Starent Networks, Corp.Q2 2008 Earnings Call Transcript

Jul.29.08 | About: Starent Networks (STAR-OLD)

Starent Networks Corp. (STAR-OLD) Q2 2008 Earnings Call July 29, 2008 5:00 PM ET

Executives

Mark Donohue - Director of Investor Relations

Ashraf Dahod - President and Chief Executive Officer

Paul Milbury - Vice President of Operations and CFO

Analysts

Brian Modoff - Deutsche Bank

Charles John - Piper Jaffray

Jeff Kvaal - Lehman Brothers

Ehud Gelblum - JPMorgan

Thomas Lee - Goldman Sachs

Blaine Carroll - FTN Midwest Securities

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Starent Networks Corporation Earnings Call. My name is Amanda, and I'll be your operator for today. At this time all participants are in listen-only mode. We will conduct a question and answer session towards the end of this conference.

(Operator instructions). I would now like to turn the call over to Mr. Mark Donohue, Director of Investor Relations. Please proceed, sir.

Mark Donohue

Thank you Amanda. 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.

Today after the market closed, we issued a press release announcing our results for the second quarter 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 the investor section of our website at www.starentnetworks.com.

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 the remainder of 2008. 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 these forward-looking statements as a result of various important factors including those discussed in our most recent filings 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 date subsequent 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 the most directly comparable GAAP measures is available in our earnings press release issued earlier today, which is posted on the investor's section of our website.

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

Ashraf Dahod

Thank you, Mark. Good evening, everyone, and thank you for joining us for our second quarter of 2008 earnings conference call. We are pleased to report that we had a successful second quarter.

Our revenue for the second quarter was $61.2 million, an increase of 98% from the second quarter of 2007. GAAP net income was $13.8 million or $0.19 cents per diluted share in the second quarter including stock based compensation of $4.5 million. Excluding the stock-based compensation charges, non-GAAP net income was $18.3 million or $0.25 cents per diluted share for the second quarter.

We attribute the positive momentum in our business to the continued increase of data traffic on our customer's network, driven by such factors as data subscriber growth, new broad band multimedia services, and higher band width radio technologies, as well as affordable multimedia handsets and data cards.

Today we would like to share with you our views on the multimedia packet core networking market by reviewing some of the trends we have seen for the first half of the year.

Our CDMA business continues to be strong, and we believe this market offers significant ongoing opportunity. For example, at the end of the second quarter, of the $420 million worldwide CDMA subscribers, only approximately $100 million or about 24%, were on broadband EV-DO networks according to wireless intelligence.

EV-DO subscriber penetration is expected to reach almost $250 million subscribers by 2012, which represents a four-year compounded annual growth rate of 26%. While this subscriber growth estimate is strong, we anticipate mobile data traffic to grow at even higher rates, due to the increased band width peruser driven by multimedia applications.

We believe we are well positioned to capitalize on the opportunities in the 3G CDMA packet core market, as we have 78% market share according to market research firm in phonetics.

We continue to expand our share in the UMTS HSPA market. We are pleased to announce that this week we signed a new UMTS carrier. Further, during this quarter, we also secured an additional UMTS win in Hungary, so we now have UMTS mobile operator activity in 11 countries throughout Europe and the Asia/Pacific.

Additionally, our SGSN product line is being well received in the marketplace, with wins at customer sites in Germany, the United Kingdom, Romania, and Hungary in the first half of the year. What we have derived from our UMTS wins to date is that broadband HSPA technology shows as a driver for packet core infrastructure decisions.

The Global Mobile Suppliers Association recently announced that there are 242 HSPA network commitments in 99 countries. As of the second quarter of 2008, there were approximately 32 million HSPA subscribers, which represent only 1% of worldwide GSM subscribers. That figure is expected to grow significantly, passing the 800 million mark in 2012, according to wireless intelligence.

This growth forecast represents a four-year compound annual growth rate of 123%. We viewed HSPA market as a significant emerging opportunity. We remain confident in our business prospects because multimedia data service offerings have become increasingly important to carriers.

