**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

| **(Mark One)**                                                                                                              |   |                                                                                                |
|-----------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                  |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**   |
|                                                                                                                        |
| **For the quarterly period ended September 30, 2003**                                                                  |
|                                                                                                                        |
| **OR**                                                                                                                      |
|                                                                                                                        |
| **o**                                                                                                                       |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                        |
| **For the transition period  from                to** |
|                                                                                                                        |
| **COMMISSION FILE NUMBER 000-29661**                                                                                        |

 

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**UTSTARCOM, INC.**

(Exact name of Registrant asspecified in its charter)

 

| **DELAWARE**                                                                      |   | **52-1782500**                       |
|-----------------------------------------------------------------------------------|--------|--------------------------------------|
| (State of Incorporation)                                                          |   | (I.R.S. Employer Identification No.) |
|                                                                              |   |                                 |
| **1275 HARBOR BAY PARKWAY,  ALAMEDA, CALIFORNIA**                                 |   | **94502**                            |
| (Address of principal executive  offices)                                         |   | (zip code)                           |
|                                                                              |
| Registrant’s  telephone number, including area code: **(510) 864-8800** |

 

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Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorterperiod that the Registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes   ý  No   o

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act).  Yes   ý  No   o

 

As of October 31, 2003 there were 103,826,082 shares (120,744,955shares assuming conversion of outstanding convertible subordinated notes) ofthe Registrant’s Common Stock outstanding, par value $0.00125.

 

 

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**TABLEOF CONTENTS**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                                 |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|         |                                                                                                                                      |
| Item 1.      | Condensed  Consolidated Financial Statements                                                                                              |
|         |                                                                                                                                      |
|         | Condensed Consolidated Balance Sheets as of  September 30, 2003 and December 31, 2002 (unaudited)                               |
|         |                                                                                                                                      |
|         | Condensed Consolidated Statements of  Operations for the three and nine month periods ended September 30,  2003 and 2002 (unaudited) |
|         |                                                                                                                                      |
|         | Condensed Consolidated Statements of Cash  Flows for the nine month periods ended September 30, 2003 and  2002 (unaudited)           |
|         |                                                                                                                                      |
|         | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                                         |
|         |                                                                                                                                      |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                               |
|         |                                                                                                                                      |
| Item 3.      | Quantitative  and Qualitative Disclosure about Market Risk                                                                                |
|         |                                                                                                                                      |
| Item 4.      | Controls  and Procedures                                                                                                                  |
|         |                                                                                                                                      |
| **PART II.** | **OTHER INFORMATION**                                                                                                                     |
|         |                                                                                                                                      |
| Item 1.      | Legal proceedings                                                                                                                         |
|         |                                                                                                                                      |
| Item 2.      | Changes in Securities and Use of Proceeds                                                                                                 |
|         |                                                                                                                                      |
| Item 3.      | Defaults Upon Senior Securities                                                                                                           |
|         |                                                                                                                                      |
| Item 4.      | Submission of Matters to a Vote of Security  Holders                                                                                      |
|         |                                                                                                                                      |
| Item 5.      | Other Information                                                                                                                         |
|         |                                                                                                                                      |
| Item 6.      | Exhibits and Reports on Form 8-K                                                                                                     |
|         |                                                                                                                                      |
|         | Signatures                                                                                                                                |
|         |                                                                                                                                      |
|         | Exhibit Index                                                                                                                             |

 

2

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**PART I****—FINANCIAL INFORMATION**

##### **ITEM 1**—CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS

 

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS****(UNAUDITED)**

**(In thousands, except share and per sharedata)**

 
|                                                                                                                                                                           |   | **September 30,  2003** |      | **December 31,  2002** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|-----------|-----------------------------|--------|
| **ASSETS**                                                                                                                                                                     |   |                         |      |                        |   |
| Current  assets:                                                                                                                                                               |   |                         |      |                        |   |
| Cash  and cash equivalents                                                                                                                                                     |   | $                            | 436,085   |                        | $      | 231,944 |   |
| Short-term  investments                                                                                                                                                        |   | 5,282                        |      | 107,305                     |   |
| Accounts  receivable, net of allowances for doubtful accounts of $27,400 and $26,250 at  September 30, 2003 and December 31, 2002, respectively                      |   | 261,105                      |      | 221,215                     |   |
| Accounts  receivable, related parties                                                                                                                                          |   | 52,581                       |      | 835                         |   |
| Notes  receivable                                                                                                                                                              |   | 18,894                       |      | 12,048                      |   |
| Inventories                                                                                                                                                                    |   | 979,810                      |      | 424,666                     |   |
| Prepaids                                                                                                                                                                       |   | 176,464                      |      | 47,220                      |   |
| Restricted  cash                                                                                                                                                               |   | 17,407                       |      | 21,251                      |   |
| Other  current assets                                                                                                                                                          |   | 64,064                       |      | 40,888                      |   |
| Total  current assets                                                                                                                                                          |   | 2,011,692                    |      | 1,107,372                   |   |
| Property,  plant and equipment, net                                                                                                                                            |   | 156,061                      |      | 98,511                      |   |
| Long-term  investments                                                                                                                                                         |   | 22,818                       |      | 35,360                      |   |
| Goodwill                                                                                                                                                                       |   | 100,346                      |      | 44,806                      |   |
| Intangible  assets, net                                                                                                                                                        |   | 48,076                       |      | 5,014                       |   |
| Other  long-term assets                                                                                                                                                        |   | 38,081                       |      | 14,489                      |   |
| Total  assets                                                                                                                                                                  |   | $                            | 2,377,074 |                        | $      | 1,305,552 |   |
|                                                                                                                                                                           |   |                         |      |                        |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                  |   |                         |      |                        |   |
| Current  liabilities:                                                                                                                                                          |   |                         |      |                        |   |
| Notes  payable                                                                                                                                                                 |   | $                            | 23,390    |                        | $      | — |   |
| Accounts  payable                                                                                                                                                              |   | 402,037                      |      | 256,980                     |   |
| Income  taxes payable                                                                                                                                                          |   | 24,315                       |      | 13,003                      |   |
| Deferred  revenue                                                                                                                                                              |   | 544,659                      |      | 164,247                     |   |
| Other  current liabilties                                                                                                                                                      |   | 186,607                      |      | 104,927                     |   |
| Total  current liabilities                                                                                                                                                     |   | 1,181,008                    |      | 539,157                     |   |
| Long-term  debt                                                                                                                                                                |   | 402,500                      |      | —                      |   |
| Total  liabilities                                                                                                                                                             |   | 1,583,508                    |      | 539,157                     |   |
| Commitments  and contingencies (Notes 8, 13, 17)                                                                                                                               |   |                         |      |                        |   |
| Minority  interest                                                                                                                                                             |   | 519                          |      | —                      |   |
| Stockholders’  equity:                                                                                                                                                    |   |                         |      |                        |   |
| Common  stock: $0.00125 par value; authorized: 750,000,000 shares; issued and  outstanding: 103,202,125 and 106,787,908 at September 30, 2003 and  December 31, 2002 |   | 130                          |      | 135                         |   |
| Additional  paid-in capital                                                                                                                                                    |   | 637,930                      |      | 658,546                     |   |
| Deferred  stock compensation                                                                                                                                                   |   | (8,916                       | )         | (11,766                     | )      |
| Retained  earnings                                                                                                                                                             |   | 163,422                      |      | 120,520                     |   |
| Receivable  from stockholders                                                                                                                                                  |   | (254                         | )         | (282                        | )      |
| Accumulated  other comprehensive income (loss)                                                                                                                                 |   | 735                          |      | (758                        | )      |
| Total  stockholders’ equity                                                                                                                                               |   | 793,047                      |      | 766,395                     |   |
| Total  liabilities and stockholders’ equity                                                                                                                               |   | $                            | 2,377,074 |                        | $      | 1,305,552 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

3

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**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS****(UNAUDITED)**

**(In thousands, except per share data)**

** **
|                                                        |   | **Three months ended**       |    | **Nine months ended**        |   |
|-------------------------------------------------------------|--------|------------------------------|---------|------------------------------|--------|
|                                                        |   | **September 30,  2003** |    | **September 30,  2002** |   | **September 30,  2003** |   | **September 30,  2002** |   |
| Net  sales                                                  |   |                         |    |                         |   |   |   |   |   |
| Unrelated  parties                                          |   | $                            | 558,328 |                         | $      | 223,486 |   | $ | 1,176,014 |   | $ | 577,270 |   |
| Related  parties                                            |   | 26,054                       |    | 42,027                       |   | 144,722 |   | 103,441 |   |
|                                                        |   | 584,382                      |    | 265,513                      |   | 1,320,736 |   | 680,711 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Cost  of sales                                              |   | 398,280                      |    | 172,696                      |   | 884,445 |   | 436,340 |   |
| Gross  profit                                               |   | 186,102                      |    | 92,817                       |   | 436,291 |   | 244,371 |   |
| Operating  expenses:                                        |   |                         |    |                         |   |   |   |   |   |
| Selling,  general and administrative                        |   | 57,371                       |    | 28,582                       |   | 129,917 |   | 81,788 |   |
| Research  and development                                   |   | 44,723                       |    | 22,958                       |   | 107,613 |   | 63,525 |   |
| In-process  research and development                        |   | 161                          |    | —                       |   | 10,809 |   | 670 |   |
| Amortization  of intangible assets                          |   | 3,081                        |    | 631                          |   | 5,259 |   | 1,764 |   |
| Total  operating expenses                                   |   | 105,336                      |    | 52,171                       |   | 253,598 |   | 147,747 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Operating  income                                           |   | 80,766                       |    | 40,646                       |   | 182,693 |   | 96,624 |   |
| Interest  income                                            |   | 530                          |    | 1,356                        |   | 2,172 |   | 4,384 |   |
| Interest  expense                                           |   | (1,506                       | )       | (88                          | )      | (3,463 | ) | (1,223 | ) |
| Other  income (expenses), net                               |   | 670                          |    | (3,334                       | )      | 4,118 |   | (4,885 | ) |
| Equity  in loss of affiliated companies                     |   | (1,560                       | )       | (145                         | )      | (4,280 | ) | (944 | ) |
| Income  before income taxes and minority interest           |   | 78,900                       |    | 38,435                       |   | 181,240 |   | 93,956 |   |
| Income  tax expense                                         |   | 19,725                       |    | 7,686                        |   | 45,310 |   | 18,790 |   |
| Minority  interest in earnings of consolidated subsidiaries |   | (35                          | )       | —                       |   | (35 | ) | (1,156 | ) |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Net  income                                                 |   | $                            | 59,140  |                         | $      | 30,749 |   | $ | 135,895 |   | $ | 74,010 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Basic  earnings per share                                   |   | $                            | 0.58    |                         | $      | 0.28 |   | $ | 1.31 |   | $ | 0.67 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Diluted  earnings per share                                 |   | $                            | 0.46    |                         | $      | 0.27 |   | $ | 1.12 |   | $ | 0.64 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| Weighted  average shares used in per-share calculation:     |   |                         |    |                         |   |   |   |   |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| -  Basic                                                    |   | 102,814                      |    | 109,776                      |   | 103,607 |   | 110,459 |   |
|                                                        |   |                         |    |                         |   |   |   |   |   |
| -  Diluted                                                  |   | 131,914                      |    | 113,508                      |   | 123,194 |   | 115,716 |   |

 

Seeaccompanying notes to condensed consolidated financial statements.

 

4

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**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS****(UNAUDITED)**

**(In thousands)**

 
|                                                                                         |   | **Nine months ended**       |    |
|----------------------------------------------------------------------------------------------|--------|-----------------------------|---------|
|                                                                                         |   | **September 30, 2003** |    | **September 30, 2002** |   |
| CASH  FLOWS FROM OPERATING ACTIVITIES:                                                       |   |                        |    |   |   |
| Net  income                                                                                  |   | $                           | 135,895 |   | $ | 74,010 |   |
| Adjustment  to reconcile net income to net cash provided by (used in) operating  activities: |   |                        |    |   |   |
| Depreciation  and amortization                                                               |   | 30,293                      |    | 15,275 |   |
| Non-qualified  stock option exercise tax benefits                                            |   | 12,605                      |    | 3,323 |   |
| Loss  on sale of assets                                                                      |   | 744                         |    | 321 |   |
| Loss  on sale of notes receivable                                                            |   | 1,931                       |    | — |   |
| In-process  research and development costs                                                   |   | 10,809                      |    | 670 |   |
| Amortization  of debt issuance                                                               |   | 1,359                       |    | — |   |
| Warrants  adjustment to fair value                                                           |   | (64                         | )       | — |   |
| Loss  on sale of investment                                                                  |   | 73                          |    | — |   |
| Impairment  of long-term investment                                                          |   | 63                          |    | 2,823 |   |
| Stock  compensation expense                                                                  |   | 3,236                       |    | 2,291 |   |
| Allowance  for doubtful accounts                                                             |   | 1,150                       |    | 6,471 |   |
| Deferred  income taxes                                                                       |   | (2,960                      | )       | (8,716 | ) |
| Inventory  reserve                                                                           |   | 9,715                       |    | 16,477 |   |
| Equity  in loss of affiliated companies                                                      |   | 4,280                       |    | 944 |   |
| Minority  interest in earnings of consolidated subsidiary                                    |   | 35                          |    | 1,156 |   |
| Changes  in operating assets and liabilities:                                                |   |                        |    |   |   |
| Accounts  receivable                                                                         |   | (92,786                     | )       | 7,660 |   |
| Inventories                                                                                  |   | (558,514                    | )       | (72,345 | ) |
| Other  current and non-current assets                                                        |   | (153,290                    | )       | (18,642 | ) |
| Accounts  payable                                                                            |   | 145,057                     |    | 43,027 |   |
| Income  taxes payable                                                                        |   | 11,312                      |    | 5,160 |   |
| Other  current liabilities                                                                   |   | 70,989                      |    | 31,516 |   |
| Deferred  revenue                                                                            |   | 370,744                     |    | 24,955 |   |
| Net  cash provided by operating activities                                                   |   | 2,676                       |    | 136,376 |   |
|                                                                                         |   |                        |    |   |   |
| CASH  FLOWS FROM INVESTING ACTIVITIES:                                                       |   |                        |    |   |   |
| Additions  to property, plant and equipment                                                  |   | (71,419                     | )       | (42,027 | ) |
| Investment  in affiliates, net of cash acquired                                              |   | (661                        | )       | (11,044 | ) |
| Issuance  of note receivable                                                                 |   | (10,071                     | )       | — |   |
| Purchase  of businesses, net of cash acquired                                                |   | (112,415                    | )       | (17,705 | ) |
| Purchase  of investments                                                                     |   | (64,643                     | )       | (74,913 | ) |
| Proceeds  from sale of investments                                                           |   | 177,923                     |    | 101,937 |   |
| Net  cash used in investing activities                                                       |   | (81,286                     | )       | (43,752 | ) |
|                                                                                         |   |                        |    |   |   |
| CASH  FLOWS FROM FINANCING ACTIVITIES:                                                       |   |                        |    |   |   |
| Issuance  of stock upon exercise of stock options, net of expenses                           |   | 51,229                      |    | 36,982 |   |
| Purchase  of calls spread                                                                    |   | (43,792                     | )       | — |   |
| Proceeds  from borrowings                                                                    |   | 414,821                     |    | 39,619 |   |
| Payments  for borrowing                                                                      |   | —                      |    | (110,101 | ) |
| Repurchase  of stock                                                                         |   | (139,609                    | )       | (72,921 | ) |
| Proceeds  from stockholder notes                                                             |   | 28                          |    | 39 |   |
| Net  cash provided by (used in) financing activities                                         |   | 282,677                     |    | (106,382 | ) |
| Effect  of exchange rate changes on cash                                                     |   | 74                          |    | (138 | ) |
| Net  increase/(decrease) in cash and cash equivalents                                        |   | 204,141                     |    | (13,896 | ) |
| Cash  and cash equivalents at beginning of period                                            |   | 231,944                     |    | 321,136 |   |
| Cash  and cash equivalents at end of period                                                  |   | $                           | 436,085 |   | $ | 307,240 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

5

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**UTSTARCOM, INC.**

**NOTES TO CONDENSED CONSOLIDATED FINANCIALSTATEMENTS (UNAUDITED)**

 

**1.****                                      BASISOF PRESENTATION:**

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of UTStarcom, Inc. (the “Company”) and its wholly-and majority-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated in the preparation of the condensedconsolidated financial statements. The minority interests in consolidatedsubsidiaries and equity in affiliated companies are shown separately in thecondensed consolidated financial statements. Investments in affiliatedcompanies are accounted for using the cost or equity method, as applicable.Certain previously reported amounts have been reclassified to conform to thecurrent presentation format.

 

The accompanying financial data as of September 30, 2003 and forthe three and nine months ended September 30, 2003 and 2002 have beenprepared by the Company, without audit, pursuant to the rules and regulationsof the Securities and Exchange Commission (“SEC”). Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. The December 31, 2002balance sheet was derived from audited financial statements, but does notinclude all disclosures required by generally accepted accounting principles.These condensed consolidated financial statements should be read in conjunctionwith the Company’s audited December 31, 2002 financial statements,including the notes thereto, and the other information set forth in theCompany’s Annual Report on Form 10-K and Form 10-K/A.

 

The Company has a 90% ownership interest inUTStarcom (Chongqing) Co., Ltd. (“CUTS”), an affiliate incorporated in Chinathat assembles and manufactures handsets for our Personal Access System, orPAS, product line. On September 23, 2003, the Company acquired controllingvoting rights of CUTS and has consolidated the results of operations of thisaffiliate as of that date.

 

In the opinion of management, theaccompanying condensed consolidated financial statements reflect alladjustments (consisting of only normal recurring adjustments) considerednecessary for a fair presentation of the Company’s financial condition, theresults of its operations and its cash flows for the periods indicated. Theresults of operations for the three and nine months ended September 30,2003 are not necessarily indicative of the operating results for the full year.

 

**2.****                                      REVENUERECOGNITION:**

 

Revenuesfrom sales of telecommunications equipment are recognized when persuasiveevidence of an arrangement exists, delivery of the product has occurred,customer acceptance has been obtained, the fee is fixed or determinable andcollectability is reasonably assured. If the fee due from the customer is not fixed or determinable due to extendedpayment terms, revenue is recognized as payments become due from the customer,assuming all other criteria for revenue recognition are met. Any paymentsreceived prior to revenue recognition are recorded as deferred revenue.Shipping and handling costs are recorded as revenues and costs of revenues.

 

Wheremultiple elements exist in an arrangement, the arrangement fee is allocated tothe different elements based upon verifiable objective evidence of the fairvalue of the elements.  Multiple elementarrangements primarily involve the sale of PAS or iPAS equipment with handsets,installation and training and the provision of such equipment to differentlocations for the same customer.  Revenue is recognized as each element isearned, namely upon installation and acceptance of equipment or delivery ofhandsets, provided that the undelivered elements are not deemed essential tothe functionality of the delivered elements and payment for the deliveredelements is not contingent on delivery of the undelivered elements.

 

Wheremultiple elements exist in an arrangement and software is more thanincidental to the equipment or services in the arrangement, software andsoftware-related elements are recognized under the provisions of Statement ofPosition 97-2, as amended, and Emerging Issues Task Force Issues No 03-05.  The Company allocates revenues to eachelement of software arrangements based on vendor-specific objective evidence(“VSOE”).  VSOE of each element is basedon the price charged when the same element is sold separately.   The Company uses the residual method to recognize revenue when anarrangement includes one or more elements to be delivered at a future date andVSOE of the fair value of all the undelivered elements exists. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is recognized as revenue. If evidenceof fair value of one or more undelivered elements does not exist, revenue isdeferred and recognized when delivery of those elements occurs or when fair valuecan be established.

 

6

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TheCompany recognizes revenue for system integration, installation and trainingupon completion of performance if all other revenue recognition criteria aremet. Other service revenue, such as that related to maintenance and supportcontracts, is recognized ratably over the contract term.

 

TheCompany assesses collectability based on a number of factors, including pasttransaction history with the customer, and the credit-worthiness of thecustomer. The Company does not request collateral from our customers. If theCompany determines that collection of a fee is not reasonably assured, theCompany defers the fee and recognizes revenue at the time collection becomesreasonably assured, which is generally upon receipt of cash.

 

**3.****                                      EARNINGSPER SHARE:**

 

Basic earningsper share is computed by dividing net income available to common stockholdersby the weighted average number of shares of the Company’s common stockoutstanding during the period. Diluted earnings per share is determined in thesame manner as basic earnings per share except that the number of shares isincreased by potentially dilutive common shares outstanding during the period.Potentially dilutive common shares consist of employee stock options, a writtencall option, warrants and convertible subordinated notes.

 

The following table presents the calculationof basic and diluted earnings per share (in thousands, except share and pershare data):

 
|                                        |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |   |
|---------------------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|--------|
|                                        |   | **2003**                                   |    | **2002**                                  |   | **2003** |   | **2002** |   |
| Numerator:                                  |   |                                       |    |                                      |   |   |   |   |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Net income (for basic EPS computation)      |   | $                                          | 59,140  |                                      | $      | 30,749 |   | $ | 135,895 |   | $ | 74,010 |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Effect of Dilutive Securities               |   |                                       |    |                                      |   |   |   |   |   |
| 7/8% Convertible Subordinated Notes         |   | 1,098                                      |    | —                                    |   | 2,473 |   | — |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Net income adjusted for dilutive securities |   | $                                          | 60,238  |                                      | $      | 30,749 |   | $ | 138,368 |   | $ | 74,010 |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Denominator:                                |   |                                       |    |                                      |   |   |   |   |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Shares used to compute basic EPS            |   |                                       | 102,814 |                                      |   | 109,776 |   |   | 103,607 |   |   | 110,459 |   |
| Dilutive common stock equivalent shares:    |   |                                       |    |                                      |   |   |   |   |   |
| Stock options                               |   | 8,810                                      |    | 3,705                                     |   | 6,977 |   | 5,229 |   |
| Written call option                         |   | 3,341                                      |    | —                                    |   | — |   | — |   |
| Convertible subordinated notes              |   | 16,919                                     |    | —                                    |   | 12,581 |   | — |   |
| Warrants                                    |   | 30                                         |    | 27                                        |   | 29 |   | 28 |   |
| Shares used to compute diluted EPS          |   | 131,914                                    |    | 113,508                                   |   | 123,194 |   | 115,716 |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Basic earnings per share                    |   | $                                          | 0.58    |                                      | $      | 0.28 |   | $ | 1.31 |   | $ | 0.67 |   |
|                                        |   |                                       |    |                                      |   |   |   |   |   |
| Diluted earnings per share                  |   | $                                          | 0.46    |                                      | $      | 0.27 |   | $ | 1.12 |   | $ | 0.64 |   |

 

7

----

 

Certain potential shares related to employeestock options, warrants and written call options outstanding during the threeand nine months ended September 30, 2003 and 2002 were excluded in thediluted per share computations, since their exercise prices were greater thanthe average market price of the common shares during the period and,accordingly, their effect is anti-dilutive. For the three months ended September 30, 2003, these shares totaled0.2 million with a weighted average exercise price of $43.16 per share,compared to 6.7 million with a weighted average exercise price of $21.20per share for the corresponding period in 2002. For the nine months endedSeptember 30, 2003, these shares totaled 17.4 million at a weightedaverage exercise price of $32.19 per share, compared to 2.2 million with aweighted average exercise price of $24.17 per share for the correspondingperiod in 2002.

 

OnSeptember 30, 2003, each of the Company’s 7/8% convertible subordinatednotes outstanding was eligible for conversion into shares of commonstock.  For each $1,000 of aggregate principal amount of notes converted,the Company will deliver approximately 42.0345 shares of common stock, if theCompany’s stock price exceeds a specified threshold. At September 30, 2003the closing price of the Company’s common stock exceeded the specifiedthreshold, which had the effect of increasing the denominator for dilutedearnings per share by 16.9 million shares and 12.6 million shares for the threeand nine months ended September 30, 2003, respectively.  Additionally, during the quarter endedSeptember 30, 2003, the average price of the Company’s stock exceeded thespecified strike prices of the convertible bond hedge and call option transactionsthat the Company entered into to reduce the potential dilution from conversionof the notes.  Both the bond hedge andcall option transactions may be settled at the Company’s option either in cashor net shares and expire on March 1, 2008.  Using the treasury stock method, under FAS 128, this would havethe effect of decreasing the denominator for diluted earnings per share by 6.8million shares for the bond hedge transaction, and increasing the denominatorfor diluted earnings per share by 3.3 million shares for the call optiontransaction.  However, only the dilutiveeffect of the 3.3 million shares with respect to the call option transaction isincluded in the Company’s diluted earnings per share calculation above.  The convertible bond hedge, under FAS 128,is always anti-dilutive.

 

The net income for the diluted EPS computation reflects the reductionin interest expense of $1.1 million and $2.5 million for the three and ninemonths ended September 30, 2003, respectively, that would result from anassumed conversion of the 7/8% convertible subordinated notes.

 

**4.****                                      STOCK-BASEDCOMPENSATION:**

 

The Company accounts for employee stock option grants in accordancewith Accounting Principles Board Opinion No. 25, “Accounting for StockIssued to Employees” (“APB 25”) and has adopted the disclosure-onlyalternative of Statement of Financial Accounting Standards (“SFAS”)No. 123, as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation” (“SFAS No. 123”). Under APB 25, compensation expense is basedon the difference, if any, on the date of grant between the fair value of thecommon stock and the exercise price of the option.

 

The fair value of warrants, options or stock granted or issued tonon-employees for services is expensed over the period benefited. The warrantsand options are valued using the Black-Scholes option pricing model.

