merchant
silicon chipsets, advanced, single-pane automated
management, a standards-based architecture and a proactive,
preventive approach to security.
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For extensibility, we have implemented a service-blade
architecture based on our Open Systems Networking (OSN)
capability. This enables us to easily extend the capabilities of
our core switching and routing products through a
100 percent compatible, slide-in approach.
The
H3C Portfolio for Large Enterprises
H3C networking products address the needs of the global large
enterprise market and these products can generally be classified
in the following categories:
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Networking LAN Switches, Router and Network
Management Software;
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Security Firewalls;
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Emerging Technology IP Storage and IP Video
Surveillance; and
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Services.
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H3C
Local Area Network, or LAN, Switches
Switches are multi-port devices, located in the network data
center/core and at the network edge, that join multiple
computers and peripheral devices and serve as the foundation for
transporting data, voice and video over a network. We offer a
number of fixed-configuration and modular chassis switches that
we believe provides the performance and flexibility required by
our customers.
Optimizing application delivery, enhancing employee productivity
and ensuring business continuity are just a few of the benefits
H3C switches deliver. H3Cs
Comware®
Operating System found in all H3C enterprise
solutions provides a common platform to expedite
network deployment and streamline staff training and system
management. Available Intelligent Resilient Framework
(IRF®)
technology enables interconnected switches to act as a virtual
chassis, which increases overall network resiliency,
availability and performance.
Our data center-to-edge switching portfolio provides a
foundation that delivers rich functionality to ensure an
always-on network experience for end users. These
products represent a broad offering, including full-featured
modular, stackable and stand-alone switches ranging from 10
Megabits per second (Mbps) to multi-Terabit per second
performance. Our switches are available as managed
units which are typically found in enterprise
environments and unmanaged, stand-alone
units typically used by small and medium-size
organizations. Our enterprise-class switches all support the
Comware Operating System, Network Access Control, or NAC, and a
Web-based, graphical user interface that reduce management
complexity and expedite staff training. This also enables
customers to readily upgrade their networks as their business
requirements grow. Our switches are built to support the
convergence of data, voice and video, and include robust
security features to safeguard mission-critical information. Our
principal switch products are as follows:
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Data Center/Core Routing Switches. The H3C
S12500 and S9500 Series 10-gigabit multi-service core routing
switches represent the next generation of high-performance
switching. They are designed to fully satisfy the requirements
of end users seeking high capability, high reliability and
multiple services. These models are extensively deployed at the
core layer of
E-government
networks, campus networks, education networks and other
enterprise networks and core layer or aggregation layer of
carriers IP Metro Area Networks (MAN).
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Multi-Service Switches. The S7500E and S7500
Series high-end multi-service switch lines feature high
performance, high port density and high flexibility. They can be
deployed in the core layer of enterprise networks, campus
networks and education MANs, in the convergence layer of
carriers IP MANs, and in the access layer of data centers.
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Flex-chassis switches. The S5820X and S5800
Series flex-chassis switches combine the resilient architecture
and flexibility of a chassis in a compact, fixed platform. They
feature high density, 10-gigabit line-rate performance and the
ability to integrate applications into the network to help
reduce total cost of ownership and enhance network performance.
These switches are generally used in the
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core or edge layer of enterprise networks, campus networks and
MANs. The S5820X can also be deployed as a top-of-rack solution
in the data center.
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Layer 3 Gigabit Stackable Switches. The S5500
and S5600 Series provide robust security, carrier-class
reliability and excellent multi-service support capability,
providing the features desired for the convergence layer of
large enterprise networks or campus networks, the core layer of
medium-size and small enterprise networks, and the edge layer of
MANs.
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Layer 2 and Layer 3 Intelligent and Resilient
Switches. Layer 2 switches offer wire-speed
Gigabit Ethernet connectivity that provides high capacity with a
full range of features. Our Layer 3 switches represent the next
generation of desktop switches, helping customers implement a
Gigabit Ethernet core network or aggregation layer with high
availability as well as scalability.
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H3C
Routers
Our routers, in combination with our other networking
infrastructure products, provide a means of transporting
converged data and voice traffic across an Internet Protocol
wide area network, or IP WAN, while preserving the quality of
service (QoS) required for mission-critical applications.
Our H3C portfolio includes router products from carrier-class
core routers to modular routers to small business access routers
designed to scale as these organizations grow. H3C router
products are classified as SR, MSR and AR Series Routers.
All SR Series routers are IPv6-ready and include carrier-class
availability with redundancy in all key modules. MSR Series
routers are oriented to support multiple-service applications,
delivering wire speed and concurrent services of data, voice and
video. The AR Series routers are easy to manage, offer VPN
functionality and support multiple security products.
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SR Series Routers. The SR family consists
of core routers ranging from products that support a super-large
capacity network core, such as national backbone networks,
provincial or state backbone networks and other super-large
networks (including those serving at the backbone network edge
and MAN core), to those working at the core networks of
industries and enterprises.
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Intelligent Multi-Service Enterprise Core
Routers. The MSR Series routers support multiple
services, integrating data, voice and video in one device. MSR
Series routers utilize an optimized hardware and software
structure to provide embedded security and significant
performance while delivering services such as IP telephony,
business video, and network analysis, among others.
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Fixed-Port Branch Routers. The AR Series
access routers are fixed-port products for small enterprises and
branch offices. They provide enhanced security, superior
reliability and advanced QoS services.
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H3C
Network and Access Management System
H3Cs Web-based Intelligent Management Center
(IMC) platform offers enterprises a comprehensive,
end-to-end, network management solution that integrates
applications, resources and users. Providing an intuitive,
single-pane user interface, IMC delivers a suite of scalable
tools that simplify network administration and access management
on an open-standards technology platform. The unique management
platform is based on a Service Oriented Architecture which we
believe offers an extensive set of capabilities for managing
large heterogeneous networks from the core to the edge.
H3C
Security
H3C security solutions are designed to provide powerful,
real-time protection, ensure continuity, lower total cost of
ownership and improve network availability and control. We
believe our integrated, adaptive, automated and centrally
managed solutions defend enterprise networks without
compromising performance.
As the information backbone of a business, an enterprise network
requires high-performing, proven security solutions to protect
its mission-critical data. H3C SecPath products are designed to
address these needs and we believe provide powerful security
defense capabilities, comprehensive virtual private network, or
VPN, services and intelligent, dynamic networking features.
These flexible appliances integrate denial of service (DoS),
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distributed denial of service (DDoS) and application-aware
defense-in-depth
capabilities with VPN and traffic management functionality, and
deliver ample throughput to help maintain robust network
performance.
H3C
Firewalls
The H3C SecPath F-Series and SecBlade VPN Firewall are
virtualized firewalls that combine state-of-the-art multi-core
processors and the full feature set of 3Coms Comware
operating system with rich networking protocol support. We
believe these solutions offer ease of integration and are
designed to lower total cost of ownership. Both the SecPath
F-Series and SecBlade VPN Firewall safeguard enterprise networks
and data centers from attacks and misuse, while delivering
policy-based multisite connectivity for real-time
business-critical applications such as voice over internet
protocol, or VoIP, video and collaboration.
Emerging
Technology
H3C IP
Storage
Currently available in China, our H3C brand is a leading
developer of IP storage area network (IP SAN) offerings. IP SAN
is a third-generation storage technology, and is based on the
most advanced architecture and open standard IP protocol. With
the goal of storage virtualization and data management
standardization, H3C integrates data management technology and
application service technology on standard IP architecture,
delivering a unified IP storage architecture.
H3C IP
Video Surveillance
Currently available in China, IP video surveillance enables our
customers to leverage existing network installations and
cost-effectively deliver video security. The features of our
switches, routers and network management such as
Power over Ethernet (PoE) to power video devices, and network
management capabilities that control access are
leveraged with surveillance equipment to deliver cost-effective
video surveillance solutions. Our H3C business unit sells
integrated surveillance offerings to targeted vertical customers
focused on integrated security solutions.
Services
3Com service offerings for our 3Com and H3C solutions cover key
aspects of support that customers need to keep their data
networking solutions operating effectively, including telephone
support, hardware replacement, software updates, dedicated
on-site
engineers and spare parts. We maintain five directly operated
global enterprise support centers offering assistance in
13 languages.
The 3Com
Portfolio for Small and Medium-Size Businesses
Our 3Com-branded solutions provide scalable, feature-rich,
high-performance, reliable and secure standards-based networking
solutions for our global customer base. 3Com-branded products
and services can generally be classified in the following
categories:
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Networking;
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IP Telephony; and
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Services.
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3Com
Networking
All of our infrastructure platforms are based on open standards,
which enable interoperability as well as the ability to
integrate emerging technologies and applications. Products
include:
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Ethernet Switching. We offer a full range of
fixed-configuration and modular Ethernet switches that deliver
performance and flexibility to the edge and core of IP networks.
At the edge, we include enterprise-class offerings such as the
3Com®
Switch 5500, Switch 4500 and Switch 4200 families, as
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well as our
OfficeConnect®
and Baseline series switches targeted at small businesses and
branch offices of larger organizations. At the core, we offer
fully resilient, high-capacity and feature-rich modular
switching products, including our high-density Switch 8800 and
our cost-effective Switch 7750 products.
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Wireless LAN. We offer wireless networking
products and solutions that provide users with secure
anytime, anywhere network access whether
in a branch office or in the field to foster
employee collaboration and increase productivity. Our wireless
portfolio comprises high-performance, standards-based (including
802.11 a/b/g /n wireless standards) wireless solutions, as well
as wireless security and policy enforcement offerings.
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Routers. We offer routing solutions that bring
enterprise-class WAN routing features, redundancy and
performance to the regional offices of large enterprise
customers and to the headquarters of medium-size businesses. We
also offer router products which provide fixed configuration
solutions to securely connect small offices and remote offices
of large enterprises.
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Security. Leveraging the award-winning
TippingPoint Intrusion Prevention System (IPS) technology and
its
DigitalVaccine®
service that automatically provides updated attack filters, 3Com
has a complete line of unified security platforms that protect
small and medium-size enterprises from a myriad of threats.
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Network Management. We offer flexible and
comprehensive network management application packages for
advanced IT environments. Our network management applications
help customers manage large and small wired and wireless
networks with tools for network monitoring, bandwidth
allocation, device control and fast problem resolution.
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3Com
Internet Protocol (IP) Telephony
Voice communications are a mission-critical function for global
businesses of all types and sizes. IP is ubiquitous today both
within an enterprise and outside of it, enabling software
applications and computers to communicate in an efficient
manner. We offer a broad portfolio of IP telephony products that
work together to deliver business-focused applications,
including: next-generation dial tone, IP messaging, IP presence,
IP conferencing, IP mobility and IP customer contact center
services. Our secure, Session Initiation Protocol (SIP)-based
platforms and applications are designed to meet the performance
expectations of todays business environments:
cost-effectiveness, increased user productivity and enhanced
customer interactions. Our VoIP products fall within the
following categories:
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IP Telephony Platforms
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Convergence Application Suite
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IP Phones
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3Com
Services
3Com provides our channel partners and customers a single point
of accountability for service performance and quality. Our
global service offerings cover key aspects of support that
customers need to keep their data networking and voice solutions
operating effectively, including telephone support, hardware
replacement, software updates, dedicated
on-site
engineers and spare parts. We also offer high-end professional
services and training to provide complete product and service
solutions to our customers.
To deliver our services, we employ a team of highly skilled and
professional in-house services experts and also partner with
select third-party service providers; we also offer customers
the benefits of virtually integrated services resources.
Additionally, we have agreements with local and regional
professional services providers to augment our
on-site
coverage and meet the demand for our services. Our international
call centers and thousands of engineers provide around-the-clock
support in 13 languages.
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TIPPINGPOINT
SECURITY PRODUCTS
TippingPoint
Security
We have a comprehensive security portfolio that includes
end-to-end solutions for core-to-edge enterprise network
protection. Organizations can choose to implement stand-alone or
embedded security solutions that offer
plug-and-play
functionality, are centrally manageable and provide adaptive and
dynamic protection.
Our security products include the following:
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Intrusion Prevention Systems;
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Security Services; and
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Network Access Control.
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TippingPoint
Intrusion Prevention Systems
Our TippingPoint line of intrusion prevention systems (IPSs) is
designed to analyze incoming data to prevent viruses and
malicious traffic from entering the network. TippingPoint IPSs
utilize high-speed network processors that operate at
multi-gigabit speeds. This hardware platform is complemented by
a robust security-oriented operating system and a suite of
vulnerability filters that can be dynamically updated. Our
TippingPoint IPS solutions offer bandwidth management,
peer-to-peer (P2P) protection and default recommended
settings that provide strong protection out of the box,
yet can be fine-tuned to address an enterprises specific
security concerns.
The TippingPoint IPS offers total packet inspection, reviewing
all data processed through it for viruses and other malicious
traffic to provide application protection, performance
protection and infrastructure protection. Application protection
capabilities provide fast, accurate, reliable protection from
internal and external attacks. Through its infrastructure
protection capabilities, the TippingPoint IPS protects IP
telephony infrastructure, routers, switches and other critical
infrastructure from targeted attacks and traffic anomalies. Our
performance protection capabilities enable customers to throttle
non-mission-critical applications that hijack valuable bandwidth
and IT resources, thereby aligning network resources and
business-critical application performance.
The switch-like performance characteristics of the TippingPoint
IPS enable it to be placed at the core, in-line at the
perimeter, on internal network segments, and at remote site
locations with minimal or no adverse network impact.
Additionally, our IPS solutions are deployed and managed using a
scalable, tiered Security Management System (SMS). Using the
SMS, customers implement and manage coherent, enterprise-wide
security policies based on rules and thresholds set within the
SMS. The SMS offers a rich reporting system that enables the
automatic generation and distribution of customized reports on a
scheduled basis. Support for multiple user profiles provides
groups of users such as administrators or
executives access to this management system.
TippingPoint
Security Services
We provide a real-time update service, called the Digital
Vaccine®
service, which automatically and rapidly delivers vulnerability
filters against the latest security threats. To facilitate the
creation of Digital Vaccine filters, our Threat Management
Center monitors and collects security intelligence from
customers and security agencies around the world. Based on this
intelligence, we perform investigations of new software
vulnerabilities and create antidotes that are delivered directly
to our products. Additionally, we offer installation, training
and high-touch maintenance programs for our IPS equipment.
Maintenance programs are offered as a bundled solution with our
Digital Vaccine updates.
9
TippingPoint
Network Access Control
Our TippingPoint Network Access Control (NAC) Enforcer offering
provides NAC features that enable enterprises to enforce device
and user policies to ensure endpoint compliance. NAC enables
enterprises to verify the identity of users before allowing them
to access different levels of the network.
SALES,
MARKETING AND DISTRIBUTION
We use a broad distribution channel to bring our products and
solutions to our customers. Our two-tier distribution channel
comprises distributors and resellers. As part of our one
company three brand strategy we also are creating an
invitation-only reseller program to support our H3C-branded
solutions outside of China.
Although a majority of our sales of enterprise networking
products is made through our two-tier distribution channel, we
also work with global systems integrators, service providers and
direct marketers. Additionally, we maintain a direct-touch
organization that works in conjunction with our partners.
COMPETITION
We compete in the networking infrastructure market, providing a
broad portfolio of secure, converged voice and data networking
products to small, medium, and large enterprises around the
world and, through our H3C segments OEM sales, carrier
customers. The market for our products is competitive,
fragmented and rapidly changing. We expect competition to
continue to intensify. Many of our competitors are bringing new
solutions to market, focusing on specific segments of our target
markets and establishing alliances and original equipment
manufacturer (OEM) relationships with larger companies, some of
which are our partners as well.
Cisco Systems, Inc. maintains a significant global leadership
position in many of our primary markets. Our other principal
competitors in the enterprise networking market include Alcatel
Lucent, Brocade Communications Systems, Inc.s Foundry
Networks division, Enterasys Networks, Inc., Extreme Networks,
Inc., F5 Networks, Inc., Nortel Networks, Hewlett-Packard
Companys ProCurve division and Juniper Networks, Inc. In
addition, H3C also competes in certain regions with competitors
such as Allied Telsis, Inc. (formerly Allied Telesyn), Buffalo
Inc., Digital China, Hitachi, Huawei, and ZTE Corporation.
TippingPoints principal competitors are IBMs
Internet Security Systems division, Juniper Networks, Inc.,
McAfee, Inc., Sourcefire, Inc. and Symantec Corporation. In the
small-medium business market, our principal competitors are:
D-Link Systems, Inc., Cisco Systems Linksys division, and
NETGEAR, Inc. Many of our competitors are larger than us and
possess greater financial resources.
We believe the primary competitive factors in the enterprise
networking infrastructure market are:
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Offer price-performance value to end-users. We
believe that a strong price-performance value proposition,
consisting of competitive pricing for robust equipment features
and energy-efficient products, may be a material competitive
factor for customers, particularly during more challenging
economic times.
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Maintain tier-one capability and presence. To
maintain tier-one capability and presence, a provider must have
a comprehensive distribution channel and a strong financial
position. In addition, that provider must have a globally
recognized and preferred brand and provide strong service and
support capabilities.
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Offer a broad line of innovative products and solutions.
A provider must have extensive research and development
resources to deliver a broad line of products and solutions and
maintain a substantial intellectual property portfolio.
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RESEARCH
AND DEVELOPMENT
Our research and development approach is to focus on activities
that deliver differentiated products and solutions and drive
reductions in product costs. Our current areas of focus include
security, convergence of applications over IP, advanced
switching, routing, solutions, network security and IP storage
and video
10
surveillance. We are focused on developing solutions for the
data center. For activities such as mature technologies or
widely available product design components, we work with
contract developers and third parties. We believe this two-fold
approach increases our ability to bring products to market in a
timely and cost-effective manner, ensures that we focus on the
products that matter most to our customers, and clearly
differentiates the products we offer from those of our
competitors.
We rely on our China-based engineering talent for new product
development of enterprise switches and routers, and on certain
third-party developers for small- and medium-size networking
offerings. Our TippingPoint segment develops the TippingPoint
intrusion prevention systems and Digital Vaccine security
products and services in Austin, Texas.
Our research and development expenditures were
$180.0 million in fiscal 2009, $206.7 million in
fiscal 2008, and $215.6 million in fiscal 2007. The
majority of the decrease resulted from the migration of the
Companys non-TippingPoint research and development
functions to China, resulting in a decrease in headcount of
230 employees from the prior fiscal year as the Company
eliminated duplicate testing and other activities.
SIGNIFICANT
CUSTOMERS AND PRODUCTS
For information regarding customer and product concentration for
each of the last three fiscal years, see Note 18 to our
Consolidated Financial Statements in Item 8 of this Annual
Report on
Form 10-K.
FINANCIAL
INFORMATION ABOUT SEGMENT, FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
We market our products in all significant global markets,
primarily through subsidiaries, sales offices, sales
representatives, and relationships with OEMs, value-added
resellers, system integrators and distributors with local
presence. Segment financial data are set forth in
Managements Discussion and Analysis of Financial Condition
and Results of Operations in Item 7, and in Note 18 of
the Notes to the Companys Consolidated Financial
Statements, which appears in Item 8 of this Annual Report
on
Form 10-K
for the fiscal year ended May 31, 2009. A significant
portion of our revenues is derived from overseas operations. The
profitability of our segments is affected by fluctuations in the
value of the U.S. dollar relative to foreign currencies,
particularly the Chinese Renminbi. See the Geographic
Information portion of Note 19 for further information
relating to sales and property and equipment by geographic area
and Managements Discussion and Analysis of Financial
Condition and Results of Operations.
Our research and development resources are principally based in
China. In addition, our TippingPoint business segment maintains
a research and development team in the United States.
BACKLOG
Our backlog as of May 29, 2009, the last day of our 2009
fiscal year, was approximately $53.9 million (including
$42.6 million of China-based sales region backlog as of
March 31, 2009), compared with backlog of approximately
$71.0 million (including $56.0 million of China-based
sales region backlog as of March 31, 2008) as of
May 30, 2008, the last day of our 2008 fiscal year. We
include in our backlog purchase orders for which a delivery
schedule has been specified for product shipment within one
year. Generally, orders are placed by our customers on an
as-needed basis and may be canceled or rescheduled by the
customers without significant penalty to them. Accordingly,
backlog as of any particular date is not necessarily indicative
of our future sales.
SEASONALITY
Our China-based sales region generally experiences some seasonal
effect on sales, due to the Chinese New Year in its first
calendar quarter (which is 3Coms fourth quarter). Our Rest
of World sales region and TippingPoint segment revenues and
earnings have not been impacted by seasonality to any
significant degree.
11
MANUFACTURING
AND COMPONENTS
The majority of our manufacturing is outsourced to contract
manufacturers. Manufacturers either procure components and
assemble products in quantities based on a forecast provided by
us or purchase components and manufacture products only upon
receiving purchase orders. The manufacturer tests the products
according to our specifications. In our Rest of World sales
region, products are shipped directly to our logistics provider.
We generally do not own the components and our customers take
title to our products upon shipment from the logistics provider
or, in certain jurisdictions, upon payment. In certain
circumstances, we may be liable for carrying costs and obsolete
material charges for excess components purchased based on our
forecasts. Our China-based sales region purchases from contract
manufacturers based on purchase orders, typically takes title to
the product directly from the contract manufacturer, builds an
inventory position for forecasted sales and ships to the
customers designated delivery hub.
In addition, our China-based sales region maintains an in-house
manufacturing capability, primarily for pilot run, low volume
production, as well as special projects. This capability
includes a state-of-the-art SMT (surface mount technology) line,
assembly and debugging integrated equipment.
We determine the components that are incorporated in our
products and design the supply chain solution. Although we have
contracts with our manufacturers, those contracts set forth a
framework within which it may accept purchase orders from us.
The contracts do not require them to manufacture our products on
a long-term basis.
A number of vendors supply standard product integrated circuits
and microprocessors for our products. We use other standard
parts and components for our products where it is appropriate.
Certain key components used in the manufacture of our products
are sourced from single or limited sources. Based on current and
forecasted demand, our contract manufacturers are expected to
have an adequate supply of components required for the
production of our products.
We believe this approach enables us to reduce fixed costs and to
quickly respond to changes in market demand.
Our rest of World sales region has contract manufacturing
arrangements with several companies, of which Lite-On and Accton
Technology Corp. were the two most significant during fiscal
2009. Jabil Circuits and Accton Technology Corp. were the two
most significant during fiscal 2008. Our China-based sales
region has contract manufacturing arrangements principally with
System Integration Electronics (SIE), Flash Electronics and
Flextronics.
INTELLECTUAL
PROPERTY AND RELATED MATTERS
Through our research and development activities over many years,
we have compiled a substantial portfolio of patents covering a
wide variety of networking technologies. This ownership of core
networking technologies creates opportunities to leverage our
engineering investments and develop more integrated, powerful,
and innovative networking solutions for customers.
We rely on U.S. and foreign patents, copyrights,
trademarks, and trade secrets to establish and maintain
proprietary rights in our technology and products. We have an
active program to file applications for and obtain patents in
the U.S. and in selected foreign countries where potential
markets for our products exist. Our general policy has been to
seek to patent those patentable inventions that we expect to
incorporate in our products or that we expect will be valuable
otherwise. As of May 29, 2009, our Rest of World sales
region had 1,450 issued U.S. patents (including 1,418
utility patents and 32 design patents) and 404 foreign issued
patents. As of May 29, 2009, our TippingPoint segment had
10 issued U.S. patents (all of which are utility patents)
and 2 issued foreign patents. Numerous patent applications that
relate to our research and development activities are currently
pending in the U.S. and other countries. We also have
patent cross license agreements with other companies. As of
March 31, 2009, the date of the H3C subsidiary financial
statements we consolidated into our 2009 fiscal year end
financial statements, the China-based sales region portfolio
included 414 issued Chinese patents, over 1,300 pending Chinese
applications, and 56 pending foreign applications.
12
Our Rest of World sales region has 25 registered trademarks in
the U.S. and has a total of 486 registered trademarks in 70
foreign jurisdictions. Our TippingPoint segment has 12
registered trademarks in the U.S. and has a total of 35
registered trademarks in about 10 foreign jurisdictions. Our
China-based sales region has 29 registered trademarks in China
and has a total of 67 registered trademarks in 24 foreign
jurisdictions. Numerous applications for registration of
domestic and foreign trademarks are currently pending for our
Rest of World sales region, TippingPoint segment and China-based
sales region.
EMPLOYEES
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Total
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Sales and marketing
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1,909
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Customer service and supply chain operations
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987
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Research and development
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2,453
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General and administrative
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519
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Total
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5,868
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Our H3C subsidiary has 4,439 employees, our Rest of World
sales regions and our corporate functions have
1,127 employees and our TippingPoint segment has
302 employees.
Our employees are not represented by a labor organization and we
consider our employee relations to be satisfactory. The non-H3C
subsidiary employee data is as of May 29, 2009 and our H3C
subsidiary employee data is as of March 31, 2009.
Please see Managements Discussion and Analysis of
Financial Condition and Results of Operations for a
discussion of certain restructuring actions affecting employee
headcount.
EXECUTIVE
OFFICERS OF THE REGISTRANT
The following table lists the names, ages and positions held by
all executive officers of 3Com as of July 24, 2009,
including the principal executive officer (PEO) and principal
financial officer (PFO). There are no family relationships
between any director (or nominee) or executive officer and any
other director (or nominee) or executive officer of 3Com.
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Name
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Age
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Position
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PEO/PFO
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Robert Y. L. Mao
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65
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Chief Executive Officer
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Jay Zager
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59
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Executive Vice President, Chief Financial Officer
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Other Executives (in alphabetical order)
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Neal D. Goldman
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58
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Executive Vice President, Chief Administrative and Legal Officer
and Secretary
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Ronald A. Sege
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52
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President and Chief Operating Officer
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Dr. Shusheng Zheng
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42
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Executive Vice President, 3Com and Chief Executive Officer, H3C
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In addition, the foregoing individuals serve on the Boards of
Directors of various subsidiaries of 3Com.
Robert Y. L. Mao has been our Chief Executive Officer
since April 2008 and a member of our Board of Directors since
March 2007. Prior to his appointment as Chief Executive Officer,
Mr. Mao was most recently our Executive Vice President,
Corporate Development from August 2006 to March 2007.
Mr. Mao has over 30 years of experience in the
telecommunications and IT industries. Before joining 3Com,
Mr. Mao was President and Chief Executive Officer of
Greater China for Nortel Networks from September 1997 to May
2006 and Regional President of Greater China for Alcatel from
September 1995 to September 1997. Nortel and Alcatel are global
suppliers of communication equipment serving both service
provider and enterprise customers. At these positions,
Mr. Mao managed operations in the Peoples Republic of
China, Taiwan, Hong
13
Kong and Macao. Mr. Mao also held senior managerial and
technical positions at Alcatel and ITT in Asia and the
U.S. Mr. Mao holds a Masters degree from Cornell
University in Material Science and Metallurgical Engineering and
earned a Masters in Management from MIT. Mr. Mao is
the past Vice Chairman of the Board of Governors of the Pacific
Telecommunication Council (from 2003 to 2005). Mr. Mao
serves on the Board of Hurray! Holding Co., Ltd., a wireless
value-added services provider.
Jay Zager has been our Executive Vice President, Chief
Financial Officer since June 2007. Immediately prior to joining
3Com, Mr. Zager was an executive at Gerber Scientific,
Inc., a leading international supplier of sophisticated
automated manufacturing systems for sign making and specialty
graphics, apparel and flexible materials, and ophthalmic lens
processing. Mr. Zager joined Gerber in February 2005 as
Senior Vice President and Chief Financial Officer and was
appointed Executive Vice President and Chief Financial Officer
in April 2006, a position he held until he left the company in
June 2007. As a member of the senior management team of Gerber,
he was responsible for financial reporting, accounting, treasury
operations, business planning, corporate development, investor
relations, tax/pension administration and information
technology. Prior to joining Gerber, Mr. Zager was Senior
Vice President and Chief Financial Officer of Helix Technology
Corp., a semiconductor equipment manufacturer, from February
2002 to February 2005. Earlier, from 2000 to 2001, he was
Executive Vice President and Chief Financial Officer of Inrange
Technologies Corp., a storage networking company. Before
Inrange, he was with the Compaq/Digital Equipment organization
for 14 years, holding a number of senior financial and
business management positions including Vice President, Business
Development and Vice President, Chief Financial Officer of
Worldwide Engineering & Research. Mr. Zager
received a Masters degree in Finance and Strategic
Planning from the Sloan School of Management, Massachusetts
Institute of Technology and a Bachelor of Science degree in
Operations Research from the Massachusetts Institute of
Technology.
Neal D. Goldman has been 3Coms Executive Vice
President, Chief Administrative and Legal Officer and Secretary
since March 2007, and he served as our Senior Vice President,
Management Services, General Counsel and Secretary from
September 2003 until March 2007. Prior to joining 3Com,
Mr. Goldman worked for Polaroid Corporation from August
1997 to September 2003. From March 2003 to September 2003, he
was Executive Vice President, Business Development and Chief
Legal Officer of Polaroid and prior to that Mr. Goldman
served as Executive Vice President, Chief Administrative and
Legal Officer from July 2001 to June 2002. From August 1997 to
July 2001, Mr. Goldman held a number of senior management
and executive positions at Polaroid, including Senior Vice
President, General Counsel and Secretary and Deputy General
Counsel. Before joining Polaroid, Mr. Goldman served as
Vice President, General Counsel and Secretary at Nets, Inc. from
March 1996 to June 1997. Before joining Nets, Inc.,
Mr. Goldman held a number of positions with Lotus
Development Corporation, including Vice President and General
Counsel from November 1995 to February 1996 and Deputy General
Counsel and Assistant Secretary from April 1990 to November 1995.
