Table of Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 
| **(Mark One)**                                         | ** ** | ** **                                                                                               |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| x                                                      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|                                                   |       |                                                                                                     |
| **For the quarterly period ended  June 30, 2008** |
| ** **                                             | ** ** | ** **                                                                                               |
| **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**

 

**UTSTARCOM, INC.**

(Exact name ofregistrant as specified 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**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.  Yes x No o

 

Indicate bycheck mark whether the registrant is a large accelerated filer, an acceleratedfiler, a non-accelerated filer, or a smaller reporting company. See definitionsof “large accelerated filer,” “accelerated filer,” and “smaller reportingcompany” in Rule 12b-2 of the Exchange Act. (Check one):

 

| Large  accelerated filer x                      | Accelerated  filer o         |
|-------------------------------------------------|-----------------------------------|
|                                            |                              |
| Non-accelerated  filer o                        | Smaller  reporting company o |
| (Do not check if a  smaller  reporting company) |                              |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

As of July 30, 2008there were 125,655,244 shares of the registrant’s common stock outstanding, parvalue $0.00125.

 

 

 

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**TABLE OF CONTENTS**

 
| PART I—FINANCIAL  INFORMATION                                                                  | 2  |
|----------------------------------------------------------------------------------------------------------|----|
| ITEM  1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                                     | 2  |
| ITEM  2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS | 28 |
| ITEM  3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                                 | 47 |
| ITEM 4—CONTROLS  AND PROCEDURES                                                                     | 48 |
| PART II—OTHER  INFORMATION                                                                     | 51 |
| ITEM 1—LEGAL  PROCEEDINGS                                                                           | 51 |
| ITEM  1A—RISK FACTORS                                                                               | 52 |
| ITEM  2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                 | 53 |
| ITEM  3—DEFAULTS UPON SENIOR SECURITIES                                                             | 53 |
| ITEM  4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                         | 54 |
| ITEM 5—OTHER  INFORMATION                                                                           | 55 |
| ITEM  6—EXHIBITS                                                                                    | 55 |
| SIGNATURES                                                                                               | 56 |

 

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**PART I—FINANCIALINFORMATION**

 

**ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                           | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                           | ** ** | **2008**          | ** ** | **2007**              | ** ** |
| **ASSETS**                                                                                                                                                                           |       |              |       |                  |       |
| Current assets:                                                                                                                                                                      |       |              |       |                  |       |
| Cash and cash equivalents                                                                                                                                                            |       | $                 | 253,901    |                  | $          | 437,449 |   |
| Short-term investments                                                                                                                                                               |       | 889               |       | 65,629                |       |
| Accounts receivable, net of allowances for  doubtful accounts of $49,589 and $45,728 at June 30, 2008 and  December 31, 2007, respectively                                 |       | 130,830           |       | 304,654               |       |
| Accounts receivable, related parties                                                                                                                                                 |       | 13,972            |       | 26,256                |       |
| Notes receivable                                                                                                                                                                     |       | 8,643             |       | 12,615                |       |
| Inventories                                                                                                                                                                          |       | 196,053           |       | 334,467               |       |
| Deferred costs                                                                                                                                                                       |       | 146,905           |       | 190,260               |       |
| Deferred tax assets                                                                                                                                                                  |       | 1,157             |       | 1,157                 |       |
| Restricted cash                                                                                                                                                                      |       | 17,394            |       | 6,442                 |       |
| Assets held for sale                                                                                                                                                                 |       | 373,929           |       | —                |       |
| Prepaids and other current assets                                                                                                                                                    |       | 120,636           |       | 114,037               |       |
| Total current assets                                                                                                                                                                 |       | 1,264,309         |       | 1,492,966             |       |
| Property, plant and equipment, net                                                                                                                                                   |       | 207,259           |       | 209,094               |       |
| Long-term investments                                                                                                                                                                |       | 16,211            |       | 16,667                |       |
| Intangible assets, net                                                                                                                                                               |       | 5,472             |       | 24,809                |       |
| Long-term deferred costs                                                                                                                                                             |       | 161,919           |       | 164,766               |       |
| Long-term deferred tax assets                                                                                                                                                        |       | 56,181            |       | 46,277                |       |
| Other long-term assets                                                                                                                                                               |       | 24,225            |       | 30,009                |       |
| Total assets                                                                                                                                                                         |       | $                 | 1,735,576  |                  | $          | 1,984,588 |   |
|                                                                                                                                                                                 |       |              |       |                  |       |
| **LIABILITIES, MINORITY INTEREST AND  STOCKHOLDERS’ EQUITY**                                                                                                                    |       |              |       |                  |       |
| Current liabilities:                                                                                                                                                                 |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                     |       | $                 | 179,984    |                  | $          | 148,440 |   |
| Short-term debt                                                                                                                                                                      |       | 29,158            |       | 322,829               |       |
| Income taxes payable                                                                                                                                                                 |       | 5,943             |       | 1,174                 |       |
| Customer advances                                                                                                                                                                    |       | 192,331           |       | 229,050               |       |
| Deferred revenue                                                                                                                                                                     |       | 111,219           |       | 100,502               |       |
| Deferred tax liabilities                                                                                                                                                             |       | 49,687            |       | 53,922                |       |
| Liabilities held for sale                                                                                                                                                            |       | 154,953           |       | —                |       |
| Other current liabilities                                                                                                                                                            |       | 175,303           |       | 247,299               |       |
| Total current liabilities                                                                                                                                                            |       | 898,578           |       | 1,103,216             |       |
|                                                                                                                                                                                 |       |              |       |                  |       |
| Long-term deferred revenue                                                                                                                                                           |       | 229,241           |       | 236,033               |       |
| Long-term debt                                                                                                                                                                       |       | —            |       | 333                   |       |
| Other long-term liabilities                                                                                                                                                          |       | 19,124            |       | 23,325                |       |
| Total liabilities                                                                                                                                                                    |       | 1,146,943         |       | 1,362,907             |       |
|                                                                                                                                                                                 |       |              |       |                  |       |
| Commitments and contingencies (Note 14)                                                                                                                                              |       |              |       |                  |       |
| Minority interest in consolidated  subsidiaries                                                                                                                                      |       | 796               |       | 3,705                 |       |
| Stockholders’ equity:                                                                                                                                                           |       |              |       |                  |       |
| Common stock: $0.00125 par value;  750,000,000 authorized shares; 125,643,769 and 123,467,204 issued and  outstanding at June 30, 2008 and December 31, 2007, respectively |       | 152               |       | 152                   |       |
| Additional paid-in capital                                                                                                                                                           |       | 1,227,729         |       | 1,216,691             |       |
| Accumulated deficit                                                                                                                                                                  |       | (704,593          | )          | (691,170              | )          |
| Accumulated other comprehensive income                                                                                                                                               |       | 64,549            |       | 92,303                |       |
| Total stockholders’ equity                                                                                                                                                      |       | 587,837           |       | 617,976               |       |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                                  |       | $                 | 1,735,576  |                  | $          | 1,984,588 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

**(Inthousands, except per share data)**

 
| ** **                                                                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                  |       |                                                |       |                                              |       |   |   |   |   |
| Unrelated party                                                            |       | $                                                   | 623,388    |                                              | $          | 518,014 |   | $ | 1,197,583 |   | $ | 980,799 |   |
| Related party                                                              |       | 9,368                                               |       | 20,231                                            |       | 21,162 |   | 33,347 |   |
|                                                                       |       | 632,756                                             |       | 538,245                                           |       | 1,218,745 |   | 1,014,146 |   |
| Cost of net sales                                                          |       |                                                |       |                                              |       |   |   |   |   |
| Unrelated party                                                            |       | 544,523                                             |       | 441,954                                           |       | 1,031,676 |   | 833,804 |   |
| Related party                                                              |       | 6,285                                               |       | 16,561                                            |       | 13,042 |   | 25,328 |   |
| Gross profit                                                               |       | 81,948                                              |       | 79,730                                            |       | 174,027 |   | 155,014 |   |
| Operating expenses:                                                        |       |                                                |       |                                              |       |   |   |   |   |
| Selling, general and administrative                                        |       | 72,010                                              |       | 88,865                                            |       | 151,754 |   | 168,701 |   |
| Research and development                                                   |       | 39,286                                              |       | 42,158                                            |       | 80,686 |   | 85,819 |   |
| Amortization of intangible assets                                          |       | 1,730                                               |       | 4,046                                             |       | 3,554 |   | 8,092 |   |
| Total net operating expenses                                               |       | 113,026                                             |       | 135,069                                           |       | 235,994 |   | 262,612 |   |
|                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Operating loss                                                             |       | (31,078                                             | )          | (55,339                                           | )          | (61,967 | ) | (107,598 | ) |
|                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Interest income                                                            |       | 1,290                                               |       | 3,395                                             |       | 4,107 |   | 8,304 |   |
| Interest expense                                                           |       | (3,457                                              | )          | (7,321                                            | )          | (9,528 | ) | (14,046 | ) |
| Other income (expense), net                                                |       | (920                                                | )          | 158                                               |       | 53,050 |   | 4,129 |   |
|                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Loss before income taxes and minority  interest                            |       | (34,165                                             | )          | (59,107                                           | )          | (14,338 | ) | (109,211 | ) |
| Income tax (expense) benefit                                               |       | (4,625                                              | )          | (3,298                                            | )          | 395 |   | (7,640 | ) |
| Minority interest in losses of consolidated  subsidiaries                  |       | 10                                                  |       | 698                                               |       | 520 |   | 1,161 |   |
| Net loss                                                                   |       | $                                                   | (38,780    | )                                                 | $          | (61,707 | ) | $ | (13,423 | ) | $ | (115,690 | ) |
|                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Loss per share - Basic and Diluted                                         |       | $                                                   | (0.31      | )                                                 | $          | (0.51 | ) | $ | (0.11 | ) | $ | (0.96 | ) |
|                                                                       |       |                                                |       |                                              |       |   |   |   |   |
| Weighted average shares used in per-share  calculation - Basic and Diluted |       | 123,119                                             |       | 120,982                                           |       | 122,608 |   | 120,941 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

 

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(Inthousands)**

 
| ** **                                                                                       | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2008**                                          | ** ** | **2007** | ** ** |
| ** **                                                                                       | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                            | ** ** | ** **                                        | ** ** | ** ** | ** ** |
| Net loss                                                                                         |       | $                                                 | (13,423    | ) | $ | (115,690 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities:       |       |                                              |       |   |   |
| Depreciation and amortization                                                                    |       | 19,904                                            |       | 29,737 |   |
| Gain on sale of investments and liquidation  of ownership interest in a variable interest entity |       | (48,375                                           | )          | (366 | ) |
| Net gain on sale of fixed assets                                                                 |       | (85                                               | )          | (2,629 | ) |
| Stock-based compensation expense                                                                 |       | 9,844                                             |       | 4,939 |   |
| Provision for doubtful accounts                                                                  |       | 2,722                                             |       | 2,370 |   |
| Provision for (recovery of) deferred costs                                                       |       | 9,089                                             |       | (8,136 | ) |
| Deferred income taxes                                                                            |       | (11,541                                           | )          | 1,267 |   |
| Other                                                                                            |       | 2,185                                             |       | (366 | ) |
| Changes in operating assets and  liabilities:                                                    |       |                                              |       |   |   |
| Accounts receivable                                                                              |       | 65,081                                            |       | 84,696 |   |
| Inventories                                                                                      |       | (69,513                                           | )          | (19,369 | ) |
| Deferred costs                                                                                   |       | 42,747                                            |       | 31,563 |   |
| Other assets                                                                                     |       | (5,513                                            | )          | (28,637 | ) |
| Accounts payable                                                                                 |       | 116,453                                           |       | (89,502 | ) |
| Income taxes payable                                                                             |       | 3,800                                             |       | 6,801 |   |
| Customer advances                                                                                |       | (16,503                                           | )          | 27,141 |   |
| Deferred revenue                                                                                 |       | (7,025                                            | )          | (23,982 | ) |
| Other current liabilities                                                                        |       | (39,986                                           | )          | (49,135 | ) |
| Net cash provided by (used in) operating  activities                                             |       | 59,861                                            |       | (149,298 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                            |       |                                              |       |   |   |
| Additions to property, plant and equipment                                                       |       | (10,271                                           | )          | (15,425 | ) |
| (Purchase of) proceeds from the disposition  of an investment interest                           |       | (2,244                                            | )          | 1,800 |   |
| Proceeds from repayment of loan by a  variable interest entity                                   |       | 7,728                                             |       | — |   |
| Change in restricted cash                                                                        |       | (6,506                                            | )          | 6,615 |   |
| Purchase of short-term investments                                                               |       | (8,567                                            | )          | (21,735 | ) |
| Proceeds from sale of short-term  investments                                                    |       | 66,580                                            |       | 13,484 |   |
| Other                                                                                            |       | 143                                               |       | (230 | ) |
| Net cash provided by (used in) investing  activities                                             |       | 46,863                                            |       | (15,491 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                            |       |                                              |       |   |   |
| Proceeds from borrowings                                                                         |       | 50,000                                            |       | 64,621 |   |
| Payments on borrowings                                                                           |       | (346,017                                          | )          | (64,732 | ) |
| Other                                                                                            |       | (3,637                                            | )          | 4,728 |   |
| Net cash (used in) provided by financing  activities                                             |       | (299,654                                          | )          | 4,617 |   |
| Effect of exchange rate changes on cash and  cash equivalents                                    |       | 9,382                                             |       | 7,972 |   |
| Net decrease in cash and cash equivalents                                                        |       | (183,548                                          | )          | (152,200 | ) |
| Cash and cash equivalents at beginning of  period                                                |       | 437,449                                           |       | 661,623 |   |
| Cash and cash equivalents at end of period                                                       |       | $                                                 | 253,901    |   | $ | 509,423 |   |
|                                                                                             |       |                                              |       |   |   |
| Supplemental disclosure of cash flow  information:                                               |       |                                              |       |   |   |
| Non-cash operating activity:                                                                     |       |                                              |       |   |   |
| Accounts receivable transferred to notes  receivable                                             |       | $                                                 | 9,278      |   | $ | 11,462 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

 

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

 

**NOTE 1 - BASIS OF PRESENTATION AND LIQUIDITY**

 

The accompanying unaudited condensed consolidatedfinancial statements include the accounts of UTStarcom, Inc. (“Company”)and its wholly and majority owned subsidiaries. All significant intercompanyaccounts and transactions have been eliminated in the preparation of thecondensed consolidated financial statements. The minority interest inconsolidated subsidiaries is shown separately in the condensed consolidatedfinancial statements.

