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Executives

Mark Donohue – Director of IR and Assistant Treasurer

Ash Dahod – Chairman, President and CEO

Paul Milbury – VP of Operations and CFO

Analysts

Brian Modoff – Deutsche Bank

Amir Rozwadowski – Barclays Capital

Mike Walkley – Piper Jaffray

Steven O’Brien – JP Morgan

Thomas Lee – Goldman Sachs

Hasan Imam – Thomas Weisel Partners

Blaine Carroll – FTN Midwest

Richard Kramer – Arete

Ted Jackson – Cantor Fitzgerald

Andy Schopick – Nutmeg Securities

Aaron Husock – Lanexa Global

Starent Networks, Corp. (STAR-OLD) Q4 2008 Earnings Call Transcript January 29, 2009 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2008 Starent Networks Corporation earnings conference call. My name is Stacy, and I'll be your conference moderator for today. At this time all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of the conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Mark Donohue, Director of Investor Relations. Please proceed.

Mark Donohue

Thank you, Stacy. Good evening, everyone. With me on the call this evening are Ashraf Dahod, our President and Chief Executive Officer, and Paul Milbury, our Vice President of Operations and Chief Financial Officer.

Tonight, after the market closed, we issued a press release announcing our results for the fourth quarter and full year of 2008. A copy of the press release along with accompanying income statement, balance sheet and operating statistics as well as a reconciliation of the most directly comparable GAAP financial measures to any non-GAAP financial measures used during this call and for certain prior periods are available on our web site.

The format for tonight's call is as follows. Ash will begin with a few summary statements and review business highlights, Paul will then review the details of our financial results and present our outlook for 2009. After that we'll open up the call for Q&A.

Before we begin, I would like to remind you that various remarks that we make about the company's future expectations, plans and prospects constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in our most recent quarterly report on Form 10-K filed with the SEC. In addition, any forward-looking statements represent our views only as of today. It should not be relied upon as representing our views as of any subsequent date.

While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, even if our estimates change, and therefore, you should not rely on these forward-looking statements as representing our views as of any subsequent date to today.

During this call, we will be referring to non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to those most directly comparable GAAP measures is available in the investor section of our web site, under the heading Non- GAAP Financial Measures.

At this time, I'd like to turn the call over to Ash.

Ash Dahod

Thank you, Mark. Good afternoon, everyone, and thank you for joining us for our fourth quarter and fiscal 2008 conference call. We are pleased to report that we ended 2008 with a strong fourth quarter.

Our revenue for the fourth quarter was $70.6 million, an increase of 40% from the fourth quarter of 2007. For the full year, revenues were $254.1 million, a growth rate of 74% year-over-year. GAAP net income was $17.5 million for the fourth quarter and $60.5 million for the full year, including stock-based compensation of $4 million in the fourth quarter and $16.5 million for the full year. Diluted GAAP EPS was $0.24 for the fourth quarter and $0.82 for the full year. Excluding stock-based compensation charges, non-GAAP net income was $21.6 million or $0.29 per diluted share in the fourth quarter and $70.4 million or $0.95 per diluted share for the full year.

Last year, we expanded our customer services across all geographies. For instance, we won business with such carriers as Bouygues Telecom in France, Willcom in Japan, a multiple Vodafone operating company. We announced wins for our WiMax solutions at Tatung InfoComm and First International Telecom, who put together, cover all regions of Taiwan. We also won new customers in the Americas and Asia Pacific, including China and India. We view China and India to be markets with great potential. In China, there have been positive developments recently with the allocation of 3G spectrum. The Ministry of Industry & Information Technology indicated 3G investments will exceed $40 billion over the next 24 months for infrastructure build out and upgrading. Although the Indian government has delayed 3G license auctions, expectations are that the auctions will occur in the coming months.

We also expanded our global presence by adding significant internal sales and marketing resources and pursuing channel relationships to broaden and strengthen our sales coverage. In 2008, we added 10 new sales channel partners worldwide to complement our direct sales team. Additionally, we recently announced a partnership agreement with Motorola to bring our 4G solutions to market. We believe this is a strong endorsement of our LTE strategy and solutions, which we will be demonstrating live at the Mobile World Congress in Barcelona next month.

