Here’s the entire text of the prepared remarks from 3Com’s (ticker: COMS) fiscal Q2 2006 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Ciel Caldwell, Director, Investor Relations
Donald Halsted, Executive Vice-President, CFO
Bruce Claflin, President, CEO
Wojtek Uzdelewicz, Bear Stearns
Jiong Shao, Lehman Brothers
Christin Armacost, SG Cowen
Jeff Evanson, Sanford Bernstein
William Becklean, Oppenheimer
Long Jiang, UBS
Alex Henderson, Citigroup
Manuel Recarey, Kaufman Brothers
Jiong Shao, Lehman Brothers
Good day everyone and welcome to this 3Com Q2 2006 Quarterly Conference Call. This call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Director of Investor Relation Ms. Ciel Caldwell. Please go ahead.
Ciel Caldwell, Director, Investor Relations
Thank you. Hello this is Ciel Caldwell, 3Com Investor Relations. Here with me today are Bruce Claflin, President and CEO and Don Halsted, Executive Vice-President and CFO. Today we will be commenting on 3Com’s performance during our second quarter of fiscal 2006. As of customary following prepared comments we will hold a Question & Answer session. As noted in the full text of our press release Management’s comment on this conference call will contain forward-looking statements about various matters. Factors that could cause actual results to differ are set forth in the press release which has been posted on 3Com’s investors relations website. For additional detail on these matters and other risks that could affect the company, please refer to the company’s annual report on Form 10-K for the fiscal year ended June 3, 2005 filed with the Securities and Exchange Commission, and in our quarterly report on Form 10-Q for the quarter ended September 2, 2005 filed with the Securities and Exchange Commission. Earlier today we issued a press release containing our financial results for the second quarter of fiscal 2006. To elaborate on our performance I will now turn the call over to our CFO Don Halsted. Don.
Donald Halsted, Executive Vice-President, CFO
Thank you Ciel. I am pleased to report our second fiscal quarter results, which demonstrate continued clear progress on our path to profitability. Revenue for the quarter was $184 million which is a 4% sequential growth in the first quarter of fiscal 2006 revenues of a $178 million and a 22% growth compared to the same period of fiscal 2005. On a geographic basis strong sequential growth in our Europe, Middle East, and Africa region, Latin and South America region and Asia and Pacific regions more than offset the sequential decline in North America compared to the same period in fiscal 2005 all region showed growth.
Second fiscal quarter revenue by geography was as follows. First, North America, revenue was $62 million a 10% sequential decline for a 44% year-over-year growth. Second, India revenue was $81 million an 8% sequential increase and in a 11% year-over-year growth. Third, Latin America, revenue was $19 million a 38% sequential increase and a 29% year-over-year growth. And fourth, APR, revenue was $22 million and 11% sequential increase and a 10% year-over-year growth.
In the first fiscal quarter we started reporting product and service revenue in five groups. The following are the worldwide second fiscal quarter revenue results for these groups. First Security, revenue was $21 million, a sequential growth of 24%, and including the revenues from the TippingPoint acquisition, a six-fold increase over the same quarter in the prior year. This includes strong double-digit percentage growth for our Embedded Firewall products.
Second Voice, revenue was $14 million, a sequential decline of 8%, but a year-over-year improvement of 56%. Voice revenues include our VCX and NBX Voice over IP product lines. The sequential decline results from seasonal declines in North America offset in part by sequential growth in the other three geographies. All regions showed at least strong double-digit growth compared to the same period in fiscal 2005.
Third Networking, revenue was a $132 million, which is a 4% increase on a sequential basis, and a 12% year-over-year growth. Networking revenue includes the balance of our product revenue and includes sales of enterprise products sourced from Huawei-3Com, our Layer 2 and Layer 3 stackable 10/100 Gigabit managed switching lines, wireless and our Office Connect and Baseline-branded SMB products. Revenue from Huawei-3Com-sourced products sold by 3Com grew by 37% sequentially to more than $20 million. This growth resulted from continuing traction with the 5500 lines of Layer 3 switches, particularly the successful introduction of the Gigabit and Power over Ethernet models. Revenue from the joint-venture-sourced products quadrupled on a year-on-year basis.
Fourth, Services, revenue was $9 million, a growth of 12% sequentially and 7% year-over-year. Services revenue includes professional services and maintenance contract, excluding the TippingPoint maintenance, which is included in Security.