 

The accompanying unaudited condensed consolidatedfinancial statements as of June 30, 2008 and for the three and six monthsended June 30, 2008 and 2007 have been prepared by the Company pursuant tothe rules and regulations of the Securities and Exchange Commission (“SEC”).Certain information and footnote disclosures normally included in financialstatements prepared in accordance with generally accepted accounting principleshave been condensed or omitted pursuant to such rules and regulations. TheDecember 31, 2007 balance sheet was derived from audited financialstatements, but does not include all disclosures required by generally acceptedaccounting principles. These condensed consolidated financial statements shouldbe read in conjunction with the Company’s December 31, 2007 financialstatements, including the notes thereto, and the other information set forth inthe Company’s Annual Report on Form 10-K for the year ended December 31,2007. The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the amounts of assets,liabilities, revenue, costs, expenses and gains and losses not affectingretained earnings that are reported in the consolidated financial statementsand accompanying disclosures.  Actualresults may be different.  See theCompany’s 2007 Annual Report for discussions of the Company’s criticalaccounting policies and estimates.

 

In the opinion of management, the accompanyingunaudited condensed consolidated financial statements reflect all adjustments (consistingof only normal recurring adjustments) considered necessary for a fair statementof the Company’s financial condition, the results of its operations and itscash flows for the periods indicated. The results of operations for the threeand six months ended June 30, 2008 are not necessarily indicative of theoperating results for the full year.

 

The Company had an operating loss of $62.0 million and a net loss of$13.4 million for the six months ended June 30, 2008. At June 30,2008, the Company had an accumulated deficit of $704.6 million.  Cash provided from operations was $59.9million during the six months ended June 30, 2008, primarily the result ofmanagement of working capital, in part, necessitated by the repayment of theconvertible subordinated notes due March 1, 2008. At June 30, 2008,the Company had cash and cash equivalents of $253.9 million, of which $157.7million was held by its China subsidiaries and continues to be subject tocurrency exchange controls on transfers of funds from China.

 

The Company reported net losses of $195.6 million,$117.3 million and $532.6 million for the years ended December 31,2007, 2006 and 2005, respectively. At December 31, 2007, the Company’saccumulated deficit aggregated $691.2 million. During the year ended December 31,2007, the Company used $218.2 million of cash in operations. At December 31,2007, the Company had cash and cash equivalents of $437.4 million of which$289.5 million was used to repay the convertible subordinated notes due onMarch 1, 2008 (the “Notes”). This amount included a principal payment of$274.6 million and $14.9 million in accrued interest. At December 31,2007, $322.4 million of the Company’s cash and cash equivalents were heldby its subsidiaries in China and China imposes currency exchange controls ontransfers of funds outside of China. Additionally, the available lines ofcredit in China are significantly less than what has been available to theCompany historically and the existing credit facilities in China expire duringthe fourth quarter of 2008. These factors raised substantial doubt as to theCompany’s ability to continue as a going concern.

 

On June 30, 2008, the Company entered into an agreement to sellUTStarcom Personal Communications LLC, a wholly-owned subsidiary of the Company(“PCD”) for a total purchase consideration of approximately $240 million andhas classified PCD’s assets and liabilities as held for sale in the June 30,2008 condensed consolidated balance sheet. The transaction closed on July 1,2008 (See Note 22). As a result of this transaction, management believes theCompany has 

 

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sufficientliquidity to finance its anticipated working capital and capital expenditurerequirements for the next twelve months. In an effort to further improve the Company’s profitability and cashflows, management continues to re-examine all aspects of the Company’s businessfor areas of improvement and continues to focus on the Company’s fixed costbase and improving the working capital position to better align withoperations, market demand and current sales levels. However, if projected salesdo not materialize, management may need to further reduce expenses. Inaddition, the Company may require additional equity or debt financing. Iffuture funds are raised through issuance of stock or debt, these securitiescould have rights, privileges or preference senior to those of the Company’scommon stock and debt covenants could impose restrictions on the Company’soperations. The sale of additional equity securities or debt financing couldresult in additional dilution to the Company’s current shareholders. There canbe no assurance that additional financing, if required, will be available onterms satisfactory to the Company.

 

**NOTE****2 – RECENTACCOUNTING PRONOUNCEMENTS**

 

*Adoptionof New Accounting Standards*

 

InSeptember 2006, the Financial Accounting Standards Board (“FASB”) issuedStatement of Financial Accounting Standards No. 157, “Fair ValueMeasurements,” (“SFAS 157”). SFAS 157 defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. Theprovisions of this standard apply to current accounting pronouncements thatrequire or permit fair value measurements. Upon adoption, the provisions ofSFAS 157 are to be applied prospectively with limited exceptions.  Effective January 1, 2008, the Companyadopted the measurement and disclosure requirements of SFAS 157 as it relatesto financial assets and financial liabilities measured at fair value on arecurring basis. The adoption of SFAS No. 157 for these financial assetsand financial liabilities did not have a material impact on the Company’sfinancial condition or results of operations in the first six months of 2008.The new disclosures required by SFAS 157 are included in Note 6. In February 2008,the FASB issued FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”),which delays the effective date of SFAS 157 for non-financial assets andnon-financial liabilities except those recorded or disclosed at fair value on arecurring basis.  Therefore, the Company has delayed application ofSFAS 157 to those non-financial assets and non-financial liabilities untilJanuary 1, 2009.  The Company is currently evaluating the impact ofSFAS 157 on those non-financial assets and non-financial liabilities onthe Company’s financial position and results of operations.  While theCompany does not expect the adoption of this statement to have a materialimpact on its consolidated financial statements in subsequent reportingperiods, the Company continues to monitor any additional implementationguidance that is issued that addresses the fair value measurements fornon-financial assets and non-financial liabilities not disclosed at fair valuein the consolidated financial statement on at least an annual basis.

 

InFebruary 2007, the FASB issued Statement of Financial Accounting Standard No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).This statement permits, but does not require, companies to report at fair valuethe majority of recognized financial assets, financial liabilities and firmcommitments. Under this standard, unrealized gains and losses on items forwhich the fair value option is elected are reported in earnings at eachsubsequent reporting date. The Company adopted SFAS 159 during the firstquarter of 2008. The Company has chosen not to elect the fair value option forany items that are not already required to be measured at fair value inaccordance with accounting principles generally accepted in the United States.As such, the adoption of SFAS 159 did not have an impact on the Company’sfinancial position or results of operations.

 

*StandardsIssued But Not Yet Effective*

 

InDecember 2007, the FASB issued Statement No. 141 (revised), “BusinessCombinations” (“SFAS 141(R)”). The standard changes the accounting forbusiness combinations including the measurement of acquirer shares issued inconsideration for a business combination, the recognition of contingentconsideration, the accounting for preacquisition gain and loss contingencies,the recognition of capitalized in-process research and development, theaccounting for acquisition-related restructuring cost accruals, the treatmentof acquisition related transaction costs and the recognition of changes in theacquirer’s income tax valuation allowance. SFAS 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  The Company will assess the impact of SFAS 141(R) ifand when a future acquisition occurs.

 

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In December 2007, the FASB issued Statement No. 160, “Non-controllingInterests in Consolidated Financial Statements, an amendment of ARB No. 51”(“SFAS 160”). The standard changes the accounting for non-controlling(minority) interests in consolidated financial statements including therequirements to classify non-controlling interests as a component ofconsolidated stockholders’ equity, and the elimination of “minority interest”accounting in results of operations with earnings attributable tonon-controlling interests reported as part of consolidated earnings.Additionally, SFAS 160 revises the accounting for both increases anddecreases in a parent’s controlling ownership interest. SFAS 160 iseffective for fiscal years beginning after December 15, 2008, with earlyadoption prohibited. The Company is currently evaluating the impact of thepending adoption of SFAS 160 on its consolidated financial statements.

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities”(“SFAS 161”), which amends and expands the disclosure requirements of FASBStatement No. 133, “Accountingfor Derivative Instruments and Hedging Activities”  (“SFAS 133”), with the intent to provideusers of financial statements with an enhanced understanding of:  (a) howand why an entity uses derivative instruments; (b) how derivativeinstruments and related hedged items are accounted for under SFAS 133 and itsrelated interpretations; and (c) how derivative instruments and relatedhedged items affect an entity’s financial position, financial performance andcash flows.  SFAS 161 requires qualitative disclosures aboutobjectives and strategies for using derivatives, quantitative disclosures aboutfair value amounts of and gains and losses on derivative instruments and disclosuresabout credit-risk-related contingent features in derivative instruments. This statement applies to all entities and all derivative instruments. SFAS 161 is effective for financial statements issued for fiscal years andinterim periods beginning after November 15, 2008.   Since SFAS 161 only provides for additionaldisclosure requirements, there will be no impact on the Company’s financialposition or results of operations.

 

InApril 2008, the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determinationof the Useful Life of Intangible Assets”. FSP 142-3 amends the factors anentity should consider in developing renewal or extension assumptions used indetermining the useful life of recognized intangible assets under FASBStatement No. 142, “Goodwill and Other Intangible Assets”. This newguidance applies prospectively to intangible assets that are acquiredindividually or with a group of other assets in business combinations and assetacquisitions. FSP 142-3 is effective for financial statements issued for fiscalyears and interim periods beginning after December 15, 2008. Earlyadoption is prohibited. The Company is currently evaluating the impact that FSP142-3 will have on its consolidated financial statements.

 

InMay 2008, the FASB issued Staff Position No. APB 14-1, “Accountingfor Convertible Debt Instruments that May be Settled in Cash UponConversion.” APB 14-1 requires that the liability and equity components ofconvertible debt instruments that may be settled in cash upon conversion(including partial cash settlement) be separately accounted for in a mannerthat reflects an issuer’s nonconvertible debt borrowing rate. The resultingdebt discount is amortized over the period the convertible debt is expected tobe outstanding as additional non-cash interest expense. APB 14-1 is effectivefor financial statements issued for fiscal years beginning after December 15,2008, and interim periods within those fiscal years. Retrospective applicationto all periods presented is required except for instruments that were notoutstanding during any of the periods that will be presented in the annualfinancial statements for the period of adoption but were outstanding during anearlier period. The Company does not anticipate the adoption of this positionto have a material impact on its financial condition, results of operations andcash flows based on its existing debt securities.

 

**NOTE 3 - STOCK-BASED COMPENSATION**

 

Duringthe three and six months ended June 30, 2008, the Company granted equityawards including restricted stock, restricted stock units and stock options.Such awards generally vest over a period of one to four years from the date ofgrant.  Restricted stock has the votingrights of common stock and the shares underlying restricted stock are issued andoutstanding.

 

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InNovember 2007, the Compensation Committee granted 962,249 shares ofperformance-based restricted stock units to certain senior executiveofficers.  On February 26, 2008, theCommittee determined, based on the Company’s and each executive officer’s levelof performance during the Company’s 2007 fiscal year, that 783,324 sharesunderlying the previously granted performance-based restricted stock units hadbeen earned, with 50% vesting immediately and 50% vesting on February 28,2009.  Each performance-based restrictedstock unit has a fair value of $2.99 per share, which equals the closing priceof the Company’s common stock on the NASDAQ Stock Market on the measurementdate of February 26, 2008.  In February 2008,the Compensation Committee also granted an additional 1,073,333performance-based awards to certain senior executive officers, subject to theattainment of goals determined by the Compensation Committee.  The Company may be subject to variable levelsof expense related primarily to the varying levels of performance, as well asfor fluctuations in the Company’s stock price as these awards are “marked tomarket” periodically prior to the date of the Compensation Committee’sdetermination on performance.