Ronald A. Sege has been our President and Chief Operating
Officer and a member of our Board of Directors since April 2008.
Prior to re-joining 3Com, Mr. Sege served as President and
Chief Executive Officer of Tropos Networks, Inc., a provider of
wireless broadband networks, from 2004 to 2008. Prior to Tropos,
Mr. Sege was President and Chief Executive Officer of
Ellacoya Networks, Inc., a provider of broadband service
optimization solutions based on deep packet inspection
technology, from 2001 to 2004. Prior to Ellacoya, Mr. Sege
was Executive Vice President of Lycos, Inc., an internet search
engine, from 1998 to 2001. Prior to Lycos, Mr. Sege spent
nine years at 3Com Corporation, from 1989 to 1998, serving in a
variety of senior management roles including Executive Vice
President, Global Systems Business Unit. Mr. Sege holds an
MBA from Harvard University and a BA from Pomona College.
Dr. Shusheng Zheng has served as our Executive Vice
President since May 2008, as the Chief Executive Officer of our
H3C subsidiary since July 2009, and as the Chief Operating
Officer of H3C from its inception in the fall of 2003 to July
2009. Previously, Dr. Zheng worked at Huawei Technologies,
a leading telecommunications equipment provider based in China,
from 1993 to 2003. At Huawei, Dr. Zheng held several senior
management positions, including manager in the research and
development department, Director of Manufacturing and Customer
Service, Head of Sales and Marketing for the datacom business,
and President of the switching business unit. Dr. Zheng
holds a PhD in Telecommunication Science from Zhejiang
University in China.
14
Risk factors may affect our future business and results. The
matters discussed below could cause our future results to differ
materially from past results or those described in
forward-looking statements and could have a material adverse
effect on our business, financial condition, results of
operations and stock price.
Risk
Related to Current Severe Global Economic Conditions and Related
Credit Crisis
Our
Operating Results Have Been Adversely Affected by Current
Unfavorable Economic and Credit Conditions in Many Regions of
the World and We May Continue to Experience These
Conditions.
The business conditions in which we operate are subject to rapid
and unpredictable change due to the global economic crisis. Many
of the worlds economies are in turmoil and severe
recession. Very tight credit conditions have made it harder for
businesses to access needed capital. These factors have
contributed to significant slowdowns in the technology industry
in general, and in many of the specific markets and geographies
in which we operate, resulting in:
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reduced demand for our products in many regions as a result of
constraints on information technology-related capital spending
by our customers, particularly in the developed markets in North
America and Europe;
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risk of excess and obsolete inventories;
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longer sales cycles;
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delayed
and/or
cancelled purchases due to factors such as tight credit
conditions and unfavorable local currency translation (noting
that we denominate sales in USD in most locations outside of
China); and
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risk of longer cash cycles as customers take longer to pay us
for products and services and some customers deal with
insolvency issues.
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Our business is heavily dependent on China, a country whose
historic strong growth rates have slowed significantly over the
last year. In addition, the challenges we have seen in two of
our other major regions, North America and Western Europe,
continue. The worldwide slowdown is also impacting many
countries in other geographies in which we operate, such as
Eastern Europe, Asia Pacific (ex-China), the Middle East and
Latin America.
We cannot predict the duration or severity of the current global
economic crisis, and we cannot know the ultimate extent of its
impact on our industry. These factors make it more challenging
to predict our future performance. If global economic and credit
conditions in the major regions in which we operate,
particularly in China, persist, spread, or deteriorate further,
or if we cannot respond with strategies that maximize our
ability to perform in this challenging business environment, we
may continue to experience a material and negative impact on our
business, operating results and financial condition.
Risks
Related to Ability to Sustain and Increase Profitability and the
Impact of our Secured Indebtedness
While
we earned a profit in our 2009 fiscal year, we have incurred
significant net losses in recent fiscal periods, including
$228.8 million for the 2008 fiscal year, and we may not be
able to sustain or increase this profitability in the
future.
While we returned to profitability in our 2009 fiscal year, we
have incurred significant net losses for many years prior and
cannot assure you that we will be able to sustain or increase
our profitability. We face a number of challenges that have
affected our operating results during the current and past
several fiscal years. Specifically, we have experienced, and may
continue to experience, the following:
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declining sales in certain regions;
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operating expenses that, as a percentage of sales, have exceeded
our desired financial model;
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significant senior leadership and other management changes;
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significant non-cash accounting charges;
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increased sales and marketing expense as part of a strategy to
help grow our market share; and
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disruptions and expenses resulting from our workforce reductions
and employee attrition.
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To sustain and increase our profitability, we must maintain or
increase our sales, and if we cannot do that, we may need to
further reduce costs. As we have implemented significant cost
reduction programs over the last several years, it may be
difficult to make significant further cost reductions without in
turn impacting our sales. In addition, we may choose to reinvest
some or all of any realized cost savings in future growth
opportunities. Any of these events or occurrences will likely
cause our expense levels to continue to be at levels above our
desired model.
If we cannot overcome these challenges, reduce our expenses
and/or
increase our revenue, we may not be able to sustain and increase
our profitability.
Our
indebtedness could adversely affect our financial condition and
ability to grow our business.
We now have, and for the foreseeable future will continue to
have, a significant amount of indebtedness. As of May 29,
2009, our total debt balance was $200 million, of which
$48 million is classified as a current liability.
Our indebtedness could have significant negative consequences to
us. For example, it could:
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increase our vulnerability to general adverse economic and
industry conditions;
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limit our ability to obtain additional financing;
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require the dedication of a substantial portion of our cash flow
from operations to satisfy debt obligations, reducing the
availability of capital to finance operations and growth;
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limit our flexibility in planning for, or reacting to, changes
in our business and our industry; and
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place us at a competitive disadvantage relative to our
competitors with less debt.
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Covenants in the agreements governing our senior secured loan
materially restrict our H3C subsidiarys operations based
in China, including H3Cs ability to incur debt, pay
dividends, make certain investments and payments, make
acquisitions of other businesses and encumber or dispose of
assets. In addition, in the event H3Cs financial results
do not meet our plans, the failure to comply with the financial
covenants contained in the loan agreements could lead to a
default. An event of default, if not cured or waived, could have
a material adverse effect on us because the lenders will be able
to accelerate all outstanding amounts under the loan or
foreclose on the collateral (which consists primarily of our H3C
business). In addition, if the LIBOR rate increases, our
interest obligations, which are based on LIBOR, will increase.
Our interest obligations are also dependent on our
leverage ratio, as defined under the credit
agreement; if the ratio increases above specified levels (i.e.,
because H3C financial results decrease), our interest
obligations will increase. Any of these actions could result in
a material adverse effect on our business and financial
condition.
In recent years, we have generated most of our positive cash
flow from operations from our China business, and our operations
outside of China have been mostly cash flow negative. The credit
agreement limits our ability to dividend cash outside of China
(i.e., outside of the H3C group) and requires that a substantial
portion of H3Cs cash flow be used to pay down debt
obligations. Accordingly, we cannot use cash generated in China
to fund our operations outside of China (except under certain
conditions we are permitted to dividend outside of China a
portion of H3Cs annual excess cash flow (as defined by the
credit agreement)). Because available and permitted dividends
under the credit agreement are determined by H3Cs
consolidated excess cash flow and leverage ratio (as defined
under the Credit Agreement), if H3Cs results decrease, the
permitted dividends, if any, we can make to our operations
outside of China will likely decrease. If we do not generate or
maintain appropriate cash on hand on a worldwide basis to
finance operations and make investments where needed or desired,
our business results and growth objectives may suffer; in
particular, our
16
cash balances outside of China could fall below our desired
levels, particularly if we do not meet the conditions necessary
to dividend cash up from China.
Risks
Related to China-based Sales region and Dependence
Thereon
We are
significantly dependent on our China-based segment; if it is not
successful we will likely experience a material adverse impact
to our business, business prospects and operating
results.
For the fiscal quarter ended May 29, 2009, our China-based
sales region was profitable, accounted for approximately
55 percent of our consolidated revenue and was our only
region to generate positive cash flow from operations. Our
China-based sales region is subject to specific risks relating
to its ability to:
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maintain a leading position in the networking equipment market
in China;
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develop and execute strategies to operate successfully in the
current global economic downturn, which has negatively impacted
the Chinese economy;
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build profitable operations in other emerging markets throughout
the world, but particularly in the Asia Pacific region;
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offer new and innovative products and services to attract and
retain a larger customer base;
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increase awareness of the H3C brand and continue to develop
customer loyalty;
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respond to rapidly changing competitive market conditions;
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respond to changes in the regulatory environment;
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manage risks associated with intellectual property rights;
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maintain effective control of costs and expenses; and
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attract, retain and motivate qualified personnel.
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In China, we face competition from domestic Chinese industry
participants, and as a foreign-owned business may not be as
successful in selling to Chinese customers, particularly those
in the public sector, to the extent that such customers favor
Chinese-owned competitors.
We expect that a significant portion of our sales will continue
to be derived from our China-based sales region for the
foreseeable future. As a result, we are subject to economic,
political, legal and social developments in China and
surrounding areas; we discuss risks related to the PRC in
further detail below. In addition, because we already have a
significant percentage of the market share in China for
enterprise networking products, our opportunities to grow market
share in China are more limited than in the past. Our
China-based sales region has experienced growth since its
inception in part due to the growth in Chinas technology
industry, which may not be representative of future growth or be
sustainable. We cannot assure you that our China-based sales
regions historical financial results are indicative of its
future operating results or future financial performance, or
that its profitability will be sustained or increased.
Given the significance of our China-based sales region to our
financial results, if it is not successful, our business will
likely be adversely affected.
We are
dependent on Huawei Technologies, or Huawei, as a significant
customer; if, as expected, Huawei significantly reduces its
business with us, it will likely materially adversely affect our
business results.
We historically have and currently derive a material portion of
our sales from Huawei, which formerly held a significant
investment in our H3C subsidiary. In the three months ended
May 29, 2009, which includes results from our China-based
sales regions March 31, 2009 quarter, Huawei
accounted for approximately 27 percent of the revenue for
our China-based sales region and approximately 15 percent
of our consolidated revenue. Huaweis percentage of our
China-based sales regions revenues has been trending
downward from 46 percent during the 3 months ended
November 30, 2006, to the current level. We expect Huawei
to continue to reduce its business with us and we believe that
its purchases in absolute dollars will likely decrease
17
significantly. Huawei does not have any minimum purchase
requirements under our existing OEM agreement, which expires in
November 2010. We believe it is likely Huawei will source
products from another vendor or internally develop products it
currently purchases from us. If any of these events occur, it
will likely have an adverse impact on our sales and business
performance. In order to minimize any adverse impact on our
results from any decreased sales to Huawei, we need to
successfully execute on our business strategies including,
without limitation, increasing direct touch sales of
enterprise-class products inside and outside of China. If we are
not successful in these efforts, the risks described above,
including adverse impacts to our financial results, may be
heightened.
Risk
Related to Core Business Strategy
If we
cannot increase our enterprise account business outside of
China, leveraging China as our home market, we
likely will not reach our growth and profitability
goals.
We strive to be increasingly successful in direct-touch sales
for larger enterprise and government accounts in all geographic
regions. In China, where we are already an established provider
of networking equipment to enterprise-class customers under the
H3C brand, we desire to maintain our market share. Our strategy
also involves leveraging China as our home market
for enterprise-class solutions, developing and introducing new
products in China and then marketing and selling them to other
regions in the global marketplace where we desire to increase
our market share.
To increase market share outside of China and develop a global
enterprise brand we must be increasingly successful in capturing
larger enterprise and government opportunities (in addition to
our
small-and-medium
size business). Such efforts will likely require a greater
investment in sales and marketing, as well as the provision and
maintenance of a global service organization that can respond to
these customers. The sales cycle is generally longer for
enterprise accounts (possibly yielding uneven and unpredictable
revenue from quarter to quarter) when compared to our
small-and-medium-size
business. We also expect intense competition from larger
industry participants, many of whom possess a significantly
larger market share and installed base than us. We will also
need to be perceived by decision making officers of large
enterprises as committed for the long-term to the high-end
networking business. We will also need to compete favorably on
the offering of features and functionality that these enterprise
customers demand; if our competitors are more effective at such
efforts, our ability to convert pipeline opportunities into
sales will suffer. We seek to develop and expand our global
channel for our H3C product portfolio, in particular outside of
China. Our push to further expand sales to large enterprises may
be disruptive in a variety of ways, including the risk our
increased direct-touch sales efforts are perceived by existing
channel partners as competitive or viewed by market participants
as indicating a diminished focus on the
small-and-medium
business market. We will need to maintain an infrastructure that
permits us to effectively document, process, manage, ship and
account for these larger transactions. To gain market share, our
new global branding strategy (H3C for enterprise, 3Com for
small-and-medium
business and TippingPoint for security solutions) must be
positively received by our customers, potential customers and
channel partners. Finally, our recent increased efforts in
marketing, public relations and investor relations involve risks
such as management diversion and additional expense, and it is
possible these efforts may not prove successful.
If we fail to manage a transition outside of China to a business
model focused more heavily on enterprise-class business, we will
not achieve our business goals and our business results may
suffer.
Our strategy also involves execution of our integration efforts.
Our H3C acquisition significantly increased the size, scope and
complexity of 3Com, and we have since taken actions designed to
maximize the potential of our integrated company. Overall, we
seek to address the different cultures, languages and business
processes of the two companies, and to leverage H3C and its
brand on a global basis. Integration efforts may include
streamlined research and development/engineering functions;
coordinated product line management efforts; integrated sales
and marketing, general and administrative, IT and supply chain
functions; new branding strategies; and continued exploration of
further initiatives to reduce expenses and unify the companies.
We have also recently announced an effort to more fully
integrate our TippingPoint business. If we are not successful in
executing the integration strategies we choose to implement, our
business may be harmed.
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Risk
Related to Personnel
Our
success is dependent on continuing to hire and retain qualified
managers and other personnel and reducing senior management
turnover; if we are not successful in attracting and retaining
key personnel, our business will suffer.
Competition for qualified employees is intense. If we fail to
attract, hire, or retain qualified personnel, our business will
be harmed. We have experienced significant turnover in our
senior management team outside of China in the last several
years and we may continue to experience change at this level. If
we cannot retain qualified senior managers, and provide
stability in the senior management team to enable them to work
together for an extended period of time, our business may not
succeed.
The senior management team at our China-based sales segment has
been highly effective. We need to continue to incentivize and
retain China-based management. We cannot be sure we will be
successful in these efforts. If we are not successful, our
China-based sales region may suffer, which, in turn, will have a
material adverse impact on our consolidated business. Many of
these senior managers, and other key China-based employees,
originally worked for Huawei prior to the inception of our
former joint venture in China. Subject to non-competition
agreements with us (if applicable), these employees could return
to work for Huawei at any time. Huawei is not subject to any
non-solicitation obligations with respect to us. Further, former
Huawei employees employed by us may retain financial interests
in Huawei.
Risks
Related to Competition
Intense
competition in the market for networking solutions and new or
developing product markets could prevent us from increasing
revenue and profitability.
The market for networking solutions is intensely competitive. In
particular, Cisco Systems, Inc., or Cisco, maintains a
significant leadership position in this market and several of
its products compete directly with our products. Ciscos
substantial resources and market leadership have enabled it to
compete aggressively. Purchasers of networking solutions may
choose Cisco because of its broader product line, larger
installed base, substantial services organization and strong
reputation in the networking market. In addition, Cisco may have
developed, or could in the future develop, new technologies that
directly compete with our products or render our products
obsolete. We cannot assure you we will be able to compete
successfully against Cisco.
We also compete with several other significant companies in the
networking industry. Some of our current and potential
competitors have greater market leverage, longer operating
histories, greater financial, technical, sales, marketing and
other resources, stronger name recognition, broader partnerships
with systems integrators and enterprise channel partners and
larger installed customer bases. Additionally, we may face
competition from new or previously unknown companies that may
offer new competitive networking solutions
and/or
alternative technologies that displace the need for some of our
products or services. We also face the possibility that
consolidation in our industry could result in two or more of our
competitors becoming a single competitor with greater resources,
broader sales coverage and superior products.
As we focus on new market opportunities for example,
IP storage and IP video surveillance and other advanced
technologies and emerging technologies we will
increasingly compete with large telecommunications equipment
suppliers as well as startup companies. We cannot assure you we
will compete favorably against these competitors for these
market opportunities.
In order to remain competitive, we must, among other things,
invest significant resources in developing new products with
superior performance at lower prices than our competitors,
enhance our current products and maintain customer satisfaction.
If we fail to do so, our products may not compete favorably with
those of our competitors and our revenue and profitability could
suffer.
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Our
competition with Huawei in the enterprise networking market
could have a material adverse effect on our sales and our
results of operations, particularly if Huawei increases its
level of competition against us.
As Huawei expands its operations, offerings and markets, there
could be increasing instances where we compete directly with
Huawei in the enterprise networking market. As a significant
customer of our China-based segment, Huawei has had, and
continues to have, access to H3C products for resale. This
access enhances Huaweis current ability to compete
directly with us both in China and in the rest of the world. In
addition, Huaweis obligation not to offer or sell
enterprise class, and small-to-medium size business (or SMB),
routers and switches that are competitive with H3C products
recently expired. Accordingly, we risk increased competition
from enterprise products that Huawei internally develops and
markets or sources from our equipment manufacturer competitors.
Huawei currently sells products purchased from us to carrier
customers (who purchase for themselves and their own enterprise
customers), and it is possible Huawei will also market and sell
more directly to enterprise customers in the future. Moreover,
Huawei maintains a strong presence within China and the Asia
Pacific region and possesses significant competitive resources,
including vast engineering talent and ownership of the assets of
Harbour Networks, a China-based competitor that possesses
enterprise networking products and technology. We cannot predict
the extent to which Huawei will compete with us. If Huawei
increases its competition with us, or if we do not compete
favorably with Huawei, it is likely that our business results,
particularly in the Asia Pacific region and specifically in
China, will be materially and negatively affected.
Risks
Related to Business and Technology Strategy
Our
industry is characterized by a short product life cycle, and we
may not be successful at identifying and responding to new and
emerging market, technology and product opportunities, or at
responding quickly enough to technologies or markets that are in
decline.
Our success depends on our ability to:
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identify new market and product opportunities;
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predict which technologies and markets will see declining demand;
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develop and introduce new products and solutions in a timely
manner;
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gain market acceptance of new products and solutions; and
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rapidly and efficiently transition our customers from older to
newer enterprise networking technologies.
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Accordingly, our business will likely suffer if:
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there is a delay in introducing new products;
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we lose key channel partners;
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our products do not satisfy customers in terms of features,
functionality or quality; or
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our products cost more to produce than we expect.
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The enterprise networking industry in which we compete is
characterized by rapid changes in technology and customer
requirements and evolving industry standards. For example, our
success depends on the convergence of technologies (such as
voice, video and data) and the timely adoption and market
acceptance of industry standards. Slow market acceptance of new
technologies, products, or industry standards could adversely
affect our sales or overall results of operations. In addition,
if our technology is not included in an industry standard on a
timely basis or if we fail to achieve timely certification of
compliance to industry standards for our products, our sales of
such products or our overall results of operations could be
adversely affected.
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We rely on our large research and development base in Beijing,
China to develop and design most of our new technologies,
products and solutions. These engineers develop products for all
of the global markets in which we participate and must design
solutions for the developed world as well as for China and other
emerging markets. Developed markets may have different products
features and customer requirements than emerging markets, and we
must timely develop product solutions that satisfy our customers
on a worldwide basis. If we are not successful at these efforts,
our business will suffer.
Risks
Related to Operations and Distribution Channels
If we
are not successful at partnering with system integrators and
expanding our base of enterprise channel partners, reaching our
growth and profitability goals will be more challenging and we
will likely not reach our full potential.
A significant portion of enterprise networking business is
conducted through and with the assistance of system integrators,
or SIs, and enterprise channel partners, including value-added
resellers. The industry leaders with whom we compete as a
general matter maintain significant relationships with at least
one SI and in some cases have stronger enterprise channels. We
seek to develop and expand our global channel for our H3C
product portfolio, in particular outside of China. If we are not
successful at increasing the number of partnerships we maintain
with these types of organizations or if the strategic
relationships we enter into are not effective or successful, it
will be more difficult to reach our goals, and we likely will
not reach our full potential to be a leading, truly global
enterprise networking company.
A
significant portion of our sales is derived from a small number
of distributors. If any of these channel partners reduces its
business with us, our business could be adversely
affected.
We distribute many of our products through two-tier distribution
channels that include distributors and value added resellers, or
VARs. In some instances, we also use a system integrator. A
significant portion of our sales is concentrated among a few
distributors; our two largest distributors accounted for a
combined 16 percent of our consolidated revenue for the
three months ended May 29, 2009. If either of these
distributors reduces its business with us, our sales and overall
results of operations could be adversely affected.
We work closely with our distributors to monitor channel
inventory levels and ensure that appropriate levels of products
are available to resellers and end users. We maintain target
ranges for channel inventory levels for supply on hand at our
distributors. Partners with a below-average inventory level may
incur stock outs that would adversely impact our
sales. Our distribution agreements typically provide that our
distributors may cancel their orders on short notice with little
or no penalty. If our channel partners reduce their levels of
inventory of our products, our sales would be negatively
impacted during the period of change.
We may
be unable to manage our supply chain successfully, which would
adversely impact our sales, gross margin and
profitability.
Our supply chain function involves the management of numerous
external suppliers, vendors and contract manufacturers. We
source component parts for our products from numerous vendors
and outsource principally all of our manufacturing, a
significant portion of our logistics and fulfillment functions
and a portion of our service and repair functions. If we cannot
adequately manage our supply chain, our business results and
financial condition will likely suffer. Our ability to manage
our supply chain successfully is subject to the following risks,
among others:
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our ability to accurately forecast demand for our products and
services;
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our reliance on, and long-term arrangements with, third-party
manufacturers (which places much of the supply chain process out
of our direct control, heightens the need for accurate
forecasting and reduces our ability to transition quickly to
alternative supply chain strategies); and
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our ability to minimize disruptions to our logistics and
effectively manage disruptions that do occur.
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We cannot be certain that in the future our suppliers will be
able or willing to meet our demand for components in a timely
and cost-effective manner. There has been a trend toward
consolidation of vendors of electronic components. Our reliance
on a smaller number of vendors and the inability to quickly
switch vendors increases the risk of logistics disruptions,
unfavorable price fluctuations or disruptions in supply. From
time-to-time, supplies of certain key components have become
tighter. We risk adverse impact to our gross margin to the
extent there is a resulting increase in component costs and time
necessary to obtain these components.
If overall demand for our products or the mix of demand for our
products is significantly different from our expectations, we
may face inadequate or excess component supply or inadequate or
excess manufacturing capacity. This would result in orders for
products that could not be manufactured in a timely manner, or a
buildup of inventory that could not easily be sold. Either of
these situations could adversely affect our market share, sales
and results of operations or financial position.
If we
fail to adequately evolve our financial and managerial control
and reporting systems and processes, our ability to manage and
grow our business may be negatively affected.
Our ability to successfully offer our products and services and
implement our business plan in a rapidly evolving market depends
in part upon effective planning and management processes and
systems. Our company has undergone substantial change in the
last several years, including strategic changes, operational
changes, personnel changes and structural changes. We have had
significant turnover in the executive management team and other
parts of our employee population, acquired H3C (which has
experienced considerable growth over a short period of time and
now represents more than half of our revenue) and implemented
substantial downsizing in our businesses and infrastructure
outside of China. In spite of these changes, we will need to
continue to improve, integrate and upgrade our financial and
managerial control and our reporting systems and procedures in
order to manage our business effectively, analyze and make sound
business decisions and improve efficiencies. If we fail to
implement improved systems and processes, our ability to manage
our business and results of operations could be adversely
affected.
Risks
Related to our Operations in the Peoples Republic of
China
Chinas
legal and regulatory regime and changing political and economic
environment may impact our business in China.
As a result of the historic reforms of the past several decades,
multiple government bodies are involved in regulating and
administrating affairs in the technology industry in China.
These government agencies have broad discretion and authority
over various aspects of the networking, telecommunications and
information technology industry in China; accordingly their
decisions may impact our ability to do business in China. Any of
the following changes in Chinas political and economic
conditions, laws, regulations and governmental policies could
have a substantial impact on our business:
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the promulgation of new laws and regulations and the
interpretation of those laws and regulations;
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enforcement and application of rules and regulations by the
Chinese government;
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the introduction of measures to control growth or inflation or
stimulate growth;
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any actions that limit our ability to develop, manufacture,
import or sell our products in China, or export our products
outside of China, or to finance and operate our business in
China; or
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laws, rules or regulations that negatively impact our ability to
pay dividends from China to outside of China, or impose
restrictions (including conditions or timing restrictions) or
additional taxes on such dividends.
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Due to our dependence on China, if China were to experience a
broad and prolonged economic slowdown, our results of operations
would suffer. China has been adversely impacted by the global
economic slowdown, and government efforts to restore growth
rates may not be effective. The Chinese government has also from
time-to-time implemented certain measures to control the pace of
economic growth. Such measures
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may cause a decrease in the level of economic activity in China,
which in turn could adversely affect our results of operations
and financial condition.
Uncertainties
with respect to the Chinese legal and regulatory system may
adversely affect us.
We conduct our business in China primarily through H3C
Technologies Co., Limited, a Hong Kong entity which in turn owns
several Chinese entities. These entities are generally subject
to laws and regulations applicable to foreign investment in
China. In addition, there are uncertainties regarding the
interpretation and enforcement of laws, rules, regulations and
policies in China. Because many laws and regulations are
relatively new and the Chinese legal and regulatory system is
still evolving, the interpretations of many laws, regulations
and rules are not always uniform and local provincial or central
authorities may exercise significant discretion in applying
them. Moreover, the interpretation of statutes and regulations
may be subject to government policies reflecting domestic
political changes. Finally, enforcement of existing laws or
contracts based on existing law may be uncertain, and it may be
difficult to obtain swift and equitable enforcement, or to
obtain enforcement of a judgment by a court of another
jurisdiction. Any litigation in China may be protracted and
result in substantial costs and diversion of resources and
managements attention. Administrative processes and
operational decisions are subject to the risks and uncertainties
described above, which could result in delays and changed
positions.
If PRC
tax benefits available to us are reduced or repealed, our
profitability or cash flow could suffer.
Effective January 1, 2008, a new corporate income tax rate
of 25 percent (phased-in over time for certain companies)
applies to companies subject to income tax in China. Companies
which benefited from preferential tax rates and rulings under
the previous Chinese tax law can continue to enjoy those
concessions, subject to transitional rules. In our case, our
principal operating subsidiary in China (H3C) was entitled to
tax concessions which began in 2004. These concessions exempted
H3C from the PRC income tax for 2004 and 2005 and entitle it to
a 50 percent reduction in income tax in
2006-2008.
(H3C maintains a calendar fiscal year end.) Calendar 2008 was
the final year of the 50 percent reduction. Although the
regular rate under the new tax law is 25 percent, the new
tax law also provides for a reduced tax rate of 15 percent
for companies which qualify as new and high
technology enterprises. Our H3C subsidiary in China has
now qualified for this reduced 15% rate under the new tax law.
Therefore we currently expect that our long-term rate in China
will be 15%. However, calendar year 2008 was the final year of
our tax concessions under the old law and the first year of our
15% reduced rate under the new law. There is currently some
uncertainty as to whether we can continue to enjoy the benefit
of the final year of our concessions at the same time as the
reduced rate under the new law. The final determination of our
2008 statutory income tax rate in China is subject to approval
by the local tax office and we expect them to consider the
complex rules concerning existing concessions under the
transition rules, as well as guidance from the PRC State Tax
Administration, in granting this approval. Until this
uncertainty is clarified, accounting rules require us to provide
for income tax for 2008 at the full 15% rate.
Dividends declared and paid by our Chinese subsidiary from post
2007 earnings are currently subject to a 5% withholding tax
discussed below.
If tax benefits we currently enjoy are withdrawn or reduced, or
if new taxes are introduced which have not applied to us before,
there would likely be a resulting increase to our statutory tax
rates in the PRC. Increases to tax rates in the PRC, where we
are profitable, could adversely affect our results of operations
and cash flow.
If the
Chinese VAT Authorities discontinue, reduce, or defer the VAT
Software Subsidy Program, our results will likely be adversely
affected.
