3Com F2Q09 (Qtr End 11/29/08) Earnings Call Transcript

Dec.18.08 | About: 3Com Corporation (COMS)

3Com Corporation (COMS) F2Q09 Earnings Call December 18, 2008 5:00 PM ET


Gene Skayne - Vice President, Finance; Corporate Treasurer; Director, Investor Relations

Robert Y.L. Mao - Chief Executive Officer, Director

Jay Zager - Chief Financial Officer, Executive Vice President

Ronald A. Sege - President, Chief Operating Officer, Director


Jeff Evanson - Sanford Bernstein

Manny Recarey - Kaufman Brothers


Good day and welcome to this 3Com quarterly earnings conference call. (Operator Instructions) Now, for opening remarks and introductions, it is my pleasure to turn the conference over to Mr. Gene Skayne, Vice President of Finance, Corporate Treasurer, and Director of Investor Relations. Please go ahead, sir.

Gene Skayne

Thank you, Operator, and good afternoon, everyone. Let me quickly run through today’s agenda. We will start with the Safe Harbor statement. Following that, I will turn the call to Bob Mao, 3COM’s Chief Executive Officer, who will provide an update on our business. Bob’s comments will be followed by 3COM’s Chief Financial Officer, Jay Zager, who will add insight into our financials. Following Jay’s comments, we will open it up to questions.

So first, our Safe Harbor disclosure: the remarks to be made on this conference call contain forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These include forward-looking statements regarding integration activities, strategic initiatives, future financial performance, financial condition, and cash flows, future expense controls and savings, product and solution development plans and strategy, and market position. These statements are neither promises nor guarantees but involve risks and uncertainties that could cause actual results to differ materially from the forward-looking statements. These risks include the risks detailed in the company’s SEC filings.

On this call, we will also discuss several non-GAAP financial measures. The most directly comparable GAAP measure and the required reconciliation can be found one, in the tables at the back of the press release announcing our results; two, attached as an exhibit to our Form 8-K for this earning’s release; or three, on the IR portion of our website, www.3com.com. The press release together with other related financial information is available on our investor relations section of our website.

Now I will turn the call over to Bob.

Robert Y.L. Mao

Thank you, Gene and thank you, everyone, for joining us on the call as we review our results for the second quarter of our fiscal year 2009. Today we’ll be walking you through the business highlights for the quarter and sharing specific details regarding our financial performance.

As I get into some of the details of our performance in the second quarter, I would like to remind you of the key goals that we set for the company: to focus on revenue growth, especially outside of China; improve operating margins through global integration and generate cash. Also as we have stated previously, our overall strategy is to use our home market advantage in China to deliver to enterprise customers worldwide a broad, well-tested product line with best-in-class price performance.

Our data center to edge solutions are easy to deploy and manage, energy efficient, and they support open interfaces for embedding a wide range of applications. Our large engineering team and focus on enterprise means we can offer unparalleled responsiveness to customer needs via an expanding direct touch sales and service force.

From a revenue perspective, we exceeded our guideline, achieving revenue of approximately $355 million. This represents year-over-year growth of 11.6% and sequential growth of 3.5%. The primary driver of our growth in revenue were our China operations, which saw year-over-year growth of 29%; our Latin America region, which achieved year-over-year growth of 14%; our Asia-Pacific region, which grew 11% over the prior year; and Tipping Point, which grew 20% over the prior year.

3Com achieved its second consecutive quarter of profitability on a GAAP basis and continued profitability on a non-GAAP basis through a combination of revenue growth along with improved operational efficiency. Our non-GAAP gross income in the quarter was 50.5%, an improvement -- our non-GAAP gross margin in the quarter was 56.5%, sorry, an improvement of 6.7% over the prior year. This is the highest gross margin we have ever achieved. We achieved a non-GAAP earnings of $0.12 per diluted share in the second quarter, exceeding our guidance, while GAAP earnings reached $0.03 per share, per diluted share. Finally, we generated $57 million in cash from operations during the quarter.