 

Thetotal stock-based compensation expense recognized in the condensed consolidatedstatements of operations is as follows:

 
| ** **                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(in thousands)**                             | ** ** |
| Cost of net sales                   |       | $                                                   | 334        |                                              | $          | 119 |   | $ | 594 |   | $ | 243 |   |
| Selling, general and administrative |       | 4,029                                               |       | 1,159                                             |       | 8,026 |   | 2,864 |   |
| Research and development            |       | 686                                                 |       | 906                                               |       | 1,224 |   | 1,832 |   |
| Total                               |       | $                                                   | 5,049      |                                              | $          | 2,184 |   | $ | 9,844 |   | $ | 4,939 |   |

 

Thefair value of each option award is estimated on the date of grant using theBlack-Scholes-Merton option valuation model and the weighted averageassumptions in the following table. The expected term of options granted isderived from historical data on employee exercise and post-vesting employmenttermination behavior. The risk free interest rate is based on the zero couponU.S. Treasury securities with an equivalent remaining term. Expected volatilityis based on the historical volatility of the Company’s stock. Theweighted-average per share fair value of stock options granted and theassumptions used, are as follows:

 
| ** **                                       | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                            | ** ** | **2007 (1)**                                 | ** ** | **2008** | ** ** | **2007 (1)** | ** ** |
| ** **                                       | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted-average per share fair value of  grants |       | $                                                   | 1.72       |                                              | —     |   | $ | 1.51 |   | — |   |
| Expected remaining term in years                 |       | 4.1                                                 |       | —                                            |       | 4.3 |   | — |   |
| Weighted average risk-free interest rate         |       | 2.77                                                | %          | —                                            |       | 2.38 | % | — |   |
| Expected dividend rate                           |       | 0.00                                                | %          | —                                            |       | 0.00 | % | — |   |
| Volatility                                       |       | 63                                                  | %          | —                                            |       | 63 | % | — |   |
|                                                  |            |                                                     |            |                                                   |            |  |  |  |  |  |  |

 

----

(1) Nostock options were granted during the three and six months ended June 30,2007.

 

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Optionactivity as of June 30, 2008 and changes during the six months ended June 30,2008 are as follows:

 
| ** **                                  | ** ** | **Number of  shares  outstanding  (in thousands)** | ** ** | **Weighted  average  exercise  price** | ** ** |
|---------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------|------------|
| Options outstanding, December 31, 2007 |       | 17,647                                                       |       | $                                      | 13.91      |   |
| Options granted                             |       | 510                                                          |       | 2.95                                   |       |
| Options exercised                           |       | (50                                                          | )          | 1.90                                   |       |
| Options forfeited or expired                |       | (3,212                                                       | )          | 16.86                                  |       |
|                                        |       |                                                         |       |                                   |       |
| Options outstanding, June 30, 2008     |       | 14,895                                                       |       | $                                      | 12.94      |   |

 

Nonvestedrestricted stock and restricted stock units as of June 30, 2008, andchanges during the six months ended June 30, 2008, are as follows:

 
| ** **                          | ** ** | **Shares  (in thousands)** | ** ** | **Weighted average  grant date fair value** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------|------------|
| Nonvested at December 31, 2007 |       | 6,370                           |       | $                                                               | 3.09       |   |
| Granted                             |       | 5,367                           |       | 2.88                                                            |       |
| Vested                              |       | (1,256                          | )          | 2.87                                                            |       |
| Forfeited                           |       | (765                            | )          | 2.88                                                            |       |
| Nonvested at June 30, 2008     |       | 9,716                           |       | $                                                               | 3.02       |   |

 

AtJune 30, 2008, there was approximately $36.6 million of total unrecognizedcompensation cost, related to non-vested stock options, restricted stock andrestricted stock units, adjusted for forfeitures, which is expected to berecognized over a weighted average period of 2.3 years. For additionalinformation regarding the Company’s stock-based compensation plans, see theCompany’s Annual Report on Form 10-K for the year ended December 31,2007.

 

**NOTE****4 - LOSS PER SHARE**

 

Basicearnings per share (“EPS”) is computed by dividing net loss available to commonstockholders by the weighted average number of shares of the Company’s commonstock outstanding during the period, which excludes nonvested restricted stock.Diluted EPS presents the amount of net loss available to each share of commonstock outstanding during the period plus each share of common stock that wouldhave been outstanding assuming the Company had issued shares of common stockfor all dilutive potential common shares outstanding during the period. TheCompany’s potentially dilutive common shares include convertible subordinatednotes prior to their maturity, outstanding stock options, nonvested restrictedstock and restricted stock units and Employee Stock Purchase Plan (“ESPP”)shares.

 

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Thefollowing is a summary of the calculation of basic and diluted loss per share:

 
| ** **                          | ** ** | **Three months ended June 30,**               | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                          | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(in thousands except per share data)** | ** ** |
| ***Numerator***                     | ** ** | ** **                                                        | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss                            |       | $                                                                 | (38,780    | )                                                 | $          | (61,707 | ) | $ | (13,423 | ) | $ | (115,690 | ) |
|                                |       |                                                              |       |                                              |       |   |   |   |   |
| ***Denominator***                   |       |                                                              |       |                                              |       |   |   |   |   |
| Weighted-average shares outstanding |       | 123,119                                                           |       | 120,982                                           |       | 122,608 |   | 120,941 |   |
|                                |       |                                                              |       |                                              |       |   |   |   |   |
| Loss per share - basic and diluted  |       | $                                                                 | (0.31      | )                                                 | $          | (0.51 | ) | $ | (0.11 | ) | $ | (0.96 | ) |

 

Forthe three and six months ended June 30, 2008 and 2007, no potential commonshares were dilutive because of the net loss in each of these periods.  The following table summarizes the totalpotential shares of common stock that were excluded from the diluted per sharecalculation:

 
| ** **                                             | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                             | ** ** |
| Stock options and ESPP shares                          |       | 17,034                                              |       | 18,302                                            |       | 17,105 |   | 18,812 |   |
| Assumed conversion of convertible  subordinated notes  |       | —                                              |       | 11,543                                            |       | 3,805 |   | 11,543 |   |
| Nonvested restricted stock and restricted  stock units |       | 9,977                                               |       | 516                                               |       | 8,982 |   | 575 |   |
|                                                   |       | 27,011                                              |       | 30,361                                            |       | 29,892 |   | 30,930 |   |

 

**NOTE 5 - COMPREHENSIVE LOSS**

 

Thereconciliation of net loss to comprehensive loss for the three and six monthsended June 30, 2008 and 2007 is as follows:

 
| ** **                                                                                     | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                     | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                                     | ** ** | **(in thousands)**                             | ** ** |
| Net loss                                                                                       |       | $                                                   | (38,780    | )                                                 | $          | (61,707 | ) | $ | (13,423 | ) | $ | (115,690 | ) |
| Unrealized gain (loss) on investments, net  of tax                                             |       | (273                                                | )          | 52,141                                            |       | (1,723 | ) | 48,271 |   |
| Reclassification adjustment related to  realization of previously unrealized gains, net of tax |       | —                                              |       | —                                            |       | (38,302 | ) | — |   |
| Foreign currency translation                                                                   |       | 4,507                                               |       | 7,241                                             |       | 12,271 |   | 11,908 |   |
| Total comprehensive loss                                                                       |       | $                                                   | (34,546    | )                                                 | $          | (2,325 | ) | $ | (41,177 | ) | $ | (55,511 | ) |

 

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Thecomponents of accumulated other comprehensive income reported in the condensedconsolidated balance sheets are as follows:

 
| ** **                                                           | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                                                           | ** ** | **(in thousands)** | ** ** |
| Unrealized (loss) gain on  available-for-sale securities, net of tax |       | $                       | (2,699     | )                     | $          | 35,949 |   |
| Foreign currency translation                                         |       | 67,248                  |       | 56,354                |       |
| Accumulated other comprehensive income                               |       | $                       | 64,549     |                  | $          | 92,303 |   |

 

**NOTE 6 - CASH, CASH EQUIVALENTS, INVESTMENTS AND FAIR VALUEMEASUREMENTS**

 

Cashand cash equivalents are recorded at cost. Short-term investments, consistingof bank notes and available-for-sale securities, were $0.9 million and$65.6 million at June 30, 2008 and December 31, 2007,respectively.   Short-term investmentsdecreased at June 30, 2008 from December 31, 2007 primarily due tothe sale of investments with a carrying value of $42.4 million at December 31,2007.  The available-for-sale securitiesinvestments are recorded at fair value (see below).  Any unrealized holding gains or losses arereported as a component of other comprehensive income, net of related incometax effects. Realized gains and losses are reported in earnings.  At June 30, 2008, the long-terminvestments included $2.7 million of unrealized holding loss which was recordedin accumulated other comprehensive income. There was no unrealized holding gainor loss in short-term investments.   At December 31,2007, the long-term and short-term investments included $1.0 million ofunrealized holding loss and $36.9 million of unrealized holding gain,respectively.

 

TheCompany accepts bank notes receivable with maturity dates of between three andsix months from its customers in China in the normal course of business.  The Company may discount these bank noteswith banking institutions in China. The Company sold $7.7 million and $30.5million of bank notes, and recorded costs of $0.1 million and $0.4 million as aresult of discounting the notes, during the three and six months ended June 30,2008, respectively.  There were no banknotes sold during the three and six months ended June 30, 2007.

 

Thefollowing table shows the break-down of the Company’s total investments at June 30,2008 and December 31, 2007:

 
| ** **                   | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                   | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
| ***Equity Securities***      | ** ** | ** **              | ** ** | ** **            | ** ** |
| Gemdale Company, Ltd         |       | $                       | —     |                  | $          | 30,595 |   |
| Infinera                     |       | —                  |       | 11,759                |       |
| Global Asia Partners L.P.    |       | 2,211                   |       | 2,113                 |       |
| Cortina                      |       | 3,348                   |       | 3,013                 |       |
| MRV                          |       | 1,808                   |       | 3,523                 |       |
| GCT SemiConductor, Inc. |       | 3,000                   |       | 3,000                 |       |
| Xalted Networks              |       | 3,302                   |       | 3,302                 |       |
| Others                       |       | 2,542                   |       | 1,716                 |       |
| ***Bank Notes***             |       | 889                     |       | 23,275                |       |
| Total investments            |       | $                       | 17,100     |                  | $          | 82,296 |   |
|                         |       |                    |       |                  |       |
| Short-term investments       |       | 889                     |       | 65,629                |       |
| Long-term investments        |       | 16,211                  |       | 16,667                |       |

 

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*Gemdale*

 

Gemdale Co., Ltd(“Gemdale”) is a real estate company that invests and develops properties inChina, primarily in Shanghai, Beijing, Shenzhen and Wuhan.  During the first quarter of 2008, the Companysold its remaining investment for approximately $32.9 million cash andrecorded a gain of $32.4 million in other income (expense), net.

 

*Infinera*

 

Infinera Corporation (“Infinera”)develops optical telecommunications systems using photonic integratedcircuits.  Infinera became a publiccompany as a result of its initial public offering in June 2007.  During the first quarter of 2008, the Companysold all of its investment in Infinera for total proceeds of $9.2 millionand recognized a gain of $7.3 million in other income (expense), net.

 

*MRV*

 

On July 1, 2007, Fiberxon, an investment in which the Company hada 7% ownership interest, completed a merger with MRV Communications (“MRV”),which is a publicly-traded company in an active market. In exchange for theCompany’s interest in Fiberxon, the Company was entitled to receive$1.5 million in cash, 1,519,365 shares of MRV common stock valued atapproximately $4.5 million and deferred consideration of approximately $2.7 million.The deferred consideration becomes payable upon the completion of certainmilestones and may be reduced by legitimate claims of MRV for certain mattersrelated to the merger. In the third quarter of 2007, the Company was paid thecash consideration of $1.5 million and received 1,519,365 shares of MRVcommon stock and recognized a gain on investment of $2.9 million. Duringthe three and six months ended June 30, 2008, the Company recorded anunrealized loss of $0.3 million and $1.7 million, respectively, in othercomprehensive income, representing the change in fair value of the investmentduring the period.  The accumulatedunrealized loss at June 30, 2008 was $2.7 million, representing thedifference between the fair value of the investment on June 30, 2008 andthe initial amount recorded of $4.5 million when the MRV shares werereceived in 2007.  Because the Companyhas the ability and intent to hold this investment until a recovery of fairvalue, the Company does not consider this investment to beother-than-temporarily impaired. At June 30, 2008, MRV is the onlyinvestment accounted for under SFAS 115, “Accounting for Certain Investments inDebt and Equity Securities”.

