Foundry Networks Q3 2007 Earnings Call Transcript

| About: Foundry Networks, (FDRY)
This article is now exclusive for PRO subscribers.

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

Operator

Good day ladies and gentlemen and welcome to today'steleconference. At this time all participants are in a listen-only mode andlater 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 toMr. Mike Iburg of Foundry Networks. Go ahead sir.

Mike Iburg

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

Earlier this afternoon, the Company issued a releasereporting this third quarter financial results. This release can be accessedfrom 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 beaccessed by telephone. This replay will take effect approximately one hourafter the call's conclusion today, and will be available for seven days. Thedial-in access number for this replay is 402-220-2653. This call is also beingwebcast live with a web replay also available. These may both be accessed fromthe Investor Relations section of Foundry's website.

Before we begin, I'd like to make a brief statementregarding forward-looking remarks. Today's call contains forward-lookinginformation regarding future events and the future financial performance of theCompany. We wish to caution you that such statements are just predictions andactual results may differ materially as a result of risks and uncertaintiesthat pertain to our business. We refer you to the documents the Company filesperiodically with the SEC, specifically the Company's recent quarterly reporton 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 thepress releases the Company issued today. These documents contain important riskfactors that could cause actual results to differ materially from thosecontained in the Company's projections or forward-looking statements. Foundryassumes no obligation to revise any forward-looking statements contained intoday's call.

In addition, today's call may reference certain Foundrycustomers in the markets we sell our product, including the different verticalmarkets, such as our enterprise, federal or service provider markets. Due tothe nature of our ongoing contractual obligations with these customers andother competitive factors, we typically will not provide the name or scope ofthese 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 pleasedto announce that Foundry continued its revenue momentum and achieved recordresults for the fifth consecutive quarter during the third quarter of 2007. Forthe quarter, we posted record revenue of $159.5 million, and a 34.2% increasedover 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 timeenterprise and service provider quarterly revenue records. Worldwide enterpriserevenues represented approximately 75% of our total revenues. Our overallenterprise record was fueled by strength in our U.S. federal business whichrepresented 22% revenues. Compared to this years second quarter, our federalrevenues were up 115% sequentially.

In the service provider markets, our revenues increased to25% of total revenues. Our service provider business grew 21% sequentially andwas up 68% year-over-year.

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

The second highlight is that our non-GAAP gross marginsimproved to 63.4%. This margin improvement was driven by manufacturing costsavings, support efficiencies and a shift to higher-end higher gross marginproducts.

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

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

In summary, our revenues, gross margins, operating margins,cash flow, market acceptance and new product shipments, all operated togetherto bring record financial results for this quarter. Overall, we were especiallypleased with the strong Federal rebound, a continued momentum in the serviceprovider market. As the third calendar quarter is the fiscal year end for theU.S. Federal Government, our revenues were strong and we had wins across manydifferent government agencies.

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

As a part of our success, in both service provider and highend enterprise markets, our router revenue continues to grow steadily, increasingapproximately 41% sequentially and 178% year-over-year. This increase doesinclude 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 performancesupercomputing cluster fabrics. We have approximately 325 customers deployingour Internet and Metro router platforms for these, plus other applications.

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

Dan Fairfax

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

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

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

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

Our North American commercial revenue increased 48%year-over-year and represented 52.5% of total revenue. Sales to Europe, theMiddle 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 wehad expected, and experienced a modest sequential decline.

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

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

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

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

Now, additional breakdown of our revenue we have got acouple of other items here. Our overall domestic revenue was 74.5% of our totalbusiness. And international sales represented 25.5% of total revenue, comparedwith 73.4% for domestic, and 26.6% for international sales in the secondquarter.

Although impacted, slowly by normal summer seasonality,enterprise customers accounted for approximately 75% of our total revenueduring the third quarter. Our service providers significantly advanced growingto 25% of the total revenue, compared to 23% in the second quarter, this wasdue 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% ofrevenue in the third quarter of 2007.

