3Com Excels in China

Amidst the gloomy economic background, there is a bright spot in the form of 3Com, a major networking player with annual revenue of $1.3 billion. Last month, on December 18, in its Q209 results, the company reported another strong quarter that beat estimates. This is the second consecutive quarter that 3Com has reported a profit and beat estimates. In my recent Networking Sector Overview, we explored how 3Com, with its Chinese cost structure, could give Cisco a run for its money.

Revenue for the second quarter was up 11.6% and 3.5% q-o-q to $354.6 million. Net income was $12.9 million or $0.03 per diluted share versus net loss of $35.6 million, or $0.09 per share last year. Non-GAAP net income was $46.9 million or $0.12 per diluted share versus net income of $13.0 million, or $0.03 per diluted share last year. Analysts were expecting earnings of $0.09 per share on revenue of $341.8 million.

Robert Mao, 3Com’s CEO, has executed well on his three key objectives to turnaround the company: revenue growth, margin improvement and cash generation. 3Com achieved the highest gross margin in its history. Non-GAAP gross margin was 56.5%, a seven-point y-o-y improvement driven mainly by favorable product mix, as well as product cost reductions. The company generated $56.8 million in cash from operations in the quarter, and its cash and cash equivalents balance at the end of the quarter was $460.8 million. 3Com bought back shares worth $50 million. It also paid off $88 million of its long-term debt, reducing the balance to $213 million from an original loan of $430 million. Q1 analysis is available here.

Revenue growth was driven by the company’s China operations, which grew 29% y-o-y and 14% q-o-q. The Tipping Point segment also saw strong revenue growth of 20% to $31 million. Revenue from Latin America was $25.1 million, up 14% y-o-y and 7% q-o-q.  Asia-Pacific revenue was $18.2 million, up 11% y-o-y and down 14% q-o-q. However, the weakening global economy affected 3Com’s performance in North America and Europe, the Middle East and Africa.

Within the China segment, sales to telecom solutions provider Huawei grew about 25% y-o-y and accounted for about 18% of total revenue. 3Com’s non-compete agreement with Huawei expired in September 2008, and their OEM agreement has been extended for another two years under the existing terms. Though Huawei will remain a strong partner, 3Com now expects that sales to Huawei will decline by about 20%.

For Q3, 3Com expects revenues to be in the $330 to $340 million range, equating to 4% to 7% y-o-y growth and a 4% to 7% sequential decline. It expects non-GAAP Q3 operating profits in the $33 to $38 million range and non-GAAP EPS between $0.10 and $0.11. Finally, the company expects the cash balance at the end of Q3 to cross $500 million. The stock is currently trading around $2.40 with market cap around $950 million. It hit a 52-week low of $1.43 on November 21.