 

**Fair Value Measurements**

 

Asdiscussed in Note 2, effective January 1, 2008, the Company adoptedSFAS 157 as it relates to financial assets and liabilities that are beingmeasured and reported at fair value on a recurring basis.  Althoughthe adoption of SFAS 157 did not materially impact its financial condition,results of operations, or cash flows, the Company is now required to provideadditional disclosures as part of its financial statements.  Inaccordance with FSP 157-2, the Company deferred adoption of SFAS 157 as itrelates to non-financial assets and liabilities measured at fair value on anonrecurring basis.

 

SFAS No. 157clarifies that fair value is an exit price, representing the amount that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants. As such, fair value is amarket-based measurement that should be determined based on assumptions thatmarket participants would use in pricing an asset or liability. As a basisfor considering such assumptions, SFAS No. 157 establishes a three-tiervalue hierarchy, which prioritizes the inputs used in measuring fair value asfollows: (Level 1) observable inputs such as quoted prices in active markets;(Level 2) inputs other than the quoted prices in active markets that areobservable either directly or indirectly, or quoted prices in less activemarkets; and (Level 3) unobservable inputs in which there is little or nomarket data, which require us to develop our own assumptions. This hierarchyrequires the Company to use observable market data, when available, and tominimize the use of unobservable inputs when determining fair value. On arecurring basis, the Company measures certain financial assets at fair value,including its marketable securities.

 

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AtJune 30, 2008, the Company’s investment in MRV is an available-for-salesecurity recorded at fair value, classified within Level 1 of the fairvalue hierarchy.  The Company has noother financial assets or liabilities that are being measured at fair value at June 30,2008.

 

**NOTE 7 - RESTRICTED CASH**

 

AtJune 30, 2008, the Company had short-term restricted cash of $17.4million, and had long-term restricted cash of $15.8 million included in otherlong-term assets. At December 31, 2007 the Company had short-termrestricted cash of $6.4 million, and had long-term restricted cash of$20.2 million included in other long-term assets. These amounts primarilycollateralize the Company’s issuances of standby and commercial letters ofcredit.

 

**NOTE 8 - NOTES RECEIVABLE AND RECEIVABLES PURCHASE AGREEMENT**

 

Commercialnotes receivable available for sale were $8.6 million and $12.6 million atJune 30, 2008 and December 31, 2007, respectively. The Company maydiscount these commercial notes with banking institutions in China. A sale ofthese notes is reflected as a reduction of notes receivable and the proceeds ofthe settlement of these notes are included in cash flows from operating activitiesin the consolidated statement of cash flows. There were no commercial notesreceivable sold during the three and six months ended June 30, 2008 and2007.

 

In August 2005,the Company entered into a Committed Receivables Purchase Agreement (“Agreement”)with a financial institution, whereby the Company could sell up to$100.0 million of its eligible accounts receivable, as defined in theAgreement.  In March 2008, theCompany terminated the Agreement. No receivables were sold pursuant to thisarrangement and no premiums or penalties were incurred by the Company inconnection with the termination of this credit facility.

 

**NOTE****9 - INVENTORIES**

 

Asof June 30, 2008 and December 31, 2007, total inventories consistedof the following:

 
| ** **        | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **        | ** ** | **(in thousands)** | ** ** |
|              |       |                    |       |                  |       |
| Raw materials     |       | $                       | 24,039     |                  | $          | 34,413 |   |
| Work-in-process   |       | 31,615                  |       | 35,853                |       |
| Finished goods    |       | 140,399                 |       | 264,201               |       |
| Total Inventories |       | $                       | 196,053    |                  | $          | 334,467 |   |

 

AtJune 30, 2008, the Company had inventories of approximately $208.0 millionincluded in assets held for sale, see Note 10.

 

**NOTE****10 – ASSETS HELD FOR SALE**

 

Beginningin the fourth quarter of 2007, the Company launched a number of initiatives,including potential divestitures of non-core assets, to focus on its coregrowth technologies, including IPTV, IP-based softswitch and broadband devices.On June 30, 2008, the Company entered into an agreement to sell UTStarcomPersonal Communications LLC, a wholly-owned subsidiary of the Company (“PCD”)to an entity controlled by AIG Global Investment Group and certain otherinvestors. The transaction closed on July 1, 2008 (See Note 22).  Previously, PCD was a reportable segment ofthe Company.

 

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Asof June 30, 2008, the Company determined that the “held for sale” criteriain FASB Statement No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets,” (“SFAS 144”) had been met for the PCD assets andliabilities. As the sale of PCD is anticipated to result in a gain to berecorded in the third quarter of 2008, no adjustments to the carrying values ofthe net assets were made. Assets and liabilities for PCD are included in assetsheld for sale and liabilities held for sale in the condensed consolidatedbalance sheet as of June 30, 2008. The following table summarizes the net assets held for sale as of June 30,2008 (in thousands):

 
| Accounts receivable, net                    |   | $       | 125,783 |   |
|---------------------------------------------|--------|---------|---------|--------|
| Inventories, net                            |   | 208,042 |    |
| Deferred costs                              |   | 13,652  |    |
| Prepaids and other current assets           |   | 9,019   |    |
| Property, plant and equipment, net          |   | 1,611   |    |
| Intangible assets, net                      |   | 15,783  |    |
| Other assets                                |   | 39      |    |
|                                        |   |    |    |
| Assets held for sale                        |   | $       | 373,929 |   |
|                                        |   |    |    |
| Accounts payable                            |   | $       | 89,856  |   |
| Customer advances                           |   | 18,262  |    |
| Deferred revenue                            |   | 7,379   |    |
| Accrued liabilities and other               |   | 39,456  |    |
|                                        |   |    |    |
| Liabilities related to assets held for sale |   | $       | 154,953 |   |
|                                        |   |    |    |
| Net assets held for sale                    |   | $       | 218,976 |   |

 

Inaccordance with SFAS 144, the Company ceased depreciation on the assets to besold upon executing the agreement to sell PCD. The operations and cash flows ofthe PCD business will not be accounted for and presented as a discontinuedoperation because of expected significant continuing direct cash flows pursuantto a three-year supply agreement whereby the Company will continue to sellhandset products to the divested entity.

 

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**NOTE 11 - INTANGIBLE ASSETS**

 

Asof June 30, 2008 and December 31, 2007, intangible assets consistedof the following:

 
| ** **                         | ** ** | **June 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **Gross**                   | ** ** | ** **                      | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                         | ** ** | **Carrying**                | ** ** | **Accumulated**                 | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Impairment** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                         | ** ** | **Amount**                  | ** ** | **Amortization**                | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Charges** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
| ** **                         | ** ** | **(in thousands)**     | ** ** |
| ***Amortized intangible assets:*** |       |                        |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Existing technology                |       | $                           | —     |                            | $          | — |   | $ | — |   | $ | 39,530 |   | $ | (5,214 | ) | $ | (33,843 | ) | $ | 473 |   |
| Customer relationships             |       | 11,128                      |       | (5,656                          | )          | 5,472 |   | 57,220 |   | (10,458 | ) | (24,676 | ) | 22,086 |   |
| Trade names                        |       | —                      |       | —                          |       | — |   | 4,940 |   | — |   | (4,940 | ) | — |   |
| Non-compete agreement              |       | —                      |       | —                          |       | — |   | 10,800 |   | — |   | (8,550 | ) | 2,250 |   |
|                               |       | $                           | 11,128     |                            | $          | (5,656 | ) | $ | 5,472 |   | $ | 112,490 |   | $ | (15,672 | ) | $ | (72,009 | ) | $ | 24,809 |   |

 

Amortizationexpense was $1.7 million and $4.0 million for the three months ended June 30,2008 and 2007, respectively, and was $3.6 million and $8.1 million for the sixmonths ended June 30, 2008 and 2007, respectively. In the fourth quarterof 2007, the Company determined that the undiscounted cash flows are notsufficient to recover the carrying value of the customer relationships andtechnology intangible assets within the Other segment and recorded anintangible asset impairment charge of $15.7 million.

 

Theestimated aggregate amortization expense for intangibles for the remainder of2008 and each of the next four years and thereafter is as follows:

 
| ** **        | ** ** | **(in thousands)** | ** ** |
|-------------------|------------|-------------------------|------------|
| Remainder of 2008 |       | $                       | 556        |   |
| 2009              |       | 1,113                   |       |
| 2010              |       | 1,113                   |       |
| 2011              |       | 1,113                   |       |
| 2012              |       | 1,113                   |       |
| Thereafter        |       | 464                     |       |
|              |       | $                       | 5,472      |   |

 

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**NOTE 12 - DEBT**

 

Thefollowing represents the outstanding borrowings at June 30, 2008 and December 31,2007:

 
| ** **                                                  | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                                                  | ** ** | **(in thousands)** | ** ** |
| Bank loans                                                  |       | $                       | 29,158     |                  | $          | 47,981 |   |
| Capital lease obligations, at 4.7%-10.0%,  due through 2011 |       | —                  |       | 581                   |       |
| Convertible subordinated notes, due  March 1, 2008     |       | —                  |       | 274,600               |       |
| Total Debt                                                  |       | $                       | 29,158     |                  | $          | 323,162 |   |
| Long-term debt                                              |       | —                  |       | 333                   |       |
| Short-term debt                                             |       | $                       | 29,158     |                  | $          | 322,829 |   |

 

AtJune 30, 2008, the Company had $29.2 million of bank loans withinterest rates ranging 6.3% to 6.6% per annum. These bank loans mature during2008 and are included in short-term debt. There are no significant covenantsassociated with these loans.

 

AtJune 30, 2008, the Company had credit facilities totaling$161.8 million, of which $43.7 million was for working capitalpurposes and the remaining $118.1 million was for use in support ofletters of credits and corporate guarantees. As of June 30, 2008, $153.8 million of the total creditfacilities remained available. All of these facilities expire in late2008.  As of June 30, 2008, theCompany had not guaranteed any debt not included in the condensed consolidatedbalance sheet.

 

On March 21,2008, the Company entered into a credit agreement providing for a $75.0 millionsecured revolving credit facility that was subject to an accounts receivableand inventory borrowing base formula and was used during the second quarter of2008 to fund the Company’s general working capital requirements.  Duringthe quarter, the Company repaid all outstanding borrowings under thisarrangement. On June 30, 2008, in connection with the entry into anagreement for the sale of the PCD segment (see Note 22), the Company terminatedthe commitments under the credit agreement. Upon termination of the creditagreement, the Company expensed the remaining unamortized debt issuance costsof approximately $1.1 million.

 

On March 12, 2003, the Company completed an offering of$402.5 million of 7/8% convertiblesubordinated notes due March 1, 2008 to qualified buyers pursuant to Rule 144Aunder the Securities Act of 1933.  In2007, the Company and holders of the remaining $274.6 million ofconvertible subordinated notes entered into two supplemental indentures waivingcertain provisions of the original agreement and providing for an increase inthe interest rate. The notes were convertible into the Company’s common stock,under certain conditions, at a conversion price of $23.79 per share and weresubordinated to all present and future senior debt of the Company.  On March 3, 2008, the Company repaid theconvertible subordinated notes of $289.5 million which included a principalpayment of $274.6 million and the accrued interest of $14.9 million.

 

**NOTE 13 - WARRANTY OBLIGATIONS AND OTHER GUARANTEES**

 

The Company provides a warranty on its equipment and handset sales fora period generally ranging from one to two years from the time of finalacceptance. At times, the Company has entered into arrangements to providelimited warranty services for periods longer than two years. The Companyprovides for the expected cost of product warranties at the time that revenueis recognized based on an assessment of past warranty experience and whenspecific circumstances dictate. From time to time, the Company may be subjectto additional costs related to non-standard warranty claims from its customers.If and when this occurs, the Company estimates additional accruals based onhistorical experience, communication with its customers and various assumptionsthat the Company believes to be reasonable under the circumstances. Suchadditional warranty accruals are recorded in the period in which the additionalcosts are identified.

 

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Warrantyobligations, included in other current liabilities, are as follows:

 
| ** **                                                                     | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **(in thousands)**                             | ** ** |
| Balance at beginning of period                                                 |       | $                                                   | 49,572     |                                              | $          | 59,819 |   | $ | 52,734 |   | $ | 66,408 |   |
| Accruals for warranties issued during the  period                              |       | 4,354                                               |       | 7,769                                             |       | 11,587 |   | 11,066 |   |
| Settlements made during the period                                             |       | (8,222                                              | )          | (11,464                                           | )          | (18,617 | ) | (21,350 | ) |
| Warranty obligations related to PCD  reclassified to liabilities held for sale |       | (10,124                                             | )          | —                                            |       | (10,124 | ) | — |   |
| Balance at end of period                                                       |       | $                                                   | 35,580     |                                              | $          | 56,124 |   | $ | 35,580 |   | $ | 56,124 |   |

 

Certainof the Company’s sales contracts include provisions under which customers wouldbe indemnified by the Company in the event of, among other things, athird-party claim against the customer for intellectual property rightsinfringement related to the Company’s products. There are no limitations on the maximum potential future payments underthese guarantees.  The Company has notaccrued any amount in relation to these provisions as no such claims havedeveloped into assertable claims and the Company believes it has defensiblerights to the intellectual property embedded in its products.