We benefit from a program run by the Chinese authorities which
effectively provides us with nontaxable subsidy payments based
on a percentage of the value-added tax, or VAT, collected by H3C
on the sales of our software. We have recorded substantial
income from this program since inception. The VAT subsidy
payments are recorded in other income on a cash
basis when actually received from the government. The timing of
the
23
receipt of payments is subject to the discretion of the Chinese
tax authorities who must approve our application for the
subsidy. The program ends on December 31, 2010 and is
subject to the complete discretion of the Chinese tax
authorities and may be discontinued, reduced, or deferred at any
time. If this occurs, our results of operations will likely be
adversely affected.
H3C is
subject to restrictions on paying dividends and making other
payments to us.
Chinese regulations currently permit payment of dividends only
out of accumulated profits, as determined in accordance with
Chinese accounting standards and regulations. Our principal
operating entity in China is required to set aside a portion of
its after-tax profits currently 10 percent up
to 50% of registered capital according to Chinese
regulations, to fund certain reserves. The Chinese government
also imposes controls on the conversion of Renminbi into foreign
currencies and the remittance of currencies out of China. We may
experience difficulties in completing the administrative
procedures necessary to obtain and remit foreign currency. These
restrictions may in the future limit our ability to receive
dividends or repatriate funds from China or impact the timing of
such payments. In addition, as discussed elsewhere in this Risk
Factors section, the credit agreement governing our senior
secured loan also imposes significant restrictions on our
ability to pay dividends or make other payments from China to
our other segments. Because available and permitted dividends
under the credit agreement are determined by H3Cs
consolidated excess cash flow and leverage ratio (as defined
under the Credit Agreement), if H3Cs results decrease, the
permitted dividends, if any, will likely decrease. While we are
in default, or event of default, under the credit agreement we
may not make permitted dividend payments. Finally, under a new
PRC tax law all distributions of earnings realized from 2008
onwards from our PRC subsidiaries to our subsidiary in Hong Kong
will be subject to a withholding tax at a rate of 5%. Our main
PRC subsidiary generates the cash used to pay principal and
interest on our H3C loan. Accordingly, we will in the future be
required to earn proportionately higher profits in the PRC to
service principal and interest on our loan, or be forced to fund
any deficiencies from cash generated from other geographies. In
sum, if we do not generate or maintain appropriate cash on hand
on a worldwide basis to finance operations and make investments
where needed or desired, our business results and growth
objectives may suffer; in particular, our cash balances outside
of China could fall below our desired levels.
We are
subject to risks relating to currency rate fluctuations and
exchange controls and we do not hedge this risk in
China.
Approximately 53 percent of our sales and a portion of our
costs are denominated in Renminbi, the Chinese currency. At the
same time, our senior secured bank loan which we
intend to service and repay primarily through cash flow from our
China-based operations is denominated in US dollars.
In July 2005, China uncoupled the Renminbi from the
U.S. dollar and let it float in a narrow band against a
basket of foreign currencies. The Renminbi could appreciate or
depreciate relative to the U.S. dollar. Any movement of the
Renminbi may materially and adversely affect our cash flows,
revenues, operating results and financial position, and may make
it more difficult for us to service our
U.S. dollar-denominated senior secured bank loan. More
specifically, if the Renminbi appreciates in value as compared
with the U.S. dollar, our reported revenues will derive a
beneficial increase due to currency translation; and if the
Renminbi depreciates, our revenues will suffer due to such
depreciation. This currency translation impacts our expenses as
well, but to a lesser degree. In some of our historical periods,
we have benefited from the currency translation of Renminbi, but
our results may in the future be harmed by it.
Our sales around the world are generally denominated in Renminbi
(in China) and in US Dollars (in the rest of the world). We
use those two currencies to price our products and generally do
not accept local currencies as payment for product. When we sell
our products in countries outside of China and the U.S. to
customers in countries whose currencies have been devalued
against the Renminbi or the US Dollar, the currency
fluctuation causes the cost of our products to these customers
to be higher. We generally do not provide currency exchange risk
protection to our customers. For these reasons, when the
Renminbi or US Dollar is stronger against local currencies,
we may experience delayed or cancelled purchases or general
business softness in the relevant region.
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We do not currently hedge the currency risk in China through
foreign exchange forward contracts or otherwise and China
employs currency controls restricting Renminbi conversion,
limiting our ability to engage in currency hedging activities in
China. Various foreign exchange controls are applicable to us in
China, and such restrictions may in the future make it difficult
for H3C or us to repatriate earnings, which could have an
adverse effect on our cash flows and financial position.
Risks
Related to Intellectual Property
If our
products contain undetected software or hardware errors, we
could incur significant unexpected expenses and could lose
sales.
High technology products sometimes contain undetected software
or hardware errors when new products or new versions or updates
of existing products are released to the marketplace. We cannot
assure you our testing programs will be adequate to detect all
defects. Undetected errors could result in customer
dissatisfaction, reduced sales opportunities, higher than
expected warranty and service costs and expenses and the
recording of an accrual for related anticipated expenses. From
time to time, such errors or component failures could be found
in new or existing products after the commencement of commercial
shipments. These problems may have a material adverse effect on
our business by causing us to incur significant warranty and
repair costs, diverting the attention of our engineering
personnel from new product development efforts, delaying the
recognition of revenue and causing significant customer
relations problems. Further, if products are not accepted by
customers due to such defects, and such returns exceed the
amount we accrued for defect returns based on our historical
experience, our operating results would be adversely affected.
Our products must successfully interoperate with products from
other vendors. As a result, when problems occur in a network, it
may be difficult to identify the sources of these problems. The
occurrence of hardware and software errors, whether or not
caused by our products, could result in the delay or loss of
market acceptance of our products and any necessary revisions
may cause us to incur significant expenses. The occurrence of
any such problems would likely have a material adverse effect on
our business, operating results and financial condition.
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.
Whether we are defending the assertion of intellectual property
rights against us, or asserting our intellectual property rights
against others, intellectual property litigation can be complex,
costly, protracted, and highly disruptive to business operations
because it may divert the attention and energies of management
and key technical personnel. Further, plaintiffs in intellectual
property cases often seek injunctive relief and the measures of
damages in intellectual property litigation are complex and
often subjective and uncertain. In addition, such litigation may
subject us to counterclaims or other retaliatory actions that
could increase its costs, complexity, uncertainty and disruption
to the business. Thus, the existence of this type of litigation,
or any adverse determinations related to such litigation, could
subject us to significant liabilities and costs. Any one of
these factors could adversely affect our sales, gross margin,
results of operations, cash flow or financial position.
In addition, the legal systems of many foreign countries do not
protect or honor intellectual property rights to the same extent
as the legal system of the United States. For example, in China,
the legal system in general, and the intellectual property
regime in particular, are still in the development stage. It may
be very difficult, time-consuming and costly for us to attempt
to enforce our intellectual property rights in these
jurisdictions.
We may
not be able to defend ourselves successfully against claims that
we are infringing the intellectual property rights of
others.
Many of our competitors, such as telecommunications, networking,
and computer equipment manufacturers, have large intellectual
property portfolios, including patents that may cover
technologies that are relevant
25
to our business. In addition, many smaller companies,
universities, patent holding companies and individual inventors
have obtained or applied for patents in areas of technology that
may relate to our business. The industries in which we operate
continue to be aggressive in assertion, licensing and litigation
of patents and other intellectual property rights. It is very
expensive to defend claims of patent infringement and we expect
over time to incur significant time and expense to defend these
claims and defend, protect, preserve and maintain our portfolio.
In the course of our business, we receive claims of infringement
or otherwise become aware of potentially relevant patents or
other intellectual property rights held by other parties. We
evaluate the validity and applicability of these intellectual
property rights, and determine in each case whether to negotiate
licenses or cross-licenses to incorporate or use the proprietary
technologies, protocols, or specifications in our products, and
whether we have rights of indemnification against our suppliers,
strategic partners or licensors. If we are unable to obtain and
maintain licenses on favorable terms for intellectual property
rights required for the manufacture, sale, and use of our
products, particularly those that must comply with industry
standard protocols and specifications to be commercially viable,
our financial position or results of operations could be
adversely affected. In addition, if we are alleged to infringe
the intellectual property rights of others, we could be required
to seek licenses from others or be prevented from manufacturing
or selling our products, which could cause disruptions to our
operations or the markets in which we compete. Finally, even if
we have indemnification rights in respect of such allegations of
infringement from our suppliers, strategic partners or
licensors, we may not be able to recover our losses under those
indemnity rights.
Many of our networking products use open source software, or
OSS, licenses. Because OSS is often compiled from multiple
components developed by numerous independent parties and usually
comes as is and without indemnification, OSS is more
vulnerable to third party intellectual property infringement
claims. Some of the more prominent OSS licenses, such as the GNU
General Public License, are the subject of litigation. It is
possible that a court could hold such licenses to be
unenforceable or someone could assert a claim for proprietary
rights in a program developed and distributed under them. Any
ruling by a court that these licenses are not enforceable or
that open source components of our product offerings may not be
liberally copied, modified or distributed may have the effect of
preventing us from selling or developing all or a portion of our
products. If any of the foregoing occurred, it could cause a
material adverse impact on our business.
Risks
Related to the Trading Market
Fluctuations
in our operating results and other factors may contribute to
volatility in the market price of our stock.
Historically, our stock price has experienced volatility. We
expect that our stock price may continue to experience
volatility in the future due to a variety of potential factors
such as:
|
|
|
|
|
fluctuations in our quarterly results of operations and cash
flow;
|
|
|
|
changes in our cash and equivalents and short term investment
balances;
|
|
|
|
our ability to execute on our strategic plan, including our core
business strategy to leverage China and emphasize larger
enterprise business;
|
|
|
|
general economic conditions, such as the current global economic
crisis;
|
|
|
|
variations between our actual financial results and published
analysts expectations; and
|
|
|
|
announcements by our competitors or significant customers.
|
Over the past several years, the stock market has experienced
significant price and volume fluctuations that have affected the
stock prices of many technology companies. These factors, as
well as general economic and political conditions or
investors concerns regarding the credibility of corporate
financial statements and the accounting profession, may have a
material adverse affect on the market price of our stock in the
future.
26
For example, many companies have recently experienced sharp
decreases
and/or
downward pressure on their stock prices as a result of the
current global economic downturn.
We may
be required to record additional significant charges to earnings
if our goodwill or intangible assets become
impaired.
Under accounting principles generally accepted in the United
States, we review our amortizable intangible assets for
impairment when events or changes in circumstances indicate the
carrying value may not be recoverable. Goodwill and other
non-amortizing
intangible assets are tested for impairment at least annually.
The carrying value of our goodwill or amortizable assets may not
be recoverable due to factors such as reduced estimates of
future cash flows and slower growth rates in our industry or in
any of our business units. Estimates of future cash flows are
based on an updated long-term financial outlook of our
operations. However, actual performance in the near-term or
long-term could be materially different from these forecasts,
which could impact future estimates. For example, if one of our
business units does not meet its near-term and longer-term
forecasts, the goodwill assigned to the business unit could be
impaired. Similarly, a significant decline in our stock price
and/or
market capitalization may result in goodwill impairment for one
or more business units. We may be required to record a charge to
earnings in our financial statements during a period in which an
impairment of our goodwill or amortizable intangible assets is
determined to exist, which may negatively impact our results of
operations. For example, in the three-month period ended
May 30, 2008, we took a charge of $158.0 million
relating to impairment of the goodwill of our TippingPoint
segment.
|
|
ITEM 1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
We lease properties in the United States and a number of foreign
countries. For information regarding property, plant and
equipment by geographic region for each of the last two fiscal
years, see Note 19 to our Consolidated Financial Statements
in Item 8 of this Annual Report on
Form 10-K.
The following table summarizes our significant leased real
estate properties as of May 29, 2009:
|
|
|
|
|
|
|
|
|
|
|
Location
|
|
Sq. Ft.
|
|
|
Owned/Leased
|
|
|
Primary Use
|
|
United States Boston Area
|
|
|
175,000
|
|
|
|
Leased
|
|
|
Corporate headquarters, Rest of World (ROW)Segment
Administration, and customer service.
|
United States Austin Area
|
|
|
87,000
|
|
|
|
Leased
|
|
|
TippingPoints main office, research and development, and
customer service.
|
Europe U.K.
|
|
|
39,000
|
|
|
|
Leased
|
|
|
Corporate and ROW offices; ROW customer service.
|
China Hangzhou
|
|
|
1,706,029
|
|
|
|
Leased
|
|
|
H3C office, research and development, manufacturing, sales, and
training.
|
China Beijing
|
|
|
512,275
|
|
|
|
Leased
|
|
|
Global research and development, training; H3C sales and
customer service.
|
As part of our initiatives to maximize our efficiency, we are
consolidating our operations wherever feasible and are actively
engaged in efforts to dispose of excess facilities. As of
May 29, 2009, we lease and sublease to third-party tenants
approximately 2,850 square feet in one of our North America
leased locations under a sub-lease that expires in fiscal 2011.
We believe that our facilities are adequate for our present
needs in all material respects.
|
|
ITEM 3.
|
LEGAL
PROCEEDINGS
|
The material set forth in Note 21 to the Consolidated
Financial Statements included in Item 8 of Part II of
this Annual Report on
Form 10-K
is incorporated herein by reference.
27
|
|
ITEM 4.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
|
None.
PART II
|
|
ITEM 5.
|
MARKET
FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
|
Our common stock trades on The NASDAQ Global Select Market under
the symbol COMS and has been traded on NASDAQ since our initial
public offering on March 21, 1984. The following table sets
forth the high and low sale prices as reported on NASDAQ during
the last two fiscal years. As of June 26, 2009, we had
approximately 4,353 stockholders of record. We have not paid,
and do not anticipate that we will pay, cash dividends on our
common stock.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal 2009
|
|
Fiscal 2008
|
|
|
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
|
|
First Quarter
|
|
$
|
2.59
|
|
|
$
|
1.83
|
|
|
$
|
4.81
|
|
|
$
|
3.24
|
|
|
|
|
|
Second Quarter
|
|
|
2.85
|
|
|
|
1.43
|
|
|
|
5.11
|
|
|
|
3.22
|
|
|
|
|
|
Third Quarter
|
|
|
2.66
|
|
|
|
1.81
|
|
|
|
4.60
|
|
|
|
2.76
|
|
|
|
|
|
Fourth Quarter
|
|
|
4.39
|
|
|
|
2.06
|
|
|
|
3.41
|
|
|
|
1.76
|
|
|
|
|
|
The following table summarizes repurchases of our stock,
including shares returned to satisfy tax withholding
obligations, in the quarter ended May 29, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Approximate Dollar
|
|
|
|
Total
|
|
|
|
|
|
Shares Purchased as
|
|
|
Value of Shares
|
|
|
|
Number
|
|
|
Average
|
|
|
Part of Publicly
|
|
|
that May yet Be
|
|
|
|
of Shares
|
|
|
Price Paid
|
|
|
Announced Plans or
|
|
|
Purchased Under the
|
|
Period
|
|
Purchased
|
|
|
per Share
|
|
|
Programs(1)
|
|
|
Plans or Programs
|
|
|
February 28, 2009 through March 27, 2009
|
|
|
59,315
|
(2)
|
|
$
|
2.66
|
|
|
|
|
|
|
$
|
50,046,813
|
|
March 28, 2009 through April 24, 2009
|
|
|
44,458
|
(2)
|
|
|
3.55
|
|
|
|
|
|
|
|
50,046,813
|
|
April 25, 2009 through May 29, 2009
|
|
|
407,079
|
(2)
|
|
|
4.05
|
|
|
|
|
|
|
|
50,046,813
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
510,852
|
|
|
$
|
3.85
|
|
|
|
|
|
|
$
|
50,046,813
|
|
|
|
|
(1) |
|
On September 24, 2008, our Board of Directors approved a
stock repurchase program providing for repurchases of up to
$100.0 million through September 23, 2009. |
|
(2) |
|
Consists of shares surrendered to us to satisfy tax withholding
obligations that arose upon the vesting of restricted stock
awards and units of 59,315 in March 2009, 44,458 in April 2009
and 407,079 in May 2009. |
COMPARISON
OF STOCKHOLDER RETURN
Set forth below is a line graph comparing the cumulative total
return of our common stock with the cumulative total return of
the Standard & Poors 500 Stock Index, our New
Peer Group(1) and our Old Peer Group(1) for the period
commencing on May 28, 2004 and ending on May 29, 2009
(fiscal year end)(2)(3). We historically have constructed our
peer group based on comparable market offerings and strategy,
revenue composition and size. In re-evaluating our peer group
this year, we removed one peer that is no longer publicly-traded
and six peers we believe no longer provide a meaningful
comparison due to differences in size, scope
and/or
primary strategic or market focus. We also added five new peers;
in light of the evolving nature of our business and our current
strategic and market focus, we believe these additions to the
peer group provide a more meaningful comparison. This
information shall not be deemed to be filed with the
Securities
28
and Exchange Commission and shall not be incorporated by
reference into any filing under the Securities Act of 1933, as
amended, or the Securities Exchange Act of 1934, as amended,
unless we specifically incorporate it by reference.
COMPARISON
OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among
3Com Corporation, The S&P 500 Index,
A New Peer Group And An Old Peer Group
|
|
|
* |
|
$100 invested on 5/28/04 in stock or 5/31/04 in index, including
reinvestment of dividends. Indexes calculated on month-end basis. |
Copyright©
2009 S&P, a division of The McGraw-Hill Companies Inc. All
rights reserved.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5/28/04
|
|
|
6/3/05
|
|
|
6/2/06
|
|
|
6/1/07
|
|
|
5/30/08
|
|
|
5/29/09
|
3Com Corporation
|
|
|
|
100.00
|
|
|
|
|
54.71
|
|
|
|
|
73.57
|
|
|
|
|
72.49
|
|
|
|
|
38.95
|
|
|
|
|
66.77
|
|
S&P 500
|
|
|
|
100.00
|
|
|
|
|
108.24
|
|
|
|
|
117.59
|
|
|
|
|
144.39
|
|
|
|
|
134.72
|
|
|
|
|
90.84
|
|
Old Peer Group
|
|
|
|
100.00
|
|
|
|
|
94.33
|
|
|
|
|
111.30
|
|
|
|
|
151.75
|
|
|
|
|
152.99
|
|
|
|
|
110.02
|
|
New Peer Group
|
|
|
|
100.00
|
|
|
|
|
91.21
|
|
|
|
|
89.69
|
|
|
|
|
118.83
|
|
|
|
|
118.59
|
|
|
|
|
86.65
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) |
|
Our New Peer Group consists of Brocade Communications Systems,
Inc., Cisco Systems Inc., Extreme Networks, Inc., F5 Networks,
Inc., Juniper Networks, Inc., McAfee, Inc., Riverbed Technology,
Inc., and Symantec Corporation. Our Old Peer Group consists of
Alcatel Lucent, Cisco Systems Inc., D-Link Corporation, Extreme
Networks, Inc., Hewlett-Packard Company, McAfee, Inc., Netgear
Inc., Nortel Networks Limited and Sourcefire, Inc. Foundry
Networks, Inc. was acquired and has therefore been removed from
the Peer Groups. |
|
(2) |
|
Assumes that $100.00 was invested on May 28, 2004 in our
common stock and each index, and that all dividends were
reinvested. No cash dividends have been declared on our common
stock. Stockholder returns over the indicated period should not
be considered indicative of future stockholder returns. |
|
(3) |
|
3Com uses a
52-53 week
fiscal year ending on the Friday nearest to May 31. |
|
|
ITEM 6.
|
SELECTED
FINANCIAL DATA
|
The data set forth below should be read in conjunction with
Item 7, Managements Discussion and Analysis of
Financial Condition and Results of Operations, and our
consolidated financial statements and related notes appearing
elsewhere in this Annual Report on
Form 10-K.
Our fiscal year ends on the Friday
29
closest to May 31. Fiscal 2009 consists of the
52 weeks ended May 29, 2009. Fiscal year 2008 consists
of the 52 weeks ended May 30, 2008. Fiscal 2007
consisted of 52 weeks and ended on June 1, 2007.
Fiscal year 2006 consisted of 52 weeks and ended on
June 3, 2006. Fiscal year 2005 consisted of 53 weeks
ended on June 2, 2005. For convenience, the consolidated
financial statements have been shown as ending on the last day
of the calendar month. The following balance sheet data and
statements of operations data for each of the five years ended
May 31, 2009 were derived from our audited consolidated
financial statements. Consolidated balance sheets as of
May 31, 2009 and 2008 and the related consolidated
statements of operations and cash flows for each of the three
years in the period ended May 31, 2009 and notes thereto
appear elsewhere in this Annual Report on
Form 10-K.
During our fiscal 2006 we acquired a majority ownership of our
then H3C joint-venture. Effective with the acquisition we began
consolidating our H3C subsidiarys results on a
2 month lag as our H3C subsidiary follows a calendar year
end. We reflected a minority interest on the balance sheet and
in the statement of operations for Huaweis remaining
interest. On March 29, 2007 we acquired Huaweis
remaining interest and therefore the minority interest was
eliminated and no minority interest in our subsidiaries assets
existed after that date.
Our acquisition of TippingPoint on January 31, 2005 was
accounted for as a purchase, and accordingly, the assets
purchased and liabilities assumed are included in the
consolidated balance sheet as of May 31, 2005. The
operating results of TippingPoint are included in the
consolidated financial statements since the date of acquisition.
Accordingly, fiscal 2006 and beyond contain full years of
TippingPoints results compared to five months of results
in fiscal 2005.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year May 31,
|
|
|
2009
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
|
(In thousands, except per share amounts)
|
|
Sales
|
|
$
|
1,316,978
|
|
|
$
|
1,294,879
|
|
|
$
|
1,267,481
|
|
|
$
|
794,807
|
|
|
$
|
651,244
|
|
Net income (loss)
|
|
|
114,725
|
(1)
|
|
|
(228,841
|
)(2)
|
|
|
(88,589
|
)
|
|
|
(100,675
|
)
|
|
|
(195,686
|
)
|
Income (loss) from continuing operations
|
|
|
114,725
|
(1)
|
|
|
(228,841
|
)(2)
|
|
|
(88,589
|
)
|
|
|
(100,675
|
)
|
|
|
(195,686
|
)
|
Income (loss) per share from continuing operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted
|
|
$
|
0.29
|
|
|
$
|
(0.57
|
)
|
|
$
|
(0.22
|
)
|
|
$
|
(0.26
|
)
|
|
$
|
(0.51
|
)
|
|
|
|
(1) |
|
During fiscal 2009 the Company had gains of $85.2 million
as a result of a favorable patent dispute resolution and from
the sale of patents. |
|
(2) |
|
During fiscal 2008 the Company recorded a goodwill impairment
charge of $158.0 million the TippingPoint reporting unit. |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances as of May 31,
|
|
|
2009
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
|
(In thousands)
|
|
Cash, equivalents and short-term investments
|
|
$
|
644,175
|
|
|
$
|
503,644
|
|
|
$
|
559,217
|
|
|
$
|
864,347
|
|
|
$
|
844,104
|
|
Total assets
|
|
|
1,815,357
|
|
|
|
1,775,130
|
|
|
|
2,151,092
|
|
|
|
1,861,361
|
|
|
|
1,592,967
|
|
Working capital(1)
|
|
|
434,460
|
|
|
|
305,444
|
|
|
|
257,614
|
|
|
|
778,064
|
|
|
|
667,949
|
|
Deferred taxes and long-term obligations
|
|
|
40,729
|
|
|
|
22,367
|
|
|
|
23,725
|
|
|
|
13,788
|
|
|
|
8,484
|
|
Long term debt
|
|
|
152,000
|
|
|
|
253,000
|
|
|
|
336,000
|
|
|
|
|
|
|
|
|
|
Retained deficit
|
|
|
(1,290,522
|
)
|
|
|
(1,405,247
|
)
|
|
|
(1,176,406
|
)
|
|
|
(1,087,512
|
)
|
|
|
(967,952
|
)
|
Stockholders equity
|
|
|
1,112,175
|
|
|
|
995,302
|
|
|
|
1,151,299
|
|
|
|
1,202,362
|
|
|
|
1,274,923
|
|
|
|
|
(1) |
|
Working capital is defined as total current assets less total
current liabilities. |
30
|
|
ITEM 7.
|
MANAGEMENTS
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
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INTRODUCTION
The following discussion should be read in conjunction with the
Consolidated Financial Statements and notes thereto included in
Item 8 of Part II of this Annual Report on
Form 10-K.
BUSINESS
OVERVIEW
We are a global enterprise networking solutions provider
incorporated in Delaware. A pioneer in the computer networking
industry, we have three global product and solutions
brands H3C, 3Com, and TippingPoint that
offer high-performance networking and security solutions to
enterprises large and small. These organizations range across a
number of vertical industries, including education, finance,
government, healthcare, insurance, manufacturing and real
estate. The
H3C®
enterprise networking portfolio one of the leading
large enterprise networking equipment brands in
China includes products that span from the data
center to the edge of the network and is targeted at large
enterprises. The
3Com®
family of products offers a strong price/performance value
proposition for the small and medium businesses. Our security
brand,
TippingPoint®
features network-based intrusion prevention systems (IPS) and
network access control (NAC) solutions, which deliver in-depth,
no-compromise application, infrastructure and performance
protection.
We believe our portfolio of products and services enable
customers to deploy and manage business-critical voice, video,
data and other advanced networking technologies in a secure,
scalable, reliable and efficient network environment. We believe
we have consistently offered customer-driven technology
solutions that help enterprises optimize their budgets and
resources, increase productivity, and realize their business
goals. 3Com designs its solutions to offer customers a unique
value proposition: lower total cost of ownership (TCO) and
expert, responsive service. Our data center-to-edge enterprise
networking solutions offer a common operating system to
streamline system management, and are based on open standards to
enable the use of best-of-breed applications from other vendors.
We believe we offer a broad, fresh portfolio of products and
solutions that disrupt the industry status quo and deliver true
no-compromise networking.
We believe we deliver high-quality, high-performance converged
networking solutions that provide exceptional business value and
help customers address the following fundamental challenges:
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Performance Bandwidth demands have increased along
with the number of users and applications IP
telephony, videoconferencing, streaming multimedia and
others on enterprise networks, yet performance
requirements never abate. 3Com routers, switches and security
devices provide robust throughput and traffic optimization
applications to ensure high-quality networking even in the most
challenging enterprise network environments.
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Cost effectiveness Todays enterprise customers
are seeking cost-effective solutions that optimize the value of
their network infrastructure investment. 3Com products are
designed to be cost-effective, competitively priced and energy
efficient 3Coms single-pane, intuitive network management
platform minimizes time spent training IT staff and network
administrators, helping to further reduce overall TCO.
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Security Todays enterprises need to protect
themselves from a constantly evolving spectrum of internal and
external threats to ensure the safety of their mission-critical
information. 3Coms pervasive network solutions provide
granular oversight, control access, quarantine malicious
programs and files, and restore data.
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We focus on delivering superior networking solutions that offer
a cost advantage to our customers through solutions that are
less expensive to acquire, power and operationally manage. Our
products are designed to provide superior value through
capability design as well as other cost conscious features such
as lower power requirements, and inter-operability in
multi-vendor networks.
We believe that our global presence, brand identity, strong
development organization and intellectual property portfolio
provide a solid foundation for achieving our objectives.
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Our products are sold on a worldwide basis through a combination
of value added resellers, distributors and direct-touch sales
representatives. We also work with service providers to deliver
managed networking solutions for enterprise customers.
Headquartered in Marlborough, Massachusetts, we have worldwide
operations, including sales, marketing, research and
development, and customer service and support capabilities.
Our products and services can generally be classified in the
following categories:
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Networking;
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Security;
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Voice; and
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Services.
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We have undergone significant changes in recent years, including:
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Significant changes to our executive leadership;
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the formation and subsequent 100 percent acquisition of our
China-based H3C subsidiary;
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financing a portion of the purchase price for our acquisition of
H3C by entering into a $430 million senior secured credit
agreement ;
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restructuring activities, which included outsourcing of
information technology, certain manufacturing activity in our
Networking Business, significant headcount reductions in other
functions, and selling excess facilities; and
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integration activities following our H3C acquisition, including
in our research and development and supply chain organizations
and integrating our TippingPoint segment.
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Business
Environment and Future Trends
We operate today in a rapidly changing business environment due
to the severe credit and adverse market conditions in many of
the worlds economies. The current global financial crisis
has led to significant business slowdowns around the world. It
is therefore increasingly difficult to predict future business
conditions in the market for enterprise networking equipment.
Our business is highly dependent on the Chinese economy, which
has experienced strong growth in recent years. Our success in
China has been due to the success of the direct-touch enterprise
model, a mixture of core and new products and solution selling,
and value creation for customers. While we believe that China
may have been less affected than other regions by the global
economic slowdown, it is now experiencing the effects of the
downturn and our growth has slowed in China. It is difficult to
predict the extent of the slowdown on our China business at this
time. Additionally, we expect a significant reduction in sales
to our largest customer, Huawei Technologies, during fiscal year
2010. For our operations outside of China, which we call
Rest of World, we expect the challenging business
environment to continue in the foreseeable future. In Rest of
World, we are experiencing reduced demand for our products,
delayed or cancelled purchases and longer sales cycles. Our Rest
of World operations have been adversely impacted by the global
economic crisis.
Our strategy to address these adverse business conditions is to
market our solutions as providing exceptional quality for a good
value and to remain competitive in the enterprise market. At the
same time, we recognize that global spending on networking
products and solutions is likely to continue to be under
significant pressure for the foreseeable future.