Recently, Verizon reported that data services represented 24.4% of the service revenues last quarter compared to 19% in the same period last year and 12.9% in the same period two years ago. Additionally, last quarter Vodafone reported that data services revenue increased by 29.4% year-over-year, after adjusting for the impact of foreign currency and acquisitions.

We believe that some of the recent events in the smartphone market bode well for the growth of our business. We plan to open source operating systems like Symbian, which has about 63% market share according to Gartners, January 2008 worldwide smartphones by operating system forecast. Smartphones are expected to become even more price competitive and accessible to users.

Additionally the establishment of open source mobile environment such as the Symbian Foundation, the Linux Mobile Foundation and the Google's Android are expected to drive smartphone application development, further driving mobile data users.

We also expect data cost to continue to play a meaningful role in growing mobile data traffic. For example, Vodafone reported an 84.1% annual increase in a number of mobile PC connectivity devices last quarter and attributed much of their growth in data services to these devices.

According to Gartner's June 2008 forecast for wireless cards and modems, the data card market was 10.7 million units in 2007 and that figure is expected to be over 51 million units by 2012, which is a five-year compound annual growth rate of 37%. A number of factors, including affordable operated data service plans and innovative form factors such as USB data cards, are contributing to this growth.

Affordable flat rate data plans increased the mobile data traffic volumes in 3G networks by at least fourfold in 2007, according to heavy readings report on flat IP architecture in mobile networks. As these plans become more commonplace, mobile operators are compelled to differentiate themselves by expanding the multimedia portfolio with offerings such as gaming, push-to-talk, mobile TV, and location based services, to name a few.

Achieving this goal often requires network customization and continuity to provide this service to our customers. While we are expanding our carrier class products to support a variety of radio networks, we are also targeting additional opportunities to software based in-line services that embed intelligence into the packet core. With our products designed to run on a single core hardware platform, the competitive difference that we continually emphasize is our software expertise.

Mobile operators are looking for strategies and solutions that will not only solve today's requirement, but also position them for the long-term migration and deployment challenges of emerging technologies such as LET, WiMAX, femtocell and IMS.

For example, when a customer uses our equipment for EV-DO or HSPA, they will be able to migrate to LTE by activating additional software on the same platform, thus eliminating forklift upgrades.

Since our company's inception, we have designed our platform to be radio access independent. For instance, this quarter, Willcom, a mobile data telecommunications provider in Japan, selected Starent for its next generation Personal Handyphone System to offer subscribers high speed internet access on their mobile network.

Willcom will use the ST40 multimedia core platform with PHS Access Gateway and Home Agent functionality. Starent was chosen based on our ability to integrate multiple network functions and services in a single platform, as well as our successful interoperability with a wide range of radio network infrastructure elements.

Of particular importance to the mobile operators is the ability to maximize the value of their WiMAX spectrum, assess finite, and manage black hole costs. Some of our customers have claimed that as much as 80% of the data traffic is coming from as few as 5% of the subscribers who are running applications like peer-to-peer data exchange.

If you envision a scenario where each subscriber had 10 Megabits per second of bandwidth available, it is not surprising why radio network efficiency and back hole costs are becoming crucial concerns for mobile carriers planning to transition to 40.

We believe this highlights the pivotal role we play in enhancing the subscriber experience to in-line services such as deep packet inspection, policy enforcement, and intelligent traffic control. Our success is driven by our best-of-breed solutions and clear focus on the multimedia core packet.

We remain confident that if we execute on our strategy and maintain this focus, we will continue to be successful. With our accomplishment in the first half of this year, we believe that we are well positioned for the rest of 2008 and beyond.

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

Paul Milbury

Thank you, Ash. Revenues were $61.2 million for the second quarter of 2008 and were $117.4 million for the first half of the year, up approximately 100% over the 2007 levels for the same periods. Non-GAAP operating profits were $17.8 million or 29% of revenue for the second quarter, and were $28.1 million for the first half of the year, up approximately 200% over the 2007 levels.

