Foundry Networks, Inc. Q4 2007 Earnings Call

Foundry Networks Inc. (FDRY)

Q4 2007 Earnings Call

January 29, 2008 5:00 pm ET

Executives

Mike Iburg - Treasurer

Bobby Johnson - President & CEO

Dan Fairfax - CFO

Analysts

Cobb Sadler - Deutsche Bank

Jason Ader - Tomas Weisel

Matt Robison - Ferris, Baker

Andy Schopick - Nutmeg Securities

Tim Long - Banc of America

Mark Sue - RBC Capital Markets

Doug Ireland - JMP Securities

Tim Daubenspeck - Pacific Crest Securities

Troy Jensen - Piper Jaffray

James Falkoff - Robert Baird

Manny Recarey - Kaufman Brothers

Presentation

Operator

Welcome to today's teleconference. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during our Q&A session. Please note this call maybe recorded.

I'll now turn the program over to Mr. Mike Iburg of Foundry Networks, gentleman please go ahead.

Mike Iburg

Thank you, Devin and good afternoon, everyone. Thank you for joining us for the Foundry Networks fourth quarter and year end 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 fourth quarter and year end 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 tape replay of this call which may be accessed by phone. 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 402-220-0681. 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 would 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 release 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.

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. Today, I am pleased to announce that Foundry continued its revenue momentum and achieved record results for the sixth consecutive quarter during the fourth quarter of 2007. For the quarter, we posted record revenue of $168.7 million, a 27.7% increase over last year and a 5.7% increase over the third quarter revenue of $159.5 million. Additionally, for the fiscal year 2007, we generated record revenues of $607.2 million, compared to $473.3 million for fiscal year 2006, an increase of approximately 28.3%. During the quarter, we again set both new all-time enterprise and all-time service provider quarterly revenue records.

Worldwide enterprise revenues represented approximately 74% of our total revenues. Our overall enterprise record was fueled by our investments and strength in our international territories with both Asia and Europe showing strong gains. Overall, international was up 36.5% sequentially and 45.7% year-over-year.

In the service provider markets, our revenues increased to 26% of total revenues. Our service provider business grew 10% sequentially and was up 65% year-over-year. Overall, we saw strength across most of our major product lines. Almost all major product areas set new record highs. Our highest gaining product lines included our MPLS-enabled routers and our Layer 4-7 application delivery products.

Our routers grew 26% sequentially while our Layer 4-7 products grew 22% sequentially. In addition to these records, I would like to highlight several other key financial successes for the quarter. These key successes included that our book-to-bill ratio was greater than one and our gross margins remained strong at approximately the same levels as in Q3 '07.

The third highlight is we continue to execute on our previously announced stock repurchase program. We spent $45 million repurchasing approximately 2.3 million shares. The fourth highlight is that over and above our stock repurchase program, we generated a net incremental $20 million in cash for the quarter and ended with a strong cash position of $965.7 million.

The fifth highlight is that our annualized revenues per employee were approximately $688,000, one of the highest revenues per employee performances in our industry.

In summary, our revenues, gross margins, operating margins, cash flow, market acceptance and new product shipments all operated together to bring record revenue results for the quarter and for the year.

Overall, we were especially pleased with the strong second half Federal rebound and continued momentum in the service provider market. During the second half of 2007 for our U.S. Federal Government Sector, our revenues were strong and we had wins across many differing government agencies, as we have continued to increase our staff while trying to diversify our coverage across mainly the Department of Defense, Intelligence and Civilian Government Agencies. For the service provider market, we had success in many different applications and markets including wired and wireless metro and regional backbones, internet exchanges, content delivery, and data center applications.

We now have four Tier 1 service providers and overall approximately 450 plus customers deploying our Internet and Metro router platforms for these, plus other applications. The last six quarters have been very positive for Foundry. This performance reflects the success in our investments, in growing our worldwide presence through our branding and expanded sales organization in the timing and execution of our product launches.

Now for a detailed review of our Q4 and 2007 financials, I will now turn the call over to Dan Fairfax, our Chief Financial Officer. Dan?

Dan Fairfax

Thank you, Bobby, and good afternoon everyone. I will take the next few minutes to present our financial results for the fourth fiscal quarter and the year ended December 31, 2007. Foundry posted record quarterly revenue for the fourth quarter of 2007 of $168.7 million as compared to $132 million in the fourth quarter of 2006, and $159.5 million in the third quarter of 2007. This represents an increase in revenue of 27.7% over the prior year. Revenue for fiscal 2007 was $607.2 million, compared to $473.3 million for fiscal 2006, an increase of 28.3%. Our ongoing investments and our product development capabilities and expanded sales force had a positive impact on Foundry's growth throughout 2007.