 

**NOTE 14 - COMMITMENTS AND CONTINGENCIES**

 

***Litigation***

 

*Securities Class Action Litigation*

 

Beginning in October 2004, several shareholder class actionlawsuits alleging federal securities violations were filed against the Companyand various officers and directors of the Company. The actions have been consolidatedin United States District Court for the Northern District of California underthe caption *In re UTStarcom, Inc.Securities Litigation*, Master File No. C-04-4908-JW (PVT). Thelead plaintiffs in the case filed a First Amended Consolidated Complaint on July 26,2005. The First Amended Complaint alleged violations of the Securities ExchangeAct of 1934, and was brought on behalf of a putative class of shareholders whopurchased the Company’s stock after April 16, 2003 and before September 20,2004. On April 13, 2006, the lead plaintiffs filed a Second AmendedComplaint adding new allegations and extending the end of the class period to October 6,2005. In addition to the Company defendants, the plaintiffs are also suingSoftbank. Plaintiffs’ complaint seeks recovery of damages in an unspecifiedamount.

 

On June 2, 2006, the Company and the individual defendants filed amotion to dismiss the Second Amended Complaint. On March 21, 2007, theCourt granted defendants’ motion and dismissed plaintiffs’ Second AmendedComplaint. The Court granted plaintiffs leave to file a Third AmendedComplaint, which plaintiffs filed on May 25, 2007. On July 13, 2007,the Company and the individual defendants filed a motion to dismiss and amotion to strike the Third Amended Complaint. On March 14, 2008, the Courtgranted defendants’ motion and dismissed plaintiffs’ Third AmendedComplaint.  The Court granted plaintiffsleave to file a Fourth Amended Complaint, which plaintiffs filed on May 14,2008.  On June 13, 2008, consistentwith the Court’s March 14, 2008 dismissal order, the Company and theindividual defendants filed objections to the form and content of the FourthAmended Complaint.  On July 24,2008, the Court overruled the objections, but stated that the Company and theindividual defendants would be permitted to file a motion to dismiss and amotion to strike the Fourth Amended Complaint.

 

On September 4, 2007, a second shareholder class action complaintcaptioned *Peter Rudolph v. UTStarcom, et al.*,Case No. C-07-4578 SI, was filed in the United States District Court forthe Northern District of California against the Company and some of its currentand former directors and officers. The complaint alleges violations of theSecurities Exchange Act of 1934 through undisclosed improper accountingpractices concerning the Company’s historical equity award 

 

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grants.Plaintiff seeks unspecified damages on behalf of a purported class ofpurchasers of the Company’s common stock between July 24, 2002 and September 4,2007. On December 14, 2007, the Court appointed James R. Bartholomew leadplaintiff. On January 25, 2008, the lead plaintiff filed an amendedcomplaint.  On April 14, 2008, theCourt granted defendants’ motion to dismiss the amended complaint.  The Court granted the lead plaintiff leave tofile a second amended complaint no later than May 16, 2008 which was filedby the lead plaintiff on May 16, 2008. On June 6, 2008, defendants filed a motion to dismiss the secondamended complaint.

 

Due to the preliminary status of these lawsuits and uncertaintiesrelated to litigation, management is unable to evaluate the likelihood ofeither a favorable or unfavorable outcome. Accordingly, management is unable atthis time to estimate the effects of these complaints on the Company’sfinancial position, results of operations, or cash flows.

 

*Governmental Investigations*

 

OnMay 1, 2008, the U.S. Securities and Exchange Commission (the “SEC”)announced a final settlement agreement with the Company in connection with aninvestigation commenced by the SEC in September 2005.  The investigation involved the Company’sfinancial disclosures during prior reporting periods, historic option grantawards practices, certain historical sales contracts in China and othermatters. Without admitting or denying the allegations in the SEC’s complaint,the Company consented to a permanent injunction against any future violationsof certain books-and-records and internal control provisions of the federalsecurities laws. No monetary penalties were assessed against the Company.  In connection with the same investigation, Mr. Lu,the Company’s Chief Executive Officer at the time of the settlement and thecurrent Chairman of the Board of Directors, individually entered into asettlement agreement with the SEC. Without admitting or denying the allegationsin the SEC’s complaint, Mr. Lu agreed to pay a civil penalty of $100,000and consented to a permanent injunction on similar terms as the Company.

 

In December 2005, the U.S. Embassy in Mongolia informed theCompany that it had forwarded to the Department of Justice (the “DOJ”)allegations that an agent of the Company’s Mongolia joint venture had offeredpayments to a Mongolian government official in possible violation of theForeign Corrupt Practices Act (the “FCPA”). The Company, through its AuditCommittee, authorized an independent investigation into possible violations ofthe FCPA, and it has been in contact with the DOJ and SEC regarding theinvestigation. The investigation has identified possible FCPA violations inMongolia, Southeast Asia, India, and China, as well as possible violations ofU.S. immigration laws. The DOJ has requested that the Company voluntarilyproduce documents related to the investigation, the SEC has subpoenaed theCompany for documents, and the Company has received a Grand Jury Subpoenarequiring the production of documents related to one aspect of the DOJinvestigation, that is, training programs the Company had sponsored. TheCompany has executed tolling agreements extending the statute of limitationsfor the FCPA issues under investigation by the DOJ. Such proceedings may resultin criminal or civil sanctions, penalties and disgorgements against theCompany. If it is probable that an obligation of the Company exists and willresult in an outflow of resources, a provision will be recorded if the amountcan be reasonably estimated. Regulatory and legal proceedings as well asgovernment investigation often involve complex legal issues and are subject tosubstantial uncertainties. Accordingly, management exercises considerablejudgment in determining whether it is probable that such a proceeding willresult in outflow of resources and whether the amount of the obligation can bereasonably estimated. The Company periodically reviews the status of theseproceedings and these judgments are subject to change as new informationbecomes available. At this time, the Company cannot predict when any inquirywill be completed or what the outcome of any inquiry will be. The Company isunable to reasonably estimate the total amount of loss, if any, associated withthe proceedings. A judgment against the Company may have a material adverseeffect on the Company’s financial position, results of operations and cashflows.

 

*Shareholder Litigation*

 

On November 17, 2006, a shareholder derivative complaint captioned*Ernesto Espinoza v. Ying Wu et al.*,Case No. RG06298775, was filed against certain of the Company’s currentand former officers and directors in the Superior Court of the County ofAlameda, California. The complaint alleges that the individual defendants,among other things, breached their duties, were unjustly enriched, and violatedthe California Corporations Code in connection with the timing of stock optiongrants. The complaint names the Company as a nominal defendant and seeksunspecified monetary damages against the 

 

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individualdefendants and various forms of injunctive relief. On February 2, 2007,the Company and the individual defendants filed demurrers against thecomplaint. On April 11, 2007, the Court sustained the individualdefendants’ demurrer, overruled the Company’s demurrer, ordered the plaintiffto file an amended complaint, and ordered the Company to answer the originalcomplaint. The plaintiff filed an amended complaint and the Company has filedan answer to the amended complaint. On August 21, 2007, the individualdefendants filed demurrers against the amended complaint. The Court sustainedthe individual defendants’ demurrers and ordered the plaintiff to file asecond amended complaint. The plaintiff has until September 5, 2008 tofile his second amended complaint.

 

Due to the preliminary status of this complaint and uncertaintiesrelated to litigation, management of the Company is unable to evaluate thelikelihood of either a favorable or unfavorable outcome. Accordingly,management of the Company is unable at this time to estimate the effects ofthis complaint on the Company’s financial position, results of operations, orcash flows.

 

*IPO Allocation*

 

On October 31, 2001, a complaint was filed in United StatesDistrict Court for the Southern District of New York against the Company, someof the Company’s directors and officers and various underwriters for theCompany’s initial public offering. Substantially similar actions were filedconcerning the initial public offerings for more than 300 different issuers,and the cases were coordinated as *In reInitial Public Offering Securities Litigation*, 21 MC 92 for pretrialpurposes. In April 2002, a consolidated amended complaint was filed in thematter against 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 inpart a motion to dismiss the claims brought by defendants including theCompany. The order dismissed all claims against the Company except for a claimbrought under Section 11 of the Securities Act of 1933, which alleges thatthe registration statement filed in accordance with the IPO was misleading. In June 2004,a stipulation of settlement and release of claims against the issuerdefendants, including the Company, was submitted to the court for approval. Theterms of the settlement, if approved, would have dismissed and released allclaims against the participating defendants (including the Company). In August 2005,the Court preliminarily approved the settlement. In December 2006, theCourt of Appeals for the Second Circuit reversed the Court’s October 2004order certifying a class in six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings. TheCompany’s case is not one of the test cases. Because class certification was acondition of the settlement, it was unlikely that the settlement would receivefinal Court approval. On June 25, 2007, the Court entered an orderterminating the proposed settlement based on a stipulation among the parties tothe settlement. Plaintiffs have filed amended master allegations and amendedcomplaints and moved for class certification in the six test cases, which thedefendants in those cases have opposed. On March 26, 2008, the Courtlargely denied the defendants’ motion to dismiss the amended complaints.  It is unclear whether there will be anyrevised or future settlement. If the litigation proceeds, management of theCompany believes that the Company has meritorious defenses and management ofthe Company intends to defend the action vigorously. The total amount of theloss associated with the above litigation is not determinable at this time.Therefore, management of the Company is unable to currently estimate the loss,if any, associated with the litigation.

 

*UTStarcom, Inc. v. Starent Patent InfringementLitigations*

 

On February 16, 2005, the Company filed a suit against Starent forpatent infringement in the U.S. District Court for the Northern District ofCalifornia. In the Complaint, the Company asserted that Starent infringesUTStarcom patent U.S. Reg. No. 6,829,473 (“the ‘473 patent”) throughStarent’s development and testing of a software upgrade for its customer’sinstalled ST-16 Intelligent Mobile Gateways. The Company seeks declaratory andinjunctive relief. Starent subsequently filed its answer and counterclaims, andthe Company then filed a motion to dismiss Starent’s counterclaim. On July 19,2005, the parties stipulated that Starent would file an amended answer andcounterclaim and the Company then responded to Starent’s 

 

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amendedcounterclaim. In early December 2006, the Company filed a reissueapplication for the ‘473 patent with the United States Patent and TrademarkOffice. Starent has also filed for reexamination of the ‘473 patent. Thereexamination and reissue are currently co-pending. The litigation is still ina preliminary stage, and is stayed pending the outcome of the reissue. Thelitigation and its outcome cannot be predicted, although management of theCompany believes the litigation has merit. Nonetheless, management of theCompany believes that any adverse judgment on Starent’s counterclaims will nothave a material adverse effect on the Company’s business, financial condition,results of operations or cash flows.

 

OnMay 8, 2007, the Company filed an additional suit against Starent andsixteen individual defendants (who were all former employees of 3Com’sCommWorks division, of which the Company acquired certain assets in May of2003) in the Northern District of Illinois. The causes of action include claimsfor patent infringement, misappropriation of trade secrets, intentionalinterference with business relations and prospective economic advantage anddeclarations of ownership of certain patent rights. The Company seekscompensatory damages, punitive damages and injunctive relief. After the courtdenied the defendant’s motion to dismiss the misappropriation of trade secretsclaims, on August 30, 2007, Starent answered the Company’s complaint,denying the Company’s allegations and asserting a number of affirmativedefenses and counterclaims. The Company has filed an Amended Complaint toallege additional related causes of action. Starent moved to dismiss certaincauses of action of the Amended Complaint. The Court has appointed a specialmaster to handle discovery and issues related to identification of the tradesecrets. On May 30, 2008, the Company amended its complaint to remove fromsuit U.S. patent 6,978,128, and to add additional factual allegations relatingto all defendants in the case. On July 23, 2008, the Court struck theCompany’s trade secret and contract-based counts.  The Company is asking the Court to clarifythat ruling and has simultaneously filed a motion for leave to file a FourthAmended Complaint.  Discovery and motionpractice is ongoing. The Company believes that any adverse judgment on Starent’scounterclaims will not have a material adverse effect on the Company’sbusiness, financial condition, results of operations or cash flows.

 

*Telemetrix, Inc. Arbitration*

 

On October 19, 2006, Telemetrix, Inc. (“Telemetrix”) filed aformal Request for Arbitration against the Company to the World IntellectualProperty Organization (“WIPO”) in Geneva, Switzerland. The Request forArbitration sought unspecified damages arising from a contract betweenTelemetrix and Telos Technology, Inc., dated October 22, 2003. TheCompany assumed Telos’ rights and obligations under this contract pursuant tothe Company’s purchase of Telos’ assets on May 19, 2004. Telemetrixalleged nine causes of action, including breach of contract, fraud, negligentmisrepresentation, interference with contractual relations, and interferencewith prospective economic advantage. In December 2006, the Company filed aformal response to the Request for Arbitration, denying all material factualallegations asserted by Telemetrix. An arbitrator was selected by the parties,and, on August 2, 2007, the arbitrator granted a pleading motion in favorof the Company due to Telemetrix’s failure to allege sufficient facts insupport of a majority of its causes of action. On August 17, 2007,Telemetrix filed an Amended Statement of Claim, alleging six causes of action,including breach of contract and fraud. Telemetrix seeks damages totalingapproximately $750,000 plus costs and attorneys’ fees.  The evidentiary hearing occurred on July 28-30,2008.  The matter has been submitted tothe Arbitrator.