Non-GAAP operating profits exclude $4.5 million of stock-based compensation for the second quarter of 2008 and $7.9 million for the first half of the year. Our total cash position increased by more than $35 million during the quarter, to approximately $321 million or over $4 per share.

In line with our plans and previous outlook, our deferred revenue balance was approximately $118 million at the end of Q2, down from Q1, but up more than $50 million from the beginning of the year.

In Q2, we had two 10% customers and our top four customers represented more than 90% of our total revenue. One of the 10% customers in Q2 was also a 10% customer in Q1. Roughly 90% of our revenue was direct and 10% indirect.

Since we exclude non-cash stock-based compensation when we evaluate our operating performance internally, I will be referring to non-GAAP figures in this call, unless I specifically state that I am referring to a GAAP figure. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures is available in our earnings press release issued earlier today, which is posted on the investor relations section of our website.

Gross margins were 78.9% in Q2, up about 1 percentage point from Q1. Product margins were about the same as in Q1, but service margins increased about 10 percentage points in the quarter to a little over 60%. As I have said in the past, as we ramp up our business, we expect volatility in our service margins.

There will be quarters where expenses grow faster than revenues, such as in Q1, and there will be quarters such as Q2, where our revenues catch up with and grow faster than our expenses. In Q2, services expenses were slightly below Q1, while services revenues grew 23% sequentially.

Operating expenses were $30.5 million, down $2.8 million from the first quarter as expected and in line with our prior guidance where we said we expected Q1 operating expenses to be the highest quarterly expenses of the year and we expected Q2 operating expenses to be 2 to $3 million below Q1.

Research and development expenses were down sequentially as a result of a small amount of non-recurring engineering expense recovery, while sales and marketing expenses were down approximately $3 million in line with our previous guidance.

G&A expenses in Q2 were up sequentially, primarily as a result of higher legal expenses. Overall for Q2, operating expenses declined to under 50% of revenue. Total headcount at the end of Q2 was 676, up $41 million from the end of Q1, and up 66 since the beginning of the year.

Other income was $1.9 million for the quarter, down from $3.2 million in Q1. This is primarily the result of having a small, negative currency revaluation impact in Q2 compared to a favorable currency revaluation impact in Q1. Tax expense was $1.3 million in Q2, making the non-GAAP tax rate approximately 7%, compared to approximately 3% in Q1.

Non-GAAP net income for Q2 was $18.3 million or $0.25 cents per diluted share on $74.4 million fully diluted shares outstanding. On our last call, we said we expected to have another strong cash flow quarter in Q2 with accounts receivable coming down and having a more normal-looking relationship relative to the current quarter's revenue.

In Q2, total cash increased by $35 million and accounts receivable were lower as expected. DSO was 58 days, but as we have said many times in the past, DSO is not a particularly relevant operating measure for Starent, since DSO relates outstanding receivables to the current quarter's revenue.

In Starent's case, given the revenue recognition cycle, outstanding receivables at the end of the quarter are usually not directly related to the current quarter's revenue. Based on our reported results and the strength of the business in the quarter, we are increasing our full year revenue outlook range to $240 to $243 million, a growth rate of approximately 66% over 2007.

I would expect gross margins to remain somewhat above our long-term model for the second half of 2008, and to be in the area of 74%, making full year gross margins approximately 76%. We expect our gross margins to be lower in the second half of the year because we don't expect the same level of software content and because we expect to incur higher services revenues as we expand the capacity of our customer service organization in the second half of the year.

We are increasing our operating expense outlook for the second half of the year to approximately $62 million, making full year operating expenses approximately $126 million. This is up about $6 million from our prior outlook and is primarily related to increases in our sales and marketing expenses.

We are ramping up our sales resources in Europe and in the Asia Pacific region to capitalize on very specific growth opportunities in these areas. We also now expect higher variable sales compensation related expenses in the second half of the year.

In addition, we have previously expected a research and development non-recurring engineering benefit of approximately $2 million in the back half of the year, which may not occur until 2009.