We are pleased with our performance in the quarter but are concerned with the weakening worldwide economic outlook. We have seen weakness in our North America and Europe, Middle East, and African regions. As a result of the current economic conditions, the selling cycle has been extended. However, we continue to believe that our value proposition of offering a full set of products and solutions at a significant price performance advantage resonates especially well in today’s economic environment. With tightening budgets, enterprises are constantly looking for ways to do more with less. Today’s value conscious customers are looking to get a higher return on their networking investment and they are increasingly turning to 3Com.

To help balance our investment in our business with the realities of today’s market, we proactively addressed the potential impact the worldwide economic slowdown may have on our company. In the second quarter, we implemented steps to balance our investments in key markets and products, while preserving cash and positioning the company for continued profitability.

We curtailed company-wide hiring on non-customer facing positions, imposed restrictions on non-customer related travel and outside meetings, and delayed employee [inaudible] increases.

We are also closely monitoring our capital expenditures.

Now let me address our individual regions and segments. First, the China segment -- our strong revenue performance in the quarter was largely due to continued growth in our China segment, which generated more than half of our total revenue. While we are seeing some slow-down in IT spending in China, this market continues to expand. Recently the Chinese Government announced plans to target minimum GDP growth of 8% in the coming year, including an economic stimulus package approaching $600 billion.

In addition, local governments throughout the country were encouraged to increase spending. With the government being one of our strongest verticals in China, these steps may benefit 3Com.

A good example of how we deliver complete networking solutions in China is the [Guanshi] province Golden Insurance Project. The first and most significant phase of this project is to build a cutting edge data center solution. As leading networking experts in China, we helped create the project plan for the data center. We then deployed a solution that included our high-end data center switches, along with our security and IP storage products. The entire solution is managed by our fully integrated intelligent, end-to-end management platform called IMC, which is fast becoming a unique differentiator for us.

The Palace Museum of China in the Forbidden City in Beijing turned to 3Com this past quarter to help deploy an IP video surveillance solution. To support the new solution, the customer also purchased our networking and storage offerings.

In total, China revenue increased 29% over the prior year period. It is also growing 14% sequentially. Our direct touch sales in China showed sequential growth of about 27% in the quarter and 40% over the prior year period. Second quarter sales to Huawei were stronger than we expected, increasing almost 25% over the same period last year, while modestly declining from the prior quarter.

As we discussed previously, our non-compete agreement with Huawei expired in September of this year. Our OEM agreement, which was scheduled to expire in November 2008, has been extended for another two years under the existing terms. While Huawei is expected to remain a strong partner, we expect our sales to Huawei to decline both in dollar terms as well as in terms of percentage of sales.

Now I will address our other geographies. We are seeing mixed results outside of China, with some regions showing impressive gains and others contracting. The tight credit markets and dramatic currency swings combined with the uncertain economic environment have impacted both our small and medium sized business, as well as our enterprise business.

We continue to make strong progress in Latin America, showing 14% year-over-year revenue growth. During the quarter, we increased our focus on selling higher margin enterprise networking solutions. One Latin American enterprise customer that recognized the value in working with 3Com in the quarter is [Info Aero], which manages all of Brazil’s airports. The million dollar plus deal includes a complete core, edge, and wireless switching solution. Our Brazilian team established a firm working relationship with the customer and was able to offer a complete high performance networking solution at attractive price points.

Other examples of large enterprise deals in Latin America include an expansion of our existing relationship with Telefonica across all of Latin America, and wins in Mexico with the Supreme Justice Court and IMSS, the Mexican Social Security Agency.

We had another strong quarter in the Asia-Pacific region, achieving 11% year-over-year revenue growth. Earlier this month, we announced a major deal with Malaysia’s largest telecom operator, Telecom Malaysia. Telecom Malaysia has standardized the networking infrastructure of its new innovation center on 3Com core and edge solutions, and our Tipping Point security solution. The new network replaces a legacy multi-platform networking environment, improving operation efficiency.

