3Com Corporation F4Q08 (Quarter End 05/30/08) Earnings Call Transcript

Jun.24.08 | About: 3Com Corporation (COMS)

3Com Corporation (COMS) F4Q08 Earnings Call June 24, 2008 5:00 PM ET

Executives

John Vincenzo - Investor Relations

Robert Mao – Chief Executive Officer

Jay Zager - Chief Financial Officer, Executive Vice President

Ron Sege – President, Chief Operating Officer

Analysts

Manuel Recarey - Kaufman Brothers

Analyst for Jeff Evenson - Sanford C. Bernstein

Operator

Welcome to 3Com’s quarterly earnings conference call. (Operator Instructions) At this time I’d like to turn the conference over to Mr. John Vincenzo, Head of Investor Relations.

John Vincenzo

Thank you for joining us today to review our financial results for the fourth quarter and full year of fiscal 2008. With me today are 3Com CEO Bob Mao, our Chief Financial Officer, Jay Zager, and our President and Chief Operating Officer, Ron Sege.

Before I turn the call over to Bob, I would like to inform you that 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 activity, strategic initiatives, future financial performance, financial condition and cash flows, future expense control 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 without limitation 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 in tables at the back of the press release announcing our results attached as an exhibit to our 8-K for this earnings release, or on the IR portion of our website, www.3com.com. The press release is also available on the Investor Relations section of our website.

With that, I will turn the call over to Bob Mao.

Robert Mao

Thank you for joining us on the call as we review our results for the fourth quarter and our fiscal year 2008. I am here today with our Chief Financial Officer, Jay Zager, as well as our new President and Chief Operating Officer, Ron Sege. We will be walking you through the business highlights for the quarter and the full fiscal year and sharing specific details regarding our financial performance.

I will also offer some thoughts on my vision for the future of 3Com. I will start by spending a few minutes discussing three main topics; one, the priorities I have set for the company and examples of how we will achieve those objectives; two, observations and changes I have made during my first two months as CEO which I believe will help transform 3Com into a growth company on a global scale; three, key highlights on the quarter and year that I believe we can leverage to propel us toward profitable growth.

As a starting point I would like to outline my top priorities as we enter fiscal year 2009 and share with you some initial changes I have made. In terms of priorities, I have identified three key objectives for 3Com.

One, increase top line revenue. Two, accelerate the integration of our worldwide operations to achieve further operational efficiency, three, generating cash.

To drive top line revenue growth we must repeat the success we have had in China throughout the rest of the world. In fact our largest growth potential is to gain market share outside of China. Some people might ask the question, “Why would you focus on an area outside of China when growth in China has been so strong and key to 3Com’s recent success?” To me the answer is clear. In China, 3Com has achieved market share parity with Cisco. Together we account for around 70% of the enterprise networking market share. With two dominant players like this we cannot grow share at the same pace we did the past several years.

However, we can leverage our leadership position in China and use China as a home market for sustaining our overall competitiveness and for fast introduction of new products and solutions. An example of how we are doing this is with our successful launch in China of our new IP storage, IP video surveillance products and solutions.

Outside of China there is significant opportunity for 3Com to accelerate profitable revenue growth and take market share. As such I have reorganized our leadership team to specifically address this opportunity. First, in addition to his global operational responsibilities, Ron Sege will oversee our sales efforts in our Europe, Middle East and Africa (EMEA), North America and Latin America regions. We have shown we can grow in certain areas such as EMEA and Latin America. We now must take whatever we have learned, apply those successes in other markets and countries.

Ron also has responsibilities for our TippingPoint business helping maximize its value as it continues on its path to greater operational autonomy. We also have promoted Dr. Shusheng Zhang who runs our China operations as Executive Vice President of 3Com. In giving him additional responsibilities he will continue our China operations but he now will manage our entire Asia Pacific region as well.

It is not easy to take market share but we have shown we can do it in China and in EMEA. I believe we can and must do it in other markets around the world via go-to-market focus and the innovation, value and breadth of our product line. It is also clear that operating as one global enterprise is critical, moving away from a structure of H3C in China and DVBU in the rest of the world.