Full year operating profit is expected to be in the range of $57 to $59 million. Other income for the year is still expected to be around $8 million, but our tax rate is now expected to be closer to 7% than 5%, putting our non-GAAP net income in a range of $60.5 to $62.5 million or $0.81 to $0.84 cents per share, and slightly under $75 million shares.

We expect stock-based compensation expenses to be about $70 million, resulting in GAAP EPS in a range of $0.59 to $0.61 cents per share. Since there continues to be a lot of questions about the UTStarcom litigation, I would like to provide you with an update.

As you'll recall, this lawsuit was initiated by UTStarcom in May, 2007 just ahead of our IPO road show, and alleged claims against Starent as well as claims against a number of individuals, both employees and former employees of Starent.

Last week, the court granted our motion to dismiss ten of UTStarcom's 15 claims, including all of their trade secret claims. The only claims that remain are UTStarcom's claims against Starent for patent infringement and declaration of ownership of a Starent patent and certain patent applications.

In its ruling, the court said that its May 2008 order required UTStarcom to provide a definite statement specifying which defendants committed which alleged acts with respect to the claims against which our motion was directed, and that UTStarcom had failed to provide the specifics required by that order.

Our assessment of the remaining claims remains the same as when this action was filed, that these claims are not well founded, we have strong defenses to each of these claims, and we plan to continue to vigorously defend the lawsuit.

Finally, before we move to Q&A, I would like to remind you that it is our policy not to disclose bookings or backlog, so we will not comment further on those topics. Secondly, we are not able to answer questions about revenue or sales activity from specific customers, because we are required to maintain the confidentiality of this customer information. Ash and I would 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, sir.

Brian Modoff - Deutsche Bank

Hi guys, and Ash, thanks for clarifying your -- upgrade ability to LTE and by SAE, because I think there has been some misinformation on that relative to your platform. Are you aware of any other vendors that have that capability, is first question? And then second, can you talk, I know you don't talk specifically around customers, but can you talk about some of your tractions month, UMTS operators like say Vodafone over in Europe, and do you expect to have other UMTS operators before year end? Thank you.

Ashraf Dahod

Thank you, Brian. To begin with, I mean we today have the only hardware platform that can be software upgraded to support LTE. Clearly our competitors are working toward having platforms that will be capable of this feature, but today we are the only ones who can actually do it, and not only that we can do it, but we also demonstrated that we have taken our platform from 2.5 G to 3 G by upgrading them to software.

We also have proven that on the same platform that we support CDMA, we can download new software and concurrently support technologies like WiMAX. We're the only platform today that can support CDMA and HSPA on the same platform and combine functionality's like SGSN and GGSN on the same platform at the same time.

So that answers your first question. As far as continued activity of UMTS, we continue to be engaged. As I have already announced in my script that we have one more win, which is a non Vodafone operator in Europe. We are confident that we are engaged with all the key players in UMTS and we expect to have additional wins in the rest of this year.

Brian Modoff - Deutsche Bank

Would you classify the non Vodafone operator in Europe? Would that also be another larger operator? Can you comment on that? Would it be a top -- say top five or top ten operator in Europe?

Ashraf Dahod

They are among the top three in the country.

Brian Modoff - Deutsche Bank

In their country. Okay.

Ashraf Dahod

Yes. And it's -- one of the larger countries in Western Europe.

Brian Modoff - Deutsche Bank

Great, thank you.

Ashraf Dahod

There are 10 million subscribers and aggressively moving to 3G technologies.

Brian Modoff - Deutsche Bank

Excellent. Thanks.

Operator

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

Charles John - Piper Jaffray

Hello, Ash and Paul, this is Charles John sitting in for Mike Walkley.

Ashraf Dahod

Hi.

Charles John - Piper Jaffray

Hi. Thanks for taking my call, and I will add my congratulations here on the good numbers. A few questions, if I could. In the recent weeks, we've heard some negative commentary from carriers like Vodafone just about the macro and the UMTS markets in general. So, just clear us up, are you seeing any pause by the operators in terms of data and do you expect them to get more cautious, if this macro environment stays as bad as it is right now? If you could give some color on that for the back half of this year and for 2009 that would be great?