Networking industry analysts and participants differ widely in
their assessments concerning the prospects for mid to long-term
industry growth, especially in light of the current weakness in
many of the major global economies. Industry factors and trends
also present significant challenges in the medium-term. Such
factors and trends include intense competition in the market for
higher end, enterprise core routing and switching
32
products and aggressive product pricing by competitors targeted
at gaining share in the small to medium-sized business market.
We believe that long-term success in this environment requires
us to (1) be a global technology leader, (2) increase
our revenue and take market share from competitors outside of
China, (3) increase and sustain our profitability and
(4) increase our generation of cash from operations.
Technology
Strategy
We believe our principal research and development base in China
provides a strong foundation for our global product development.
Our strategy involves continuing to innovate, using China as a
home market to introduce new products in the networking
equipment industry and related markets and providing leading
solutions for global markets. Our approach is to focus on
activities that deliver differentiated products and solutions
and drive reductions in product costs. Our current areas of
focus include security, convergence of applications over IP,
advanced switching, routing solutions and other advanced
technologies.
Revenue
and Market Share Goals
We believe that our differentiated, comprehensive product
portfolio which provides end-to-end IP solutions based on open
standards offers a compelling value proposition for customers,
particularly in the current economic environment.
Our intention is to leverage our global footprint to more
effectively sell these products. A key element of our strategy
is to increasingly focus on sales to larger enterprise and
government accounts in all of our regions.
We intend to execute on three regional strategies as follows:
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China In China, we have been successful in
direct-touch sales to enterprise and government customers. To
maintain a leadership position in China, we intend to increase
our focus on direct-touch sales as well as pursue other
distribution channels. We believe that growing market share in
China will be more challenging than in the past given that we
already have a significant enterprise networking market share in
China. We also intend to continue to introduce innovative new
product offerings in the China market, such as IP video
surveillance and IP storage, which may offer additional growth
opportunities.
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Our strategy involves leveraging our significant China-based
engineering team and strong brand of networking solutions
designed for enterprise and government accounts into greater
success in markets outside of China, as further described below.
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Emerging markets outside of China We expect to
target growth opportunities outside of China in other developing
markets. We believe that our successful penetration of the
Chinese market has provided experience that is transferable to
many emerging markets. We believe this experience will position
us to gain market share in developing markets.
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Developed global markets Our goal in developed
markets is to increase our market share. Our strategy is to
focus on large enterprise and government accounts and to
implement this strategy we intend to increase go to market
resources. We intend to offer these customers our comprehensive
end to end solutions and highlight our products price to
performance value proposition and energy efficiency. As
discussed earlier, the results of these efforts have been
hampered by the global economic slowdown.
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Profitability
and Cash Generation Objectives
We believe that our long-term success is also dependent on our
ability to increase our overall profit and cash generation. We
believe that by continuing to integrate our worldwide operations
we can achieve further operational efficiencies to support
continued investment in sales and marketing to grow our
business. We may also continue to require targeted investments
in infrastructure designed to meet our market share growth
objectives.
For our TippingPoint business we plan to focus on growing its
top line and improving operational
33
efficiency and segment profitability. We plan to achieve
operational efficiency by integrating supply chain and finance
activities, among others. We also plan to leverage our existing
sales channels and global footprint to more effectively sell
TippingPoint products and services.
Segment
Reporting
In the prior fiscal year we reported H3C, Data and Voice
Business Unit (DVBU), TippingPoint Security Business
(TippingPoint) and Corporate as segments. In the
first quarter of fiscal 2009, we realigned the manner in which
we manage our business and internal reporting, and based on the
information provided to our chief operating decision-maker
(CODM) for purposes of making decisions about allocating
resources and assessing performance, we have two primary
businesses, our Networking Business and TippingPoint Security
Business. Accordingly, our previously reported segment
information has been restated to reflect our new operating and
reporting structure. Our Networking Business consists of the
following sales regions as operating segments: China-based, Asia
Pacific Region excluding China-based sales region (Japan and
Hong Kong SAR) (APR), Europe Middle East and Africa (EMEA),
Latin America (LAT), and North America (NA) regions. The APR,
EMEA, LAT and NA operating segments have been aggregated given
their similar economic characteristics, products, customers and
processes, and have been consolidated as one reportable segment,
Rest of World. The China-based sales region does not
meet the aggregation criteria at this time.
The China-based and Rest of World reporting segments benefit
from shared support services on a world-wide basis. The costs
associated with providing these shared central functions are not
allocated to the China-based and Rest of World reporting
segments and instead are reported and disclosed under the
caption Central Functions. Central Functions consist
of indirect cost of sales, such as supply chain operations
expenses, and centralized operating expenses, such as research
and development, indirect sales and marketing, and general and
administrative support.
BASIS OF
PRESENTATION
Our fiscal year ends on the Friday closest to May 31.
Fiscal 2009 consisted of 52 weeks and ended on May 29,
2009. Fiscal year 2008, consisted of 52 weeks ended on
May 30, 2008, and fiscal year 2007 consisted of
52 weeks and ended on June 1, 2007. For convenience,
the consolidated financial statements have been shown as ending
on the last day of the calendar month.
Our 3Com Technologies subsidiary completed the purchase of
Huaweis remaining interest in H3C for $882 million in
March 2007. Our H3C subsidiary follows a calendar year basis of
reporting and therefore, H3C is consolidated on a two-month lag.
On May 25, 2007, our subsidiary H3C Holdings Limited
(Borrower) entered into an amended and restated
credit agreement with various lenders, including Goldman Sachs
Credit Partners L.P., as Mandated Lead Arranger, Bookrunner,
Administrative Agent and Syndication Agent, and Industrial and
Commercial Bank of China (Asia) Limited, as Collateral Agent
(the Credit Agreement). Under the original credit
agreement, the Borrower borrowed $430 million in the form
of a senior secured term loan to finance a portion of the
purchase price for 3Coms acquisition of 49 percent of
H3C discussed above.
CRITICAL
ACCOUNTING POLICIES
Our significant accounting policies are outlined in Note 2
to the Consolidated Financial Statements, which appear in
Item 8 of Part II of this Annual Report on
Form 10-K.
Some of those accounting policies require us to make estimates
and assumptions that affect the amounts reported by us. The
following items require the most significant judgment and often
involve complex estimation:
Revenue recognition: We recognize a sale when
the product has been delivered and risk of loss has passed to
the customer, collection of the resulting receivable is
reasonably assured, persuasive evidence of an arrangement
exists, and the fee is fixed or determinable. The assessment of
whether the fee is fixed or determinable considers whether a
significant portion of the fee is due after our normal payment
terms. If we determine that the fee is not fixed or
determinable, we recognize revenue at the time the fee becomes
fixed
34
and determinable, provided that all other revenue recognition
criteria have been met. Also, sales arrangements may contain
customer-specific acceptance requirements for both products and
services. In such cases, revenue is deferred at the time of
delivery of the product or service and is recognized upon
receipt of customer acceptance.
For arrangements that are not considered software arrangements
and which involve multiple elements, such as sales of products
that include maintenance or installation services, revenue is
allocated to each respective element. We use the residual method
to recognize revenue when an arrangement includes one or more
elements to be delivered at a future date and objective evidence
of the fair value of all the undelivered elements exists. Under
the residual method, the revenue related to the undelivered
element is deferred at its fair value and the remaining portion
of the arrangement fee is recognized as revenue. If evidence of
fair value of one or more undelivered elements does not exist,
revenue is deferred and recognized when delivery of those
elements occurs or when fair value can be established.
We assess collectability based on a number of factors, including
general economic and market conditions, past transaction history
with the customer, and the creditworthiness of the customer. If
we determine that collection of the fee is not reasonably
assured, then we defer the fee and recognize revenue upon
receipt of payment. We do not typically request collateral from
our customers. In our China-based sales region, certain
customers pay accounts receivable with notes receivable from
Chinese banks with maturities less than six months. These are
also referred to as bankers acceptances.
A significant portion of our sales is made to distributors and
value added resellers (VARs). Revenue is generally recognized
when title and risk of loss pass to the customer, assuming all
other revenue recognition criteria have been met. Sales to these
customers are recorded net of appropriate allowances, including
estimates for product returns, price protection, and excess
channel inventory levels. We maintain reserves for potential
allowances and adjustments; if the actual level of returns and
adjustments differ from the assumptions we use to develop those
reserves, additional allowances and charges might be required.
For sales of products that contain software that is marketed
separately, we apply the provisions of AICPA Statement of
Position
97-2,
Software Revenue Recognition, as amended.
Accordingly, we apply
SOP 97-2
for the majority of sales from our TippingPoint segment, our
voice sales from our Networking Business and other insignificant
specific product sales within our Networking Business. We
generally sell our software products with maintenance services,
which includes the rights to unspecified updates and product
support, and, in some cases, also with consulting services. For
these undelivered elements, we determine vendor-specific
objective evidence (VSOE) of fair value to be the price charged
when the undelivered element is sold separately. We determine
VSOE for maintenance sold in connection with product based on
the amount that will be separately charged for the maintenance
renewal period. We determine VSOE for consulting services by
reference to the amount charged for similar engagements when a
software license sale is not involved.
We recognize revenue from software licenses sold together with
maintenance
and/or
consulting services upon shipment using the residual method,
provided that the above criteria have been met. Under the
residual method, revenue associated with undelivered elements is
deferred at its VSOE of fair value, and any remaining amounts
are considered related to the delivered elements and recognized
providing all other revenue recognition criteria are met. If
VSOE of fair value for the undelivered elements cannot be
established, we defer all revenue from the arrangement until the
earlier of the point at which such sufficient VSOE does exist or
all elements of the arrangement have been delivered.
We recognize maintenance revenue ratably over the term of the
applicable agreement. Sales of services, including professional
services, system integration, project management, and training,
are recognized upon completion of performance.
Allowance for doubtful accounts: We monitor
payments from our customers on an on-going basis and maintain
allowances for doubtful accounts for estimated losses resulting
from the inability of our customers 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
35
debts, and geographic and political risk. If the financial
condition of our customers were to deteriorate, resulting in an
impairment of their ability to make payments, additional
allowances might be required.
Inventories: Inventory is stated at the lower
of standard cost, which approximates cost, or net realizable
value. We perform detailed reviews related to the net realizable
value of inventory on an ongoing basis, for both inventory on
hand and inventory that we are committed to purchase, giving
consideration to deterioration, obsolescence, and other factors.
If actual market conditions differ from those projected by
management and our estimates prove to be inaccurate, additional
write-downs or adjustments to cost of sales might be required;
alternatively, we might realize benefits through cost of sales
for sale or disposition of inventory that had been previously
written off.
Goodwill and intangible assets: We apply the
provisions of SFAS No. 142 Goodwill and Other
Intangible Assets to goodwill and intangible assets with
indefinite lives which are not amortized but are reviewed
annually for impairment or more frequently if impairment
indicators arise. We performed our annual goodwill impairment
review as of February 27, 2009 for our TippingPoint segment
and December 31, 2008 for our China-based region (as our
China-based region reports on a two month lag), and noted no
impairment of goodwill or intangible assets with indefinite
lives. There were no triggering events in the fourth quarter of
fiscal year 2009 that required an additional impairment test. In
the fourth quarter of fiscal 2008 we conducted an additional
impairment test of our goodwill and indefinite lived intangible
assets due to the decline of our stock price which resulted in a
$158.0 million impairment charge to our TippingPoint
goodwill as discussed in Note 9. In estimating the fair
value of our reporting units, we relied on a number of factors
including operating results, business plans, economic
projections, anticipated future cash flows, and transactions and
marketplace data. There are inherent uncertainties related to
these factors and our judgment in applying them to the analysis
of goodwill impairment. Reporting unit valuations have been
calculated using a combination of an income approach based on
the present value of future cash flows of each reporting unit
and a market approach. The income approach incorporates many
assumptions including future growth rates, discount factors,
expected capital expenditures and income tax cash flows. Changes
in economic and operating conditions impacting these assumptions
could result in a goodwill impairment in future periods. In
conjunction with our annual goodwill impairment tests, we
reconcile the sum of the valuations of all of our reporting
units to our market capitalization as of such dates.
Stock-based Compensation. In December 2004,
the Financial Accounting Standards Board (FASB)
issued SFAS No. 123(R), which requires all stock-based
compensation to employees (as defined in
SFAS No. 123(R)), including grants of employee stock
options, restricted stock awards, and restricted stock units, to
be recognized in the financial statements based on their fair
values.
Estimates of the fair value of equity awards granted in future
periods will be affected by the market price of our common
stock, as well as the actual results of certain assumptions used
to value the equity awards. These assumptions include, but are
not limited to, the expected volatility of the common stock, the
expected term of options granted, and the risk free interest
rate.
The fair value of stock options and employee stock purchase plan
shares is determined by using the Black-Scholes option pricing
model and applying the single-option approach to the stock
option valuation. The options generally have vesting on an
annual basis over a vesting period of four years. We estimate
the expected option term by analyzing the historical term period
from grant to exercise and also considers the expected term for
those options that are outstanding. The expected term of
employee stock purchase plan shares is the purchase periods
under each offering period. The volatility of the common stock
is estimated using historical volatility.
The risk-free interest rate used in the Black-Scholes option
pricing model is determined by looking at historical
U.S. Treasury zero-coupon bond issues with terms
corresponding to the expected terms of the equity awards. In
addition, an expected dividend yield of zero is used in the
option valuation model, because we do not expect to pay any cash
dividends in the foreseeable future. Lastly, in accordance with
SFAS No. 123(R), we are required to estimate
forfeitures at the time of grant and revise those estimates in
subsequent periods if actual forfeitures differ from those
estimates. In order to determine an estimated pre-vesting option
forfeiture rate, we analyzed historical forfeiture data, which
yielded a current forfeiture rate of 23 percent as of the
end of the current fiscal year. We believe this historical
forfeiture rate to be reflective of our anticipated rate on a
go-forward basis. An estimated forfeiture rate has been
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applied to all unvested options and restricted stock outstanding
as of June 1, 2006 and to all options and restricted stock
granted since June 1, 2006. Therefore, stock-based
compensation expense is recorded only for those options and
restricted stock that are expected to vest.
Restructuring charges: Over the last several
years we have undertaken significant restructuring initiatives.
These initiatives have required us to record restructuring
charges related to severance and outplacement costs, lease
cancellations, accelerated depreciation and write-downs of held
for sale properties, write-downs of other long-term assets, and
other restructuring costs. Given the significance of our
restructuring activities and the time required for execution and
completion of such activities, the process of estimating
restructuring charges is complex and involves periodic
reassessments of estimates made at the time the original
decisions were made. The accounting for restructuring costs and
asset impairments requires us to record charges when we have
taken actions or have the appropriate approval for taking
action, and when a liability is incurred. Our policies require
us to periodically evaluate the adequacy of the remaining
liabilities under our restructuring initiatives. As we continue
to evaluate the business, we might be required to record
additional charges for new restructuring activities.
Product Warranty: A limited warranty is
provided on most of our products for periods ranging from
90 days to limited lifetime, depending upon the product,
and allowances for estimated warranty costs are recorded during
the period of sale. The determination of such allowances
requires us to make estimates of product return rates and
expected costs to repair or replace the products under warranty.
If actual return rates
and/or
repair and replacement costs differ significantly from our
estimates, adjustments to recognize additional cost of sales
might be required.
Income taxes: We are subject to income tax in
a number of jurisdictions. A certain degree of estimation is
required in recording the assets and liabilities related to
income taxes, and it is reasonably possible such assets may not
be recovered and that such liabilities may not be paid or that
payments in excess of amounts initially estimated and accrued
may be required. We assess the likelihood that our 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 valuation allowance. We consider historical taxable income,
estimates of future taxable income, and ongoing prudent and
feasible tax planning strategies in assessing the amount of the
valuation allowance. We have not provided valuation allowances
against our deferred tax assets in China. We have provided
valuation allowances in certain tax jurisdictions outside of
China based on various factors, including our historical losses,
retained deficit, operating performance in fiscal 2009, and
estimates of future profitability, we have concluded that future
taxable income will, more likely than not, be insufficient to
recover most of net deferred tax assets as of May 31, 2009.
Accordingly, we have established an appropriate valuation
allowance to offset such deferred tax assets.
In June 2006, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109
(FIN 48), that clarifies the accounting and
recognition for income tax positions taken or expected to be
taken in our tax returns. FIN 48 provides guidance on
derecognition of tax benefits, classification on the balance
sheet, interest and penalties, accounting in interim periods,
disclosure, and transition. We adopted FIN 48 on
June 2, 2007, which resulted in no adjustment to the
opening balance of retained earnings. As of May 31, 2009
the Company had unrecognized tax benefits of $21.9 million
including interest, all of which, if recognized, would affect
our effective tax rate.
We recognize tax liabilities for uncertain items in accordance
with FIN 48 and we adjust these liabilities when our
judgment changes as a result of the evaluation of new
information not previously available. Due to the complexity of
some of these uncertainties, the ultimate resolution may result
in a payment that is materially different from our current
estimate of the tax liabilities.
We recognize interest and penalties relating to unrecognized tax
benefits within the income tax expense line in the accompanying
consolidated statement of operations. As of May 31, 2009,
the amount of interest included on unrecognized tax benefits was
$2.4 million, representing a decrease of $0.1 million
during fiscal 2009. There were no penalties accrued in all
periods presented.
We have net operating loss carryforwards related to the
following income tax jurisdictions and expiration periods:
U.S. federal loss carryforwards of approximately
$2.7 billion expiring between fiscal years 2017 and
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2029; various state loss carryforwards of approximately
$983.0 million expiring between 2010 and 2029; and foreign
loss carryforwards of $385.3 million with an unlimited
carryforward period.
RESULTS
OF OPERATIONS
YEARS ENDED MAY 31, 2009, 2008, AND 2007
In the prior fiscal year we reported H3C, Data and Voice
Business Unit (DVBU), TippingPoint Security Business
(TippingPoint) and Corporate as segments. In the
first quarter of fiscal 2009, we realigned the manner in which
we manage our business and internal reporting, and based on the
information provided to our chief operating decision-maker
(CODM) for purposes of making decisions about allocating
resources and assessing performance, we have two primary
businesses, our Networking Business and TippingPoint Security
Business. Accordingly, our previously reported segment
information has been restated to reflect our new operating and
reporting structure. Our Networking Business consists of the
following sales regions as operating segments: China-based, Asia
Pacific Region excluding China-based sales region (Japan and
Hong Kong SAR) (APR), Europe Middle East and Africa (EMEA),
Latin America (LAT), and North America (NA) regions. The APR,
EMEA, LAT and NA operating segments have been aggregated given
their similar economic characteristics, products, customers and
processes, and have been consolidated as one reportable segment,
Rest of World. The China-based sales region does not
meet the aggregation criteria at this time.
The China-based and Rest of World reportable segments benefit
from shared support services on a world-wide basis. The costs
associated with providing these shared central functions are not
allocated to the China-based and Rest of World reporting
segments and instead are reported and disclosed under the
caption Central Functions. Central Functions consist
of indirect cost of sales, such as supply chain operations
expenses, and centralized operating expenses, such as research
and development, indirect sales and marketing, and general and
administrative support.
The following table sets forth, for the fiscal years indicated,
the percentage of total sales represented by the line items
reflected in our consolidated statements of operations.
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2009
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2008
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2007
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Sales
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100.0
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%
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100.0
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%
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100.0
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%
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Cost of sales
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42.9
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49.5
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54.4
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Gross profit margin
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57.1
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50.5
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45.6
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Operating expenses (income):
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Sales and marketing
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25.7
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24.4
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25.2
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Research and development
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13.7
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15.9
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17.0
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General and administrative
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8.6
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10.0
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|
|
|
7.4
|
|
Amortization
|
|
|
7.2
|
|
|
|
8.0
|
|
|
|
3.4
|
|
Realtek settlement and patent sale
|
|
|
(6.5
|
)
|
|
|
|
|
|
|
|
|
Goodwill impairment
|
|
|
|
|
|
|
12.2
|
|
|
|
|
|
In-process research and development
|
|
|
|
|
|
|
|
|
|
|
2.8
|
|
Restructuring charges
|
|
|
0.7
|
|
|
|
0.3
|
|
|
|
0.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses, net
|
|
|
49.4
|
|
|
|
70.8
|
|
|
|
56.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
7.7
|
|
|
|
(20.3
|
)
|
|
|
(10.5
|
)
|
Interest (expense) income, net
|
|
|
(0.4
|
)
|
|
|
(1.0
|
)
|
|
|
3.2
|
|
Other income, net
|
|
|
3.9
|
|
|
|
3.4
|
|
|
|
3.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations before income taxes and minority
interest in income of consolidated joint venture
|
|
|
11.2
|
|
|
|
(17.9
|
)
|
|
|
(4.1
|
)
|
Income tax benefit (provision)
|
|
|
(2.5
|
)
|
|
|
0.2
|
|
|
|
(0.8
|
)
|
Minority interest in income of consolidated joint venture
|
|
|
|
|
|
|
|
|
|
|
(2.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
|
8.7
|
%
|
|
|
(17.7
|
)%
|
|
|
(7.0
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
38
Comparison
of fiscal 2009 and 2008
During the year ended May 31, 2009 we continued to
experience sales growth in our China-based sales region and
TippingPoint security segment, which was significantly offset by
declines in our Rest of World sales region. We also experienced
an improvement in gross profit margin in all regions, primarily
due to changes in product mix to more profitable enterprise
related business as well as to reduced costs. We also continued
to reduce Central Function operating expenses due to expense
control and integration efforts, offset in part by investments
in our direct touch sales force in our China-based and Rest of
World sales regions.
Sales
Consolidated revenues increased by $22.1 million or
1.7 percent from fiscal 2008.
The following table shows our sales from our segments in dollars
and as a percentage of total sales for fiscal 2009 and fiscal
2008 (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2009
|
|
|
2008
|
|
|
China-based sales region
|
|
$
|
727.9
|
|
|
|
55
|
%
|
|
$
|
647.7
|
|
|
|
50
|
%
|
Rest of World sales region
|
|
|
471.1
|
|
|
|
36
|
%
|
|
|
546.9
|
|
|
|
42
|
%
|
TippingPoint security business
|
|
|
124.9
|
|
|
|
9
|
%
|
|
|
104.1
|
|
|
|
8
|
%
|
Eliminations and other
|
|
|
(6.9
|
)
|
|
|
0
|
%
|
|
|
(3.8
|
)
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated sales
|
|
$
|
1,317.0
|
|
|
|
100
|
%
|
|
$
|
1,294.9
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales in our China-based sales region increased
$80.2 million or 12.4 percent from fiscal 2008. The
increase in sales was primarily driven by appreciation of
$55.4 million on the Renminbi as well as increased
direct-touch sales of $42.6 million in China, partially
offset by decreased sales of $11.1 million to Huawei and
decreased sales of $6.7 million in Hong Kong and Japan.
Sales in our Rest of World sales region decreased
$75.8 million or 13.9 percent from fiscal 2008. The
decrease in sales was primarily attributable to decreased sales
of $58.5 million and $20.3 million in our EMEA and
North America sales regions, respectively, due primarily to
longer sales cycles, delayed or cancelled purchases and reduced
incoming orders because of the global economic downturn. We also
believe that our SMB business has been impacted more
significantly than our larger enterprise business. The decrease
was partially offset by increased sales in our Latin America
sales region.
Sales in our TippingPoint security business increased
$20.8 million, or 19.9 percent from fiscal 2008. The
increase in sales was primarily attributable to increased
maintenance revenue of $11.1 million to $46.4 million
as a result of an increased number of maintenance contracts as
well as increased security product sales of $9.7 million to
$78.4 million. We are seeing continued interest in security
products and services even in the economic downturn.
TippingPoint customers purchase IPS hardware and a maintenance
contract entitling them to Digital Vaccine maintenance services.
Digital Vaccine services provide
continually-updated
protection from viruses and other external intrusions.
Eliminations and other increased by $3.1 million from
fiscal 2008. This increase was primarily due to increased sales
from our TippingPoint segment to our Rest of World sales region.
39
The following table shows our sales by major product categories
in dollars and as a percentage of total sales for fiscal 2009
and fiscal 2008 (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2009
|
|
|
2008
|
|
|
Networking
|
|
$
|
1,061.8
|
|
|
|
81
|
%
|
|
$
|
1,061.2
|
|
|
|
82
|
%
|
Security
|
|
|
163.9
|
|
|
|
12
|
%
|
|
|
133.4
|
|
|
|
10
|
%
|
Services
|
|
|
45.9
|
|
|
|
4
|
%
|
|
|
39.6
|
|
|
|
3
|
%
|
Voice
|
|
|
45.4
|
|
|
|
3
|
%
|
|
|
60.7
|
|
|
|
5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,317.0
|
|
|
|
100
|
%
|
|
$
|
1,294.9
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Networking revenue includes sales of our Layer 2 and Layer 3
stackable
10/100/1000
managed switching lines, our modular switching lines, routers,
IP storage and our small to medium business market products.
Sales of our networking products remained flat from fiscal 2008.
Networking revenue was primarily impacted by appreciation of the
Renminbi, and to a lesser extent, increased direct-touch sales
in China, mostly offset by decreased sales in Western Europe and
North America due to longer sales cycles, delayed or cancelled
purchases and reduced incoming orders due to adverse business
conditions relating to the global economic downturn.
Security revenue includes our
TippingPointtm
products and services, as well as other security products, such
as our embedded firewall, or EFW and virtual private network, or
VPN, products. Sales of our security products increased
$30.5 million or 22.9 percent from fiscal 2008. The
increase in sales was primarily related to $19.4 million
increased product sales, as we are seeing continued interest in
security products and services even in the economic downturn, as
well as increased sales of security products in our China-based
sales region and increased maintenance revenue in our
TippingPoint business of $11.1 million as a result of an
increased number of maintenance contracts in our TippingPoint
segment.
Services revenue includes professional services and maintenance
contracts, excluding TippingPoint maintenance which is included
in security revenue. Services revenue increased
$6.3 million or 15.9 percent from fiscal 2008. The
increase in service revenue was driven primarily by increased
service sales of $4.3 million tied to growth in our
China-based sales region of our Networking Business and, to a
lesser extent, increases in sales of $0.66 million in both
our Latin America and Asia Pacific Rim regions. The increase in
the APR region primarily relates to increased service revenue in
Malaysia and Thailand, while the increase in LAT relates to
increased networking revenue in fiscal year 2009.
Voice revenue includes our
VCXtm
and
NBX®
voice-over-internet protocol, or VoIP, product lines, as well as
voice gateway offerings. Sales of our Voice products decreased
$15.3 million or 25.2 percent from fiscal 2008. The
decrease in voice revenue was primarily due to decreased sales
in all four of our Rest of World sales regions. The most
significant decrease of $11.9 million occurred in our North
America region. The primary reasons for the decrease in this
region relates to longer sales cycles, delayed or cancelled
purchases and reduced incoming orders due to adverse business
conditions relating to the global economic downturn.
Gross
Margin
Gross margin by segment was as follows:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
2009
|
|
2008
|
|
Networking Business
|
|
|
55.8
|
%
|
|
|
50.0
|
%
|
TippingPoint Security Business
|
|
|
68.5
|
%
|
|
|
67.4
|
%
|
Consolidated gross margin
|
|
|
57.1
|
%
|
|
|
50.5
|
%
|
Gross margin in our Networking Business improved 5.8 points to
55.8 percent from 50.0 percent in fiscal 2008. The
improvement in gross profit margin is primarily attributable to
a change in product mix in all regions to greater higher margin
H3C sourced enterprise related solutions and reduced costs. The
reduced costs
40
primarily relate to a change in our customer service delivery
model. During the third quarter of fiscal 2008 we changed from
an outsourced service provider to a more cost effective hybrid
model involving the use of both outsourced and in-house
resources.
Gross margin in our TippingPoint Security Business increased 1.1
points to 68.5 percent from 67.4 percent in fiscal
2008. The improvement in fiscal 2009 is explained primarily by
reduced supply chain costs.
Gross margin on a consolidated basis increased 6.6 points to
57.1 percent from 50.5 percent in fiscal 2008. The
increase in fiscal 2009 is due principally to the items
discussed above, as well as the absence of purchase accounting
related adjustments to inventory in connection with our 2007 H3C
acquisition in the current fiscal year that were present in the
previous fiscal year.
Operating
Expenses (Income)
Operating expenses in fiscal 2009 were $650.8 million,
compared to $917.9 million in fiscal 2008, a net decrease
of $267.1 million, or 29.1 percent. The decrease
primarily relates to the absence of a $158.0 million
goodwill impairment charge recorded in the fourth quarter of
fiscal 2008 relating to our carrying value for our acquired
TippingPoint business, a favorable resolution of a patent
dispute in fiscal 2009 of $70.0 million, net proceeds from
a patent sale of $15.2 million and decreased research and
development costs due to integration benefits. These reductions
were partially offset by increased sales and marketing expenses
due to increased investment in our global direct-touch sales
force.
