Foundry Networks Q3 2007 Earnings Call Transcript

Foundry Networks (FDRY)

Q3 2007 Earnings Call

October 25, 2007 5:00 pm ET

Executives

Mike Iburg - Treasurer

Bobby Johnson - President & CEO

Dan Fairfax - CFO

Analysts

Cobb Sadler - Deutsche Bank

Troy Jensen - Piper Jaffray

Tim Long - Banc of America

Jason Ader - Tomas Weisel

Nigel Frankson - Citigroup

Ken Muth - Robert Baird

Mark Sue - RBC Capital Markets

Long Jiang - UBS Securities

Manny Recarey - Kaufman Brothers

Tim Daubenspeck - Pacific Crest Securities

Subu Subrahmanyan - Sanders Morris

Matt Robison - Ferris, Baker Watts

Erik Suppiger - Signal Hill

Presentation

Operator

Good day ladies and gentlemen and welcome to today's teleconference. At this time all participants are in a listen-only mode and later you'll have the opportunity to ask questions during our Q&A session. Please note that this call may be recorded. I'll now turn the program over to Mr. Mike Iburg of Foundry Networks. Go ahead sir.

Mike Iburg

Thank you. And good afternoon everyone. Thank you for joining us for the Foundry Networks Third Quarter 2007 Financial Results Conference Call. I am joined today by Bobby Johnson, President and Chief Executive Officer; and Dan Fairfax, Chief Financial Officer of Foundry Networks.

Earlier this afternoon, the Company issued a release reporting this third quarter financial results. This release can be accessed from our Investor Relations section of Foundry's website at www.foundrynet.com. For reference, we have arranged for a taped replay of this call, which may be accessed by telephone. This replay will take effect approximately one hour after the call's conclusion today, and will be available for seven days. The dial-in access number for this replay is 402-220-2653. This call is also being webcast live with a web replay also available. These may both be accessed from the Investor Relations section of Foundry's website.

Before we begin, I'd like to make a brief statement regarding forward-looking remarks. Today's call contains forward-looking information regarding future events and the future financial performance of the Company. We wish to caution you that such statements are just predictions and actual results may differ materially as a result of risks and uncertainties that pertain to our business. We refer you to the documents the Company files periodically with the SEC, specifically the Company's recent quarterly report on Form 10-Q and annual report on Form 10-K for the year-ended December 31, 2006.

As well as the Safe Harbor statement in the press releases the Company issued today. These documents contain important risk factors that could cause actual results to differ materially from those contained in the Company's projections or forward-looking statements. Foundry assumes no obligation to revise any forward-looking statements contained in today's call.

In addition, today's call may reference certain Foundry customers in the markets we sell our product, including the different vertical markets, such as our enterprise, federal or service provider markets. Due to the nature of our ongoing contractual obligations with these customers and other competitive factors, we typically will not provide the name or scope of these customer relationships during the call.

I would now like to turn the call over to Bobby Johnson, President and CEO of Foundry Networks. Bobby?

Bobby Johnson

Thank you, Mike. And good afternoon, everyone. I am pleased to announce that Foundry continued its revenue momentum and achieved record results for the fifth consecutive quarter during the third quarter of 2007. For the quarter, we posted record revenue of $159.5 million, and a 34.2% increased over the last year and 11.3% increased over the second quarter revenue of $143.2 million.

During the quarter, we are again set both new all time enterprise and service provider quarterly revenue records. Worldwide enterprise revenues represented approximately 75% of our total revenues. Our overall enterprise record was fueled by strength in our U.S. federal business which represented 22% revenues. Compared to this years second quarter, our federal revenues were up 115% sequentially.

In the service provider markets, our revenues increased to 25% of total revenues. Our service provider business grew 21% sequentially and was up 68% year-over-year.

Overall, we saw strength across all of our major product lines with all major product areas setting new record times. In addition to these records I'd like to highlight the several other key financials successes for the quarter. These key successes included, number one, our router growth was exceptional and it increased 41% sequentially. This growth included our first revenue shipments of our new high-end 32-slot systems.

The second highlight is that our non-GAAP gross margins improved to 63.4%. This margin improvement was driven by manufacturing cost savings, support efficiencies and a shift to higher-end higher gross margin products.

The third highlight is that we began to execute on our previously discussed stock repurchase program. Throughout the quarter we spent $38 million repurchasing 2.1 million shares. The fourth highlight is that over and above our stock repurchase program, we generated an incremental $25 million in cash for the quarter and ended with a strong cash position of $946 million.

The fifth highlight was that our book-to-bill ratio was equal to one. The sixth highlight was our annualized revenues per employee increased to approximately $717,000, one of the highest revenues per employee performances in the networking industry.

In summary, our revenues, gross margins, operating margins, cash flow, market acceptance and new product shipments, all operated together to bring record financial results for this quarter. Overall, we were especially pleased with the strong Federal rebound, a continued momentum in the service provider market. As the third calendar quarter is the fiscal year end for the U.S. Federal Government, our revenues were strong and we had wins across many different government agencies.

For the service provider market we had success in many different applications and markets including the wired and wireless metro and regional backbones, content delivery and data center applications.

As a part of our success, in both service provider and high end enterprise markets, our router revenue continues to grow steadily, increasing approximately 41% sequentially and 178% year-over-year. This increase does include initial revenues shipments of our new ultra high performance 32-slot systems.