 

The following table illustrates the effect on net income and earningsper share if the Company had applied the fair value recognition provisions ofSFAS No. 123 to stock-based employee compensation (in thousands, exceptper share data):

 

8

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|                                                                                                                    |   | **Three  months ended** |   | **Nine  months ended** |   |
|-------------------------------------------------------------------------------------------------------------------------|--------|-------------------------|--------|------------------------|--------|
|                                                                                                                    |   | **September  30,**      |   | **September  30,**     |   |
|                                                                                                                    |   | **2003**                |   | **2002**               |   | **2003** |   | **2002** |   |
| Basic                                                                                                                   |   |                    |   |                   |   |   |   |   |   |
| Net income available for common  stockholders:                                                                          |   |                    |   |                   |   |   |   |   |   |
| As reported                                                                                                             |   | $59,140                 |   | $30,749                |   | $135,895 |   | $74,010 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects             |   | 115                     |   | 353                    |   | 2,304 |   | 1,677 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Deduct: Total compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (7,199                  | )      | (5,054                 | )      | (21,409 | ) | (14,379 | ) |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Pro forma net income                                                                                                    |   | $52,056                 |   | $26,048                |   | $116,790 |   | $61,308 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Basic income per share:                                                                                                 |   |                    |   |                   |   |   |   |   |   |
| As reported                                                                                                             |   | $0.58                   |   | $0.28                  |   | $1.31 |   | $0.67 |   |
| Pro forma                                                                                                               |   | $0.51                   |   | $0.24                  |   | $1.13 |   | $0.56 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Diluted                                                                                                                 |   |                    |   |                   |   |   |   |   |   |
| Net income available for common  stockholders:                                                                          |   |                    |   |                   |   |   |   |   |   |
| As reported                                                                                                             |   | $59,140                 |   | $30,749                |   | $135,895 |   | $74,010 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Effect of dilutive securities                                                                                           |   |                    |   |                   |   |   |   |   |   |
| 7/8% Convertible subordinated notes                                                                                     |   | 1,098                   |   | —                 |   | 2,473 |   | — |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Add: Stock-based employee compensation expense included in reported  net income, net of related tax effects             |   | 115                     |   | 353                    |   | 2,304 |   | 1,677 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Deduct: Total compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (7,199                  | )      | (5,054                 | )      | (21,409 | ) | (14,379 | ) |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Pro forma net income                                                                                                    |   | $53,154                 |   | $26,048                |   | $119,263 |   | $61,308 |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
|                                                                                                                    |   |                    |   |                   |   |   |   |   |   |
| Diluted income per share:                                                                                               |   |                    |   |                   |   |   |   |   |   |
| As reported                                                                                                             |   | $0.46                   |   | $0.27                  |   | $1.12 |   | $0.64 |   |
| Pro forma                                                                                                               |   | $0.41                   |   | $0.24                  |   | $0.99 |   | $0.55 |   |

 

**5.****                                      COMPREHENSIVEINCOME:**

 

The reconciliation of net income tocomprehensive income for the three and nine months ended September 30,2003 and 2002 is as follows (in thousands):

 
|                                          |   | **Three Months Ended September 30** |   | **Nine Months Ended September 30** |   |
|-----------------------------------------------|--------|------------------------------------------|--------|-----------------------------------------|--------|
|                                          |   | **2003**                                 |   | **2002**                                |   | **2003** |   | **2002** |   |
| Net  income                                   |   | $                                        | 59,140 |                                    | $      | 30,749 |   | $ | 135,895 |   | $ | 74,010 |   |
| Unrealized  gains (losses) on investments     |   | (309                                     | )      | (18                                     | )      | 874 |   | (239 | ) |
| Change  in cumulative translation adjustments |   | 663                                      |   | 3                                       |   | 619 |   | (138 | ) |
|                                          |   |                                     |   |                                    |   |   |   |   |   |
| Total  comprehensive income                   |   | $                                        | 59,494 |                                    | $      | 30,734 |   | $ | 137,388 |   | $ | 73,633 |   |

 

**6.****                                      CASH,CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS:**

 

All of the Company’s short-term investmentsare classified as available-for-sale. At September 30, 2003, $19.7 millionof available-for-sale securities were included in cash equivalents and$5.3 million of available-for-sale securities were included in short-terminvestments. At December 31, 2002, $105.0 million of available-for-salesecurities were included in cash equivalents and $107.3 million ofavailable-for-sale securities were included in short-term investments. Theseavailable-for-sale securities consist of government-backed notes, commercialpaper, floating rate corporate bonds and fixed income corporate bonds. Theseinvestments are recorded at fair value. Any unrealized holding gains or lossesare reported as a component of comprehensive income.

 

**7.****                                      SUPPLEMENTALDISCLOSURES OF CASH FLOWS INFORMATION:**

 
|                                                  |   | **Nine  Months Ended** |    |
|-------------------------------------------------------|--------|------------------------|---------|
|                                                  |   | **September  30,**     |    |
| **(In  thousands)**                                   |   | **2003**               |    | **2002** |   |
| Non-cash operating activities:                        |   |                   |    |   |   |
|                                                  |   |                   |    |   |   |
| Accounts receivable transferred to notes  receivable  |   | $                      | 256,526 |   | $ | — |   |
|                                                  |   |                   |    |   |   |
| Non-cash investing and financing  activities:         |   |                   |    |   |   |
|                                                  |   |                   |    |   |   |
| Common stock issued in conjunction with  acquisitions |   | $                      | 3,000   |   | $ | 750 |   |

 

**8.****                                      RESTRICTEDCASH:**

 

At September 30, 2003, the Company had restricted cash of $17.4million comprised of $13.8 million of standby letters of credit and a $3.6million of a time deposit required for Japanese tax purposes.  At December 31, 2002, the Company hadrestricted cash of $21.3 million comprised of $9.8 million of standby lettersof credit, and an $11.5 million deposit required by China regulatoryauthorities.

 

The Companyissues standby letters of credit primarily to support international salesactivities outside of China. When the Company submits a bid for a sale, oftenthe potential customer will require that the Company issue a bid bond or astandby letter of credit to demonstrate its commitment through the bidprocess.  In addition, the Company may be required to issue standbyletters of credit as guarantees for advance customer payments upon contractsigning or performance guarantees. The standby letters of credit usually expiresix to nine months from date of issuance without being drawn by the beneficiarythereof.

 

9

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**9.****                                      INVENTORIES:**

 

Inventories as of September 30, 2003 andDecember 31, 2002 consist of the following (in thousands):

 
|            |   | **September 30, 2003** |    | **December 31, 2002** |   |
|-----------------|--------|-----------------------------|---------|----------------------------|--------|
|            |   |                        |    |                       |   |
| Raw  materials  |   | $                           | 95,259  |                       | $      | 84,715 |   |
| Work-in-process |   | 88,792                      |    | 26,915                     |   |
| Finished  goods |   | 795,759                     |    | 313,036                    |   |
|            |   | $                           | 979,810 |                       | $      | 424,666 |   |

 

**10.****                               ACCOUNTSRECEIVABLE:**

 

The Companyaccepts bank notes receivable and commercial notes receivable, with maturitydates between three and six months, from our customers in China in the normal courseof business. The Company may discount these notes with banking institutions inChina. A sale of these notes is reflected as a reduction of other currentassets and the proceeds of the settlement of these notes are included in cashflows from operating activities in the consolidated statement of cash flows.Notes receivable sold during the three and nine months ended September 30,2003 were $110.8 million and $237.6 million, respectively.  These notes are not included in ourconsolidated balance sheet as the criteria for sale treatment established byStatement of Financial Accounting Standards No. 140, “Accounting for Transfersand Servicing of Financial Assets and Extinguishment of Liabilities” (“SFAS140”), has been met. Under SFAS 140, upon a transfer, the transferer or entitymust derecognize financial assets when control has been surrendered and thetransferee obtains control over the assets. In addition, the transferred assetshave been isolated from the transferor, beyond the reach of its creditors, andthe transferee has the right, without conditions or constraints, to pledge orexchange the assets it has received. The costs of settling or transferring these notes receivable were $1.0million and $1.9 million for the three and nine months ended September 30,2003, respectively, and were included in other income (expense), net in theConsolidated Statements of Operations. Notes receivable available for sale were$18.9 million and $12.0 million at September 30, 2003 and December 31,2002, respectively.

 

**11.****                               ACQUISITIONS:**

 

On May 23, 2003, the Company completed its acquisition from 3ComCorporation, a Delaware corporation, (“3Com”) of selected assets andliabilities from 3Com’s CommWorks division (“CommWorks”). The Company paid$100.0 million in cash and incurred related transaction and other related costsof $9.3 million.  The Company funded the consideration for the acquisitionfrom cash on hand.

 

Selected assets acquired included CommWork’s portfolio ofcarrier-focused voice and data networking products and customer support andprofessional services. In addition, the Company acquired or licensed all of the3Com intellectual property used by CommWorks. CommWorks develops and deployscarrier-class, IP-based multi-service access and service-creation platforms fortelecommunications service providers.

 

Subsequent tothe May 23, 2003 acquisition of CommWorks, the Company made a preliminaryallocation of the purchase price based in part upon a preliminary appraisalfrom an independent valuation specialist.  During the three months ended September 30, 2003, the Companycompleted the allocation of the purchase price of CommWorks. The estimatedamounts for intangible assets and goodwill changed due to revised assumptionsof future revenues from existing customers. The amount of the purchase priceallocated to in-process research and development (“IPR&D”) of $1.3 millionwas charged to the Company’s results of operations, as no alternative futureuses existed at the acquisition date. Goodwill of $52.5 million was recorded inconnection with the acquisition.  Theresults of operations of CommWorks have been included in the Company’sconsolidated results of operations beginning on the acquisition date ofMay 23, 2003.

 

In assessingCommWorks’ IPR&D projects, the key characteristics of the products underdevelopment were considered as well as future prospects, the rate at whichtechnology changes in the telecommunications equipment industry, product lifecycles, and the projects’ stages of development.

 

As of the date of the acquisition, CommWorkshad two projects under development that qualified for IPR&D, SLAP and HighDensity Voice (“HDV”) 2.0.  SLAP is anIPR&D project in the Wireless division of CommWorks.  The objective of SLAP is to develop aninterface that connects UTStarcom’s products with radio switch manufacturers’products in China in order to connect a cellular network to the Internet.  HDV 2.0 is an IPR&D project in theWireline product line of CommWorks.  HDV2.0 utilizes software technology to increase data capacity for Voice overInternet Protocol (“VoIP”) solutions.

 

10

----

 

There aresignificant risks associated with those technologies.  The technological risks stem from the fact that the newtechnologies are in an early stage of development.  As of the closing date, CommWorks’ SLAP IPR&D project wasapproximately 60% complete and HDV 2.0 was approximately 40% complete.  Therefore, there are significant risksassociated with reaching the technological milestones on time and onbudget.  Commercial risks are associatedwith the competitive nature of the telecommunications equipment market.

 

Significant additional costs will be requiredto complete the IPR&D projects.  TheSLAP product is approximately 80% complete as of September 30, 2003 and isexpected to be commercialized in the first quarter of fiscal 2004. Remainingcosts required to complete the project are estimated to be $0.1 million.  The HDV 2.0 product is approximately 50%complete as of September 30, 2003, and is expected to be commercialized in thefirst quarter of fiscal 2004. Remaining costs required to complete the projectare estimated to be $0.2 million.

 

The following table summarizes the finalallocation of the purchase price for CommWorks based upon the final independentvaluation. The final valuation resulted in changes in estimated fair value,changes in the estimated useful lives of the intangible assets acquired and achange in the amount attributable to goodwill, mainly due to revised assumptionsof future revenues from existing customers. The Company also recorded additional employee-related liabilities.

 
|                                                                                                  |   | **September 30, 2003** |    | **June 30, 2003** |   | **Change**         |   |
|-------------------------------------------------------------------------------------------------------|--------|-----------------------------|---------|------------------------|--------|--------------------|--------|
|                                                                                                  |   | **(in thousands)**          |    | **(in thousands)**     |   | **(in thousands)** |   |
| Fair  value of tangible net assets                                                                    |   |                        |    |                   |   |               |   |
| Property,  plant and equipment                                                                        |   | $                           | 10,973  |                   | $      | 10,973             |   | $ | — |   |
| Other  tangible assets                                                                                |   | 6,522                       |    | 6,522                  |   | —             |   |
| Deferred  transition costs                                                                            |   | 6,588                       |    | 6,588                  |   | —             |   |
| Fair  value of identified intangible assets                                                           |   |                        |    |                   |   |               |   |
| Customer  relationships                                                                               |   | 27,820                      |    | 6,360                  |   | 21,460             |   |
| Backlog                                                                                               |   | 1,950                       |    | 1,950                  |   | —             |   |
| Trade  names                                                                                          |   | 940                         |    | 940                    |   | —             |   |
| Existing  technology                                                                                  |   | 14,190                      |    | 10,840                 |   | 3,350              |   |
| In-process  research and development                                                                  |   | 1,290                       |    | 1,260                  |   | 30                 |   |
| Liabilities  assumed                                                                                  |   | (13,481                     | )       | (11,193                | )      | (2,288             | )      |
| Excess  of costs of acquiring CommWorks over fair value of identified net assets  acquired (goodwill) |   | 52,515                      |    | 75,067                 |   | —

(22,552    | )      |
|                                                                                                  |   | $                           | 109,307 |                   | $      | 109,307            |   | $ | — |   |

 

The followingpro forma results of operations reflect the combined results of the Company andCommWorks for the three and nine months ended September 30, 2003 and 2002as if the business combination occurred at the beginning of the period.  These results do not purport to beindicative of what would have occurred had the acquisition been made as of thatdate or the results of operations which may occur in future periods.

 
| **(In  thousands, except per share data)**            |   | **Three Months Ended  September 30,** |    | **Nine Months Ended  September 30,** |   |
|-------------------------------------------------------|--------|--------------------------------------------|---------|-------------------------------------------|--------|
|                                                  |   | **2003**                                   |    | **2002**                                  |   | **2003** |   | **2002** |   |
| Pro  forma adjusted net revenue                       |   | $                                          | 584,382 |                                      | $      | 309,124 |   | $ | 1,362,524 |   | $ | 780,083 |   |
| Pro  forma adjusted net income (loss)                 |   | $                                          | 59,140  |                                      | $      | (10,841 | ) | $ | 111,916 |   | $ | 13,565 |   |
| Pro  forma adjusted basic

Earnings (loss) per share  |   | $                                          | 0.58    |                                      | $      | (0.10 | ) | $ | 1.08 |   | $ | 0.12 |   |
| Pro forma adjusted diluted

Earnings (loss) per share |   | $                                          | 0.46    |                                      | $      | (0.10 | ) | $ | 0.92 |   | $ | 0.12 |   |

 

The pro formaresults of operations include historical operations of the Company andCommWorks.  Certain non-recurring

 

11

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charges were recorded byCommWorks and are included above including a $15.0 million restructuring chargein both the first and second quarter of 2002 and a $15.0 million and $6.1million charge relating to goodwill impairment, which was recorded in thesecond quarter of 2002 and the first quarter of 2003, respectively.

 

OnJune 30, 2003, the Company completed the acquisition of RollingStreamsSystems, Ltd. (“RollingStreams”), a development-stage company, pursuant to ashare exchange agreement. RollingStreams designs streaming, end-to-endTV-over-Internet-Protocol (“TVoIP”) solutions for telecommunications operatorsand broadband service providers. The Company’s investment in RollingStreams was$0.4 million prior to the acquisition. The purchase consideration for all theoutstanding shares of RollingStreams, other than those already held by theCompany prior to the acquisition, was 301,074 shares of the Company’s commonstock. In addition, the Company assumed all outstanding RollingStreams options,which became options to purchase an aggregate of 12,742 shares of the Company’scommon stock, valued at $0.5 million. Of the 301,074 shares, 164,115 sharesvalued at $5.8 million, were issued at the closing, 28,696 of which are held inescrow for any undisclosed liabilities or contingencies incurred byRollingStreams prior to the closing or for any breach of the share exchangeagreement. These shares will be distributed to the former shareholders ofRollingStreams within ten days of the six-month anniversary of the closing,after deducting any claims. Up to 147,592 of the 301,074 shares will be payablein the form of an earnout after an earnout period expiring 18 months after theclosing, subject to the achievement of certain revenue milestones during suchearnout period.

 

Subsequent tothe June 30, 2003 acquisition of RollingStreams, the Company made apreliminary allocation of the purchase price. During the three months ended September 30, 2003, the Companycompleted the allocation of the purchase price of RollingStreams. The amount ofthe purchase price allocated to IPR&D was $6.2 million. This amount wascharged to the Company’s results of operations, as no alternative future usesexisted at the acquisition date. The results of operations of RollingStreamshave been included in the Company’s consolidated results of operationsbeginning on July 1, 2003.

 

As of the dateof the acquisition, the Company had one project under development thatqualified for IPR&D, MediaSwitch. MediaSwitch is an end-to-end solutiondesigned for telecom operators and broadband service providers to deliverbroadcast quality TV and on-demand entertainment services over InternetProtocol networks.

 

MediaSwitch isconsidered an IPR&D project because there are significant risks associatedwith the development of this technology. These risks include technological and commercial risks.  The technological risks stem from the factthat the technology was 70% complete as of September 30, 2003.  Therefore, there are significant risksassociated with reaching the technological milestones on time and onbudget.  Commercial risks are associatedwith the lack of market acceptance for the TVoIP concept.

 

In addition to the technological andcommercial risks stated above, significant additional costs will be required tocomplete the IPR&D project. MediaSwitch is now expected to be commercialized in the second quarterof 2004.  Remaining costs required tocomplete the project are estimated to be $4.5 million. This involves adding newfeatures and functionalities and stabilizing the software code.

 

The following table represents the final allocation of the purchaseprice for RollingStreams.  Theallocation of the purchase price is based upon an independent valuation.

 
|                                        |   | **(in thousands)** |   |
|---------------------------------------------|--------|--------------------|--------|
| Fair  value of tangible net assets acquired |   | $                  | 31     |   |
| In-process  research and development        |   | 6,193              |   |
| Investment                                  |   | (363               | )      |
| Deferred  compensation                      |   | 434                |   |
| Liabilities  assumed                        |   | (3                 | )      |
|                                        |   | $                  | 6,292  |   |

 

On May 7, 2003, the Company completed the purchase of all of theassets of Xebeo Communications, Inc. (“Xebeo”) for $2.4 million in cash. Xebeodevelops and manufactures optical packet switches that enabletelecommunications carriers to provide single fiber, multi-service access tocustomers. In addition, an amount up to $0.7 million may be payable based onfuture contingencies related to employment.

 

Subsequent tothe May 7, 2003 acquisition of Xebeo, the Company made a preliminaryallocation of the purchase price. During

 

12

----

 

the three months endedSeptember 30, 2003, the Company completed the allocation of the purchaseprice of Xebeo. The amount of the purchase price allocated to IPR&D of$2.0 million was charged to the Company’s results of operations, as noalternative future uses existed at the acquisition date.

 

As of the date of the acquisition, Xebeo wasfocusing its resources on the development of its first product, MetroBridge, anoptical packet switching solution, and was considered in the development stage.The development of MetroBridge was 60% complete as of the closing date.  The technological feasibility of thetechnology was not established and the technology had no future alternativeuses, therefore the development of MetroBridge is considered IPR&D.  Significant additional costs would berequired to complete the development of MetroBridge, which is now expected tobe commercialized in the fourth quarter of 2004. Remaining costs required tocomplete the project were estimated to be $1.1 million as of September 30,2003.

 

The followingtable represents the final allocation of the purchase price for Xebeo basedupon the independent valuation.

** **
|                                        |   | **(in thousands)** |   |
|---------------------------------------------|--------|--------------------|--------|
| Fair  value of tangible net assets acquired |   | $                  | 661    |   |
| In-process  research and development        |   | 2,005              |   |
| Liabilities  assumed                        |   | (248               | )      |
|                                        |   | $                  | 2,418  |   |

 

**12.****                               DEBT:**

 

The following represents the outstanding borrowings atSeptember 30, 2003 and December 31, 2002 (in thousands):

 
| **Note**                        |   | **Rate**      |   | **Maturity**          |   | **September 30, 2003** |    | **December 31, 2002** |   |
|---------------------------------|--------|---------------|--------|-----------------------|--------|-----------------------------|---------|----------------------------|--------|
| Notes  Payable                  |   | 2.97  - 3.36% |   | October 3,  2003 |   | $                           | 23,390  |                       | $      | — |   |
| Convertible  Subordinated Notes |   | 7/8%          |   | March 1,  2008   |   | 402,500                     |    |                       |   |
| Total  Debt                     |   |          |   |                  |   | $                           | 425,890 |                       | $      | — |   |
| Long-term  debt                 |   |          |   |                  |   | 402,500                     |    | —                     |   |
| Short-term  debt                |   |          |   |                  |   | $                           | 23,390  |                       | $      | — |   |

 

The Company had unutilized borrowing facilities under lines of creditof $547.7 million as of September 30, 2003. $71.3 million of thesefacilities expire in 2003 and $476.4 million of these facilities expire between2004 and 2010.

 

On March 12, 2003, the Company completed an offering of $402.5million of convertible subordinated notes due March 1, 2008 to qualifiedbuyers pursuant to Rule 144A under the Securities Act of 1933.  The notes bear interest at a rate of 7/8% per annum and are convertibleinto the Company’s common stock at a conversion price of $23.79 per share andare subordinated to all present and future senior debt of the Company. Holdersof the notes may convert their notes only if: (i) the price of the Company’s common stock issuable upon conversion ofa note reaches a specified threshold, (ii) specified corporate transactionsoccur, or (iii) the trading price for the notes falls below certainthresholds.  At the initialconversion price, each $1,000 principal amount of notes will be convertibleinto approximately 42.0345 shares of common stock.

 

Concurrentwith the issuance of the convertible notes, the Company entered intoconvertible bond hedge and call option transactions with respect to its commonstock, the exposure for which is held by Banc of America Securities LLC andCredit Suisse First Boston LLC. Both the bond hedge and call optiontransactions may be settled at the Company’s option either in cash or netshares and expire on March 1, 2008. The convertible bond hedge and calloption transactions are expected to reduce the potential dilution fromconversion of the notes. The options have been included in stockholders’ equityin accordance with the guidance in Emerging Issues Task Force IssueNo. 00-19, “Accounting for Derivative Financial Instruments Indexed to,and Potentially Settled in, a Company’s Own Stock.”

 

**13.****                               WARRANTYOBLIGATIONS AND OTHER GUARANTEES:**

 

Warranty obligations are as follows (in thousands):

 

13

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|                                              |   | **Three months ended  September 30** |   | **Nine months ended  September 30** |   |
|---------------------------------------------------|--------|-------------------------------------------|--------|------------------------------------------|--------|
|                                              |   | **2003**                                  |   | **2002**                                 |   | **2003** |   | **2002** |   |
|                                              |   |                                      |   |                                     |   |   |   |   |   |
| Beginning  of period                              |   | $                                         | 16,428 |                                     | $      | 8,894 |   | $ | 13,297 |   | $ | 6,721 |   |
| Accruals  for warranties issued during the period |   | 11,730                                    |   | 3,003                                    |   | 28,440 |   | 9,354 |   |
| Adjustments  to accruals for changes in estimates |   | —                                    |   | —                                   |   | (4,552 | ) | — |   |
| Settlements  made during the period               |   | (6,598                                    | )      | (1,560                                   | )      | (15,625 | ) | (5,738 | ) |
| Balance  at September 30, 2003               |   | $                                         | 21,560 |                                     | $      | 10,337 |   | $ | 21,560 |   | $ | 10,337 |   |

 

Certain of the Company’s sales contracts include provisions under whichcustomers would be indemnified by the Company in the event of, among otherthings, a third-party claim against the customer for intellectual propertyrights infringement related to the Company’s products. There are no limitationson the maximum potential future payments under these guarantees. The Companyhas accrued no amounts in relation to these provisions as no such claims havebeen made.  The Company believes it hasvalid, enforceable rights to the intellectual property embedded in itsproducts.

 

The Company issues standby letters of credit primarily to supportinternational sales activities outside of China. When the Company submits a bidfor a sale, often the potential customer will require that the Company issue abid bond or a standby letter of credit to demonstrate its commitment throughthe bid process.  In addition, the Company may be required to issuestandby letters of credit as guarantees for advance customer payments uponcontract signing or performance guarantees. The standby letters of creditusually expire six to nine months from date of issuance without being drawn bythe beneficiary thereof.

 

**14.****                               LONG-TERMINVESTMENTS:**

 

The Company’s long-term investments are asfollows (in thousands):

 
|                                         |   | **September 30, 2003** |   | **December 31, 2002** |   |
|----------------------------------------------|--------|-----------------------------|--------|----------------------------|--------|
| Softbank  China                              |   | $                           | 5,320  |                       | $      | 5,526 |   |
| Cellon  International                        |   | 8,000                       |   | 8,000                      |   |
| Restructuring  Fund No. 1                    |   | 1,861                       |   | 1,981                      |   |
| Global  Asia Partners L.P.                   |   | 1,782                       |   | 882                        |   |
| Fiberxon  Inc.                               |   | 2,000                       |   | 2,000                      |   |
| InterWave  Communications International Ltd. |   | 1,656                       |   | 1,546                      |   |
| China  Telecom                               |   | —                      |   | 9,106                      |   |
| Joint  Venture with Matsushita               |   | 779                         |   | 4,683                      |   |
| Others                                       |   | 1,420                       |   | 1,636                      |   |
|                                         |   |                        |   |                       |   |
| Total                                        |   | $                           | 22,818 |                       | $      | 35,360 |   |

 

The Companyhas a $5.3 million investment in Softbank China, an investment fundestablished by SOFTBANK CORP. focused on investments in Internet companies inChina. This investment permits the Company to participate in the anticipatedgrowth of Internet-related businesses in China. SOFTBANK CORP. and its relatedcompanies are significant stockholders of the Company. The Company’s investmentconstitutes 10% of the funding for Softbank China, with SOFTBANK CORP.contributing the remaining 90%. The fund has a separate management team, andnone of the Company’s employees are employed by the fund. Many of the fund’sinvestments are and will be in privately held companies, many of which arestill in the start-up or development stages. These investments are inherentlyrisky as the markets for the technologies or products the companies have underdevelopment are typically in the early stages and may never materialize. TheCompany accounts for this investment under the cost method and recorded lossesof $0.1 million and $0.2 million due to an other than temporary decline inthe carrying value of this investment during the three and nine months endedSeptember 30, 2003, respectively, and recorded losses of $0.0 million and$0.5 million due to an other than temporary decline in the carrying valueof this investment during the three and nine months ended September 30,2002, respectively.

 

During the first quarter of fiscal 2002, the Company invested$2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliatedwith SOFTBANK CORP., is a significant stockholder of the Company. The fundfocuses on leveraged buyout investments in companies in Asia undergoingrestructuring or bankruptcy procedures. The total fund offering is expected tobe between approximately $150.0 million and $226.0 million, with eachinvestor contributing a minimum of $0.8 million.

