3Com’s Turnaround Looks Promising

3Com, one of the key networking players with annual revenue of $1.3 billion, has been steadily improving. In its 3Q results for fiscal 2009 reported on March 19, 3Com Corporation (NASDAQ:COMS) reported a third consecutive quarter of profits that beat estimates. The company’s performance was driven by its cost control efforts and strength in China as well as in the TippingPoint (intrusion prevention systems, or IPS) business.

Q309 revenue, however, was down 3.5% to $324.7 million and also missed analyst estimates of $332.3 million and its own guidance last quarter. Net income was $1.9 million, or $0.00 per diluted share, compared with a net loss of $7.8 million, or $(0.02) per share in Q308. Non-GAAP net income was $49.1 million, or $0.13 per diluted share, compared with net income of $34.2 million, or $0.08 per diluted share last year.

But year-to-date revenue increased 5% to $1,021.9 million. Year-to-date net income was $94.6 million, or $0.24 per diluted share, compared with a net loss of $62.1 million, or $(0.16) per diluted share for the first nine months of the previous year.

3Com generated $100 million in cash from operations in the third quarter. Its cash and cash equivalents balance at the end of the quarter was $560.0 million. Non-GAAP operating expenses declined sequentially by more than $12 million. Spending declined to $1.3 million from $3.7 million and travel expenses declined 30% q-o-q. Non-GAAP gross margin was 57.4%, an improvement of 4 percentage points as a result of changing product mix and shift toward the high margin enterprise business.

The slow economy is forcing more and more enterprises to look for a networking alternative at a lower price. Its enterprise business now accounts for 75% of total networking revenue up from 69% last year. Last quarter, it signed an exclusive distributorship agreement with Inspira Enterprise in India. Inspira will emphasize integrated end-to-end 3Com solutions focusing on the enterprise market.

By segment, TippingPoint sales were up 40.8% to $33.3 million. Networking revenue declined 6.7% y-o-y and 9.9% q-o-q to $293.2 million with China-based networking revenue of $190.4 million.

Within the China segment, sales to telecom solutions provider Huawei accounted for 17% of total 3Com sales and 29% of China-based sales. In the first quarter since the non-compete agreement with Huawei expired, sales declined 8.2% y-o-y and 12.5% q-o-q to $55.8 million.

In December’s Networking Sector Overview I discussed how the low-cost Chinese structure is driving 3Com’s performance. China-based revenue, which includes revenue from China, Hong Kong and Japan, accounted for about 59% of the total revenue in the quarter and grew 6% y-o-y and 4.7% q-o-q despite a slowdown in China’s economic growth from 12% per year to high single digits.

The rest of world networking segment had sales of $102.8 million, down 24% y-o-y. Revenue from North America declined 12% y-o-y and 21% q-o-q to $24.0 million, EMEA declined 35% y-o-y and 16% q-o-q to  $43.6 million, Latin America declined 3% y-o-y and 20% q-o-q to $19.9 million, and Asia-Pacific was down 21% y-o-y and 16% q-o-q to $15.3 million.

For Q4, 3Com expects revenue to be lower than Q3 due to the impact of the Chinese New Year and the economic downturn. Q4 revenues are projected to be in the $290 to $300 million range with China-based sales declining 15% q-o-q. Non-GAAP EPS is expected between $0.04 and $0.06 for Q4 and $0.39 and $0.41 for full year 2009.

In Q4, 3Com plans to make a $13 million of prepayment on its outstanding loan balance, which will further reduce it to $200 million from the original $430 million loan. It will also pay yearly bonuses to its Chinese employees and therefore expects the cash balance at end of Q4 to be slightly higher than Q3 and full-year cash from operations to exceed $200 million. The stock is currently trading around $3 with a market cap of about $1.2 billion. It hit a 52-week high of $3.32 on March 27, not bad progress at all in this dreadful down market.