As a percent of sales, total operating expenses in fiscal 2009
were 49.4 percent, compared to 70.8 percent in fiscal
2008. In the aggregate, sales and marketing, research and
development, and general and administrative expenses were
48.0 percent of sales in fiscal 2009, compared to
50.3 percent in fiscal 2008, a decrease of
$19.5 million in fiscal 2009 compared to fiscal 2008. We
believe that to a significant degree, these expenses are
controllable and discretionary over time, but they are not
directly variable with sales levels within a particular period.
The most significant component of the decrease of
$19.5 million was $26.7 million of decreased research
and development costs due to integration as well as decreased
general and administrative expenses of $15.2 million. These
reductions were partially offset by increased sales and
marketing expenses due to increased investment in our
direct-touch sales force.
A more detailed discussion of the factors affecting each major
component of total operating expenses is provided below.
Sales and
Marketing.
Sales and marketing expenses in fiscal 2009 increased
$22.4 million compared to fiscal 2008. The increase
primarily relates to our increased investment in our
direct-touch sales force in our China-based sales region and in
our EMEA region and increased stock-based compensation expenses
in the current fiscal year as a result of a decrease in our
forfeiture rate.
Research
and Development.
Research and development expenses in fiscal 2009 decreased
$26.7 million compared to fiscal 2008. The most significant
factor contributing to the decrease was continued savings from
integration of research and development in all regions in our
Networking Business. The majority of the decrease resulted from
the migration of the Companys non-TippingPoint research
and development functions to China, resulting in a decrease in
headcount of 230 employees from the prior fiscal year as
the Company eliminated duplicate testing activities and other
activities.
General
and Administrative.
General and administrative expenses in fiscal 2009 decreased
$15.2 million compared to fiscal 2008. The decrease
primarily relates to the absence in fiscal 2009 of deal related
costs of $10.6 million related to the now terminated
proposed acquisition of the Company, a law firm success fee of
$9.0 million related to the jury verdict in our Realtek
litigation, a $4.9 million charge related to TippingPoint
proposed IPO related costs.
41
These decreases were partially offset by costs in connection
with litigation matters of $4.4 million, an impairment
charge related to a decrease in the value of our Hemel, UK land
of $1.2 million and increased stock-based compensation
expense primarily as a result of a decrease in our forfeiture
rate.
Amortization.
Amortization decreased $8.7 million from the previous
fiscal year. The decrease reflects one of our intangible assets
becoming fully amortized in the fourth quarter of fiscal 2008
and the amortization of the Huawei non-compete agreement
becoming fully amortized at the end of our second quarter of
fiscal 2009, partially offset by currency translation
adjustments recorded in the current fiscal year due to the
strengthening of the Renminbi.
Patent
dispute resolution and patent sale.
The Company and Realtek Group reached an agreement with respect
to certain networking technologies of the Company that resolved
a long-standing patent dispute between the companies. Under the
terms of the agreement, Realtek paid the Company
$70.0 million, all of which was received in the three
months ended August 31, 2008. On May 29, 2009, the
Company sold 35 patents for $17.0 million to Parallel
Technology, LLC. The Company received all of the funds on
May 29, 2009. The $17.0 million of proceeds were
partially offset by a $1.8 million finders fee.
The Company recognized the $70.0 million and the net
$15.2 million as operating income in the first and fourth
quarters, respectively, of fiscal 2009.
Restructuring
Charges
Restructuring charges were $8.7 million in fiscal 2009 and
$4.5 million in fiscal 2008. Restructuring charges in
fiscal 2009 and 2008 were primarily the result of reductions in
workforce and continued efforts to consolidate and dispose of
excess facilities. The reduction in workforce primarily related
to reductions in research and development employees in our Rest
of World region and a change in our TippingPoint executive
structure. Further actions may be taken if our business activity
declines or additional cost reduction efforts are necessary.
See Note 6 to Condensed Consolidated Financial Statements
for a more detailed discussion of restructuring charges.
Interest
Expense, Net
Interest expense, net in fiscal 2009 decreased $7.5 million
compared to fiscal 2008. The decrease was primarily due to the
decreased principal balance of our long term debt due to
scheduled and voluntary payments of principal, coupled with a
lower LIBOR rate on the loan, as well as increased interest
income earned on a higher average balance of cash and notes
receivable during most of the current fiscal year.
Other
Income, Net
Other income, net in fiscal 2009 increased $7.4 million
compared to fiscal 2008. This increase was primarily due to an
additional $6.6 million in nontaxable subsidy payments
received under a program run by the Chinese VAT authorities on
increased sales. The subsidy payments are taken into income on a
cash basis. The timing of the receipt, and the continuation of
the program, are subject to the discretion of the Chinese VAT
authorities. This program is scheduled to terminate on
December 31, 2010. The increase was also driven by net
foreign currency gains in the current year of $2.8 million
compared to a net foreign currency loss of $4.2 million in
the prior year.
Income
Tax Provision
We had an income tax provision of $32.6 million in fiscal
2009 compared to an income tax benefit of $2.9 million in
fiscal 2008.
42
The income tax provision for fiscal 2009 represents an effective
tax rate of 22.1%, and was primarily the result of providing for
income tax on our Chinese profits at 15%, together with a
provision of 5% withholding tax ($16.5 million) for the
eventual distribution of those profits from the PRC to Hong Kong
. This provision was partially offset by the recognition of
previously unrecognized tax benefits of $1.4 million as a
result of the effective settlement of certain foreign
examinations. Under the new PRC tax law, effective
January 1, 2008, companies which qualify as new and
high technology companies will pay corporate income tax at
a reduced rate of 15%. Our H3C subsidiary in China has now
qualified for this reduced rate, so that our tax rate in China
will be 15%, as long as the law and our circumstances remain
unchanged. Notwithstanding the issue discussed above, our H3C
subsidiary in China was entitled to tax concessions which began
in 2004 and exempted it from the PRC income tax for its initial
two years and entitled it to a 50 percent reduction in
income tax in the following three years. Calendar year 2008 was
the final year of our tax concessions under the old law and the
first year of our 15% reduced rate under the new law. There is
currently some uncertainty as to whether we can continue to
enjoy the benefit of the final year of our concessions at the
same time as the reduced rate under the new law. The final
determination of our 2008 statutory income tax rate in China is
subject to approval by the local tax office and we expect them
to consider the complex rules concerning existing concessions
under the transition rules, as well as guidance from the PRC
State Tax Administration, in granting this approval. Until this
uncertainty is clarified, accounting rules require us to provide
for income tax on profits arising in calendar year 2008 at the
15% rate, and this is reflected in the fiscal 2009 tax
provision. The tax rate in China for calendar year 2007 was 7.5%
as a result of the tax concessions discussed above. The
remainder of the net provision for the year was the result of
providing for taxes in certain foreign jurisdictions.
The income tax benefit for fiscal 2008 was primarily the result
of the recognition of previously unrecognized tax benefits of
$13.2 million as a result of the effective settlement of
certain foreign examinations. This benefit was partially offset
by the revaluation in the third quarter of our deferred assets
and liabilities relating to our H3C subsidiary in China,
following changes in the Chinese tax rate under the new PRC tax
law. The net effect of these revaluations was an increase in our
tax provision for fiscal 2008 of $6.1 million. The balance
of the net benefit for the year was the result of providing for
taxes in certain state and foreign jurisdictions.
Segment
Analysis (tables in thousands)
The results of our regional Networking segments, Central
Functions, and our TippingPoint Security business as our CODM
reviews their profitability are presented below.
China-based
sales region:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2009
|
|
|
2008
|
|
|
Sales
|
|
$
|
727,939
|
|
|
$
|
647,718
|
|
Gross profit(a)
|
|
|
486,888
|
|
|
|
407,382
|
|
Direct sales and marketing expenses
|
|
|
136,194
|
|
|
|
115,996
|
|
|
|
|
|
|
|
|
|
|
Segment contribution profit
|
|
$
|
350,694
|
|
|
$
|
291,386
|
|
Segment contribution profit in fiscal 2009 increased
$59.3 million to $350.7 million when compared to the
prior fiscal year. Segment contribution profit is standard
profit less segment direct sales and marketing expenses. The
increase was primarily driven by increased sales and gross
profit, partially offset by increased direct sales and marketing
expenses due to increased investment in our direct-touch sales
force.
|
|
|
a |
|
Gross profit is defined for this region as standard
margin, which is sales less standard cost of sales (which
excludes certain indirect cost of goods sold, such as supply
chain operations which are included in Central Functions). |
43
Rest
of World sales region:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2009
|
|
|
2008
|
|
|
Sales
|
|
$
|
471,055
|
|
|
$
|
546,868
|
|
Gross profit(a)
|
|
|
273,706
|
|
|
|
306,556
|
|
Direct sales and marketing expenses
|
|
|
99,683
|
|
|
|
99,121
|
|
|
|
|
|
|
|
|
|
|
Segment contribution profit
|
|
$
|
174,023
|
|
|
$
|
207,435
|
|
Segment contribution profit in fiscal 2009 decreased
$33.4 million to $174.0 million when compared to the
prior fiscal year. Segment contribution profit is standard
profit less segment direct sales and marketing expenses. The
decrease was primarily related to decreased sales in our EMEA
and North America regions due to the weakening of the global
economy, partially offset by improved margins due to a change in
product mix to more H3C sourced products.
|
|
|
a |
|
Gross profit is defined for this region as standard
margin, which is sales less standard cost of sales (which
excludes certain indirect cost of goods sold, such as supply
chain operations which are included in Central Functions). |
Central
Functions:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
2009
|
|
|
2008
|
|
|
Gross profit(a)
|
|
$
|
(91,585
|
)
|
|
$
|
(116,370
|
)
|
Operating expenses
|
|
|
285,007
|
|
|
|
312,341
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
$
|
376,592
|
|
|
$
|
428,711
|
|
Total costs and expenses in fiscal 2009 decreased
$52.1 million to $376.6 million when compared to the
prior fiscal year. Total expenses include supply chain costs and
operating expenses exclusive of those items contained in
Eliminations and Other. The decrease was due primarily to a
change from an outsourced service provider for customer service
activities in the year ago period to a hybrid model, involving
the use of both outsourced and in-house resources in the
delivery of customer services in the current period. In addition
we continued to realize savings from integration of research and
development in all regions in our Networking Business, partially
offset by increased costs to support the multi-national
expansion of our business.
|
|
|
a |
|
Gross profit represents indirect cost of sales, such
as supply chain operations expenses; these costs are not
allocated to the sales regions. |
TippingPoint
Security business:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
2009
|
|
|
2008
|
|
|
Sales
|
|
$
|
124,864
|
|
|
$
|
104,101
|
|
Gross profit
|
|
|
85,483
|
|
|
|
70,197
|
|
Operating expenses
|
|
|
83,038
|
|
|
|
70,694
|
|
|
|
|
|
|
|
|
|
|
Segment profit (loss)
|
|
$
|
2,445
|
|
|
$
|
(497
|
)
|
TippingPoint segment profit in fiscal 2009 was $2.4 million
compared to segment loss of $0.5 million in the prior
fiscal year. Segment profit is gross profit less operating
expenses, exclusive of those items contained in Eliminations and
Other. The increase in segment profit was primarily related to
increased sales due to increased maintenance revenue of
$11.1 million as a result of increased maintenance
contracts as well as $9.7 million increased security
product sales due primarily to large account sales.
44
Comparison
of fiscal 2008 and 2007
During the year ended May 30, 2008 we continued to
experience increased performance in our China-based sales region
and our TippingPoint security segment offset by declines in our
ROW sales region and we continued to reduce operating expenses,
offset in part by investment in ROW services.
Sales
The following table shows our sales from our segments in dollars
and as a percentage of total sales for fiscal 2008 and fiscal
2007 (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2008
|
|
|
2007
|
|
|
China-based sales region
|
|
$
|
647.7
|
|
|
|
50
|
%
|
|
$
|
634.6
|
|
|
|
49
|
%
|
Rest of World sales region
|
|
|
546.9
|
|
|
|
42
|
%
|
|
|
542.7
|
|
|
|
44
|
%
|
TippingPoint security business
|
|
|
104.1
|
|
|
|
8
|
%
|
|
|
90.2
|
|
|
|
7
|
%
|
Eliminations and other
|
|
|
(3.8
|
)
|
|
|
0
|
%
|
|
|
|
|
|
|
0
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consolidated sales
|
|
$
|
1,294.9
|
|
|
|
100
|
%
|
|
$
|
1,267.5
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales in our China-based sales region increased
$13.1 million or 2.1 percent from fiscal 2007. The
increase in sales was primarily driven by appreciation of
$36.0 million on the Renminbi as well as increased
direct-touch sales of $34.2 million in China, partially
offset by decreased sales of $50.0 million to Huawei and
decreased sales in the regions outside of China.
Sales in our Rest of World sales region increased
$4.2 million or 1.0 percent from fiscal 2007. The
increase in sales was primarily attributable to increased sales
in our EMEA, APR and LAT regions substantially offset by
decreased sales in our North America region. The decline in
sales in North America was primarily due to weakness in sales of
our voice solutions and an economic slowdown as well as
perceived apprehension in the market related to the
now-terminated proposed acquisition of the Company by affiliates
of Bain Capital.
Sales in our TippingPoint security business increased
$13.9 million, or 15.4 percent from fiscal 2007. The
increase in sales was primarily attributable to significant
customer wins in North America in fiscal year 2008.
Eliminations and other increased by $3.8 million from
fiscal 2007. This increase was primarily due to increased sales
from our TippingPoint segment to our Rest of World sales region.
Consolidated revenues increased by $27.4 million or
2.2 percent from fiscal 2007.
The following table shows our sales by major product categories
in dollars and as a percentage of total sales for fiscal 2008
and fiscal 2007 (dollars in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2008
|
|
|
2007
|
|
|
Networking
|
|
$
|
1,061.2
|
|
|
|
82
|
%
|
|
$
|
1,043.5
|
|
|
|
82
|
%
|
Security
|
|
|
133.4
|
|
|
|
10
|
%
|
|
|
120.1
|
|
|
|
10
|
%
|
Voice
|
|
|
60.7
|
|
|
|
5
|
%
|
|
|
68.0
|
|
|
|
5
|
%
|
Services
|
|
|
39.6
|
|
|
|
3
|
%
|
|
|
35.9
|
|
|
|
3
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,294.9
|
|
|
|
100
|
%
|
|
$
|
1,267.5
|
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Networking revenue includes sales of our Layer 2 and Layer 3
stackable
10/100/1000
managed switching lines, our modular switching lines, routers,
IP storage and our small to medium-sized enterprise market
products. Sales of our networking products in fiscal 2008
increased $17.7 million, or 1.7 percent, from fiscal
2007. The increase in sales was primarily driven by expansion in
our global sales of our H3C subsidiarys developed
products, and appreciation on the Renminbi related to our sales
in our China-based sales region, partially offset by reduced
sales to Huawei and slower than expected sales in our North
America sales region.
45
Security revenue includes our TippingPoint products and
services, as well as other security products, such as our
embedded firewall, or EFW and virtual private network, or VPN,
products. Sales of our security products in fiscal 2008
increased $13.3 million, or 11.1 percent, from fiscal
2007. The increase is primarily attributable to increased sales
of our TippingPoint products in our North America region due to
certain significant customers wins and slightly increased sales
on a global basis.
Voice revenue includes our
VCXtm
and
NBX®
voice-over-internet protocol, or VoIP, product lines, as well as
voice gateway offerings. Sales of our VoIP telephony products in
fiscal 2008 decreased $7.3 million, or 10.7 percent,
from fiscal 2007 due primarily to decreased sales in North
America.
Services revenue includes professional services and maintenance
contracts, excluding TippingPoint maintenance which is included
in security revenue. Services revenue in fiscal 2008 increased
$3.7 million, or 10.3 percent, from fiscal 2007. The
increase was driven primarily by increased service sales tied to
growth in networking product sales.
Gross
Margin
Gross margin by segment is as follows:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
2008
|
|
2007
|
|
Networking Business
|
|
|
50.0
|
%
|
|
|
44.6
|
%
|
TippingPoint Security Business
|
|
|
67.4
|
%
|
|
|
66.9
|
%
|
Consolidated gross margin
|
|
|
50.5
|
%
|
|
|
45.6
|
%
|
Gross margin in our Networking Business improved 5.4 points to
50.0 percent from 44.6 percent in fiscal 2007. The
improvement in gross profit margin is driven by favorable
product mix, improved pricing of products and reduced costs of
products, partially offset by costs associated with our change
from an outsourced service provider to a hybrid of outsourced
and in-house performance of services to our customers.
Gross margin in our TippingPoint Security Business increased 0.5
points to 67.4 percent from 66.9 percent in fiscal
2007. This increase is primarily due to more favorable product
mix of sales in the current fiscal year, offset in part by
certain cost increases.
Gross margin on a consolidated basis increased 4.9 points to
50.5 percent from 45.6 percent in fiscal 2007. The
increase in fiscal 2008 is due principally to the items
discussed above.
Operating
Expenses
Operating expenses in fiscal 2008 were $917.9 million,
compared to $711.0 million in fiscal 2007, a net increase
of $206.9 million, or 29 percent. The increase
primarily relates to a $158.0 million goodwill impairment
charge recorded in the fourth quarter of fiscal 2008 as well as
increased amortization costs of $61.1 million due to a full
year of amortization expense in current fiscal period as opposed
to one day of amortization expense related to the
49 percent purchase of our H3C subsidiary in the prior
fiscal year and to a lesser extent costs related to the
now-terminated proposed acquisition of the Company by affiliates
of Bain Capital of $10.6 million, a law firm success fee of
$9.0 million related to the jury verdict in our Realtek
litigation (a dispute which we resolved favorably through an
agreement with Realtek to provide it with nonexclusive licenses
in exchange for $70 million of license fees), a
$4.9 million charge related to expenses incurred in
connection with TippingPoints then-proposed IPO, and
$5.1 million of increased FAS 123R expenses. These
expenses were partially offset by the absence of a
change-in-control
portion of our H3C subsidiarys EARP bonus program, which
contributed compensation expenses of $51.5 million in the
year ended May 31, 2007 as well as in-process research and
development expenses of $35.8 million in the year ended
May 31, 2007.
As a percent of sales, total operating expenses in fiscal 2008
were 70.8 percent, compared to 56.1 percent in fiscal
2007. In aggregate, sales and marketing, research and
development, and general and administrative expenses were
50.3 percent of sales in fiscal 2008, compared to
49.6 percent in fiscal 2007, an increase of
46
$22.6 million in fiscal 2008 compared to fiscal 2007. We
believe that to a significant degree, these expenses are
controllable and discretionary over time, but they are not
directly variable with sales levels within a particular period.
The most significant component of the increase of
$22.6 million was the incurrence of deal related costs of
$10.6 million related to the now terminated proposed
acquisition of the Company, a law firm success fee of
$9.0 million related to the jury verdict in our Realtek
litigation a dispute which we resolved favorably through an
agreement with Realtek to provide it with nonexclusive licenses
in exchange for $70 million of license fees), increased
stock-based compensation expenses of $5.1 million,
TippingPoint IPO related costs of $4.9 million and
increased spending in all areas partially offset by the absence
of
change-in-control
portion of our H3C subsidiarys EARP bonus program, which
contributed compensation expenses of $51.5 million in the
year ended May 31, 2007.
A more detailed discussion of the factors affecting each major
component of total operating expenses is provided below.
Sales and
Marketing.
Sales and marketing expenses in fiscal 2008 decreased
$3.7 million compared to fiscal 2007. This decrease was due
primarily to a $7.0 million decrease in our China-based
sales region sales and marketing expenses partially offset by
increased sales and marketing expenses in our Rest of World
sales region and TippingPoint security business. The
$7.0 million decrease in our China-based sales region
primarily relates to the absence of the
change-in-control
portion of our H3C subsidiarys EARP bonus program of
$17.7 million in the prior fiscal period partially offset
by investments in our China-based sales region direct touch
sales force.
Research
and Development.
Research and development expenses in fiscal 2008 decreased
$9.0 million compared to fiscal 2007. This decrease was due
primarily to decreased spending in both our Networking Business
and TippingPoint segment. The decrease in our Networking
Business primarily relates to the absence of the
change-in-control
portion of our H3C subsidiarys EARP bonus program of
$27.2 million in the current fiscal period, partially
offset by increased investment in our research and development
activities. The TippingPoint segment decreased $3.0 million
from the prior fiscal year due to constricted spending.
General
and Administrative.
General and administrative expenses in fiscal 2008 increased
$35.2 million from fiscal 2007. This increase is primarily
due to the incurrence of deal related costs of
$10.6 million related to the now terminated proposed
acquisition of the Company, a law firm success fee of
$9.0 million related to the jury verdict in our Realtek
litigation (a dispute which we resolved favorably through an
agreement with Realtek to provide it with nonexclusive licenses
in exchange for $70 million of license fees), a
$4.9 million charge related to TippingPoint IPO related
costs, and $5.0 million of increased FAS 123R expenses
partially offset by the absence of the
change-in-control
portion of our H3C subsidiarys EARP bonus program of
$6.6 million in the year ended May 31, 2007.
Amortization.
Amortization was $103.7 million in fiscal 2008 and
$42.5 million in fiscal 2007, an increase of
$61.2 million. Amortization increased due primarily to the
inclusion of our H3C subsidiarys amortization expenses for
the entire fiscal year ended May 31, 2008. The fiscal 2007
amortization expense related to the March 29, 2007 purchase
of 49 percent of our H3C subsidiary in 2007 was through
March 31, 2007 as we record our H3C subsidiarys
results on a two month lag.
In-process
research and development,
In fiscal 2007 $34.0 million of the total purchase price of
our acquisition of Huaweis remaining minority interest in
our H3C subsidiary was allocated to in-process research and
development and was expensed in the fourth quarter of fiscal
2007. Projects that qualify as in-process research and
development represent those that
47
have not yet reached technological feasibility and which have no
alternative future use. At the time of acquisition, our H3C
subsidiary had multiple in-process research and development
efforts under way for certain current and future product lines.
We had no in-process research and development charges in fiscal
2008.
Restructuring
Charges.
Restructuring charges were $4.5 million in fiscal 2008 and
$3.5 million in fiscal 2007. Restructuring charges in
fiscal 2008 and 2007 were the result of reductions in workforce
and continued efforts to consolidate and dispose of excess
facilities.
Interest
(Expense) Income
Interest expense was $13.1 million in fiscal 2008, a
decrease of $54.0 million compared to interest income of
$40.9 million in fiscal 2007. The net change in interest
expense relates to the interest expense from the
$430 million of debt incurred in the fourth quarter of
fiscal 2007, as well as decreased interest income from our
reduced cash balance in the current fiscal year.
Other
Income, Net
Other income, net was $44.8 million in fiscal 2008, an
increase $6.1 million compared to other income, net of
$38.3 million in fiscal 2007. The increase was primarily
due to an increase of other income from our H3C subsidiary for
an operating subsidy program by the Chinese VAT authorities in
the form of a partial refund of VAT taxes collected by our H3C
subsidiary from purchasers of software products.
Income
Tax Benefit (Provision)
We had an income tax benefit of $2.9 million in fiscal 2008
compared to an income tax provision of $10.2 million in
fiscal 2007. The income tax benefit for fiscal 2008 was
primarily the result of the recognition of previously
unrecognized tax benefits of $13.2 million as a result of
the effective settlement of certain foreign examinations. This
benefit was partially offset by the revaluation in the third
quarter of our deferred assets and liabilities relating to our
H3C subsidiary in China due to a change in tax rates. The net
effect of these revaluations was an increase in our tax
provision for fiscal 2008 of $6.1 million. The balance of
the net benefit for the year was the result of providing for
taxes in certain foreign jurisdictions.
The income tax provision for fiscal 2007 was the result of
providing for taxes in certain state and foreign jurisdictions.
Minority
Interest in Income of Consolidated Joint Venture
In fiscal 2007, we recorded a charge of $26.2 million
related to the acquisition of the 49 percent interest in
our H3C subsidiary held by Huawei prior to our purchase. In
fiscal 2008 we had no minority interest.
Segment
Analysis (tables in thousands)
The results of our regional Networking segments, Central
Functions, and our TippingPoint Security business as our CODM
reviews their profitability are presented below.
China-based
sales region:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2008
|
|
|
2007
|
|
|
Sales
|
|
$
|
647,718
|
|
|
$
|
634,649
|
|
Gross profit(a)
|
|
|
407,382
|
|
|
|
369,866
|
|
Direct sales and marketing expenses
|
|
|
115,996
|
|
|
|
111,487
|
|
|
|
|
|
|
|
|
|
|
Segment contribution profit
|
|
$
|
291,386
|
|
|
$
|
258,379
|
|
48
Segment contribution profit in fiscal 2008 increased
$33.0 million to $291.4 million when compared to the
prior fiscal year. Segment contribution profit is standard
profit less segment direct sales and marketing expenses. The
increase in segment contribution profit was primarily driven by
increased sales and gross profit due to increased higher margin
direct-touch sales.
|
|
|
a |
|
Gross profit is defined for this region as standard
margin, which is sales less standard cost of sales (which
excludes certain indirect cost of goods sold, such as supply
chain operations which are included in Central Functions). |
Rest
of World sales region:
|
|
|
|
|
|
|
|
|
|
|
Fiscal Year
|
|
|
|
2008
|
|
|
2007
|
|
|
Sales
|
|
$
|
546,868
|
|
|
$
|
542,654
|
|
Gross profit(a)
|
|
|
306,556
|
|
|
|
258,350
|
|
Direct sales and marketing expenses
|
|
|
99,121
|
|
|
|
92,809
|
|
|
|
|
|
|
|
|
|
|
Segment contribution profit
|
|
$
|
207,435
|
|
|
$
|
165,541
|
|
Segment contribution profit in fiscal 2008 increased
$41.9 million to $207.4 million when compared to the
prior fiscal year. Segment contribution profit is standard
profit less segment direct sales and marketing expenses. The
increase primarily relates to increased gross margin due to
increased sales of H3C sourced products.
|
|
|
a |
|
Gross profit is defined for this region as standard
margin, which is sales less standard cost of sales (which
excludes certain indirect cost of goods sold, such as supply
chain operations which are included in Central Functions). |
Central
Functions:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
2008
|
|
|
2007
|
|
|
Gross profit(a)
|
|
$
|
(116,370
|
)
|
|
$
|
(102,712
|
)
|
Operating expenses
|
|
|
312,341
|
|
|
|
284,046
|
|
|
|
|
|
|
|
|
|
|
Total costs and expenses
|
|
$
|
428,711
|
|
|
$
|
386,758
|
|
Total costs and expenses in fiscal 2008 increased
$42.0 million to $428.7 million when compared to the
fiscal year. Total expenses include supply chain costs and
operating expenses exclusive of those items contained in
Eliminations and Other. The increase was due primarily to
increased costs to support the multi-national expansion of our
business.
|
|
|
a |
|
Gross profit represents indirect cost of sales, such
as supply chain operations expenses; these costs not allocated
to the sales regions. |
TippingPoint
Security business:
|
|
|
|
|
|
|
|
|
|
|
Year Ended
|
|
|
|
2008
|
|
|
2007
|
|
|
Sales
|
|
$
|
104,101
|
|
|
$
|
90,178
|
|
Gross profit
|
|
|
70,197
|
|
|
|
60,307
|
|
Operating expenses
|
|
|
70,694
|
|
|
|
70,750
|
|
|
|
|
|
|
|
|
|
|
Segment profit (loss)
|
|
$
|
(497
|
)
|
|
$
|
(10,443
|
)
|
TippingPoint segment loss in fiscal 2008 was $0.5 million
compared to segment loss of $10.4 million in the prior
fiscal year. Segment profit is gross profit less operating
expenses, exclusive of those items contained
49
in Eliminations and Other. The decrease was primarily related to
increased sales as well as slightly improved margins.
LIQUIDITY
AND CAPITAL RESOURCES
Cash and equivalents and short-term investments as of
May 31, 2009 were $644.2 million, an increase of
approximately $140.6 million compared to the balance of
$503.6 million as of May 31, 2008. These balances were
comprised of the following (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
Cash and equivalents
|
|
$
|
545.8
|
|
|
$
|
503.6
|
|
|
$
|
559.2
|
|
Short-term investments
|
|
|
98.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and equivalents and short term investments
|
|
$
|
644.2
|
|
|
$
|
503.6
|
|
|
$
|
559.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The May 31, 2009 and 2008 balance included cash and
equivalents and short-term investments in our H3C subsidiary of
$527.7 million and $338.9 million, respectively.
Short-term investments were invested in Chinese government bonds
and central bank bills, with maturity periods from three months
to one year.
