FOOL CONFERENCE CALL SYNOPSIS*
By Debora Tidwell (MF Debit)

3Com Corporation <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: COMS)") else Response.Write("(Nasdaq: COMS)") end if %>
5400 Bayfront Plaza
Santa Clara, CA 95052
(408) 764-5000
http://www.3com.com/

UNION CITY, CA (March 22, 1997)/FOOLWIRE/ --- 3Com Corporation announced financial results for its third fiscal quarter of 1997. Sales for the quarter of $786.8 million increased 30% from $606 million in the year ago quarter and they are down 4% sequentially. These results are roughly in the middle of the range of company expectations previously disclosed on February 10th. Net income for the quarter was $87.6 million, or $0.47 per share, up from $0.42 per share in the year-ago period. These results were in line with the company's expectations, previously announced on February 10th and were a penny over analyst estimates of $0.46 per share. The absolute number of shares outstanding at quarter end was 177.5 million, an increase of 1.6 million from the prior quarter. The weighted average share count used to calculate earnings per share was 187.2 million.

SPECIFICS ON THE FINANCIALS

SALES BY GEOGRAPHY. Geographically, the breakdown of sales between the US and international markets is as follows: US sales in Q3 were $346.1 million, 44% of the total, down 11% sequentially and up 25% year over year; international sales were $440.7 million, 56% of the total, up 2% sequentially and up 34% year over year. Many analysts have commented about softness in certain international markets, yet 3Com's sales were relatively better outside the US. Sequential growth was particularly high in Canada and Latin America.

SALES BY PRODUCT LINE. The quarterly breakdown of sales by product line is as follows: adapters were $346.3 million or 44% of the mix, down 2% sequentially and up 39% year over year; systems were $432.6 million, 55% of the total, down 6% sequentially and up 24% year over year; other products were $7.9 million, 1% of the total, up 22% sequentially and 6% year over year.

MARGINS. Gross margins of 54.5% dropped only slightly, 0.2%, from Q2. The primary drivers of the decrease in gross margin percentage were lower sales and price reductions in adaptors, specifically price cuts on the fast Ethernet adaptors.

EXPENSES. Q3 expenses were $299.1 million or 38% of sales, an increase of approximately 4% sequentially from 34.1% last quarter, driven largely by lower sales. Dollar expense growth was split roughly equally between R&D and Sales & Marketing, as G&A expenses actually decreased during the quarter. Reduced sales and profitability led to lower accruals for employee profit sharing programs. Headcount at quarter end was 7059 compared to 6449 in Q2, a 9.5% sequential increase. Clearly their headcount growth and their expense growth were not consistent with the resulting revenues. During the quarter they initiated company-wide expense and headcount controls aimed at bringing expense growth and headcount growth back in line with revenue growth. Q3 operating income decreased approximately 4% to 16.4% from 20.6% in Q2, again attributable to lower sales and the associated impact on operating expenses as a percentage of sales. Other income increased $1.7 million to $6.5 million, primarily reflecting an increase in cash and, thus, interest income. Their tax rate remains unchanged at 35.5%.

BALANCE SHEET. Their balance was less affected by Q3 results and remains strong with cash an equivalents increasing $51.5 million to $794 million. As predicted on last quarter's conference call, receivables DSO rose to 58 days from 55 days in the year-ago quarter and 51 days last quarter. The increase in DSO was primarily due to the shipment pattern during the quarter. It was also impacted by the short month of February which has historically made Q3 the highest DSO quarter of the year. During the quarter, inventory levels increased by $20 million from Q2. As a result, inventory turns of 5.8 decreased from Q2's 6.4, but were up from the year-ago level of 5.5.

COMMENTS ON Q3 RESULTS

PRICE CORRECTIONS/ORDER WEAKNESS. Revenues and earnings are consistent with the expectations the company set in early February. They are clearly disappointed they have been unable to post sequential growth for the first time in several years. They indicated that they had seen weakness in order rates in December. January was a better month and February better yet, both in sales into and out of the channel. But, this result was insufficient for them to meet their original plans, particularly in light of the price correction in NICs stackable hubs and switches. At the same time, they are winning an increasing amount of large projects for building and campus infrastructures, particularly on the strength of their richer Encore platform and their market-leading ATM backbone products including their Cellplex family and the products from the recent acquisition of OnStream.

OUTLOOK ON ORDERS. In January they indicated that their pipeline of projects was at an all-time high. That number continued to grow in February. As they look to Q4 and beyond, while they are clearly starting from a lower revenue base than they would have liked, they do not expect that the demand weakness that they saw in December will recur, nor do they expect the industry to have ASP corrections of the magnitude they saw in the last quarter. They have also taken steps to bring their expenses and headcount growth in line with their lower revenue starting points and begin the process of reconvergeance towards their long-term financial models.