And fifth Connectivity Products, revenue was $9 million, a 16% sequential decline, which was in line with expectations.
Gross Profit margins for the quarter was 40%. The net sequential increase of 1 percentage pointed margin was primarily the result of improvements in cost. Compared to the same period in fiscal 2005, the gross profit margin improved 5 percentage points primarily due to improvements in product mix and cost. Total operating expenses for the current quarter were about flat sequentially at a $117 million, including restructuring charges of $3 million and amortization of intangible assets of $4 million. The second quarter's restructuring charges included costs primarily related to the realization of our restructuring actions announced in our first fiscal quarter of 2006.
Sales and marketing, research and development, and general and administrative expenses totaled a $109 million, including the expenses of the brand awareness campaign launched in October, compared to a $110 million in the first quarter of fiscal 2006. Compared to the same period of fiscal 2005, these expenses increased $13 million primarily due to the inclusion of TippingPoint expenses post acquisition.
The number of full-time employees at the end of the quarter was approximately 1,750, compared to 1,800 at the end of the previous quarter.
Operating loss for the second quarter of fiscal 2006 was $42 million, which compares to an operating loss of $47 million, reported for the previous quarter. This $5 million improvement resulted primarily from increased gross profits. The operating loss in the same period of our prior fiscal year was $50 million. The second quarter results represent an $8 million year-over-year improvement, primarily from the increased gross profit margin on higher revenues, offset in part by the expected increase in operating expenses resulting from the acquisition of TippingPoint.
The net gain on investments was $4 million, resulting primarily from the sale of certain equity investments. Interest and other income, net, was $7 million, which is a $1million, increase over the first fiscal quarter. This increase is a result of a $1 million gain for the foreign exchange impact associated with the foreign tax settlement in the quarter. The remaining interest and other income of $6 million is consistent with the prior quarter.
In the second quarter, the income tax provision was a net benefit of $22 million, made up of a current period provision of $1 million and a benefit of $23 million resulting from the tax settlement with foreign tax authorities regarding issues covering multiple years. The tax benefit results from the release of specific tax provisions based upon the settlement terms, and interest income of $3 million earned on the outstanding tax refund claims, which had been held by the tax authorities pending this settlement. The provision release is a non-cash benefit. The actual settlement is not expected to have a cash impact because it is largely offset by the outstanding tax refund claims that were also settled as part of this agreement.
During its calendar third quarter ended September 30, 2005, the Huawei-3Com joint venture revenues were $111 million, an increase of 16% compared to its calendar second quarter of 2005. Compared to the same period in the prior year, revenue grew 69%.
Gross margin for the quarter was 42% and the net loss was $2 million, after recognizing $7 million in expense for amortization of intangible assets.
In the second quarter, we reported a loss of $1 million as our share of the financial performance of the unconsolidated Huawei-3Com joint venture in its calendar third quarter. We have provided, at the end of the earnings release, a table that summarizes that previously disclosed data for the Huawei-3Com joint venture along with its third quarter results.
Returning to 3Com's results, the net loss for the second quarter was $11 million or $0.03 per share, of which restructuring and amortization expense represented about $0.02 per share, and the tax settlement and benefit represented about $0.06 per share.
The weighted average number of shares outstanding during the quarter was approximately 385 million shares. This net increase of 1 million shares from the prior quarter level of 384 million shares primarily reflects the exercise of stock options.
There were 58 million stock options outstanding at the end of the second quarter of fiscal 2006, compared to 62 million at the end of the first quarter of fiscal 2006.
Cash, cash equivalents and short-term investments totaled $754 million, a net decrease of $28 million from the balance at the end of the previous quarter. The change includes an increase in cash and cash equivalents of $84 million and a decrease in short-term investments of $112 million. Key components of the change in cash and cash equivalents are as follows, cash provided by the sale of short-term investments totaled $110 million.
Cash used in operations was $27 million, including $4 million for restructuring-related payments. Cash provided by the issuance of common stock was $5 million and cash used for capital expenditures amounted to $4 million.
My remaining comments include forward-looking statements about various matters pertaining to the third quarter of 2006. Please refer to the safe harbor language in the earnings release available on our website, for factors that could cause actual results to vary.