Investing in R&D is one of the keys to our success. In that regard, we maintain strong technical engagement with our customers, and strive for quick time to deployment for feature and function. Our product is based on our ability to integrate multiple network functions and services on a single platform, while providing a compelling long-term vision to our customers. Among the most notable product introductions in 2008 was the successful deployment of the Serving GPRS Support Node or SGSN. To our knowledge, Starent Networks is the only non-radio vendor offering SGSN. The product has been well received in GSN GPRS, UNPS, and HSPA networks with wins in eight countries today. Additionally, we launched products which provide mobile operators a high-performance exit gateway for technologies such as WiMax and personal handy phone systems as well as secure access for unsecure networks like femtocell and wireless local area network.

As the multimedia packet core becomes increasingly complex, mobile operators are expecting Starent Networks to deliver integrated solutions. Consequently, we have started to develop partnerships with companies that have complementary technologies and combine them with our best of these products.

In 2008, the market hit some important milestones. At the end of the year, there were about four billion wireless subscribers, representing an annual growth rate of about 18% according to Wireless & Television. Subscribers are expected to continue to grow at double-digit percentage over the next couple of years and reach five billion subscribers by the end of 2010. Additionally, smartphone growth continues to be strong with the US exceeding 170 million by the end of 2008, an increase of 40% year-over-year according to Informer. As an example, in the fourth quarter, smartphones made up more than 37% of retail devices sold at Verizon Wireless, up from 30% the prior quarter. The smartphone market also experienced growth driven by touchscreen 3G devices such as Blackberry Storm, HTC G1, Nokia 5800 and iPhone.

Industrial reports suggest that data traffic increased between four and eight four [ph] in 2008. As several key (inaudible) data as a percentage of revenue hit the 25% mark. This week, Verizon Wireless reported wireless data revenue growth of 41.4% to $3 billion in the fourth quarter, which represents about 27% of their wireless service revenue.

And finally, key customers have started to make commitments to higher bandwidth technologies such as LTE and WiMax. We will continue to make significant investment to maintain our technical lead. The key to our success is in technology leadership, organizational ability, and our intense customer focus.

We had another successful year in 2008 and I would like to thank our customers, the entire Starent team and our shareholders. I believe we are well positioned to execute our plan this year. Our main goals are to remain focused, flexible, and aggressively pursue our business objectives.

I will now turn the call over to Paul to provide you with a review of our fourth quarter and fiscal year 2008 financial results and our outlook for 2009, after which we will be happy to answer questions.

Paul Milbury

Thank you, Ash. First of all, I would like to remind you that since we exclude non-cash stock-based compensation when we evaluate our operating performance internally, I will be referring to non-GAAP figures on this call unless I specifically state that I am referring to a GAAP figure.

We are very pleased with our financial performance for the fourth quarter and for the year as a whole. Our revenues increased 40% year-over-year to $70.6 million in the fourth quarter and our operating profits, excluding stock-based compensation, were $22 million or 31% of revenues.

For the year, our revenues were $254.1 million, up 74% from 2007 and our operating profits were $68.7 million or 27% of revenue. We exceeded our internal plans in spite of a significant slowdown in activity from one of our major accounts. For the year, our largest customer represented approximately 60% of revenues and our second largest customer represented about 19%. Together, our top five customers represented approximately 93% of total revenue.

From a new bookings perspective, we had more diversification with our top five customers representing a little less than 80% of the total.

Gross margins were 78.6% for the fourth quarter and 78.5% for the full year. Product gross margins were 81.3% for the fourth quarter and 81.7% for the full year. As we have said in the past, we do not expect that we will be able to sustain product gross margins at this level as we grow our market share with new customers in evolving markets. Service gross margins were 63.7% for the fourth quarter and were 60.4% for the full year.

Operating expenses were $33.5 million in Q4 and were $130.9 million for the year. For the full year, operating expenses as a percent of revenue declined almost 10 points from 60.8% to 51.5%.

During the year, we made significant investments in people and infrastructure to support the growth of our business and provide the foundation for capturing additional market share in the future. We increased our headcount by 164 to 774. Our direct sales customer basing resources and our customer support resources increased by more than 50% during the year. We also added 70 engineers during the year, almost all in our India operations. In total, 401 of our 774 employees are in India.

Other income was $1.1 million for the quarter and $6.8 million for the full year. Our cash is conservatively invested in US government and government-related money market securities.

Tax expense was $1.6 million for the quarter and $5 million for the full year.

Non-GAAP net income was $21.6 million in the fourth quarter or $0.29 per diluted share based on 73.8 million average shares. For the full year, net income was $70.4 million or $0.95 per diluted share based on 74.3 million average shares.