BOOK-TO-BILL. While they don't typically comment on orders, they chose to do so this time. They have historically not done so because orders and sales are almost always in a range of 0.95 to 1.05 and because their business is not one where there is a lot of backlog, so orders are not particularly indicative of future business results. This quarter was no different. Their book-to-bill ratio was exactly 1.0. Unit shipments for the quarter were flat at 4.4 million units and aggregate average selling prices were down slightly, 1%, from Q2 1997.

TRENDS AFFECTING RESULTS

STRONG DEMAND FOR HIGH-END SOLUTIONS. 3Com feels its stature as a leading provider of end-to-end networking systems continues to grow. During the quarter they saw strong demand for their high-end networking solutions, particularly ATM systems, and the number of multi-million dollar orders received from large accounts has never been greater. Their stature as a large-scale provider of line infrastructures is continuing to rise. Market analysts such as Gartner, Dataquest, Yankee, and IDC are not consistently recognizing 3Com as one of the top two systems vendors in the industry for the first time.

INDUSTRY TRANSITIONS. At the same time, their industry is in the midst of many important transitions including the adoption of higher-speed technologies, new paradigms for switching and routing network traffic, and more volume-based pricing and distribution. While these changes are all positive for 3Com and the industry in the long run, during the current quarter 3Com results reflected increased price competition and a pause in industry demand as enterprise networking customers and network service providers assess how best to maximize their networking investments.

ADAPTORS. Network adaptor results this quarter reflected an acceleration of the transition from 10-megabit per second Ethernet NICs to 10/100-megabit per second or Fast Ethernet adaptors. No doubt, a major factor was price declines in the Fast Ethernet segment where both 3Com and Intel reduced prices up to 40%. These price declines adversely affected Q3 revenues, in part due to the impact of price protecting inventory in the channel. On the plus side, unit volume for Fast Ethernet adaptors spiked sharply to over 1 million units, up 64% sequentially and more than 6 times the year-ago volumes. They continue to believe they are gaining market share in this segment. Sales of mobile products which include LAN and LAN plus modem PC cards were also good, reflecting the growing trend for portable desktop computers and strong performance in both Europe and Asia Pacific.

NETWORK READY PROGRAM. Also during the quarter they strengthened their 3Com Network Ready program with the addition of 7 new partners including Ingram Micro, Entex, and Siemens Nixdorf, bringing the total number of Network Ready partners to 25.

SYSTEMS. 3Com's systems revenues increased 24% year over year but were down 6% from the previous quarter. Systems business in Q3 was below Q2 as a result of lower demand for 10-megabit per second stackable hub systems and increased pricing pressure in this segment, particularly in the Americas. In addition, several of 3Com's large core internetworking customers slowed down their purchases this quarter. On the positive side, demand for their high-end networking equipment was very strong, particularly in ATM systems. Although 10-megabit per second stackable hub business was soft in Q3, office-connect and fast Ethernet hubs showed very good growth during the quarter. Workgroup switches were flat sequentially but had very good year-over-year growth reflecting more ports but lower ASPs. Responding to the changing competitive environment, 3Com initiated several advertising and promotional programs in Q3 which should benefit Q4. Overall, their switching business, including both workgroup and high-end switches is growing nicely and demand for chassis switches is high. ATM continues to be a hot technology for customers and 3Com is winning major deals. Large ATM deals in Q3 include Deutsche Bank, Ministry of Defense France, Long Island Medical, Sony, Random House, Morgan Stanley in the UK, and Johnson & Johnson.

MERGER WITH U.S. ROBOTICS

ANNOUNCEMENT/RATIONALE. On February 26th, 3Com announced a definitive agreement to merge with U.S. Robotics Corporation, the leading supplier of products and systems for accessing information across the wide area network, including modems and remote access products. The combined company, which will retain the 3Com name, will have revenues in excess of $5 billion annually and employ over 12,000 people worldwide. By combining 3Com's capabilities and leadership position in the enterprise and local area networking market with U.S. Robotics capabilities and leadership position in remote access and modem markets, they believe they can create a networking company with the ability to deliver integrated end-to-end LAN and WAN solutions to the broadest set of customers in the industry. By leveraging their combined investments in R&D, manufacturing and distribution, they can take advantage of the synergies that exist between the two companies in order to earn a better return for shareholders.