Revenue by product category was as follows, for our layer2-3 switches 58.6%, Internet and Metro routers was 17%, layer 4-7 was 10.3% andour 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 GAAPbasis was $52.3 million, or $0.34 per diluted share, compared to GAAP netincome of $23 million, or $0.15 per diluted share, for the same period of 2006.

Before I begin discussing our gross margins and operatingexpense, I'd like to point out the figures I discussed next are all non-GAAPnumbers. We have excluded certain charges including stock-based compensation tomake our results more comparable to prior periods and to those reported byother companies. The detail GAAP to non-GAAP reconciliation again can be foundin 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 grossmargins of 60.6%. Q3 margins benefited from favorable product mix, reducedmanufacturing cost and a beneficial pricing environment. Product gross margins were60.1% for the third quarter, representing a 260 basis point increase from thesecond quarter level of 57.5%. And our service gross margins were 83.2% for thethird quarter, representing a 560 basis point increase from the second quarterlevel of 77.6%. Our service gross margin improved principally due to moreeffective support inventory management in the third quarter.

Details of our operating expenses are as follows. Foundry'sResearch and Development cost increased to $13.5 million, this is 8.4% of revenuein the third quarter. And the reduction was due to a lower prototyping expensesfollowing the release for the new 32-slot routers. This was compared to $14.4million 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 seasonaldecrease 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 thefirst, second and fourth quarters where we see a higher yield from our workinginvestments.

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

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

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

We anticipate continuing to purchase shares from time totime depending on market conditions and other factors in accordance withSecurities and Exchange Commission requirements. We would like to reiteratethat it is our objective to complete the $200 million buyback within the timeallocated by the Board, and we'll continue to report our progress on aquarterly basis.

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

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

Our net inventories were essentially flatquarter-over-quarter in absolute dollars, resulting in our inventory turnsimproving sequentially. In Q3 our book-to-bill was equal to one, meaning thatthe flow of new orders in the quarter was essentially equal to the reportedrevenue. And put in other way our back log neither increased nor decreased inthe quarter.

As you may recall we ended July with an unusual large backlog of federal orders coming out of the June quarter. These orders were shippedfor revenue in the third quarter. And the federal revenue reflected in today'sresults includes several million dollars attributed to this Q2 back log carryforward.

We ended the quarter with a total headcount of 890 employeescompared to 873 in the second quarter of 2007. The increased personnel in Q3were primarily in engineering departments, as our sales organization grew moremodestly this quarter.

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

Looking at the fourth quarter, we believe that our NorthAmerica European commercial businesses have re-bounced seasonally from Q3'ssummer time level, which showed solid growth for 2007. We are currently notexperiencing any direct impact from the current credit crunch and the financialservices market.

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

We once again expect our federal order flow from the fourthquarter to be consistent with the third quarter. Therefore, as we look at thefourth quarter revenues, we would expect federal revenue to be down from Q3 andnot equal to the small unusual opening federal backlog balance from the secondquarter.

With respect to our service provide business, we expectservice provider revenues continue to grow faster than our overall enterprisebusiness, as our router business continues to expand and most large accountsbegin meaningful deployments.

As discussed in the last call, the number of engagements withTier 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 thismarket. And deliver increasingly meaningful results. Although, we cannot alwayspredict the exact timing of each deal, the opportunity in front of us and themomentum we are seeing today is exciting.

With respect to our target operating merger range of 20% to25%, although we have delivered results well above the range in Q3, in thefourth quarter we would expect our operating expenses to increase. Theincreases will come from the planned increase in sales and marketing activitiesand an increase in sales recruiting and personnel costs.

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

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

Bobby Johnson

Thank you, Dan. Foundry is continuing to be a leader in thehigh performance IP, switching, routing and application delivering networksectors. We continue to focus on market share gains and on building a balancedenterprise and service provider company. Our last five quarters have been verypositive for Foundry, as we've continued to execute well. Our performancereflects the success in our investments, in expanding our worldwide presencethroughout branding, and expanded sales utilization the timing and execution ofour product launches.

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

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

And, we will continually endeavor to increase our salesforce and sales presence in both established and new territories for Foundry.We believe that the investments we have made and continue to make in thebusiness will drive improved performance and establish a stronger foundationfor 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 ourquestion-and-answer period.