The following table shows the major components of our
consolidated statements of cash flows for the last three fiscal
years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(In millions)
|
|
|
Cash and equivalents, beginning of period
|
|
$
|
503.6
|
|
|
$
|
559.2
|
|
|
$
|
501.1
|
|
Net cash provided by operating activities
|
|
|
280.5
|
|
|
|
54.9
|
|
|
|
165.5
|
|
Net cash used in investing activities
|
|
|
(99.4
|
)
|
|
|
(16.4
|
)
|
|
|
(505.9
|
)
|
Net cash (used in) provided by financing activities
|
|
|
(147.8
|
)
|
|
|
(123.9
|
)
|
|
|
387.9
|
|
Currency impact on cash
|
|
|
8.9
|
|
|
|
29.8
|
|
|
|
10.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and equivalents, end of period
|
|
$
|
545.8
|
|
|
$
|
503.6
|
|
|
$
|
559.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities was
$280.5 million for fiscal 2009 compared to
$54.9 million in fiscal 2008. The primary factor in the
increase was the strong cash generation from our China
operations. More specifically, the $225.6 million dollar
increase is primarily a result of net income in fiscal 2009 of
$114.7 million compared to a net loss of
$228.8 million in the previous fiscal year as well as
working capital sources during fiscal 2009 of approximately
$33.7 million compared to working capital uses in the prior
fiscal year of approximately $29.3 million. The primary
reasons for the increase in net income relates to the absence of
a $158.0 million goodwill impairment in the current fiscal
year, as well as our Realtek patent dispute resolution of
$70.0 million, increased sales and decreased cost of sales
due to product mix changes and cost reductions and a change from
an outsourced service provider in the year ago period to a
hybrid of outsourced and in-house services to our customers,
partially offset by increased sales and marketing expenses.
The net change in operating assets and liabilities of
$33.7 million was primarily related to an increase in other
liabilities of $43.4 million, mostly due to increased
customer advance payments in China, increased deferred revenue,
and higher VAT and other taxes payable. The increase also
relates to the collecting of notes receivable (due primarily
form Huawei) in the current fiscal year partially offset by
a decrease in accounts payable of ($32.1) million,
primarily due to the timing of payments.
On September 24, 2008, our board of directors authorized a
stock repurchase program of up to $100 million, effective
for one year. The timing and actual number of shares repurchased
will depend on a variety of factors and we cannot determine at
this time the amount of cash we will use under this program. We
have already purchased approximately half of the authorized
amount under this program. We are authorized to
50
repurchase the remaining $50 million of common stock under
the authorized stock program and may do so at any time without
prior notice.
Significant commitments that will require the use of cash in
future periods include obligations under debt, lease, contract
manufacturing and outsourcing agreements, as shown in the
following table (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
Less Than
|
|
|
|
|
|
|
|
|
More Than
|
|
Contractual Obligations(1)(2)
|
|
Total
|
|
|
One Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
|
Operating leases(3)
|
|
$
|
72.5
|
|
|
$
|
22.7
|
|
|
$
|
26.3
|
|
|
$
|
7.0
|
|
|
$
|
16.5
|
|
Purchase commitments with contract manufacturers(4)
|
|
|
64.2
|
|
|
|
64.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long term debt(5)
|
|
|
200.0
|
|
|
|
48.0
|
|
|
|
68.0
|
|
|
|
84.0
|
|
|
|
|
|
Outsourcing agreements(6)
|
|
|
11.3
|
|
|
|
6.0
|
|
|
|
4.7
|
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
348.0
|
|
|
$
|
140.9
|
|
|
$
|
99.0
|
|
|
$
|
91.6
|
|
|
$
|
16.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Includes our non-H3C subsidiary
related obligations as of May 31, 2009 and our H3C
subsidiary obligations as of March 31, 2009.
|
|
(2)
|
|
As discussed in
Note 16 Income Taxes, we have
recorded a liability for unrecognized tax benefits of
$21.9 million. This liability is included in the balance
sheet under the caption Deferred taxes and long-term
obligations. The table above excludes this liability
because it is not possible to estimate with reasonable certainty
if or when any or all of the liability will be settled in cash.
|
|
(3)
|
|
Includes rent for our Marlborough,
MA facility as to which a lease was renewed on June 8, 2009.
|
|
(4)
|
|
We have entered into purchase
agreements with our contract manufacturers. Pursuant to these
agreements, if our actual orders and purchases fall below
forecasted levels, we may be required to purchase finished goods
inventory manufactured to meet our requirements. In addition, we
may be required to purchase raw material and work in process
inventory on-hand that is unique to our products, and we may be
required to compensate the contract manufacturers with respect
to their non-cancelable purchase orders for such inventory. The
amount shown in the table above represents our estimate of
inventory held by contract manufacturers that we could be
required to purchase within the next 12 months. We do not
expect any such required purchases to exceed our requirements
for inventory to meet expected sales of our products to our
customers.
|
|
(5)
|
|
Represents required principal
payments on our senior secured loan, but does not include
required excess cash flow payments, for periods
greater than one year, which are dependent on whether H3C
generates any excess cash flow. The amounts above exclude
expected interest payments of $7.2 million that will be
paid in the next fiscal year. Interest payments are expected to
decline ratably with the debt balance in future years.
|
|
(6)
|
|
Under our IT outsourcing agreements
and research and development agreement we are subject to service
level commitments and contractor commitments levels providing
for annual minimum payments that vary depending on the levels we
choose. The amounts shown in the table above represent the
amounts that would be payable, based on current levels, through
the expiration of the agreements. However, our IT agreement may
be terminated after 14 months upon 180 days notice. At
this time if we were to terminate the contract we would incur a
termination fee of approximately $4.5 million
|
Net cash used in investing activities was $99.4 million for
fiscal 2009, resulting primarily from outflows related to
purchases of short-term investments of $98.2 million and
property and equipment of $16.6 million partially offset by
net proceeds from patent sales of $15.2 million.
We have no material commitments for capital expenditures as of
May 31, 2009 other than ordinary course of business
purchases of computer hardware, software and leasehold
improvements which we generally believe to be consistent with
prior practice. In addition, although no firm commitments exist
today, as we further develop our worldwide integration plans we
may decide to make capital expenditure investments in
infrastructure to support a more integrated Company in amounts
which could be material.
51
Net cash used in financing activities was $147.8 million in
fiscal 2009. During fiscal 2009, we made principal payments of
$101.0 million related to our long term debt,
$53.0 million of which was a voluntary prepayment. In
addition, we repurchased $53.3 million of shares of stock,
of which $50 million was part of our stock repurchase
program discussed above. This was partially offset by proceeds
of $6.6 million from issuances of our common stock upon
exercise of stock options.
With respect to our debt payment obligations for the next year,
we are required to make interest payments in September 2009 and
in March 2010 and a $48 million principal payment in
September 2009.
As of May 31, 2009, bank-issued standby letters of credit
and guarantees totaled $6.6 million, including
$5.7 million relating to potential foreign tax, custom, and
duty assessments. We provide the bank with cash collateral for
100 percent of these amounts.
On December 30, 2008 our H3C subsidiary, which operates our
China-based business, renewed the lease for its Hangzhou, China
headquarters, effective January 1, 2009. The lease is for a
three-year term from January 1, 2009 through and including
December 31, 2011. Under the terms of the lease agreement
with landlord Huawei Technologies, our H3C subsidiary will pay
rent of approximately RMB 34,003,653 (or
USD 5 million) per year. On June 8, 2009, we
renewed a lease on our Marlborough, MA facility. The lease is
for a ten year and two month term from June 1, 2009 through
and including July 31, 2019. Under the terms of the lease
agreement with landlord Bel Marlborough 1 LLC we will pay an
average annual rent of $3.0 million per year.
In recent years, we have generated most of our positive cash
flow from our China operations. Our capital requirements in Rest
of World have been met from cash flow from operations as well as
from existing cash balances and permitted dividends from China.
Dividends from our China operations to our Rest of World
operations are generally subject to the following restrictions:
(1) a 10 percent reserve requirement imposed by PRC
law (capped at 50% of registered capital), which was
$43.9 million at May 31, 2009), (2) a 5%
withholding tax imposed by the PRC on profits earned on or after
January 1, 2008 and (3) a credit agreement restriction
limiting our ability to dividend cash outside of the H3C Group
and requiring that a specified percentage of excess cash flow
from China be annually used to prepay debt. There are also
administrative requirements for making dividends out of China
that involve filings with government agencies seeking approval
to pay a dividend. Government officials can dictate when we can
pay a dividend and can specify specific terms or conditions for
making the payment. As of March 31, 2009 the H3C
Groups net assets were $881.3 million and are subject
to these dividend restrictions.
An important exception to the credit agreement restriction
permits us to annually dividend from China to Rest of World the
percentage of H3Cs excess cash flow that is not required
to be prepaid to the banks under the terms of the agreement,
provided that certain conditions are met. We used this exception
in 2008 to make a $33.1 million dividend and, assuming we
meet all of these conditions and comply with regulatory
requirements, we anticipate having the ability to continue to
make dividends in the future. In June 2009 we made a dividend of
$55.6 million and in July 2009, we paid another
$99.4 million. No dividends for these amounts were made to
our parent company. We have no prepayment penalty on our loan
and at this time our cash and cash equivalents balances
significantly exceed our outstanding principal loan balance.
In Rest of World we currently do not generate positive cash flow
and are experiencing adverse impacts from the global economic
slowdown. As a result of these factors, we intend to more
aggressively prudently manage cash and monitor discretionary
cash spending, especially in periods prior to receipt of any
available and permitted annual dividend payments from China.
We currently believe that our existing cash and cash equivalents
and cash generated from operations will be sufficient to satisfy
our anticipated cash requirements and required loan payments for
at least the next 12 months.
On May 25, 2007, our subsidiary H3C Holdings Limited
(Borrower) entered into an amended and restated
credit agreement with various lenders, including Goldman Sachs
Credit Partners L.P., as Mandated Lead Arranger, Bookrunner,
Administrative Agent and Syndication Agent, and Industrial and
Commercial Bank of China (Asia) Limited, as Collateral Agent
(the Credit Agreement). Under the original credit
52
agreement, the Borrower borrowed $430 million in the form
of a senior secured term loan with two tranches (Tranche A
and Tranche B) to finance a portion of the purchase
price for 3Coms acquisition of 49 percent of H3C
Technologies Co., Limited, or H3C. Remaining principal is
$200 million as of May 31, 2009 and the final loan
maturity date is on September 28, 2012.
Interest on borrowings is payable semi-annually on March 28 and
September 28. All amounts outstanding under the
Tranche A Term Facility will bear interest, at the
Borrowers option, at the (i) LIBOR, or (ii) Base
Rate (i.e., prime rate), in each case plus the applicable margin
percentage set forth in the table below, which is based on a
leverage ratio of consolidated indebtedness of the
Borrower and its subsidiaries to EBITDA (as defined in the
Credit Agreement) for the relevant twelve-month period:
|
|
|
|
|
|
|
|
|
Leverage Ratio
|
|
LIBOR +
|
|
Base Rate +
|
|
>3.0:10
|
|
|
2.25
|
%
|
|
|
1.25
|
%
|
≤3.0:1.0 but > 2.0:1.0
|
|
|
2.00
|
%
|
|
|
1.00
|
%
|
≤2.0:1.0 but > 1.0:1.0
|
|
|
1.75
|
%
|
|
|
0.75
|
%
|
≤1.0:1.0
|
|
|
1.50
|
%
|
|
|
0.50
|
%
|
All amounts outstanding under the Tranche B Term Facility
will bear interest, at the Borrowers option, at the
(i) LIBOR plus 3 percent or (ii) Base Rate (i.e.,
prime rate) plus 2 percent. We have elected to use LIBOR as
the reference rate for borrowings to date, and expect to do so
for the foreseeable future. Applicable LIBOR rates at
May 31, 2009 were 1.79 percent and the effective
interest rate is currently 3.29 percent for the
Tranche A Term Facility and 4.79 percent for the
Tranche B Term Facility.
Covenants and other restrictions under the Credit Agreement
apply to the Borrower and its subsidiaries, which we refer to as
the H3C Group, but not to 3Coms Rest of World
reporting units or TippingPoint. The loans are secured by assets
at the H3C level. H3C also guarantees the loans.
The loans may be prepaid in whole or in part without premium or
penalty. The Borrower will be required to make mandatory
prepayments using net proceeds from H3C Group (i) asset
sales, (ii) insurance proceeds and (iii) equity
offerings or debt incurrence. In addition, the Borrower will be
required to make annual prepayments in an amount equal to
75 percent of excess cash flow of the H3C
Group. This percentage will decrease to the extent that the
Borrowers leverage ratio is lower than specified amounts.
Any excess cash flow amounts not required to prepay the loan may
be distributed to and used by the Companys other segments,
provided certain conditions are met.
The Borrower must maintain a minimum debt service coverage,
minimum interest coverage, maximum capital expenditures and a
maximum total leverage ratio. Negative covenants restrict, among
other things, (i) the incurrence of indebtedness by the
Borrower and its subsidiaries, (ii) the making of dividends
and distributions to 3Coms other segments, (iii) the
ability to make investments including in new subsidiaries,
(iv) the ability to undertake mergers and acquisitions and
(v) sales of assets. Also, cash dividends from the PRC
subsidiaries to H3C, and H3C to the Borrower, will be subject to
restricted use pending payment of principal, interest and excess
cash flow prepayments. Standard events of default and defaulted
interest rates apply.
Remaining payments of the $200.0 million principal on the
loans are due as follows on September 28, for fiscal years
ending May 31 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Calendar Year
|
|
3Com Fiscal Year
|
|
Tranche A
|
|
Tranche B
|
|
2009
|
|
|
2010
|
|
|
$
|
46,000
|
|
|
$
|
2,000
|
|
2010
|
|
|
2011
|
|
|
|
46,000
|
|
|
|
2,000
|
|
2011
|
|
|
2012
|
|
|
|
|
|
|
|
20,000
|
|
2012
|
|
|
2013
|
|
|
|
|
|
|
|
84,000
|
|
The closing of the remaining 49 percent acquisition of our
H3C subsidiary triggered a bonus program for substantially all
of our H3C subsidiarys approximately 4,800 employees.
This program, which was implemented by Huawei and 3Com in a
prior period, is called the Equity Appreciation Rights Plan, or
EARP, and
53
funds a bonus pool based upon a percentage of the appreciation
in our H3C subsidiarys value from the initiation of the
program to the time of the closing of the Acquisition. A portion
of the program is also based on cumulative earnings of our H3C
subsidiary. The total value of the EARP is expected to be
approximately $166 million as of May 31, 2009.
Approximately $94 million (related to cumulative earnings
and
change-in-control)
was accrued by March 31, 2007 and was paid in the first
quarter of fiscal year 2008. In the first quarter of fiscal 2009
we paid an additional $34 million. At May 31, 2009, we
accrued $24.4 million for the fiscal 2009 EARP plan which
is expected to be paid in the first quarter of fiscal year 2010.
We expect the unvested portion amounting to $14 million
will be accrued in our H3C subsidiarys operating segment
over the next fiscal year serving as a continued retention and
incentive program for our H3C subsidiarys employees. The
only stipulation for payout is that the participants remain
employed with the Company on the date of the payout which is
required to be made within a specified period after the
anniversary date of our 49 percent H3C acquisition on
March 29, 2007.
Remaining cash payment requirements under the Equity
Appreciation Rights Plan for fiscal years ending May 31 are
approximately as follows (in thousands):
|
|
|
|
|
2010
|
|
$
|
24,364
|
|
2011
|
|
|
14,000
|
|
It is expected that we will have significant cash outflows in
fiscal 2010 of $55.2 million of loan payments for principal
and interest and approximately $24.4 million for EARP
commitments.
EFFECTS
OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
For additional information regarding recently issued accounting
pronouncements, see Note 2 to our Consolidated Financial
Statements in Item 8 of this Annual Report on
Form 10-K.
|
|
ITEM 7A.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|
Market Risk Disclosures. The following
discussion about our market risk disclosures involves
forward-looking
statements. Actual results could differ materially from those
projected in the forward-looking statements. We are exposed to
market risk related to changes in interest rates and foreign
currency exchange rates. We do not use derivative financial
instruments for speculative or trading purposes.
Interest Rate Sensitivity. Interest to be paid
by us on our senior secured loan is at an interest rate based,
at our option, on either the LIBOR or the prime rate, plus an
applicable margin. We expect the base interest rate generally to
be based on the published LIBOR rate, which is subject to change
on a periodic basis. Recently, interest rates have trended
downwards in major global financial markets, stabilizing at
relatively low levels over the past few months. If these
interest rate trends were to reverse, this will result in
increased interest rate expense as a result of higher LIBOR
rates. We believe a ten percent increase in LIBOR would not have
a material effect on our financial position or results of
operations. Continued increases in interest rates could have a
material adverse effect on our financial position, results of
operations and cash flows, particularly if such increases are
substantial. In addition, interest rate trends could affect
global economic conditions.
Foreign Currency Exchange Risk. A significant
portion of our sales and a portion of our costs are denominated
in Renminbi, the Chinese currency. At the same time, our senior
secured bank loan which we intend to service and
repay primarily through cash flow from H3Cs PRC
operations is denominated in US dollars. In July
2005, China uncoupled the Renminbi from the U.S. dollar and
let it float in a narrow band against a basket of foreign
currencies. The Renminbi could appreciate or depreciate relative
to the U.S. dollar. Any movement of the Renminbi may
materially and adversely affect our cash flows, revenues,
operating results and financial position, and may make it more
difficult for us to service our U.S. dollar-denominated
senior secured bank loan. More specifically, if the Renminbi
appreciates in value as compared with the U.S. dollar, our
reported revenues will derive a beneficial increase due to
currency translation; and if the Renminbi depreciates, our
revenues will suffer due to such depreciation. This currency
translation impacts our expenses as well, but to a lesser degree.
54
Outside of China, most of our sales are invoiced and collected
in US dollars, while selling and administrative expenses are
incurred in local currency. A depreciation of the US dollar will
result in higher selling and administrative expenses outside of
the United States, while an appreciation of the US dollar will
reduce the reported selling and administrative expenses. With
the exception of China, changes in currency valuations should
not have a significant impact on our revenue or margin. We
believe that a sudden or significant change in foreign exchange
rates would not have a material impact on future net income or
cash flows other than with respect to the Chinese Renminbi.
Cash Investments and Short-Term Investments. A
significant portion of our cash is invested in China, These
funds are primarily invested in Chinese Central Bank Bills,
Chinese government bonds, and the major state-owned, or state
controlled banks, and are denominated in the Chinese Renminbi.
Any movement in the value of the Renminbi may materially affect
our cash balance. Chinese government bonds typically carry
maturity of less than one year. The remainder of the portfolio
carries maturities of less than 90 days. We may also invest
in offshore money market funds with a rating of Aaa/AAA.
Cash holdings outside of China are mostly denominated in US
dollars, and are invested in US Treasury Money Market Funds and
Repurchase Agreements backed by US Treasuries. We may also
invest in US government agency debt rated Aaa/AAA, Banks and
Corporate rated A1/P1, Sovereign, non-US Banks &
Corporate rated Aa3/AA-, and Money Market Funds rated Aaa/AAA.
These investments typically carry maturities of less than
7 days.
55
|
|
ITEM 8.
|
FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
|
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT
SCHEDULES
|
|
|
|
|
|
|
Page
|
|
Consolidated Financial Statements:
|
|
|
|
|
|
|
|
57
|
|
|
|
|
58
|
|
|
|
|
59
|
|
|
|
|
60
|
|
|
|
|
61
|
|
|
|
|
62
|
|
Financial Statement Schedules:
|
|
|
|
|
|
|
|
107
|
|
|
|
|
112
|
|
All other schedules are omitted, because they are not required,
are not applicable, or the information is included in the
consolidated financial statements and notes thereto.
56
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board
of Directors and Stockholders of 3Com Corporation
Marlborough, Massachusetts
We have audited the accompanying consolidated balance sheets of
3Com Corporation and subsidiaries (3Com) as of May 29, 2009
and May 30, 2008, and the related consolidated statements
of operations, stockholders equity, and cash flows for
each of the three years in the period ended May 29, 2009.
Our audits also included the consolidated financial statement
schedules listed in the Index at Item 15. These financial
statements and financial statement schedules are the
responsibility of 3Coms management. Our responsibility is
to express an opinion on the financial statements and financial
statement schedules based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present
fairly, in all material respects, the financial position of 3Com
at May 29, 2009 and May 30, 2008, and the results of
their operations and their cash flows for each of the three
years in the period ended May 29, 2009, in conformity with
accounting principles generally accepted in the United States of
America. Also, in our opinion, such financial statement
schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
We have also audited, in accordance with the standards of the
Public Company Accounting Oversight Board (United States),
3Coms internal control over financial reporting as of
May 29, 2009, based on the criteria established in
Internal Control Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated July 24, 2009 expressed an
unqualified opinion on 3Coms internal control over
financial reporting.
/s/ DELOITTE & TOUCHE LLP
Boston, Massachusetts
July 24, 2009
57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands, except per share amounts)
|
|
|
Sales
|
|
$
|
1,316,978
|
|
|
$
|
1,294,879
|
|
|
$
|
1,267,481
|
|
Cost of sales
|
|
|
565,514
|
|
|
|
640,424
|
|
|
|
689,027
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
751,464
|
|
|
|
654,455
|
|
|
|
578,454
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses (income):
|
|
|
|
|
|
|
|
|
|
|
|
|
Sales and marketing
|
|
|
338,401
|
|
|
|
316,019
|
|
|
|
319,696
|
|
Research and development
|
|
|
179,979
|
|
|
|
206,653
|
|
|
|
215,632
|
|
General and administrative
|
|
|
113,900
|
|
|
|
129,116
|
|
|
|
93,875
|
|
Amortization
|
|
|
95,013
|
|
|
|
103,670
|
|
|
|
42,525
|
|
Patent dispute resolution and patent sale
|
|
|
(85,200
|
)
|
|
|
|
|
|
|
|
|
Goodwill impairment
|
|
|
|
|
|
|
157,977
|
|
|
|
|
|
In-process research and development
|
|
|
|
|
|
|
|
|
|
|
35,753
|
|
Restructuring charges
|
|
|
8,679
|
|
|
|
4,501
|
|
|
|
3,494
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses, net
|
|
|
650,772
|
|
|
|
917,936
|
|
|
|
710,975
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income (loss)
|
|
|
100,692
|
|
|
|
(263,481
|
)
|
|
|
(132,521
|
)
|
Interest (expense) income, net
|
|
|
(5,563
|
)
|
|
|
(13,087
|
)
|
|
|
40,863
|
|
Other income, net
|
|
|
52,200
|
|
|
|
44,824
|
|
|
|
39,434
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations before income taxes and minority
interest in income of consolidated joint venture
|
|
|
147,329
|
|
|
|
(231,744
|
)
|
|
|
(52,224
|
)
|
Income tax (provision) benefit
|
|
|
(32,604
|
)
|
|
|
2,903
|
|
|
|
(10,173
|
)
|
Minority interest in income of consolidated joint venture
|
|
|
|
|
|
|
|
|
|
|
(26,192
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
114,725
|
|
|
$
|
(228,841
|
)
|
|
$
|
(88,589
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net income (loss) per share:
|
|
$
|
0.29
|
|
|
$
|
(0.57
|
)
|
|
$
|
(0.22
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing per share amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
392,092
|
|
|
|
399,524
|
|
|
|
393,894
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
394,207
|
|
|
|
399,524
|
|
|
|
393,894
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
58
|
|
|
|
|
|
|
|
|
|
|
May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
|
(In thousands, except per share amounts)
|
|
|
ASSETS
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and equivalents
|
|
$
|
545,818
|
|
|
$
|
503,644
|
|
Short-term investments
|
|
|
98,357
|
|
|
|
|
|
Notes receivable
|
|
|
40,590
|
|
|
|
65,116
|
|
Accounts receivable, less allowance for doubtful accounts of
$9,645 and $12,253, respectively
|
|
|
112,771
|
|
|
|
116,281
|
|
Inventories
|
|
|
90,395
|
|
|
|
90,831
|
|
Other current assets
|
|
|
56,982
|
|
|
|
34,033
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
944,913
|
|
|
|
809,905
|
|
Property and equipment, less accumulated depreciation and
amortization of $172,717 and $205,835, respectively
|
|
|
40,012
|
|
|
|
54,314
|
|
Goodwill
|
|
|
609,297
|
|
|
|
609,297
|
|
Intangible assets, net
|
|
|
198,624
|
|
|
|
278,385
|
|
Deposits and other assets
|
|
|
22,511
|
|
|
|
23,229
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
1,815,357
|
|
|
$
|
1,775,130
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
68,350
|
|
|
$
|
90,280
|
|
Current portion of long-term debt
|
|
|
48,000
|
|
|
|
48,000
|
|
Accrued liabilities and other
|
|
|
394,103
|
|
|
|
366,181
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
510,453
|
|
|
|
504,461
|
|
Deferred taxes and long-term obligations
|
|
|
40,729
|
|
|
|
22,367
|
|
Long-term debt
|
|
|
152,000
|
|
|
|
253,000
|
|
Stockholders 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 and outstanding: 389,284 and 405,656,
respectively
|
|
|
2,336,961
|
|
|
|
2,353,688
|
|
Retained deficit
|
|
|
(1,290,522
|
)
|
|
|
(1,405,247
|
)
|
Accumulated other comprehensive income
|
|
|
65,736
|
|
|
|
46,861
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
1,112,175
|
|
|
|
995,302
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
1,815,357
|
|
|
$
|
1,775,130
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unamortized
|
|
|
|
|
|
Other
|
|
|
|
|
|
|
Common Stock
|
|
|
Treasury Stock
|
|
|
Stock-based
|
|
|
Retained
|
|
|
Comprehensive
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Shares
|
|
|
Amount
|
|
|
Compensation
|
|
|
Deficit
|
|
|
Income (Loss)
|
|
|
Total
|
|
|
|
(In thousands)
|
|
|
Balances, May 31, 2006
|
|
|
393,442
|
|
|
$
|
2,300,396
|
|
|
|
|
|
|
|
|
|
|
$
|
(7,565
|
)
|
|
$
|
(1,087,512
|
)
|
|
$
|
(2,957
|
)
|
|
$
|
1,202,362
|
|
Elimination of unamortized stock-based compensation
|
|
|
|
|
|
|
(7,565
|
)
|
|
|
|
|
|
|
|
|
|
|
7,565
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Components of comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(88,589
|
)
|
|
|
|
|
|
|
(88,589
|
)
|
Unrealized gain on available-for-sale securities, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,310
|
|
|
|
2,310
|
|
Accumulated translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4,996
|
|
|
|
4,996
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(81,283
|
)
|
Repurchase of common stock
|
|
|
(2,359
|
)
|
|
|
(9,041
|
)
|
|
|
(870
|
)
|
|
|
(4,259
|
)
|
|
|
|
|
|
|
(163
|
)
|
|
|
|
|
|
|
(13,463
|
)
|
Common stock issued under stock plans, net of cancellations
|
|
|
7,981
|
|
|
|
19,471
|
|
|
|
870
|
|
|
|
4,259
|
|
|
|
|
|
|
|
(142
|
)
|
|
|
|
|
|
|
23,588
|
|
Stock-based compensation expense
|
|
|
|
|
|
|
20,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
20,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, May 31, 2007
|
|
|
399,064
|
|
|
|
2,323,356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,176,406
|
)
|
|
|
4,349
|
|
|
|
1,151,299
|
|
Components of comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(228,841
|
)
|
|
|
|
|
|
|
(228,841
|
)
|
Unrealized gain on available-for-sale securities, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(209
|
)
|
|
|
(209
|
)
|
Accumulated translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
42,721
|
|
|
|
42,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive loss
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(186,329
|
)
|
Repurchase of common stock
|
|
|
(952
|
)
|
|
|
(3,180
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3,180
|
)
|
Common stock issued under stock plans, net of cancellations
|
|
|
7,544
|
|
|
|
8,305
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,305
|
|
Stock-based compensation expense
|
|
|
|
|
|
|
25,207
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25,207
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, May 31, 2008
|
|
|
405,656
|
|
|
|
2,353,688
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1,405,247
|
)
|
|
|
46,861
|
|
|
|
995,302
|
|
Components of comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
114,725
|
|
|
|
|
|
|
|
114,725
|
|
Accumulated translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
18,875
|
|
|
|
18,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
133,600
|
|
Repurchase of common stock
|
|
|
(22,699
|
)
|
|
|
(53,378
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(53,378
|
)
|
Common stock issued under stock plans, net of cancellations
|
|
|
6,327
|
|
|
|
6,571
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,571
|
|
Stock-based compensation expense
|
|
|
|
|
|
|
30,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
30,080
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balances, May 31, 2009
|
|
|
389,284
|
|
|
$
|
2,336,961
|
|
|
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
(1,290,522
|
)
|
|
$
|
65,736
|
|
|
$
|
1,112,175
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
|
(In thousands)
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
114,725
|
|
|
$
|
(228,841
|
)
|
|
$
|
(88,589
|
)
|
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
124,794
|
|
|
|
136,030
|
|
|
|
74,990
|
|
Loss (gain) on property and equipment disposals
|
|
|
1,257
|
|
|
|
2,224
|
|
|
|
(14,714
|
)
|
Impairment of property and equipment
|
|
|
1,150
|
|
|
|
|
|
|
|
|
|
Minority interest
|
|
|
|
|
|
|
|
|
|
|
26,192
|
|
Stock-based compensation expense
|
|
|
30,080
|
|
|
|
25,207
|
|
|
|
20,095
|
|
Gain on investments, net
|
|
|
|
|
|
|
(185
|
)
|
|
|
(1,417
|
)
|
Deferred income taxes
|
|
|
(10,078
|
)
|
|
|
(8,206
|
)
|
|
|
(10,487
|
)
|
Goodwill impairment
|
|
|
|
|
|
|
157,977
|
|
|
|
|
|
In-process research and development
|
|
|
|
|
|
|
|
|
|
|
35,753
|
|
Gain on sale of patent
|
|
|
(15,200
|
)
|
|
|
|
|
|
|
|
|
Changes in assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts and notes receivable
|
|
|
35,747
|
|
|
|
7,895
|
|
|
|
(24,677
|
)
|
Inventories
|
|
|
(3,342
|
)
|
|
|
32,621
|
|
|
|
50,589
|
|
Other assets
|
|
|
(9,945
|
)
|
|
|
18,429
|
|
|
|
32,368
|
|
Accounts payable
|
|
|
(32,075
|
)
|
|
|
(22,926
|
)
|
|
|
(34,760
|
)
|
Other liabilities
|
|
|
43,356
|
|
|
|
(65,348
|
)
|
|
|
100,195
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
280,469
|
|
|
|
54,877
|
|
|
|
165,538
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Purchases of held-to-maturity investments
|
|
|
(98,235
|
)
|
|
|
|
|
|
|
(225,005
|
)
|
Proceeds from maturities and sales of investments
|
|
|
|
|
|
|
442
|
|
|
|
609,342
|
|
Proceeds from patent sale, net of $1.8 million fee
|
|
|
15,200
|
|
|
|
|
|
|
|
|
|
Purchases of property and equipment
|
|
|
(16,587
|
)
|
|
|
(17,893
|
)
|
|
|
(28,331
|
)
|
Businesses acquired in purchase transactions, net of cash
acquired
|
|
|
|
|
|
|
|
|
|
|
(898,529
|
)
|
Proceeds from sale of property and equipment
|
|
|
228
|
|
|
|
1,096
|
|
|
|
36,580
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
|
(99,394
|
)
|
|
|
(16,355
|
)
|
|
|
(505,943
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuances of common stock
|
|
|
6,571
|
|
|
|
8,305
|
|
|
|
23,588
|
|
Repurchases of common stock
|
|
|
(53,378
|
)
|
|
|
(3,180
|
)
|
|
|
(13,463
|
)
|
Net proceeds from long term debt
|
|
|
|
|
|
|
|
|
|
|
415,811
|
|
Repayments of borrowings
|
|
|
(101,000
|
)
|
|
|
(129,000
|
)
|
|
|
|
|
Dividend paid to minority interest shareholder
|
|
|
|
|
|
|
|
|
|
|
(40,785
|
)
|
Other, net
|
|
|
|
|
|
|
|
|
|
|
2,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash (used in) provided by financing activities
|
|
|
(147,807
|
)
|
|
|
(123,875
|
)
|
|
|
387,938
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and equivalents
|
|
|
8,906
|
|
|
|
29,780
|
|
|
|
10,587
|
|
Net change in cash and equivalents during year
|
|
|
42,174
|
|
|
|
(55,573
|
)
|
|
|
58,120
|
|
Cash and equivalents, beginning of year
|
|
|
503,644
|
|
|
|
559,217
|
|
|
|
501,097
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and equivalents, end of year
|
|
$
|
545,818
|
|
|
$
|
503,644
|
|
|
$
|
559,217
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
14,373
|
|
|
$
|
24,362
|
|
|
$
|
5,596
|
|
Income tax payments, net of refunds
|
|
|
19,248
|
|
|
|
14,199
|
|
|
|
18,970
|
|
Inventory transferred to property and equipment
|
|
|
7,202
|
|
|
|
5,565
|
|
|
|
8,814
|
|
The accompanying notes are an integral part of these
consolidated financial statements.