Other key customer wins in the quarter include deals with Samsung FMI and [Yungdai] in Korea, and the multi-million dollar with the Malaysia Administrative Modernization and Management Planning Unit.

While we are gaining traction in large enterprises in North America, we have seen a significant slow-down in this geography. We saw year-over-year and sequential revenue decline modestly in the second quarter, which we attribute to the economic environment.

In Q2, we continued to make progress in winning larger deals in the higher education vertical, with wins including the University of North Florida and [inaudible] University. We also extended our relationship with GE Medical, as they continue to purchase additional products from our switching portfolio.

Q2 was a difficult one in our EMEA region overall. Several sub-regions within the region, including the Middle East, Central Europe and Eastern Europe, did show good year-over-year growth. On the other hand, Northern Europe, Spain, and Italy showed significant weakness due to difficult credit and foreign exchange conditions. Despite generally difficult conditions in EMEA, our pipeline activities remained strong. We announced several important wins in the quarter, which suggest that our overall strategy is gaining traction.

For example, we announced that we won an exclusive multi-year, multi-million dollar contract to provide the Government of Israel with advanced networking solutions for its new LAN infrastructure project. The Israeli Government determined that 3Com provided the best value for an end-to-end solution in support of their plans to build a modern network to support its growing online initiatives.

Many organizations like the Government of Israel recognize that they can’t have a robust, high-performance networking solution without paying an unnecessary premium. They understand that 3Com delivers next generation, energy efficient solutions that reduce their expense without compromising performance. And by leveraging a common operating system across our comprehensive portfolio, and a single management platform, we helped them lower their total cost of ownership through ease of use and streamlined deployment.

Our other customers in the EMEA region turning to 3Com in Q2 for complete network solutions include the South African Social Security Agency, which is implementing a core edge and wireless network solution and [inaudible] table, the largest ISP in the Ukraine.

Overall, I am pleased with our worldwide performance, with particular strength in China, Asia-Pacific, and Latin America. I am confident that we have the right people and strategy in place to execute and deliver confident results.

Finally, let me update you on some of our other key initiatives. First, Tipping Point -- in the second quarter, our Tipping Point segment revenue grew to $31 million, which is an increase of 20% over the prior year period. Key customers in Q2 included Intuit, BMW, American Express, and the Federal Commission of Electricity in Mexico. We are pleased with the performance of Tipping Point in the quarter. We believe that the security market will outperform the overall networking market and we believe Tipping Point has the products and solutions to remain an industry leader.

Finally, I would like to provide an update on our worldwide integration efforts. To date, we have captured more than $50 million in annualized savings, primarily through R&D rationalization and through efficiencies we have gained in our supply channel organization.

In closing, I am pleased with our strong financial results. We executed on our strategy to grow revenue, improve margin, and generate cash, and we delivered solid financial results while operating in what has become a very difficult economic environment. Notwithstanding our performance, we remain cautious in light of the current economic climate. We have the right products and people and are executing to a solid plan. We continue to be strong in China and we are leveraging our resources there to strengthen our position in the rest of the world.

As customers are doing due diligence to determine price and quality leaders, 3Com is involved in more deals than in the past. Our price performance leadership, combined with end-to-end solutions on a standard platform, is resonating with value conscious customers. Customers understand that they can build their network infrastructure and get a full set of products and solutions from 3Com. We are winning in the marketplace.

With that, I will turn the call to Jay.

Jay Zager

Thank you, Bob and good afternoon, everyone. 3Com had a strong second quarter. Consolidated sales were $354.6 million, an increase of 11.6% from a year ago and a sequential improvement to 3.5%. Foreign currency translation provided 4.8 points of the year-over-year growth. For the first six months of the fiscal year, sales were $697.2 million, an increase of 9.4%. Five points of this growth came from foreign currency translation.