 

14

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The fund has a separate management team, and none of the Company’semployees are employed by the fund. The Company accounts for this investmentunder the equity method of accounting. During the three and nine months ended September 30, 2003, the Companyrecorded equity losses of $0.1 million and $0.1 million, respectively. Thebalance in this investment is $1.9 million at September 30, 2003.

 

The Company has also invested directly in anumber of private technology-based companies in the early stages ofdevelopment. These investments are accounted for on the cost basis. The Companycontinually evaluates the carrying value of these investments for possibleimpairment based on the achievement of business objectives and milestones, thefinancial condition and prospects of these companies and other relevantfactors. During the three months and nine months ended September 30, 2003,no impairment charge was considered necessary, based upon a review of thecarrying value of these investments. During the three and nine months endedSeptember 30, 2002, impairment charges in respect of these privatetechnology investments were $1.7 and $2.3 million, respectively.

 

InJune 2002, the Company invested $1.0 million in Global Asia PartnersL.P., and an additional $1.0 million in June 2003, with a commitment toinvest up to a maximum of $5.0 million. The remaining amount is due atsuch times and in such amounts as shall be specified in one or more futurecapital calls to be issued by the general partner. The fund size is anticipatedto be $100 million and the fund was formed to make private equityinvestments in private or pre-IPO technology and telecommunications companies.The fund’s geographic focus is on technology investments in Asia, in particularIndia and China. The Company accounts for this investment under the equitymethod of accounting.  During the threeand nine months ended September 30, 2003, the Company recorded equity losses of$0.1 million and $0.1 million, respectively. The balance in this investment is$1.8 million at September 30, 2003.

 

During 2002, the Company purchased approximately 5.8 millionshares of common stock of InterWave Communications, Inc., a technologycompany listed on NASDAQ, for approximately $3.0 million. In addition, theCompany received warrants to purchase 2.0 million shares of InterWave’scommon stock at $0.21 per share. The Company’s holdings were adjusted for a1:10 reverse stock split on April 30, 2003, and were 0.6 million shares ofcommon stock and warrants to purchase 0.2 million shares of InterWave’s commonstock at $2.10 per share. The warrants were valued at $0.4 million atSeptember 30, 2003, using the Black-Scholes option-pricing model. TheCompany recorded the decrease in the carrying value of these securities of $0.3million as of September 30, 2003, in comprehensive income in equity. TheCompany recorded a gain (loss) of $(0.1) million and $0.1 million for the threeand nine months ended September 30, 2003, respectively, to reflect thechange in the fair value of the warrants.

 

On July 5, 2002, the Company entered into a joint ventureagreement with Matsushita Communication Industrial Co., Ltd., astockholder of the Company, to jointly design and develop, manufacture and selltelecommunication products. The Company has a 49% ownership interest in thejoint venture company, which has a registered share capital of$10.0 million. The cash consideration of $4.9 million payable by theCompany was paid in October 2002. As the Company does not have votingcontrol over significant matters of the joint venture company, the investmentin and results of operations of the joint venture company are accounted forusing the equity method of accounting. During the three and nine months endedSeptember 30, 2003, the Company recorded equity losses of $1.3 million and $3.9million, respectively.

 

In November 2002, the Company purchased approximately0.5 million shares of common stock of China Telecom in its initial publicoffering for approximately $10.0 million. China Telecom is listed on theNew York Stock Exchange. During the first and second quarters of 2003, theCompany sold these shares realizing a loss of $0.7 million. China Telecom isthe leading provider of wireline telephone, data and Internet and leased lineservices in four of the most economically developed regions of China, and itsaffiliates are customers of the Company.

 

**15.****                               GOODWILLAND INTANGIBLE ASSETS:**

 

The Company’s goodwill and intangible assets are as follows (inthousands):

 
|                          |   | **September 30, 2003** |    | **December 31, 2002** |   |
|-------------------------------|--------|-----------------------------|---------|----------------------------|--------|
|                          |   |                        |    |                       |   |
| Goodwill                      |   | $                           | 113,169 |                       | $      | 57,629 |   |
| Less accumulated amortization |   | (12,823                     | )       | (12,823                    | )      |
|                          |   | $                           | 100,346 |                       | $      | 44,806 |   |
|                          |   |                        |    |                       |   |
| Identified intangible assets  |   |                        |    |                       |   |
|                          |   |                        |    |                       |   |
| Existing technology           |   | $                           | 25,180  |                       | $      | 7,570 |   |
| Less accumulated amortization |   | (6,080                      | )       | (2,556                     | )      |
|                          |   | $                           | 19,100  |                       | $      | 5,014 |   |
|                          |   |                        |    |                       |   |
| Customer relationships        |   | $                           | 27,820  |                       | $      | — |   |
| Less accumulated amortization |   |                        | (927    | )                          | — |   |
|                          |   | $                           | 26,893  |                       | $      | — |   |
|                          |   |                        |    |                       |   |
| Trade names                   |   | $                           | 940     |                       | $      | — |   |
| Less accumulated amortization |   | (157                        | )       | —                     |   |
|                          |   | $                           | 783     |                       | $      | — |   |
|                          |   |                        |    |                       |   |
| Backlog                       |   | $                           | 1,950   |                       | $      | — |   |
| Less accumulated amortization |   | (650                        | )       | —                     |   |
|                          |   | $                           | 1,300   |                       | $      | — |   |

 

Amortization expense for intangible assets was $3.1 million and$0.6 million for the three months ended September 30, 2003

 

15

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and 2002, respectively, and was$5.3 million and $1.8 million for the nine months ended September 30, 2003and 2002, respectively. Expected amortization expense for the next five fiscalyears, beginning the year ended December 31, 2004, is $10.4 million, $7.3million, $5.8 million, $5.6 million and $4.0 million, respectively.

 

During the second quarter of 2003, theCompany completed the acquisition of CommWorks. The Company made a preliminaryallocation of the purchase price based on a preliminary appraisal by anindependent valuation specialist, subsequent to the acquisition. During thethree months ended September 30, 2003, the Company completed theallocation of the purchase price of CommWorks. The estimated amounts forintangible assets and goodwill changed during the three months endedSeptember 30, 2003, mainly due to revised assumptions of future revenuesfrom existing customers.

 

Goodwill increased by $55.5 million andintangible assets increased by $48.1 million during the nine months endedSeptember 30, 2003. The increase during the nine months endedSeptember 30, 2003 was mainly attributable to goodwill of $52.5 millionand intangible assets of $44.9 million which was comprised of purchased technologyof $14.2 million, customer relationships of $27.8 million and other intangiblesof $2.9 million that was recorded on the acquisition of CommWorks, based on thefinal purchase price allocation. The estimated useful life of purchasedtechnology is from one to five years, the estimated useful life of customerrelationships is ten years, and the estimated useful lives of backlog and tradenames are from one to two years.

 

In July 2001, the FASB issued SFASNo. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requiresthat goodwill and intangible assets with indefinite useful lives no longer beamortized, but instead tested for impairment at least annually. SFASNo. 142 also requires that intangible assets with definite useful lives beamortized over their respective estimated useful lives to their estimatedresidual values, and reviewed for impairment in accordance with SFASNo. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

The Company adopted SFAS No. 142 onJanuary 1, 2002. SFAS No. 142 had the effect of eliminatingamortization of goodwill commencing January 1, 2002; however, impairmentreviews may result in future periodic write-downs. The Company performs itsannual impairment review in the fourth quarter of each year or when changes incircumstances indicate a potential impairment.

 

**16.****                               SEGMENTREPORTING:**

 

The Companyprovides telecommunications equipment through an integrated suite of networkaccess systems, optical transmission products and subscriber terminal products.The Company primarily operates in three geographic areas: China, Japan andother regions. The chief operating decision-makers evaluate performance, makeoperating decisions, and allocate resources based on consolidated financialdata. Gross profit, operating income and income taxes are not allocated tospecific individual departments within the organization. In accordance withSFAS No. 131 “Disclosures about Segments of an Enterprise and RelatedInformation,” the Company is considered a single reportable segment. TheCompany is required to disclose certain information about product revenues,information about geographic areas, information about major customers, andinformation about long-lived assets.

 

During the third quarter of 2002, the provincial-level telecommunicationsservice entity in the Zhejiang province of China began to consolidatetelecommunications purchasing decisions for that province. As a result of thisdevelopment in the Zhejiang province, the Company has grouped alltelecommunications service entities in the Zhejiang province together and hastreated these as one customer. At September 30, 2003, the Company hadapproximately 12 such telecommunications service entities in the Zhejiangprovince. Giving effect to this treatment, for the three months endedSeptember 30, 2003, no customer accounted for 10% or more of consolidatednet sales.  For the three months endedSeptember 30, 2002, sales to the Zhejiang province, Softbank BBCorporation (“SBBC”) and Kunming PTB accounted for 16%, 15% and 11% of net sales,respectively.  For the nine months endedSeptember 30, 2003, sales to SBBC accounted for 11% of net sales and noother customer accounted for 10% or more of consolidated net sales. For thenine months ended September 30, 2002, sales to the Zhejiang province andSBBC accounted for 21% and 14% of net sales, respectively. Revenue attributableto Japan was primarily due to sales to SBBC. Sales to SBBC were$26.1 million for the three months ended September 30, 2003 and$39.8 million for the three months ended September 30, 2002. Sales toSBBC were $144.7 million for the nine months ended September 30, 2003and $96.7 million for the nine months ended September 30, 2002.

 

Geographical area data and product data areas follows (in thousands):

 

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|            |   | **Three  Months Ended September 30, 2003** |    | **Three  Months Ended September 30, 2002** |   |
|-----------------|--------|-------------------------------------------------|---------|-------------------------------------------------|--------|
|            |   | **Telecommunications  Equipment**               |    | **Subscriber  Handsets**                        |   | **Total** |   | **Telecommunications  Equipment** |   | **Subscriber  Handsets** |   | **Total** |   |
| Net sales:      |   |                                            |    |                                            |   |   |   |   |   |   |   |   |   |
| China           |   | $                                               | 184,656 |                                            | $      | 333,538 |   | $ | 518,194 |   | $ | 117,405 |   | $ | 100,836 |   | $ | 218,241 |   |
| Japan           |   | 33,042                                          |    | —                                          |   | 33,042 |   | 42,029 |   | — |   | 42,029 |   |
| Other           |   | 33,082                                          |    | 64                                              |   | 33,146 |   | 5,241 |   | 2 |   | 5,243 |   |
|            |   |                                            |    |                                            |   |   |   |   |   |   |   |   |   |
| Total net sales |   | $                                               | 250,780 |                                            | $      | 333,602 |   | $ | 584,382 |   | $ | 164,675 |   | $ | 100,838 |   | $ | 265,513 |   |

 
|            |   | **Nine  Months Ended September 30, 2003** |    | **Nine  Months Ended September 30, 2002** |   |
|-----------------|--------|------------------------------------------------|---------|------------------------------------------------|--------|
|            |   | **Telecommunications  Equipment**              |    | **Subscriber  Handsets**                       |   | **Total** |   | **Telecommunications  Equipment** |   | **Subscriber  Handsets** |   | **Total** |   |
| Net sales:      |   |                                           |    |                                           |   |   |   |   |   |   |   |   |   |
| China           |   | $                                              | 461,041 |                                           | $      | 658,631 |   | $ | 1,119,672 |   | $ | 313,700 |   | $ | 254,168 |   | $ | 567,868 |   |
| Japan           |   | 153,629                                        |    | —                                         |   | 153,629 |   | 102,705 |   | — |   | 102,705 |   |
| Other           |   | 45,376                                         |    | 2,059                                          |   | 47,435 |   | 10,136 |   | 2 |   | 10,138 |   |
|            |   |                                           |    |                                           |   |   |   |   |   |   |   |   |   |
| Total net sales |   | $                                              | 660,046 |                                           | $      | 660,690 |   | $ | 1,320,736 |   | $ | 426,541 |   | $ | 254,170 |   | $ | 680,711 |   |

 

Revenue attributable to the United States ofAmerica was insignificant during the three and nine months endedSeptember 30, 2003 and 2002.

 

Long-lived assets by geography are as follows(in thousands):

 
|                     |   | **September 30,  2003** |    | **December 31,  2002** |   |
|--------------------------|--------|------------------------------|---------|-----------------------------|--------|
| U.S.                     |   | $                            | 159,443 |                        | $      | 43,600 |   |
| Foreign                  |   | 145,040                      |    | 104,731                     |   |
| Total  long-lived assets |   | $                            | 304,483 |                        | $      | 148,331 |   |

 

 

 

**17.****                               COMMITMENTSAND CONTINGENCIES:**

 

*Litigation:*

 

On October 31, 2001, a complaint wasfiled in United States District Court for the Southern District of New Yorkagainst the Company, some of its directors and officers and variousunderwriters for its initial public offering. Substantially similar actionswere filed concerning the initial public offerings for more than 300 differentissuers, and the cases were coordinated as *Inre Initial Public Offering Securities Litigation*, 21 MC 92. InApril 2002, a consolidated amended complaint was filed in the matteragainst the Company, captioned *In reUTStarcom, Initial Public Offering Securities Litigation*, CivilAction No. 01-CV-9604. Plaintiffs allege violations of the Securities Actof 1933 and the Securities Exchange Act of 1934 through undisclosed improperunderwriting practices concerning the allocation of IPO shares in exchange forexcessive brokerage commissions, agreements to purchase shares at higher pricesin the aftermarket, and misleading analyst reports. Plaintiffs seek unspecifieddamages on behalf of a purported class of purchasers of the Company’s commonstock between March 2, 2000 and December 6, 2000. The Company’sdirectors and officers have been dismissed without prejudice pursuant to astipulation.  On February 19, 2003,the Court granted in part and denied in part a motion to dismiss brought bydefendants including the Company. The order dismisses all claims against theCompany except for a claim brought under Section 11 of the Securities Actof 1933, which alleges that the Company’s initial public offering registration statementcontained untrue statements of material fact and omitted to state materialfacts required to be stated in the registration statement, or necessary to makethe statements therein not misleading. A proposal has been made for the settlement and release of claimsagainst the issuer defendants, including UTStarcom. The settlement is subjectto a number of conditions, including approval of the proposed settling partiesand the court. If the settlement does not occur, and litigation againstUTStarcom continues, UTStarcom believes it has meritorious defenses and intendsto defend the case vigorously. We are unable to currently estimate the loss, ifany, associated with the above litigation.

 

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*Investment Commitments:*

 

As of September 30, 2003, the Companyhad invested a total of $2.0 million in Global Asia Partners L.P. The fundsize is anticipated to be $100 million and the fund was formed to makeprivate equity investments in private or pre-IPO technology andtelecommunications companies in Asia. The Company has a commitment to invest upto a maximum of $5.0 million. The remaining amount is due at such timesand in such amounts as shall be specified in one or more future capital callsto be issued by the general partner.

 

**18.****                               RELATEDPARTY TRANSACTIONS:**

 

The Company recognized related party revenue of $26.1 million and$144.7 million during the three and nine months ended September 30, 2003,respectively, and $42.0 million and $103.4 million during the three and ninemonths ended September 30, 2002, respectively, primarily with respect tosales of telecommunications equipment to SBBC, an affiliate of SOFTBANK CORP.SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., asignificant stockholder of the Company. SBBC offers asynchronous digitalsubscriber line (“ADSL”) coverage throughout Japan, which is marketed under thename YAHOO. The Company provides ADSL technology to SBBC. The contract wascompetitively bid and the terms of this contract were on terms no morefavorable than those with unrelated parties. At September 30, 2003, therewas $52.6 million related to this agreement in related party receivables. Therewere no amounts included in deferred revenue in respect of this agreement atSeptember 30, 2003. Included in accounts receivable in respect of thisagreement at December 31, 2002 was $0.8 million. There were noamounts included in deferred revenue in respect of this agreement atDecember 31, 2002.

 

The Company has invested in Softbank Chinaand Restructuring Fund No. 1, which are investment vehicles established bySOFTBANK CORP. and its affiliates. See Note 14.

 

On April 5, 2003, the Company repurchased 8.0 million shares ofthe Company’s common stock beneficially owned by SOFTBANK America Inc., at apurchase price of $17.385 per share. The total cost of the repurchase was$139.6 million, including transaction fees. In connection with this repurchasetransaction, SOFTBANK America Inc. entered into an agreement with the Companynot to offer, sell or otherwise dispose of the Company’s common stock for aperiod of one year, subject to a number of exceptions. As of September 30,2003, SOFTBANK America Inc. beneficially owned approximately 14.4% of theCompany’s outstanding stock as of September 30, 2003.

 

On July 17, 2003, the Company entered into a Mezzanine Loan Agreementwith BB Modem Rental PLC ("BB Modem"), an affiliate of SOFTBANKCORP.  Under the terms of the agreementthe Company loaned BB Modem $10.1 million, for the purposes of investingin a portfolio of ADSL modems and associated modem rental agreements, fromSOFTBANK BB CORP., formerly BB Technologies, an affiliate of SOFTBANKCORP.  SOFTBANK BB CORP. will continueto service such modems and modem rental agreements.  The Company’s loan is subordinated to certain senior lenders ofBB Modem, and repayments are payable to us over a forty-two month periodthrough January 31, 2007, with a substantial portion of the principalamount of the loan schedule to be repaid during the last 16 months of thisperiod.  The Company’s recourse fornonpayment of the loan is limited to the assets of BB Modem, the account intowhich subscriber payments are made and its rights under the securitizationtransaction documents.  The value of BBModem's modems that serve as collateral for the loan may decrease over time andmay not be sufficient upon sale to pay the outstanding amounts on theloans.  During the three and nine monthsended September 30, 2003, the Company recorded $0.2 million in interestincome in respect of this loan.  Theloan receivable at September 30, 2003 was approximately $10.6 million.

 

**19.****                               COUNTRYRISKS:**

 

Approximately 89% and 82% of the Company’s net sales for the threemonths ended September 30, 2003 and 2002, respectively, and approximately85% and 83% of the Company’s net sales for the nine months endedSeptember 30, 2003 and 2002, respectively, were made in China.Accordingly, the Company’s business, financial condition and results ofoperations are likely to be influenced by the political, economic and legalenvironment in China and by the general state of China’s economy. The Company’soperations in China are subject to special considerations and significant risksnot typically associated with companies in the United States. These includerisks associated with, among others, the political, economic and legalenvironments and foreign currency exchange. The Company’s results may beadversely affected by, among other things, changes in the political, economic,competitive and social conditions in China, including changes in governmentalpolicies with respect to laws and regulations, changes in China’stelecommunications industry and regulatory rules and policies,anti-inflationary measures, currency conversion and remittance abroad, and ratesand methods of taxation.

 

Under China’s current regulatory structure,the communications products that the Company offers in China must meetgovernment and industry standards, and a network access license for theequipment must be obtained. Without the license, the equipment is not allowedto be connected to public telecommunications networks or sold in China.Moreover, the Company must ensure that the quality of the telecommunicationsequipment for which it has obtained a network access license is stable andreliable, and may not lower the quality or performance of other installedlicensed products. China’s State Council’s product quality supervisiondepartment, in concert with China’s Ministry of Information Industry, performsspot checks to track and supervise the quality of licensed telecommunicationsequipment and publishes the results of such spot checks.

 

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The regulations implementing these requirements are not very detailed,have not been applied by a court and may be interpreted and enforced byregulatory authorities in a number of different ways. The Company has obtainedthe required network access licenses for its AN-2000B platform. The Company hasalso obtained a probationary network access license for its mSwitch product,and after the trial period, an official network access license will be issuedif the trial demonstrates that mSwitch satisfies all applicable government andindustry standards. The Company applied for, but has not yet received, anetwork access license for its PAS systems and handsets. Based uponconversations with the Ministry of Information Industry, the Companyunderstands that its PAS systems and handsets are considered to still be in thetrial period and that sales of the Company’s PAS systems and handsets maycontinue to be made during this trial period, but a license will ultimately berequired. Network access licenses will also be required for most additionalproducts that the Company is selling or may sell in China, including themSwitch platform. If the Company fails to obtain the required licenses, theCompany could be prohibited from making further sales of the unlicensedproducts, including the PAS systems and handsets, in China, which wouldsubstantially harm its business, financial condition and results of operations.The Company’s counsel in China has advised that China’s governmentalauthorities may interpret or apply the regulations with respect to whichlicenses are required and the ability to sell a product while a product is inthe trial period in a manner that is inconsistent with the information receivedby such counsel in China, either of which could have a material adverse effecton the Company’s business, financial condition and results of operations.

 

Approximately6% and 16% of the Company’s sales for the three months ended September 30,2003 and 2002, respectively, and approximately 12% and 15% of the Company’ssales for the nine months ended September 30, 2003 and 2002, respectively,were made in Japan. Accordingly, the political, economic and legal environmentand the general state of Japan’s economy may influence the Company’s business,financial condition and results of operations.

 

**20.****                               INCOMETAX ASSETS AND LIABILITIES:**

 

In establishing its deferred income tax assets and liabilities, theCompany makes judgments and interpretations based on the enacted tax laws andpublished tax guidance applicable to its operations.  The Company records deferred tax assets and liabilities andevaluates the need for valuation allowances to reduce the deferred tax assetsto realizable amounts.  The likelihoodof a material change in the Company’s expected realization of these assets isdependent on future taxable income, its ability to use foreign tax creditcarryforwards and carrybacks, and the effectiveness of its tax planningstrategies in the various relevant jurisdictions.  Changes to the Company’s income tax provision or in the valuationof the deferred tax assets and liabilities may affect its annual effective incometax rate.

 

**21.****                               RECENTACCOUNTING PRONOUNCEMENTS:**

 

In November 2002, the Emerging Issues Task Force reached aconsensus on Issue No. 00-21, “Revenue Arrangements with MultipleDeliverables” (“EITF No. 00-21”). This issue addresses how revenue arrangementswith multiple deliverables should be divided into separate units of accountingand how the arrangement consideration should be allocated to the identifiedseparate accounting units. EITF No. 00-21 is effective for fiscal periodsbeginning after June 15, 2003. Where multiple elements exist in anarrangement, the arrangement fee is allocated to the different elements basedupon verifiable objective evidence of the fair value of the elements. TheCompany adopted EITF No. 00-21 on July 1, 2003, and the adoption didnot have a significant impact on the consolidated results of operations andfinancial position.

 

InJanuary 2003, the Financial Accounting Standards Board issuedInterpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN46”). FIN 46 provides accounting guidance for consolidation of variableinterest entities (“VIE”), formerly referred to as special purpose entities.FIN 46 applies to public and private business enterprises that have acontrolling interest or business or contractual relationship with a VIE. FIN 46requires consolidation of existing non-controlled affiliates if the VIE isunable to finance its operations without investor support, or where the otherinvestors do not have exposure to the significant risks and rewards ofownership. FIN 46 will be effective for the quarter ended December 31, 2003.The adoption of FIN 46 is not expected to have an impact on the consolidatedfinancial statements.

 

InApril 2003, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instruments and HedgingActivities” (“SFAS 149”). This statement amends SFAS 133 to provideclarification on the financial accounting and reporting of derivativeinstruments and hedging activities. The adoption of SFAS 149, which iseffective for contracts entered into or modified after June 30, 2003, didnot have a material effect on the Company’s consolidated financial condition orresults of operations.

 

InMay 2003, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity” (“SFAS 150”).SFAS 150 establishes standards for how an issuer classifies and measurescertain financial instruments with characteristics of both liabilities andequity. It requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances). Many ofthese instruments were previously classified as equity.

 

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As the Company does not haveany of these financial instruments, the adoption of FAS 150 is not expectedhave any impact on the Company’s consolidated financial statements.

 

**ITEM 2****—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

This Report onForm 10-Q contains forward-looking statements within the meaning of thefederal securities laws. These statements are based on information that iscurrently available to management. We intend such forward-looking statements tobe covered by the safe harbor provisions of the Private Securities LitigationReform Act of 1995, and we are including this statement for purposes ofcomplying with those provisions. The forward-looking statements include,without limitation, those concerning the following: our expectations as to thenature of possible trends; the manner in which customers in Chinese provincesnegotiate for the purchase of our products; our expectation regarding continuedgrowth in our business and operations; our expectation that our PAS networkaccess system will continue to be allowed in China’s county-level cities andcounties; our expectation that there will be no penalties or fines for ournon-compliance with the licensing requirements in China for our PAS system andother products; our expectation concerning the anticipated cost and completiondate of our new Hangzhou manufacturing facility; our expectation that therewill be fluctuations in our overall gross profit, gross margin, product mix,quarter to quarter results, customer base and selling prices; our plans forexpanding the direct sales organization and our selling and marketing campaignsand activities; our expectation that we may use cash, debt or securities of theCompany to acquire or invest in complementary businesses, technologies orproduct offerings; our expectation that there will be increases in selling,marketing, research and development, general and administrative expenses; ourexpectations regarding future growth of our business and operations; ourexpectation that we will continue to invest significantly in research anddevelopment; our expectations regarding our future levels of backlog orders;our expectations regarding our future investments, particularly in SoftbankChina; our expectation that existing cash and cash equivalents will besufficient to finance our operations for at least the next 12 months; ourexpectations regarding the development of a 3G network in China; statementsregarding the impact of a reorganization of China Netcom; and the impact ofchanges in general world and domestic economic conditions in light of themilitary conflict in Iraq. Additional forward-looking statements may beidentified by the words, “anticipate,” “expect,” “believe,” “intend,” “will”and similar expressions, as they relate to us or our management. Investors arecautioned that these forward-looking statements are inherently uncertain. Thesestatements are subject to risks and uncertainties that may cause actual resultsand events to differ materially. For a detailed discussion of these risks anduncertainties, see the “Factors Affecting Future Operating Results” section ofthis Form 10-Q. We do not guarantee future results and undertake noobligation to update the forward-looking statements to reflect events orcircumstances occurring after the date of this Form 10-Q.

 

**OVERVIEW**

 

Incorporatedin 1991, UTStarcom designs, manufactures, and markets wireline and wirelessbroadband access and switching equipment that enables migration to nextgeneration IP-based networks. Our operations are conducted primarily by ourforeign subsidiaries that manufacture, distribute and support our products,principally in China. Our systems and products allow service providers to offercost-efficient and expandable voice, data and Internet access services. Becauseour systems are based on widely adopted international communications standards,service providers can easily integrate our systems into their existing networksand deploy our systems in new broadband, Internet Protocol and wireless networkrollouts.