By integrating our worldwide operations we will put the full strength of our organization to use as we look to grow. First, we are moving to one worldwide product line management organization led by Ron, which will build one global product strategy. We also completed the integration of our R&D operations. Dr. Zheng will have responsibilities for this function although he will work very closely with Ron Sege in his role as head of our world PRM team to ensure we are meeting the needs of our global customer base.

This will promote tight linkage between R&D and our go-to-market functions to fully align how we develop, market, sell and support our products.

Next we have combined supply chain teams under one leader based in Hangzhou, China reporting to Dr. Zheng. This move places our supply channel division closer to our manufacturing base in China and to our ODM suppliers in parts of APR. We will maintain a global supply channel [inaudible] as we have customers as well as key component suppliers located throughout the world.

Finally, we are expanding the responsibilities of our regional managers to include responsibility for service and support in their particular regions. To date we have not maximized value from our service organizations and we believe that including services as an integral part of each sale’s P&L will help drive revenue and better meet the needs of our customers and channel partners.

Implementing these changes will not only result in cost savings but it will support our efforts to profitably grow our revenue and market share around the world and generate cash.

Now that I have talked about how we will operate going forward let me spend a few minutes talking about a few key results from the past quarter and fiscal year. Jay will get into more details in his review but here are the highlights from my perspective.

For Q4 sales were approximately $321 million compared to $311 million a year ago. Much of the increase was in China and EMEA. For the full fiscal year revenue was approximately $1.3 billion, about a 2% year-to-year increase. We also achieved a record gross margin of 54%. On a non-GAAP basis we were profitable for the seventh consecutive quarter and for the full year. In Q4 non-GAAP net profit was $36 million or $0.09 per diluted share compared to $4.6 million or $0.01 per diluted share in last year’s Q4. For the full year non-GAAP net income was almost $95 million or $0.23 per diluted share.

Also in Q4 we generated $63 million of cash from operations which contributed to our cash balance at the end of the quarter of almost $504 million. Growing revenue in all regions, with the exception of North America, the increasing gross margins and maintaining a strong cash position are all excellent signs that our business is moving in the right direction and are clear reasons why I am optimistic about this company’s future.

At the regional level to be successful a company must have the right cost structure as well as a differentiated product portfolio that meets the needs of its target customers and the go-to-market strategy to reach those customers. In Q4 and in fiscal year 2008 we had several markets we have shown we have the right product and go-to-market approach.

For example, on an annual basis, Latin America, APR and EMEA all experienced double-digit year-over-year growth. Our ability to grow in these key regions proved we are able to grow outside China. We now must accelerate this growth and execute consistently. To do this effectively we intend to invest in our direct touch sales force which will target enterprises looking for cost effective, high performance network solutions.

Consistent with what we discussed with you last quarter our North America region continues to be an area we need to improve. Revenue declined year-over-year which offset the gains in other regions. However, North America did show a sequential improvement and we have made management changes to help facilitate the turnaround in this key market. Many of you have seen the announcement from last week that we hired a new Vice President and General Manager for our North America business. We believe this new leadership will help improve performance in North America.

Moving on to our China business, H3C had revenue of $190 million and achieved the highest gross margin in its history. The team has done an excellent job in establishing 3Com as a significant business in the China market. In China our sales strategy is similar to how we approach all of our regional sales. We leverage our direct touch sales teams to create a level of customer intimacy while fulfilling the sales through our channel partners, or our channel partners sell our products on their own.

Since we founded the joint venture Huawei has been our exclusive channel to the Chinese carrier market. While early in our relationship, Huawei represented more than 30% of our H3C revenue. It now represents less than 25% and we are currently expecting this downward trend to continue. The rest of our sales in China come from our direct touch sales effort or through other partners. Enterprises buying via 3Com Direct Touch channels in China, our sales team has consistently won new business because the robust, high performance products we offer at attractive price points.