Our net income for the quarter was $12.9 million, or $0.03 per diluted share. Year-to-date, our net income was $92.7 million, or $0.23 per diluted share. On a non-GAAP basis, net income for the quarter was $46.9 million, or $0.12 per diluted share. And for the first six months, non-GAAP net income was $90.3 million, or $0.23 per diluted share.

These calculations reflect average shares outstanding of 404 million shares in Q1 and 395 million shares in Q2.

With respect to revenue, our networking business had sales of $325.5 million, 11.1% higher than a year ago and 3.1% higher sequentially. Looking within our networking business, our China based sales segment had revenue of $199.8 million, consisting of China Direct touch sales of $129.1 million, a year-over-year increase of 40% and a sequential increase of 27%.

Sales to Huawei of $63.8 million, which was 25% higher than a year ago and down 3% sequentially, and other sales of $6.9 million, primarily reflecting sales in Hong Kong and Japan.

Overall, this represents a 29% increase over the prior year period and a 14% sequential increase. The year-over-year improvement was principally due to strength in direct touch sales and to a lesser extent sales to Huawei. In addition, about 10 points of the 29 point improvement were attributable to the strengthening of the RMB relative to the dollar.

Sales to Huawei were 18% of 3Com's consolidated revenue this quarter, compared with 19% of revenue in Q1 and 16% of revenue a year ago. Our China based standard margin, defined as sales less direct product costs, was 66.0%, unchanged from Q1 and four points higher than a year ago. The year-over-year improvement is attributable to both favorable product mix and product cost reductions. The China based contribution margin was 47.7%, a 0.6 point sequential improvement and five points higher than a year ago. The year-over-year improvement was due primarily to improved standard margins.

Our rest of world segment had sales of $125.7 million, a year-over-year decline of 9% and a sequential reduction of slightly over 10%. Within rest of world sales, North America had sales of $30.5 million, a 13% decline over the prior year period and an 11% sequential decline. EMEA had sales of $51.9 million, about 20% lower than a year ago and 16% lower than Q1. As these results attest, the effects of the global economic slow-down were felt most severely in the more established industrial countries in North America and Western Europe. While sales declined, our pipeline in these key geographies remained strong, and we are now participating in many more sales opportunities, particularly for enterprise accounts.

Latin America had sales of $25.1 million, a year-over-year improvement of 14% and a sequential improvement of 7%. Asia-Pacific had sales of $18.2 million, down 14% sequentially but 11% higher than a year ago. The standard margin for our rest of the world segment was 57.2%, a three point improvement year over year and one-half point lower than Q1. The year-over-year improvement reflects favorable product mix and lower product costs. The contribution margin for the rest of the world was 36.7%, slightly lower than the prior year and prior period. While the standard margin has improved compared with last year, additional investments in sales and marketing have offset this improvement on a contribution margin basis.

Central functions costs for our China based and rest-of-the-world segments were $102.7 million, down 7% year over year and up 4% sequentially. The year-over-year reductions are due primarily to our integration efforts, as well as lower customer service delivery costs. You may recall that in Q2 fiscal year 2008, we incurred significant one-time costs associated with the limitation of our new customer service delivery system. With respect to our integration efforts, we have now captured on an annual basis more than $30 million in reduced R&D expenses and more than $20 million in reduced product procurement costs.

Overall, the networking business had a gross margin of 55.1%, a seven-point year over year and a one point sequential improvement. The networking business operating income of $38.8 million was almost a five-fold increased when compared with the prior year operating income of $6.7 million.

Tipping Point’s Q2 sales were $31.0 million, an increase of $5.2 million, or 20%, over the prior year period and $2.8 million, or 10% higher than the prior quarter. Within this total, product revenue was $19.3 million and maintenance revenue was $11.7 million. This compares with prior year product revenue of $17.6 million and maintenance revenue of $8.2 million.