Question-and-AnswerSession

Operator

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

Cobb Sadler -Deutsche Bank

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

Bobby Johnson

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

Cobb Sadler - Deutsche Bank

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

Bobby Johnson

It is a competitive environment. We have a great deal ofinterest. We purchase orders, do take a while, and we can fluctuate from just acouple of systems to multiple systems, and they usually come in waves. So, itsnot 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 mightdo a $3 million, an account a given quarter.

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

When you measure it over time, the 32-Slot device startedshipping for revenue last quarter. It has a great deal of interest across theboard in a wide range of service providers, but also very high in enterprisesand any particular in what we call the HPC the high performance cost tocomputing sector. So, it goes into government agencies, it goes in theuniversities, it goes in to service providers. And so we are seeing substantialinterest in that platform.

Cobb Sadler - Deutsche Bank

Okay. Thanksa lot.

Operator

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

Troy Jensen - PiperJaffray

Congrats on the nice quarter, gentlemen.

Bobby Johnson

Thank you.

Troy Jensen - PiperJaffray

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

Dan Fairfax

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

Troy Jensen - PiperJaffray

Okay. Perfect. And all of that, it is safe to assume, allthe 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 areseveral key metrics here. One is service provider total, enterprise total orwhich federal is account of the enterprise. The routers spread across high inenterprise. They go to some federal agencies. They go to a lots of serviceproviders, so, its kind of spread across, larger scale, application, largerscale customers.

Troy Jensen - PiperJaffray

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

Bobby Johnson

As we mentioned, overall, the Ethernet switching, androuter, 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, isa 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 largegovernment agencies, but a vast majority of the router revenue is serviceprovider. The one thing that we've seen over that time is that we have notreally seen cannibalization of our Layer 3 Switching business within theservice provider market. So that’s still continues on a consistent pace as weseen in the past, but a lot of the business that we've added in the serviceprovider market, which I think Dan quoted at 68% year-over-year growth, that’srouter growth.

Troy Jensen - PiperJaffray

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 ofAmerica. Go ahead please.

Tim Long - Banc of America

Thank you. A question on the U.S. commercial business then I'llhave a follow-up after that. You talked a little bit about the backlog, thestrong federal performance coming out of a lot of backlog you had entering inand the backlog was flat. So should we assume that a lot of that was build inwith commercial and then when you said, you talked about a rebound, really twoof 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 majorrebound, because the climate of the industry because of the federal business.

Dan Fairfax

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

Bobby Johnson

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

Tim Long - Banc of America

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

Dan Fairfax

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

Bobby Johnson

This is Bobby. Certainly there is pricing pressure at thelower end, but at the higher end we have a price performance advantage. So whenwe take a look at our blended business, where we can sell a “higher endproducts” blended with some of our “commodity products”, for lack of betterword. Things will work out well for us. And so where there is a shift toward ahigher end enterprise federal service provider your model really gets kicked inand our operating efficiencies really show. And I think, as Dan talked aboutand 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 arepretty optimistic and bullish.

Dan Fairfax

And to your question on the gross margins, so we have beentalking on the prior calls about expecting to see some costs efficiency fromour newer generation of 10 gigabit products, and really start to see thatsignificantly in this quarter. So, that's something that you can expect, whichwe know that we have further room for improvement and should see some moreupcoming.

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 - TomasWeisel

Yeah thank you. Just wanted to see if you guys could give usa ballpark number for the Q2 carry over backlog from federal, just because itwould help tremendously to sort of just get the slice there, is it $5 millionto $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 inthe past and I think your ballpark getting in the several million dollar range.

Jason Ader - TomasWeisel

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

Mike Iburg

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

Jason Ader - TomasWeisel

Okay.

Mike Iburg

So we think it hold up pretty well.

Jason Ader - TomasWeisel

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

Mike Iburg

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

Jason Ader - TomasWeisel

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'tthink all the guidance are this good as our guidance, but all the qualitativecommentary that the Dan has provided in his outlook section point in thedirection that you summarized.