Organizations such as Beijing Capital Airport and the top four banks in China including the Bank of China turn directly to 3Com for their network solutions. As most of you know we formed H3C as a joint venture with Huawei in 2003. In March 2007 the joint venture ended when we bought out Huawei’s remaining ownership. The buyout figured the 18-month non-compete clause in the original shareholder’s agreement which expired at the end of this September. As is natural when a joint venture ends the partner’s relationship generally changes to reflect the new structure. We value our relationship with Huawei and we will continue to offer them the high quality products and support we have for the past five years to maintain that relationship.

In fact we are in the process of negotiating a new OEM agreement with Huawei as the current agreement runs through November 2008. We expect Huawei to continue to be a strategic partner and an important channel to Chinese carriers. However, it is important to note that going forward we expect revenue from Huawei to decline both in terms of absolute dollars and as a percentage of our revenue. At the same time we expect to expand our sales to carriers through traditional channels.

We have built a solid, growing and profitable business in China that we believe can be maintained going forward by growing direct touch sales and expanding our channels in China to help support additional revenue growth.

Moving on to TippingPoint, Q4 revenue was approximately $29 million compared with just under $24 million in our third quarter which included a $3.2 million one-time unfavorable adjustment. For the full year TippingPoint had revenue of close to $104 million, an increase of 15% over fiscal 2007 revenue. This solid performance was primarily driven by growth in North America and EMEA and includes key customer wins such as Fidelity, The U.S. Navy and [inaudible] the largest communications service provider in [inaudible].

In closing, I believe we have made significant progress in several key areas and we are taking the necessary steps to grow our business. The new leadership team is focused on accelerating the execution of our business plan and turning 3Com into a growing, profitable company. I look forward to speaking with you and sharing news of our continued progress through the days and months ahead.

With that I will now turn the call over to Jay Zager.

Jay Zager

Today I’d like to provide some insights on the fourth quarter and year-end financial results we just released and provide some guidance for our first quarter of fiscal year 2009.

Consolidated sales for the fourth quarter were $321.3 million, an increase of 3% from a year ago. Full-year 2008 sales were $1.295 billion, an increase of 2% over our fiscal year 2007. Our fourth quarter results included a $158 million or $0.39 per share non-cash impairment charge on the good will associated with our 2005 TippingPoint acquisition.

In our fourth quarter the overall reduction in the market capitalization of 3Com led to an accounting review of our reporting unit valuations. As a result of this review we have taken a charge to lower the TippingPoint book value. Primarily as a result of this charge we reported a net loss for the quarter of $166.7 million or $0.41 per share and a net loss for the year of $228.8 million or $0.57 per share. This compares to a net loss of $66.2 million or $0.17 per share for Q4 of fiscal year 2007 and a loss of $88.6 million or $0.22 per share for the full year fiscal 2007.

On a non-GAAP basis net income for the quarter was $35.6 million or $0.09 per diluted share compared with $4.6 million or $0.01 per diluted share in the year ago period. Our full year non-GAAP net income was $94.9 million or $0.23 per diluted share compared with our fiscal 2007 net income of $18.5 million or $0.05 per diluted share. Simply put, our 2008 full-year, non-GAAP net income has increased by more than five times from the fiscal 2007 level.

This non-GAAP portrayal excludes restructuring, amortization, in-process research and development, stock based compensation expenses and certain unusual non-recurring items the most significant of which in the fourth quarter was the TippingPoint impairment charge. A full reconciliation between GAAP and non-GAAP results and an itemization of exclusions for each period is included in the press release in Table C as well as on our web page.

Let’s look behind these revenue levels. Our H3C segment levels for the quarter were $190.0 million, 8% higher than a year ago but down 11% on a sequential basis. This sequential decline was expected and was due to the impact of the Chinese New Year. The H3C segment had full-year sales of $772.3 million up 6% from fiscal 2007.

Revenue for the fourth quarter for the data and voice business unit or the DVBU was $137.0 million, a sequential increase of 2% but a 1% decline over the prior year period. For the full year DVBU had sales of $551.0 million, essentially unchanged from one year ago. TippingPoint revenue for the quarter was $29.2 million, an increase of $5.6 million or 24% sequentially.