Tipping Point’s gross margin in Q2 was 67.7%, slightly lower than a year ago and down 1.7 points sequentially. The sequential decline in the Q2 gross margin was due primarily to increased inventory reserves.

Tipping Point had a net loss of $400,000 in the quarter, compared with a small net profit in the prior year and prior quarter. The loss this quarter was attributable to a $700,000 charge associated with a retention bonus for key Tipping Point employees.

From a consolidated viewpoint, 3Com's non-GAAP gross profit was $200.4 million in Q2, or 56.5% of sales, the highest gross margin percentage in our history. This represents an almost seven-point improvement over the corresponding period last year and about a one point improvement sequentially. As we have discussed, this year over year improvement was driven largely by favorable product mix, as well as product cost reductions.

R&D expenses on a non-GAAP basis were $47 million, or 13.2% of sales, compared with $51.2 million, or 16% of sales a year ago. This year-over-year reduction was the result of the integration efforts previously discussed.

Sales and marketing expenses on a non-GAAP basis were $87 million, or 24.5% of sales, compared with $79.4 million, or 25.0% of sales a year ago. While we have taken a more cautious approach to increasing our expenses, we continue to believe that prudent investments in sales and marketing to support our direct touch sales will help us achieve our growth objectives.

General and administrative expenses on a non-GAAP basis were $28 million, or 7.9% of sales, compared with $20.4 million, or 6.4% of sales, in the prior year period. And headcount at the end of the quarter was 5,898 people, a net reduction of 35 people in the quarter and about 200 people lower than our year-end level.

Operating profits on a non-GAAP basis were $38.4 million, or 10.8% of revenue, compared with $37 million or 10.8% of revenue in Q1 and $7.3 million, or 2.3% of sales in the prior year period. Through the first six months of this fiscal year, our non-GAAP operating profits were $75.4 million. This profit level was higher than our non-GAAP operating profits for all of fiscal year 2008.

Net interest expense was $500,000 in the period. Other income was $15.9 million, reflecting primarily the recording of the VAT software subsidy in China.

Our non-GAAP profit before tax was $53.8 million. A tax provision of $6.9 million primarily reflects the tax expense in jurisdictions unable to leverage our net operating losses.

As a result of these factors, we had non-GAAP net income in the quarter of $46.9 million, compared with non-GAAP net income in the prior year period of $13 million.

Let me now turn to our balance sheet -- at the end of the quarter, our cash balance was $461 million, compared with $541 million at the end of Q1. During the quarter, we generated $57 million of cash from operations. In September, we made an $88 million principal payment against our outstanding debts. Of this total, $48 million was the annual prescribed payment and $40 million represented a voluntary prepayment. By making this voluntary prepayment, we lowered our interest obligations and gained additional flexibility in moving cash from China to the rest of the world. Accordingly, we reduced our debt obligations from $301 million to $213 million in the quarter. We also purchased $50 million of stock during the quarter under our approved stock buy-back program. We purchased approximately 21.3 million shares at an average price of $2.35 per share, including $0.03 per share of commissions.

While we are still authorized under this program to purchase an additional $50 million of stock, we have suspended purchases in light of the current economic environments. We continue to have board of directors approval to reinitiate the purchases. And as a result of the buy-back program, we ended the quarter with 386.8 million shares outstanding. Notes receivable were $113.3 million, an increase of $25 million from the prior period. This increase is primarily due to increased activity with Huawei as Huawei often pays us in bankers’ acceptances in China. Accounts receivable were $131.2 million, a $12 million decrease from Q1.

Our DSO in the second quarter was 33 days, compared with 38 days in the first quarter. Inventory was $111.5 million, up slightly from the prior period, and capital spending was $3.8 million in the quarter.