As Bobby mentioned, our book-to-bill ratio in Q4 was greater than one. During the fourth quarter, we experienced particular strength in two key areas. First, growth in our international business was very strong. We saw a strong growth in both EMEA and Asia and across both enterprise and service provider vertical markets. EMEA, Japan and the rest of Asia increased 54%, 16%, and 23% respectively from the third quarter of 2007. The secondary strength was in our router business, where the growth rate continued to out space our other product lines, growth 26% sequentially and 78% year-over-year, routers now represent 20% of our total revenue.

Consistent with our outlook on the last earnings call, revenue from our Federal business declined seasonally in the fourth quarter of 2007 and now represents 19% of total revenue. We are, however, particularly pleased with our Federal sales performance in 2007 and especially the improved feasibility we have gained within this market. Our Federal business generated revenues of $109 million in the full year of 2007, representing 18% of our total revenue and grew 33% over the full year revenues of 2006.

When explaining the components of our revenue for you, we define the enterprise market to mean both commercial and government customers including the US Federal Government. When we use the term commercial market, we are describing enterprise and service provider market customers, excluding just the US Federal Government.

North American commercial revenue was essentially flat in the fourth quarter and represented 48% of total revenue. North American commercial bookings, however, were strong, but less linear than our international bookings. As a result, our international customers consumed some inventory we had originally planned to ship domestically, leaving us with a modestly increased North American commercial backlog. North American commercial revenue grew 34% year-over-year and was 54% of total revenue for the full fiscal year 2007.

Sales to Japan posted a modest recovery in the quarter representing 6% of revenue, while the rest of Asia increased 9% of revenue due in part to continued sales to Baidu in China.

GAAP net income for Q4 was $28.9 million or $0.18 per diluted share, compared to net income of $15.7 million or $0.10 per diluted share in the fourth quarter of 2006 and net income of $27.6 million or $0.18 per diluted share in the third quarter of 2007.

Included in Foundry's results for the fourth quarter of 2007 was $13.2 million of non-cash stock-based compensation expense. Excluding these expenses and the related tax effect, non-GAAP net income in the fourth quarter of 2007 was $37.8 million or $0.24 per diluted share. Non-GAAP net income for the fiscal year of 2007 was $118.9 million or $0.76 per diluted share. Contained in our press release is a reconciliation of GAAP to non-GAAP figures.

Let me now provide you with additional analysis of our revenue. Our overall domestic revenue in the fourth quarter of 2007 was 57.1% of our total business, and international sales represented 32.9% of total revenue. That was compared with 74.5% for domestic and 25.5% for international sales in the third quarter. If we pull out our Federal business from the domestic revenue and with the commercial revenue worldwide, the split in the fourth quarter is 59.3% domestic and 40.7% international.

During the fourth quarter enterprise customers accounted for approximately 74% of our total revenue, while service providers continued to advance growing to 26% of total revenue compared to 25% in the third quarter, due to increased router sales. The service provider business grew 10% sequentially and 65% year-over-year.

With respect to our products, our router revenue in the fourth quarter was 20% of total revenue. Layer 2/3 switching represented 54%, Layer 4-7 revenue increased to 12% and our service revenue was 14% of total revenue. Revenue for fiscal 2007 was $607.2 million compared to a $473.3 million for fiscal 2006, an increase of 28.3%. Net income for fiscal 2007 was $81.1 million or $0.52 per diluted share compared to net income of $38.7 million or $0.26 per diluted share for the same period in 2006.

Before I begin discussing our gross margins and operating expense, I would like to point out that the figures I discuss next are all non-GAAP numbers. We have excluded charges for stock-based compensation and other non-recurring items to make our results more comparable to prior periods and to those reported by other companies. The detailed GAAP to non-GAAP reconciliation can be found in the press release we issued earlier today.

Our corporate gross margins in the fourth quarter were 63.1% and 61.7% for the full fiscal year. Router gross margins were 60.8% for the fourth quarter, representing a 70 basis point increase from the third quarter level of 60.1%, up slightly on favorable mix in the quarter. Service gross margins were 77.1% for the fourth quarter, representing a 610 basis point decrease from the third quarter level of 83.2%. The Service gross margin decrease was primarily driven by additional investments and service inventories.