In the current quarter we had a favorable non-recurring revenue adjustment of $1.4 million while the Q3 results had included an unfavorable non-recurring revenue adjustment of $3.2 million. Including this adjustment TippingPoint revenue increased 18% over the prior year period.

Full year revenue for the TippingPoint segment was $104.1 million, a 15% increase over the fiscal year 2007 level. Inter company eliminations were $34.9 million for the quarter and $132.5 million for the full year. Eliminations take into account inter company sales between our business segments.

From a fourth quarter geographic perspective China revenue was $149.8 million, a 5% increase year-over-year and represented 47% of our total revenue as compared to 46% in the prior year. Europe, Mid East and Africa revenue was $74.2 million, an increase of 11% year-over-year and represented 23% of our total revenue as compared to 21% in the prior year.

North America revenue was $46.7 million, a 24% decrease year-over-year and represented 15% of our total revenue as compared to 20% in the prior year. The Asia Pacific Rim revenue which excludes China was $30.5 million, an increase of 28% year-over-year and represented 9% of our total as compared to 8% in the prior year. Latin American revenue was $20.1 million, an increase of 20% year-over-year representing 6% of our total revenue compared with 5% in the prior year.

From a fourth quarter product perspective sales from networking products were $261.2 million, 4% higher than a year ago. Sales from security products which include Tipping Point products and services as well as H3C and DVBU’s security specific offerings was $36.4 million, 13% higher than the year ago period. Sales from voice products were $12.6 million, a 25% decline over the prior year period primarily tied to our North American softness and sales of our service offerings were $10.3 million, up 13% from a year ago.

Let’s take a look at each segment’s performance in the fourth quarter. H3C revenue of $190 million reflects an 8% increase over the corresponding period a year ago. The majority of this increase is due to the strengthening of the RMB relative to the dollar. Direct Touch sales in China increase 24% from $81.4 million in Q4 fiscal 2007 to $100.6 million in Q4 fiscal 2008.

Sales to the DVBU which are not affected by the RMB currency fluctuation increased 26%. Sales to Huawei declined 19% year-over-year. Although Huawei remains H3C’s largest customer it is only about 20% of H3C’s business down from almost 35% in the prior period.

On a consolidated basis sales to Huawei were 15% of total corporate revenue. H3C’s gross margin in Q4 was 57.7%, the highest level in its history and 9.6 points higher than a year ago. This improvement is primarily driven by a shift in product mix to higher margin products and channels as well as cost improvements. H3C’s segment operating income was $40.4 million, 38% higher than a year ago and for the full year H3C’s segment operating income was $142.0 million, a 35% year-over-year increase.

DVBU segment revenue of $137.0 million was slightly below last year’s numbers.

We continue to be pleased with DVBU’s performance outside of North America. In Q4 Latin America and APR both had double-digit year-over-year growth while our EMEA region grew just under 10%. We continue to see softness in our North American performance with the year-over-year decline more than offsetting the gains in other regions. North America did have a sequential improvement of 12% and we believe that our new North American leadership team will improve performance in that region.

With the strength of our product lines and targeted go-to-market investments we can drive profitable revenue growth globally. We continue to deliver on our objective of increasing sales of H3C products throughout the DVBU. In the current quarter DVBU sold over $60 million in H3C source products up 1% sequentially and 7% over the year ago period. In our fourth quarter sales of H3C sourced products by the DVBU represented just under 45% of total DVBU sales.

DVBU gross margins were 33.1% in the quarter, an improvement of 1.2 points over the prior year period and a 0.9 point sequential improvement. DVBU reported a segment loss of $5.6 million in the quarter compared with a loss of $6.1 million in the third quarter. This loss was primarily attributable to the weakness in the North American performance and included a non-recurring royalty write down of $3.1 million.