Initial customer applications include Internet Exchanges, UltraNet, high speed our Ethernet Internet Service Backbones and high performance supercomputing cluster fabrics. We have approximately 325 customers deploying our Internet and Metro router platforms for these, plus other applications.

For a detailed review of our Q3 financials, I will now turn the call over to Dan Fairfax, our Chief Financial Officer.

Dan Fairfax

Thank you, Bobby, and good afternoon everyone. I will take the next few minutes to present the financial results for our third fiscal quarter ended September 30, 2007. Foundry posted record quarterly revenue for the third quarter of 2007 of $159.5 million, as compared to $118.8 million in the third quarter of 2006 and $143.2 million in the second quarter of 2007. This represents an increase in revenue of 34.3% over the prior year and 11.4% sequentially.

Our investments in expanding our sales force, and the depth of our refresh product portfolio, are continuing to drive Foundry's growth. During the third quarter a key area of strength was our federal business, which represented 22% of total sales.

Sales were seasonally strong in the third quarter, benefiting from the fiscal year end of the Federal Government. But our success in this market goes well beyond the seasonal rebound and can be attributed to our investment in our federal vertical market development, including our focus on diversification of our sales efforts, the various entities and agencies within federal, the state of art products, and our improving ability to navigate the unique federal market space.

The sequential increase in revenues from the second quarter was more than 100%. Let me provide you now with the geographic breakdown of our revenues.

Our North American commercial revenue increased 48% year-over-year and represented 52.5% of total revenue. Sales to Europe, the Middle East and Africa or AMEA region, represented 12.2% of the total revenue in the period, growing 12% year-over-year. Both regions were impacted by normal summer seasonality, as we had expected, and experienced a modest sequential decline.

Sales to Japan represent a 5.4% of revenue, down slightly as a percentage of revenue from the June quarter, but up in absolute dollars. We also experienced good growth in our rest of Asia region, with particular strength in China, as we entered another phase of deployments with Baidu: the dominant Chinese search engine.

GAAP net income for Q3 was $27.6 million, or $0.18 per diluted share, compared to net income of $12.2 million, or $0.08 per diluted share, in the third quarter of 2006. A net income of $15.6 million, or $0.10 per diluted share, in the second quarter of 2007.

Included in Foundry's results for the third quarter of 2007 was $13.3 million of non-cash stock-based compensation expense. Excluding these expenses and the related tax effect, non-GAAP net income for the third quarter of 2007 was $35.9 million or $0.23 per diluted share.

Foundry uses non-GAAP net income and non-GAAP net income per share for internal planning purposes to assess the results of its business on an ongoing basis and for the convenience of the analysts and investors. These measures are not in accordance with, or an alternative to similarly-named measures under GAAP. Contained in our press release is the reconciliation of GAAP to non-GAAP for further reference.

Now, additional breakdown of our revenue we have got a couple of other items here. Our overall domestic revenue was 74.5% of our total business. And international sales represented 25.5% of total revenue, compared with 73.4% for domestic, and 26.6% for international sales in the second quarter.

Although impacted, slowly by normal summer seasonality, enterprise customers accounted for approximately 75% of our total revenue during the third quarter. Our service providers significantly advanced growing to 25% of the total revenue, compared to 23% in the second quarter, this was due to increased later sales in Q3.

Our service provider business grew 21% sequentially and 58% year-over-year. Revenue from our chassis based products represented 71.3% of revenue in the third quarter of 2007.

Revenue by product category was as follows, for our layer 2-3 switches 58.6%, Internet and Metro routers was 17%, layer 4-7 was 10.3% and our service and support revenues for 14.1%.

Revenue for the first nine months of 2007 was $438.6 million, compared to the $341.2 million, for the first nine months in 2006, a 28.5% increase year-over-year. Net income for the first nine months of 2007 on a GAAP basis was $52.3 million, or $0.34 per diluted share, compared to GAAP net income of $23 million, or $0.15 per diluted share, for the same period of 2006.

Before I begin discussing our gross margins and operating expense, I'd like to point out the figures I discussed next are all non-GAAP numbers. We have excluded certain charges including stock-based compensation to make our results more comparable to prior periods and to those reported by other companies. The detail GAAP to non-GAAP reconciliation again can be found in the press release we issued earlier today.

Our gross margins increased to 63.4% in the third quarter, representing a 280 basis point improvement from the second quarter on gross margins of 60.6%. Q3 margins benefited from favorable product mix, reduced manufacturing cost and a beneficial pricing environment. Product gross margins were 60.1% for the third quarter, representing a 260 basis point increase from the second quarter level of 57.5%. And our service gross margins were 83.2% for the third quarter, representing a 560 basis point increase from the second quarter level of 77.6%. Our service gross margin improved principally due to more effective support inventory management in the third quarter.

Details of our operating expenses are as follows. Foundry's Research and Development cost increased to $13.5 million, this is 8.4% of revenue in the third quarter. And the reduction was due to a lower prototyping expenses following the release for the new 32-slot routers. This was compared to $14.4 million or 10% of revenue in the second quarter of 2007.

Sales and marketing expenses decreased to $33.3 million, or 20.9% of revenue in the third quarter helped primarily by the planned seasonal decrease in expenses associated with our trade show and marketing activities. This compared to $34.6 million or 24% of revenue in the second quarter of 2007. We are typically focused on marketing efforts and related spending on the first, second and fourth quarters where we see a higher yield from our working investments.