Details of our operating expenses are as follows; Foundry's research and development costs increased to $14.7 million or 8.7% of revenue in the fourth quarter, compared to $13.5 million or 8.4% revenue in the third quarter of 2007, the increase was driven by increase payroll cost. We added 27 engineers in the fourth quarter. Sales and marketing expenses increased to $38 million, or 22.5% of revenue in the fourth quarter, compared to $33.3 million or 20.9% of revenue in the third quarter. We continue to invest in our sales footprint, adding 43 new sales people in Q4 and in addition, we saw increased compensation costs related to commissions earned by our sales teams.

General and administrative expenses increased to $9.7 million or 5.8% of revenue for the fourth quarter, compared to $8 million or 5% of revenue in the third quarter of 2007. This was primarily due to increased hiring. We added 12 people in the fourth quarter. We also saw an increase in legal expenses from the third quarter.

As you can see from my comments, we have continued to invest in our business and in Q4 our total personnel increased by 91. Foundry's total personnel as of 12/31/07 was 981 employees. As a result of these investments, operating margins decreased to 26%, but remained above our long-term target range, which is 20% to 25%. The operating margin for the full year 2007 was 23.4%.

Our tax rates for the fourth quarter and full year 2007 were 31.4% and 36% respectively. The quarter and full year tax rates benefited primarily from the one-time effect in Q4 of a tax return to provision adjustment. We expect the 2008 tax rate to return to the levels of the second and third quarters of 2007.

Looking forward, operating expenses are expected to continue to increase in the first quarter, due to payroll taxes, which resets for our US employees into January.

Increased sales and marketing costs associated with the seasonally heavy spring trade shows schedule and the increased R&D prototyping and our expectation to continue adding to our sales and engineering headcount. We remain committed to expanding our sales and engineering capabilities in 2008.

Now turning to the balance sheet for a few comments. I would like to now take a moment to update you first on the status of our $200 million share repurchase program approved by our Board of Directors last July.

We are periodically in the market purchasing shares based on criteria that had been approved by our Board. We have chosen not to establish an accelerated repurchase program or a 10b5-1 trading program and as a result, we only purchase shares in our open trading window, when we are not in possession of material non-public information. As of year-end, we have returned $83 million to shareholders by purchasing 4.4 million Foundry shares. These shares were purchased at an average price of $18.93. In the fourth quarter, we repurchased 2.3 million shares returning $45 million.

Further detail would be provided in our Form 10-K, to be filled in late February, and we will continue to report our progress to you on a quarterly basis. The company's cash and marketable securities balance grew by $20 million in the fourth quarter of 2007. The total value of cash and marketable securities now stands at $966 million.

During the quarter, stock option exercises generated an additional $17 million in cash. We know that the credit market turmoil has created special concerns for own investors, and in particular, I would like to address a recent report issued by an investment firm that suggested our cash reserves are at risk or otherwise invested in risky asset classes.

To set the stage I would like to remove some of the immediate concerns investors may have. Foundry holds no asset-backed securities, no mortgage-backed securities, no collateralized debt obligations also known as CDOs, no structured investment vehicles also known as SIVs. And in all cases, we have never held any of these types of investments. We invest our cash according to our Board approved investment policy, which prioritizes preservation of capital over return. To get a level of our cash balance in relation to our other assets, we comply with the operating company requirements of the Investment Company Act of 1940, also known as the 40 Act. It only holds approximately $125 million of our portfolio in securities that the 40 Act declines as investments. The remaining cash must be maintained in lower risk, financial estimates which are exempt as to find by the 40 Act. These lower risk constraints include US Treasuries, US Government sponsored agencies, and money market funds.

As a result, the majority of our cash balance is invested in US Government agencies, also known as Government Sponsored Enterprise securities (GSEs). These GSEs have an imply guarantee from the US Federal Government and are broadly believed to carry little to no risk of default. The GSEs we hold, we believe trade with the second highest credit quality in the country next US Treasuries and have been independently reaffirmed as AAA quality by Moody's and S&P.

Most GSEs offer two types of investment vehicles, mortgage-backed securities and debt securities. Foundry only owns the debt securities. None of our GSE investments are assets-backed or mortgage-backed, they are direct debt obligations of the issuing agency. These obligations are backed by the credit worthiness of the agency and the implied Federal guarantee. They are not backed by a pool of mortgages or other assets.