Ashraf Dahod

Clearly the whole macro economy, there's a lot of uncertainties around it. However, if you look at the numbers from Verizon and Vodafone in the last few days, the one area that continues to grow, and grow very rapidly, is the total revenues they get from data services.

And we see this trend globally and we expect this trend to continue because that's where the demand lies today, and we don't see it having any negative impact. As I said in my script, we expect the data services to continue to grow, and we expect carriers to continue to invest in adding multimedia services and upgrading their infrastructure to support these services for the rest of this year and into next year.

Charles John - Piper Jaffray

Okay. So longer term, how should we think of the mix between CDMA and UMTS, if you take 2009 based on the traction you're gaining in the UMTS market, do you think it's option to push UMTS to maybe above 30 or 40, 35% above your total sales in '09 or will Verizon and Starent, the CDMA carriers, will they still be a key part of the 2009 growth story?

Ashraf Dahod

I think we'll have to defer answering that question in detail until the next call when we talk about 2009 really for the first time.

Charles John - Piper Jaffray

Okay. That's fine. And if you can just talk about the competitive landscape and the progress some of the larger OEMs have made in the space, especially Ericsson and Nokia, how close they've come to providing the integrated solution, and the platform that you all have, and if they've made any progress in bridging the gap, so to speak?

Ashraf Dahod

We continue to have the same competitive advantages that we had at the beginning of this year, and as you know, we also continue to enhance our product. So, just as our competitors are trying to make progress, we are also trying to continue to push the envelope.

Charles John - Piper Jaffray

Okay. Good, all right. Thanks and good luck, guys.

Ashraf Dahod

Thank you.

Operator

Your next question comes from the line of Jeff Kvaal with Lehman Brothers, please proceed.

Jeff Kvaal - Lehman Brothers

Yes, Ash and Paul, thanks very much. I was wondering, if you could talk a little about the puts and takes in the deferred revenue line? What are some of the variables involved there, and how might we expect that to trend over the balance of the year and beyond that, if you can comment?

Paul Milbury

Well, as you know from previous discussions, there are a lot of timing elements in our business model. Sometimes we get orders from customers and they ask for everything to be delivered immediately, there are other times when we get orders and they ask for the shipments be staged and delivered over time.

And we've also talked about in the past that we have some situations where, in general, we invoice for a product when it's shipped, but there are times when we are unable to invoice for product that's shipped. So there are a lot of timing factors that go into it and that's kind of the issue, I guess, with deferred revenue, it was a little lower than the end of Q1, but it was up more than 50 million since the beginning of the year and obviously that's impacted by all these timing issues that I referred to a little bit earlier.

Deferred revenue goes up with invoicing and down with revenue, so obviously just from a mathematical point of view, invoicing was a little lower than revenue in the quarter. We generally don't provide any guidance for deferred revenue, because these timing factors are too difficult to predict going forward, but I do think it's more likely that at least in Q3 deferred revenue will go up than go down.

Jeff Kvaal - Lehman Brothers

Would it be fair to think that over time the trajectory would be down as some of the deferred revenue for Vodafone, some of the Vodafone business, turns from deferred business into booking ship business?

Paul Milbury

Again, I think it's a function of the growth of the business, so there are always things going in and coming out of the deferred revenue. It's also a function of our product cycle and there are times where that has an impact on it as well.

Jeff Kvaal - Lehman Brothers

Okay. And then finally, Ash, China, is that an opportunity for you? How far away are they in terms of thinking about putting GGSNs and SGSNs into their networks?

Ashraf Dahod

Obviously as you know that the Chinese operators are finally reorganized and it is becoming very clear that 3G spectrums will be awarded imminently and we are engaged with all the three major operators there on all three technologies, EV-DO technology for China Telecom, DDS CDMA technology for China Mobile and HSPA, UMTS technology for China Unicom. I believe that at least two of the three are likely to actually come out with RSPs and go through a procurement cycle sometime this year.