We ended the year with cash and short-term investments totaling $369.4 million, an increase of approximately $145 million for the year. Accounts Receivable was down approximately $2.5 million from the prior quarter to $53.7 million. DSO was 68 days, but as we had mentioned in the past, this is not a very useful measure, given that receivables are related to current quarter billings, which do not directly relate to the prior quarter revenues due to revenue recognition timing.

Capital expenditures, primarily for engineering and customer lab equipment, were approximately $4 million in Q4, making them $20.8 million for the year.

Balance sheet deferred revenues increased sequentially to $152.7 million, which is an increase of approximately $89 million for the year and was a major factor in our cash increase for the year.

Now I would like to turn to our outlook for 2009.

On our last call, we provided a preliminary outlook for revenue in the area of $315 million, target operating model profitability of 25% of revenue, and non-GAAP EPS in the range of $0.65 to $0.68 per share. Today, we would like to affirm that outlook. We have completed our budgeting process and have plans to grow our operating expenses by up to 20% in 2009 depending on business conditions. Our 25% operating profit target is achieved with operating expenses approximately 50% of revenue and gross margins in the 75% area. As we discussed in detail last quarter, our 2009 guidance assumes that we will be unable to convert a portion of the current backlog in some of our 2009 bookings to GAAP revenue under the revenue recognition requirements of SOP 97-2.

With other income in the $4 million to $6 million area depending on short-term interest rates and at tax rate in the 37% to 39% area, we are anticipating non-GAAP EPS in the area of $0.65 to $0.68 on 76 million to 77 million shares. Stock-based compensation before tax is expected to be approximately $5 million per quarter or about $20 million for the year, resulting in GAAP EPS in the range of $0.46 to $0.49 per diluted share.

Ash and I will be happy to take your questions now.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Brian Modoff with Deutsche Bank. Please proceed.

Brian Modoff – Deutsche Bank

Hi, guys. Couple of questions for you. First, Ash, can you give us an update on the EHRPD upgrades at Verizon? How do you see those progressing and do you see that as revenue opportunity in ’09? And then, can you discuss kind of the developing markets here getting some penetration into some key large operators in places like Africa, China, and Southeast Asia. Can you kind of talk about how that is coming along and perhaps talk about incremental opportunities you see in places like Latin America and the Middle East? Thank you.

Ash Dahod

Okay, As far as EHRPD at Verizon is concerned, it is on track and we expect it to be deployed this year and we expect it to be converted into revenue following the procedure that is laid out by Verizon. But there is no change in the EHRPD plan for Verizon.

As far as the new markets that we have to pursue, we obviously had some deployments in Africa already and we still have a lot of activity in China and in some of the Asia-Pacific markets. We believe we are very well positioned with the combination of our direct presence and some of our channel partners who pursued the markets in the Asia-Pac region and also in some of the Middle-Eastern markets.

Brian Modoff – Deutsche Bank

And Paul, given the accounting treatment in these non-European markets, would you expect that these turn into revenues in ’09?

Paul Milbury

We are not expecting to have the same kind of accounting issues that we have had with some of the recent EMEA wins, but I think given the timing, we're not counting on any significant contributions to 2009 revenue.

Brian Modoff – Deutsche Bank

Okay, thank you. I will turn it over to the next caller.

Operator

Your next question comes from the line of Amir Rozwadowski with Barclays Capital. Please proceed.

Amir Rozwadowski – Barclays Capital

Thank you very much for taking the question, gentlemen. Certainly, given the macro backdrop, some carriers, including some of your partners have indicated sort of reduction in CapEx in 2009. Can you give us some color on what you folks are seeing in terms of your carrier partners, specifically given that data still seems to be a robust area of growth?

Paul Milbury

Well, I guess the main thing we comment on is the results today. I think with the exception of one large carrier that I mentioned earlier in the script being soft in 2008 pre the macroeconomic conditions, we really haven't seen any great change in behavior or activity with our customers or prospects, and obviously we are hoping that that continues to be the case and we continue to invest and support that robust growth in data traffic.

Amir Rozwadowski – Barclays Capital

So in terms of just sort of the potential RNPs that you folks are seeing, have you seen any timing shifts or even sort of the real lifelines that you folks have pushed back?

Ash Dahod

I mean, as you know, even in the normal times, RNP timing is very difficult to predict and shifts occur in most directions that normally takes 10 years longer than they expect. So we haven't seen any unusual delays even in RNP activity.