 

*Other Litigation*

 

The Company is a party to other litigation matters and claims that arenormal in the course of operations, and while the results of such litigationmatters and claims cannot be predicted with certainty, management of the Companybelieves that the final outcome of such matters will not have a materialadverse impact on the Company’s financial position, results of operations orcash flows.

 

***Uncertain Tax Positions***

 

Effective January 1, 2007, the Company adopted the provisions ofFIN 48.  As of June 30, 2008, the Company had $82.8 million of grossunrecognized tax benefits. If recognized, the portion of gross unrecognized taxbenefits that would decrease the provision for income taxes and increase theCompany’s net income is $9.1 million. The impact on net income reflects thegross unrecognized tax benefits net of certain deferred tax assets and thefederal tax benefit of state income tax items totaling $73.7 million.

 

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***Letters of credit***

 

TheCompany issues standby letters of credit primarily to support internationalsales activities outside of China.  Whenthe Company submits a bid for a sale, often the potential customer will requirethat the Company issue a bid bond or a standby letter of credit to demonstrateits commitment through the bid process. In addition, the Company may be required to issue standby letters ofcredit as guarantees for advance customer payments upon contract signing orperformance guarantees.  The standbyletters of credit usually expire without being drawn by the beneficiarythereof.  Finally, the Company may issuecommercial letters of credit in support of purchase commitments.  As of June 30, 2008 the Company hadoutstanding letters of credit approximating $59.3 million.

 

**NOTE 15 - SEGMENT REPORTING**

 

During the fourth quarter of 2007, the Company announced a neworganization structure to align the business units with its corporate strategy.This new organization structure changed the reporting segments on which theCompany measures performance and allocates resources. Effective October 1,2007, the new reporting segments are as follows:

 

·                  BroadbandInfrastructure—Focused on the Company’s world class portfolio of broadbandproducts.

 

·                  MultimediaCommunications—Focused on development and market opportunities in IPTVsolutions and Wireless infrastructure technologies.

 

·                  Personal Communications Division(PCD)—Focused on distribution of mobile handsets, mainly in the UnitedStates.  On July 1, 2008 the Companysold PCD (See Note 22).

 

·                  Handsets—Focused on mobilephone business with continued focus on the PAS and CDMA handset market, as wellas data cards markets.

 

·                  Services—Focused onproviding services and support of our Broadband Infrastructure and MultimediaCommunications product lines.

 

·                  Other—includes Mobile Solutions which focusedon development, sales and services for the IPCDMA market; and Custom Solutionswhich focused on customized telecommunication solution.

 

The Company’smanagement makes financial decisions based on information it receives from itsinternal management system and currently evaluates the operating performance ofand allocates resources to the reporting segments based on segment revenue andgross profit. Cost of sales and direct expenses in relation to production areassigned to the reporting segments.  Theaccounting policies used in measuring segment assets and operating performanceare the same as those used at the consolidated level.

 

Summarizedbelow are the Company’s segment net sales, gross profit and segment margin forthe three and six months ended June 30, 2008 and 2007 based on the currentreporting segment structure.  The Companyhas reclassified its previously reported segment information for the three andsix months ended June 30, 2007 to conform to the current segmentpresentation.

 

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| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **% of net  sales**                     | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of net  sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| ***Net Sales by Segment*** | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Broadband Infrastructure                  |       | $                                                   | 35,888     |                                              | 6          | % | $ | 38,237 |   | 7 | % | $ | 61,479 |   | 5 | % | $ | 64,781 |   | 6 | % |
| Multimedia Communication                  |       | 74,018                                              |       | 12                                                | %          | 63,439 |   | 12 | % | 141,464 |   | 12 | % | 135,994 |   | 14 | % |
| PCD                                       |       | 448,864                                             |       | 71                                                | %          | 357,797 |   | 66 | % | 879,588 |   | 72 | % | 646,127 |   | 64 | % |
| Handsets                                  |       | 49,461                                              |       | 8                                                 | %          | 62,177 |   | 12 | % | 93,484 |   | 8 | % | 131,896 |   | 13 | % |
| Services                                  |       | 15,884                                              |       | 2                                                 | %          | 11,106 |   | 2 | % | 26,975 |   | 2 | % | 23,665 |   | 2 | % |
| Other                                     |       | 8,641                                               |       | 1                                                 | %          | 5,489 |   | 1 | % | 15,755 |   | 1 | % | 11,683 |   | 1 | % |
|                                      |       | $                                                   | 632,756    |                                              | 100        | % | $ | 538,245 |   | 100 | % | $ | 1,218,745 |   | 100 | % | $ | 1,014,146 |   | 100 | % |

 
| ** **                    | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                            | ** ** | **Gross  Profit %**                          | ** ** | **2007** | ** ** | **Gross  Profit %** | ** ** | **2008** | ** ** | **Gross  Profit %** | ** ** | **2007** | ** ** | **Gross  Profit %** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                  | ** ** |
| ***Gross profit by Segment*** | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Broadband Infrastructure      |       | $                                                   | 1,669      |                                              | 5          | % | $ | 10,105 |   | 26 | % | $ | 3,890 |   | 6 | % | $ | 14,314 |   | 22 | % |
| Multimedia Communication      |       | 28,818                                              |       | 39                                                | %          | 27,616 |   | 44 | % | 61,974 |   | 44 | % | 50,410 |   | 37 | % |
| PCD                           |       | 36,169                                              |       | 8                                                 | %          | 15,922 |   | 4 | % | 69,005 |   | 8 | % | 32,767 |   | 5 | % |
| Handsets                      |       | 6,781                                               |       | 14                                                | %          | 22,396 |   | 36 | % | 22,996 |   | 25 | % | 47,443 |   | 36 | % |
| Services                      |       | 4,794                                               |       | 30                                                | %          | 98 |   | 1 | % | 7,113 |   | 26 | % | 730 |   | 3 | % |
| Other                         |       | 3,717                                               |       | 43                                                | %          | 3,593 |   | 65 | % | 9,049 |   | 57 | % | 9,350 |   | 80 | % |
|                          |       | $                                                   | 81,948     |                                              | 13         | % | $ | 79,730 |   | 15 | % | $ | 174,027 |   | 14 | % | $ | 155,014 |   | 15 | % |

 
| ** **                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                               | ** ** | **(in thousands)**                             | ** ** |
| ***Segment Margin and Operating  Loss*** |       |                                                |       |                                              |       |   |   |   |   |
| Broadband Infrastructure                 |       | $                                                   | (4,715     | )                                                 | $          | 2,832 |   | $ | (8,941 | ) | $ | (1,407 | ) |
| Multimedia Communication                 |       | 16,262                                              |       | 9,540                                             |       | 32,457 |   | 14,883 |   |
| PCD                                      |       | 28,612                                              |       | 7,873                                             |       | 53,576 |   | 16,079 |   |
| Handsets                                 |       | (6,443                                              | )          | 9,138                                             |       | (5,422 | ) | 22,902 |   |
| Services                                 |       | 3,849                                               |       | (1,036                                            | )          | 4,795 |   | (1,257 | ) |
| Other                                    |       | (6,185                                              | )          | (5,347                                            | )          | (10,343 | ) | (8,999 | ) |
| Total segment margin                     |       | 31,380                                              |       | 23,000                                            |       | 66,122 |   | 42,201 |   |
| General and Corporate                    |       | (62,458                                             | )          | (78,339                                           | )          | (128,089 | ) | (149,799 | ) |
| Operating Loss                           |       | $                                                   | (31,078    | )                                                 | $          | (55,339 | ) | $ | (61,967 | ) | $ | (107,598 | ) |

 

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Assetsby segment are as follows:

 
| ** **                                | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                                | ** ** | **(in thousands)** | ** ** |
| ***Property, Plant and  Equipment, net*** |       |                    |       |                  |       |
| Broadband Infrastructure                  |       | $                       | 42,451     |                  | $          | 42,756 |   |
| Multimedia Communication                  |       | 78,281                  |       | 77,478                |       |
| PCD (1)                                   |       | —                  |       | 1,513                 |       |
| Handsets                                  |       | 42,883                  |       | 43,191                |       |
| Services                                  |       | 43,609                  |       | 43,922                |       |
| Other                                     |       | 35                      |       | 234                   |       |
|                                      |       | $                       | 207,259    |                  | $          | 209,094 |   |

 

----

(1)Included in assets held for sale at June 30, 2008

 
| ** **               | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|--------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **               | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **               | ** ** | **(in thousands)** | ** ** |
| ***Total assets***       |       |                    |       |                  |       |
| Broadband Infrastructure |       | $                       | 424,084    |                  | $          | 518,742 |   |
| Multimedia Communication |       | 552,501                 |       | 605,930               |       |
| PCD                      |       | 3,735                   |       | 357,004               |       |
| Handsets                 |       | 251,715                 |       | 360,075               |       |
| Services                 |       | 94,908                  |       | 85,269                |       |
| Other                    |       | 34,704                  |       | 57,568                |       |
| Assets held for sale (1) |       | 373,929                 |       | —                |       |
|                     |       |                    |       |                  |       |
|                     |       | $                       | 1,735,576  |                  | $          | 1,984,588 |   |

 

----

(1) Includes PCD assets held for sale at June 30, 2008

 

Sales are attributed to a geographical area based upon the location ofthe customer. Sales data by geographical area are as follows:

 
| ** **                               | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | ** **                                          | ** ** | **% of net**                            | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                               | ** ** | **2008**                                            | ** ** | **sales**                                         | ** ** | **2007** | ** ** | **sales** | ** ** | **2008** | ** ** | **sales** | ** ** | **2007** | ** ** | **sales** | ** ** |
| ** **                               | ** ** | **(in thousands)**                             | ** ** |
| ***Net sales by region*** | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States                            |       | $                                                   | 442,780    |                                              | 70         | % | $ | 361,334 |   | 67 | % | $ | 864,643 |   | 70 | % | $ | 654,502 |   | 65 | % |
| China                                    |       | 110,752                                             |       | 18                                                | %          | 129,222 |   | 24 | % | 227,874 |   | 19 | % | 265,956 |   | 26 | % |
| Japan                                    |       | 9,756                                               |       | 1                                                 | %          | 20,523 |   | 4 | % | 22,393 |   | 2 | % | 34,838 |   | 3 | % |
| Other                                    |       | 69,468                                              |       | 11                                                | %          | 27,166 |   | 5 | % | 103,835 |   | 9 | % | 58,850 |   | 6 | % |
| Total net sales                          |       | $                                                   | 632,756    |                                              | 100        | % | $ | 538,245 |   | 100 | % | $ | 1,218,745 |   | 100 | % | $ | 1,014,146 |   | 100 | % |

 

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Long-livedassets, consisting of property, plant and equipment, by geographical area areas follows:

 
| ** **              | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| U.S.                    |       | $                       | 17,645     |                  | $          | 18,470 |   |
| China                   |       | 184,090                 |       | 185,070               |       |
| Other                   |       | 5,524                   |       | 5,554                 |       |
| Total long-lived assets |       | $                       | 207,259    |                  | $          | 209,094 |   |

 

**NOTE 16 - RELATED PARTY TRANSACTIONS**

 

*Softbank and affiliates*

 

TheCompany recognizes revenue with respect to sales of telecommunicationsequipment to affiliates of Softbank, a significant stockholder of the Company.Softbank offers ADSL coverage throughout Japan, which is marketed under thename “YAHOO! BB.” The Company supports Softbank’s fiber-to-the-home servicethrough sales of its carrier class GEPON product as well as its NetRingÔ product. In addition, the Company supportsSoftbank’s internet protocol television (“IPTV”), through sales of itsRollingStreamÔ product. The Company recognized revenue forsales of telecommunications equipment and services to affiliates of Softbank of$9.4 million and $20.2 million, respectively, during the three months ended June 30,2008 and 2007 and $21.2 million and $33.3 million, respectively, during the sixmonths ended June 30, 2008 and 2007.

 

Includedin accounts receivable at June 30, 2008 and December 31, 2007 were$14.0 million and $26.3 million, respectively, related to thesetransactions. The Company had immaterial amounts of accounts payable toSoftbank and its affiliates at June 30, 2008 and December 31, 2007.

 

Salesto Softbank include a three year service period and a penalty clause if productfailure rates exceed a certain level over a seven year period. As of June 30,2008 and December 31, 2007, the Company’s customer advance balance relatedto Softbank agreements was $0.9 million and $0.3 million, respectively.  The current deferred revenue balance relatedto Softbank was $6.5 million and $5.6 million as of June 30, 2008 and December 31,2007, respectively.  As of June 30,2008, the Company’s non-current deferred revenue balance related to Softbankwas $9.7 million compared to $10.1 million as of December 31, 2007.