General administrative expenses were $8 million, or 5% of revenue for the third quarter, compared to $10 million, or 7% of revenue in the second quarter of 2007. This decrease was primarily driven by lower legal accounting expense, as a result of our expanding top line, improved gross margins and operating expense improvements. Our operating margins increased to 29% significantly higher than our long-term target range of 20 to 25%. Our tax rate for the quarter was 37.8%.

Now let me turn to the balance sheet for a few comments. On our last earnings call we discussed the $200 million share repurchase program our Board of Directors approved in July. During the third quarter we repurchased approximately 38 million or 2.1 million Foundry shares at an average price a $17.84.

Our Board has directed us to execute repurchased opportunistically through December of 2008, taking advantages where possible of natural volatility of our share price. Together with the Board, we will continue to reassess our liquidity needs in the future particularly in light of our focus on potentially acquiring technology, products or companies.

We anticipate continuing to purchase shares from time to time depending on market conditions and other factors in accordance with Securities and Exchange Commission requirements. We would like to reiterate that it is our objective to complete the $200 million buyback within the time allocated by the Board, and we'll continue to report our progress on a quarterly basis.

The Company's cash and marketable securities balance grew by $25 million in the third quarter 2007. The total value of cash and marketable securities now stands at $946 million. During the quarter $32.5 million in cash was generated from stock option exercises.

Our day sales outstanding and accounts receivable was 63 days in Q3, up from 56 days in the second quarter. Although our linearity on orders was very good, actual shipments were more back end loaded during the quarter and caused our DSO to extend out several days. We do not see any particular risk of delayed payments though in outstanding receivables.

Our net inventories were essentially flat quarter-over-quarter in absolute dollars, resulting in our inventory turns improving sequentially. In Q3 our book-to-bill was equal to one, meaning that the flow of new orders in the quarter was essentially equal to the reported revenue. And put in other way our back log neither increased nor decreased in the quarter.

As you may recall we ended July with an unusual large back log of federal orders coming out of the June quarter. These orders were shipped for revenue in the third quarter. And the federal revenue reflected in today's results includes several million dollars attributed to this Q2 back log carry forward.

We ended the quarter with a total headcount of 890 employees compared to 873 in the second quarter of 2007. The increased personnel in Q3 were primarily in engineering departments, as our sales organization grew more modestly this quarter.

Consistent with our practice, we will not be providing formal quantified revenue or EPS guidance. We would however like to provide a qualitative view at the current quarter.

Looking at the fourth quarter, we believe that our North America European commercial businesses have re-bounced seasonally from Q3's summer time level, which showed solid growth for 2007. We are currently not experiencing any direct impact from the current credit crunch and the financial services market.

Regarding our federal business, in each of the last two years, our fourth quarter sales total up well and were in parity with our strong third quarter results. As previously discussed the strong federal revenue in Q3 of 2007 was helped by several million dollars of additional backlog carried forward from Q2.

We once again expect our federal order flow from the fourth quarter to be consistent with the third quarter. Therefore, as we look at the fourth quarter revenues, we would expect federal revenue to be down from Q3 and not equal to the small unusual opening federal backlog balance from the second quarter.

With respect to our service provide business, we expect service provider revenues continue to grow faster than our overall enterprise business, as our router business continues to expand and most large accounts begin meaningful deployments.

As discussed in the last call, the number of engagements with Tier 1 service providers as well as Tier 2 and Tier 3 service providers, continue to demonstrate our ability to bring value and to complete well in this market. And deliver increasingly meaningful results. Although, we cannot always predict the exact timing of each deal, the opportunity in front of us and the momentum we are seeing today is exciting.

With respect to our target operating merger range of 20% to 25%, although we have delivered results well above the range in Q3, in the fourth quarter we would expect our operating expenses to increase. The increases will come from the planned increase in sales and marketing activities and an increase in sales recruiting and personnel costs.

We still believe that 20% to 25% is an appropriate long-term operating margin range for the company. However, despite our planned operating expenses estimates in Q4, we expect that Foundry will perform above the target range in the fourth of 2007.

Now with those comments, I will turn the call back over to Bobby.

Bobby Johnson

Thank you, Dan. Foundry is continuing to be a leader in the high performance IP, switching, routing and application delivering network sectors. We continue to focus on market share gains and on building a balanced enterprise and service provider company. Our last five quarters have been very positive for Foundry, as we've continued to execute well. Our performance reflects the success in our investments, in expanding our worldwide presence throughout branding, and expanded sales utilization the timing and execution of our product launches.

Our strategy of diversifying within our U.S. Federal business to branch on to new agencies is continuing to be successful and continues to give us optimism for the long-term. Additionally, we continue to focus new efforts on our expanding service provider business, and we believe we will continue to gain traction in key strategic accounts. Our strategy and execution our major goals, continues this year much the same as last year.

Specifically throughout this year we've three key objectives. We'll continually endeavor to introduce leading edge products and price performance and features into our targeted and adjacent markets. We'll continually endeavor to create even bigger Foundry brands and keep its products in our customer’s minds and networks.

And, we will continually endeavor to increase our sales force and sales presence in both established and new territories for Foundry. We believe that the investments we have made and continue to make in the business will drive improved performance and establish a stronger foundation for the longer term.

In closing, I would like to thank all of our employees, partners, customers and shareholders for their commitment to Foundry.