TRANSACTION SPECIFICS. Under the terms of the agreement, each share of U.S. Robotics stock will be exchanged for 1.75 shares of 3Com stock. The transaction will be accounted for as a pooling of interests, and is expected to be neutral to slightly accretive to 3Com earnings in fiscal 1998. Completion of the transaction is subject to approval of both companies shareholders as well as certain regulatory approvals.

POSITIVE REACTIONS TO MERGER RATIONALE. Over the last three weeks they have had numerous conversations with their customers, partners, market analysts, and employees to communicate the strategic rationale behind the transaction and the new possibilities it creates for their various constituencies. They found it particularly gratifying to measure how overwhelmingly positive and excited the reactions from these audiences have been so far.

POLL/KEY CUSTOMER RESPONSE. Several members of their strategic advisory council, a group made up of the CIOs of some of their largest customer organizations, has come forward and communicated their desire to expand their existing relationship with 3Com to include WAN access solutions contributed by US Robotics. This week's issue of Communications Week contains the results of a readers poll they conducted over the last couple of weeks. To the question, "Will a combined 3Com/US Robotics provide better end-to-end LAN/WAN solutions than Cisco?" the response was 86% Yes and 14% No. This early feedback from real customers and partners validates several of the strategic premises upon which a planned combination with US Robotics was founded.

WHERE THEY ARE WITH THE PAPERWORK. They completed their S-4 and HSR filing last Monday as planned. They are currently planning to conduct a traditional road show and visits with the investment community beginning in 5 weeks after US Robotics reports their fiscal Q2 efforts. That schedule is somewhat dependent on the processing of their applications to the various regulatory agencies and they will communicate logistical details as they finalize them. Current schedule for completion of the transaction calls for a range of dates starting with the first week of June to early August, again depending on regulatory approvals. They have been in active discussions with people at US Robotics to work through their plans for products, organization, international model, etc. and they are increasingly excited about the opportunities and synergies but it is premature for them to comment on the specifics of these plans.

OUTLOOK FOR THE INDUSTRY AND DISCUSSION OF INDUSTRY TRENDS

INDUSTRY FUNDAMENTALS STRONG. They find it important to point out that the networking sector continues to enjoy strong growth and continues to be one of the most exciting sectors in high technology with the brightest prospects in years ahead. Despite many recent speculations in the media, the fundamentals of the industry remain very strong and the potential remains for the industry to sustain growth rates in the 30-50% range over the next few years. 3Com is growing right now at the low end of this range and has the potential to get back into the middle or high-end of the range, but not in the Q4 timeframe. The data they receive every day from the marketplace indicates that the number and the average size of network infrastructure projects continues to grow at a healthy clip and is internally corroborated by the data they see in their own project pipelines around the world. The hunger for connectivity and bandwidth is showing no signs of abating.

FACTORS CONTRIBUTING TO GROWTH. Several factors continue to contribute to this growth -- the continued expansion of the client/server application waves, now reinforced by overlayed requirements for intranets and extranet applications; the beginnings of a new wave to enhance data networking infrastructures to support multimedia traffic, both voice and video; the continued deployment of remote access services for both business users and consumers, with increasing amounts of bandwidth at the periphery; the continuation of several upgrade cycles begun a few months ago such as the migration from shared media to switched media, from 10-megabits to 100-megabits per second Ethernet, from Token Ring to Ethernet, from FDDI backbones to ATM and upcoming Gigabit Ethernet backbones, from routed infrastructures to switched infrastructures.

INCREASED COMPETITION. Despite these positive dynamics, there were two less-favorable factors that affected industry growth in the last quarter. The first is simply increased competition. No major new competitor has come on the scene, but several existing broad-based networking companies, including 3Com and Cisco, Bay, and niche vendors have introduced new products in categories in which they previously did not compete as broadly. This broadening of product lines across the industry has expanded the areas in which major competitors are now engaged in head-to-head competition. 3Com has benefitted from this in some higher-end markets including ATM, but this last quarter they saw the effects of increased competition in the workgroup hubs and, to a lesser extent, switching.

HOW THIS AFFECTS 3COM. They posted both unit and revenue growth, but their results were below their plans. However, they have taken action in their marketing, pricing, and product plans and are extremely confident in their ability to compete and gain share. They also believe these changes in the industry work in their favor because they place a bigger premium on competing as a sole-line vendor, a bigger premium on software integration across products, and a bigger premium on lower-cost higher volume skills -- in all of these areas, 3Com is an industry leader.