Amir Rozwadowski – Barclays Capital

That is helpful, Ash; and then secondly, in terms of China, I mean certainly some aggressive spending targets put out by some of the carriers there. Can you give us a little color in terms of your opportunity or perhaps when you think some of that could start to contribute to bookings and your top line and whether or not there is potential opportunity to partner with some of the local OEM houses in terms of maybe a similar announcement to what you folks have had with Motorola?

Ash Dahod

We do have a local partner in China that we haven't announced yet and at some point, once we get their written consent, we hope to announce that relationship. At the same time, we have several other partnerships in China that will allow us to pursue opportunities; there is both China Unicom and China Telecom, and China Mobile. Clearly, China Telecom is already a customer of ours but we also are directly engaged with both China Unicom and China Mobile and our product is well-suited and it is going through the appropriate certification for us to be qualified as a biller directly or indirectly for both the SGSN and the GPSN.

Amir Rozwadowski – Barclays Capital

Great, that is very helpful. Thank you very much, Ash.

Operator

Your next question comes from the line of Mike Walkley with Piper Jaffray. Please proceed.

Mike Walkley – Piper Jaffray

Okay, thanks guys and congrats on a strong result in a tough environment. Just wanted to ask a question really on cash and cash management with approximately $5 a share in cash; I realize you need to have a strong cash balance to support a large carrier customers, but how should we think about potential acquisitions that you might be looking at and also with the way the Vodafone contract is booked, how should we think about cash flow in ’09 relative to ‘08. Should we see deferred grow it into another strong cash flow generation yet?

Paul Milbury

From a cash and acquisition or investment perspective, there are always opportunities out there. There are lots of small companies that we partner with in various aspects of the business, some of which are more strategic than others. There may be times when it is appropriate to make some kind of investment in that company to achieve our business objectives. We don't have anything major on the radar screen at this juncture and – with respect to the cash flow in 2009, we wouldn't expect it to be the kind of year that we had in 2008, where cash increased by roughly 2x our net income. So that was pretty dramatic increase in cash flow as to income generation. We would expect cash generation in 2009 to be sort of 1x or less the net income for the year. We don't really try to predict deferred revenue over the course of the year here at the year end because there are so many sorts of timing elements that can affect that one way or the other.

Ash Dahod

I think one thing I want to assure you that the amount of cash we have is not going to drive what we invest in or if we do an acquisition. I think it would be a decision that is made based on the strategic value of a company that we really considering investing in or acquiring. I will assure you that just because we have the cash, we have no desire to spend it.

Mike Walkley – Piper Jaffray

Great. That is helpful, thank you. And then, Ash, just in terms of competitive landscape out there, are you seeing any of the larger OEMs making inroads or any kind of change in the competitive landscape since last quarter’s call?

Ash Dahod

We have never really seen any changes in the competitive landscape (inaudible) three months ago. Clearly, again the new major milestone will be delivering functionality for 4G technologies like LTE.

Mike Walkley – Piper Jaffray

Thank you. And then, final question and I will pass it on. In terms of the pricing environment out there, I know you talked a little bit about gross margin coming down due to the new customer mix, but is any of your larger existing customers – is any kind of contract renewal that could add to a near-term pricing trend?

Paul Milbury

Nothing specific.

Mike Walkley – Piper Jaffray

Okay, thank you very much.

Operator

Your next question comes from the line of Steven O’Brien with JP Morgan. Please proceed.

Steven O’Brien – JP Morgan

Hi, thanks for taking my question. First off, on the deferred revenues this quarter at 153, a slight lead quarter over quarter. Does this reflect incremental uptick from your UNPS contracts from Vodafone and Bweeg? So was there a mix change within the deferred for this quarter or was there any unexpected sort of change in the deferred balance you anticipated kind of going into the quarter?

Paul Milbury

No, nothing that we didn't anticipate. The deferred revenue balance is still largely CDMA-based but there is an increasing component of the UNPS business in there.

Steven O’Brien – JP Morgan

So would the UNPS revenues, I guess how does that trend through 2009, when do they start to become say 10% of revenue?

Paul Milbury

When?

Steven O’Brien – JP Morgan

In any given quarter. Is it a ramp through the year or is it – do they start first thing in Q1?

Paul Milbury

I don't think we really have any significant UNPS-based revenues in Q1. In 2008, our non-CDMA revenues were maybe 8% to 10% of our revenue. That might double over the course of the year and maybe be 15% of our revenue over the course of the full year next year. As we said in the last call, there is $40 million of revenue that wouldn’t have been recognized as revenue had we not had deferred over time. So, I wouldn't expect our UMTS revenue to be – I’d expect it to be maybe 15% for the year. But I don't really have a comment of any given quarter’s contribution.