Now I'd like to turn the call back to Blake to open up our question-and-answer period.

Question-and-Answer Session

Operator

(Operator Instructions). It looks like first we'll go to the side of Cobb Sadler of Deutsche Bank. Go ahead please.

Cobb Sadler - Deutsche Bank

Hey, thanks a lot guys. I had a question on the Federal Government, and it sounds like its going to be your run rate at least flat quarter-on-quarter adjusted based on the adjusted business, which exclude some carrier revenue. But, can you talk about the level or rate at which you're winning new programs, just kind of looking out maybe six to 12 months. There is a number of programs that should be designed into winning of the government, is that going up or it is about the same and you are just getting additional business within the deal that you've already won? Thanks a lot.

Bobby Johnson

So this is Bobby. I think it's somewhere between above the same and up as we've increased our presence both going deeper into existing agencies and programs, but we are also getting into new programs. So, we are operating above as well and Federal as we ever have. And as we said, as we continue to focus on Federal, we are pretty optimistic for the long-term.

Cobb Sadler - Deutsche Bank

Okay, great. And then on the Carrier Routing side, it sounds like you don't want talk about customers, but can you talk about the size of deals that you are looking. It sounds like you have done a very good job from North American and Asia ISP type customers, but on some of the bigger customers, the kind of Tier 1 type customers. Wouldn’t you think those deals might start contribute, are they long sales cycles and what's the overall level of interest that you are seeing out there versus the two other big competitors that you have?

Bobby Johnson

It is a competitive environment. We have a great deal of interest. We purchase orders, do take a while, and we can fluctuate from just a couple of systems to multiple systems, and they usually come in waves. So, its not necessarily any one quarter, it’s the cumulative effect over a long term. And I’ll give you a range that we might do $25,000 on one account, or we might do a $3 million, an account a given quarter.

So, that is kind of unfortunately the range, it's all over the map and it is honestly tied to specific counter quarters, its tied to the roll out and economies etcetera. So, overall, once again, kind of like the federal response, we're operating at the top of our game so far, and we are very optimistic on much longer term.

When you measure it over time, the 32-Slot device started shipping for revenue last quarter. It has a great deal of interest across the board in a wide range of service providers, but also very high in enterprises and any particular in what we call the HPC the high performance cost to computing sector. So, it goes into government agencies, it goes in the universities, it goes in to service providers. And so we are seeing substantial interest in that platform.

Cobb Sadler - Deutsche Bank

Okay. Thanks a lot.

Operator

Next we'll go to the site of Troy Jensen from Piper Jaffray. Go ahead please.

Troy Jensen - Piper Jaffray

Congrats on the nice quarter, gentlemen.

Bobby Johnson

Thank you.

Troy Jensen - Piper Jaffray

So, a quick one on the router side, I know you got a lot of question on here. But, can you tell me were there any Tier 1 revenues in the September quarter?

Dan Fairfax

Yes, we had Tier 1 revenues in the third quarter.

Troy Jensen - Piper Jaffray

Okay. Perfect. And all of that, it is safe to assume, all the router sales are a service provider sales?

Dan Fairfax

No. That's not true.

Bobby Johnson

This is Bobby. I've mentioned that the routers, there are several key metrics here. One is service provider total, enterprise total or which federal is account of the enterprise. The routers spread across high in enterprise. They go to some federal agencies. They go to a lots of service providers, so, its kind of spread across, larger scale, application, larger scale customers.

Troy Jensen - Piper Jaffray

Yes. So this is the follow-up thing, it looks like historically your mix between enterprise and service providers has been 80:20 for a long time several years. I guess, I thought that the service provider piece will be higher now at the router growth. Can you comment on your Ethernet switching business on the carrier market? How that has been doing recently?

Bobby Johnson

As we mentioned, overall, the Ethernet switching, and router, and overall service provider markets, are all at a post bubble high.

Mike Iburg

Yeah, Troy. This is Mike. I think we are pretty please with the progress that we have made, certainly going from 20% of the total revenue to 25% of those total revenue, is a huge step forward and almost all that growth is router driven. As Bobby said, the routers do find their way into a few large enterprise and few large government agencies, but a vast majority of the router revenue is service provider. The one thing that we've seen over that time is that we have not really seen cannibalization of our Layer 3 Switching business within the service provider market. So that’s still continues on a consistent pace as we seen in the past, but a lot of the business that we've added in the service provider market, which I think Dan quoted at 68% year-over-year growth, that’s router growth.

Troy Jensen - Piper Jaffray

Okay. It's perfect, keep up the good work.

Mike Iburg

Thank you. Next question?

Opeartor

Our next question comes from the side of Tim Long of Banc of America. Go ahead please.

Tim Long - Banc of America

Thank you. A question on the U.S. commercial business then I'll have a follow-up after that. You talked a little bit about the backlog, the strong federal performance coming out of a lot of backlog you had entering in and the backlog was flat. So should we assume that a lot of that was build in with commercial and then when you said, you talked about a rebound, really two of the last three years we saw really huge jump in North American commercial. Are we seeing a modest jump this time around or should we expect a pretty major rebound, because the climate of the industry because of the federal business.

Dan Fairfax

Let me address that, this is Dan, addressing the backlog question. So your supposition is correct; what we had is the as federal backlog was really replaced by enterprise and commercial backlog.

Bobby Johnson

And overall we're fairly optimistic, all enterprise sectors on a going forward basics.