Jason Ader - TomasWeisel

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

Bobby Johnson

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

Jason Ader - TomasWeisel

Okay. Thank you.

Operator

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

Nigel Frankson -Citigroup

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

Dan Fairfax

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

Nigel Frankson -Citigroup

Yes, it does, thanks. And one last question. In the pastyear, you commented that the PBT marketis one that you're watching and one that Foundry may look to invest in it atsome point in the future, if you deem it where the opportunity. I thought yourinformation if you could give us any kind of an update there anything that’schanged, anything that you have seen, anything at all?

Bobby Johnson

PBT is a very interesting technology to us. There's a lot ofother technologies as well. We won't do initially our product announcements onthe earnings call. So there is many different technologies, many differentthings we're adding to our products. And I would just say Foundry continues tofocus 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 fromRobert Baird. Go ahead please.

Ken Muth - RobertBaird

Hi. On the operating margin question, your guidance is stillkind of longer term a 20 to 25, given you guys have always consistently been aconservative spender on your dollars you are. Just trying to figure out how youwould able to take your numbers that low, what is kind of the Federal nottaking your guidance up just a little bit and not too much, but I am saying itseems like its almost unapproachable, you guys were dipped down sequentiallythat 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 ofall, 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 isalways been focused on profitable growth and we'll continue to do that. And ouroperating model may fluctuate a little bit, but I think we have always had afairly respectable, given economic operating ranges. And we'll over the nexttwo to four quarters be able to give you more specific guidance as we are ableto seize the overall academies, traction on new products and headcount growth.

Dan Fairfax

And we did have some natural cycle in our operating expensesin 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 thenback-end there drop out and we recycle back up again. And then there were alsosome cycle depending on where we are on product introduction for prototypingand then also some significant lumpiness in our product or in our marketing fortrade shows and other programs.

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

Ken Muth - RobertBaird

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

Dan Fairfax

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

Ken Muth - RobertBaird

Great. Thank you.

Operator

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

Mark Sue - RBCCapital 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 smallercompanies within the financial vertical? Or is it because most of the projectdollars have already been allocated?

Mike Iburg

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

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

Mark Sue - RBCCapital Markets

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

Mike Iburg

Well, this is Mike again. I'll just, and Dan could or Bobbycould add some other thoughts. We are looking at 2008, and Q1 pretty closely, aswe are coming through the fourth quarter here. We do agree that we haven'thistorically seen a seasonally soft March quarter. It's usually one of thetougher quarters of the year. We are trying to evaluate the momentum that wehave both, on the enterprise side and the service provider side and see howthat 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 thingthat 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 orperhaps more robust first half of next year than what we saw in 2007 or 2006 or2005.

So, although we are having a very strong back half of '07within 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 halfof '08. So if that make sense.

Mark Sue - RBCCapital Markets

Okay.

Bobby Johnson

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

Mark Sue - RBCCapital Markets

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

Mike Iburg

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

Mark Sue - RBCCapital 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. Goahead, please.

Long Jiang - UBSSecurities

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 talkabout your outlook for that market and whether it's a competitively speakingmore of a due to your major customers, next generation network they were buildout or your sales cycle for that market?

Bobby Johnson

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

Most like the answer on the Federal, its little bit tooearly to tell, if the turnaround is what’s the magnitude of the turnaround when.And I was in Japanin both the June and September to try to evaluate as best I can. The overallview, 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 willgreatly effect our overall results. So not despaired over, actually little bitfrom renewed optimism before what I have seen and experienced.

Long Jiang - UBSSecurities

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 thecredit market crunch. And, but some of your competitors also mentioned recentlyabout the weakness in the financial end market vertical. So do you see anydisconnection there and I mean what did you see for that vertical?

Bobby Johnson

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

Mike Iburg

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

Long Jiang - UBSSecurities

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

Mike Iburg

Thanks a lot. Thank you.

Bobby Johnson

Thank you.

Operator

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

Manny Recarey -Kaufman Brothers

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

Dan Fairfax

This is Dan, I'll talk about linearity. We saw for oursummer time quarter a historically record linearity, it was very solid. Oursales teams were performing consistently throughout the quarter. Bobby willanswer the second part of the question.