In additional to the GSEs, we maintain $125 million in municipal notes, bonds and auction-rate certificates. With regards to the auction-rate certificates, they are collateralized with student loans that are in most cases guaranteed by the Department of Education. For the portion of the auction-rate certificates that we hold that are not guaranteed by the DOE, these are typically over collateralized by 10% to 13%. The historical default rate of student loans is about 3% to 5%, and we would like to add that there has never been a student loan backed municipal default.

The options for the securities we hold have not been impaired and as a result these securities are highly liquid. The other municipal notes and bonds that we hold carry AAA ratings, with insurance enhancements and the underlying municipalities have either A or AA ratings. We've selected these municipalities based on their fiscal strength, taxing authority and historical track record. The remaining cash resides in several money market funds, none of which have had any redemption restrictions or downward pressure on net asset value.

Today, I can tell you that we have not been required to markdown on our balance sheet any of our investments under generally accepted accounting principles. As such, we have every reason to believe our cash position is both fully compliant with our investment policy and prudent financial management, given the current economic environment.

Day sales outstanding and accounts receivable were 63 days in Q4 flat when compared to the third quarter. Our net inventories decreased slightly in Q4 and our inventory in turns improved. As mentioned earlier, our book-to-bill is again greater than one.

We ended the quarter with a total headcount of 981 employees compared to 890 in the third quarter of 2007. The increased personnel in Q4 were primarily in sales and engineering departments.

Now consistent with our practice, we will not be providing formal revenue or EPS guidance, but we would, however, like to provide a qualitative view of the current quarter.

All of my comments are going to be taken into consideration with the evolving macroeconomic environment we operate in. We believe we are currently not experiencing any direct impact from the current credit crunch in the financial services market, probably because we have exposure to those customers than other verticals. Our strongest commercial verticals remain education and healthcare. Considering our current visibility into the first quarter, we believe that our commercial business may experience a normal amount of Q1 seasonal softness. We have built modest backlog in our North American commercial business but we are unsure if it will be enough to offset a normal seasonal slowdown.

Our European commercial business was strong in Q4 and we believe may have some momentum coming out of the fourth quarter. We expect our Federal business to remain robust, but would be flat to slightly down when compared to the fourth quarter of 2007, due to normal seasonality.

With respect to our service provider business, we believe our service provider revenues will continue to grow faster than our overall enterprise business as our routers continue to be adopted by service providers and more large accounts begin meaningful deployments. We continue to demonstrate our ability to bring value to our Tier 1 service providers as well as Tier 2 and Tier 3 service providers, as they build their networks with high performance, world-class data networking equipment to meet their needs to deliver additional product offerings and network capacity to their customers.

Our operating margin is expected to contract in the first quarter but remain in a long-term target range of 20% to 25%. The decline is driven by continued expansion of our sales and engineering organizations. This typical first quarter of margin contraction has historically been followed by second quarter margin expansion. We will provide more color on the second quarter on our next earnings call.

Thank you for your attention. I will now turn the call back over to Bobby for some closing remarks.

Bobby Johnson

Thank you, Dan. Given our recent revenue headcount, product and cash growth, Foundry is well positioned for the future. As such, Foundry continues to focus on its leadership position in the high performance IP switching, routing and application delivery networks. We continue to focus on market share gains and building a balanced enterprise and service provider solutions company. Our strategy of diversifying within our US Federal business to branch out and through 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 cracks and keys for [strategic] accounts.

Our strategy and execution on our major goals throughout this year will have five key objectives. The first objective is we will focus on expanding into new geographic territories where we previously have not had a direct presence. The second key objective is we will continue to focus on increasing our sales force and specific market segmentation of our sales forces. The third key objective will be we will continue to focus on marketing programs [secreted] in the ever bigger Foundry brand in the press and in our customers’ minds and networks. The fourth key objective is in an extensive of our marketing and sales expansion. We will be focusing on increased partner, both for joint solution sales and resell. And additionally, we will continually endeavor to introduce new leading edge products and price performance into our targeted enterprise service provider and Layer 4-7 markets.

In spite of the volatility in the markets, we believe we are well positioned to continue to gain in both the enterprise and service provider markets. We believe that the investments we have made and continue to make in the business will continue to drive improved performance and establish a stronger foundation for the longer-term. As we have just completed yet another record quarter and record year, I would like to thank all of our employees, partners, customers, and shareholders for their commitment to Foundry.

I would now like to turn the call over to the operator for question-and-answer period.