Tim Long - Banc of America

Okay. And then may be if I could just follow-up on the gross margin side, you mentioned several factors, I'm just curious about a favorable pricing environment: what does that mean and how sustainable is that? And also just the other support efficiencies in manufacturing just, if you could just give us sense as to how sustainable you think those are particularly the pricing?

Dan Fairfax

Frank, we were pleased with the pricing environment. I don't think we believe right now that that's shifted on us, don't know how sustainable that will be, certainly competitors are making noise about entering some of our markets and that may change the dynamic there.

Bobby Johnson

This is Bobby. Certainly there is pricing pressure at the lower end, but at the higher end we have a price performance advantage. So when we take a look at our blended business, where we can sell a “higher end products” blended with some of our “commodity products”, for lack of better word. Things will work out well for us. And so where there is a shift toward a higher end enterprise federal service provider your model really gets kicked in and our operating efficiencies really show. And I think, as Dan talked about and as you can see in our model we are above long-term model for the quarter. Obviously, we got to continue to work on all areas of growth and efficiencies, but there will always be products shocker waves etcetera, but in general we are pretty optimistic and bullish.

Dan Fairfax

And to your question on the gross margins, so we have been talking on the prior calls about expecting to see some costs efficiency from our newer generation of 10 gigabit products, and really start to see that significantly in this quarter. So, that's something that you can expect, which we know that we have further room for improvement and should see some more upcoming.

Tim Long - Banc of America

Okay. Thank you.

Operator

Next we'll go to the site of Jason Ader from Thomas Weisel, go ahead please.

Jason Ader - Tomas Weisel

Yeah thank you. Just wanted to see if you guys could give us a ballpark number for the Q2 carry over backlog from federal, just because it would help tremendously to sort of just get the slice there, is it $5 million to $10 million, less than $5 million?

Mike Iburg

Hi, its less than $5 million, this is Mike. I think we've sized it at several million in the past and I think your ballpark getting in the several million dollar range.

Jason Ader - Tomas Weisel

So, federal shouldn't be down dramatically then based on that?

Mike Iburg

No from what we said today, we think it will be down several million which was what was the size of the backlog that we carried over out of June.

Jason Ader - Tomas Weisel

Okay.

Mike Iburg

So we think it hold up pretty well.

Jason Ader - Tomas Weisel

So, service providers are growing faster than enterprises, federal is down only a few million in North American, European has solid growth. Is there any reason to think there wouldn't be sequential revenue growth in Q4?

Mike Iburg

We feel very comfortable with Q4 revenue and continued growth of the business to the end of 2007.

Jason Ader - Tomas Weisel

Okay.

Bobby Johnson

A lot depends upon macro economic things. But right now.

Mike Iburg

Yeah, all things been (inaudible) pretty good and I don't think all the guidance are this good as our guidance, but all the qualitative commentary that the Dan has provided in his outlook section point in the direction that you summarized.

Jason Ader - Tomas Weisel

And then last follow-up, just obviously you guys have been performing very well. You have a technology refresh that's helping. Is there anything going on competitively, that’s helping, is there anything on in Cisco or some of your other competitors that is helping you, either, from an execution stand point or from the product standpoint?

Bobby Johnson

Well, the primary thing is that we do have an expended sales balance. We've got more product appliance compared to our competitors. We continue to be re-performance company. We were the first gigi vendor, first in the research, then first 10 gigi vendor coming in to pass a 1 billion package and 2 billion package in the second. So, when people think performance, they think Foundry and so that all helps. And as you can see in general, we are optimistic on the overall enterprise and service provider economies, so we are just continuing to put one foot in front of the other and focus on really a longer term horizons.

Jason Ader - Tomas Weisel

Okay. Thank you.

Operator

Next we'll go the site of Paul Mansky from Citigroup. Go ahead please.

Nigel Frankson - Citigroup

Hi. This is Nigel Frankson calling in for Paul. Can you tell us what the router sales growth was quarter-over-quarter excluding the new routers XMR 3200 and the MLX 32?

Dan Fairfax

Short answer is no, we don't have, we just have the total sequential growth in front of us. We don't have the XMR 32 slot numbers in front of us. We can't tell you that, we would be in the 32 slot chassis in the second half of September, they ship for us in about two weeks. And so, the initial volumes, because of the short runway, is relatively small. So, we saw growth in the overall platforms both the XMR and the MLX, so it was not necessarily entirely driven by the 32 slot platform. Did that help?

Nigel Frankson - Citigroup

Yes, it does, thanks. And one last question. In the past year, you commented that the PBT market is one that you're watching and one that Foundry may look to invest in it at some point in the future, if you deem it where the opportunity. I thought your information if you could give us any kind of an update there anything that’s changed, anything that you have seen, anything at all?

Bobby Johnson

PBT is a very interesting technology to us. There's a lot of other technologies as well. We won't do initially our product announcements on the earnings call. So there is many different technologies, many different things we're adding to our products. And I would just say Foundry continues to focus on both near-term and long-term, customer needs and stay tuned.

Nigel Frankson - Citigroup

Thank you.

Operator

Next we will take a question from the side of Ken Muth from Robert Baird. Go ahead please.