61
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
|
|
Note 1:
|
Description
of Business
|
We are incorporated in Delaware. A pioneer in the computer
networking industry, we provide secure, converged networking
solutions, as well as maintenance and support services, for
enterprises and public sector organizations of all sizes.
Headquartered in Marlborough, Massachusetts, we have worldwide
operations, including sales, marketing, research and
development, and customer service and support capabilities.
|
|
Note 2:
|
Significant
Accounting Policies
|
Fiscal
year
Our fiscal year ends on the Friday closest to May 31.
Fiscal 2009 consisted of 52 weeks and ended on May 29,
2009. Fiscal 2008 consisted of 52 weeks and ended on
May 30, 2008 and fiscal 2007 consisted of the 52 weeks
ended on June 1, 2007. For convenience, the consolidated
financial statements have been shown as ending on the last day
of the calendar month.
Use of
estimates in the preparation of consolidated financial
statements
The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the
United States of America requires us to make assumptions and
estimates that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities
at the date of the consolidated financial statements and the
reported amounts of sales, costs and expenses during the
reporting periods. Such management assumptions and estimates
include allowances for doubtful accounts receivable, product
returns, rebates and price protection; provisions for inventory
to reflect net realizable value, goodwill and other intangible
assets, estimation of fair value of acquired businesses, and
properties held for sale; valuation allowances against deferred
income tax assets; and accruals for severance costs,
compensation, product warranty, other liabilities, and income
taxes, among others. Actual results could materially differ from
those estimates and assumptions.
Basis of
presentation
The consolidated financial statements include the accounts of
3Com, and its wholly-owned subsidiaries. All intercompany
balances and transactions are eliminated in consolidation. As
discussed in Note 3 we accounted for our investment in the
H3C joint venture by the equity method until fiscal 2006, during
which we exercised an option to acquire a further 2% interest in
the joint venture and obtained control of H3C. We were granted
regulatory approval by the Chinese government and subsequently
completed this control transaction on January 27, 2006
(date of acquisition). Since that time, we have owned a majority
interest in the joint venture and have determined that the
criteria of Emerging Issues Task Force
No. 96-16,
Investors Accounting for an Investee When the
Investor Has a Majority of the Voting Interest but the Minority
Shareholder or Shareholders Have Certain Approval or Veto
Rights have been met. Accordingly, we consolidate
H3Cs financial statements beginning February 1, 2006,
a date used under the principle of convenience close. We
acquired the remaining 49 percent minority interest of H3C
on March 29, 2007. H3C follows a calendar year basis of
reporting and therefore, H3C is consolidated on a two-month lag.
Prior to acquiring majority ownership on January 27, 2006,
we accounted for our investment by the equity method. Under this
method, we recorded our proportionate share of H3Cs net
income or loss based on the most recently available quarterly
financial statements.
Segment
reporting
In the prior fiscal year we reported H3C, Data and Voice
Business Unit (DVBU), TippingPoint Security business
(TippingPoint) and Corporate as segments. In the
first quarter of fiscal 2009, we realigned the manner in which
we manage our business and internal reporting, and based on the
information provided to our chief operating decision-maker
(CODM) for purposes of making decisions about allocating
resources and assessing performance, we have two primary
businesses, our Networking Business and TippingPoint Security
Business. Accordingly, our previously reported segment
information has been restated to reflect our new
62
operating and reporting structure. Our Networking Business
consists of the following sales regions as operating segments:
China-based, Asia Pacific Region excluding China-based sales
region (Japan and Hong Kong SAR) (APR), Europe Middle East and
Africa (EMEA), Latin America (LAT), and North America (NA)
regions. The APR, EMEA, LAT and NA operating segments have been
aggregated given their similar economic characteristics,
products, customers and processes, and have been consolidated as
one reportable segment, Rest of World. The
China-based sales region does not meet the aggregation criteria
at this time.
The China-based and Rest of World reporting segments benefit
from shared support services on a world-wide basis. The costs
associated with providing these shared central functions are not
allocated to the China-based and Rest of World reporting
segments and instead are reported and disclosed under the
caption Central Functions. Central Functions consist
of indirect cost of sales, such as supply chain operations
expenses, and centralized operating expenses, such as research
and development, indirect sales and marketing, and general and
administrative support.
Management evaluates the China-based sales region and the Rest
of World sales region performance based on segment contribution
profit. Segment contribution profit for these regions is defined
as gross profit less segment direct sales and
marketing expenses. Gross profit for these regions
is defined as sales less standard cost of sales (which
excludes certain indirect cost of goods sold, such as supply
chain operations which are included in central functions).
Our TippingPoint Security business segment is measured on
segment profit (loss). Gross profit for the TippingPoint segment
is defined as sales less cost of sales. This measure includes
all operating costs except those items included in
Eliminations and Other. Eliminations and other
include intercompany sales eliminations, stock-based
compensation expense, amortization of intangible assets,
restructuring in all periods as well as purchase accounting
inventory related adjustments, net patent sale and Realtek
patent dispute resolution where applicable.
Cash
equivalents
Cash equivalents consist of highly liquid investments with
maturities of three months or less when purchased.
Short-term
investments
Short-term investments are invested in Chinese government bonds
and central bank bills, with maturity periods from three months
to one year. These investments were classified as
held-to-maturity. As of March 31, 2009, held-to-maturity
securities have amortized costs of $98.4 million which
approximates fair value according to prevailing market prices.
Notes
receivable
Notes receivable represent bills receivable from eleven Chinese
banks to our H3C subsidiary that have maturities of less than
six months. These notes originate from customers who settle
their commitments to H3C by providing us these bills issued by
the Chinese banks. The Chinese banks are responsible to pay our
H3C subsidiary. The notes are also commonly referred to as
bankers acceptances. The notes are carried on
our balance sheet at amortized cost which approximates fair
value.
Allowance
for doubtful accounts
We monitor payments from our customers on an on-going basis and
maintain allowances for doubtful accounts for estimated losses
resulting from the inability of our customers 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
political risk. If the financial condition of our customers were
to deteriorate, resulting in an impairment of their ability to
make payments, additional allowances might be required.
63
Equity
securities and other investments
We account for non-marketable equity securities and other
investments at historical cost or, if we have the ability to
exert significant influence over the investee, by the equity
method. At May 31, 2009 and 2008 we no longer held any
equity securities. During the years ended May 31, 2009,
2008 and 2007, investment gains (losses) were
$(0.2) million, 0.5 million and $1.4 million,
respectively and have been recorded in other income, net.
Fair
Value of Financial Instruments
The Companys financial instruments consist primarily of
cash and cash equivalents, short-term investments, accounts
receivable, notes receivable, accounts payable, and long-term
debt. The carrying value of cash, short-term investments,
accounts receivable, notes receivable and accounts payable
approximates their fair market values due to their short-term
nature. The Company believes that the carrying value of its
outstanding debt approximates fair value.
Concentration
of credit risk
Financial instruments that potentially subject us to
concentrations of credit risk consist principally of cash and
equivalents, short-term investments, notes receivable and
accounts receivable. More than 90% our cash and equivalents and
short term investment were invested in A- or above and the
average credit rating was A for the period ended May 31,
2009. See Note 18 for sales and accounts receivable
concentration disclosures.
Inventories
Inventories are stated at the lower of standard cost or market,
which approximates actual cost. Cost is determined using the
first-in,
first-out method.
Property
and equipment
Property and equipment is stated at cost, net of accumulated
depreciation and amortization. Equipment under capital leases is
stated at the lower of fair market value or the present value of
the minimum lease payments at the inception of the lease. We
capitalize eligible costs related to the application development
phase of software developed internally or obtained for internal
use. Capitalized costs related to internal-use software are
amortized using the straight-line method over the estimated
useful lives of the assets, which range from two to five years;
the amounts charged to amortization expense were zero in fiscal
2009, $0.3 million in fiscal 2008, and $0.4 million in
fiscal 2007.
Long-lived
assets
Long-lived assets and certain identifiable intangible assets to
be held and used are subject to periodic amortization and are
reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of such assets
may not be recoverable. Determination of recoverability of
long-lived assets is based on an estimate of undiscounted future
cash flows resulting from the use of the asset and its eventual
disposition. Measurement of an impairment loss for long-lived
assets and certain identifiable intangible assets that
management expects to hold and use is based on the fair value of
the asset. Long-lived assets and certain identifiable intangible
assets to be disposed of are reported at the lower of carrying
amount or fair value less costs to sell.
Depreciation
and amortization
Depreciation and amortization are computed using the
straight-line method over the estimated useful lives of the
assets. Estimated useful lives of property and equipment are
generally 2-15 years, except for buildings for which the
useful lives are
25-40 years.
As of the date of the balance sheets presented we did not own
any buildings with a remaining net book value. Depreciation and
amortization of leasehold improvements are computed using the
shorter of the remaining lease terms or estimated useful life.
64
Goodwill
and intangible assets
Statement of Financial Accounting Standards (SFAS) No. 142,
Goodwill and Other Intangible Assets, requires
goodwill and other indefinite lived intangibles to be tested for
impairment on an annual basis and between annual tests when
events or circumstances indicate a potential impairment. We test
our goodwill and other indefinite lived intangibles for
impairment annually during our third fiscal quarter. In the
fourth quarter of fiscal 2008 we conducted an additional
impairment test due to the decline in our stock price as
discussed more fully in Note 9. As a result of this
testing, we recorded a $158 million goodwill impairment in
fiscal year 2008. There was no impairment of goodwill in fiscal
years 2009 or 2007. Furthermore, SFAS No. 142 requires
intangible assets other than goodwill to be amortized over their
useful lives unless these lives are determined to be indefinite.
Intangible assets are carried at cost less accumulated
amortization. Amortization is computed over the estimated useful
lives of the respective assets, generally 2-7 years.
Revenue
recognition
We recognize a sale when the product has been delivered and risk
of loss has passed to the customer, collection of the resulting
receivable is reasonably assured, persuasive evidence of an
arrangement exists, and the fee is fixed or determinable. The
assessment of whether the fee is fixed or determinable considers
whether a significant portion of the fee is due after our normal
payment terms. If we determine that the fee is not fixed or
determinable, we recognize revenue at the time the fee becomes
fixed and determinable, provided that all other revenue
recognition criteria have been met. Also, sales arrangements may
contain customer-specific acceptance requirements for both
products and services. In such cases, revenue is deferred at the
time of delivery of the product or service and is recognized
upon receipt of customer acceptance.
For arrangements that are not considered software arrangements
and which involve multiple elements, such as sales of products
that include maintenance or installation services, revenue is
allocated to each respective element. We use the residual method
to recognize revenue when an arrangement includes one or more
elements to be delivered at a future date and objective evidence
of the fair value of all the undelivered elements exists. Under
the residual method, the revenue related to the undelivered
element is deferred at its fair value and the remaining portion
of the arrangement fee is recognized as revenue. If evidence of
fair value of one or more undelivered elements does not exist,
revenue is deferred and recognized when delivery of those
elements occurs or when fair value can be established.
We assess collectability based on a number of factors, including
general economic and market conditions, past transaction history
with the customer, and the creditworthiness of the customer. If
we determine that collection of the fee is not reasonably
assured, then we defer the fee and recognize revenue upon
receipt of payment. We do not typically request collateral from
our customers. In the H3C segment, certain customers pay
accounts receivable with notes receivable from Chinese banks
with maturities less than six months. These are also referred to
as bankers acceptances.
A significant portion of our sales is made to distributors and
value added resellers (VARs). Revenue is generally recognized
when title and risk of loss pass to the customer, assuming all
other revenue recognition criteria have been met. Sales to these
customers are recorded net of appropriate allowances, including
estimates for product returns, price protection, and excess
channel inventory levels. We maintain reserves for potential
allowances and adjustments; if the actual level of returns and
adjustments differ from the assumptions we use to develop those
reserves, additional allowances and charges might be required.
For sales of products that contain software that is marketed
separately, we apply the provisions of AICPA Statement of
Position
97-2,
Software Revenue Recognition, as amended.
Accordingly, we applied
SOP 97-2
for the majority of sales from our TippingPoint segment, our
Voice sales from our Networking Business and other insignificant
specific product sales within our Networking Business. We
generally sell our software products with maintenance services,
which includes the rights to unspecified updates and product
support, and, in some cases, also with consulting services. For
these undelivered elements, we determine vendor-specific
objective evidence (VSOE) of fair value to be the price charged
when the undelivered element is sold separately. We determine
VSOE for maintenance sold in connection with product based on
the amount that
65
will be separately charged for the maintenance renewal period.
We determine VSOE for consulting services by reference to the
amount charged for similar engagements when a software license
sale is not involved.
We recognize revenue from software licenses sold together with
maintenance
and/or
consulting services upon shipment using the residual method,
provided that the above criteria have been met. Under the
residual method, revenue associated with undelivered elements is
deferred at the greater of either the contractually defined
amount or the established VSOE of fair value, and any remaining
amounts are considered related to the delivered elements and
recognized providing all other revenue recognition criteria are
met. If VSOE of fair value for the undelivered elements cannot
be established, we defer all revenue from the arrangement until
the earlier of the point at which such sufficient VSOE does
exist or all elements of the arrangement have been delivered.
We recognize maintenance revenue ratably over the term of the
applicable agreement. Sales of services, including professional
services, system integration, project management, and training,
are recognized upon the completion of performance.
Product
warranty
We provide limited warranty on most of our products for periods
ranging from 90 days to the lifetime of the product,
depending upon the product. The warranty generally includes
parts, labor and service center support. We estimate the costs
that may be incurred under our warranty obligations and record a
liability in the amount of such costs at the time sales are
recognized. Factors that affect our warranty liability include
the number of installed units, historical and anticipated rates
of warranty claims, and cost per claim. We periodically assess
the adequacy of our recorded warranty liabilities and adjust the
amounts as necessary.
Advertising
All other advertising costs are expensed as incurred in sales
and marketing and were $26.2 million, $28.3 million,
and $34.0 million for the years ended May 31, 2009,
2008 and 2007, respectively.
Restructuring
charges
In recent fiscal years, we have undertaken several initiatives
involving significant changes in our business strategy and cost
structure. In connection with these initiatives, we have
recorded significant restructuring charges, as more fully
described in Note 6. Generally, costs associated with an
exit or disposal activity are recognized when the liability is
incurred. Costs related to employee separation arrangements
requiring future service beyond a specified minimum retention
period are generally recognized over the service period.
Foreign
currency remeasurement and translation
Our foreign operations are subject to exchange rate fluctuations
and foreign currency transaction costs. Substantially all of our
Rest of World sales region and TippingPoint security segment
sales transactions are denominated in U.S. dollars.
Substantially all of our China-based sales region sales are
denominated in Renminbi. For foreign operations with the local
currency as the functional currency, local currency denominated
assets and liabilities are translated at the year-end exchange
rates, and sales, costs and expenses are translated at the
average exchange rates during the year. Gains or losses
resulting from foreign currency translation are included as a
component of accumulated other comprehensive income in the
consolidated balance sheets. For foreign operations with the
U.S. dollar as the functional currency, foreign currency
denominated assets and liabilities are remeasured at the
year-end exchange rates except for property and equipment which
are remeasured at historical exchange rates. Foreign currency
denominated sales, costs and expenses are recorded at the
average exchange rates during the year. Gains or losses
resulting from foreign currency remeasurement are included in
other income, net, in the consolidated statements of operations.
Our risk management strategy uses forward contracts to settle
certain forecasted foreign currency cash flows outside of China.
Due to the limitations on converting Renminbi, we do not engage
in currency hedging activities in China at this time. The
Company has not designated these contracts for hedge accounting
and
66
gains and losses on these contracts are recorded in earnings and
have not been significant during the years ended May 31,
2009, 2008 and 2007.
We had no outstanding foreign exchange forward contracts as of
May 31, 2009. We had forward contracts with aggregate
notional amounts of $43.6 million outstanding as of
May 31, 2008. The fair value of foreign exchange forward
contracts is based on prevailing financial market information.
The carrying amounts, which were also the estimated fair values,
of foreign exchange forward contracts were not significant as of
May 31, 2008.
Other income, net included net foreign currency gains of
$2.9 million in fiscal year 2009 and net foreign currency
losses of $4.2 million in fiscal year 2008 and
$1.2 million in fiscal year 2007.
Income
taxes
We are subject to income tax in a number of jurisdictions. A
certain degree of estimation is required in recording the assets
and liabilities related to income taxes, and it is reasonably
possible such assets may not be recovered and that such
liabilities may not be paid or that payments in excess of
amounts initially estimated and accrued may be required. We
assess the likelihood that our 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 valuation
allowance. We consider historical taxable income, estimates of
future taxable income, and ongoing prudent and feasible tax
planning strategies in assessing the amount of the valuation
allowance. We have not provided valuation allowances against our
deferred tax assets in China. Based on various factors,
including our recent losses, retained deficit, operating
performance in fiscal 2009, and estimates of future
profitability, we have concluded that future taxable income
will, more likely than not, be insufficient to recover most of
net deferred tax assets as of May 31, 2009. Accordingly, we
have established an appropriate valuation allowance to offset
such deferred tax assets.
In June 2006, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes an
interpretation of FASB Statement No. 109
(FIN 48), that clarifies the accounting and
recognition for income tax positions taken or expected to be
taken in our tax returns. FIN 48 provides guidance on
derecognition of tax benefits, classification on the balance
sheet, interest and penalties, accounting in interim periods,
disclosure, and transition. We adopted FIN 48 on
June 2, 2007, which resulted in no adjustment to the
opening balance of retained earnings. As of May 31, 2009
the Company had unrecognized tax benefits of $21.9 million
including interest, all of which, if recognized, would affect
our effective tax rate.
We recognize tax liabilities for uncertain items in accordance
with FIN 48 and we adjust these liabilities when our
judgment changes as a result of the evaluation of new
information not previously available. Due to the complexity of
some of these uncertainties, the ultimate resolution may result
in a payment that is materially different from our current
estimate of the tax liabilities.
We recognize interest and penalties relating to unrecognized tax
benefits within the income tax expense line in the accompanying
consolidated statement of operations. As of May 31, 2009,
the amount of interest included in unrecognized tax benefits was
$2.4 million, representing a decrease of $0.1 million
during fiscal 2009. There were no penalties accrued in all
periods presented.
Comprehensive
income (loss)
Comprehensive income (loss) consists of our net income (loss),
the impact of foreign currency translation and unrealized gains
(losses) on available-for-sale securities.
67
An analysis of accumulated other comprehensive income (loss)
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
Other
|
|
|
|
|
|
|
Unrealized
|
|
|
Translation
|
|
|
Comprehensive
|
|
|
|
|
|
|
Gain (Loss)
|
|
|
Adjustments
|
|
|
Income (Loss)
|
|
|
|
|
|
Balance as of May 31, 2006
|
|
$
|
(2,101
|
)
|
|
$
|
(856
|
)
|
|
$
|
(2,957
|
)
|
|
|
|
|
Change in period
|
|
|
2,310
|
|
|
|
4,996
|
|
|
|
7,306
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2007
|
|
|
209
|
|
|
|
4,140
|
|
|
|
4,349
|
|
|
|
|
|
Change in period
|
|
|
(209
|
)
|
|
|
42,721
|
|
|
|
42,512
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2008
|
|
|
|
|
|
|
46,861
|
|
|
|
46,861
|
|
|
|
|
|
Change in period
|
|
|
|
|
|
|
18,875
|
|
|
|
18,875
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2009
|
|
$
|
|
|
|
$
|
65,736
|
|
|
$
|
65,736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock-based
Compensation
As described in Note 14, effective June 3, 2006, we
adopted the fair value method of accounting for stock-based
compensation under SFAS 123(R) Share-Based
Payment. Under the fair value method, compensation cost
associated with a stock award is measured based on the estimated
fair value of the award itself, determined using established
valuation models and principles, and is generally measured as of
the date of grant. The fair value of the award is generally
recognized as expense over the requisite service period, which
is typically the vesting period.
Estimates of the fair value of equity awards in future periods
will be affected by the market price of our common stock, as
well as the actual results of certain assumptions used to value
the equity awards. These assumptions include, but are not
limited to, the expected volatility of the common stock, the
expected term of options granted, the risk free interest rate
and dividend yield.
The fair value of stock options and employee stock purchase plan
shares is determined by using the Black-Scholes option pricing
model and applying the single-option approach to the stock
option valuation. The options generally vest on an annual basis
over four years. We estimate the expected option term by
analyzing the historical term period from grant to exercise and
also consider the expected term for those options that are
outstanding. The expected term of employee stock purchase plan
shares is the purchase periods under each offering period. The
expected volatility of the common stock is estimated using
historical volatility.
The risk-free interest rate used in the Black-Scholes option
pricing model is determined by looking at historical
U.S. Treasury zero-coupon bond issues with terms
corresponding to the expected terms of the equity awards. In
addition, an expected dividend yield of zero is used in the
option valuation model, because we do not expect to pay any cash
dividends in the foreseeable future.
In order to determine the fair value of restricted stock awards
and restricted stock units we utilize the closing market price
of 3Coms common stock on the date of grant.
We estimate forfeitures at the time of grant and revise those
estimates in subsequent periods if actual forfeitures differ
from those estimates. In order to determine an estimated
pre-vesting option forfeiture rate, we analyzed historical
forfeiture data, which yielded a forfeiture rate of
23 percent as of the end of the current fiscal year. We
believe this historical forfeiture rate to be reflective of our
anticipated rate on a go-forward basis. An estimated forfeiture
rate has been applied to all unvested options and restricted
stock awards and restricted stock units outstanding as of
June 1, 2006 and to all options and restricted stock awards
and restricted stock units granted since June 1, 2006.
Therefore, stock-based compensation expense is recorded only for
those options and restricted stock awards and restricted stock
units that are expected to vest.
We recognize stock-based compensation expense on a straight-line
basis over the requisite service period of time-based vesting
awards for stock options, restricted stock awards, restricted
stock units, and the employee stock purchase plan. We recognize
compensation expense for performance based restricted stock in
the fiscal quarter when it becomes is probable that the
performance metric will be achieved. For unvested
68
stock options outstanding as of May 31, 2006, we continue
to recognize stock-based compensation expense using the
accelerated amortization method prescribed in FASB
Interpretation No. 28, Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award
Plans.
Net
income (loss) per share
Basic earnings per share is computed using the weighted-average
number of common shares outstanding. Diluted earnings per share
is computed using the weighted-average number of common shares
and potentially dilutive common shares outstanding during the
period. Potentially dilutive common shares consist of employee
stock options, restricted stock awards and restricted stock
units, and are excluded from the diluted earnings per share
computation in periods where net losses were incurred.
Recently
issued accounting pronouncements
In December 2007, the FASB issued SFAS No. 141R,
Business Combinations (SFAS 141R)
to improve reporting and to create greater consistency in the
accounting and financial reporting of business combinations. The
standard requires the acquiring entity in a business combination
to recognize all (and only) the assets acquired and liabilities
assumed in the transaction; establishes the acquisition-date
fair value as the measurement objective for all assets acquired
and liabilities assumed; and requires the acquirer to disclose
to investors and other users all of the information they need to
evaluate and understand the nature and financial effect of the
business combination. SFAS No. 141R applies
prospectively to business combinations for which the acquisition
date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008, with the
exception of the accounting for valuation allowances on deferred
taxes and acquired tax contingencies. SFAS No. 141R
amends SFAS 109, Accounting for Income Taxes,
such that adjustments made to valuation allowances on deferred
income taxes and acquired income tax contingencies associated
with acquisitions that closed prior to the effective date of
SFAS No. 141R would apply the provisions of
SFAS No. 141R. Given that SFAS No. 141R
relates to prospective and not historical business combinations,
the potential effects of adoption of SFAS No. 141R on
the Companys consolidated financial statements is
dependent on future acquisition activity.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements to improve the relevance, comparability, and
transparency of financial information provided to investors by
requiring all entities to report noncontrolling (minority)
interests in subsidiaries in the same way as required in the
consolidated financial statements. Moreover,
SFAS No. 160 eliminates the diversity that currently
exists in accounting for transactions between an entity and
non-controlling interests by requiring that they be treated as
equity transactions. SFAS No. 160 is effective for
fiscal years, and interim periods within those fiscal years,
beginning on or after December 15, 2008. Earlier adoption
is prohibited. The Company is currently evaluating whether the
adoption of SFAS No. 160 will have an effect on its
consolidated financial position, results of operations or cash
flows.
In February 2008, the FASB issued FASB Staff Position
No. SFAS 157-2,
Effective Date of FASB Statement No. 157, which
provides a one-year deferral of the effective date of
FAS No. 157 for non-financial assets and non-financial
liabilities, except those that are recognized or disclosed in
the financial statements at fair value at least annually.
Effective June 1, 2008, we adopted the provisions of
SFAS No. 157 with respect to our financial assets and
liabilities recorded at fair value, which had no material impact
on our consolidated financial position, results of operations or
cash flow. We have not yet determined the impact, if any, of the
portion of SFAS No. 157, for which the implementation
has been deferred, will have on our consolidated financial
position, results of operations or cash flow. Under
SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities Including
an amendment of FASB Statement No. 115
(SFAS No. 159), entities are permitted to
choose to measure many financial instruments and certain other
items at fair value that previously were not required to be
measured at fair value. We did not elect the fair value
measurement option under SFAS No. 159 for any of these
financial assets or liabilities.
In April 2008, the FASB issued FASB Staff Position
(FSP)
FAS No. 142-3,
Determination of the Useful Life of Intangible
Assets (FSP
FAS No. 142-3).