 

We have derived most of our revenues from sales of telecommunicationsequipment to service providers in China. However, we continue to expand oursales to service providers in other growing communications markets outside ofChina, including Japan, Taiwan, Vietnam, India, Africa, Europe, Latin Americaand the United States. Our customers often make a large initial purchase of ourequipment followed by supplemental purchases of enhancements and upgrades. As aresult, our largest revenue-producing customers typically vary from period toperiod. The evaluation period for our products by potential customers may spana year or more and our business generally depends on a relatively small numberof large deployments.

 

Approximately 89% and 85% of our net sales, respectively, for the threeand nine months ended September 30, 2003 and approximately 82% and 83% ofour net sales, respectively, for the three and nine months endedSeptember 30, 2002 were made in China. Accordingly, our business,financial condition and results of operations are likely to be influenced bythe political, economic and legal environment in China, and by the generalstate of China’s economy. Our results may be adversely affected by, among otherthings, changes in the political, economic, competitive and social conditionsin China, including changes in China’s governmental policies with respect tolaws and regulations, changes in telecommunications industry and regulatoryrules and policies, anti-inflationary measures, currency conversion andremittance abroad, and rates and methods of taxation. We extend credit to ourcustomers in China without requiring collateral. We monitor our exposure forcredit losses and maintain allowances for doubtful accounts.

 

We have historically considered local telecommunications serviceproviders serving municipalities and counties to be our primary customers inChina. Recently, however, the provincial-level telecommunications serviceentity in the Zhejiang province of China has begun to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend in the Zhejiang 

 

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province, wehave grouped all telecommunications service entities in the Zhejiang provincetogether and have treated these as one customer. At September 30, 2003, wehad approximately 12 telecommunications service entities in Zhejiangprovince.  Giving effect to thistreatment, for the three months ended September 30, 2003, no customersaccounted for 10% or more of consolidated net sales.  For the three months ended September 30, 2002, sales to theZhejiang province, SBBC and Kunming PTB accounted for 16%, 15% and 11% ofconsolidated net sales, respectively.  For the nine months ended September 30, 2003, sales to SBBCaccounted for 11% of consolidated net sales and no other customer accounted for10% or more of consolidated net sales. For the nine months endedSeptember 30, 2002, sales to the Zhejiang province and SBBC accounted for21% and 14% of consolidated net sales, respectively.

 

Whether thisrepresents the beginning of a greater trend throughout China towards increasedconsolidation of negotiations and purchasing decisions into the control ofprovincial-level telecommunications service entities is unclear. To ourknowledge, no telecommunications service entities in the other Chineseprovinces in which we operate have centralized this process. However, thenature of negotiations in China is still evolving. If a trend towardconsolidation of purchasing decisions into the control of provincial-leveltelecommunications service entities in China does emerge, it could possiblytake a variety of forms. For example, some provincial-level telecommunicationsservice entities could simply coordinate purchase decisions to be made by localtelecommunications service providers, with local service providers retainingultimate control over purchasing decisions. In other cases, however,provincial-level entities could wield greater control over the decision ofwhether or not to purchase our products. In any event, such a trend couldstreamline the negotiation process within Chinese provinces, but it could alsoplace downward pressure on the prices we can charge for our products. We willcontinue to monitor business practices in China closely, and to the extent thatany of these changes affect the manner in which our customers make theirdecisions about whether or not to purchase our products, we will re-evaluatewhat entities may best be described as our customers.

 

Under China’s current regulatory structure, the communications productsthat we offer in China must meet government and industry standards, and anetwork access license for the equipment must be obtained. Without the license,the equipment is not allowed to be connected to public telecommunicationsnetworks or sold in China. Moreover, we must ensure that the quality of thetelecommunications equipment for which we have obtained a network accesslicense is stable and reliable, and may not lower the quality or performance ofother installed licensed products. China’s State Council’s quality supervisiondepartment, in concert with China’s Ministry of Information Industry, performsspot checks to track and supervise the quality of licensed telecommunicationsequipment and publishes the results of such spot checks.

 

The regulations implementing these requirements are not very detailed,have not been applied by a court and may be interpreted and enforced byregulatory authorities in a number of different ways. We have obtained therequired network access licenses for our AN-2000B platform.  We have also obtained a probationary networkaccess license for our mSwitch product, and after the trial period, an officialnetwork access license will be issued if the trial demonstrates that mSwitchsatisfies all applicable government and industry standards. We have appliedfor, but have not yet received, a network access license for our PAS systemsand handsets. Based upon conversations with the Ministry of InformationIndustry, we understand that our PAS systems and handsets are considered tostill be in the trial period and that sales of our PAS systems and handsets maycontinue to be made by us during this trial period. However, a license willultimately be required. Network access licenses will also be required for mostadditional products that we are selling or may sell in China, including ourmSwitch platform. If we fail to obtain the required licenses, we could beprohibited from making further sales of the unlicensed products, including ourPAS systems and handsets, in China, which would substantially harm ourbusiness, financial condition and results of operations. Our counsel in Chinahas advised us that China’s governmental authorities may interpret or apply theregulations with respect to which licenses are required and the ability to sella product while a product is in the trial period in a manner that isinconsistent with the information received by our counsel in China, either ofwhich could have a material adverse effect on our business, financial conditionand results of operations.

 

Remittances from China, which are of a capital nature, such as therepayment of bank loans denominated in foreign currencies, require approvalfrom appropriate governmental authorities before Renminbi can be used topurchase foreign currency. Although the payment of cash dividends is permittedso long as our subsidiaries have sufficient reserves and adequate amounts ofRenminbi to purchase foreign currency, regulations restrict the ability of oursubsidiaries to transfer funds to us through intercompany loans and advances.

 

Business activity in China and many other countries in Asia declinesconsiderably during the first quarter of each year in observance of the LunarNew Year. As a result, sales during the first quarter of our fiscal year havetypically been lower than sales during the fourth quarter of the precedingyear, and we expect this trend to continue.

 

Revenues from sales of telecommunications equipment are recognized whenpersuasive evidence of an arrangement exists, delivery of the product hasoccurred as evidenced by customer acceptance, the fee is fixed or determinableand collectability is reasonably assured. If the fee due from the customer isnot fixed or determinable due to extended payment terms, revenue is recognizedas payments become due from the customer, assuming all other criteria forrevenue recognition are met. Any payments received prior to revenue recognitionare recorded as deferred revenue. Shipping and handling costs are recorded asrevenues and costs of revenues.

 

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Where multipleelements exist in an arrangement, the arrangement fee is allocated to thedifferent elements based upon verifiable objective evidence of the fair valueof the elements.  Our multiple elementarrangements primarily involve the sale of PAS or iPAS equipment with handsets,installation and training and the provision of such equipment to differentlocations for the same customer. Revenue is recognized as each element is earned, namely uponinstallation and acceptance of equipment or delivery of handsets, provided thatthe undelivered elements are not deemed essential to the functionality of thedelivered elements and payment for the delivered elements is not contingent ondelivery of the further elements.

 

Cost of salesconsists primarily of material costs, third party commissions, costs associatedwith manufacturing, assembly and testing of products, costs associated withinstallation and customer training and overhead and warranty costs. Cost ofsales also includes import taxes and tariffs on components and assemblies. Somecomponents and materials used in our products are purchased from a singlesupplier or a limited group of suppliers and, in some cases, are subject to ourobtaining Chinese import permits and approvals. We also rely on third partymanufacturers in China to manufacture and assemble most of our handsets.

 

During the three months ended September 30, 2003, the Companyestablished a just in time (“JIT”) inventory process as part of our contractmanufacturing process, in order to minimize handset inventory costs and handsetinventory levels. Hangzhou UTStarcom Telecom Co., Ltd.  (“HSTC”), one of the Company’s subsidiariesin China, entered into an agreement with a third party supplier to procure handsetcomponents on a JIT basis. Under the agreement, the supplier will directlyplace orders for handset components with various vendors. Title to theinventories will pass to HSTC upon delivery. At the inception of thisagreement, HSTC sold handset components on hand to the supplier at cost. HSTCsold approximately $134.0 million of handset components to this supplier duringthe three months ended September 30, 2003.

 

Our gross profit has been affected by product mix, average sellingprices and material costs. Our gross profit, as a percentage of net sales,varies among our product families. We expect that our overall gross profit, asa percentage of net sales, will fluctuate from period to period as a result ofshifts in product mix, anticipated decreases in average selling prices and ourability to reduce cost of sales.

 

Selling, general and administrative expenses include compensation andbenefits, professional fees, sales commissions, provision for doubtful accountsreceivable and travel and entertainment costs. A large percentage of our costsare fixed and are difficult to quickly reduce in periods of reduced sales. Weintend to pursue aggressive selling and marketing campaigns and to expand ourdirect sales organization, and, as a result, our sales and marketing expenseswill increase in future periods. We also expect that in support of ourcontinued growth, general and administrative expenses will continue to increasefor the foreseeable future.

 

Research and development expenses consist primarily of salaries andrelated costs of employees engaged in research, design and developmentactivities, the cost of parts for prototypes, equipment depreciation and thirdparty development expenses. A large percentage of our costs are fixed and aredifficult to quickly reduce in periods of reduced sales. We believe thatcontinued investment in research and development is critical to our long-termsuccess. Accordingly, we expect that our research and development expenses willincrease in future periods.

 

The equity loss for the current year is primarily due to our share oflosses relating to a joint venture agreement we entered into on July 5,2002 with Matsushita Communication Industrial Co., Ltd., and MatsushitaElectric Industrial Co., Ltd., to jointly design, develop, manufacture and selltelecommunications products. We have a 49% ownership interest in this jointventure company. The equity loss for 2002 is in respect of losses at GuangdongUTStarcom Telecom Co., Ltd., (“GUTS”) our Guangdong manufacturing subsidiary.In May 2002, we acquired the remaining 49% ownership interest in GUTS,which is now a wholly-owned subsidiary. Its results of operations are includedin our consolidated financial statements beginning June 1, 2002. Prior toMay 2002, GUTS was accounted for using the equity method of accounting.

 

Under current regulations in China, foreign investment enterprises thathave been accredited as technologically advanced enterprises are entitled toadditional tax incentives. These tax incentives vary in different locales andcould include preferential national enterprise income tax treatment at 50% ofthe usual rates for different periods of time. All of our active subsidiariesin China were accredited as technologically advanced enterprises. The taxholidays applicable to our wholly-owned subsidiaries, UTStarcom China andUTStarcom Telecom Co., Ltd. (“HUTS”), which together accounted forapproximately 76% of our revenues for the nine months ended September 30,2003, expired at the end of 2002 and 2001, respectively. The tax holidays were notextended for the entities, and for 2003, the national enterprise tax rates wereincreased from 7.5% to 15%, and from 10% to 15%, respectively. During thefourth quarter of 2002, we formed a new entity, Hangzhou UTStarcomTelecom Co., Ltd., to manufacture and sell handsets. This entity willbenefit from a two-year national enterprise income tax exemption from the firstprofit-making year and a 50% national enterprise income tax reduction in thefollowing three years. The Chinese government is considering the imposition ofa “unified” corporate income tax that would phase out, over time, thepreferential tax treatment to which foreign investment enterprises, such asUTStarcom, are currently entitled. We cannot be certain whether the governmentwill implement such a unified tax structure, or, if implemented, whether itwill adversely affect our financial results.

 

Minority interest in earnings of consolidated subsidiaries for thethree months ended September 30, 2003, represented the 

 

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10% share ofearnings of CUTS, our Chongqing manufacturing joint venture, attributable toour joint venture partner. Minority interest in earnings of consolidatedsubsidiaries for the nine months ended September 30, 2002, represented theshare of earnings in HUTS, our Zhejiang manufacturing joint venture,attributable to our joint venture partner, prior to our acquisition of theremaining 12% ownership interest in HUTS in May 2002.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our financial condition and results of operations are based on certaincritical accounting policies and estimates, which include judgments, estimates,and assumptions on the part of management. Estimates are based on historicalexperience, knowledge of economic and market factors and various otherassumptions that management believes to be reasonable under the circumstances.Actual results may differ from those estimates. The following summary ofcritical accounting policies and estimates highlights those areas ofsignificant judgment in the application of our accounting policies that affectour financial condition and results of operations.

 

Our business is concentrated in China. Therefore, a material adversechange in economic, political and social conditions in China could have anadverse effect on our accounting estimates and result in additional charges tooperations.

 

**Revenue Recognition, Allowances for DoubtfulAccounts and Product Warranty**

 

We recognizerevenue from sales of telecommunications equipment when persuasive evidence ofan arrangement exists, delivery of the product has occurred, customeracceptance has been obtained, the fee is fixed or determinable andcollectability is reasonably assured. For transactions where we have yet toobtain customer acceptance, revenue is deferred until the terms of acceptanceare satisfied.  For transactions wherethe fee is not fixed or determinable due to extended payment terms, werecognize revenue as payments become due from the customer assuming all otherrevenue recognition criteria are met. We recognize system integration, installation and training revenues uponperformance completion.  Revenue frommaintenance and support contracts is recognized ratably over the contract term.A sales reserve is established based on historical trends in sales returns. Ifactual future sales returns do not reflect the historical data, our revenuecould be affected. Historically, the level of sales returns and our collectionhistory have been within our expectations.

 

We alsomaintain allowances for doubtful accounts based on our assessment of thecollectability of our accounts receivable. We continually monitor collectionsfrom our customers and maintain allowances for doubtful accounts based upon theage of outstanding invoices and any specific customer collection issues.  If we determine that fee collection is notreasonably assured, we defer the fee and recognize the revenue at the timecollection becomes reasonably assured, which is generally upon the receipt ofcash.  Historically, doubtful accountsor credit losses have been within our expectations, and our doubtful accountallowances have been adequate.

 

We provide a warranty on ourequipment and handset sales for a period generally ranging from twelve toeighteen months. We provide for the expected cost of product warranties at thetime that we recognize revenue, based on our assessment of past warrantyexperience. We continually monitor the level of our warranty expenses. If,however, there were a material adverse change in our product failure rates, anadditional warranty provision would be required. Historically, our warrantyexperience has been within our expectations.

 

**Inventories**

 

Our inventories are stated at the lower of cost or net realizablevalue, net of write-downs for excess, slow moving and obsolete inventory.Inventory write-downs are based on our assumptions about future marketconditions and customer demand. We continually monitor our inventory valuation.Historically, the level of inventory write-downs, our inventory turnover andobsolescence experience have been within our expectations.

 

**Research and Development and SoftwareDevelopment Costs**

 

Our researchand development costs are charged to expense as incurred. We capitalize costsincurred in the development of software that will ultimately be sold whentechnological feasibility has been attained and /or the development of therelated product has been completed. Management judgment is required inassessing expected future revenues and changes in product technologies, and theultimate recoverability of our capitalized software development costs.

 

**Deferred Income Taxes**

 

We recognize deferred income taxes as the difference between the taxbasis of assets and liabilities and their financial statement amounts based onenacted tax rates. Management judgment is required in the assessment of therecoverability of our deferred tax assets based on our assessment of projectedtaxable income. Numerous factors could affect our results of operations in the 

 

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future. Ifthere were a significant decline in our future operating results, ourassessment of the recoverability of our deferred tax assets would need to berevised, and any such adjustment to our deferred tax assets would be charged toincome in that period.

 

**Goodwill and Intangibles**

 

We have recorded goodwill and intangible assets in connection with ourbusiness acquisitions. Management judgment is required in the assessment of therelated useful lives, assumptions regarding our ability to successfully developand ultimately commercialize acquired technology, and assumptions regarding thefair value and the recoverability of these assets. Historically, there havebeen no circumstances that resulted in revised assumptions or impairment charges.We perform our annual goodwill impairment review in the fourth quarter of eachyear or when changes in circumstances indicate a potential impairment.

 

**Long-Term Investments**

 

We have invested in a fund focused on investments in Internet companiesin China and a fund focused on investments in companies in Asia undergoingrestructuring or bankruptcy procedures. We have also invested directly in anumber of private technology-based companies in the early stages of developmentand in publicly listed technology companies traded on Nasdaq and NYSE. Whilequoted market prices are readily available to determine the fair value of ourinvestments in these publicly-traded companies, management judgment is requiredin evaluating the carrying value of our private company investments forpossible impairment. For our private technology company investments, we assessimpairment based on an evaluation of the achievement of business objectives andmilestones, the financial condition and prospects of these companies and otherrelevant factors. We continually monitor these investments for impairment, andcharge to income any impairment amounts in the period such a determination ismade.

 

**RELATED PARTY TRANSACTIONS**

 

We recognizedrelated party revenue of $26.1 million and $144.7 million during the threeand nine months ended September 30, 2003, respectively, and $42.0 millionand $103.4 million during the three and nine months ended September 30,2002, respectively, primarily with respect to sales of telecommunicationsequipment to SBBC, an affiliate of SOFTBANK CORP. SOFTBANK America Inc.,an entity affiliated with SOFTBANK CORP., a significant stockholder of ours.SBBC offers asynchronous digital subscriber line (“ADSL”) coverage throughoutJapan, which is marketed under the name “YAHOO! BB.” We provide ADSL technologyto SBBC. The contract was competitively bid on and its terms were no morefavorable than those in contracts with unrelated parties. Included in accountsreceivable at September 30, 2003 was $52.6 million related to thisagreement. There were no amounts included in deferred revenue in respect ofthis agreement at September 30, 2003. Included in accounts receivable inrespect of this agreement at December 31, 2002 was $0.8 million.There were no amounts included in deferred revenue in respect of this agreementat December 31, 2002.

 

During 2000, we invested $10.0 million in Softbank China, aninvestment fund established by SOFTBANK CORP. focused on investments inInternet companies in China. This investment permits us to participate in theanticipated growth of Internet-related businesses in China. SOFTBANK CORP. andits related companies are significant stockholders of ours. Our investmentconstitutes 10% of the funding for Softbank China, with SOFTBANK CORP. contributingthe remaining 90%. The fund has a separate management team, and none of ouremployees are employed by the fund. Many of the fund’s investments are and willbe in privately held companies, many of which are still in the start-up ordevelopment stages. These investments are inherently risky as the market forthe technologies or products the companies have under development are typicallyin the early stages and may never materialize. We account for this investmentunder the cost method and recorded losses of $0.1 million and $0.2 milliondue to an other-than-temporary decline in the carrying value of this investmentduring the three and nine months ended September 30, 2003, respectively,and recorded losses of $0.0 million and $0.5 million due to an other-than-temporarydecline in the carrying value of this investment during the three and ninemonths ended September 30, 2002, respectively.

 

During the first quarter of fiscal 2002, we invested $2.0 millionin Restructuring Fund No. 1, a venture capital investment limitedpartnership established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANKCORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., isa significant stockholder of ours. The fund focuses on leveraged buyoutinvestments in companies in Asia undergoing restructuring or bankruptcyproceedings. The total fund offering is expected to be between approximately$150.0 million and $226.0 million, with each investor contributing aminimum of $0.8 million. The fund has a separate management team, and noneof our employees are employed by the fund. We account for this investment underthe equity method of accounting. The balance in this investment was$1.9 million at September 30, 2003.

 

On April 5, 2003, we repurchased 8.0 million shares of our commonstock beneficially owned by SOFTBANK America Inc., at a purchase price of$17.385 per share. The total cost of the repurchase was $139.6 millionincluding transaction fees. In connection with this repurchase transaction,SOFTBANK America Inc. entered into an agreement with us not to offer, sell orotherwise dispose of our common stock for a period of one year, subject to anumber of exceptions. As of September 30, 2003, SOFTBANK America Inc. 

 

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beneficiallyowned approximately 14.4% of our outstanding stock.

 

On July 17, 2003, we entered into a Mezzanine Loan Agreement withBB Modem Rental PLC ("BB Modem"), an affiliate of SOFTBANKCORP.  Under the terms of the agreementwe loaned BB Modem $10.1 million, for the purposes of investing in aportfolio of ADSL modems and associated modem rental agreements, from SOFTBANKBB CORP., formerly BB Technologies, an affiliate of SOFTBANK CORP.  SOFTBANK BB CORP. will continue to servicesuch modems and modem rental agreements. Our loan is subordinated to certain senior lenders of BB Modem, andrepayments are payable to us over a forty-two month period throughJanuary 31, 2007, with a substantial portion of the principal amount ofthe loan schedule to be repaid during the last 16 months of this period.  Our recourse for nonpayment of the loan islimited to the assets of BB Modem, the account into which subscriber paymentsare made and its rights under the securitization transaction documents.  The value of BB Modem's modems that serve ascollateral for the loan may decrease over time and may not be sufficient uponsale to pay the outstanding amounts on the loans.  During the three and nine months ended September 30, 2003,we recorded $0.2 million in interest income in respect of this loan.  The loan receivable at September 30,2003 was approximately $10.6 million.

 

**RESULTS OF OPERATIONS**

 

**THREE MONTHS ENDED SEPTEMBER 30, 2003AND SEPTEMBER 30, 2002**

 

NET SALES

 

Our net sales increased 120% to $584.4 million for the threemonths ended September 30, 2003 from $265.5 million for the correspondingperiod in 2002. Sales of telecommunications equipment for the three monthsended September 30, 2003 were $250.8 million, an increase of $86.1 million or 52% as compared to thethree months ended September 30, 2002. Sales of subscriber handsets forthe three months ended September 30, 2003 were $333.6 million, anincrease of $232.8 million or 231%, as compared to the three months endedSeptember 30, 2002. In particular, sales of PAS/iPAS equipment,AN-2000/IP-DSLAM equipment, PAS handsets and other products were $191.9million, $36.7 million, $333.6 million and $22.2 million, respectively, andrepresented 33%, 6%, 57% and 4% of our net sales for the three months ended September 30,2003, respectively.  Sales of PAS/iPASequipment, AN-2000/IP-DSLAM equipment, PAS handsets and other products were$117.4 million, $46.0 million, $101.0 million and $1.1 million, respectively,and represented 44%, 17%, 38% and 1% of our net sales for the three monthsended September 30, 2002, respectively. Our mSwitch products are includedwith our iPAS product offering. We do not expect the percentage of revenuesattributed to these products to change significantly in the near future. In particular,we expect that 2003 sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment andPAS handsets will represent approximately 35%, 15% and 50% of our net sales,respectively.

 

Sales of iPAS/PAS equipment and sales of subscriber handsets increaseddue to the continued growth in spending on telecommunications infrastructure inChina, which accounted for 89% and 82% of our net sales for the three monthsended September 30, 2003 and 2002, respectively. International sales oftelecommunications equipment increased to $66.1 million for the threemonths ended September 30, 2003 as compared to $47.3 million for thethree months ended September 30, 2002, mainly driven by sales of our newlyacquired CommWorks product and service offerings. Sales in Japan for the threemonths ended September 30, 2003 and 2002 accounted for 6% and 16% of ournet sales, respectively. During 2002, the provincial-level telecommunicationsservice entity in the Zhejiang province of China began to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend, we have grouped all telecommunications service entities in the Zhejiangprovince together and have treated them as one customer.  At September 30, 2003, we hadapproximately 12 telecommunications service entities in the Zhejiangprovince.  For the three months endedSeptember 30, 2003, no customers accounted for 10% or more of consolidatednet sales. For the three months ended September 30, 2002, sales to theZhejiang province, SBBC and Kunming PTB accounted for 16%, 15% and 11% of netsales, respectively.

 

GROSS PROFIT

 

Gross profit increased by 101% to $186.1 million for the three monthsended September 30, 2003 from $92.8 million for the correspondingperiod in 2002. Gross profit, as a percentage of net sales, was 32% for thethree months ended September 30, 2003 and 35% for the three months endedSeptember 30, 2002. Gross profit, as a percentage of net sales, wasimpacted by our changing product mix as well as market conditions.  Our higher margin AN-2000/IP-DSLAM equipmentsales were 6% of our net sales for the three months ended September 30, 2003,as compared to 17% for the three months ended September 30, 2002.  In addition, our handset sales generallyhave lower margins than our AN 2000/IP-DSLAM sales, and comprised 57% and 38%of our net sales for the three months ended September 30, 2003 and 2002,respectively.  The telecom market, ingeneral, has been experiencing competitive pricing pressures.  Market competition and margin pressure onour sales of AN-2000/IP-DSLAM equipment and on our sales of PAS/iPAS equipmentcontributed to the decrease in our gross margin as a percentage of sales forthe three months ended September 30, 2003.

 

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SELLING, GENERALAND ADMINISTRATIVE

 

Selling,general and administrative expenses increased 101% to $57.4 million forthe three months ended September 30, 2003 from $28.6 million for thecorresponding period in 2002. The increase in absolute dollars in selling,general and administrative expenses was primarily due to increased sales andadministrative personnel and related expenses, including sales commissions,associated with the growth in net sales and the expansion of our overall levelof business activities. Selling and administrative headcount increased to 2,464employees at September 30, 2003 as compared to 1,366 employees atSeptember 30, 2002.  We increasedour international presence and our higher cost international sales force as ofSeptember 30, 2003, significantly.  Thiscontributed to the increase in selling, general and administrativeexpenses.  Selling, general andadministrative expenses as a percentage of net sales were 10% and 11% for thethree months ended September 30, 2003 and 2002, respectively. The decreasein selling, general and administrative expenses as a percentage of net saleswas mainly due to increasing sales during the three months endedSeptember 30, 2003.  We expect ourselling, general and administrative expenses to increase in absolute dollaramounts and to be approximately 9% to 10% of net sales in 2003.

 

RESEARCH ANDDEVELOPMENT

 

Research and development expenses increased 95% to $44.7 million for thethree months ended September 30, 2003 from $23.0 million for thecorresponding period in 2002. The increase in research and development expenseswas primarily due to the hiring of additional technical personnel, our recentacquisition of CommWorks and increased prototype expenses and licensing fees tosupport our research and development efforts. Research and developmentheadcount increased to 2,215 employees at September 30, 2003 as comparedto 1,228 employees at September 30, 2002. As a percentage of net sales,research and development expenses were 8% and 9% for the three months endedSeptember 30, 2003 and 2002, respectively. We expect our research anddevelopment expenses to increase in absolute dollar amounts in 2003 as weexpand our research and development organization to support new productdevelopment.