Analyst

So would UMTS being relatively I guess lower in Q1 and potentially ramping through the year, how does that reflect on the revenue pattern you expect for 2009? Should we see – do you have any outlook or guidance for us on how revenue should trend through your 3.15 guidance?

Mark Donohue

No. Our policy is not to provide quarterly guidance. And so, we’ve given 3.15, and I wouldn’t expect Q1 to be dramatically different from Q4, maybe slightly higher but other than that we don’t provide quarterly guidance.

Steven O’Brien – JP Morgan

Great. And then if I could another, based on the full year 10% customers, I think it was 60% for your top customer and 19% for your second customer. It sounds like the top customer might have had lower orders or lower revenues I guess in the fourth quarter of this year. How is linearity in the quarter, and linearity from your largest customer through 2008?

Mark Donohue

I don't know how you concluded that what you just said about the largest customer in the fourth quarter. And then from a linearity point of view it’s really not a relative concept for us because most of the revenue that’s recognized in our accounting statements in the quarter is coming out of the backlog as opposed to new booking (inaudible) we would talk linearity, they are talking about how the business is coming into the company over the course of the quarter. Substantially all of that fourth quarter revenue has been booked in previous quarters.

Steven O’Brien – JP Morgan

Okay, thanks.

Mark Donohue

You are welcome.

Operator

Your next question comes from the line of Thomas Lee with Goldman Sachs. Please proceed.

Thomas Lee – Goldman Sachs

Hi, thanks for taking my call. Just I guess a follow up on the last question. So, then I think you’ve indicated UMTS revenues could be about 15% for the year. I'm just curious to know, I guess some thought on the revenue guidance. On the CDMA side, can we assume that CDMA can still grow double digits for you, just curious any kind of ballpark in terms of how should we think about growth rates for CDMA in 2009?

Paul Milbury

We don't break it out that specifically, but the answer to the question you posed, yes we feel good about the prospects for CDMA, growth continues to be double digits in ’09 and beyond.

Thomas Lee – Goldman Sachs

Got it, okay. And then just a question I guess just on the RFP landscaping. I am curious to know is it sure that most tier 1 operators, maybe Exxon, Asia-Pac, China, India, have they largely their made decisions on packet core vendors for 3G or is there some opportunity?

Ash Dahod

No. I think in India, China and most of the Asia Pac market – yes, they have not yet made a 3G core decision.

Thomas Lee – Goldman Sachs

But in other regions is it safe to assume, most of the operators have – everybody has firmed up their –

Ash Dahod

I think, as we have said in the past, even some of the Western European operators haven’t yet decided on the 3G core supplier.

Thomas Lee – Goldman Sachs

They have not?

Ash Dahod

That’s right.

Thomas Lee – Goldman Sachs

Got it. But in North America, it looks like those decisions have largely been made.

Ash Dahod

In North American, (inaudible) today has 3G network.

Thomas Lee – Goldman Sachs

Okay. And then on the WiMax, I am just curious to know like do you expect to generate a significant amount of WiMax related revenue this year? How should we think about the growth related to this technology?

Ash Dahod

At the present time the demand for WiMax is coming from nearly two places. One is a major deployment nationwide is significant. One is driven by K-wire and second one with Taiwan. And then there is a large number of small WiMax deployments which are essentially fixed line replacement or WiMax unit for the last line. We believe that this (inaudible) compared to other macrocellular technologies, WiMax will not be that difficult. So, it’s clearly been a growing field.

Thomas Lee – Goldman Sachs

Got it. Okay. And then just lastly I just had a question on the recent announcement with your – the Motorola partnership. Does that suggest that full radio core offering becomes more important with LTE, or if it’s not the case, Motorola looking to kind of enhance their portfolio?

Ash Dahod

All of the radio suppliers, as well as relatively VOD plan to have some sort of a core either internally or externally through partnership. So, Motorola had been developing (inaudible) will create a core vendor, there is a (inaudible) these would provide us better solution. (inaudible) variety of radio suppliers and doing lot of testing.

Thomas Lee – Goldman Sachs

But it’s not an indication one way or the other in terms of how operators are thinking as they make their vendor selections for LTE that maybe the appetite for selecting just a core vendor perhaps maybe lessens I guess as we move to 4G.

