3Com Rises Sequentially on All Fronts

Dec.24.09 | About: 3Com Corporation (COMS)

The networking gear maker, 3Com Corporation (COMS) showed sequential improvement on all fronts as ­revenue, earnings and operating margin were better than the company’s own guidance.

The sequential improvements were due to the effects of the global economic recovery, which were felt across all geographies, particularly in the Europe, Middle East and Africa region and in Latin America, along with strong performance in its China based business. Moreover, the company benefited from lower expenses and a favorable tax adjustment in the quarter.

The tax adjustment of $10.8 million was offset in part by transaction costs of approximately $4.6 million relating to the company’s pending merger with Hewlett-Packard Company (NYSE:HPQ).

The second-quarter earnings (excluding one-time items) of 9 cents per share exceeded the Zacks consensus estimate of 6 cents a share. EPS was 3 cents below the year-ago quarter but increased sequentially by a penny.

Revenue of $322.2 million decreased 9.1% from $354.6 million in the year-ago quarter, but increased 10.9% sequentially from $290.5 million. This was partially offset by sales to Huawei, which fell 35.3% sequentially to $18.2 million, while China based direct-touch sales reached $151.1 million in the quarter, up 21.9% sequentially. Moreover, Networking business sales for the quarter were $288.6 million, down 10.5% from $322.5 million in the year-ago quarter. Within the Networking business, the China-based sales segment had revenue of $169.3 million, a decrease of 15.3% from the year-ago period.

3Com's gross margin was 60.1% in the first quarter, a 380 basis point improvement over the corresponding period last year, largely driven by product cost reductions, a pronounced shift to the enterprise market and relatively lowers sales to Huawei, which carry lower gross margins. Non-GAAP operating profit margin was a record 13.5% in the second quarter, compared to 10.8% in the year-ago quarter as operating expenses fell 8% from the year-ago quarter.

The company ended the quarter with $704.1 million in cash and cash equivalents, compared to $665.8 million in the previous quarter. During the quarter, 3Com generated $118.2 million in cash from operations, versus $16.9 million generated in the previous quarter. Long-term debt (including the current portion) was $112 million, as the company repaid $88.0 million of its debt, including a voluntary payment of $40.0 million during the quarter.

The company’s results for the second quarter shows that the economy is on the mend and gives us confidence that 3Com will be able to sustain recent improvements. 3Com outperformed management expectations and has consistently achieved profitability for the sixth consecutive quarter.

Moreover the company’s announced acquisition by Hewlett Packard for $2.7 billion in Nov 2009 is an ideal fit in our opinion as 3Com has an expertise in the networking products for data centers particularly in in China. Thus if the deal closes, HP will strengthen its position in China. This acquisition will also challenge networking leader Cisco Systems Inc. (CSCO - Analyst Report) in the data center switch market.

We maintain our Neutral recommendation on 3Com shares.