Jeff Kvaal - Lehman Brothers

Perfect. Thank you.

Operator

Your next question comes from the line of David Gelblum with JPMorgan. Please proceed.

Ehud Gelblum - JPMorgan

Hi, I think that's me, Ehud. Hi, it's me. A couple of questions I would like to heard. Can you give us a little more insight as well into the deferred revenue balance that you have right now? How much is UMTS versus how much is CDMA, and did actually UMTS revenues go or UMTS bookings, I assume, or billings, I'm not sure what you call them, go into deferred revenues this quarter?

Next question, last conference call, Paul, you'd said that there were two customers that were 10%ers and four over 90% and when the 10-Q came out, it turned out that two customers were over 90%. Is that the case again, that two customers themselves were over 90% or were two customers less than 90?

Paul Milbury

Two customers this quarter were roughly 85%.

Ehud Gelblum - JPMorgan

85, that's comparison for the 91% before, but it sounds like one of these was different?

Paul Milbury

Yeah. And 83% for the first half of the year.

Ehud Gelblum - JPMorgan

Not the same two customers, were they?

Paul Milbury

The same two customers as in Q1 are the two customers -- two 10% customers for the first half representing 83% of the business.

Ehud Gelblum - JPMorgan

Got it. And now we have a new 10% customer in Q2?

Paul Milbury

Right.

Ehud Gelblum - JPMorgan

Replacing one of the two before?

Paul Milbury

Yes.

Ehud Gelblum - JPMorgan

Okay. What were these two as a percentage of the total in the first half? Do we have that, or that's not significant? I would imagine it's still probably in the 80s.

Paul Milbury

Yeah. I'm, as you know, we disclose what we have to file, and the 85% and the 83% is what's in the draft of the 10-Q right now, so that's what I can disclose along with the fact that we had two 10% customers.

Ehud Gelblum - JPMorgan

That's helpful. Could you help us with any of UMTS revenue that went into deferred revenue? This quarter I know that none was going to be recognized, I think, you said until the second half of the year. Was any in deferred revenue as of now?

Paul Milbury

We have some, not a lot. The majority of our deferred revenue is, and continues to be, CDMA.

Ehud Gelblum - JPMorgan

Okay. So we didn't really add -- the UMTS revenue that we're hoping to get from Vodafone has not made its way into deferred revenue yet for the most part? That will either go straight into revenue in the second half of the year, or go to revenue, perhaps in the next quarter, and come out again in Q4, and is that one of the reasons why you anticipate deferred revenue to be up in Q3? This is the addition of the Vodafone UMTS revenue?

Paul Milbury

That would be one of the factors, yeah.

Ehud Gelblum - JPMorgan

Okay. That's very helpful. When you look at what is going on in Europe with respect to network sharing that first started last year and now has continued Vodafone and Orange, with several others, how does that work with respect to you; do you become a, do they become, both companies and carriers become a customer of yours? Do you sell under both, do you sell under one? How does kind of network sharing impact the business with UMTS, given that Vodafone is involved in that?

Ashraf Dahod

When the operators share a network, they really share the radio network and they continue to have a very distinct core and accounting, billing and the security infrastructure. So generally when a carrier shares the radio network, there's a greater need for intelligence in the call, when it comes to sharing the bandwidth and apportioning the radio resource.

So from an overall business point of view, it really doesn't affect us in terms of the number of subscribers that we need to support, and the throughput. What it helps us is that generally it requires little more intelligence.

Ehud Gelblum - JPMorgan

I see. So the core usually is not shared?

Ashraf Dahod

Yes, it is not shared.

Ehud Gelblum - JPMorgan

Okay. Last question, if I could be, the new customer that you have in Europe, is it somewhat exclusive, the way you seem to have Verizon and Sprints and others in the CDMA side, or is it more of a two vendor situation, the way you have with Vodafone, where you have a license to go after different business within Vodafone against Ericsson? Is it similar in this new customer or that you win it and that's it, you have their entire business?

Ashraf Dahod

Yeah, I think this is really -- it's an operator that is going to just deploy our equipment.