Ash Dahod

We believe that ultimately in the 4G LTE market, the radio and the core will be separated as we go into the CDMA, UMTS and you will be vibrant. So, we believe there maybe some trials if they go out, whereas if they integrate solutions from one supplier when the network is commercially deployed to the extent that you are going to only get a best of breed when you are combined with a best of breed core.

Thomas Lee – Goldman Sachs

Got it. Thank you.

Operator

Your next question comes from the line of Hasan Imam with Thomas Weisel Partners. Please proceed.

Hasan Imam – Thomas Weisel Partners

Thank you. Congrats on a pretty strong performance. I am looking to get a harp on the macro environment a little bit in terms of guidance. So, every operator that’s talked about CapEx plans are directionally down in 2009. So, 25% or so revenue growth would be very impressive under that kind of macro-tech backdrop. So, I am just wondering your affirmation of guidance. Is that view based on recent conversations with your biggest existing customers or you are kind of extrapolating from orders not dropping off in the recent quarter or in terms of your Q1 visibility through the full year.

Paul Milbury

The visibility we have to 2009, we think it clearly supports the guidance that we’ve affirmed. For the next two quarters, obviously the visibility comes out of the backlog that we have which is the deferred revenue plus the unbilled orders on hand. So, the back half of the year visibility obviously is based on the pipeline of business activity that we have and can see and through conversions with the existing customer base.

Hasan Imam – Thomas Weisel Partners

Great. And then just one other question on that front. In terms of the guidance, are you primarily expecting the existing customers to ramp meaningfully or is it that existing deployments are somewhat stable and then you have incremental revenues from new deployments?

Paul Milbury

I think, it’s a combination. Most of the revenue – we do have a significant contribution to revenue in 2009 from customers where we have previously not had revenue in the past. So, there will be a significant contribution from new customers from that perspective. These are – they are not new customers in terms of customers we need to go find and run the business. They are customers that we sign deals with, but we will be recognizing revenue for the first time in 2009. So, there is a meaningful contribution from those customers. We are expecting good continued business from our existing larger customers as well.

Hasan Imam – Thomas Weisel Partners

Great. Thanks. And one last question maybe for Ash in terms of the competitive landscape. I think another person asked that question, a similar question. You know there is some talk about Cisco becoming a lot more aggressive with the new product set coming after this target segment. Can you share your thoughts on that?

Ash Dahod

Cisco has always been very aggressive. And we expect Cisco to continue to be aggressive. As I mentioned earlier, I think what we see as we peddled it down, the competitive position that we have against Cisco hasn’t really changed dramatically.

Hasan Imam – Thomas Weisel Partners

Got it. Thank you.

Operator

Your next question comes from the line of Blaine Carroll with FTN Midwest. Please proceed.

Blaine Carroll – FTN Midwest

Yes, thank you. Nice quarter guys. Paul, looking at the – just a housekeeping question on the R&D line. I was a little surprised to see it down sequentially. Was there some project in the third quarter that have the R&D inflated or do you expect R&D to step up going into the first quarter?

Paul Milbury

I think a little bit of both. The answer is little bit of yes to both of those questions. It was a heavy amount of IOT activity, interoperability testing activity, in the third quarter. And we didn’t have a similar amount in the fourth quarter, which is running at notched down a little bit, but I would expect it to hit back up in the first quarter.

Blaine Carroll – FTN Midwest

Okay. Thanks. And then, Ash, as far as Nortel, and I am assuming the answer is no here, any implications with the problems that Nortel is having?

Ash Dahod

Probably, they don’t know really the contention, as you known the largest customer that we had, the Nortel, has decided home users direct, a while ago. So, we don’t really believe that we need to test [ph] an impact. We will continue to working with them.

Blaine Carroll – FTN Midwest

With Nortel or with that large customer?

Ash Dahod

With Nortel, for some of the properties that we already have with customers.

Blaine Carroll – FTN Midwest

All right. And then that large customer that you referred to, do you expect business with them to come back in 2009?

Ash Dahod

Yes. We are expecting to do business with that customer in 2009, yes.

Blaine Carroll – FTN Midwest

Okay. So, maybe not on the levels that we previously saw, Paul?

Paul Milbury

Well, I am not going to – I guess I can’t really comment specifically. And what – what you see in the financials is revenue activity, that’s the books activity. I would expect bookings activity hopefully to be materially better with that particular customer in 2009.

Blaine Carroll – FTN Midwest

Okay. Beautiful. Thanks.

Paul Milbury

You are welcome.