TippingPoint Q4 revenue was $29.2 million compared to $23.6 million in our current quarter. As indicated earlier in the current quarter an adjustment of $1.4 million for non-recurring deferred revenue was recognized while the Q3 results had included an unfavorable revenue adjustment of $3.2 million. Within this total product revenue was $18.3 million and maintenance revenue was $10.9 million. Maintenance revenue represents an annuity revenue stream which is growing within the TippingPoint business.

TippingPoint’s gross margin in Q4 was 66.6%, a sequential decline of 3.5 points but an increase of 0.7 points over the prior year period. This sequential decline was driven by both mix and product sales as well as certain unusual manufacturing charges in the period. TippingPoint reported segment operating income of $300,000 in the quarter which included the $1.4 million non-recurring recognition of deferred revenue. This compares to a segment loss of $2.5 million in the prior year period.

From a consolidated viewpoint our gross profit was $173.7 million in Q4 or 54.1% of sales, a record high. This is slightly higher sequentially and a 9.6 improvement of the last year’s corresponding period. This year-over-year improvement was largely driven by cost improvements in our H3C and DVBU units as well as favorable mix of product sales.

R&D expenses were $51.6 million on a GAAP basis and $50.4 million or 15.7% of revenue on a non-GAAP basis. By comparison the fourth quarter of fiscal year 2007 had R&D expenses of $71.3 million on a GAAP basis and $43.2 million or 13.9% of revenue on a non-GAAP basis. It is important to note that the fourth quarter of fiscal 2007 had included a $27.2 million charge for the EARP vesting in our H3C units.

Sales and marketing expenses were $78.4 million on a GAAP basis and $76.6 million or 23.8% of revenue on a non-GAAP basis. The fourth quarter of fiscal 2007 had sales and marketing expenses of $89 million on a GAAP basis and $69.9 million or 22.5% of revenue on a non-GAAP basis. Again, the fourth quarter of fiscal 2007 included a $17.7 million charge for EARP vesting. We intend to continue to make selective investments in R&D and sales and marketing to grow our business.

General and administrative expenses were $50.3 million on a GAAP basis and $24.3 million or 7.6% of revenue on a non-GAAP basis. The fourth quarter of fiscal 2007 had G&A expenses of $28.8 million on a GAAP basis and $19.9 million or 6.4% of revenue on a non-GAAP basis. The fourth quarter of fiscal 2007 included a $6.6 million charge for EARP vesting. Our Q4 G&A results included certain one-time items that we excluded from our non-GAAP performance. Specifically a $9.0 million for a law firm success fee in conjunction with the Realtek jury award of $45 million, a $6.1 million write off for a VAT recovery dispute whose collection is no longer considered likely and a $4.9 million charge for the expensing of transaction costs.

To date we have not collected the Realtek jury award which we announced on April 10 but we are currently in active settlement negotiations with Realtek. We are also continuing to seek the $66 million break up fee from Bain Capital through the appropriate legal processes.

Included in our non-GAAP results are severance fees for the separation of our former CEO and a royalty write down. Collectively these charges contributed $3.8 million in G&A expense in the period. Headcount at the end of the year was 6,102 people, a reduction of approximately 200 people in the fiscal year. Looking forward we expect that while we will be making certain targeted investments in sales and marketing and R&D we will be able to continue reducing duplicative resources through our integration activities.

On a GAAP basis we had an operating loss of $190.4 million primarily resulting from the impairment charge taken in the quarter. The prior year operating loss was $93.3 million. On a non-GAAP basis our operating profit was $23.2 million or 7.2% of revenue compared with a non-GAAP operating profit of $29.0 million in Q3 and $11.7 million a year ago. For the full year the GAAP operating loss was $263.5 million compared to a loss of $132.5 million in fiscal 2007. On a non-GAAP basis full year operating income was $69.6 million compared to operating income in the prior year of $26.7 million.

Net interest expense was $2.7 million in the period while other income was $11.4 million primarily reflecting the recording of the VAT software subsidy at H3C. As a result of these factors we had a pre-tax operating loss of $181.6 million. In this period we had a benefit for income taxes of $14. 9 million. This included a release of $11.3 million in non-cash provisions for tax uncertainty which will result favorably in the period and a net tax benefit of $4.4 million at H3C.