Bobby Johnson

Okay. So, the diversification to the adjacent marketsactually does have both elements. One is adding new sales territories where wehave not been before. That involves some places in Europe, expansion in someplaces in Asia. In terms of the other aspectof the adjacent markets, it includes adjacent technologies, and it gets back tosome 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 theenterprise. We are evaluating expansion in as well as adjacent service providermarkets. So, it has most dimensions of the product, as well as the geographicterritory.

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 PacificCrest Securities, go ahead please.

Tim Daubenspeck -Pacific Crest Securities

Thank you. The first question, there is a lot of investmentwithin enterprise and (inaudible) going after sales guys, are you seeing anyareas 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 aregoing after business. Certainly in some, either vertical markets, geographies,and in product categories, yes, those are just, all are lots of differentsolutions. But in others, where we got primarily differentiation, no we don’tthink there is too many, as matter of fact, some competition in some marketshelps. It helps bring attention to the market sector. In terms of recruiting,it is a robust recruiting environment. We are not constrained necessarily aboutthe calls associated with that. We are more focused on the quality of theindividual, and the experience level.

Tim Daubenspeck -Pacific Crest Securities

And then just one follow-up you talked about, in terms ofsome late shipments. Is that just the 32 slot or where there some issues forsecuring 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 shipdate, and we put it in the market right around the middle of September, whichwas 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 andtry all the products here as well. So, over the summer when we were comfortablewith the first customer ship, we were ready and we shipped out starting inSeptember

Tim Daubenspeck -Pacific Crest Securities

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

Bobby Johnson

No. The order linearity was really the internal directionwithin the company through the month of July. We had shifted our attention tosome other programs and that had effect of basically sliding from Julyshipments into August

Tim Daubenspeck - PacificCrest 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 SandersMorris. Go ahead please.

Subu Subrahmanyan -Sanders Morris

Thank you. Two questions, first on operating margin, I justwanted to put it from a different direction. If you think about continuingrevenue growth prospects and the margin prospects, can you talk about whatkinds 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 ifthere is a new range for operating margin?

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

Dan Fairfax

Okay. Subu, this is Dan, let me take a stab at yourquestions. So in terms of what we're investing, we have a great deal ofinterest in expanding our engineering teams, as well as our sales and marketingresources. So we feel very comfortable with the products we've available forthose 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 continueto keep our growth moving over to the new products or engineering teams whodevelops, both those areas will be areas of investment for us. As I mentionedearlier 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 mightcontrol some additional expense.

And then moving to the book-to-bill, the company reallycomes 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 spacethey tend to drive the customer expectations. We like to fill our orders assoon as we have product and when we have the order in hand really attempt tofill it as quickly as possible.

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

Mike Iburg

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

And the target range of 20% to 25%, he stated what remainscurrently our long-term operating margin range and we are continuing toevaluate that range. And if we determine, whether we determine to the nextthree 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 thatdetermination yet, because so far we have only got one quarter, where we havebeen above the range. Now, we probably that in the next model or probably lotmore model than you guys have done about '08 and '09. But, at this point we arenot 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 overtimeto 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 fromFerris, Baker Watts. Go ahead, please.

Matt Robison -Ferris, Baker Watts

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

Dan Fairfax

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

Matt Robison -Ferris, Baker Watts

So that build out of depots and sort of fixed costassociated 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 theside 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 atthe end of Q2. I am curious, it sounds like linearity was relatively good. Whydon’t you work the backlog down?

Dan Fairfax

This is Dan, as I was trying to express. First, when we getan 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 behavefrom one quarter to the next. We intended to have a, bulk of federal orderscome into bookings right at the end of Q2. Those orders we were able to ship inJuly and get them out to those agencies. And then in Q3, they shifted to thelate, in to the last week of the quarter, enterprise business and we weren'table to sell those orders.

Erik Suppiger -Signal Hill

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

Bobby Jhonson

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

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 appraisingeverybody of our calendar Q4 results in approximately 90days.

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: transcripts@seekingalpha.com. Thank you!