 

AMORTIZATIONOF INTANGIBLE ASSETS

 

Amortization of intangible assets was $3.1 million for the threemonths ended September 30, 2003 and $0.6 million for the three monthsended September 30, 2002. The increase in amortization expense was mainlydue to additional amortization of intangibles recorded upon our acquisition ofCommWorks in May 2003. We recorded intangibles of $44.9 million inconnection with our acquisition of CommWorks based on a final purchase priceallocation. The estimated useful lives of these purchased intangibles are fromone to ten years.  Expected amortizationexpense for the next five years, beginning the year ended December 31,2004, is $10.4 million, $7.3 million, $5.8 million, $5.6 million and $4.0million, respectively.

 

INTERESTINCOME (EXPENSE), NET

 

Net interest income (expense) was $(1.0) million for the threemonths ended September 30, 2003 and $1.3 million for thecorresponding period in 2002. The decrease was primarily due to interestexpense and amortization of debt issuance costs relating to $402.5 million ofconvertible subordinated notes that we issued in March 2003.  In addition, there were lower balances incash and cash equivalents on average during the three months endedSeptember 30, 2003 as compared to 2002.

 

OTHER INCOME(EXPENSE), NET

 

Other income(expense), net was $0.7 million for the three months ended September 30,2003 and $(3.3) million for the corresponding period in 2002. The currentquarter’s other income was comprised of a $3.2 million government incentiverelated to UTStarcom operations in Japan, offset by $1.4 million of foreigncurrency transaction losses and expenses of approximately $1.0 millionattributable to settling or transferring notes receivable.  Other income (expense), net for the threemonths ended September 30, 2002 was primarily comprised of investmentimpairment losses of $1.7 million, foreign currency transaction losses of$2.1 million, offset by investment income of $0.7 million.

 

EQUITY IN LOSSOF AFFILIATED COMPANIES

 

Consolidated equity in the net loss of affiliated companies was$1.6 million for the three months ended September 30, 2003 and$0.1 million for the corresponding period in 2002. The equity loss for thethree months ended September 30, 2003 and 2002 was primarily due to ourshare of losses relating to a joint venture agreement we entered into onJuly 5, 2002 with Matsushita Communication Industrial Co., Ltd., andMatsushita Electric Industrial Co., Ltd., to jointly design, develop,manufacture and sell telecommunication products. We have a 49% ownership interestin this joint venture company.

 

INCOME TAXEXPENSE

 

Income tax expense was $19.7 million for the three months endedSeptember 30, 2003 and $7.7 million for the corresponding period in2002. The increase in income tax expense was due to our increasing income andan increase in the effective tax rate. The 

 

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effective taxrate was 25% and 20% for the three months ended September 30, 2003 and2002, respectively. The increase in our effective tax rate was due primarily tothe expiration of certain tax holidays in China and the fact that more of ourrevenue has become subject to higher tax rate jurisdictions as we expand ourbusiness globally. The future rate may vary due to a variety of factors, including,but not limited to, the relevant income contribution by domestic and foreignoperations, changes in statutory tax rates, the amount of tax exempt interestincome generated during the year, the ability to utilize foreign tax creditsand non-deductible items relating to acquisitions, or other non-recurringcharges. We will continue to monitor the effective tax rate on a quarterlybasis.

 

**NINE MONTHS ENDED SEPTEMBER 30, 2003 ANDSEPTEMBER 30, 2002**

 

NET SALES

 

Our net sales increased 94% to $1,320.7 million for the ninemonths ended September 30, 2003 from $680.7 million for thecorresponding period in 2002. Sales of telecommunications equipment for thenine months ended September 30, 2003 were $660.0 million, an increaseof $233.5 million or 55%, as compared to the nine months endedSeptember 30, 2002. Sales of subscriber handsets for the nine months endedSeptember 30, 2003 were $660.7 million, an increase of$406.5 million or 160%, as compared to the nine months endedSeptember 30, 2002. In particular, sales of PAS/iPAS equipment,AN-2000/IP-DSLAM equipment, PAS handsets and other products were $456.4million, $178.5 million, $660.7 million and $25.2 million, respectively, andrepresented 35%, 13%, 50% and 2% of our net sales for the nine months endedSeptember 30, 2003, respectively. Sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment, PAS handsetsand other products were $304.5 million, $117.1 million, $254.3 million and $4.7million, respectively, and represented 45%, 17%, 37% and 1% of our net sales forthe nine months ended September 30, 2002, respectively. Our mSwitchproducts are included with our iPAS product offering. We do not expect thepercentage of revenues attributed to these products to change significantly inthe near future.  In particular, weexpect that 2003 sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment andPAS handsets will represent approximately 35%, 15% and 50% of our net sales,respectively.

 

Sales of iPAS/PAS equipment and sales of subscriber handsets increaseddue to the continued growth in spending on telecommunications infrastructure inChina, which accounted for 85% and 83% of our net sales for the nine monthsended September 30, 2003 and 2002, respectively. Sales oftelecommunications equipment also increased due to a $86.2 millionincrease in international sales, primarily driven by the sale of equipment toSBBC in Japan to support its ADSL rollout. Sales in Japan for the nine monthsended September 30, 2003 and 2002, accounted for 12% and 15% of our net sales,respectively. For the nine months ended September 30, 2003, sales to SBBCaccounted for 11% of our net sales and no other customer accounted for 10% ormore of our consolidated net sales. For the nine months endedSeptember 30, 2002, sales to the Zhejiang province and SBBC accounted for21% and 14% of our net sales, respectively.

 

GROSS PROFIT

 

Gross profit increased 79% to $436.3 million for the nine monthsended September 30, 2003 from $244.4 million for the correspondingperiod in 2002. Gross profit, as a percentage of net sales, was 33% for thenine months ended September 30, 2003 as compared to 36% for the ninemonths ended September 30, 2002. Gross profit, as a percentage of netsales, was impacted by our changing product mix as well as market conditions.  Our higher margin AN-2000/IP-DSLAM equipmentsales were 13% of our net sales for the nine months ended September 30, 2003,as compared to 17% for the nine months ended September 30, 2002.  In addition, our handset sales generallyhave lower margins than our AN 2000/IP-DSLAM sales, and comprised 50% and 37%of our net sales for the nine months ended September 30, 2003 and 2002,respectively.  Market competition andmargin pressure on our sales of AN-2000/IP-DSLAM equipment and on our sales ofPAS/iPAS equipment contributed to the decrease in our gross margin as apercentage of sales for the nine months ended September 30, 2003.

 

SELLING,GENERAL AND ADMINISTRATIVE

 

Selling,general and administrative expenses increased 59% to $129.9 million forthe nine months ended September 30, 2003 from $81.8 million for thecorresponding period in 2002. Selling, general and administrative expenses as apercentage of net sales was 10% and 12% for the nine months endedSeptember 30, 2003 and 2002, respectively. The increase in selling,general and administrative expenses in absolute dollars was primarily due toincreased sales and administrative personnel and related expenses, includingsales commissions, associated with the growth in net sales and the expansion ofour overall level of business activities. Selling and administrative headcountincreased to 2,464 employees at September 30, 2003 as compared to 1,366employees at September 30, 2002. We increased our international presence and our higher costinternational sales force significantly. This contributed to the increase in selling, general, and administrativeexpenses. The decrease in selling, general and administrative expenses as apercentage of net sales was partly attributable to significant cash collectionsin China in respect of previously recorded doubtful accounts.

 

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This had the effect of reducingthe requirement for allowances for doubtful accounts as compared with previousperiods although our net sales and accounts receivable have increasedsubstantially during the nine months ended September 30, 2003. In addition, dueto the SARS outbreak in China, our travel to Asia was curtailed for a number ofmonths, with a resulting reduction in travel expenses. We expect our selling,general and administrative expenses to increase in absolute dollar amounts andto return to our previous percentage of net sales level in 2003 as sales andmarketing activities increase and we incur additional expenses related to theanticipated growth of our business and operations.

 

RESEARCH ANDDEVELOPMENT

 

Research and development expenses increased 69% to $107.6 millionfor the nine months ended September 30, 2003 from $63.5 million forthe corresponding period in 2002. The increase in research and developmentexpenses was primarily due to the hiring of additional technical personnel,increased prototype expenses and licensing fees to support our research anddevelopment efforts. Research and development headcount increased to 2,215 employeesat September 30, 2003 as compared to 1,228 employees at September 30,2002. As a percentage of net sales, research and development expenses were 8%and 9% for the nine months ended September 30, 2003 and 2002,respectively. We expect our research and development expenses to increase inabsolute dollar amounts in 2003 as we expand our research and developmentorganization to support new product development.

 

IN-PROCESSRESEARCH AND DEVELOPMENT COSTS

 

In-processresearch and development expense was $10.8 million for the nine monthsended September 30, 2003, and $0.7 million for the corresponding period in2002. The charge for the nine months ended September 30, 2003 resultedfrom our acquisition of CommWorks, a former division of 3Com, and three smalleracquisitions: RollingStreams, Xebeo and Shanghai Yi Yun Telecom TechnologyCo. Ltd., which accounted for $1.3 million, $6.2 million, $2.0 million and$1.3 million, respectively, and were based on appraisals by an independentvaluation specialist. The charge for the nine months ended September 30,2002 arose from our acquisition of Issanni Communications, Inc. onApril 19, 2002 and was based on an appraisal by an independent valuationspecialist.

 

On May 23, 2003, the Company completed its acquisition from 3ComCorporation, a Delaware corporation, (“3Com”) of selected assets andliabilities from 3Com’s CommWorks division (“CommWorks”).

 

The amount ofthe purchase price allocated to in-process research and development(“IPR&D”) of $1.3 million, based on an appraisal by an independentvaluation specialist, was charged to the Company’s results of operations, as noalternative future uses existed at the acquisition date.

 

In assessingCommWorks’ IPR&D projects, the key characteristics of the products underdevelopment were considered as well as future prospects, the rate at whichtechnology changes in the telecommunications equipment industry, product lifecycles, and the projects’ stages of development.

 

As of the date of the acquisition, CommWorks had two projects underdevelopment that qualified for in-process research and development(“IPR&D”), SLAP and High Density Voice (“HDV”) 2.0.  SLAP is an IPR&D project in the Wirelessdivision of CommWorks.  It is aninterface that connects UTStarcom’s products with radio switch manufacturers’products in China in order to connect a cellular network to the Internet.  HDV 2.0 is an IPR&D project in theWireline product line of CommWorks.  HDV2.0 utilizes software technology to increase data capacity for Voice overInternet Protocol (“VoIP”) solutions.

 

There are significant risks associatedwith those technologies.  Thetechnological risks stem from the fact that the new technologies are in anearly stage of development.  As of theclosing date, CommWorks’ SLAP IPR&D project was approximately 60% completeand HDV 2.0 was approximately 40% complete. Therefore, there are significant risks associated with reaching thetechnological milestones on time and on budget.  Commercial risks are associated with the competitive nature ofthe telecommunications equipment market.

 

Additional costs will be required to complete the IPR&D projects.  The SLAP product is now expected to becommercialized in the first quarter of fiscal 2004. Remaining costs required tocomplete the project, are estimated to be $0.1 million.  The HDV 2.0 product is now expected to becommercialized in the first quarter of fiscal 2004. Remaining costs required tocomplete the project are estimated to be $0.2 million.

 

OnJune 30, 2003, the Company completed the acquisition of RollingStreamsSystems, Ltd. (“RollingStreams”), a development-stage company. RollingStreamsdesigns streaming, end-to-end TV-over-Internet-Protocol (“TVoIP”) solutions fortelecommunications operators and broadband service providers. The amount of thepurchase price allocated to in-process research and development was $6.2million, based on an appraisal by an independent valuation specialist. Thisamount was charged to the Company’s results of operations, as no alternativefuture uses existed at the acquisition date.

 

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As of the dateof the acquisition, the Company had one project under development thatqualified for in-process research and development, MediaSwitch. MediaSwitch isan end-to-end solution designed for telecom operators and broadband serviceproviders to deliver broadcast quality TV and on-demand entertainment servicesover Internet Protocol networks.

 

MediaSwitch is considered an IPR&Dproject because there are significant risks associated with the development ofthis technology.  These risks includetechnological and commercial risks.  Thetechnological risks stem from the fact that the technology is 70%complete.  Therefore, there aresignificant risks associated with reaching the technological milestones on timeand on budget.  Commercial risks areassociated with the lack of market acceptance for the TVoIP concept.

 

In addition tothe technological and commercial risks stated above, significant additionalcosts will be required to complete the IPR&D project.  MediaSwitch is now expected to becommercialized in the second quarter of 2004. Remaining costs required to complete the project are estimated to be$4.5 million. Remaining engineering tasks include the productization of thecomplete solution.  This involves addingnew features and functionalities and stabilizing the software code.

 

On May 7, 2003, the Company completed the purchase of all of theassets of Xebeo Communications, Inc. (“Xebeo”), a development stage company. Xebeodevelops and manufacturers optical packet switches that enabletelecommunications carriers to provide single fiber, multi-service access tocustomers.

 

The amount ofthe purchase price allocated to in-process research and development of$2.0 million, based on an appraisal by an independent valuationspecialist, was charged to the Company’s results of operations, as noalternative future uses existed at the acquisition date.

 

As of the dateof the acquisition, Xebeo was focusing its resources on the development of itsfirst product, MetroBridge, an optical packet switching solution, and wasconsidered in the development stage. The development of MetroBridge was 60%complete as of the closing date.  Thetechnological feasibility of the technology was not established and thetechnology had no future alternative uses, therefore the development ofMetroBridge is considered IPR&D. Significant additional costs are requiredto complete the development of MetroBridge, which is now expected to becommercialized in the fourth quarter of 2004. Remaining costs required tocomplete the project were estimated to be $1.1 million as of September 30,2003.

 

AMORTIZATIONOF INTANGIBLE ASSETS

 

Amortization of intangible assets increased to $5.3 million forthe nine months ended September 30, 2003 from $1.8 million for thecorresponding period in 2002. The increase in amortization of intangible assetswas primarily due to additional intangibles recorded in connection with ouracquisition of CommWorks. The estimated useful lives of these purchasedintangibles are from one to ten years. Expected amortization expense for the next five years, beginning theyear ended December 31, 2004, is $10.4 million, $7.3 million, $5.8million, $5.6 million and $4.0 million, respectively.

 

 

INTERESTINCOME (EXPENSE), NET

 

Net interest income (expense) was $(1.3) million for the ninemonths ended September 30, 2003 and $3.2 million for thecorresponding period in 2002. The decrease was primarily due to interestexpense and amortization of debt issuance costs relating to $402.5 million ofconvertible subordinated notes that we issued in March 2003.  In addition, there were lower balances incash and cash equivalents on average during the nine months endedSeptember 30, 2003 as compared to 2002.

 

OTHER INCOME(EXPENSE), NET

 

Other income (expense), net was $4.1 million for the nine monthsended September 30, 2003 and other income (expense), net was $(4.9)million for the corresponding period in 2002. Other income (expense), net forthe nine months ended September 30, 2003 was primarily comprised of areinvestment incentive payment received in China of $3.9 million, an incentivepayment for exports and value added taxes in China of $2.6 million, agovernment incentive related to UTStarcom’s operations in Japan of $3.2million, offset by foreign exchange losses of $2.9 million relating to foreigncurrency transaction losses and expenses of approximately $1.9 millionattributable to settling or transferring notes receivable.  Other income (expense), net for the threemonths ended September 30, 2002 was primarily related to write-downs oflong-term investments of $2.8 million and foreign exchange losses of $2.3million offset by investment income of $0.7 million.

 

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EQUITY IN LOSSOF AFFILIATED COMPANIES

 

Consolidated equity in net loss of affiliated companies was$4.3 million for the nine months ended September 30, 2003 and$0.9 million for the corresponding period in 2002. The equity loss for thenine months ended September 30, 2003 and 2002 was primarily comprised ofour share of losses relating to a joint venture agreement we entered into onJuly 5, 2002 with Matsushita Communication Industrial Co., Ltd., andMatsushita Electric Industrial Co., Ltd., to jointly design, develop,manufacture and sell telecommunication products. We have a 49% ownershipinterest in this joint venture company.

 

INCOME TAXEXPENSE

 

Income tax expense was $45.3 million for the nine months endedSeptember 30, 2003 and $18.8 million for the corresponding period in2002. The effective tax rate was 25% and 20% for the nine months endedSeptember 30, 2003 and 2002, respectively. The increase in our effectivetax rate was due primarily to the expiration of certain tax holidays in China andthe fact that more of our revenue has become subject to higher tax ratejurisdictions as we expand our business globally. The future rate may vary dueto a variety of factors, including, but not limited to, the relevant incomecontribution by domestic and foreign operations, changes in statutory taxrates, the amount of tax exempt interest income generated during the year, theability to utilize foreign tax credits and non-deductible items relating toacquisitions, or other non-recurring charges. We will continue to monitor theeffective tax rate on a quarterly basis.

 

MINORITYINTEREST IN EARNINGS OF CONSOLIDATED SUBSIDIARIES

 

Minority interest in earnings of consolidated subsidiaries was$0.0 million for the nine months ended September 30, 2003 and $1.2 millionfor the corresponding period in 2002. The decrease is due to the acquisition ofthe remaining 12% ownership interest in HUTS during the nine months endedSeptember 30, 2002. Minority interest in earnings of consolidatedsubsidiaries for the nine months ended September 30, 2003, represented the10% share of earnings of CUTS, our Chongqing manufacturing joint venture,attributable to our joint venture partner. Minority interest in earnings ofconsolidated subsidiaries for the nine months ended September 30, 2002,represented the share of earnings in HUTS, our Zhejiang manufacturing jointventure, attributable to our joint venture partner, prior to our acquisition ofthe remaining 12% ownership interest in HUTS in May 2002. HUTS is now a wholly-ownedsubsidiary.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

AtSeptember 30, 2003, we had lines of credit totaling $547.7 millionavailable for future borrowings, and we had not guaranteed any debt notincluded in the consolidated balance sheet. At September 30, 2003, we hadworking capital of $830.7 million, including $436.1 million in cash and cashequivalents and $5.3 million of short-term investments.

 

Net cashprovided by operations for the nine months ended September 30, 2003 of$2.7 million was primarily due to net income of $135.9 million, adjusted fornon-cash charges including depreciation and amortization expense of $30.3million, in-process research and development costs of $10.8 million,amortization of deferred stock compensation expense of $3.2 million, non-qualifiedstock option exercise tax benefits of $12.6 million and an increase ininventory reserves of $9.7 million, as well as growth in accounts payable of$145.1 million, other accrued liabilities of $71.0 million, and deferredrevenue of $370.7 million and income taxes payable of $11.3 million.  This was offset by an increase ininventories, accounts receivable and other current and non-current assets of$558.5 million, $92.8 million and $153.3 million, respectively.  Net cash provided by operations for the ninemonths ended September 30, 2002 of $136.4 million was primarily dueto net income of $74.0 million, adjusted for depreciation and amortizationexpense of $15.3 million, and increases in inventory reserves of$16.5 million, allowance for doubtful accounts of $6.5 million,accounts payable of $43.0 million, other accrued liabilities of$31.5 million, deferred revenue of $25.0 million and income taxespayable of $5.2 million, and a decrease in accounts receivable of $7.7 million.This was offset by an increase in inventories other current and non-currentassets of $72.3 million and $18.6 million, respectively.

 

Net cash usedin investing activities for the nine months ended September 30, 2003 of$81.3 million was primarily due to business acquisitions of $112.4 million,purchases of property, plant and equipment of $71.4 million of which $21.2million related to our new manufacturing facility in Hangzhou, investment inaffiliates of $0.7 million, issuance of notes receivable of $10.1 million, andpurchase of investments of $64.6 million, offset by sales of investments of$177.9 million.  Net cash used ininvesting activities for the nine months ended September 30, 2002 of$43.8 million was primarily due to purchases of property, plant andequipment of $42.0 million of which $12.1 million related to our newmanufacturing facility in Hangzhou, business acquisitions of $17.7 millionincluding $14.1 million relating to the purchase of the remaining interestin HUTS, $1.5 million net of cash acquired relating to the purchase of theremaining interest in GUTS and $2.1 million relating to the acquisition ofIssanni and investment in affiliates of $11.0 million which comprisedinvestments in private technology companies, offset by net sales of short-terminvestments of $27.0 million.

 

Net cash provided by financing activities for the nine months endedSeptember 30, 2003 of $282.7 million was primarily due to the offering ofconvertible subordinated notes with net proceeds of $391.4 million, proceedsfrom notes payable of $23.4 million and proceeds from the exercise of stockoptions of $51.2 million, offset by a repurchase of Softbank shares for $139.6million and purchases

 

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of call spread for $43.8million.  Net cash used in financingactivities for the nine months ended September 30, 2002 of$106.4 million was primarily due to the repurchase of our stock andrelated transaction costs for $72.9 million and net payments of$70.5 million on borrowings under our lines of credit.  This was offset by $36.9 million inproceeds from the sale of common stock in connection with the Softbank resaleand the issuance of common stock through the exercise of stock options.

 

OnMay 23, 2003, we completed the acquisition from of selected assets andliabilities from 3Com’s CommWorks division. We paid $100 million in cash,related transaction costs of $4.6 million and related transition costs of $4.7million, such consideration was determined through negotiations between theCompany and 3Com.  We funded the consideration for the acquisition fromcash on hand.

 

We completedan offering on March 12, 2003 of $402.5 million of convertiblesubordinated notes due in 2008 to qualified buyers pursuant to Rule 144A underthe Securities Act of 1933. We used $43.8 million of the net proceeds in thesecond quarter to enter into convertible bond hedge and call optiontransactions with respect to our common stock to reduce the potential dilutionfrom conversion of the notes.  We used$139.6 million of the net proceeds in the second quarter to repurchase 8.0million of our shares of common stock beneficially owned by SOFTBANK America,Inc., pursuant to an agreement we entered into on March 7, 2003.

 

In 2001, wepurchased the rights to use 49 acres of land located in Zhejiang Science andTechnology Industry Garden of Hangzhou Hi-tech Industry Development Zone. As ofSeptember 30, 2003, we had completed the foundation and groundwork of afacility to be located there and have commenced construction of the building.We expect that construction of the new facility will be completed in early 2004at a projected cost of approximately $95.6 million. We revised theexpected completion date of that facility from late 2003 to early 2004, due toa slow down in construction during the first quarter of fiscal 2003 resultingfrom the SARS outbreak and inclement weather. Capital expenditures for thefacility were $38.6 million in 2002 and $8.8 million and $21.2million in the three and nine months ended September 30, 2003,respectively.

 

Our principal commitments at September 30, 2003 consisted ofobligations under operating leases and a commitment to invest up to anadditional $3.0 million in one of our investments. We lease certain of ourfacilities under noncancelable operating leases, which expire at various datesthrough 2007. We did not have any borrowings under our lines of credit atSeptember 30, 2003.

 

We accept bank notes receivable and commercial notes receivable fromour customers in China in the normal course of business. We may discount thesenotes with banking institutions in China. A sale of these notes is reflected asa reduction of other current assets and the proceeds of the settlement of thesenotes are included in cash flows from operating activities in the consolidatedstatement of cash flows. Notes receivable sold during the three and nine monthsended September 30, 2003 were $110.8 million and $237.6 million,respectively.

 

We have not engaged in any transactions or arrangements withunconsolidated entities or other persons that are reasonably likely tomaterially affect our liquidity or the availability of, or requirements for,capital resources.

 

Our China sales are generally denominated in local currency. Due to thelimitations on converting Renminbi, we are limited in our ability to engage incurrency hedging activities in China. Sales outside China are generallydenominated in US dollars. We cannot guarantee that fluctuations in currencyexchange rates in the future will not have a material adverse effect onrevenues from international sales and, correspondingly, on our business,financial condition and results of operations. We have contracts negotiated inJapanese Yen and a multi-currency bank account in Japanese Yen for purchasingportions of our inventories and supplies. The balance of this Japanese Yenaccount as of September 30, 2003 was approximately $8.0 million. As ofSeptember 30, 2003 and December 31, 2002, we were not engaged in anyhedging activities and did not hold any derivative financial instruments inrespect of these Japanese Yen purchases.

 

We believe that our existing cash and cash equivalents, short-terminvestments and cash from operations will be sufficient to finance ouroperations through at least the next 12 months. As of September 30,2003, we had cash, restricted cash and investments of $458.8 million and linesof credit totaling $547.7 million available for future borrowings. With respectto these facilities, $71.3 million expire in 2003 and $476.4 million expire between2004 and 2010. However, in the event that our current cash balances,anticipated future cash flows from operations and current lines of credit arenot sufficient to meet our obligations or strategic needs or in the event thatmarket conditions are favorable, we would consider raising additional funds inthe capital or equity markets. If additional financing is needed, there can beno assurance that such financing will be available to us on commerciallyreasonable terms, or at all.

 

**CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIALCOMMITMENTS**

 

Our obligations under contractual obligations and commercialcommitments are primarily with regard to leasing

 

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arrangements,standby letters of credit and convertible subordinated notes and are as follows(in thousands):

 
|                            |   | **September 30,  2003  Payments Due by Period** |    |
|---------------------------------|--------|------------------------------------------------------|---------|
|                            |   | **Total**                                            |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   |
| *Contractual  Obligations*      |   |                                                 |    |   |   |   |   |   |   |
| Notes Payable                   |   | $                                                    | 23,390  |   | $ | 23,390 |   | — |   | — |   |
| Convertible Subordinated  Notes |   | $                                                    | 402,500 |   | $ | — |   | $ | — |   | $ | 402,500 |   |
| Operating leases                |   | $                                                    | 22,954  |   | $ | 9,696 |   | $ | 13,062 |   | $ | 196 |   |
| *Other  Commercial Commitments* |   |                                                 |    |   |   |   |   |   |   |
| Standby letters of credit       |   | $                                                    | 13,838  |   | $ | 11,938 |   | $ | 1,900 |   | $ | — |   |

 

Certain salescontracts include provisions under which customers would be indemnified by usin the event of, among other things, a third-party claim against the customerfor intellectual property rights infringement related to our products. Thereare no limitations on the maximum potential future payments under theseguarantees. We have not accrued any amounts in relation to these provisions asno such claims have been made and we believes we have valid, enforceable rightsto the intellectual property embedded in our products.