 

Asof June 30, 2008, Softbank beneficially owned approximately 12% of theCompany’s outstanding stock.

 

*Audiovox*

 

Oneof the Company’s officers serves as a director for Audiovox Corporation (“Audiovox”).The Company paid approximately $0.4 million during each of the three months endedJune 30, 2008 and 2007 and $0.8 million during each of the six monthsended June 30, 2008 and 2007 for IT services provided by Audiovox.

 

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**NOTE 17 - RESTRUCTURING COSTS**

 

Inthe fourth quarter of 2007, the Company implemented a restructuring plan (the “2007Plan”) to reduce operating costs. During the first quarter of 2008, the Companycompleted the reduction in force, reducing the Company’s headcount byapproximately 12%, or approximately 800 employees. The workforce reduction wasprimarily in the United States and China and, to a lesser degree, otherinternational locations.

 

AtJune 30, 2008 and December 31, 2007, the restructuring accrualincluded within other current liabilities in the consolidated balance sheet wasapproximately $1.2 million and $3.2 million, respectively. The decrease of $2.0million during the six months ended June 30, 2008 relates primarily tocash payments against the accrual related to the workforce reductions and leasecosts. The remaining restructuring liability is primarily related to a leaseobligation and will be settled over the remaining lease term, which expires infiscal year 2010.

 

**NOTE 18 - OTHER INCOME (EXPENSE), NET**

 

Otherincome (expense), net for the three and six months ended June 30, 2008 and2007, respectively are comprised of the following:

 
| ** **                                                                     | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **(in thousands)**                             | ** ** |
| Gain on sale of investments                                                    |       | $                                                   | —     |                                              | $          | — |   | $ | 39,679 |   | $ | 2,813 |   |
| Gain on liquidation of investment in a  variable interest entity (See Note 21) |       | —                                              |       | —                                            |       | 8,169 |   | — |   |
| Foreign exchange (losses) gains                                                |       | (1,559                                              | )          | (244                                              | )          | 4,150 |   | 814 |   |
| Other                                                                          |       | 639                                                 |       | 402                                               |       | 1,052 |   | 502 |   |
| Total                                                                          |       | $                                                   | (920       | )                                                 | $          | 158 |   | $ | 53,050 |   | $ | 4,129 |   |

 

**NOTE 19 - CREDIT RISK AND CONCENTRATION**

 

Thefollowing customers accounted for 10% or more of the Company’s net sales:

 
| ** **       | ** ** | **For the three** | ** ** | **For the six** | ** ** |
|------------------|------------|-----------------------------|------------|---------------------------|------------|
| ** **       | ** ** | **months ended**       | ** ** | **months ended**     | ** ** |
| ** **       | ** ** | **June 30,**           | ** ** | **June 30,**         | ** ** |
| ** **       | ** ** | **% of net**      | ** ** | **% of net**    | ** ** |
| **2008**         | ** ** | **sales**                   | ** ** | **sales**                 | ** ** |
| Verizon Wireless |       | 30                          | %          | 27                        | %          |
| Sprint Spectrum  |       | 13                          | %          | 15                        | %          |

 
| **2007**           | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------|------------|------------|------------|------------|------------|
| Verizon Wireless   |       | 21         | %          | 19         | %          |
| T-Mobile USA, Inc. |       | 19         | %          | 16         | %          |
| Sprint Spectrum    |       | 10         | %          | 11         | %          |

 

AtDecember 31, 2007, Sprint Spectrum L.P. and T-Mobile USA, Inc.accounted for approximately 16% and 15%, respectively, of the total accountsreceivable of the Company. Sales to Verizon, Sprint Spectrum and T-Mobile areprimarily from the PCD segment.  On July 1,2008 the Company sold the PCD segment (See Note 22).

 

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Approximately 11% and 18% of the Company’s net salesduring the three months ended June 30, 2008 and 2007, respectively, andapproximately 12% and 18%of the Company’s net sales during the six months ended June 30, 2008 and2007, respectively, were to entities affiliated with the government of China.Accounts receivable balances from these China government affiliated entities orstate owned enterprises were $129.7 million and $129.5 million, respectively,as of June 30, 2008 and December 31, 2007. The Company extends credit to its customers in China generally withoutrequiring collateral. With respect to global sales outside of China, theCompany may require letters of credit from its customers. The Company monitorsits exposure for credit losses and maintains allowances for doubtful accounts.

 

Approximately 18% and 24% of the Company’s net salesduring the three months ended June 30, 2008 and 2007, respectively, andapproximately 19% and 26%of the Company’s net sales during the six months ended June 30, 2008 and2007, respectively, were made in China.Accordingly, the political, economic and legal environment, as well as thegeneral state of China’s economy may influence the Company’s business,financial condition and results of operations. The Company’s operations inChina are subject to special considerations and significant risks not typicallyassociated with companies in the United States. These include risks associatedwith, among others, the political, economic and legal environments and foreigncurrency exchange. The Company’s results may be adversely affected by, among otherthings, changes in the political, economic and social conditions in China, andby changes in governmental policies with respect to laws and regulations,changes in China’s telecommunications industry and regulatory rules andpolicies, anti-inflationary measures, currency conversion and remittanceabroad, and rates and methods of taxation.

 

**NOTE 20 - INCOME TAX ASSETS AND LIABILITIES**

 

TheCompany adopted the provisions of FASB Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109”(FIN 48) on January 1, 2007. As of December 31, 2007, the Company’sgross unrecognized tax benefits totaled $79.7 million and are included in otherlong-term liabilities, net of certain deferred tax assets and the federal taxbenefit of state income tax items totaling $71.3 million. If recognized, theportion of gross unrecognized tax benefits that would decrease the provisionfor income taxes and increase the Company’s net income is approximately $8.4million.

 

Asof June 30, 2008, the Company’s gross unrecognized tax benefits totaled$82.8 million and are included in other long-term liabilities, net of certaindeferred tax assets and the federal tax benefit of state income tax itemstotaling $73.7 million. If recognized, the portion of gross unrecognized taxbenefits that would decrease the provision for income taxes and increase theCompany’s net income is approximately $9.1 million. The total unrecognized taxbenefits and increase for the current period of these unrecognized tax benefitsrelate primarily to the allocations of revenue and costs among the Company’sglobal operations.

 

TheCompany recognizes interest expense and penalties related to the aboveunrecognized tax benefits within income tax expense. The Company had accruedinterest and penalties of approximately $3.2 million as of December 31,2007 and approximately $3.6 million as of June 30, 2008.

 

TheCompany is subject to taxation in the U.S. federal jurisdiction and variousU.S. state and foreign jurisdictions. The Company’s income tax returns for the2003, 2004, and 2005 tax years are currently under audit by the United StatesInternal Revenue Service. The Company is also under audit by the taxingauthorities in China on a recurring basis. The material jurisdictions that theCompany is subject to examination are in the United States and China. TheCompany believes that it is reasonably possible that the amount of grossunrecognized tax benefits related to the resolution of income tax matters couldbe reduced by approximately $26 million during the next twelve months as incometax audits are settled and statute of limitations expire.  The portion of the $26 million of grossunrecognized tax benefits that would decrease the provision for income taxesand increase the Company’s net income is approximately $1 million, while theremainder would have no net impact on the Company’s financial statements.

 

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FIN48 established criteria for recognizing or continuing to recognize onlymore-likely-than tax positions, which may result in income tax expensevolatility in future periods. While the Company believes that it has adequatelyprovided for all tax positions, amounts asserted by taxing authorities could begreater than the Company’s accrued position. Accordingly, additional provisionson income tax related matters could be recorded in the future as revisedestimates are made or the underlying matters are settled or otherwise resolved.

 

Inestablishing its deferred income tax assets and liabilities, the Company makesjudgments and interpretations based on the enacted tax laws and published taxguidance applicable to its operations as well as the amount and jurisdiction offuture taxable income. The Company records deferred tax assets and liabilitiesand evaluates the need for valuation allowances to reduce the deferred taxassets to realizable amounts. The Company will maintain a full valuationallowance on its net deferred tax assets in China, the United States, and othercountries until an appropriate level of profitability that generates taxableincome is sustained or until the Company is able to develop tax strategies thatwould enable it to conclude that it is more likely than not that a portion ofits deferred tax assets will be realizable. Any reversal of valuationallowances will favorably impact the Company’s results of operations in theperiod of the reversal.

 

Incometax expense was $4.6 million and $3.3 million for the three months ended June 30,2008 and 2007, respectively.  Income taxbenefit was $0.4 million for the six months ended June 30, 2008compared to tax expense of $7.6 million for the six months ended June 30,2007.

 

TheChina Corporate Income Tax Law (“CIT Law”) became effective on January 1,2008.  As a result of the enactment ofnew regulations during the first quarter of 2008 which address CIT Law, theCompany had recorded an income tax benefit of $11.7 million in the firstquarter of 2008 related to reversing a deferred tax liability on foreignwithholding taxes related to the unremitted earnings of the Company’ssubsidiaries which the Company determined to not be permanently reinvestedoutside the United States.  The Companyalso had accrued $3.2 million of foreign withholding taxes in the first quarterof 2008 related to the realized gain on the sale of its investment inGemdale.  The Company has not providedany tax benefit on any forecasted current year losses incurred and tax creditsgenerated in the United States and other countries, because management believesthat it is more likely than not that the tax benefit associated with theselosses will not be realized. Also, the Company continues to accrue tax expensein jurisdictions where the Company has been historically profitable. Estimatesof the annual effective tax rate at the end of the interim periods are based onevaluations of possible future events and transactions and may be subject tosubsequent refinement or revision.

 

**NOTE 21—VARIABLE INTEREST ENTITIES**

 

During the fourth quarter of 2005, the Company provided aninterest free, $12.4 million loan to a party in China as seed capital fora venture organized to participate in providing technical service, networkingtechnology and equipment to the emerging market for IPTV products in China. Theloan, partially secured by an indirect ownership interest in the venture, waspayable in 10 years and could be called early without penalty. As a resultof the foregoing, and the fact that the venture’s continuing viability washeavily dependent on the further provision of network and terminal equipment bythe Company, the Company determined that the venture was a variable interestentity (“VIE”) and that the Company was the primary beneficiary of the venture.Therefore, the Company was required to consolidate the VIE’s financialstatements. The consolidation of this VIE in prior years did not have asignificant impact on the Company’s consolidated financial statements. In March 2008,the Company received a repayment in full of the loan’s principal balance,eliminating its interest in the VIE, and resulting in reconsideration of theCompany’s position as the primary beneficiary. Based on this reconsiderationevent, management has concluded the Company is no longer the primarybeneficiary under FIN 46R, “Consolidation of Variable Interest Entities” and isno longer required to consolidate the VIE’s financial statements. The Company’sConsolidated Statement of Operations for the six month period ended June 30,2008 includes the operating results of the VIE through February 2008, atwhich point the VIE was deconsolidated from the Company’s financial statements.In the first quarter of 2008, the Company recorded an $8.2 million gain uponthe repayment of the loan and deconsolidation that was included in otherincome.  As management expects continuing involvementwith the ongoing entity’s business as a supplier of IPTV equipment, the Companyhas determined the conditions for presentation as a discontinued operation werenot met.

 

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**NOTE 22– SUBSEQUENT EVENTS**

 

OnJune 30, 2008, the Company entered into an agreement to sell PCD to anentity controlled by AIG Global Investment Group and certain other investors.The total purchase consideration to the Company of approximately $240 million(approximately $24 million of which is subject to escrow and may be subject toa post-closing adjustment to the purchase price, if any, and certain othercontingencies) is based primarily on the working capital of PCD as of theclosing of the transaction, subject to certain adjustments. The transactionclosed on July 1, 2008.  Pursuant tothe terms of the divestiture agreement, the Company may be entitled to receiveup to an additional $50 million earnout payment in 2011 based on theachievement of cumulative earnings levels of the divested business through December 31,2010.  Previously, PCD was a reportable segment of the Company. Concurrentwith the closing of the transaction, the Company entered into a three-yearsupplier agreement with the divested business whereby the Company will supplyhandset products to the divested entity. The assets and liabilities of PCD have been classified as held for salein the June 30, 2008 condensed consolidated balance sheet (See Note10).  Due to the ongoing direct cashflows pursuant to the supplier agreement, the sale of the PCD assets does notmeet the criteria for presentation as a discontinued operation under SFAS 144.