Question-and-Answer-Session

Operator

(Operator Instructions). And our first question comes from Cobb Sadler with Deutsche Bank. Go ahead please.

Cobb Sadler - Deutsche Bank

Thanks a lot. I just had a question on the XMR router. It looks like it was up a lot quarter-on-quarter 20% of sales and you mentioned four Tier 1s it's only one more than I was aware. So, I guess, my question is where are you in the stage of deployment with these Tier 1s? Is it early and I guess, you're probably [a bet] to second source there, so how do these carriers determine whether they are going to pull the XMR or maybe one of their traditional products? Is it primarily cost? Thanks a lot.

Bobby Johnson

So when I refer to our MPLS-enabled routers it's both the XMR and the MLX, number one. Number two, we are in early trials of some production and we run the [router] from New Metro to New Backbone.

Cobb Sadler - Deutsche Bank

Okay. And so at what stage would you think that -- your answers sounds like it’s kind of in the beginning stages of deployments with these Tier 1s -- we are talking field trials or kind of early stage material deployment?

Bobby Johnson

We are, I would say, fairly early. We do have production traffic on many of these units, but I would say we are very early and I would hope to see continued expansion of both revenues within these existing four Tier 1s; I am referring to as well as new additional wins.

Operator

Thank you. And our next question comes from Jason Ader with Thomas Weisel. Go ahead, please.

Jason Ader - Thomas Weisel

Thank you, just a couple of quick questions. One is quick and maybe one is not so quick, but the Federal budget was delayed as you guys know at the end of the year. I was wondering what kind of impact it had on the business. And secondly, Bobby could you comment on the Cisco and Juniper product launches over the last couple of days -- it feels like it’s been a flurry of news around the enterprise switch market? How do your products compare to what was introduced by those other vendors and how do you see the competitive landscape shaking out here over the next couple of years?

Bobby Johnson

Okay, so two different questions let me take the first one on Federal, we were very happy and did not perceive a major impact by the budget. So we were very happy with our results in the second half in Federal. And didn’t see any --

Dan Fairfax

I think Bobby, we can really say we saw the continued benefits of being in more program spending where that's always been delegated earlier in that the money flow that’s the projects are ready to deploy the gear and that benefited the company in the quarter.

Bobby Johnson

Right, we didn’t see the impact that we saw, say, a couple of years ago, when the budget was delayed and fund shifted from IT to [VoIPs]. So we were very happy with the results and the last two quarters in Federal. The second question is a much longer answer so let me start with that. Foundry is actually quite pleased to see renewed interest in the LAN switching market. We have felt like we've been the only innovators in the LAN switching market for the last couple of years. So we are very glad to see renewed attention on the LAN switching market, I believe that it will be good for everybody.

We feel we are very well positioned, I guess all of the new product announcements by both Juniper and Cisco for instance by taking Juniper’s latest announcements, occurred this morning. They have announced what we will call fixed configuration or stackable products in a category that Foundry's been shipping for more than four years. So there is nothing at all novel or unique about what they are doing and we have two or three generations above the existing product in that same category, plus they don't have a complete product portfolio for the edge. So they have a little bit of a point product family and products that we've had for four plus year. And we will continually refresh our product family in that general arena throughout this year. So we don't see anything unique or novel in pricing performance future sets there.

The second thing with the Juniper announcement is they are announcing for shipment sometime in Q3 or Q4 a chassis-based product, its specs read somewhat similar to a product we been shipping for six months. So if it doesn't ship another six months Foundry will have at least a one year lead on that. And Foundry will continue to refresh its product portfolio there. Once again they've announced a kind of a point product or point family in this case. Once again without a complete enterprise core and [wiser] edge solution.

So, we think Juniper is a quality company. We think Juniper has got a quality brand and a quality franchise, but as they are coming into this market, they are coming in with point solutions that already well exist from multiple vendors with Foundry having the leading price performance. So, we don't see anything different than what we encounter everyday in our sales activities.

For the Cisco announcement, Cisco has announced a set of capabilities and of a specific product as long as they've announced what we would generally call a marketechture. So, what they will be delivering in the short-term is a new generation Ethernet switch. It's oversubscribed. They even admit we have several times the switching capacity in their own charts. So from a price performance we see no immediate leadership there compared to Foundry. And we compete with Cisco in, I would say, nearly 90% to 95% of every deal we encounter.