 

The Companyissues standby letters of credit primarily to support international salesactivities outside of China. When the Company submits a bid for a sale, oftenthe potential customer will require that the Company issue a bid bond or astandby letter of credit to demonstrate its commitment through the bidprocess.  In addition, the Company may be required to issue standbyletters of credit as guarantees for advance customer payments upon contractsigning or performance guarantees. The standby letters of credit usually expiresix to nine months from date of issuance without being drawn by the beneficiarythereof.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

In November 2002, the Emerging Issues Task Force reached aconsensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”(“EITF No. 00-21”). This issue addresses how revenue arrangements with multipledeliverables should be divided into separate units of accounting and how thearrangement consideration should be allocated to the identified separateaccounting units. EITF No. 00-21 is effective for fiscal periods beginningafter June 15, 2003. Where multiple elements exist in an arrangement, thearrangement fee is allocated to the different elements based upon verifiableobjective evidence of the fair value of the elements. We adopted EITFNo. 00-21 on July 1, 2003, and the adoption did not have asignificant impact on the consolidated results of operations and financialposition.

 

InJanuary 2003, the Financial Accounting Standards Board issuedInterpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN46”). FIN 46 provides accounting guidance for consolidation of variableinterest entities (“VIE”), formerly referred to as special purpose entities.FIN 46 applies to public and private business enterprises that have acontrolling interest or business or contractual relationship with a VIE. FIN 46requires consolidation of existing non-controlled affiliates if the VIE isunable to finance its operations without investor support, or where the other investorsdo not have exposure to the significant risks and rewards of ownership. FIN 46will be effective for the quarter ended December 31, 2003. The adoption of FIN46 is not expected to have a significant impact on the consolidated financialstatements.

 

InApril 2003, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 149 “Amendment of Statement 133 on Derivative Instruments and HedgingActivities” (“SFAS 149”). This statement amends SFAS 133 to provide clarificationon the financial accounting and reporting of derivative instruments and hedgingactivities. The adoption of SFAS 149, which is effective for contracts enteredinto or modified after June 30, 2003, did not have a material effect onthe Company’s consolidated financial condition or results of operations.

 

InMay 2003, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards No. 150, “Accounting for Certain FinancialInstruments with Characteristics of both Liabilities and Equity” (“SFAS 150”).SFAS 150 establishes standards for how an issuer classifies and measurescertain financial instruments with characteristics of both liabilities andequity. It requires that an issuer classify a financial instrument that is withinits scope as a liability (or an asset in some circumstances). Many of theseinstruments were previously classified as equity. The guidance in SFAS 150 isgenerally effective for all financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective at the beginning of thefirst interim period beginning after June 15, 2003. As we do not have anyof these financial instruments, the adoption of SFAS 150 did not have anyimpact on our consolidated financial statements.

 

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**RISKS RELATED TO OUR COMPANY**

 

**Ourfuture product sales are unpredictable, our operating results are likely tofluctuate from quarter to quarter, and if we fail to meet the expectations ofsecurities analysts or investors, our stock price could decline significantly.**

 

Our quarterlyand annual operating results have fluctuated in the past and are likely tofluctuate in the future due to a variety of factors, some of which are outsideof our control. As a result, period-to-period comparisons of our operatingresults are not necessarily meaningful or indicative of future performance.Furthermore, it is likely that in some future quarters our operating resultswill fall below the expectations of securities analysts or investors. If thisoccurs, the trading price of our common stock could decline.

 

Factors thatmay affect our future operating results include:

 

•                  the timing,number and size of orders for our products, as well as the relative mix oforders for each of our products, particularly the volume of lower marginhandsets;

 

•                  cancellation,deferment or delay in implementation of large contracts;

 

•                  the evolving andunpredictable nature of the economic, regulatory, competitive and politicalenvironments in China and other countries in which we market or plan to marketour products;

 

•                  price reductionsby our competitors;

 

•                  competitivemarket pressures resulting in decreased gross margins or increased inventorylevels;

 

•                  changes in ourcustomers’ subscriber growth rate;

 

•                  currencyfluctuations;

 

•                  marketacceptance of our products and product enhancements;

 

•                  the lengthy andunpredictable sales cycles associated with sales of our products combined withthe impact of this variability on our suppliers’ ability to provide us withcomponents on a timely basis;

 

•                  the impact ofchanges in general world and domestic economic conditions in light of themilitary and political situation in Iraq;

 

•                  longercollection periods of accounts receivable in China and other countries; and

 

•                  a seasonalreoccurance of an outbreak of severe acute respiratory syndrome (SARS);

 

•                  the decline inbusiness activity we typically experience during the Lunar New Year, whichleads to decreased sales during our first fiscal quarter.

 

The limited performancehistory of some of our products, our limited forecasting experience andprocesses and the emerging nature of our target markets make forecasting ourfuture sales and operating results difficult. Our expense levels are based, inpart, on our expectations regarding future sales, and these expenses arelargely fixed, particularly in the short term. In addition, to enable us topromptly fill orders, we maintain inventories of finished goods, components andraw materials. As a result, we commit to considerable costs in advance ofanticipated sales. In the past, a substantial portion of our sales in eachquarter resulted from orders received and shipped in that quarter, and we haveoperated with a limited backlog of unfilled orders. Accordingly, we may not beable to reduce our costs in a timely manner to compensate for any unexpectedshortfall between forecasted and actual sales. Any significant shortfall ofsales may require us to maintain higher levels of inventories of finishedgoods, components and raw materials than we require, thereby increasing ourrisk of inventory obsolescence and corresponding inventory write-downs andwrite-offs.

 

**Competitionin our markets may lead to reduced prices, revenues and market share.**

 

We areincreasingly facing intense competition in our target markets, especially fromdomestic companies in China. We believe that our strongest competition in thefuture may come from these companies, many of which operate under lower coststructures and more favorable governmental policies and have much larger salesforces than we do. Furthermore, other companies not presently offeringcompeting products may also enter our target markets, particularly with thereduction of trade restrictions as a result of 

 

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China’s admission to the WorldTrade Organization, or WTO. Many of our competitors have significantly greaterfinancial, technical, product development, sales, marketing and other resourcesthan we do. As a result, our competitors may be able to respond more quickly tonew or emerging technologies and changes in service provider requirements. Ourcompetitors may also be able to devote greater resources than we can to thedevelopment, promotion and sale of new products. These competitors may also beable to offer significant financing arrangements to service providers, in somecases facilitated by government policies, which is a competitive advantage inselling systems to service providers with limited financial and currencyresources. Increased competition is likely to result in price reductions,reduced gross profit as a percentage of net sales and loss of market share, anyone of which could materially harm our business, financial condition andresults of operations.

 

Moreover, currentand potential competitors have established or may establish cooperativerelationships among themselves or with third parties, includingTelecommunications Administrations and other local organizations in China, toincrease the ability of their products to address the needs of prospectivecustomers in our target markets. Accordingly, alliances among competitors orbetween competitors and third parties may emerge and rapidly acquiresignificant market share. To remain competitive, we believe that we must continueto partner with Telecommunications Administrations and other localorganizations in China, maintain a high level of investment in research anddevelopment and in sales and marketing, and manufacture and deliver products toservice providers on a timely basis and without significant defects. If we failto meet any of these objectives, our business, financial condition and resultsof operations could be harmed.

 

Theintroduction of inexpensive wireless telephone service or other competitiveservices in China may also have an adverse impact on sales of our PAS systemsand handsets in China. We may not be able to compete successfully againstcurrent or future competitors, and competitive pressures in the future maymaterially adversely affect our business, financial condition and results ofoperations.

 

**Ourbusiness may suffer if we are unable to collect payments from our customers ona timely basis.**

 

Our customersoften must make a significant commitment of capital to purchase our products.As a result, any downturn in a customer’s business that affects the customer’sability to pay us could harm our financial condition. Moreover, accountsreceivable collection cycles historically tend to be much longer in China thanin other markets. The failure of any of our customers to make timely paymentscould require us to write-off accounts receivable or increase our accountsreceivable reserves, either of which could adversely affect our financialcondition.

 

**Ouracquisition of CommWorks could be difficult to integrate, may disrupt ourbusiness and could harm our operating results.**

 

InMay 2003, we completed our acquisition of certain assets of 3ComCorporation’s CommWorks division (“CommWorks”). However, our management andfinancial controls, personnel, computer systems and other corporate supportsystems may not be adequate to manage the increase in the size and scope of ouroperations as a result of the completed acquisition. In addition, we may not beable to generate revenue from the CommWorks operations consistent withhistorical results. We may not be able to realize the synergies that we expectwill result from the addition of the CommWorks assets to our business. Althoughour acquisition of CommWorks is structured as an acquisition of selected assetsand liabilities, we cannot assure you that we will not assume or become subjectto, as a result of the acquisition, liabilities that have an adverse impact onour financial position or results of operations. We also expect that CommWorkswill need a significant working capital investment from us and/or an availabledebt facility. If additional financing is needed to fund the CommWorksoperations, we cannot assure you that such financing will be available to us oncommercially reasonable terms, or at all.

 

Moreover,based on information provided by 3Com Corporation, CommWorks has experiencedsequentially declining annual revenue for the past several years and hasexperienced substantial operating losses during these periods. There can be noassurance that CommWorks will not continue to do so following its acquisitionby us. Furthermore, historical results of the CommWorks operations may not beindicative of the results to be expected from those operations as they areintegrated into our business.

 

**Ourmarket is subject to rapid technological change, and to compete effectively, wemust continually introduce new products that achieve market acceptance.**

 

The emergingmarket for communications equipment in developing countries is characterized byrapid technological developments, frequent new product introductions andevolving industry and regulatory standards. Our success will depend in largepart on our ability to enhance our network access and switching technologiesand develop and introduce new products and product enhancements that anticipatechanging service provider requirements and technological developments. We mayneed to make substantial capital expenditures and incur significant researchand development costs to develop and introduce new products and enhancements.If we fail to timely develop and introduce new products or enhancements toexisting products that effectively respond to technological change, ourbusiness, financial condition and results of operations could be materiallyadversely affected. From time 

 

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to time, our competitors or wemay announce new products or product enhancements, technologies or servicesthat have the potential to replace or shorten the life cycles of our productsand that may cause customers to defer purchasing our existing products,resulting in inventory obsolescence. Future technological advances in thecommunications industry may diminish or inhibit market acceptance of ourexisting or future products or render our products obsolete.

 

Even if we areable to develop and introduce new products, they may not gain marketacceptance. Market acceptance of our products will depend on various factorsincluding:

 

•                  our ability toobtain necessary approvals from regulatory organizations;

 

•                  the perceivedadvantages of the new products over competing products;

 

•                  our ability toattract customers who have existing relationships with our competitors;

 

•                  product costrelative to performance; and

 

•                  the level ofcustomer service available to support new products.

 

Specifically,sales of PAS, our wireless access system, will depend in part upon consumeracceptance of the mobility limitations of this service relative to otherwireless service systems, such as GSM or CDMA. If our existing or new productsfail to achieve market acceptance for any reason, our business could beseriously harmed.

 

**Ourbusiness will suffer if we are unable to deliver quality products on a timelyand cost effective basis.**

 

Our operatingresults depend on our ability to manufacture products on a timely and costeffective basis. In the past, we have experienced reductions in yields as aresult of various factors, including defects in components and human error inassembly. If we experience deterioration in manufacturing performance or adelay in production of any of our products, we could experience delays inshipments and cancellations of orders. Moreover, networking products frequentlycontain undetected software or hardware defects when first introduced or as newversions are released. In addition, our products are often embedded in ordeployed in conjunction with service providers’ products, which incorporate avariety of components produced by third parties. As a result, when a problemoccurs, it may be difficult to identify the source of the problem. Theseproblems may cause us to incur significant warranty and repair costs, divertthe attention of our engineering personnel from our product development effortsand cause significant customer relation problems or loss of customers, any oneof which could harm our business.

 

We contractwith third parties in China to undertake high volume manufacturing and assemblyof our handsets. In addition, we sometimes use third parties for high volumeassembly of circuit boards. We do not have any long-term contracts with thesethird party manufacturers, and in the event that these manufacturers are unableor unwilling to continue to manufacture our products, we may be unable tosecure alternative manufacturers or could experience delays in qualifying newmanufacturers.

 

**Wedepend on some sole source and other key suppliers for handsets, base stations,components and materials used in our products, and if these suppliers fail toprovide us with adequate supplies of high quality products at competitiveprices, our competitive position, reputation and business could be harmed.**

 

Somecomponents and materials used in our products are purchased from a singlesupplier or a limited group of suppliers. If any supplier is unwilling orunable to provide us with high-quality components and materials in thequantities required and at the costs specified by us, we may not be able tofind alternative sources on favorable terms, in a timely manner, or at all. Ourinability to obtain or to develop alternative sources if and as required couldresult in delays or reductions in manufacturing or product shipments. Moreover,these suppliers may delay product shipments or supply us with inferior qualityproducts. If any of these events occur, our competitive position, reputationand business could suffer.

 

Our ability tosource a sufficient quantity of high-quality components used in our productsmay be limited by China’s import restrictions and duties. We require asignificant number of imported components to manufacture our products in China.Imported electronic components and other imported goods used in the operationof our business are subject to a variety of permit requirements, approvalprocedures, import duties and registration requirements. Non-payment ofrequired import duties could subject us to penalties and fines and couldadversely affect our ability to manufacture and sell our products in China. Inaddition, import duties increase the cost of our products and may make themless competitive.

 

In particular,components of our PAS system include the handset used by subscribers to makeand receive mobile telephone calls and the base station unit. Our inability toobtain a sufficient number of high-quality components and assemblies forhandsets and base 

 

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stations could severely harmour business. From time to time, there has been a worldwide shortage ofhandsets, and there currently exists a shortage of low-priced handsets, whichwe have found to be popular with many consumers in China. We have only usedthird parties to assemble and manufacture handsets in China for us for alimited period of time. These manufacturers may be unable to produce adequatequantities of high-quality handsets to meet the demand of our customers. Inaddition, we may be unable to obtain adequate quantities of base stations andmay be unable to find alternative sources on favorable terms, in a timelymanner, or at all. Our inability to obtain or to develop alternative sources ifand as required could result in delays or reductions in manufacturing orproduct shipments.

 

**Ifwe are unable to expand our direct sales organization in China and indirectdistribution channels elsewhere or successfully manage our expanded salesorganization, our operating results may suffer.**

 

Ourdistribution strategy focuses primarily on developing and expanding our directsales organization in China and our indirect distribution channels outside ofChina. We may not be able to successfully expand our direct sales organizationin China and the cost of any expansion may exceed the revenue generated fromthese efforts. Even if we are successful in expanding our direct salesorganization in China, we may not be able to compete successfully against thesignificantly larger and better-funded sales and marketing operations ofcurrent or potential competitors. In addition, if we fail to developrelationships with significant international resellers or manufacturers’representatives, or if these resellers or representatives are not successful intheir sales or marketing efforts, we may be unsuccessful in our expansionefforts outside China.

 

**Weexpect average selling prices of our products to decrease, which may reduce ourrevenues and our gross margin as a percentage of net sales, and, as a result,we must introduce new products and reduce our costs in order to maintainprofitability.**

 

The averageselling prices for communications access and switching systems and subscriberterminal products, such as handsets, in China have been declining as a resultof a number of factors, including:

 

•                  increasedcompetition;

 

•                  aggressive pricereductions by competitors; and

 

•                  rapidtechnological change.

 

We anticipatethat average selling prices of our products will decrease in the future inresponse to product introductions by us or our competitors or other factors,including price pressures from customers. Therefore, we must continue todevelop and introduce new products and enhancements to existing products thatincorporate features that can be sold at higher average selling prices. Failureto do so could cause our revenues and gross profit, as a percentage of netsales, to decline.

 

Our costreduction efforts may not allow us to keep pace with competitive pricingpressures or lead to improved gross profit, as a percentage of net sales. Inorder to be competitive, we must continually reduce the cost of manufacturingour products through design and engineering changes. We may not be successfulin these efforts or in delivering our products to market in a timely manner. Inaddition, any redesign may not result in sufficient cost reductions to allow usto reduce the prices of our products to remain competitive or to improve ormaintain our gross profit, as a percentage of net sales.

 

**Shiftsin our product mix may result in declines in gross profit, as a percentage ofnet sales.**

 

Our grossprofit, as a percentage of net sales, varies among our product groups. Weanticipate that the gross profit, as a percentage of net sales, may be lowerfor our newly developed products due to start-up costs and may improve as unitvolumes increase and efficiencies can be realized. Our overall gross profit, asa percentage of net sales, has fluctuated from period to period as a result ofshifts in product mix, the introduction of new products, decreases in averageselling prices for older products and our ability to reduce manufacturingcosts.

 

**Serviceproviders sometimes evaluate our products for long and unpredictable periods,which causes the timing of purchases and our results of operations to beunpredictable.**

 

The period oftime between our initial contact with a service provider and the receipt of anactual purchase order may span a year or more. During this time, serviceproviders may subject our products to an extensive and lengthy evaluationprocess before making a purchase. The length of these qualification processesmay vary substantially by product and service provider, making our results ofoperations unpredictable. We may incur substantial sales and marketing expensesand expend significant management effort during this process, which ultimatelymay not result in a sale. These qualification processes often make it difficultto obtain new customers, 

 

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as service providers arereluctant to expend the resources necessary to qualify a new supplier if theyhave one or more existing qualified sources.

 

**Ourmulti-national operations subject us to various economic, political, regulatoryand legal risks.**

 

We market andsell our products in China and other markets, including Taiwan, Japan, Vietnam,India, Africa, Europe and Latin America. The expansion of our existingmulti-national operations and entry into additional international markets willrequire significant management attention and financial resources.Multi-national operations are subject to inherent risks, including:

 

•                  difficulties indesigning products that are compatible with varying internationalcommunications standards;

 

•                  longer accountsreceivable collection periods and greater difficulty in accounts receivablecollection;

 

•                  unexpectedchanges in regulatory requirements or the regulatory environment;

 

•                  changes ingovernmental control or influence over our customers;

 

•                  changes to importand export regulations, including quotas, tariffs and other trade barriers;

 

•                  delays ordifficulties in obtaining export and import licenses;

 

•                  potentialforeign exchange controls and repatriation controls on foreign earnings;

 

•                  exchange ratefluctuations and currency conversion restrictions;

 

•                  the burdens ofcomplying with a variety of foreign laws and regulations;

 

•                  difficulties andcosts of staffing and managing multi-national operations, including but notlimited to internal control and compliance;

 

•                  reducedprotection for intellectual property rights in some countries;

 

•                  potentiallyadverse tax consequences; and

 

•                  political andeconomic instability.

 

Multi-nationalcompanies are required to establish intercompany pricing for transactions betweentheir separate legal entities operating in different taxing jurisdictions.These intercompany transactions are subject to audit by taxing authorities inthe jurisdictions in which multi-national companies operate. An additional taxliability may be incurred if it is determined that intercompany pricing was notdone at arm’s length. We believe we have adequately estimated and recorded ourliability arising from intercompany pricing, but an additional tax liabilitymay result from audits of our intercompany pricing policies.

 

In marketsoutside of China, we rely on a number of original equipment manufacturers, orOEMs, and third-party distributors and agents to market and sell our networkaccess products. If these OEMs, distributors or agents fail to provide thesupport and effort necessary to service developing markets effectively, ourability to maintain or expand our operations outside of China will benegatively impacted. We may not successfully compete in these markets, ourproducts may not be accepted and we may not successfully overcome the risksassociated with international operations.

 

Moreover, inless developed markets we may face additional risks, such as inconsistentinfrastructure support, unstable political and economic environments, and lackof a secure environment for our personnel, facilities and equipment. We have inthe past experienced cases of vandalism and armed theft of our equipment thathad been or was being installed in the field. If disruptions for any of thesereasons become too severe in any particular market, it may become necessary forus to terminate contracts and withdraw from that market and suffer theassociated costs and lost revenue.

 

Due to themulti-national nature of our business and operations, we are subject to regulationin multiple governmental jurisdictions. Furthermore, as a result of the heavilyregulated nature of the markets in which we operate, we are continually subjectto the risk of governmental investigations regarding our compliance with therules and regulations of such jurisdictions. Should we become subject to anysuch investigations, there may be significant and unanticipated expenses, andrisks such as the distraction of our 

 

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key employees and disruptionsto our operations. Such expenses and risks may result even in the event thatsuch investigations are decided in our favor and no instances of non-complianceare found.

 

**Weare subject to risks relating to currency exchange rate fluctuations.**

 

We are exposedto foreign exchange rate risk because our sales to China are denominated inRenminbi and portions of our accounts payable and our notes receivable aredenominated in Japanese Yen. Due to the limitations on converting Renminbi, weare limited in our ability to engage in currency hedging activities in China.Although the impact of currency fluctuations of Renminbi to date has beeninsignificant, fluctuations in currency exchange rates in the future may have amaterial adverse effect on our results of operations.

 

**Ourfailure to meet international and governmental product standards could bedetrimental to our business.**

 

Many of ourproducts are required to comply with numerous government regulations andstandards, which vary by market. As standards for products continue to evolve,we will need to modify our products or develop and support new versions of ourproducts to meet emerging industry standards, comply with governmentregulations and satisfy the requirements necessary to obtain approvals. Our inabilityto obtain regulatory approval and meet established standards could delay orprevent our entrance into or force our departure from particular markets.

 

**Ourrecent growth has strained our resources, and if we are unable to manage andsustain our growth, our operating results will be negatively affected.**

 

We haverecently experienced a period of rapid growth and anticipate that we mustcontinue to expand our operations to address potential market opportunities. Ifwe fail to implement or improve systems or controls or to manage any futuregrowth and expansion effectively, our business could suffer.

 

Our expansionhas placed and will continue to place a significant strain on our management,operational, financial and other resources. To manage our growth effectively,we will need to take various actions, including:

 

•                  enhancingmanagement information systems and forecasting procedures;

 

•                  furtherdeveloping our operating, administrative, financial and accounting systems andcontrols;

 

•                  maintainingclose coordination among our engineering, accounting, finance, marketing, salesand operations organizations;

 

•                  expanding,training and managing our employee base; and

 

•                  expanding ourfinance, administrative and operations staff.

 

**Wemay not be able to sustain profitability.**

 

We may not beable to remain profitable in future periods. We anticipate continuing to incursignificant sales and marketing, research and development and general andadministrative expenses and, as a result, we will need to generate higherrevenues to remain profitable. Numerous factors could negatively impact ourresults of operations, including a decrease in sales, price pressures andsignificant fixed costs. Our past results should not be relied on as anindication of our future performance.

 

**Oursuccess is dependent on continuing to hire and retain qualified personnel, andif we are not successful in attracting and retaining these personnel, ourbusiness would be harmed.**

 

The success ofour business depends in significant part upon the continued contributions ofkey technical and senior management personnel, many of whom would be difficultto replace. In particular, our success depends in large part on the knowledge,expertise and services of Hong Liang Lu, our Chairman of the Board, Presidentand Chief Executive Officer, and Ying Wu, our Executive Vice President andChief Executive Officer of China Operations. The loss of any key employee, thefailure of any key employee to perform satisfactorily in his or her currentposition or our failure to attract and retain other key technical and seniormanagement employees could have a significant negative impact on ouroperations.

 

To effectivelymanage our recent growth as well as any future growth, we will need to recruit,train, assimilate, motivate and retain qualified employees. Competition forqualified employees is intense, and the process of recruiting personnel withthe combination of skills and attributes required to execute our businessstrategy can be difficult, time-consuming and expensive. We are 

 

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actively searching for researchand development engineers and sales and marketing personnel, who are in shortsupply. Additionally, we have a need for and have experienced difficulty in findingqualified accounting personnel knowledgeable in U.S. and China accountingstandards who are resident in China. If we fail to attract, hire, assimilate orretain qualified personnel, our business would be harmed.

 

Competitorsand others have in the past and may in the future attempt to recruit ouremployees. In addition, companies in the telecommunications industry whoseemployees accept positions with competitors frequently claim that thecompetitors have engaged in unfair hiring practices. We may be the subject ofthese types of claims in the future as we seek to hire qualified personnel.Some of these claims may result in material litigation and disruption to ouroperations. We could incur substantial costs in defending ourselves againstthese claims, regardless of their merit.

 

**Anyacquisitions that we undertake could be difficult to integrate, disrupt ourbusiness, dilute our stockholders and harm our operating results.**

 

We may acquireother businesses, products and technologies. For example, on May 23, 2003,we purchased certain assets and liabilities of the CommWorks division of 3ComCorporation for $100.0 million in cash and incurred related transactionand other related costs of $9.3 million. In addition, during 2002 we acquired Issanni, a remote access server andlocal access technology company and assets and intellectual property ofShanghai Yi Yun, a provider of synchronous digital hierarchy transmissionequipment. Any anticipated benefits of an acquisition may not be realized. Wehave in the past and will continue to evaluate acquisition prospects that wouldcomplement our existing product offerings, augment our market coverage, enhanceour technological capabilities, or that may otherwise offer growthopportunities. Acquisitions may result in dilutive issuances of equitysecurities, use of our cash resources, the incurrence of debt and theamortization of expenses related to intangible assets. In addition,acquisitions involve numerous risks, including difficulties in the assimilationof operations, technologies, products and personnel of the acquired company,diversion of management’s attention from other business concerns, risks ofentering markets in which we have no direct or limited prior experience, andthe potential loss of key employees of the acquired company.

 

**Wemay be unable to adequately protect the loss or misappropriation of ourintellectual property, which could substantially harm our business.**

 

We rely on acombination of patents, copyrights, trademarks, trade secret laws and contractualobligations to protect our technology. We have applied for patents in theUnited States and have also acquired United States patents and pendingapplications as a result of our purchase of CommWorks on May 23, 2003.  At present, we possess 74 issued UnitedStates patents, and have 114 pending United States patent applications. We havealso filed patent applications in other countries. Additional patents may notbe issued from our pending patent applications and our issued patents may notbe upheld. In addition, we have, from time to time, chosen to abandonpreviously filed applications. Moreover, we have not yet obtained, and may notbe able to obtain, patents in China on our products or the technology that weuse to manufacture our products.  Moreover,we may face difficulties in registering our existing trademarks in newjurisdictions in which we operate.  Oursubsidiaries and joint ventures in China rely upon our trademarks, technologyand know-how to manufacture and sell our products. We cannot guarantee thatthese and other intellectual property protection measures will be sufficient toprevent misappropriation of our technology or trademarks or that ourcompetitors will not independently develop technologies that are substantiallyequivalent or superior to ours. In addition, the legal systems of many foreigncountries, including China, do not protect or honor intellectual propertyrights to the same extent as the legal system of the United States.