Overall in the third quarter of fiscal 2006, we expect total company revenue to be a $190 to $195 million. In the third quarter, we expect the gross profit margin to be about flat to the second quarter at 40%. In the third quarter, we expect sales and marketing, research and development, and general and administrative expenses to also be about flat to the second quarter including the ongoing expenses of the brand awareness campaign and in its fourth calendar quarter, we expect the joint venture to deliver double-digit sequential growth. We expect our equity share of its earnings to be positive in our third fiscal quarter.
For planning purposes, our third quarter earnings release is scheduled for Thursday, March 23, 2006.
At this time, I’ll turn the call over to our CEO, Bruce Claflin.
Bruce Claflin, Chief Executive Officer
Thanks very much Don. Our fiscal second quarter marks another quarter of solid progress in the execution of our strategy. We generated our fourth consecutive quarter of sequential revenue expansion, and our year-over-year revenue growth of 22% is the best the company has reported in eight fiscal years.
In addition to the continued success we've experienced with TippingPoint products, this quarter demonstrated that we are gaining revenue traction across all our products. For example, heritage 3Com enterprise products; that is excluding TippingPoint and connectivity products, with a primary driver of our year-over-year top-line improvement delivering growth in the mid teens. Also of note is that this growth was in each of our geographic regions.
So that is the backdrop. I want to comment on our North American performance, last year after a very strong fiscal first quarter we experienced a substantial revenue decline in the second quarter. The primary reason is that our fiscal first quarter is a seasonally strong quarter for education, our largest vertical, while our second quarter is seasonally the slowest quarter for that vertical. We knew that the same dynamics would be at work again this year, but we believed our stronger portfolio of enterprise products and partnerships would offset this historic seasonality. They did, but not to the degree we had anticipated. Specifically, last year our sequential North American decline in our second fiscal quarter was 30%, while this year it was only 10%. Perhaps the best way to think about our progress in North America is on a year-over-year basis as we achieved a 44% growth, the best of any geography.
As Don mentioned, our EMEA and Latin American regions demonstrated strong year-over-year growth and sequential improvements this past quarter. Raul Ros who was named as Vice President and General Manager for our EMEA region three months ago has restructured his operation to put more focus on high-growth products such as security and Voice over IP, while continuing to drive our volume-oriented, small mid sized business through a dedicated organization. In addition, he is lowering the overall cost to serve this market. The vacancy his promotion created in Latin America was filled by Robert Ruiz and with 38% sequential performance, it's clear we did not miss a beat in that transition.
Let me turn to Huawei-3Com, the joint venture we formed two years ago with Huawei. Revenue for the joint venture's most recent quarter was a $111 million, a year-over-year improvement of 69%. Gross Margins were 42% and as a result, its operating performance was a modest loss of $2 million, which includes $7 million of amortization charges. Huawei-3Com now has more than 3,400 employees, 1,700 of whom are engineers. With this growth in engineering talent, the joint venture has taken increased responsibility to develop infrastructure products for 3Com. For example, the recently announced Switch 4500 is targeted to the SMB market and sold through 3Com's historically strong two tier distribution system. This is the first volume-oriented switch developed by the H-3C and is indicative of the increasing mission we have given them.
As a result of the success of Huawei-3Com, we successfully concluded negotiations with Huawei to acquire an additional 2% ownership, which upon completion would give 3Com majority control. We are in the process of obtaining government approvals and upon receiving them, we will consummate the transaction shortly thereafter. Being majority owner gives us several benefits: It provides stronger governance rights, it's reassuring to our customers, which supports our sales efforts, and it will allow us to consolidate the joint venture's financial results.
Let me close by commenting on our overall performance. We are very encouraged by revenue trends, as we have experienced two quarters of year-over-year growth and four consecutive quarters of sequential growth. For some time now we have said that improving revenue performance would result in improving financial returns. With the completion of the first half of our fiscal year, that has proven to be the case. Our gross margins this quarter are up 5 percentage points from where we ended last fiscal year, our operating expenses are down $8 million and our net loss before taxes has improved by over $20 million.
We accomplished all this while integrating the TippingPoint acquisition and negotiating rights to have majority ownership in Huawei-3Com. Having said that, we are a long way from being satisfied. Our intent is to continue to show progress on all three key measurement, top line growth, gross margin expansion and expense control, as we execute our strategy and drive to profitability in the coming fiscal year. Don and I would be pleased now to take your questions. Jennifer let me turn it over to you.
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