Now I would like to provide some insights into the current quarter -- we expect Q3 to be another solid quarter for the company. We should caution that in this rapidly changing economic environment, it becomes increasingly difficult to provide accurate financial projections. Our business is highly dependent on the Chinese economy, an economy that has experienced strong growth in recent years. While we believe that China may be less affected than other regions by the global economic slowdown, it has recently begun to experience the effects of the downturn and it is therefore harder to predict the ultimate impact on our China business.

Outside of China, we expect the difficult business environment to continue in the foreseeable future, particularly in the fully developed markets of North America and Western Europe.

With those caveats, we are projecting Q3 revenues to be in the $330 million to $340 million range. While this forecast represents a 4% to 7% sequential decline, it also represents 4% to 7% year-over-year growth.

Within this total, we expect that direct touch sales in China will be essentially flat with Q2. Sales to Huawei should decline about 20%. In the networking rest of world segment, revenue should be essentially flat to down slightly when compared with the current quarter, and Tipping Point revenues should be essentially flat to slightly higher than the reported Q2 levels.

On a consolidated basis, we expect gross margins to be slightly below Q2 due to the lower revenue projections, while overall non-GAAP operating expenses will be slightly lower. As a result of these factors, we anticipate that Q3 operating profits on a non-GAAP basis should be in the $33 million to $38 million range, and earnings per diluted share on a non-GAAP basis should be between $0.10 and $0.11.

We also expect that we will continue to generate significant amounts of cash from our operations and expect that our Q3 ending cash balance will be in excess of $500 million.

As we have indicated, we continue to believe that our value proposition will enable us to remain competitive and ultimately result in increasing success in our enterprise accounts. At the same time, we recognize that global spending on networking products and solutions is likely to be under significant pressure in the coming months and well into 2009.

Finally, while we are not offering specific guidance today for our fourth quarter, we want to make sure that our investors recognize that our fourth quarter results include the China operations for the January to March period. That period includes a two-week shut-down for the China New Year and is a seasonally soft period in the region. We therefore expect to see a sequential decline in our China based revenues in Q4 and consequently a sequential decline in our consolidated revenues. These lower revenue projections will result in sequentially lower operating profits and earnings per share.

We intend to provide specific guidance for the fourth quarter at our next earnings conference call.

And now I would like to open the meeting to questions. Operator.

Question-and-Answer Session


(Operator Instructions) It looks like we will take our first question from Jeff Evanson with Sanford Bernstein.

Jeff Evanson - Sanford Bernstein

Thank you. I noticed during the quarter that your R&D expenses were a bit higher sequentially. I was wondering if you could go over why that is.

Jay Zager

I don’t think there’s anything particularly significant about that. Our R&D expense basically have two elements to it -- our headcount related spending and then non-headcount project spending. We continue to manage our headcount and R&D essentially flat to slightly down, so on a particular quarter, depending upon non-headcount or project spending, you might see a little bit of an increase but there’s nothing particularly significant to draw from that.

Jeff Evanson - Sanford Bernstein

I guess I would draw if your headcount is slightly down and you went up by $2 million that you are spending a bit more on projects that might portend to future product announcements.

Jay Zager

I wouldn’t draw that conclusion. We have several products that we’ve introduced in the last year and we have several products in development across all of our portfolio. But when you look at sequential quarters, things like the way we might accrue for salaries and bonuses and other factors can alter sometimes a quarterly projection, so as I said, I wouldn’t read into it anything substantial in the modest increase.

Jeff Evanson - Sanford Bernstein

According to my notes, in the last quarter we heard that you had attained about $40 million in annualized cost savings from the integration efforts and today I heard Bob say we were up to about $50 million. Assuming those are the right numbers, you’ve got an additional $10 million this quarter. But if I look at R&D and SG&A, it looks like all the expenses went up. Where should I look on your income statement to see the proof of that $10 million improvement in the annualized savings?