 

**Wemay be subject to claims that we infringe the intellectual property of others,which could substantially harm our business.**

 

The industryin which we compete is moving towards aggressive assertion, licensing, andlitigation of patents and other intellectual property rights. From time totime, we have become aware of the possibility or have been notified that we maybe infringing certain patents or other intellectual property rights of others.Regardless of their merit, responding to such claims could be time consuming,divert management’s attention and resources and cause us to incur significantexpenses. In addition, although some of our supplier contracts provide forindemnification from the supplier with respect to losses or expenses incurredin connection with any infringement claim, some of our contracts do not providefor such protection. Moreover, certain of our sales contracts provide that wemust indemnify our customers against claims by third parties for intellectualproperty rights infringement related to our products.  There are no limitations on the maximum potential future paymentsunder these guarantees. Therefore, we may incur substantial costs related toany infringement claim, which may substantially harm our results of operationsor financial condition.

 

We may, in thefuture, become subject to litigation to defend against claimed infringements ofthe rights of others or to determine the scope and validity of the proprietaryrights of others. Future litigation may also be necessary to enforce andprotect our trade secrets and other intellectual property rights. Anyintellectual property litigation or threatened intellectual property litigationcould be costly, and adverse determinations or settlements could result in theloss of our proprietary rights, subject us to significant liabilities, requireus to seek licenses from or pay royalties to third parties which may not beavailable on commercially reasonable terms, if at all, and/or prevent us frommanufacturing or selling our products, which could cause disruptions to ouroperations or the markets in which we compete.

 

In the eventthat there is a successful claim of infringement against us and we fail todevelop non-infringing technology or license the propriety rights oncommercially reasonable terms and conditions, our business, results ofoperations or financial condition could 

 

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be materially and adverselyimpacted.

 

**Businessinterruptions could adversely affect our business.**

 

Our operationsare vulnerable to interruption by fire, earthquake, power loss,telecommunications failure and other events beyond our control. We do not havea detailed disaster recovery plan. Our headquarters facility in the State ofCalifornia was subject to electrical blackouts as a consequence of a shortageof available electrical power. In the event these blackouts resume, they coulddisrupt the operations at our headquarters. In addition, we do not carrysufficient business interruption insurance to compensate us for losses that mayoccur and any losses or damages incurred by us could have a material adverseeffect on our business.

 

**Weare exposed to fluctuations in the values of our portfolio investments.**

 

We maintain aninvestment portfolio of various holdings, types, and maturities. Part of thisportfolio includes equity investments in publicly traded companies, the valueof which are subject to market price volatility. Recent events have adverselyaffected the public equities market and general economic conditions maycontinue to worsen. Should the fair value of our publicly traded equityinvestments decline below their cost basis in a manner deemed to beother-than-temporary, it may become necessary for us to take an impairmentcharge.

 

We have alsoinvested in several privately held companies as well as investment funds whichinvest primarily in privately held companies, many of which can still beconsidered to be in the start-up or development stages. These investments areinherently risky, as the market for the technologies or products they have underdevelopment are typically in the early stages and may never materialize. Wecould lose our entire initial investment in these companies and investmentfunds.

 

**Ifwe seek to secure additional financing we may not be able to do so. If we areable to secure additional financing our stockholders may experience dilution oftheir ownership interest or we may be subject to limitations on our operations.**

 

We currentlyanticipate that our available cash resources, which include existing cash andcash equivalents, short-term investments and cash from operations, will besufficient to meet our anticipated needs for working capital and capitalexpenditure during the next 12 months. If we are unable to generatesufficient cash flows from operations to meet our anticipated needs for workingcapital and capital expenditures, we may need to raise additional funds todevelop new or enhanced products, respond to competitive pressures, takeadvantage of acquisition opportunities or raise capital for strategic purposes.If we raise additional funds through the issuance of equity securities, ourstockholders may experience dilution of their ownership interest, and the newlyissued securities may have rights superior to those of common stock. If weraise additional funds by issuing debt, we may be subject to limitations on ouroperations.

 

**Wehave been named as a defendant in securities litigation.**

 

We, andvarious underwriters for our initial public offering are defendants in aputative shareholder class action. The complaint alleges undisclosed improperunderwriting practices concerning the allocation of IPO shares, in violation ofthe federal securities laws. Similar complaints have been filed concerning theIPOs of more than 300 companies, and the litigation has been coordinated inUnited States District Court for the Southern District of New York as *In re Initial Public Offering Securities Litigation*,21 MC 92. Although we believe we have meritorious defenses to the claimsagainst us and intend to defend the litigation vigorously, until the matter isresolved, it will be necessary for us to continue to expend time and financialresources on the matter.  Morevoer, anadverse  judgment in the litigationcould materially harm our operations.

 

**RISKS RELATING TO THE STRUCTURE AND REGULATIONOFCHINA’S TELECOMMUNICATIONS INDUSTRY**

 

**China’stelecommunications industry is subject to extensive government regulation.**

 

China’stelecommunications industry is heavily regulated by the Ministry of InformationIndustry. The Ministry of Information Industry has broad discretion andauthority to regulate all aspects of the telecommunications and informationtechnology industry in China, including managing spectrum bandwidths, settingnetwork equipment specifications and standards and drafting laws andregulations related to the electronics and telecommunications industries.Additionally, the Ministry of Information Industry can unilaterally, or inconcert with other relevant authorities, decide what types of equipment may beconnected to the national telecommunications networks, the forms and types ofservices that may be offered to the public, the rates that are charged tosubscribers for those services and the content of material available in Chinaover the Internet. If the Ministry of Information Industry sets standards withwhich we are unable to comply or which render our products noncompetitive, ourability to sell products in China may be limited, resulting in substantial harmto our operations.

 

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At the end ofMay 2000, we became aware of an internal notice, circulated within theMinistry of Information Industry, announcing a review of PHS-basedtelecommunications equipment for future installation into China’stelecommunications infrastructure. The Ministry of Information Industryrequested service providers to temporarily halt new deployments of PHS-basedtelecommunications equipment, including our PAS systems and handsets, pendingconclusion of a review by the Ministry of Information Industry. Subsequently,at the end of June 2000, the Ministry of Information Industry issued anotice stating that it had concluded its review of PHS-based equipment and thatthe continued deployment of PHS-based systems, such as our PAS systems andhandsets, in China’s county-level cities, towns and villages would bepermitted. In addition, the notice stated that deployments within large andmedium-sized cities would only be allowed in very limited areas of densepopulation, such as campuses, commercial buildings and special developmentzones. The notice confirmed, however, that new citywide deployments of our PASsystem in large and medium cities would not be permitted. Failure of theMinistry of Information Industry to permit the sale or deployment of our PAS systemsand handsets, or the sale or deployment of our other products, or theimposition of additional limitations on their sale in the future could have amaterial adverse effect on our business and financial condition. The Ministryof Information Industry may conduct further reviews or evaluations of PHS-basedtelecommunications equipment or may change its position regarding PHS-basedsystems in the future.

 

**China’stelecommunications regulatory framework is in the process of being developed,which has led to uncertainties regarding how to conduct our business in China.**

 

China does notyet have a national telecommunications law. However, to provide a uniformregulatory framework for the telecommunications industry, the Chinesegovernment is currently preparing a draft of such a law (the“Telecommunications Law”). If and when the Telecommunications Law is adopted bythe National People’s Congress or its standing committee, it is expected toprovide a new regulatory framework for telecommunications regulation in China.We do not yet know the final nature or scope of the regulation that would becreated if the Telecommunications Law is passed. Accordingly, we cannot predictwhether it will have a positive or negative effect on us or on some or allaspects of our business.

 

China’stelecommunications regulatory framework is in the process of being developed.In September 2000, China’s State Council issued the TelecommunicationsRegulations of the People’s Republic of China, known as the TelecomRegulations. The Telecom Regulations cover telecommunications services andmarket regulations, pricing, interconnection and connection, as well astelecommunications construction and security issues. In May 2001, China’sMinistry of Information Industry issued the Administrative Measures of NetworkAccess Licenses to implement the Telecom Regulations. Regulations in this areaoften require subjective interpretation and, given the relative infancy of theTelecom Regulations and the implementing regulations, we do not know how theregulations will be interpreted or enforced. As a result, our attempts tocomply with these regulations may be deemed insufficient by the appropriateregulatory agencies, which could subject us to penalties that adversely affectour business.

 

**Ourbusiness may be disrupted if our major customers or entities that control themsignificantly restructure their operations or if China further restructures itstelecommunications industry.**

 

Our businessmay be disrupted if any of our major customers or entities that control themrestructure their operations or if China undertakes to restructure itstelecommunications industry.  Forexample, in February 1999, China announced plans to restructure the ChinaTelecom system.  Following theannouncement of the restructuring, we observed a reduction in orders from ourmain customers in China, the local telecommunications companies, which weattributed to the uncertainties surrounding the restructuring and the ultimateimpact the restructuring would have on those customers.  More recently, it has been reported thatChina Netcom has been restructuring its operations for its initial publicoffering, and this restructuring could impact our ability to do business withlocal telephone companies that are within China Netcom’s zone ofinfluence.  If China undertakes torestructure its telecommunications industry further, or if any of our majorcustomers in China, or entities that control those customers, significantlyrestructure their operations, our business could again be disrupted and ouroperating results could fluctuate.

 

**Wedo not have some of the licenses we are required to have to sell our networkaccess products in China.**

 

Under China’scurrent regulatory structure, the communications products that we offer inChina must meet government and industry standards, and a network access licensefor the equipment must be obtained. Without the license, the equipment is not 

 

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allowed to be connected topublic telecommunications networks or sold in China. Moreover, we must ensurethat the quality of the telecommunications equipment for which we have obtaineda network access license is stable and reliable, and may not lower the qualityor performance of other installed licensed products. China’s State Council’sproduct quality supervision department, in concert with China’s Ministry ofInformation Industry, performs spot checks to track and supervise the qualityof licensed telecommunications equipment and publishes the results of such spotchecks.

 

Theregulations implementing these requirements are not very detailed, have notbeen applied by a court and may be interpreted and enforced by regulatoryauthorities in a number of different ways. We have obtained the requirednetwork access licenses for our AN-2000B platform. We have also obtained aprobationary network access license for our mSwitch product, and after thetrial period, an official network access license will be issued if the trialdemonstrates that mSwitch satisfies all the applicable government and industrystandards. We have applied for, but have not yet received, a network accesslicense for our PAS systems and handsets. Based upon conversations with China’sMinistry of Information Industry, we understand that our PAS systems andhandsets are considered to still be in the trial period and that sales of ourPAS systems and handsets may continue to be made by us during this trialperiod, but a license will ultimately be required. Network access licenses willalso be required for most additional products that we are selling or may sellin China, including our mSwitch platform. If we fail to obtain the requiredlicenses, we could be prohibited from making further sales of the unlicensedproducts, including our PAS systems and handsets, in China, which wouldsubstantially harm our business, financial condition and results of operations.Our counsel in China has advised us that China’s governmental authorities mayinterpret or apply the regulations with respect to which licenses are requiredand the ability to sell a product while a product is in the trial period in amanner that is inconsistent with the information received by our counsel inChina, and either of these conditions could have a material adverse effect onour business, financial condition and results of operations.

 

**Weare required to register the software incorporated in our products inaccordance with relevant Chinese regulations.**

 

InOctober 2000, the Ministry of Information Industry issued regulationswhich prohibit the production and sale of software products, or productsincorporating software, in China unless the software is registered with thegovernment. We have accomplished the necessary registration with regard to thesoftware incorporated in our AN-2000, PAS and mSwitch products. However,additional registration is required for software incorporated in additionalproducts that we are selling or may sell in China. Based upon advice receivedorally from the Ministry of Information Industry, we believe that we will beable to sell products incorporating our software while any of our applicationsfor registration may be pending. However, the Chinese government may interpretor apply the regulations in such a way as to prohibit sales of productsincorporating our unregistered software prior to registration. If thegovernment prohibits sales pending registration, or if we fail in our effortsto register any software required to be registered, we could be prohibited frommaking further sales of products incorporating our unregistered software inChina, which could substantially harm our business and financial condition.

 

**Mostof our customers in China have historically been part of the China Telecomsystem and under China Telecom’s ultimate control; following the restructuringof China Telecom, most of our customers in China are now part of the new ChinaTelecom or China Netcom, and are subject to their ultimate control.**

 

Our maincustomers in China are the local telecommunications companies (formerly knownas telecommunications bureaus), which historically operated under ChinaTelecom, China’s state-owned fixed line operator, and were subject to itsultimate control. Following the restructuring of China Telecom, thetelecommunications companies now operate under the ultimate control of eitherthe new China Telecom or China Netcom. China Telecom completed its initialpublic offering in November 2002, and is listed on the New York StockExchange, and China Netcom is reported to be under reorganization and preparingfor an initial public offering.  Wecannot be certain of the impact of these transactions on our ability to dobusiness with these companies or the companies that they control. Policystatements may be issued and decisions may be made by the new China Telecom andChina Netcom, which govern the equipment purchasing decisions of most of ourcustomers in China. For example, in late 1999, China Telecom prohibited alltelecommunications companies from purchasing PHS systems, such as our PASsystems, for implementation in large cities, even before these sales wereprohibited by China’s Ministry of Information. Moreover, it has been reportedthat additional local telecommunications companies have recently becomeaffiliated with China Telecom, which could impact our ability to do businesswith these companies. As most of our sales are generated from our operations inChina, any decisions by the new China Telecom or China Netcom restricting orprohibiting the sales or deployment of our products could cause significant harmto our business.

 

**Ourcustomer base in China could effectively become increasingly concentrated ifmore purchasing decisions are coordinated or made by provincial or greaterregional telecommunications service entities rather than by localtelecommunications service providers.**

 

We havehistorically considered local telecommunications service providers servingmunicipalities and counties to be our primary customers in China. Recently,however, the provincial-level telecommunications service entity in the Zhejiangprovince of China has begun to consolidate telecommunications purchasingdecisions for that province. As a result of this trend in the Zhejiangprovince, we have grouped all telecommunications service entities in theZhejiang province together and have treated these as one customer for the threeand nine months ended September 30, 2003 and the comparative periodspresented. At September 30, 2003, we had approximately 12telecommunications service entities in the Zhejiang province. For the threemonths ended September 30, 2003, no customers accounted for 10% or more ofconsolidated net sales. For the three months ended September 30, 2002,sales to the Zhejiang province, SBBC and Kunming PTB and accounted for 16%, 15%and 11% of net sales, respectively. For the nine months ended

 

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September 30, 2003, salesto SBBC accounted for 11% of our net sales and no other customer accounted for10% or more of our consolidated net sales. For the nine months ended September 30,2002, sales to the Zhejiang province and SBBC accounted for 21% and 14% of ournet sales, respectively.

 

Whether thisrepresents the beginning of a greater trend throughout China toward increasedconsolidation of negotiations and purchasing decisions into the control ofprovincial-level telecommunications service entities is unclear. If anincreasing number of purchasing decisions and negotiations are controlled on alarger regional level in China by provincial-level telecommunications serviceentities, this would effectively result in a concentration of our customerbase. Our financial results may increasingly depend in significant part uponthe success of a few major customers and our ability to meet their futurecapital equipment needs. Although the composition of the group comprising ourlargest customers may vary from period to period, the loss of a significantcustomer or any reduction in orders by any significant customer, includingreductions due to market, economic or competitive conditions in thetelecommunications industry, may have a material adverse effect on ourbusiness, financial condition and results of operations. In addition to thebusiness risks associated with dependence on major customers, significantcustomer concentration may also result in significant concentrations ofaccounts receivable. Significant and concentrated receivables would expose usto additional risks, including the risk of default by one or more customersrepresenting a significant portion of our total receivables. If we are requiredto take additional accounts receivable reserves, our business, financialcondition and results of operations would be materially adversely affected.

 

**Ourability to sell our PAS wireless systems and handsets could be significantlyimpaired if the new China Telecom or China Netcom are granted, or if theyotherwise acquire, mobile licenses allowing the new China Telecom or ChinaNetcom to deliver cellular services.**

 

The new ChinaTelecom and China Netcom hold and operate the fixed line telephone and datacommunications assets in China, and currently do not have the licensesnecessary to offer cellular services. To offer wireless services to end users,the Telecommunications Companies must offer services that can be delivered overwireline networks, such as those delivered over our PAS wireless systems andhandsets. China’s media sources have widely reported that after therestructuring of China Telecom, China’s Ministry of Information Industry maygrant mobile licenses to the new China Telecom or China Netcom, or to both. IfChina’s Ministry of Information Industry does grant a mobile license to the newChina Telecom or China Netcom, or to both, or if such entities otherwiseacquire mobile licenses, local Telecommunications Companies will be free tooffer cellular services such as GSM or CDMA to their customers, and they maytherefore elect not to deploy our PAS systems and handsets. If this were tooccur, we could lose current and potential customers for our PAS systems andhandsets, and our financial condition and results of operations could bematerially adversely affected.

 

**Changesin telecommunications rates or pricing policies may result in decreased demandfor our products.**

 

InNovember 2000, China’s Ministry of Information Industry announcedsignificant changes in rates for telecommunications services in China. Whilelong distance, international, leased line and Internet connection fees were cutby up to 70%, the rates for local telephone services, which include certaintypes of wireless access services such as those offered over our PAS systemsand handsets, were increased, from approximately $0.01 per minute toapproximately $0.02 per minute. The increase in rates may result in a reduceddemand by end users for wireless services delivered over our PAS system and acorresponding decline in demand for our products. In addition, mobile operatorsare offering price incentive plans that could impact demand for our products.Additionally, China’s Ministry of Information Industry may implement futurerate changes for wireline or wireless services in China or changetelecommunications pricing policies, including allowing carriers to set pricesbased on market conditions, any of which may lead to reduced demand for oursystems and products and result in a material adverse effect on our business orresults of operations.

 

**Promotionalor incentive programs offered by mobile operators such as China Mobile andChina Unicom may adversely impact the competitiveness and pricing of our PASSystems and related products.**

 

The officialtariffs and per-minute usage rates charged to mobile users in China aregenerally set by the Ministry of Information Industry and the NationalDevelopment and Reform Commission, and are usually adhered to by mobile operators.However, from time to time, certain mobile operators such as China Mobile andChina Unicom have offered special promotional pricing or incentives tocustomers, such as free incoming calls or free mobile-to-mobile calls. Thecontinued use of such incentive programs by mobile operators may adverselyimpact the competitiveness and pricing of our PAS Systems and related productsand their rollout by the new China Telecom and China Netcom. Such incentiveprograms may continue or be expanded in the future. We cannot be certain as towhat impact such incentive programs may have on our financial condition.However, it is possible that the continuation or expansion of such programs mayhave a material adverse effect on our business or results of operations.

 

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**RISKS RELATING TO CONDUCTING OPERATIONS INCHINA**

 

**Salesin China have accounted for most of our total sales, and therefore, ourbusiness, financial condition and results of operations are to a significant degreesubject to economic, political and social events in China.**

 

Approximately$518.2 million, or 89% and $218.2 million or 82%, of our net sales inthe three months ending September 30, 2003 and 2002, respectively, andapproximately $1,119.7 million, or 85% and $567.9 million or 83%, of ournet sales in the nine months ending September 30, 2003 and 2002,respectively, occurred in China. Additionally, a substantial portion of ourfixed assets is located in China. Of our total fixed assets, approximately 79%and 88%, as of September 30, 2003 and December 31, 2002,respectively, were in China. We expect to make further investments in China inthe future. Therefore, our business, financial condition and results ofoperations are to a significant degree subject to economic, political, socialand other events in China.

 

**Devaluationof the Renminbi versus the U.S. dollar and fluctuations in exchange rates couldadversely affect our financial results.**

 

Exchange ratefluctuations could have a substantial negative impact on our financialcondition and results of operations. We purchase substantially all of ourmaterials in the United States and Japan and a significant portion of our costof goods sold is incurred in U.S. dollars and Japanese yen. A significant portionof our operating expenses is incurred in U.S. dollars. At the same time, mostof our sales are denominated in Renminbi. The value of the Renminbi is fixed byChina’s national government and is subject to changes in China’s governmentalpolicies and to international economic and political developments. China maychoose to devalue the Renminbi against the U.S. dollar. Additionally, China’sgovernment has considered from time to time whether to partially or fullyabandon the official exchange rate for Renminbi to the U.S. dollar. Theabandonment of this official exchange rate policy may lead to sharpdepreciation of the Renminbi against the U.S. dollar and other foreigncurrencies and to significantly more volatility in the Renminbi exchange ratein the future, both of which would adversely affect our financial results andmake our future results more subject to fluctuation.

 

In the past,financial markets in many Asian countries have experienced severe volatilityand, as a result, some Asian currencies have experienced significantdevaluation from time to time. The devaluation of some Asian currencies mayhave the effect of rendering exports from China more expensive and lesscompetitive and therefore place pressure on China’s government to devalue theRenminbi. Any devaluation of the Renminbi could result in an increase involatility of Asian currency and capital markets. Future volatility of Asianfinancial markets could have an adverse impact on our ability to expand ourproduct sales into Asian markets outside of China. Moreover, due to thelimitations on the convertibility of Renminbi, we are limited in our ability toengage in currency hedging activities in China and do not currently engage incurrency hedging activities with respect to international sales outside ofChina.

 

**Currencyrestrictions in China may limit the ability of our subsidiaries and jointventures in China to obtain and remit foreign currency necessary for thepurchase of imported components and may limit our ability to obtain and remitforeign currency in exchange for Renminbi earnings.**

 

China’sgovernment imposes controls on the convertibility of Renminbi into foreigncurrencies and, in certain cases, the remittance of currency out of China.Under the current foreign exchange control system, sufficient foreign currencymay not be available to satisfy our currency needs. Shortages in theavailability of foreign currency may restrict the ability of our Chinesesubsidiaries to obtain and remit sufficient foreign currency to pay dividendsto us, or otherwise satisfy their foreign currency denominated obligations,such as payments to us for components, which we export to them, and fortechnology licensing fees. We may also experience difficulties in completingthe administrative procedures necessary to obtain and remit needed foreigncurrency. Our business could be substantially harmed if we are unable toconvert and remit our sales received in Renminbi into U.S. dollars. Underexisting foreign exchange laws, Renminbi held by our China subsidiaries can beconverted into foreign currencies and remitted out of China to pay currentaccount items such as payments to suppliers for imports, labor services,payment of interest on foreign exchange loans and distributions of dividends solong as the subsidiaries have adequate amounts of Renminbi to purchase theforeign currency. Expenses of a capital nature such as the repayment of bankloans denominated in foreign currencies, however, require approval fromappropriate governmental authorities before Renminbi can be used to purchaseforeign currency and then remitted out of China. This system could be changedat any time by executive decision of China’s State Council to impose limits oncurrent account convertibility of the Renminbi or other similar restrictions.Moreover, even though the Renminbi is intended to be freely convertible underthe current account, the State Administration of Foreign Exchange, which isresponsible for administering China’s foreign currency market, has asignificant degree of administrative discretion in implementing the laws. Fromtime to time, the State Administration of Foreign Exchange has used thisdiscretion in ways, which effectively limit the convertibility of currentaccount payments and restrict remittances out of China. Furthermore, in manycircumstances the State Administration of Foreign Exchange must approve foreigncurrency conversions and remittances. Under the current foreign exchangecontrol system, sufficient foreign currency may not be available at a givenexchange rate to satisfy our currency demands.

 

**Chinasubjects foreign investors in the telecommunications industry to ownership andgeographic limitations.**

 

China’sgovernment and its agencies, including China’s Ministry of Information Industryand China’s State Council, regulate 

 

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foreign investment in thetelecommunications industry through the promulgation of various laws andregulations and the issuance of various administrative orders and decisions.Currently, foreign investors may engage in such activities only in accordancewith certain ownership and geographic limitations. China may promulgate newlaws or regulations, or issue administrative or judicial decisions orinterpretations, which would further restrict foreigners from engaging intelecommunications-related activities. The promulgation of laws or regulationsor the issuance of administrative orders or judicial decisions orinterpretations restricting telecommunications activities by foreigners couldhave a substantial impact on our ongoing operations.

 

**Governmentalpolicies in China could impact our business.**

 

Since 1978,China’s government has been and is expected to continue reforming its economicand political systems. These reforms have resulted in and are expected tocontinue to result in significant economic and social development in China.Many of the reforms are unprecedented or experimental and may be subject tochange or readjustment due to a number of political, economic and social factors.We believe that the basic principles underlying the political and economicreforms will continue to be implemented and provide the framework for China’spolitical and economic system. New reforms or the readjustment of previouslyimplemented reforms could have a significant negative effect on our operations.Changes in China’s political, economic and social conditions and governmentalpolicies, which could have a substantial impact on our business, include:

 

•                  new laws andregulations or the interpretation of those laws and regulations;

 

•                  the introductionof measures to control inflation or stimulate growth;

 

•                  changes in therate or method of taxation;

 

•                  the impositionof additional restrictions on currency conversion and remittances abroad; and

 

•                  any actionswhich limit our ability to develop, manufacture, import or sell our products inChina, or to finance and operate our business in China.

 

**Economicpolicies in China could impact our business.**

 

The economy ofChina differs from the economies of most countries belonging to theOrganization for Economic Cooperation and Development in various respects suchas structure, government involvement, level of development, growth rate,capital reinvestment, allocation of resources, self-sufficiency, rate of inflationand balance of payments position. In the past, the economy of China has beenprimarily a planned economy subject to one- and five-year state plans adoptedby central government authorities and largely implemented by provincial andlocal authorities, which set production and development targets.

 

Since 1978,increasing emphasis had been placed on decentralization and the utilization ofmarket forces in the development of China’s economy. Economic reform measuresadopted by China’s government may be inconsistent or ineffectual, and we maynot in all cases be able to capitalize on any reforms. Further, these measuresmay be adjusted or modified in ways, which could result in economicliberalization measures that are inconsistent from time to time or from industryto industry or across different regions of the country. China’s economy hasexperienced significant growth in the past decade. This growth, however, hasbeen accompanied by imbalances in China’s economy and has resulted insignificant fluctuations in general price levels, including periods ofinflation. China’s government has implemented policies from time to time toincrease or restrain the rate of economic growth, control periods of inflationor otherwise regulate economic expansion. While we may be able to benefit fromthe effects of some of these policies, these policies and other measures takenby China’s government to regulate the economy could also have a significantnegative impact on economic conditions in China with a resulting negative impacton our business.