Ken Muth - Robert Baird

Hi. On the operating margin question, your guidance is still kind of longer term a 20 to 25, given you guys have always consistently been a conservative spender on your dollars you are. Just trying to figure out how you would able to take your numbers that low, what is kind of the Federal not taking your guidance up just a little bit and not too much, but I am saying it seems like its almost unapproachable, you guys were dipped down sequentially that meaningful or even for the next year?

Bobby Johnson

Well, there is many different ways to answer the question. First of all, we're just happy to be operating at this higher level. Second of all, we need to continue to invest in the business to gain market share, etcetera. So I think Dan statement, my statement, Mike statement is that Foundry is always been focused on profitable growth and we'll continue to do that. And our operating model may fluctuate a little bit, but I think we have always had a fairly respectable, given economic operating ranges. And we'll over the next two to four quarters be able to give you more specific guidance as we are able to seize the overall academies, traction on new products and headcount growth.

Dan Fairfax

And we did have some natural cycle in our operating expenses in the back half of the year, a large portion of our employee basis is U.S. residence. But we see front end loaded payroll taxes at the year end and then back-end there drop out and we recycle back up again. And then there were also some cycle depending on where we are on product introduction for prototyping and then also some significant lumpiness in our product or in our marketing for trade shows and other programs.

So all those things combined, we can clearly vision a quarter where we won't see this type of performance in the future, but we think on a long-term model. We are pleased with where we are operating margin wise and we could move that up when we see the business expanding into the next year, but right now we think longer term that’s only place to be.

Ken Muth - Robert Baird

Okay. And just a quick follow up you guys used to give some metrics about new customers and was there anything that drove these margins kind of on typically high here because you had a lot of repeat business or are you still very healthy in your new customer, the []BP business mix.

Dan Fairfax

We actually stopped giving guidance on number of new customer wins on a quarter after we got some place north of 10,000. We had a very respectable new customer win, not giving any total and not to continue to repeat it, but I believe we added just in the service provider or the router market, I forget exactly the specific, it was over 50 new customers, just in that either market or product category last quarter.

Ken Muth - Robert Baird

Great. Thank you.

Operator

We'll take our next question from the site of Mark Sue of RBC Capital Markets. Go ahead, please.

Mark Sue - RBC Capital Markets

Thank you. There is no impact from the financial customers, and I am just wondering why that is. Is it because you are targeting smaller companies within the financial vertical? Or is it because most of the project dollars have already been allocated?

Mike Iburg

Well, this is Mike, and I'll just jump in and say that, as we've mentioned that the number of the conferences through the seller, we don't have a huge exposure to financial services. That vertical for us represents less than 10% of the total revenue, and historically, we've not been perhaps as successful at either retail banking or retail brokerage. Most of those accounts seem to be controlled by the 800 pound gorilla in the market. So, we've done a lot of work at other types of financial service companies within this vertical.

But not necessarily directly tied to retail bank and retail brokerage. As a result, the types of companies that we're talking to, we are dealing with or we are establishing a relationship with, aren’t necessarily seeing an impact from this sub-prime mortgage crisis.

Mark Sue - RBC Capital Markets

Okay. Got it. And then, the March quarter is usually a tougher quarter for the Foundry, I think you missed some in the March quarters in the past. Any thoughts on why your bullishness wouldn't spill over into early 2008? And I am asking since I think a lot of the sales effort now seems to be accelerator, there’d still be balance of 2007.

Mike Iburg

Well, this is Mike again. I'll just, and Dan could or Bobby could add some other thoughts. We are looking at 2008, and Q1 pretty closely, as we are coming through the fourth quarter here. We do agree that we haven't historically seen a seasonally soft March quarter. It's usually one of the tougher quarters of the year. We are trying to evaluate the momentum that we have both, on the enterprise side and the service provider side and see how that quarter is shaping up.

Historically, we've been down sequential, a modest decline, we are trying to see if there is enough momentum to offset that. The one thing that we do believe is similar to the commentary we've had earlier on this call, regarding federal. We believe federal may or but will have a slightly better or perhaps more robust first half of next year than what we saw in 2007 or 2006 or 2005.

So, although we are having a very strong back half of '07 within federal, we believe that momentum continues, perhaps at the same level, but it continues above what we saw in the first half of '07, in the first half of '08. So if that make sense.

Mark Sue - RBC Capital Markets

Okay.

Bobby Johnson

We are evaluating that right now, we'll no more and certainly give you our current thoughts when we do the call on January.

Mark Sue - RBC Capital Markets

Okay. Then it’s prudent for us to model a down sequential March quarter?

Mike Iburg

Well, we are not perhaps giving guidance on this call. You can look at past performance and evaluate it yourself.

Mark Sue - RBC Capital Markets

Okay. Thank you. And good luck, gentlemen.

Mike Iburg

Thanks, Mark.

Operator

Next, we'll go the site of Long Jiang of UBS Securities. Go ahead, please.

Long Jiang - UBS Securities

Yeah. Good afternoon, gentlemen. I have a question about Japan, I mean this market, as a percent of your total sales has declined since 2003, so obviously this market is not keeping with your other markets. Can you talk about your outlook for that market and whether it's a competitively speaking more of a due to your major customers, next generation network they were build out or your sales cycle for that market?

Bobby Johnson

Okay. So, Japan has represented in the last four to six quarters, a challenge not just for Foundry, but for most US based networking companies. And lot of this as you eluded to that the market is somewhat strong, because NTT is evaluating their next generation backbone offering, in terms of build out technologies etcetera. And that has a ripple effect throughout other service provider etcetera. We actually had some modest improvement in calendar Q3 over calendar Q2. We hope that that is sustainable turnaround and typically calendar Q1 for us is a good Japanese quarter, historically because that is their, equivalent of their fiscal year end.