So they're not bringing anything in the short-term, especially saying as the product isn’t shipping yet, so the forefront their marketechture really addresses the integration of the SAN and the LAN. I don't know their pricing. I don't know their delivery. Because those were not announced and Foundry competes with Cisco everyday, and we see this is nothing upsetting what our value proposition is and we just continue forward. Next question?

Operator

Our next question comes from Matt Robison with Ferris Baker. Go ahead, please.

Matt Robison - Ferris Baker

Hi, good afternoon, and congratulations. You did a pretty good job of recruiting in the quarter, obviously. What do you expect to be doing in the current quarter? Are you going to have a similar increase in headcount? And then I guess my follow up is if you could talk a little bit about your revenue funnel? If it’s changed in terms of how far it goes out into the future? And where are you, where do you find yourselves strongest in service providers? One of that callers asked -- mentioned the hype of the Tier 1 service providers -- but there is a lot of non-traditional service providers out there and I had be curious to know where you see the most growth?

Bobby Johnson

Okay, so the first question is our staffing outlook. We will continue to expand, I mean, in all areas of the company, particularly in our sales and R&D organizations. I don't know if we will expand at the exact same rate that we expanded in Q4, but we will continue to focus on investments for the future. The second question is in the service provider market where are we the strongest? We are winning in a lot of what we would call any new Metro build out focused around Gig and 10Gig aggregation. We are in traditional Layer 3 edge aggregation and traditional service providers as well as new edge providers providing MPLS and VPLS services as well as we dominate the internet exchange sector.

Matt Robison - Ferris Baker

And the third question was on the pipe line?

Bobby Johnson

Okay. Well we felt strong about our pipeline and we continue to make investments in the service provider sales force. As we've stated previously about Federal service providers somewhat but similar they can be large and lumpy. But our visibility is good, we feel very comfortable with our positioning and we continue to see new wins and deeper penetration. Next question?

Operator

Our next question comes from Andy Schopick with Nutmeg Securities. Go ahead please.

Andy Schopick - Nutmeg Securities

Good afternoon. I'd like to direct this question to Dan, because Foundry faces a particular challenge in the year ahead, given its relatively large cash balances and the aggressive Fed rate cuts that will lead to far lower interest rates and returns on your cash. With over one third of your pre-tax income in Q4, and over one half of your earnings having come from interest income in 2007, how do you intend to mitigate the effects of these lower rates on your projected income for the current year?

Dan Fairfax

Thanks, Andy, for the question. So we obviously look very [closely] and you can see from our prepared comments up front that there is a lot of concern about whether we are putting our cash in too risky investments, trying to get too much return out of it. We felt a lot of pressure coming should we roll that back and so we look at that, but we are as a business we will follow the Board's direction on our investment policy and assets to look forward capital preservation first. Getting a return on that as we can, but we are principally an operating company, we'll look to grow our business by using that cash wisely and by expanding our operating margins, that's our goal.

Andy Schopick - Nutmeg Securities

Okay. Can you tell about the average maturity length right now?

Mike Iburg

Yeah, Andy, this is Mike. The [wintered] average maturity of the entire portfolio, the entire $966 million is 114 days. That's three and half months.

Operator

Thank you. Our next question comes from Tim Long with Banc of America. Go ahead please. Thank you.

Tim Long - Banc of America

Thank you. Two questions if I could. First, you touched a little bit on the North American commercial market, but could you just give us a little more color there looking at kind of two quarters in a row where we've seen declines? What would you attribute it to? I know there was a little bit of backlog built in the quarter, but would you characterize it as just lumpiness or some changes in competition or economy, number one? And second, I think Bobby talked about one of the objectives for the year was to get into some new geographies -- can you just give us some hints as to where you are looking there? Are there real low hanging fruits and what are the key products categories that you think you are going to be able to drive into some of these new regions that you would like to get into? Thank you.

Dan Fairfax

Let me take the question on the trend in the North American commercial business. Our second quarter [hygienic] is what the base line period we are going back to was benefited significantly by some larger customer accounts in the quarter. So your speculation was due to some lumpiness is really the point there. The percent we’ve seen is what we consider to be good productivity from the North American sales team, in Q3 which is seasonally a tough quarter and the fourth quarter this year. So we are not unhappy with that, but again, this trend is based on some lumpiness and benefit from that in the second quarter.