Jay Zager

It’s in R&D and you won’t see it in the sequential quarter because, as I mentioned, we actually took some headcount out this quarter. That ultimately, as we cost out the savings from that headcount, results in additional R&D savings but you may not see it in the quarter, depending upon non-headcount savings. So at this point compared to last quarter, we have continued to take R&D costs out on an annualized basis. And when we talk about these savings, we’re talking about them on an annualized basis, not on a quarter by quarter basis.

Jeff Evanson - Sanford Bernstein

The Obama administration appears to be targeting broadband and other networking related infrastructure build for schools and for healthcare. Historically those have been fairly strong segments for you. Are you doing anything in particular to maximize the benefits of those efforts right now?

Robert Y.L. Mao

Not directly on his initiative because broadband deals with more the carrier side but if you will, as carriers build broader highways for information, that will allow the schools to deploy larger enterprise systems and that would benefit us.

Jeff Evanson - Sanford Bernstein

Are there any lessons that you might learn about the infrastructure build-out from what’s going on in China right now, related to the network that might be useful for your participation in North America?

Robert Y.L. Mao

Certainly. You probably know for years the North America communications community had been screaming that we in North America in fact are falling way behind many countries in broadband deployment and that’s affecting many fronts, so yes, there are lessons.

Jeff Evanson - Sanford Bernstein

I guess what I meant in particular is that I think the Chinese Government recently announced a $600 billion stimulus package. Is there anything of that stimulus that is going to networking that you think that the Chinese Government stimulus might imply opportunities in the U.S.?

Robert Y.L. Mao

Not in the front phase because what’s announced mostly is roads and bridges, this kind of infrastructure.

Jeff Evanson - Sanford Bernstein

Okay. Last question from me is VAT subsidies and rebates once again made a meaningful contribution to your results. I’m wondering if your expectation is for continued constancy of the laws in China and therefore rebates to you, or if there are any changes on that front that we should expect.

Robert Y.L. Mao

We have not heard any news to the contrary, so based on no news of reversing that, we expect that to continue. And probably, particularly in a difficult environment, the Chinese Government will want to stimulate the economic growth. For example, it’s not in our sector but they have given a reversed rebate -- not reversed, reinstituted rebates in the textile and toy sector.

Jeff Evanson - Sanford Bernstein

Thanks very much.


Thank you. We will now take our second question from Manny Recarey with Kaufman Brothers.

Manny Recarey - Kaufman Brothers

Thanks. Good afternoon, guys. One clarification first, just so I understand it -- you had your China based business revenue is just basically $200 million. What timeframe is that? Is that the July/August/September months or is that like a combination of different months? If you can help me understand how that is broken out.

Jay Zager

You’re exactly right -- it’s July/August/September.

Manny Recarey - Kaufman Brothers

Okay, so you didn’t see any of the impact, obviously, from the slow-down that’s going on there to the rest of the world in October and November?

Jay Zager

We haven’t commented directly on October/November. What we did say was that for the next three months, which is October/November/December in China, we expected direct sales in China to be flat, so one could argue that is an impact because it had been growing, so it remains robust but it’s -- we are seeing growth rates come down. We talked about on the call that the government is targeting GDP growth of 8% this year. Had we been talking three, six months ago, we would have been talking about growth rates in the low double-digits, so there is a slow-down taking place in China but the best that we can determine, it’s far less severe than what we are seeing in North America and Western Europe.

Manny Recarey - Kaufman Brothers

Okay -- [it would seem like at the] macro level, you guys mentioned about Eastern Europe where your growth is kind of holding up better than in Western Europe. I was kind of curious -- what do you think was driving that, because it seems like a lot of the Eastern European economies have been hit by the financing, the credit crunch, pretty significantly.

Jay Zager

Well you know, in places like Eastern Europe, the numbers tend to be fairly small so for example, I think in Bob’s comments he mentioned a major win for us in the Ukraine. You get one or two of those wins and it makes the region look pretty good. So in the small emerging areas, as we deploy our sales force and grow our business, we can do better in a bigger area where there’s an established base and it takes much greater sales to move the needle.