Let me now turn to our balance sheet. At the end of the quarter our cash balance was $503.6 million compared with $466.0 million at the end of Q3. During the quarter we generated $63.3 million of cash from operations and we made a $35 million prepayment on our debt. For the full year our cash position declined $55.6 million as our cash flow from operations was more than offset by our debt payments of $130 million on our H3C loan and $93 million in incentives to H3C employees. Year-over-year our net cash position improved from $129.2 million to $202.6 million. In the first quarter of fiscal 2009 we expect to pay an additional $45 million in long-term incentives to our H3C employees.

Notes receivable were $65.1 million, down $41.5 million from Q3 and down $4.3 million from the prior year. Accounts receivable were $116.3 million, a $26 million decrease from the prior quarter but a $13 million increase from the year end fiscal 2007. Our DSO at the end of the quarter was 33 days compared to 38 days for the third quarter and 30 days at the end of fiscal 2007.

Our inventory was $90.8 million, down $2.8 million sequentially and $17.2 million lower than our year-end 2007 levels. Capital spending in the quarter was $4.6 million compared with $3.5 million in Q3. For the full year capEx was $17.9 million compared with $28.3 million a year ago.

Now I’d like to provide some insights into fiscal year 2007 (sic). Starting with our first quarter results we currently expect to be changing our segment reporting to align with the way we are managing our business. We intend to report our business under two segments; networking, which will include our current segments of H3C, DVBU and corporate functions and security which will reflect the results of our TippingPoint business. By point of reference the reported H3C $190 million of Q4 FY08 revenue consists of the following components:

Direct Touch sales in China of $100.6 million, international H3C sales including sales to the DVBU of $40.2 million and sales to Huawei of $49.2 million. The China revenue that I referenced in the geographic perspective included just Direct Touch sales in China and sales to Huawei. All other sales were reported in the region in which the sale occurred.

Looking forward we are forecasting consolidated Q1 revenues to be modestly above our Q4 levels in the $325 to $330 million range. Within this total we expect that Direct Touch sales in China will be essentially unchanged sequentially at approximately $100 million. This is about 15-20% higher than a year ago. We anticipate that sales to Huawei will be about 10% higher than the Q4 levels we just reported.

In Q1 FY09 in all other geographies our networking segment should deliver modest sequential growth. TippingPoint revenues should show a small decline from the reported Q4 levels which as we discussed included a positive $1.4 million adjustment. This will be about 10-15% above last year’s results.

On a consolidated basis we should see our gross margin percentage remain essentially unchanged while overall non-GAAP operating expenses will see a small sequential increase. As a result of these factors we anticipate that Q1 operating profits on a non-GAAP basis should be in the $15-20 million range. In Q4 we had a net tax benefit of $14.9 million. In Q1 we expect to record a modest tax provision and as a result we expect that non-GAAP earnings per share should be between $0.03 and $0.05. For the purpose of these non-GAAP estimates we exclude restructuring, amortization and stock based compensation.

As a result of long-term incentive payments being made in China we expect to see a reduction in our Q1 cash position to approximately $450 million. While we are not providing specific guidance beyond Q1 we do expect to see two significant trends in our second fiscal quarter in China. Number one is Direct Touch sales in China are expected to decline sequentially as many companies will temporarily halt networking buying decisions until after the 2008 Olympic Games and we also expect that sales to Huawei will decline from the Q1 FY09 levels.

Now I’d like to open the meeting to questions.

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from Manuel Recarey - Kaufman Brothers.

Manuel Recarey - Kaufman Brothers

Bob you had mentioned some leadership changes you had made to help with the integration. Can you give a little bit more color on what you are planning to do or how long is it going to take to peak from a systems perspective to get the company as one integrated entity?

Robert Mao

These integration efforts in the supply chain, [inaudible] and R&D are already ongoing and the benefits and cost reductions are starting to come in. As far as moving the company on to one IT system we are evaluating the steps toward moving in that direction.