Most like the answer on the Federal, its little bit too early to tell, if the turnaround is what’s the magnitude of the turnaround when. And I was in Japan in both the June and September to try to evaluate as best I can. The overall view, I am bullish. We are making good strides in many sectors in Japan, but the magnitude of the bullishness and the exact timing of NTT rollout will greatly effect our overall results. So not despaired over, actually little bit from renewed optimism before what I have seen and experienced.

Long Jiang - UBS Securities

Okay. And that’s helpful. And just another quick question, or did you mention during the call that you don't see a major impact from the credit market crunch. And, but some of your competitors also mentioned recently about the weakness in the financial end market vertical. So do you see any disconnection there and I mean what did you see for that vertical?

Bobby Johnson

So, as I think Mike addressed, we probably see less impact because of our exposure is to financial services. So our customers aren’t in the financial services areas, aren’t directly themselves impacted by the credit crunch. And so as a result we are not seeing it from the results we have with them. I guess we would wish to have said, in the past we had a huge exposure to that market, but today we are happy we have less and don't have that pushed basically into our results.

Mike Iburg

Yeah, the other thing I will mention, I am not sure which competitor you are referring to, but we -- what we have seen is that we have Foundry primarily in the enterprise our core network infrastructure. And so if you are comparing us to somebody else who might be selling something that's not the core infrastructure that might -- they may have a different answer. I think there was a survey done at CIOs recently that's says that the core infrastructure get a last slice of cut, that cut software first and some other pieces factored into them, third and fourth and finally they get to the core infrastructure. But, the actually pluming was something that was fairly immune, at least at a survey done over the summer.

Long Jiang - UBS Securities

Okay, well that’s useful and congratulations again on a good quarter.

Mike Iburg

Thanks a lot. Thank you.

Bobby Johnson

Thank you.

Operator

Next we'll go to the side of Manny Recarey from Kaufman Brothers. Go ahead please.

Manny Recarey - Kaufman Brothers

Thank you. Two quick questions, you just comment linearity in the quarter? And then second question is that Bobby you mentioned the objective of growing into adjacent market. Can you give a little bit more color? You're talking more product markets or geographic markets. Any total will be helpful thanks.

Dan Fairfax

This is Dan, I'll talk about linearity. We saw for our summer time quarter a historically record linearity, it was very solid. Our sales teams were performing consistently throughout the quarter. Bobby will answer the second part of the question.

Bobby Johnson

Okay. So, the diversification to the adjacent markets actually does have both elements. One is adding new sales territories where we have not been before. That involves some places in Europe, expansion in some places in Asia. In terms of the other aspect of the adjacent markets, it includes adjacent technologies, and it gets back to some of the earlier statements about what new technologies or what new markets, are might we pursue. We touched on one but there is other thing within the enterprise. We are evaluating expansion in as well as adjacent service provider markets. So, it has most dimensions of the product, as well as the geographic territory.

Manny Recarey - Kaufman Brothers

Okay. Thanks guys, congratulations on a great quarter.

Bobby Johnson

Thank you.

Dan Fairfax

Thanks Manny.

Operator

Next we'll go to the side of Tim Daubenspeck from Pacific Crest Securities, go ahead please.

Tim Daubenspeck - Pacific Crest Securities

Thank you. The first question, there is a lot of investment within enterprise and (inaudible) going after sales guys, are you seeing any areas of saturation in terms of too many guys, went after the same business. And additionally, are you having any issues with, finding the guys you want, and the cost involved with finding those sales people?

Bobby Johnson

So, on your first comment about, that too many people are going after business. Certainly in some, either vertical markets, geographies, and in product categories, yes, those are just, all are lots of different solutions. But in others, where we got primarily differentiation, no we don’t think there is too many, as matter of fact, some competition in some markets helps. It helps bring attention to the market sector. In terms of recruiting, it is a robust recruiting environment. We are not constrained necessarily about the calls associated with that. We are more focused on the quality of the individual, and the experience level.

Tim Daubenspeck - Pacific Crest Securities

And then just one follow-up you talked about, in terms of some late shipments. Is that just the 32 slot or where there some issues for securing some capacity or components for some of your products?

Mike Iburg

Yes, this is Mike. I am not aware of any component issues, for product the ways that help things up. But we introduced the 32 slots [sharply] in May. We announced that or we introduced it with a September ship date, and we put it in the market right around the middle of September, which was right on time, before we announced

Bobby Johnson

We trial products, we trialed 32 slot systems in the field, starting in June as well as we provided labs here for customers to come in and try all the products here as well. So, over the summer when we were comfortable with the first customer ship, we were ready and we shipped out starting in September

Tim Daubenspeck - Pacific Crest Securities

But the 32-slot was part of the reason for the late shipment relative to order linearity?

Bobby Johnson

No. The order linearity was really the internal direction within the company through the month of July. We had shifted our attention to some other programs and that had effect of basically sliding from July shipments into August

Tim Daubenspeck - Pacific Crest Securities

Great. Thank you. It's very helpful.

Bobby Johnson

Yeah, it wasn’t the 32 sloters.

Mike Iburg

Thanks, Tim. Next question

Operator

Next will go to the side of Subu Subrahmanyan from Sanders Morris. Go ahead please.