Ehud Gelblum - JPMorgan

There is an RFP you won, that's it, unless someone steals it from you, you're the only person?

Ashraf Dahod

Correct.

Ehud Gelblum - JPMorgan

Okay, very helpful. Thank you very much, guys.

Ashraf Dahod

You're 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. I just wanted to go back to the China question again. Can you just help frame up the, you know, from a competitive landscape perspective, is it the usual suspects that you expect to be bidding on those RFPs, or is it likely that, is it likely that you will also see some of the local Chinese vendors also participate? Any color you could provide there would be helpful.

Ashraf Dahod

Obviously we'll be competing with the same set of players that we have been competing with in the rest of the world. In some of the technologies, we do expect some of the local players like ZTE and also vigorously in the RFPs. We continue to have a significant competitive advantage over them, and especially since the strategy of some of the key operators in China is to really build a state-of-the-art network that can support a large number of subscribers at very high bandwidth, especially for carriers like China telecom, going into EV-DO and planning to use data as the thrust of their marketing strategy. We believe that we will be in a strong position to deliver greater value with our product.

Thomas Lee - Goldman Sachs

Is the competitive environment both on the CDMA and HSPA side relatively similar or would you say it's a little bit more fierce, perhaps maybe on the HSPA side versus CDMA?

Ashraf Dahod

I think it's more fierce in the sense that there are more players in the UMTS side than there are on the CDMA side.

Thomas Lee - Goldman Sachs

Got it.

Ashraf Dahod

As far as our value proposition and the competitive advantage we have, it is equally strong in UMTS as it is in CDMA.

Thomas Lee - Goldman Sachs

That's helpful. And then, I just was hoping you could maybe clarify or reconcile some of the comments you made in terms of CDMA health, you know, relative to some of the comments were that we've heard recently, I think Alcatel Lucent this morning said that they took down a pretty big CDMA write down as they indicated that CDMA spending in North America particularly is going to slowdown meaningfully, and I was hoping maybe if you can kind of reconcile some of these comments with some of the more positive comments that you made in your prepared remarks?

Ashraf Dahod

I think there's a big difference in the way the radio networks’ capacity is initially built and then deployed versus a core network. So some of the comments made from Alcatel Lucent are driven more by their revenues from the radio side, because the radio side when you try to get ubiquity, you end up deploying a lot more capacity, versus on the core, capacity gets added only as the carrier is needed. So, in our case today, as I mentioned in my script, that only 25% of the CDMA subscribers today are in EV-DO. And there's more and more subscribers signup for EV-DO services, with multimedia application that would drive up the demand for core products like ours.

Thomas Lee - Goldman Sachs

Got it, great.

Paul Milbury

And then obviously the percentage of the carriers capital spending on our area is a very small percentage of their overall capital spending.

Thomas Lee - Goldman Sachs

That's helpful. And then just last question. You know, as you just kind of look at kind of lay the LAN, particularly from an RFP perspective, would you say, as you kind of look at the situation now versus, say 6 to 12 months ago, is perhaps the decision process that some of these operators are tacking is a little bit longer than you initially expected, and maybe some of the decisions that you expected would take place earlier in the year, are they perhaps being pushed out to sometime in 2009?

Ashraf Dahod

I think the RFP activity continues to be pretty strong. We do expect some significant decisions in the second half of this year dealing with major carriers, there is a schedule and we do expect that there are some slips at times, because these are pretty complex decisions. But we still believe that some decisions are likely to come in the second half of this year.

Thomas Lee - Goldman Sachs

Perfect. Thank you.

Ashraf Dahod

You're welcome.

Operator

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

Blaine Carroll - FTN Midwest Securities

Yes, thank you, and congratulations on the quarter, guys.

Ashraf Dahod

Thank you.

Blaine Carroll - FTN Midwest Securities

Ash, as you look at your competitive position within the market, particularly on the product side, where do you see the product migrating towards? Or I guess to word it in another way, where are you spending most of your R&D time and budget at this point?