 

**China’sentry into the World Trade Organization creates uncertainty as to the futureeconomic and business environments in China.**

 

China’s entryinto the WTO was approved in September 2001. Entry into the WTO willrequire China to further reduce tariffs and eliminate non-tariff barriers,which include quotas, licenses and other restrictions by 2005 at the latest.While China’s entry into the WTO and the related relaxation of traderestrictions may lead to increased foreign investment, it may also lead toincreased competition in China’s markets from international companies. China’sentry into the WTO could have a negative impact on China’s economy with aresulting negative impact on our business.

 

**Uncertaintiesrelated to a rollout of 3G networks in China could harm our business.**

** **

It isanticipated that the government of China will grant 3G network licenses totelecommunications service providers beginning in the second half of 2004.  We face several potential risks inconnection with a 3G rollout.  Forexample, if telecommunications service providers invest heavily in 3G networks,capital expenditures to build-out PAS networks that utilize our existingproducts may decline.  Moreover, it ispossible that current PAS frequency bands utilized by PAS networks may bereallocated for use by 3G networks, which would have the effect of restrictingor shutting down PAS networks.  Ineither case, our ability to sell our PAS products in China would decline significantly,and our operating results would be harmed.

 

We also facerisks relating to our ability to compete within any emerging 3Gmarketplace.  For example, we haveinvested most heavily in WCDMA technology; however, alternative technologies,such as CDMA 2000 and TDSCDMA, may become the dominant technologies within 3Gnetworks.  If an alternative technologybecomes the dominant technology of 3G networks in China, our ability to sell 3Gproducts in China will suffer. Moreover, within the 3G marketplace, we will likely face stiffcompetition and may not be able to establish or maintain significant marketshare for our 3G products, in which case our operating results would suffer.

 

**Iftax benefits available to our subsidiaries located in China are reduced orrepealed, our business could suffer.**

 

Oursubsidiaries and joint ventures located in China enjoy tax benefits in Chinawhich are generally available to foreign 

 

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investment enterprises,including full exemption from national enterprise income tax for two yearsstarting from the first profit-making year and/or a 50% reduction in nationalincome tax rate for the following three years. In addition, local enterpriseincome tax is often waived or reduced during this tax holiday/incentive period.Under current regulations in China, foreign investment enterprises that havebeen accredited as technologically advanced enterprises are entitled toadditional tax incentives. These tax incentives vary in different locales andcould include preferential national enterprise income tax treatment at 50% ofthe usual rates for different periods of time. All of our active subsidiariesin China were accredited as technologically advanced enterprises. The taxholidays applicable to our wholly-owned subsidiaries, UTStarcom China and HUTS,which together accounted for approximately 76% of our revenues in the ninemonths ended September 30, 2003, expired at the end of 2002 and 2001,respectively. The tax holidays were not extended for the entities, and for 2003,the national enterprise tax rates were increased from 7.5% to 15% and from 10%to 15%, respectively, which could negatively impact our financial condition andresults of operations. During the fourth quarter of 2002, we formed a newentity, Hangzhou UTStarcom Telecom Co., Ltd., to manufacture and sellhandsets. This entity will benefit from a two-year national enterprise incometax exemption from the first profit-making year, and a 50% national enterpriseincome tax reduction in the following three years. The Chinese government isconsidering the imposition of “unified” corporate income tax that would phaseout, over time, the preferential tax treatment to which foreign investmententerprises, such as UTStarcom, are currently entitled. While it is not certainwhether the government will implement such a unified tax structure or whether,if implemented, UTStarcom will be grandfathered into the new tax structure, ifthe new tax structure is implemented, it will adversely affect our financialcondition.

 

**China’slegal system embodies uncertainties that could negatively impact our business.**

 

China has acivil law system. Decided court cases do not have binding legal effect onfuture decisions. Since 1979, many new laws and regulations covering generaleconomic matters have been promulgated in China. Despite this activity todevelop the legal system, China’s system of laws is not yet complete. Evenwhere adequate law exists in China, enforcement of existing laws or contractsbased on existing law may be uncertain and sporadic and it may be difficult toobtain swift and equitable enforcement, or to obtain enforcement of a judgmentby a court of another jurisdiction. The relative inexperience of China’sjudiciary in many cases creates additional uncertainty as to the outcome of anylitigation. Further, interpretation of statutes and regulations may be subjectto government policies reflecting domestic political changes. Moreover,government policies and internal rules promulgated by governmental agencies maynot be published in time, or at all. As a result, we may operate our businessin violation of new rules and policies without having any knowledge of theirexistence.

 

China hasadopted a broad range of related laws, administrative rules and regulationsthat govern the conduct and operations of foreign investment enterprises andrestrict the ability of foreign companies to conduct business in China. Theselaws, rules and regulations provide some incentives to encourage the flow ofinvestment into China, but also subject foreign companies, and foreigninvestment enterprises, including our subsidiaries in China, to a set ofrestrictions that may not always apply to domestic companies in China. As aresult of its admission into the WTO, China is increasingly according foreigncompanies and foreign investment enterprises established in China the samerights and privileges as Chinese domestic companies. These special laws,administrative rules and regulations governing foreign companies and foreigninvestment enterprises may still place us and our subsidiaries at adisadvantage in relation to Chinese domestic companies and may adversely affectour competitive position. Moreover, as China’s legal system develops, thepromulgation of new laws, changes to existing laws and the pre-emption of localregulations by national laws may adversely affect foreign investors andcompanies. Many of our activities and products in China are subject toadministrative review and approval by various national and local agencies ofChina’s government. Because of the changes occurring in China’s legal andregulatory structure, we may not be able to secure the requisite governmentalapproval for our activities and products. Failure to obtain the requisitegovernment approval for any of our activities or products could substantiallyharm our business.

 

**Weface uncertainties regarding the timing for the completion of our newmanufacturing facility.**

 

In 2001, wepurchased the rights to use 49 acres of land located in Zhejiang Science andTechnology Industry Garden of Hangzhou Hi-tech Industry Development Zone. As ofSeptember 30, 2003, we had completed the foundation and groundwork of afacility to be located there and have commenced construction of the building.We expect that construction of the new facility will be completed in early 2004at a projected cost of approximately $95.6 million. We revised theexpected completion date of that facility from late 2003 to early 2004, due toa slow down in construction during the first quarter of fiscal 2003, resultingfrom the SARS outbreak and inclement weather. Capital expenditures for thefacility were $38.6 million in 2002 and $8.8 million and $21.2million in the three and nine months ended September 30, 2003,respectively.

 

**RISKS RELATING TO OUR STOCK PERFORMANCE ANDCONVERTIBLE DEBT SECURITIES**

 

OnMarch 12, 2003 we sold $402.5 million of convertible subordinated notes(referred to as the “notes” in the following risk factors) due in 2008 toqualified institutional buyers pursuant to Rule 144A under the Securities Actof 1933, as amended. The notes bear interest at a rate of 7/8% percent perannum, are convertible into UTStarcom common stock at a conversion price of$23.79 per share and are subordinated to all present and future senior debt ofUTStarcom. Holders of the notes may convert their notes only if: (i) 

 

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the price of our common stockissuable upon conversion of a note reaches a specified threshold, (ii)specified corporate transactions occur, or (iii) the trading price for thenotes falls below certain thresholds. At the initial conversion price, each$1,000 principal amount of notes will be convertible into approximately 42.0345shares of our common stock.

 

**Ourstock price is highly volatile.**

 

The tradingprice of our common stock has fluctuated significantly since our initial publicoffering in March 2000. Our stock price could be subject to widefluctuations in the future in response to many events or factors, includingthose discussed in the preceding risk factors relating to our operations, aswell as:

 

•                  actual oranticipated fluctuations in operating results, actual or anticipated grossprofit as a percentage of net sales, levels of inventory, our actual oranticipated rate of growth and our actual or anticipated earnings per share;

 

•                  changes inexpectations as to future financial performance or changes in financialestimates or buy/sell recommendations of securities analysts;

 

•                  changes ingovernmental regulations or policies in China, such as the temporary suspensionof sales of our PAS systems that occurred in May and June of 2000,which caused our stock price to drop;

 

•                  our, or acompetitor’s, announcement of new products, services or technologicalinnovations;

 

•                  the operatingand stock price performance of other comparable companies; and

 

•                  news andcommentary emanating from the media, securities analysts, and government bodiesin China relating to UTStarcom and to the industry in general.

 

General marketconditions and domestic or international macroeconomic factors unrelated to ourperformance may also affect our stock price. For these reasons, investorsshould not rely on recent trends to predict future stock prices or financialresults. In addition, following periods of volatility in a company’ssecurities, securities class action litigation against a company is sometimesinstituted. This type of litigation could result in substantial costs and thediversion of management time and resources.

 

In addition,public announcements by China Telecom and China Netcom, each of which exertsignificant influence over many of our major customers in China, may contributeto volatility in the price of our stock. In 2002, China Telecom completed itsinitial public offering, which has caused that entity to issue press releasesmore frequently than in prior years. The price of our stock may react to suchannouncements. More recently, it has been reported that China Netcom has beenrestructuring its operations for its own initial public offering. More frequentpublic announcements from China Netcom relating to or resulting from theirinitial public offering could cause the price of our stock to become even morevolatile.

 

**SoftbankCorp. and its related entities, including Softbank America Inc., hassignificant influence over our management and affairs, which it could exerciseagainst your best interests.**

 

SOFTBANK CORP.and its related entities, including SOFTBANK America Inc., beneficiallyowned approximately 14.4% of our outstanding stock as of September 30,2003. As a result, SOFTBANK CORP. and its related entities, including SOFTBANKAmerica Inc., have the ability to exercise influence over all matterssubmitted to our stockholders for approval and exert significant influence overour management and affairs. This concentration of ownership may delay orprevent a change of control or discourage a potential acquirer from making atender offer or otherwise attempting to obtain control of our company, whichcould decrease the market price of our common stock. Matters that could requirestockholder approval include:

 

•                  election andremoval of directors;

 

•                  merger orconsolidation of our company; and

 

•                  sale of all orsubstantially all of our assets.

 

The interestsof SOFTBANK America Inc. may not always coincide with our interests.SOFTBANK America Inc., acting through its designees on our board ofdirectors and through its ownership of voting securities, will have the abilityto exercise significant influence over our actions irrespective of the desiresof our other stockholders or directors.

 

SOFTBANK hasentered into an agreement with us not to offer, sell or otherwise dispose ofour common stock prior to March 7, 2004, subject to a number ofexceptions.

 

**Delawarelaw and our charter documents contain provisions that could discourage orprevent a potential takeover, even if the transaction would benefit ourstockholders.**

 

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Othercompanies may seek to acquire or merge with us. An acquisition or merger of ourcompany could result in benefits to our stockholders, including an increase inthe value of our common stock. Some provisions of our Certificate ofIncorporation and Bylaws, as well as provisions of Delaware law, maydiscourage, delay or prevent a merger or acquisition that a stockholder mayconsider favorable. These provisions include:

 

•                  authorizing theboard of directors to issue additional preferred stock;

 

•                  prohibitingcumulative voting in the election of directors;

 

•                  limiting thepersons who may call special meetings of stockholders;

 

•                  prohibitingstockholder action by written consent;

 

•                  creating aclassified board of directors pursuant to which our directors are elected forstaggered three year terms; and

 

•                  establishingadvance notice requirements for nominations for election to the board ofdirectors and for proposing matters that can be acted on by stockholders atstockholder meetings.

 

**Theconvertible debt securities rank below our senior debt and liabilities of oursubsidiaries, and we may be unable to repay our obligations under the notes.**

 

Theconvertible debt securities (the “notes”) are unsecured and subordinated inright of payment in full to all of our existing and future senior debt. Becausethe notes are subordinated to our senior debt, in the event of (i) ourliquidation or insolvency, (ii) a payment default on our designated seniordebt, (iii) a covenant default on our designated senior debt, or(iv) acceleration of the notes due to an event of default, we will makepayments on the notes only after our senior debt has been paid in full. Afterpaying our senior debt in full, we may not have sufficient assets remaining topay any or all amounts due on the notes.

 

The notes areobligations exclusively of UTStarcom. Since substantially all of UTStarcom’soperations are conducted through subsidiaries, our cash flow and our ability toservice our debt, including the notes, is dependent upon the earnings of oursubsidiaries and the distribution of those earnings to us. Our subsidiaries areseparate legal entities and have no obligation to make any payments on thenotes or make any funds available for payment on the notes, whether bydividends, loans or other payments. The payment of dividends and the making ofloans and advances to us by our subsidiaries may be subject to statutory orcontractual restrictions and are dependent upon the earnings of oursubsidiaries. Our subsidiaries do not guarantee the payment of the notes. Ourright to receive assets of any of our subsidiaries upon their liquidation or reorganization,and your right to participate in these assets, are effectively subordinated tothe claims of that subsidiary’s creditors. Consequently, the notes will beeffectively subordinated to all liabilities, including trade payables, of anyof our subsidiaries and any subsidiaries that we may in the future acquire orestablish, except to the extent that we are recognized as a creditor of suchsubsidiary, in which case our claims would still be subordinate to any securityinterests in the assets of such subsidiary and any debt of such subsidiarysenior to that held by us.

 

As ofSeptember 30, 2003, (i) we had no senior debt outstanding, and(ii) our subsidiaries had notes payable of $23.4 million and approximately$514.3 million of other liabilities, including trade payables, butexcluding intercompany liabilities, as to which the notes would have beeneffectively subordinated.

 

Neither we norour subsidiaries are prohibited or limited from incurring debt or acting asguarantors of debt for others in whom we or our subsidiaries may have aninterest under the indenture. Our ability to pay our obligations on the notescould be adversely affected by our or our subsidiaries’ incurrence ofadditional indebtedness or other liabilities. We and our subsidiaries may fromtime to time incur additional indebtedness and other liabilities, includingsenior debt.

 

**Wemay be limited in our ability to purchase the notes in the event of a change incontrol.**

 

Our ability topurchase the notes upon the occurrence of a change in control is subject tolimitations. We may not have sufficient financial resources or the ability toarrange financing to pay the purchase price for all the notes delivered byholders seeking to exercise their purchase right. Although we may elect, subjectto satisfaction of certain conditions, to pay the purchase price for the notesin common stock, our ability to purchase the notes in cash may be limited orprohibited by the terms of any future borrowing arrangements existing at thetime of a change in control. Any failure by us to purchase the notes upon achange in control would result in an event of default under the indenture,whether or not the purchase is permitted by the subordination provisions of theindenture. Any such default may, in turn, cause a default under our seniordebt. Moreover, the occurrence of a change in control could result in an eventof default under the terms of our then existing senior debt. As a result, anypurchase of the notes may be prohibited until the senior debt is paid in full.

 

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In the eventwe elect to pay the purchase price in common stock, our common stock will bevalued at a price determined prior to the applicable repurchase date,therefore, holders of the notes bear the market risk that our common stock willdecline in value between the date the price is calculated and the purchasedate.

 

**Absenceof a trading market for the notes.**

 

The notes area new issue of securities with no established trading market. At the time ofthe original issuance of the notes in March 2003, the initial purchasersof the notes advised us that they intended to make a market in the notes.However, as initial purchasers, they are not obligated to make a market in thenotes and any market making by the initial purchasers may be discontinued atany time at the sole discretion of the initial purchasers without notice. Wecannot assure you that a market for the notes will develop and continue uponcompletion of the offering or that the market price of the notes will notdecline. Various factors, such as changes in prevailing interest rates orchanges in perceptions of our creditworthiness could cause the market price ofthe notes to fluctuate significantly. The trading price of the notes will alsobe significantly affected by the market price of our common stock, which couldbe subject to wide fluctuations in response to a variety of factors. The noteswill not be listed on any securities exchange or quoted on the Nasdaq NationalMarket and will only be traded on the over-the-counter market.

 

**Wehave significantly increased our leverage as a result of the sale of the notes.**

 

In connectionwith the sale of the notes, we incurred $402.5 million of indebtedness. Asa result of this indebtedness, our principal and interest payment obligationshave increased substantially. The degree to which we are leveraged couldmaterially and adversely affect our ability to obtain financing for workingcapital, acquisitions or other purposes and could make us more vulnerable toindustry downturns and competitive pressures. Our ability to meet our debtservice obligations will be dependent upon our future performance, which willbe subject to financial, business and other factors affecting our operations,many of which are beyond our control.

 

**Hedgingtransactions and other transactions may affect the value of the notes and ofour common stock.**

 

We haveentered into convertible bond hedge and call option transactions with respectto our common stock, the exposure for which is held by Banc of AmericaSecurities LLC and Credit Suisse First Boston LLC. The convertible bond hedgeand call option transactions are expected to reduce the potential dilution fromconversion of the notes. In connection with these hedging arrangements, Banc ofAmerica Securities LLC and Credit Suisse First Boston LLC have taken and/orwill take positions in our common stock in secondary market transactions and/orhave entered and/or will enter into various derivative transactions after thepricing of the notes. Such hedging arrangements could increase the price of ourcommon stock. Banc of America Securities LLC and Credit Suisse First Boston LLCare likely to modify their hedge positions from time to time prior toconversion or maturity of the notes by purchasing and selling shares of ourcommon stock, other securities of the Company or other instruments they maywish to use in connection with such hedging. We cannot assure you that suchactivity will not adversely affect the market price of our common stock.

 

**Thenotes may not be rated or may receive a lower rating than anticipated.**

 

We believe itis unlikely that the notes will be rated. However, if one or more ratingagencies rates the notes and assigns the notesa rating lower than the ratingexpected by investors, or reduces their rating in the future, the market priceof the notes and our common stock would be harmed.

 

**ITEM3****—QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

We are exposed to the impact of interest rate changes, changes inforeign currency exchange rates and changes in the stock market.

 

*Interest Rate Risk.*  Our exposure to market risk for changes ininterest rates relates primarily to our investment portfolio. The fair value ofour investment portfolio would not be significantly affected by either a 10%increase or decrease in interest rates due mainly to the short-term nature ofmost of our investment portfolio. However, our interest income can be sensitiveto changes in the general level of U.S. interest rates since the majority ofour funds are invested in instruments with maturities less than one year. Ourpolicy is to limit the risk of principal loss and ensure the safety of investedfunds by generally attempting to limit market risk. Funds in excess of currentoperating requirements are mostly invested in government-backed notes,commercial paper, floating rate corporate bonds, fixed income corporate bondsand tax exempt instruments. In accordance with our investment policy, allshort-term investments are invested in “investment grade” rated securities withminimum A or better ratings. Currently, most of our short-term investments haveAA or better ratings.

 

The table below represents carrying amounts and relatedweighted-average interest rates of maturity of interest bearing instruments inour investment portfolio at September 30, 2003:

 

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| **(in thousands except interest rates)**                 |   |   |    |
|----------------------------------------------------------|--------|--------|---------|
|                                                     |   |   |    |
| Cash and cash equivalents                                |   | $      | 436,085 |   |
| Average interest rates                                   |   | 1.2    | %       |
| Short-term investments                                   |   | $      | 5,282   |   |
| Average interest rates                                   |   | 1.4    | %       |
| Total cash, cash  equivalents and short-term investments |   | $      | 441,367 |   |
| Average interest rate                                    |   | 1.2    | %       |

 

 

Part of ourinvestment portfolio has recently included equity investments in publiclytraded companies, the value of which are subject to market price volatility.Recent events have adversely affected the public equities market and generaleconomic conditions may continue to worsen. Should the fair value of ourpublicly traded equity investments decline below their cost basis in a mannerdeemed to be other-than-temporary, it may become necessary for us to take animpairment charge. We have also invested in several privately held companies aswell as investment funds which invest primarily in privately held companies,many of which can still be considered in the start-up or development stages.These investments are inherently risky, as the market for the technologies orproducts they have under development are typically in the early stages and maynever materialize. We could lose our entire initial investment in thesecompanies and investment funds.

 

*Foreign Exchange Rate Risk.*  We are exposed to foreign exchange rate riskbecause most of our sales in China are denominated in Renminbi and portions ofour accounts payable and our notes receivable are denominated in Japanese Yen.Due to the limitations on converting Renminbi, we are limited in our ability toengage in currency hedging activities in China. Although the impact of currencyfluctuations of Renminbi to date has been insignificant, fluctuations incurrency exchange rates in the future may have a material adverse effect on ourresults of operations. We have a multi-currency bank account in Japanese Yenfor purchasing portions of our inventories and supplies. The balance of thisJapanese Yen account as of September 30, 2003 is approximately$8.0 million.  The balance of ourlong-term note receivable denominated in Japanese Yen was $10.6 million at September 30,2003.

 

*Credit Risk.* Wecompleted an offering on March 12, 2003, of $402.5 million of convertiblesubordinated notes due March 1, 2008. Concurrent with the issuance of theconvertible notes, we entered into convertible bond hedge and call optiontransactions with respect to its common stock, the exposure for which is heldby Banc of America Securities LLC and Credit Suisse First Boston LLC. Boththe bond hedge and call option transactions may be settled at the Company’soption either in cash or net shares and expire on March 1, 2008.  Theconvertible bond hedge and call option transactions are expected to reduce thepotential dilution from conversion of the notes. Subject to the movement in theshare price of our common stock, we could be exposed to credit risk in thesettlement of these options in our favor. Based on a review of the possible netsettlements and the credit strength of Banc of America Securities LLC and itsaffiliates and Credit Suisse First Boston LLC and its affiliates, we believethat we do not have a material exposure to credit risk arising from theseoption transactions.

 

**ITEM 4****—CONTROLS AND PROCEDURES**

 

Ourmanagement, including the Chief Executive Officer and the Chief FinancialOfficer, have conducted an evaluation of the effectiveness of disclosurecontrols and procedures, pursuant to Exchange Act Rule 13a-15(b) as of  September 30, 2003.  Based on that evaluation, the ChiefExecutive Officer and the Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in ensuring that all material informationrequired to be filed in this quarterly report has been made known to them in atimely fashion and no changes are required at this time.

 

In connection with the evaluation by our management, including theChief Executive Officer and Chief Financial Officer, of our internal controlover financial reporting, pursuant to the Exchange Act Rule 13a-15(d), nochanges during the quarter ended September 30, 2003 were identified thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

**PART II—OTHER INFORMATION**

 

**ITEM 1—LEGAL PROCEEDINGS**

 

On October 31, 2001, a complaint was filed in United StatesDistrict Court for the Southern District of New York against the Company, someof its directors and officers and various underwriters for its initial publicoffering. Substantially similar actions were filed concerning the initialpublic offerings for more than 300 different issuers, and the cases werecoordinated as *In re Initial Public OfferingSecurities Litigation*, 21 MC 92. In April 2002, a consolidatedamended complaint was filed in the matter against the 

 

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Company,captioned *In re UTStarcom, Initial PublicOffering Securities Litigation*, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarket,and misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock betweenMarch 2, 2000 and December 6, 2000. The Company’s directors andofficers have been dismissed without prejudice pursuant to a stipulation.  On February 19, 2003, the Court grantedin part and denied in part a motion to dismiss brought by defendants includingthe Company. The order dismisses all claims against the Company except for aclaim brought under Section 11 of the Securities Act of 1933.  A proposal has been made for the settlementand release of claims against the issuer defendants, including UTStarcom. Thesettlement is subject to a number of conditions, including approval of theproposed settling parties and the court. If the settlement does not occur, andlitigation against UTStarcom continues, UTStarcom believes it has meritoriousdefenses and intends to defend the case vigorously. The total amount of theloss associated with the above litigation is not determinable at thistime.  Therefore we are unable tocurrently estimate the loss if any associated with the litigation.

 

**ITEM 2—CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

[None.]

 

#### **ITEM 3– DEFAULTS UPON SENIOR SECURITIES**

 

[None.]

 

##### **ITEM 4 –SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

On September 24, 2003, a special meeting of stockholders of theCompany was held in Oakland, California. At the meeting, an amendment to our certificate of incorporation wasapproved, increasing the number of authorized shares of common stock from 250million to 750 million.  79,358,851votes were cast in favor of the amendment, 11,610,322 votes were cast againstthe amendment, and 102,800 were withheld.

 

**ITEM5—OTHER INFORMATION**

 

Our directors, officers, or employees have entered, and may from timeto time enter, into good faith trading plans pursuant to SECRule 10b5-1(c).

 

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**ITEM6—EXHIBITS AND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits:

 
| **NUMBER** |   | **EXHIBIT  DESCRIPTION**                                                                                                                                           |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                               |
| 31.1       |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
| 31.2       |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
| 32.1       |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2       |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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(b)                                 Reportson Form 8-K:

 

1.               Amendment No. 1 to Report on Form 8-K,dated May 23, 2003, filed on July 10, 2003 under Item 7, containingfinancial information related to the Company’s acquisition of the CommWorksdivision of 3Com Corporation.

 

2.               Report on Form 8-K dated July 10,2003, filed on July 10, 2003 under Item 5, containing risk factorsrelating to the Company.

 

3.               Report on Form 8-K datedSeptember 24, 2003, filed on September 25, 2003 under Item 5,relating to the approval by the Company’s stockholders of an amendment to theCompany’s certificate of incorporation.

 

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**UTSTARCOM, INC.**

 

**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
| Date:  November 12, 2003 | UTSTARCOM,  INC.                                  |
|------------------------------------|---------------------------------------------------|
|                               |                                              |
|                               |                                              |
|                               | BY:                                               |
|                               |                                              |
|                               |                                              |
|                               | /s/ Hong  Liang Lu                                |
|                               | Hong Liang  Lu                                    |
|                               | *President, Chief Executive Officer and Director* |
|                               | *(Principal Executive Officer)*                   |
|                               |                                              |
|                               |                                              |
|                               | /s/ Michael  J. Sophie                            |
|                               | Michael J.  Sophie                                |
|                               | *Chief Financial Officer and Assistant Secretary* |
|                               | *(Principal Financial Officer)*                   |

 

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**UTSTARCOM, INC.**

**EXHIBIT INDEX**

** **
| **NUMBER** |   | **EXHIBIT  DESCRIPTION**                                                                                                                                           |
|------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |   |                                                                                                                                                               |
| 31.1       |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
| 31.2       |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                      |
|       |   |                                                                                                                                                               |
| 32.1       |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2       |   | Certification  of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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