Bobby Johnson

Okay. So let me add to that I think year-over-year results were very good there, now on your second question about where are the new territories. Well the first statement is we will kind of double down in all existing territories -- so throughout the U.S., throughout Federal , throughout Asia, throughout Europe, and the Middle East we will expand on our footprint in our existing geographies. That is, we'll add more staff for both sales teams as well as new European typical assistant center throughout all existing geographies. As part of the expansion we will move into -- with a direct presence into more the outlying European countries such as Poland, et cetera -- we'll move more into new Middle East geographies. We'll move into more Near East geographies as well. So we will expand with a direct presence in territories that A) we’ve either only had a minor resell engagement in the past; or B) we haven't been in at all. So it will be Eastern Europe, Middle East, Near East, a little bit more in Latin America will be the primary new geographies. Next question?

Operator

Our next question comes from Mark Sue with RBC Capital Markets, go ahead please.

Mark Sue - RBC Capital Markets

Thank you. Any thoughts on how things are starting to the year in the commercial segment. Perhaps maybe you could share some discussions from your customers on their planned spend and their actual spend and maybe their eagerness to purchase networking switches?

Bobby Johnson

Well it's very early in the quarter. Haven't had as much customer interaction because of the way the calendar falls in January. But all the customer interaction I have had has been on major build ups for the year. So there has been no real specific conversations on, is it going to happen this quarter, next quarter. But people have at least the ones I am talking to big appetites.

Mark Sue - RBC Capital Markets

So no changes relative to this point a year ago in terms of demand and their thoughts on going through with your projects?

Bobby Johnson

Right now and you have to understand that it is very early in the quarter and I am talking mostly to our bigger prospects, I am hearing mostly good things.

Operator

Thank you. And our next question comes from Samuel Wilson with JMP Securities, go ahead please.

Doug Ireland – JMP Securities

Thank you. This is Doug Ireland for Sam Wilson. I would like to know what your headcount expectations are for 2008, it has been expanding and you did mention that you are growing your sales force and your margins are taking a hit early. I was just wondering if you could give a little color on that?

Bobby Johnson

Without getting very specific, if we take a look at Q4 of '07, we had major headcount expansion. Certainly, I believe that will be a high watermark. It would be very difficult to continue at that trend for Foundry. So if you perceive that as a high watermark and you look back we'll average probably somewhat less than that, but a lot of it will depend upon, as we expand, how comfortable we feel. If we see some deterioration in the economy we may re-jigger our operating model, but right now we're planning to power through this year.

Dan Fairfax

And I think as we said on our last call as well the third quarter hiring had fallen below our targets, Q4 caught up, some of that was folks that were in the pipeline that weren’t unable to come on board until the fourth quarter. So again, as we look back we always see some summertime seasonality and so again you wouldn't expect it to keep going at that rate all year along.

Bobby Johnson

And I think just to pile on, we added a total of 165 people in 2007, so that works out to be roughly about 40 heads a quarter and of course we had a much higher number in Q4 but a much, much lower number in Q3. So I think, we probably would be somewhere in the ballpark in 2008.

Doug Ireland - JMP Securities

Thank you. I also was wondering about the day sales outstanding and I saw that over the last six months, they have sort of grown out from about 56 to about 65. I was wondering if you could talk about why that's happening?

Dan Fairfax

So day sales has expanded I think principally for a couple reasons. One is, I think we've talked about some of those investments we made back in the third quarter which had delayed our ability to shift. So some of that was related to the SKUs. At the end of the year we had commitments from some of our larger customers that didn't come in, the money spent collected now in the first quarter, don’t know whether that's people. Again probably just managing their cash balances and we wouldn't expect it to go, above this level. On an on-going basis we think this is kind of the threshold number should drop back.

Mike Iburg

Right, and this is Mike, I would also add that with a large shift towards international business, many of our European and Asian customers have typically longer terms than our domestic customers what will do and that’s 60 more off internationally more and net 30 more off in domestically.

Operator

Thank you. And our next question comes from Tim Daubenspeck with Pacific Crest Securities. Go ahead, please.

Tim Daubenspeck - Pacific Crest Securities

Thanks, can you just give us a relative impact of the commissions in the fourth quarter in terms of on OpEx? And then maybe a relative impact on where you think trade show is going to be, that’s the first question. Then the second quarter Layer 4-7 what’s like your share gain? Were there any new products or new software releases there? Why was Layer 4-7 so good for this quarter?

Dan Fairfax

So let me take question one, Bobby. Commission was a significant part of the increase in sales and marketing expense in the fourth quarter, due as much to as we bring new sales people on board and we talked about a quite a large number that came onboard will give them through hours and that will hit the commission figures in the period as well as the fact revenues had ramped and the commission dollars are just greater on that basis. So most of that growth is related to commissions and I’ll let Bobby talk about the trade show timing.