Ashraf Dahod

We spend a significant percentage of our R&D dollars in software enhancement and in-line services that allows us to go into an existing customer and offer new services on our platform. We also are spending R&D dollars in getting ready for ITE. Our goal is to be one of the early players with LTE solutions and having introduced our ST40 platform, we obviously have already started working on our next generation, which I believe will be the right platform to have when LTE is about to take off.

Blaine Carroll - FTN Midwest Securities

Okay. And do you ever get pushed back, Ash, in the competitive space, that maybe your solution is a little bit too robust, maybe we look for an ST40 light or something along that way?

Ashraf Dahod

There are obviously certain markets, especially with the WiMAX technology, where our ST16 and ST40 platform tend to be a much higher density and much more expensive and maybe an overkill. So we have introduced a new platform called the XT2 that we sell only through our re-saler and OEM partners. I believe we announced it a few months ago and all our initial activity with the XT2 platform is obviously with smaller operators, and mostly in the WiMAX arena.

Blaine Carroll - FTN Midwest Securities

Okay. And then, Paul as far as the tax rate goes, we're bumping it up a little bit this year. What should we use for a tax rate for modeling purposes in 2009?

Paul Milbury

Since we first started talking about 2009, we've been saying the mid-to-upper 30s is the appropriate tax rate for 2009 and we're still looking at that as the tax rate to use.

Blaine Carroll - FTN Midwest Securities

Okay. And then on the litigation expense, I think we've been talking about somewhere around a $1 million a quarter. Is that still consistent, based on the developments with UTStarcom and where do you see the high water mark on litigation expense?

Paul Milbury

Well, we spent a little bit more than $1 million this quarter, and that's one of the reasons our G&A went up, as I said earlier. At this point, as I said, 10 of the 15 claims have been dismissed by the court, but we're assuming that the litigation is going to continue for the remaining claims. We're still building in about a million and a quarter for our expenses.

Blaine Carroll - FTN Midwest Securities

Okay. And does it ramp in 2009 -- does it ramp in 2009 or --

Paul Milbury

It could ramp a little bit if we are approaching getting to trial.

Blaine Carroll - FTN Midwest Securities

Okay.

Paul Milbury

But not dramatically.

Blaine Carroll - FTN Midwest Securities

Okay. Fair enough. Thanks.

Paul Milbury

You're welcome.

Operator

Your next question comes from the line of Brian Modoff with Deutsche Bank. Please proceed.

Brian Modoff - Deutsche Bank

Hi, guys, another kind of a follow-up. On the competitive, if you look at your competitors, in looking at CISCO, they only supply GGSN functionality at AT&T, and the SGSN comes from one of the other vendors, and you're in the labs at AT&T. I'm curious how that is moving along, and similarly in Europe, with Ericsson and their Redback GGSN product not likely being GA until 2010 and the fact that they're going to use a legacy SGSN product as that platform, how do you see them as a competitor in Europe and how is your platform playing out with the operators over there from a traction standpoint? Thank you.

Ashraf Dahod

Let me address the CISCO question first. Compared with CISCO, the same platform on which we delivered a GGSN solution, we also offer a very competitive state-of-the-art SGSN. And clearly there is message, we are conveying very strongly to all tier-1 operators, including AT&T.

So not only is our GGSN, superior in technology and performance, but also our SGSN, and as you know, we are the only non-radio vendor that has an SGSN solution that is bought and deployed commercially by tier-1 operator.

As far as Ericssion is concerned, I mean for them to sell a story, their platform can migrate to LTE, they need to go to Redback and the Redback solution as you mentioned is not going to be available for a while and that gives us a significant competitive window to continue to push our competitive advantage of selling superior GGSN that can be software upgraded to support LTE.

Brian Modoff - Deutsche Bank

Okay. Thank you.

Operator

Ladies and gentlemen that concludes the question and answer portion of today's call, and I'd like to turn it back to management now for closing remarks.

Ashraf Dahod

Well, thank you very much for everybody for joining our second quarter earnings call. Thanks. See you next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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