Manny Recarey - Kaufman Brothers

Okay. How is the ability to provide financing because of the credit crunch, is that something that you are looking to do or is that something your customers or your distributors, resellers are looking for you towards -- to you for?

Jay Zager

We won’t do that. We made a very conscious decision that we are not providing financing activities to our customers because that’s not our business model. Having said that, we are getting more active in some cases working with local banks and local financing organizations to help guarantee credits.

Manny Recarey - Kaufman Brothers

Okay. So you are looking at that and trying to help customers where if possible, you can?

Jay Zager

It’s done on a case-by-case basis, based upon the business risks that we see.

Manny Recarey - Kaufman Brothers

Okay, and then the last question, where do you see your customers as you -- as they are buying products, where do you see them looking to put it? Is it in the data center where I think Bob had mentioned earlier a win that you had in China? Or is it upgrading or replacing the existing equipment that they have? Kind of give some color on where you see the spending still occurring.

Robert Y.L. Mao

The data center is our new leading edge but if you talk about volume, it’s still -- it’s in the switches router deployed in the general business networking.

Jay Zager

One of the things we’ve talked about, Manny, is we are making a very conscious effort as a strategic thrust of the company to move much more into the enterprise market and away from SMB. Now we’re foregoing SMB but we think for us our products and our growth opportunities are more geared to the enterprise business and we are -- the enterprise is moving for us from the edge to the core and in some cases, into the data center. So we are seeing that we are participating in a much broader aspect of the networking environment and that’s very positive for us.

Robert Y.L. Mao

And we’re also seeing, as I said, the fact that we have a common network management platform cutting across [inaudible] to the edge is increasingly seen by many customers as an advantage.

Manny Recarey - Kaufman Brothers

Okay, great. Thank you very much.


(Operator Instructions) We will take our next question from [inaudible] with Barclays Capital Partners.

Unidentified Analyst

Thanks for taking my question. I was wondering if you could maybe just talk a little bit more about the education vertical. It sounds like it’s -- it managed to stay strong, even against some of the slowing SMB enterprise. Are you starting to see maybe even a little bit of a hint of slow-down or delays -- any color there?

Robert Y.L. Mao

The education sector actually is seasonal. So we are -- right now we are not seeing any delay on top of these seasonalities.

Unidentified Analyst

Okay. And then if I could just ask a question on Tipping Point, it sounded like it was better than expected. I think last quarter you had said that you were expecting for modest [control] growth, and you mentioned some pretty good customer wins. I was wondering if that was driven by maybe a new product cycle or was there maybe some increased sales efforts there?

Robert Y.L. Mao

There certainly not new product cycle but increasing sales efforts and there’s also, as we said, from what we see, we believe the security sector is going to outperform the general networking sector. You know, increasingly we are living in a more complex cyber world and security is -- I mean, threats to the security is immune to economic downturns and we are a leading supplier in this high-end space.

Unidentified Analyst

Okay. And finally on Huawei, it sounds like the past few quarters, it’s exceeded your expectations. I know you have mentioned longer term you expect it to decline on a dollar basis and also percentage of sales. Has that trajectory changed at all, just given some of the recent better-than-expected results?

Robert Y.L. Mao

Well, we really have no visibility into Huawei’s future procurement plans, and we are very thankful to our good fortune that while yes, we believe the gradual or the decline will have -- will very likely to happen, but any upside we can get from quarter to quarter, we’ll be very gladly taking it.

Unidentified Analyst

Okay, great. I think that’s all from my end. Thanks a lot.


All right, gentlemen, it appears we have no further questions at this time. We will now turn the program back to Mr. Bob Mao for closing comments.

Robert Y.L. Mao

I just want to thank you all very much for joining us today and we look forward to talking with you next quarter again.


This does conclude today’s conference. You may disconnect at any time. Thank you for calling in and have a good day and a great holiday.

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