Bobby Johnson

Tim so, I will first talk about the Layer 4-7. Foundry has robust Layer 4-7 customer base reversed protocol [framings]. We didn't have anything significantly new in Q4, we will continue to put more marketing and more sales focus behind our Layer 4-7. We will have a refreshed Layer 4-7 product line later in 2008, but it is basically just in marketing and sales focus on the increased result. In terms of trade shows, calendar Q2 is traditionally our largest trade show quarter. We typically have our two largest trade shows of the year that would be N+1 Las Vegas and N+1 Tokyo. They usually hit in that time period. And they can have anywhere from $0.05 million to $1 million in expense each or even greater depending upon what we are launching and the efforts we put behind each one. So calendar Q2 is usually our largest of the other quarters typically have the smaller trade shows and ongoing symposiums and seminars and other marketing campaigns. Next question?

Operator

Our next question comes from Troy Jensen with Piper Jaffray. Go ahead please.

Troy Jensen - Piper Jaffray

Hi, congrats on the nice quarter gentlemen. Just trying to a follow-up on Cobb had some questions Tier 1 wins. Could you give us, first of all could you confirm that you only have three Tier 1 accounts at the end of last quarter? And wondering if you could give us a sense for what percent of router sales came from Tier 1 customers?

Bobby Johnson

So there is timing of shipments versus winning, so I can't really exactly say whether it was three or four. In terms or percentage of revenue, the revenue percentage is still relatively small from the Tier 1s. As I mentioned earlier, with early trial deployments of with many of these, we expect more robust deployments later this year. Many of these Tier 1s are taking our 32 Slotter, which was only released in the late Q3 timeframe. Next question?

Operator

Our next question comes from Ken Muth with Robert Baird. Go ahead, please.

James Falkoff - Robert Baird

Hi, this is James Falkoff on for Ken. Just a quick question on Japan. Are you starting to see a light at the end of the tunnel for NTT or is that still a few quarters away?

Bobby Johnson

Well, there are many different divisions, departments, projects within NTT. So I am firm we have seen light at the end of the tunnel, some were waiting for light at the end of the tunnel and part of the issue there is the whole NexGen architecture for NTT. So if you've looked at the results of a lot of equipment providers, all have been less than stellar over the last one to two years because of the overhang of the NTT NexGen architecture. So we are in line with that, but we are seeing lights -- light at the end of the tunnel on some deployments, but we too would like to see both an improved Japanese economy and final architectures and roll outs.

James Falkoff - Robert Baird

Great. Thank you.

Bobby Johnson

Last question.

Operator

And the next question comes from Manny Recarey with Kaufman Brothers. Go ahead please.

Manny Recarey - Kaufman Brothers

Thanks for taking my question, I have two. First, can you give a little bit more color on EMEA, the strength there? Was it driven by some larger deals or should we look at it as the investment that you made there and that the, this level or somewhere around there is kind of a run rate to that region can stay at? And the second question is that, at the end of the third quarter conference call you had spoken that there was a possibility that you wouldn’t see the typical seasonality between the forth and first quarter. So, I'm just kind of curious what has changed over the past three months? Was it just the economic environment or is it something else? Thanks.

Bobby Johnson

Okay. Let me take the first question. The first question is on the growth in EMEA. There is not one or two dominating accounts there. It's a series of morphine on the street. In all geographies that we've really been doing over the last two plus years, two to three years. So, it's a lot of singles, doubles an occasional triple, an occasional home run. It's not dominated by a slugfest of homeruns. So, we would hope that, on balance it's sustainable and will even grow.

Dan, you want to take the second question?

Dan Fairfax

Yeah, I think the answer to the visibility question really goes back to, as we said all through 2007 we are winning larger accounts, those larger accounts give as better visibility as to when projects will deploy. At this particular point and as we look into Q1, we are feeling as probably maybe not as bullish it was earlier. But as Bobby said our bread and butter business is still singles and doubles and we feel really good that those customers will continue buying from us. Until now we are really projecting back that you may see some of the normal gain of the year seasonality, but forget about what the business is.

Bobby Johnson

So at this time I would like to conclude the question-and-answer period. I'd like to thank you and the operator for joining us today and I'd like to invite everybody back in approximately 90 days for our Q1 '08 results. Thank you.

Operator

This concludes today's teleconference. You may disconnect at any time. Thank you and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!