FSP
FAS No. 142-3
amends the factors that should
69
be considered in developing renewal or extension assumptions
used to determine the useful life of a recognized intangible
asset under FAS No. 142, Goodwill and Other
Intangible Assets (FAS No. 142). The
intent of FSP
FAS No. 142-3
is to improve the consistency between the useful life of a
recognized intangible asset under FAS No. 142 and the
period of expected cash flows used to measure the fair value of
the asset under FAS No. 141R Business
Combinations, and other accepted accounting principles
generally accepted in the United States of America. FSP
FAS No. 142-3
is effective for financial statements issued for fiscal years
beginning after December 15, 2008. We are currently
evaluating the potential impact of FSP
FAS No. 142-3
on our consolidated results of operations and financial position.
In June 2008, the FASB issued FASB Staff Position
(FSP)
EITF 03-6-1,
Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities
(FSP
EITF 03-6-1).
FSP
EITF 03-6-1
addresses whether instruments granted in share-based payment
transactions are participating securities prior to vesting and,
therefore, need to be included in the earnings allocation in
computing earnings per share (EPS) under the two-class method
described in FASB Statement No. 128, Earnings per
Share. FSP
EITF 03-6-1
is effective for financial statements issued for fiscal years
beginning after December 15, 2008. We are currently
evaluating the potential impact of FSP
EITF 03-6-1
on our consolidated results of operations and financial position.
In May 2009, the FASB issued FASB Statement No. 165,
Subsequent Events (SFAS 165). SFAS 165
intends to establish general standards of accounting for and
disclosures of subsequent events that occurred after the balance
sheet date but prior to the issuance of financial statements.
SFAS 165 is effective for financial statements issued for
interim or fiscal years ending after June 15, 2009. The
adoption of SFAS 165 will not have significant impacts on
its financial position, results of operations or cash flows.
H3C
On November 17, 2003, we formed H3C, formerly known as the
Huawei-3Com joint venture, with a subsidiary of Huawei
Technologies, Ltd. (Huawei). H3C is domiciled in Hong Kong, and
has its principal operating center in Hangzhou, China.
At the time of formation, we contributed cash of
$160.0 million, assets related to our operations in China
and Japan, and licenses related to certain intellectual property
in exchange for a 49 percent ownership interest. We
recorded our initial investment in H3C at $160.1 million,
reflecting our carrying value for the cash and assets
contributed. Huawei contributed its enterprise networking
business assets including Local Area Network (LAN)
switches and routers; engineering, sales and marketing resources
and personnel; and licenses to its related intellectual
property in exchange for a 51 percent ownership
interest. Huaweis contributed assets were valued at
$178.2 million at the time of formation.
Two years after formation of H3C, we had the one-time option to
purchase an additional two percent ownership interest from
Huawei. On October 28, 2005, we exercised this right and
entered into an agreement to purchase an additional
2 percent ownership interest in H3C from Huawei for an
aggregate purchase price of $28.0 million. We were granted
regulatory approval by the Chinese government and subsequently
completed this transaction on January 27, 2006 (date of
acquisition). Since then, we have owned a majority interest in
the joint venture and determined that the criteria of Emerging
Issues Task Force
No. 96-16,
Investors Accounting for an Investee When the
Investor Has a Majority of the Voting Interest but the Minority
Shareholder or Shareholders Have Certain Approval or Veto
Rights were met and, therefore, consolidated H3Cs
financial statements beginning February 1, 2006, a date
used under the principle of convenience close. As H3C reports on
a calendar year basis, we consolidate H3C based on H3Cs
most recent financial statements, two months in arrears.
Three years after formation of H3C, we and Huawei each had the
right to initiate a bid process to purchase the equity interest
in H3C held by the other. 3Com initiated the bidding process on
November 15, 2006 to buy Huaweis 49 percent
stake in H3C and our bid of $882 million was accepted by
Huawei on
70
November 27, 2006. The transaction closed on March 29,
2007, at which time the purchase price was paid in full.
The acquisition transactions were all accounted for as
purchases, and accordingly, the purchase price was allocated to
the assets purchased and liabilities assumed based on their
estimated fair values. Due to our consolidation determination,
the operating results of H3C for the period February 1,
2006 to March 31, 2006 are included in the consolidated
financial statements, resulting in the latter two months of
H3Cs three months ended March 31, 2006 being included
in our year ended May 31, 2006 statement of operations.
The purchase prices for our various transactions are shown below
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
2006
|
|
|
2007
|
|
|
|
Investment
|
|
|
Purchase
|
|
|
Purchase
|
|
|
Cash paid for common stock
|
|
$
|
160.0
|
|
|
$
|
28.0
|
|
|
$
|
882.0
|
|
Assets contributed
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
Acquisition direct costs
|
|
|
0.0
|
|
|
|
0.2
|
|
|
|
8.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total purchase price
|
|
$
|
160.1
|
|
|
$
|
28.2
|
|
|
$
|
890.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In accordance with SFAS No. 141, Business
Combinations, the purchase price was allocated to the
tangible and intangible assets acquired and liabilities assumed,
including in-process research and development, based on their
estimated fair values. The excess purchase price over those
values is recorded as goodwill. The fair values assigned to
tangible and intangible assets acquired and liabilities assumed
are based on managements estimates and assumptions, and
other information compiled by management. Goodwill recorded as a
result of these acquisitions is not deductible for tax purposes.
In accordance with SFAS No. 142, goodwill is not
amortized but will be reviewed at least annually for impairment.
Purchased intangibles with finite lives will be amortized on a
straight-line basis over their respective estimated useful
lives. The total purchase price has been allocated as follows
(in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2003
|
|
|
2006
|
|
|
2007
|
|
|
|
Investment
|
|
|
Purchase
|
|
|
Purchase
|
|
|
Net tangible assets assumed
|
|
|
|
|
|
$
|
7.4
|
|
|
$
|
148.6
|
|
Amortizable intangible assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
Existing technology
|
|
$
|
111.7
|
|
|
|
17.8
|
|
|
|
180.6
|
|
Non-compete agreement with Huawei
|
|
|
|
|
|
|
|
|
|
|
33.0
|
|
Distributor agreements
|
|
|
2.7
|
|
|
|
0.4
|
|
|
|
29.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amortizable intangible assets
|
|
|
114.4
|
|
|
|
18.2
|
|
|
|
242.7
|
|
Amortization prior to the 2006 acquisition
|
|
|
(65.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net amortizable intangible assets
|
|
|
48.7
|
|
|
|
18.2
|
|
|
|
242.7
|
|
In-process research and development
|
|
|
24.7
|
|
|
|
0.7
|
|
|
|
34.0
|
|
Trade name and trademarks
|
|
|
|
|
|
|
|
|
|
|
55.5
|
|
Goodwill
|
|
|
43.2
|
|
|
|
1.9
|
|
|
|
409.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total purchase price allocation
|
|
|
|
|
|
$
|
28.2
|
|
|
$
|
890.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets include amounts recognized for the fair value
of existing technology, maintenance agreements, trade name and
trademarks, distributor agreements and non-compete agreement.
These intangible assets have a weighted-average useful life of
approximately five years.
In-process research and development (IPR&D) represents
incomplete H3C research and development projects that had not
reached technological feasibility and had no alternative future
use as of the acquisition dates. Technological feasibility is
established when an enterprise has completed all planning,
designing, coding, and testing activities that are necessary to
establish that a product can be produced to meet its design
specifications including functions, features, and technical
performance requirements. At the dates of acquisition, H3C had
multiple IPR&D efforts under way for certain current and
future product lines. Purchased
71
IPR&D relates primarily to projects associated with the H3C
routers and switch products, which had not yet reached
technological feasibility as of the acquisition date and had no
alternative future use.
Of the total purchase price paid in 2007, approximately
$148.6 million was allocated to net assets acquired. Net
assets were valued at their respective carrying amounts, which
management believes approximate fair value, except for
adjustments to inventory and deferred revenue. Inventory was
adjusted by an increase of $11.1 million in the
consolidated balance sheet as of June 2, 2007, to adjust
inventory to the actual fair value less direct selling expense.
Deferred revenues were reduced by $0.5 million in the
consolidated balance sheet as of June 2, 2007, to adjust
deferred revenue to the estimated cost plus an appropriate
profit margin to perform the support and maintenance services.
Approximately $298.2 million of the 2007 purchase price was
allocated to acquired identifiable intangible assets. Existing
core technology is comprised of products that have reached
technological feasibility, which includes most of H3Cs
technology. The remainder of intangible assets is associated
with maintenance agreements, trademarks, and non-compete
agreements. One day worth of the amortization expense related to
the amortizable intangible assets was reflected in the
consolidated statements of operations for the year ended
June 2, 2007.
Of the total 2007 purchase price, approximately
$409.9 million was allocated to goodwill. Goodwill
represents the excess of the purchase price over the fair value
of the net assets acquired. Goodwill amounts are not amortized,
but rather are tested for impairment at least annually. In the
event that we determine that the value of the goodwill has
become impaired, an accounting charge for the amount of the
impairment will be incurred in the quarter in which such
determination is made.
Pro forma
Results of Operations
The following unaudited pro forma financial information presents
the consolidated results of operations of 3Com and H3C as if the
acquisition of 100 percent of H3C had occurred as of the
beginning of the periods presented below. Adjustments, which
reflect the amortization of purchased intangible assets,
in-process research and development and charges to cost of sales
for inventory
write-ups,
have been made to the consolidated results of operations. We
also eliminate the inter-company activity between the parties in
the consolidated results. The unaudited proforma financial
information is not intended, and should not be taken as
representative of our future consolidated results of operations
or financial condition or the results that would have occurred
had the acquisition occurred as of the beginning of the earliest
period.
|
|
|
|
|
|
|
Fiscal Year
|
|
|
2007
|
|
|
(In millions,
|
|
|
except per share amounts)
|
|
Net sales
|
|
$
|
1,267.5
|
|
Net loss
|
|
|
(201.3
|
)
|
Basic and diluted net loss per share
|
|
$
|
(0.51
|
)
|
Roving
Planet Acquisition
On December 5, 2006, we acquired certain assets and
liabilities of Roving Planet, Inc. (Roving Planet)
to support our strategy of extending our appliance-based
intrusion prevention system (IPS) business to
include network access control (NAC) features. Under
the terms of the definitive agreement we acquired the Roving
Planet assets for $8.0 million in cash, plus assumption of
liabilities of approximately $0.2 million.
72
Based upon the use of established valuation techniques we
assigned the purchase price for the acquisition in the following
manner (in millions):
|
|
|
|
|
|
|
|
|
|
|
2007 Purchase Price
|
|
|
Useful Life for Purchased
|
|
|
|
Allocation
|
|
|
Intangible Assets
|
|
|
In-process research and development
|
|
$
|
1.7
|
|
|
|
|
|
Purchased core technology
|
|
|
3.1
|
|
|
|
3years
|
|
Goodwill
|
|
|
3.2
|
|
|
|
|
|
Other
|
|
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total acquisition value
|
|
$
|
8.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
Value Hierarchy
SFAS No. 157 establishes a fair value hierarchy that
requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair
value. Observable inputs are obtained from independent sources
and can be validated by a third party, whereas unobservable
inputs reflect assumptions regarding what a third party would
use in pricing an asset or liability. A financial
instruments categorization within the fair value hierarchy
is based upon the lowest level of input that is significant to
the fair value measurement. SFAS No. 157 establishes
three levels of inputs that may be used to measure fair value:
Level 1 Observable inputs that reflect
quoted prices (unadjusted) for identical assets or liabilities
in active markets.
Level 2 Include other inputs that are
directly or indirectly observable in the marketplace.
Level 3 Unobservable inputs which are
supported by little or no market activity.
The fair value hierarchy also requires an entity to maximize the
use of observable inputs and minimize the use of unobservable
inputs when measuring fair value.
In accordance with SFAS 157, we measure our cash
equivalents at fair value and classify them within Level 1
or Level 2 of the fair value hierarchy. The classification
has been determined based on the manner in which we value our
cash equivalents, primarily using quoted market prices or
alternative pricing sources and models utilizing market
observable inputs.
73
Assets
Measured at Fair Value on a Recurring Basis
Assets measured at fair value on a recurring basis consisted of
the following types of instruments and were reported as cash
equivalents as of May 31, 2009:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements at Reporting Date Using
|
|
|
|
Quoted Prices
|
|
|
|
|
|
|
|
|
|
|
|
|
in Active
|
|
|
Significant
|
|
|
|
|
|
|
|
|
|
Markets for
|
|
|
Other
|
|
|
Significant
|
|
|
|
|
|
|
Identical
|
|
|
Observable
|
|
|
Unobservable
|
|
|
|
|
|
|
Instruments
|
|
|
Inputs
|
|
|
Inputs
|
|
|
Total
|
|
|
|
(Level 1)
|
|
|
(Level 2)
|
|
|
(Level 3)
|
|
|
Balance
|
|
|
|
(In thousands)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash equivalents:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Time deposits and bank deposits with a maturity less than
3 months
|
|
$
|
|
|
|
$
|
313,315
|
|
|
$
|
|
|
|
$
|
313,315
|
|
Money market fund deposits
|
|
|
132,380
|
|
|
|
|
|
|
|
|
|
|
|
132,380
|
|
China government bonds and bank bills with a maturity of less
than 3 months
|
|
|
100,123
|
|
|
|
|
|
|
|
|
|
|
|
100,123
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets measured at fair value
|
|
$
|
232,503
|
|
|
$
|
313,315
|
|
|
$
|
|
|
|
$
|
545,818
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Money market funds, China government bonds and bank bills are
measured based on quoted market prices. Time deposits and bank
deposits are measured based on similar assets
and/or
subsequent transactions.
|
|
Note 5:
|
Realtek
Patent Dispute Resolution and Patent Sale
|
On July 11, 2008, 3Com Corporation and Realtek
Semiconductor Corp. (the Realtek Group) entered into
three agreements which document the resolution of a
several-year-long
patent litigation between the parties and provide for the
non-exclusive license by 3Com to the Realtek Group of certain
patents and related network interface technology for license
fees totaling $70.0 million, all of which was received in
the three months ended August 31, 2008.
The basic agreement between 3Com and the Realtek Group documents
the resolution of the litigation between the parties and
provides for the dismissal of the lawsuit and mutual releases
between the parties.
Under the terms of the agreements, the payments are
non-refundable and the Company has no future performance
obligations, apart from certain customary covenants not to sue
Realtek, its customers or its suppliers on the licensed
technology, and non-material notice and tax assistance
obligations. Accordingly, the $70.0 million was recognized
as income in the first quarter of fiscal 2009 in the operating
expense (income) section of the consolidated statements of
operations.
On May 29, 2009, 3Com Corporation sold 35 patents for
$17.0 million to Parallel Technology, LLC. The proceeds
were partially offset by a $1.8 million finders fee
associated with selling these patents. Accordingly, the net
$15.2 million was recognized as income in the fourth
quarter of fiscal 2009 in the operating expense (income) section
of the consolidated statements of operations. All cash was
received on May 29, 2009. As of May 29, 2009, the
Company had no significant unfulfilled performance obligations.
|
|
Note 6:
|
Restructuring
Charges
|
In recent fiscal years, we have undertaken several initiatives
involving significant changes in our business strategy and cost
structure.
74
We continued a broad restructuring of our business to enhance
the focus and cost effectiveness of our segments in serving
their respective markets. These restructuring efforts continued
through fiscal 2009. We took the following specific actions in
fiscal 2004 through 2009 (the Fiscal 2004 2009
Actions):
|
|
|
|
|
reduced our workforce; and
|
|
|
|
continued efforts to consolidate and dispose of excess facilities
|
Restructuring charges related to these various initiatives were
$8.7 million in fiscal 2009, $4.5 million in fiscal
2008, and $3.5 million in fiscal 2007. Such charges were
net of credits of $0.7 million in fiscal 2009,
$0.5 million in fiscal 2008, and $13.3 million in
fiscal 2007. The 2007 credits primarily related to an
$8.8 million gain on the sale of our former
Santa Clara, CA building, which had previously been
included in restructuring charges, and $4.2 million related
to employee separation expenses for which the right to continue
to receive payments was forfeited. The $8.7 million of net
expense in fiscal 2009 consists of severance and outplacement
costs of $7.3 million and $1.4 million of facilities
and other restructuring items. The severance and outplacement
costs primarily relate to a decrease in headcount of research
and development employees as the Company eliminated duplicate
testing activities as well as $2.0 million of severance
costs related to the integration of our TippingPoint segment.
The $1.4 million of facilities and other restructuring
expenses primarily relate to vacating part of our Marlborough,
MA facility for which we ceased use during the second quarter of
fiscal 2009.
Accrued liabilities associated with restructuring charges are
included in the caption Accrued liabilities and
other in the accompanying consolidated balance sheets.
These liabilities are classified as current because we expect to
satisfy such liabilities in cash within the next 12 months.
Fiscal
2009 Actions
Activity and liability balances related to the fiscal 2009
restructuring actions are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
Facilities-
|
|
|
Other
|
|
|
|
|
|
|
|
|
|
Separation
|
|
|
Related
|
|
|
Restructuring
|
|
|
|
|
|
|
|
|
|
Expense
|
|
|
Charges
|
|
|
Costs
|
|
|
Total
|
|
|
|
|
|
Balance as of May 31, 2008
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
Provisions
|
|
|
6,146
|
|
|
|
617
|
|
|
|
801
|
|
|
|
7,564
|
|
|
|
|
|
Payments and non-cash charges
|
|
|
(4,685
|
)
|
|
|
(617
|
)
|
|
|
(801
|
)
|
|
|
(6,103
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2009
|
|
$
|
1,461
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
1,461
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee separation expenses include severance pay, outplacement
services, medical and other related benefits. The reduction in
workforce affected employees involved in research and
development, sales and marketing, customer support, and general
and administrative functions. Through May 31, 2009, the
total reduction in workforce associated with actions initiated
during fiscal 2009 included approximately 110 employees who
had been separated or were currently in the separation process.
Facilities-related charges relate to vacating part of our
Marlborough, MA facility for which we ceased use during the
second quarter of fiscal 2009. Non-cash charges include
depreciation against restructured assets, and stock-based
compensation charges as applicable.
We believe that all remaining payments will be completed by the
end of fiscal 2010.
75
Fiscal
2008 Actions
Activity and liability balances related to the fiscal 2008
restructuring actions are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
|
|
|
|
Separation
|
|
|
|
|
|
|
Expense
|
|
|
Total
|
|
|
Balance as of May 31, 2007
|
|
$
|
|
|
|
$
|
|
|
Provisions
|
|
|
4,285
|
|
|
|
4,285
|
|
Payments
|
|
|
(3,598
|
)
|
|
|
(3,598
|
)
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2008
|
|
$
|
687
|
|
|
$
|
687
|
|
|
|
|
|
|
|
|
|
|
Provisions
|
|
|
1,288
|
|
|
|
1,288
|
|
Payments
|
|
|
(1,975
|
)
|
|
|
(1,975
|
)
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2009
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Employee separation expenses include severance pay, outplacement
services, medical and other related benefits. The reduction in
workforce affected employees primarily involved in research and
development. Through May 31, 2009, the total reduction in
workforce associated with actions initiated during fiscal 2008
included approximately 122 employees who had been separated
or were currently in the separation process.
Fiscal
2007 Actions
Activity and liability balances related to the fiscal 2007
restructuring actions are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
Facilities-
|
|
|
Other
|
|
|
|
|
|
|
Separation
|
|
|
Related
|
|
|
Restructuring
|
|
|
|
|
|
|
Expense
|
|
|
Charges
|
|
|
Costs
|
|
|
Total
|
|
|
Balance as of May 31, 2006
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
Provisions
|
|
|
12,134
|
|
|
|
(7,501
|
)
|
|
|
247
|
|
|
|
4,880
|
|
Payments and non-cash charges
|
|
|
(10,804
|
)
|
|
|
7,765
|
|
|
|
(247
|
)
|
|
|
(3,286
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2007
|
|
|
1,330
|
|
|
|
264
|
|
|
|
|
|
|
|
1,594
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provisions
|
|
|
(93
|
)
|
|
|
71
|
|
|
|
53
|
|
|
|
31
|
|
Payments
|
|
|
(1,237
|
)
|
|
|
(198
|
)
|
|
|
(53
|
)
|
|
|
(1,488
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2008
|
|
$
|
|
|
|
$
|
137
|
|
|
$
|
|
|
|
$
|
137
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provisions
|
|
|
|
|
|
|
(36
|
)
|
|
|
|
|
|
|
(36
|
)
|
Payments
|
|
|
|
|
|
|
(54
|
)
|
|
|
|
|
|
|
(54
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2009
|
|
$
|
|
|
|
$
|
47
|
|
|
$
|
|
|
|
$
|
47
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee separation expenses include severance pay, outplacement
services, medical and other related benefits. The reduction in
workforce affected employees involved in research and
development, sales and marketing, customer support, and general
and administrative functions. Through May 31, 2009, the
total reduction in workforce associated with actions initiated
during fiscal 2007 included 233 employees. In fiscal 2007
we received $16 million of proceeds from the sale of our
Santa Clara facility resulting in a $8.8 million gain.
Non-cash charges include depreciation against restructured
assets as applicable.
76
Fiscal
2004, 2005 and 2006 Actions
Activity and liability balances related to the fiscal 2004, 2005
and 2006 restructuring actions are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Employee
|
|
|
Long-term
|
|
|
Facilities-
|
|
|
Other
|
|
|
|
|
|
|
Separation
|
|
|
Asset
|
|
|
Related
|
|
|
Restructuring
|
|
|
|
|
|
|
Expense
|
|
|
Write-downs
|
|
|
Charges
|
|
|
Costs
|
|
|
Total
|
|
|
Balance as of May 31, 2006
|
|
$
|
6,720
|
|
|
$
|
255
|
|
|
$
|
6,532
|
|
|
$
|
18
|
|
|
$
|
13,525
|
|
Provisions
|
|
|
(2,083
|
)
|
|
|
(255
|
)
|
|
|
949
|
|
|
|
3
|
|
|
|
(1,386
|
)
|
Payments and non-cash charges
|
|
|
(4,334
|
)
|
|
|
|
|
|
|
(6,002
|
)
|
|
|
(21
|
)
|
|
|
(10,357
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2007
|
|
|
303
|
|
|
|
|
|
|
|
1,479
|
|
|
|
|
|
|
|
1,782
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provisions
|
|
|
133
|
|
|
|
|
|
|
|
49
|
|
|
|
3
|
|
|
|
185
|
|
Payments
|
|
|
(408
|
)
|
|
|
|
|
|
|
(980
|
)
|
|
|
(3
|
)
|
|
|
(1,391
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2008
|
|
$
|
28
|
|
|
$
|
|
|
|
$
|
548
|
|
|
$
|
|
|
|
$
|
576
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provisions
|
|
|
(6
|
)
|
|
|
|
|
|
|
(131
|
)
|
|
|
|
|
|
|
(137
|
)
|
Payments
|
|
|
(6
|
)
|
|
|
|
|
|
|
(417
|
)
|
|
|
|
|
|
|
(423
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance as of May 31, 2009
|
|
$
|
16
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The reductions in workforce affected employees involved in
sales, customer support, product development, and general and
administrative positions.
Facilities-related charges included accelerated depreciation of
buildings, write-downs of land and buildings held for sale,
losses on sales of facilities, and lease obligations.
Other restructuring costs included payments to suppliers and
contract termination fees.
Non-cash charges include depreciation against restructured
assets as applicable.
Inventories consist of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
Finished goods
|
|
$
|
69,860
|
|
|
$
|
62,055
|
|
Work-in-process
|
|
|
3,420
|
|
|
|
6,119
|
|
Raw materials
|
|
|
17,115
|
|
|
|
22,657
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
90,395
|
|
|
$
|
90,831
|
|
|
|
|
|
|
|
|
|
|
77
|
|
Note 8:
|
Property
and Equipment
|
Property and equipment, net, consists of (in thousands):
|
|
|
|
|
|
|
|
|
|
|
May 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
Land
|
|
$
|
574
|
|
|
$
|
1,724
|
|
Machinery and equipment
|
|
|
153,655
|
|
|
|
196,933
|
|
Software
|
|
|
27,994
|
|
|
|
25,988
|
|
Furniture and fixtures
|
|
|
5,324
|
|
|
|
6,668
|
|
Leasehold improvements
|
|
|
23,674
|
|
|
|
23,390
|
|
Construction in progress
|
|
|
1,508
|
|
|
|
5,446
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
212,729
|
|
|
|
260,149
|
|
Accumulated depreciation and amortization
|
|
|
(172,717
|
)
|
|
|
(205,835
|
)
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
$
|
40,012
|
|
|
$
|
54,314
|
|
|
|
|
|
|
|
|
|
|
Significant
property and equipment transactions
During fiscal 2009 depreciation expense was $25.6 million
compared to $34.4 million in fiscal 2008 and
$32.5 million in fiscal 2007.
We continue to carry the Hemel Hempstead, UK land, which was
damaged in December of 2005, as held for use on our
balance sheet. With no feasible business necessity to keep this
property, we are soliciting offers from prospective buyers to
acquire the building and land. We believe this process will take
more than one year and as a result we have kept the land
classified as held for use. During fiscal 2009 we conducted an
impairment analysis of the Hemel land due to the decline in
market values of real estate. We determined that the fair market
value of the land was $0.6 million and recorded a charge of
$1.2 million. During 2007 we received insurance proceeds of
approximately $28 million in connection with the damaged
property and recorded a gain of approximately $3 million.
During fiscal 2009 we removed from service fully depreciated
fixed assets of $45.5 million.
|
|
Note 9:
|
Goodwill
and Other Intangible Assets
|
We apply the provisions of SFAS No. 142 Goodwill
and Other Intangible Assets to goodwill and intangible
assets with indefinite lives which are not amortized but are
reviewed annually for impairment or more frequently if
impairment indicators arise. We performed our annual goodwill
impairment review as of February 27, 2009 for our
TippingPoint reporting unit and December 31, 2008 for our
China-based reporting unit (as our China-based region reports on
a two month lag), and noted no impairment of goodwill or
intangible assets with indefinite lives. There were no
triggering events in the fourth quarter of fiscal year 2009 that
required an additional impairment test. In making this
assessment, we rely on a number of factors including operating
results, business plans, economic projections, anticipated
future cash flows, and transactions and marketplace data. There
are inherent uncertainties related to these factors and our
judgment in applying them to the analysis of goodwill
impairment. Reporting unit valuations have been calculated using
a combination of an income approach based on the present value
of future cash flows of each reporting unit and a market
approach. The income approach incorporates many assumptions
including future growth rates, discount factors, expected
capital expenditures and income tax cash flows. Changes in
economic and operating conditions impacting these assumptions
could result in a goodwill impairment in future periods. In
conjunction with our annual goodwill impairment tests, we
reconcile the sum of the valuations of all of our reporting
units to our market capitalization as of such dates.
In the fourth quarter of fiscal 2008, subsequent to our annual
goodwill impairment review, a significant reduction in our
market value occurred. As a result, we concluded that we needed
to evaluate whether an impairment in the fair value of our
reporting units had occurred subsequent to our annual test.
78
As a result of these triggering events, we tested goodwill and
other indefinite-lived intangible assets related to our H3C and
TippingPoint reporting units for impairment as of April 25,
2008. The fair value of the reporting units was considered using
both an income approach and market approach. Based on the
results of our appraisal and valuation activities H3Cs
fair value was greater than its carrying value and no other
action was deemed necessary related to H3C. Based on the results
of our appraisal and valuation activities, the TippingPoint
reporting units fair value was determined to be below its
carrying value. We then determined the implied fair value of
goodwill by determining the fair value of all the assets and
liabilities of the TippingPoint reporting unit. As a result of
this process, we determined that the fair value of goodwill for
the TippingPoint reporting unit was $153.4 million. The
carrying value of the TippingPoint goodwill was
$311.4 million, resulting in an impairment charge of
$158.0 million. Our other long-lived assets within the H3C
and TippingPoint asset groups were also tested for impairment
due to this triggering event, concluding that the assets are
recoverable from their projected cash flows.
The following table summarizes the changes in goodwill (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
China-Based
|
|
|
TippingPoint
|
|
|
|
|
|
|
Sales Region
|
|
|
Segment
|
|
|
Total
|
|
|
Balance May 31, 2007
|
|
$
|
455,894
|
|
|
$
|
311,380
|
|
|
$
|
767,274
|
|
Impairment charge
|
|
|
|
|
|
|
(157,977
|
)
|
|
|
(157,977
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance May 31, 2008
|
|
|
455,894
|
|
|
|
153,403
|
|
|
|
609,297
|
|
Impairment charge
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance May 31, 2009
|
|
$
|
455,894
|
|
|
$
|
153,403
|
|
|
$
|
609,297
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Intangible assets consist of (in thousands, except for weighted
average remaining life):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
May 31, 2009
|
|
|
May 31, 2008
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
Amortization
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
Period
|
|
|
Gross
|
|
|
Amortization
|
|
|
Net
|
|
|
Period
|
|
|
Gross
|
|
|
Amortization
|
|
|
Net
|
|
|
Existing technology
|
|
|
3.6
|
|
|
$
|
398,178
|
|
|
$
|
(272,460
|
)
|
|
$
|
125,718
|
|
|
|
4.6
|
|
|
$
|
380,254
|
|
|
$
|
(198,682
|
)
|
|
$
|
181,572
|
|
Trademark
|
|
|