Subu Subrahmanyan - Sanders Morris

Thank you. Two questions, first on operating margin, I just wanted to put it from a different direction. If you think about continuing revenue growth prospects and the margin prospects, can you talk about what kinds of including this expenses can put it back in your 20% to 25% range, versus the 29% level and when would it be appropriate to look at it and see if there is a new range for operating margin?

And second just on book-to-bill, I think for the last several quarter you kind of book-to-bill creating one versus a book-to-bill of one, how should we interpret that if at all?

Dan Fairfax

Okay. Subu, this is Dan, let me take a stab at your questions. So in terms of what we're investing, we have a great deal of interest in expanding our engineering teams, as well as our sales and marketing resources. So we feel very comfortable with the products we've available for those sales force and we know we can expand the field and increase revenues, that ways that’s worthwhile estimate.

But, at the same time we're looking at -- how do we continue to keep our growth moving over to the new products or engineering teams who develops, both those areas will be areas of investment for us. As I mentioned earlier we have a predominantly U.S. centric work force. So we are looking at how do we expand from our primary U.S. focused revenue base and those would be also areas that we would expect might control some additional expense.

And then moving to the book-to-bill, the company really comes down to what orders come in and when we have the product to ship them. One of our competitors does publish some backlog information and in our space they tend to drive the customer expectations. We like to fill our orders as soon as we have product and when we have the order in hand really attempt to fill it as quickly as possible.

So based on that we had come into the quarter with this little bubble of federal backlog which we are able shift to those customers who didn't have rating issues on those critical orders. And there is nothing I think truly different or unusual about the book-to-bill, its just the timing of that federal business as we are able to ship it in the third quarter, as we came in late in the second.

Mike Iburg

So this is Mike, I just want to add one more comment and just, this is a second question on the operating margins. And I just want to make sure people understood when Dan, what Dan said in the outlook. He did say regarding operating margins that we believe in the current fourth quarter that we are in right now that we will continue to deliver results that are above the target range

And the target range of 20% to 25%, he stated what remains currently our long-term operating margin range and we are continuing to evaluate that range. And if we determine, whether we determine to the next three or six months that its practical to run the business above the 20% to 25% range, but we will simply raise the range. So we haven’t made that determination yet, because so far we have only got one quarter, where we have been above the range. Now, we probably that in the next model or probably lot more model than you guys have done about '08 and '09. But, at this point we are not ready to change that range. So took that range out there as a long-term. We’ve said in the short term we will be above the range, but we expect overtime to glide back into it.

Subu Subrahmanyan - Sanders Morris

Got it. That’s helpful. Thank you.

Mike Iburg

Next question.

Operator

We'll take our next question from the site of Matt Robison from Ferris, Baker Watts. Go ahead, please.

Matt Robison - Ferris, Baker Watts

Hi, guys. An easy one. Why was the cost-to-good sold for services down, sequentially?

Dan Fairfax

Yeah. So our services, cost-to-sales was down. It was all related to our material management for our support organization, and so, the quarter-over-quarter shift was just a lower expense we had from how we charged spot for materials.

Matt Robison - Ferris, Baker Watts

So that build out of depots and sort of fixed cost associated with that is stabilized?

Dan Fairfax

At the current time, yeah.

Matt Robison - Ferris, Baker Watts

Okay. Thanks.

Bobby Johnson

Blake, we'll take our last question.

Operator

Sure, we'll go ahead and take the last question from the side of Erik Suppiger of Signal Hill, go ahead please.

Erik Suppiger - Signal Hill

Congratulations.

Bob Johnson

Thanks, Erik.

Erik Suppiger - Signal Hill

Why didn't backlog come down yet? An unusual situation at the end of Q2. I am curious, it sounds like linearity was relatively good. Why don’t you work the backlog down?

Dan Fairfax

This is Dan, as I was trying to express. First, when we get an order and we have a product to fill the order, we’ll ship the order. And so, that the timing is everything in terms of how the backlog is going to behave from one quarter to the next. We intended to have a, bulk of federal orders come into bookings right at the end of Q2. Those orders we were able to ship in July and get them out to those agencies. And then in Q3, they shifted to the late, in to the last week of the quarter, enterprise business and we weren't able to sell those orders.

Erik Suppiger - Signal Hill

And then secondly, are you seeing any competition from the MX Routers from Juniper, in the metro Ethernet space?

Bobby Jhonson

Yeah. This is going to sound, you kind of tend, this is a question that I ask our sales force all the time. Juniper is getting so established relationships, we have both established in new relationships. We are not seeing MX as often as one would like, so that means it is opportunity for both parties. So, in other words, we don't see them that often and therefore, I believe there is a real opportunity for both parties in that space.

Erik Suppiger - Signal Hill

Is it just Cisco or Alcatel.

Bobby Jhonson

We see Cisco and Alcatel, Cisco all the time, Alcatel a lot.

Erik Suppiger - Signal Hill

Then it falls off substantially from there.

Bobby Jhonson

Yes.

Erik Suppiger - Signal Hill

Very good. Congratulations.

Bobby Jhonson

Okay. Thank you. Thanks again.

Bobby Jhonson

Okay. Blake I think we'll wrap the call then.

Dan Fairfax

Okay, thank you Blake. And I look forward to appraising everybody of our calendar Q4 results in approximately 90days.

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