Operator

Your next question comes from the line of Richard Kramer with Arete. Please proceed.

Richard Kramer – Arete

Thanks very much. A couple of questions if I may. On the Motorola partnership deal, can you say whether that’s exclusive return [ph] or whether you would expect to bring similar OEMs in on similar deals? And also, Ash, I think you mentioned partnerships with complementary companies, could you give us a sense of the areas you would be looking at to form these partnerships and sort of what depth that we might expect to take.

Ash Dahod

Sure. Having aside Motorola is simply considered as non-exclusive. I think the area where our focus is more in the complementary technology more towards, and moving to the multimedia core, and trying to create an ecosystem (inaudible) application that was set on top of our infrastructure and also how do we take this on the packaged infrastructure and service infrastructure. And there are few areas that we can specifically focus on and combine those products and technologies with our products and be able to offer an integrated solution for the customer, especially, as we use IMS, there is an underlying technology.

Richard Kramer – Arete

And another question about the competitive environment. And we understand that in some carriers, perhaps in Asia, if someone has might have been able to replace some top tier OEMs, are you finding there is incremental business in existing accounts from replacing competitors who are alongside you in those accounts or is it more that you have to win RFPs in beauty contest in carriers to sustain your revenue growth?

Ash Dahod

I think in most cases, to initially penetrate a house, we really have to go to the house to process. And once we are in there then obviously (inaudible) business not having to go to RFP process and be able to replace an incumbent.

Richard Kramer – Arete

And Paul, a couple of quick questions for you. When we see the 10-Q for fourth quarter 2008, will we see at any stage any meaningful European revenues? And just as a baseline since you mentioned the rough 15% of sales in 2009, as the target for UMTS, can you give us a sense what level that was in 2008.

Paul Milbury

It was roughly half that as a percentage of revenue. And we said roughly 8% in ‘08 and 15% in 2009.

Richard Kramer – Arete

And geographically, will we be able to see in any of the fourth quarter 10-Q that you started to recognize some revenue in Europe or is that still something to come for 2009?

Paul Milbury

Substantially, very little in the fourth quarter of 2008.

Richard Kramer – Arete

Okay. Thanks very much.

Paul Milbury

You are welcome.

Operator

Your next question comes from the line of Ted Jackson with Cantor Fitzgerald. Please proceed.

Ted Jackson – Cantor Fitzgerald

I am just going to stick mainly with some financial questions. If you don’t mind, and then maybe one sort of larger strategic one. One is, if you could provide a geographic break down. Number two is, if you could give a discussion of direct versus indirect. And I have a couple more behind that.

Paul Milbury

For the year, roughly 90% of our revenues were North America and about the remaining 10% were Asia Pacific. And then from direct/indirect perspective, about 90% of our revenues were direct and about 10% were indirect.

Ted Jackson – Cantor Fitzgerald

And that’s for the year also?

Paul Milbury

Yes.

Ted Jackson – Cantor Fitzgerald

On the balance sheet, you had a line item pop up at 9.7 million deferred tax asset, could you just quickly say what that is. And that would convert your revenue going into 2009.

Paul Milbury

No. That is connected with the reversal of our tax valuation allowance. And –

Ted Jackson – Cantor Fitzgerald

Yes, I got it. And then just you had in the last year or so, there has been a pretty steady pickup in terms of inventory and a trend down in terms of turns. I am just curious if you could spend a little time talking about trend and what the outlook for that is as we look for 2009?

Paul Milbury

At a high level, the increase in inventory directly related to the increase in deferred revenue on the balance sheet for the different COGS associated with that deferred revenue. It’s what is striking a year over year increase.

Ted Jackson – Cantor Fitzgerald

And then the more strategic question is, as we look at LTE and the outlook for deployment, some of the demands that will be placed on networks for this deployment to come into being, how far do you think you can get within the world of LTE with the ST40 platform? You view LTE and its impendings before (inaudible) goes off is being something that is going to drive you to upgrade your hardware platform, and have you begun developments towards that end?

Ash Dahod

We clearly, we look at ST40 in that position to support demand for the LTE network, but at the same time we also believe that depending on how the LTE network is designed carriers could have as high as 20%, 25% of the locations where they may need a platform that is bigger than the ST40. Evidently, no need will occur on day one. Need might occur as the networks get larger and LTE penetration increases. Clearly, as we have said in the past that we intend to invest in R&D and make sure that we continue to have a strong competitive link. So, we believe that when the LTE market is ready for a platform that is bigger than the ST40, we expect to have it.