Manuel Recarey - Kaufman Brothers

Have you made any decisions on what you are going to be doing with TippingPoint?

Robert Mao

TippingPoint, as we had said, is moving toward more economy since this is part of the direct responsibilities of Ron, I will ask Ron to add some more color on this.

Ron Sege

As Bob said we do continue to lay the groundwork for more operational autonomy but I think even in the meantime there is a couple of other things we can and are doing. One is just focus on improving the operational effectiveness. I think we can run the business better as it currently stands.

The second is to continue to invest in the business particularly in sales and marketing to grow the top line faster. We have a growing business, we are adding customers, and we’ve got a great brand. I’ve only been here two months but as I have gone around and seen customers in our worldwide field organization TippingPoint is a great brand. We broke $100 million in revenue for the last fiscal year and grew at a decent clip but I think we can do better even as we continue to move towards being a more autonomous company.

Manuel Recarey - Kaufman Brothers

In the North American region can you talk a little bit more about the economic environment out there? It did increase sequentially so are enterprises still reluctant to spend or is has their spending picked up a little bit?

Ron Sege

I’ve only been here for two months. Certainly we are feeling the effects of the economic slow down but frankly a lot of our issues are self inflicted. We had relatively small market share so we’ve got a lot of opportunity to do better even in a slow economy. I can’t say it has gotten worse or it has gotten better but I think the sequential improvement is more a function of our executing better than any changes in macro economy factors.

Operator

Your next question comes from Analyst for Jeff Evenson - Sanford C. Bernstein.

Analyst for Jeff Evenson - Sanford C. Bernstein

I was wondering if you think that gross margin in the mid 50’s are sustainable going forward?

Robert Mao

For the product mix we have been setting we think this is sustainable but as we continue to drive our overall revenue increase we may be addressing products in market segments where the gross margin may be somewhat lower than this. So it is sometimes a trade off between revenue growth, market share and gross margin.

Jay Zager

I would just add that there are obviously a lot of factors contributing to our gross margin performance. With a strong gross margin we obviously have the ability to use that as a tool where appropriate to drive incremental business. We have talked on prior calls about the opportunities we see in the supply chain to consolidate suppliers and we think that is going to have a positive effect on our cost of goods and a positive effect on our gross margin so there are several factors contributing and I think overall we should see the gross margin staying in the 50+% range at least for the foreseeable future.

Analyst for Jeff Evenson - Sanford C. Bernstein

How big is the education market for 3Com today and are you seeing any slow down in the education segment?

Robert Mao

We are not seeing a slow down in the education market. Of course the education market is seasonal and in the northern and southern hemisphere it is reversed. The answer to your question is overall we are not seeing a slow down in the education market.

Ron Sege

I would just add that yes the education segment is an important one for us.

Operator

Your next question is a follow-up from Manuel Recarey - Kaufman Brothers.

Manuel Recarey - Kaufman Brothers

The IPO fees write off and the patent litigation, are those all non-cash charges?

Jay Zager

No, they are cash charges. The items I referred to, the legal fees, contingency fees that I mentioned is a cash payment basically to cover our litigation costs of the Realtek litigation and just according to the quirks of accounting rules we record the costs before we can take advantage of the benefits.

The IPO cost we wrote down also, the $4.9 million, consist of costs that we incurred over the last twelve months around the IPO with TippingPoint and because we didn’t bring that to a full closure on a timely basis we decided it was prudent to record those costs as well.

Manuel Recarey - Kaufman Brothers

And the VAT recovery dispute again? If you can just review that for me again. What prompted that and is that in cash or non-cash?

Jay Zager

That again is a non-cash settlement where we were hoping to recover some VAT fees that were in question and we determined this quarter based upon input from our tax and legal folks over in Europe that the likelihood of recovery had gone down substantially so we took the charge but there is no cash associated with that charge.

Operator

That is all the time we have for questions.

Robert Mao

Well since there are no more questions thank you everybody for joining this earnings call. We look forward to more engagement with you as the days and weeks come in the future. Thank you.

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