RAPID DROP IN ASP (AVERAGE SELLING PRICES). The second unfavorable trend that affected the last quarter was a more rapid drop in ASPs than had been projected for the industry. This is particularly true of stackable hubs, stackable switches, and NICs -- in other words, products at the edge of the network where 3Com happens to enjoy the leading market share and derive a large part of their revenues. The stackable hubs sequential decline in ASPs was about 8%. In stackable switches, the sequential decline in ASPs was about 9%. In NICs, the ASPs were impacted by a sequential decline of 21% in 10/100 NICs. These declines are clearly directly related to tighter competition. While they had a negative effect in the quarter, they do not indicate an acceleration in price erosion, but more of a rare adjustment reflecting the full engagement of all relevant competitors in these segments. 3Com will enjoy the stimulation of the market that results from these aggressive prices over the next few quarters.

TWO FACTORS MENTIONED BY COMPETITOR. For completeness, they felt it necessary to mention two other negative factors that were reported by their largest competitor. One points at macro-economic weaknesses in countries such as Japan and Germany. The other at network service providers postponing decisions about large infrastructure investments. While this may be anecdotally true, it is hard for 3Com to confirm or deny these trends. They find that the overall market strengths of Asia mitigates any weakness in Japan and likewise strengths in the UK and Northern Europe mitigates weaknesses in Germany. As to changes in investment patterns of carriers, 3Com is less exposed to this lumpiness by virtue of their business mix and their channel mix.

PC CONNECTION TO THE NETWORK. Other important trends that became quite visible over the last three months include the growing importance of the PC's connection to the network in a deployment of switched infrastructures. Their fast IP switching architecture which they introduced in January capitalizes on this trend and on 3Com's strong position and expertise in NIC connections. They find that customer reactions to this approach have been extremely positive. They like its ease of deployment, its simplicity, its added cost-of-ownership advantages which creates new and different opportunities for 3Com to compete in the marketplace.

NETWORK POLICY MANAGEMENT. Related to the strength is the growing importance of policy management in networks that would generally have intelligent network software to make network infrastructures more flexible, more secure, and more manageable. Last month, 3Com introduced their TranscendWare software road map that will add a new dimension of policy management, including security, priority, latency, and quality of service to their network infrastructures. They have set the stage for a TranscendWare software strategy several months ago and will be building upon it aggressively in the coming months consistent with their continued thrust to add architectural coherence and a systems quality to their networking solutions.

LOOKING AHEAD

LONG-TERM FINANCIAL MODEL UNCHANGED. As previously noted, Q3 was a challenging quarter for 3Com and they were disappointed to report a sequentially down quarter for the first time in several years. However, they remain confident about their long term prospects and, in fact, they are not changing their long-term financial model. Their model for 3Com's business calls for gross margins of 53-55% of sales and expenses of 33-35% of sales, resulting in operating margins from the high teens to the low 20s as a percentage of sales. Clearly their expense management this quarter landed outside the range as expense growth reflected an anticipated higher revenue performance. They now have to work to correct that. However, that doesn't change what they believe to be the best model for allocating resources and generating shareholder return over the long term, so there is no current change to the model.

USR IMPACT ON MODEL. Many have asked them if the U.S. Robotics transaction would alter the long-term model for the combined company and the answer is yes, it will. Questions about exactly how it will change are premature for them to answer at this point. They will get back to us with more specifics on this later.

OUTLOOK FOR Q4. Pricing pressure continues at the edge as they have seen intense competition as companies attempt to gain market share. As a result or pricing actions taken in Q3, gross margin percentage will be down sequentially, likely closer to the low end of their long-term model range. Although they have constrained headcount growth, the ramp up in Q3 headcount means most probably that expense in dollars will grow some amount in Q4. So, their ability to have expenses get closer to their long-term model range is dependent on revenue growth being above expense growth. In recent quarters, they have invested heavily in their sales force and, in fact, their Q3 results reflect growth in the product categories that would benefit from such investment, such as high-end switching. Their fiscal Q4 has 6 more selling days than Q3. They enter Q4 with a strong funnel for high-end networking equipment and 3Com is increasingly being recognized as a leading systems company with a growing portfolio of large enterprise customers.

WHY THEY ARE OPTIMISTIC. In Q3 they launched many marketing initiatives designed to stimulate sales. The edge of the network where 3Com is best positioned continues to grow in importance. 3Com software architecture is becoming more valuable and an important competitive factor -- specifically, TranscendWare, Fast IP, and Dynamic Access are all representative of the value added by approaching the network with a view from end to end. While Q3 was a disappointment, they remain optimistic about their competitive position and their long-term prospects for the following reasons. One, they have the broadest range of products. Two, in many important markets they have the highest market share and the strongest brands. Three, they own their key technologies. Four, they are the low-cost producer. Five, they have the broadest coverage both geographically and in channels of distribution.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.