Ted Jackson – Cantor Fitzgerald

And just back on the LTE front, and then I will be done. If you were to have a third dog when LTE starts to show some traction in actual deployment, when do you cease the initial performance royalty happen?

Ash Dahod

I believe that some of our initial testing of LTE perhaps really has entered this year with significant wires and key trials occurring next year. (inaudible) that a large could happen in the second half of next year with extensive deployment in place in 2011.

Ted Jackson – Cantor Fitzgerald

Okay. Thanks very much and congrats on a good quarter.

Ash Dahod

Thanks.

Operator

Your next question comes from the line of Andy Schopick with Nutmeg Securities. Please proceed.

Andy Schopick – Nutmeg Securities

Thank you. Paul, I would like to ask just a couple of questions to you. First and the foremost, given the fact that you are going to be fully taxed for re-financial reporting purposes in 2009. Had you given any thought for consideration for calendar 2009 only and for financial reporting or press release purposes to doing some kind of a non-GAAP comparison looking at 2008 earnings as if they had been taxed at the same anticipated level of 2009, because you know what’s going to happen, people see headlines and react to things when just said something that’s a sort of concern to you.

Paul Milbury

I guess, the direct answer to the question is, well, we haven’t really consider doing anything specifically right there to go back and normalize 2008 for whole tax rate, obviously it would be relatively easy for us to do it or anyone else to do it.

Andy Schopick – Nutmeg Securities

We encourage you to give it some thought. Who can do it for sure, but I am just worried about how the actual reports may look at first glance and it’s just something that is probably worth some consideration.

Paul Milbury

Okay.

Andy Schopick – Nutmeg Securities

Secondly, are you concerned at all about the level of stock based compensation? Are there any efforts internally to kind of look at that and see how you might reduce the level of stock based comp going forward.

Paul Milbury

I think that the company feels relatively comfortable with the current levels of stock based compensation. We look at it very carefully. We look at the level of stock based compensation that we are using relative to other companies in our peer group and as a percentage of our revenues and operating profitability and the like. And so I would say at this point in time, we feel comfortable with that level.

Andy Schopick – Nutmeg Securities

So you don’t expect to really change your option awards or anything of that nature that might help to reduce that?

Paul Milbury

I’m not anticipating that at this point. No.

Andy Schopick – Nutmeg Securities

Okay. Thank you.

Operator

Your final question comes from the line of Aaron Husock with Lanexa Global. Please proceed.

Aaron Husock – Lanexa Global

Thanks for taking my question. I was hoping you could give us a little bit more granularity on your China business, as it is down right now. Have you already started making – where are you in the China Telecom relationship. Kind of give us, having already started shipping product to them, already recognizing revenue and the various gradients in between. And I have a follow.

Ash Dahod

I think, you are right. China Telecom has done an initial purchase to get decent amount of coverage in all of the provinces. And it quickly has been shipped and installed product to them.

Aaron Husock – Lanexa Global

Okay. And then the MIIT in their recent announcement said that they want China Telecom the 3G coverage of 100 CDs by the end of March. Is you sense that that’s going to require significant further installation of Starent equipment or is that more direct to kind of at the radio level?

Ash Dahod

I believe it is more in the radio level. And I believe that most of that network is only in the plain.

Aaron Husock – Lanexa Global

Okay. Great. And then at what point do you think you like to bill or recognize some of that China Telecom revenue?

Ash Dahod

We will be recognizing some of it this year.

Aaron Husock – Lanexa Global

Here are we talking too wider or is it more –

Paul Milbury

Later. The back half of this year.

Aaron Husock – Lanexa Global

Okay. Do you see China Telecom, are the customer of the size where they could eventually be a 10% customer or they smaller than that?

Ash Dahod

From the current subscriber point of view, and if you look at the – I mean from its subscriber point of view, they need to grow dramatically because they acquired the CDMA property of China Unicom of the three major networks, they were the smallest of the three. But their plans are to really aggressively market 3G data services and if they are successful in their marketing program, we do expect them to become a significant player in the high-speed data market.

Aaron Husock – Lanexa Global

Okay. Great, thank you.

Ash Dahod

You are welcome.

Operator

At this time, I would like to turn the presentation back over to Mr. Ash for closing remarks.

Ash Dahod

Well, I would like to thank everyone for taking their time to participate in our call.

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Source: Starent Networks, Corp. Q4 2008 Earnings Call Transcript
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