 

**ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

**FORWARD-LOOKING STATEMENTS**

 

ThisQuarterly Report on Form 10-Q contains forward-looking statementsregarding future events and our future results that are subject to the safeharbors created under the Securities Act of 1933 and the Securities ExchangeAct of 1934. Forward-looking statements are based on current expectations,estimates, forecasts and projections about us, our future performance and theindustries in which we operate as well as on our management’s assumptions andbeliefs. Statements that contain words like “expects,” “anticipates,” “may,” “will,”“targets,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” orvariations of such words and similar expressions are forward-lookingstatements. In addition, any statements that refer to trends in our businesses,future financial results, and our liquidity and business plans areforward-looking statements. Readers are cautioned that these forward-lookingstatements are only predictions and are subject to risks and uncertainties,including those discussed in “Part II, Item 1A-Risk Factors” of this Form 10-Q.  Therefore, actual results may differmaterially and adversely from those expressed in any forward-lookingstatements. We do not guarantee future results, and actual results,developments and business decisions may differ from those contemplated by thoseforward-looking statements.  We undertakeno obligation to update these forward-looking statements to reflect events orcircumstances occurring after the date of this Form 10-Q.

 

**EXECUTIVE SUMMARY**

 

Wedesign, manufacture and sell telecommunications infrastructure, handsets andcustomer premise equipment, and provide services associated with theirinstallation, operation, and maintenance. Our products are sold primarily totelecommunications service providers or operators. We sell an extensive rangeof products that are designed to enable voice, data and video services for ouroperator customers and consumers around the world. Over the past few years, wehave expanded our focus to build a global presence and currently sell ourproducts in several established and emerging growth markets, including NorthAmerica, China, Japan, India, Central and Latin America, Europe, the MiddleEast, Africa and Southeast and North Asia.

 

Wedifferentiate ourselves with products designed to reduce network complexity,integrate high performance capabilities and allow a simple transition to nextgeneration networks. We design our products to facilitate cost-effective andefficient deployment, maintenance and upgrades.

 

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Becauseour products are IP-based, our customers can more easily integrate our productswith other industry standard hardware and software. Additionally, we believe wecan introduce new features and enhancements that can be cost-effectively addedto our customers’ existing networks. IP-based devices can be changed orupgraded in modules, saving our customers the expense of replacing their entiresystem installation. Our strategy is built upon the following key concepts:

 

·                  identify key technology shifts and trendsbefore our competitors;

 

·                  develop differentiated products, which aredesigned to offer new and innovative revenue-generating features and enhancedfunctionality for our customers;

 

·                  reduce overall operational and deploymentcosts of our customers’ networks, enabling them to meet the demands of agreater number of consumers by expanding their addressable markets; and

 

·                  develop tailored products and services tosuit customers’ current needs and to anticipate future needs.

 

Our current strategy is tofocus on the key segments of the IP technology market which we have identifiedas having the greatest potential for profitable growth. Specifically, ourstrategy is to:

 

·                  Invest our R&D resources in selectIP-based technologies where we believe we can create unique end-to-endsolutions that will deliver strong market share and create value for ourcustomers;

 

·                  Drive revenue from this technology in selectcore geographic markets where there is high acceptance of the disruptive shiftto IP technologies and where we have established credibility with customers;and

 

·                  Supplement revenue outside of core markets byusing regional technology and sales partners in areas where we can leveragetheir strong customer relationships.

 

*ManagementSuccession Plan*

 

Inthe second quarter, we implemented our management succession plan. Effective July 1, 2008, Peter Blackmore, President of the Company,was appointed Chief Executive Officer and a member of the Board ofDirectors.  Hong Liang Lu, who was serving as Chief Executive Officer andas a member of the Board, was appointed Executive Chairman of the Board. ThomasToy, who was serving as Chairman of the Board, was appointed as Lead Directorof the Board.

 

*Sale ofInvestments*

 

During thefirst quarter of 2008, we sold our remaining investment in Gemdale forapproximately $32.9 million and recognized a gain of $32.4 million in otherincome(expense), net.  We also sold ourinvestment in Infinera for approximately $9.2 million and recognized a gain of$7.3 million in other income (expense), net.

 

*Sale of Non-core Assets and Restructuring Programs*

 

OnJune 30, 2008, we entered into an agreement to sell UTStarcom PersonalCommunications LLC, a wholly-owned subsidiary of the Company (“PCD”) to anentity controlled by AIG Global Investment Group and certain other investorsfor a total purchase consideration of approximately $240 million. Thetransaction closed on July 1, 2008. Pursuant to the terms of thedivestiture agreement, we may be entitled to receive up to an additional $50million earnout payment in 2011 based on the achievement of certain earningslevels of the divested business through December 31, 2010.  Weanticipate a nominal gain from the divestiture and any gain will be included asa component of continuing operations in the third quarter of 2008.  As a result of the divestiture of PCD, wewill lose a substantial part of our revenue; however management expects 

 

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improvementin gross margin as a percent of total sales as the gross margins from itsremaining core segments are generally higher than that of the PCD segment.

 

InSeptember 2007, we announced the results of an in-depth strategic analysisof the Company undertaken by the management team with the aim of defining a newcorporate strategy and making UTStarcom an even stronger global competitor. Wecompleted the workforce reduction during the first quarter of 2008, havingreduced our worldwide work force by approximately 800 employees, orapproximately 12% of the Company’s headcount. We expect cost savings from planned restructuring activities to provideliquidity for operations, to be used to offset market forces or to bereinvested in our businesses to strengthen our competitiveness.

 

Wewill continue our efforts to evaluate certain operations and will consideropportunities to divest additional non-core assets and may incur additional costsassociated with future actions to further align our business operations andstreamline our business processes.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Management’sDiscussion and Analysis of Financial Condition and Results of Operations isbased upon our Condensed Consolidated Financial Statements, which we haveprepared in accordance with U.S. generally accepted accounting principles. Thepreparation of these financial statements requires management to make estimatesand assumptions that affect the reported amounts of assets, liabilities,revenue and expenses, and related disclosure of contingent assets andliabilities. Estimates are based on historical experience, knowledge ofeconomic and market factors and various other assumptions that managementbelieves to be reasonable under the circumstances. Actual results may differfrom those estimates.

 

On a regular basiswe evaluate our estimates, assumptions and judgments and make changesaccordingly. An accounting policy is deemed to be critical if it requires anaccounting estimate to be made based on assumptions about matters that arehighly uncertain at the time the estimate is made, if different estimatesreasonably could have been used, or if changes in the estimate that arereasonably likely to occur could materially impact the financialstatements.  We believe that theestimates, assumptions and judgments involved in revenue recognition,receivables and allowances for doubtful accounts, accruals including thirdparty commissions payable, restructuring liabilities, litigation and othercontingencies, stock-based compensation, product warranty, variable interestentities, inventories, deferred costs, research and development and capitalizedsoftware development costs, income taxes, impairment of goodwill, intangibleassets and long-lived assets, and valuation and impairment of investments havethe greatest potential impact on our Condensed Consolidated FinancialStatements, so we consider these to be our critical accounting policies.  Management believes that there have been nosignificant changes during the six months ended June 30, 2008 to the itemsthat we disclosed as our critical accounting policies and estimates inManagement’s Discussion and Analysis of Financial Condition and Results of Operationsin our Annual Report on Form 10-K for the year ended December 31,2007.

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

Fora description of the new accounting pronouncements that affect us, seeNote 2 to our Condensed Consolidated Financial Statements included under Part I,Item 1 of this Quarterly Report on Form 10-Q.

 

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**RESULTS OF OPERATIONS**

 

Duringthe fourth quarter of 2007, the Company announced a new organization structureto align the business units with its corporate strategy. This new organizationstructure changed the reporting segments on which the Company measuresperformance and allocates resources. Effective October 1, 2007, the newreporting segments were as follows:

 

·                  Broadband Infrastructure;

 

·                  Multimedia Communications;

 

·                  Personal Communications Division;

 

·                  Handsets;

 

·                  Services; and

 

·                  Other, which includes the Mobile Solutionsand Custom Solutions business units.

 

OurBroadband Infrastructure segment is responsible for software and hardwareproducts that enable end users to access high-speed, cost effective wirelinedata, voice and media communication. Our products within each of thesecategories include multiple hardware and software subsystems that can be offeredin various combinations to suit individual carrier needs. Our system productsare based on widely-adopted global communications standards and are designed toallow service providers to quickly and cost-efficiently integrate our systemsinto their existing networks and deploy our systems in new broadband, IP andwireless network rollouts. Our products are also designed for quick andcost-effective transition to future network technologies, enabling ourcustomers to make the best use of their existing infrastructure.

 

OurMultimedia Communications segment is responsible for the development andmanagement of IPTV and related technologies (such as surveillance) plus ourcore Next Generation Network (“NGN”) software. The Personal Handyphone System (“PHS”)infrastructure and wireless systems teams are also a part of this segment.

 

OurPersonal Communications Division markets, sold and supported handsets otherthan Personal Access System (“PAS”) handsets, mainly in the United States.Historically, most of our handset sales in this division were designed andbuilt by other manufacturers. However, in 2005 we began shipping handsetsdesigned and manufactured by us, and during the year ended December 31,2007 handsets manufactured by us made up approximately 35% of the total unitsales of this segment. During the six months ended June 30, 2008 handsetsmanufactured by us made up approximately 25% of the total unit sales of thissegment. On July 1, 2008, we sold PCD (See Note 22 to our CondensedConsolidated Financial Statements included under Part I, Item 1 ofthis Quarterly Report on Form 10-Q).

 

OurHandsets segment designs, builds and sells consumer handset devices, includingPAS handsets, that allow customers to access wireless services. All handsetrevenues within China are included in this segment.

 

Wesupport the growth and operation of the installed base of our system solutionsthrough our professional services business, UTStarcom Services. Ourglobally-deployed experts assist the Company’s customers with activitiesranging from network planning, circuit-to-packet network migration planning, systemsintegration, program management, operations management and support, andknowledge transfer.

 

Includedin our “Other” segment are our Mobile Solutions business unit and our CustomSolutions business unit. Our Mobile Solutions business unit is responsible forthe development, sales and service of our wireless IPCDMA/IPGSM product lineand our Packet Data Services Node (“PDSN”) product line which connects CDMAcellular network infrastructure equipment to IP network. Our Custom Solutionsbusiness unit is responsible for the development, sales and service of othernon-core products such as IP messaging, transaction gateways, and Remote AccessServer (“RAS”) which enables users to access network data and services fromremote locations.

 

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**NETSALES**

 
| ** **                 | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|----------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                            | ** ** | **% of net  sales**                     | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of  net sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                 | ** ** | **(in thousands)**                             | ** ** |
| ***Net Sales by Segment*** |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband  Infrastructure  |       | $                                                   | 35,888     |                                              | 6          | % | $ | 38,237 |   | 7 | % | $ | 61,479 |   | 5 | % | $ | 64,781 |   | 6 | % |
| Multimedia  Communication  |       | 74,018                                              |       | 12                                                | %          | 63,439 |   | 12 | % | 141,464 |   | 12 | % | 135,994 |   | 14 | % |
| PCD                        |       | 448,864                                             |       | 71                                                | %          | 357,797 |   | 66 | % | 879,588 |   | 72 | % | 646,127 |   | 64 | % |
| Handsets                   |       | 49,461                                              |       | 8                                                 | %          | 62,177 |   | 12 | % | 93,484 |   | 8 | % | 131,896 |   | 13 | % |
| Services                   |       | 15,884                                              |       | 2                                                 | %          | 11,106 |   | 2 | % | 26,975 |   | 2 | % | 23,665 |   | 2 | % |
| Other                      |       | 8,641                                               |       | 1                                                 | %          | 5,489 |   | 1 | % | 15,755 |   | 1 | % | 11,683 |   | 1 | % |
|                       |       | $                                                   | 632,756    |                                              | 100        | % | $ | 538,245 |   | 100 | % | $ | 1,218,745 |   | 100 | % | $ | 1,014,146 |   | 100 | % |

 
| ** **                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|---------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                | ** ** | ** **                                          | ** ** | **% of net**                            | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                | ** ** | **2008**                                            | ** ** | **sales**                                         | ** ** | **2007** | ** ** | **sales** | ** ** | **2008** | ** ** | **sales** | ** ** | **2007** | ** ** | **sales** | ** ** |
| ** **                | ** ** | **(in thousands)**                             | ** ** |
| ***Net sales by region*** | ** ** | ** **                                          | ** ** | ** **                                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| United  States            |       | $                                                   | 442,780    |                                              | 70         | % | $ | 361,334 |   | 67 | % | $ | 864,643 |   | 70 | % | $ | 654,502 |   | 65 | % |
| China                     |       | 110,752                                             |       | 18                                                | %          | 129,222 |   | 24 | % | 227,874 |   | 19 | % | 265,956 |   | 26 | % |
| Japan                     |       | 9,756                                               |       | 1                                                 | %          | 20,523 |   | 4 | % | 22,393 |   | 2 | % | 34,838 |   | 3 | % |
| Other                     |       | 69,468                                              |       | 11                                                | %          | 27,166 |   | 5 | % | 103,835 |   | 9 | % | 58,850 |   | 6 | % |
| Total  net sales          |       | $                                                   | 632,756    |                                              | 100        | % | $ | 538,245 |   | 100 | % | $ | 1,218,745 |   | 100 | % | $ | 1,014,146 |   | 100 | % |

 

*Three months ended June 30, 2008 and2007*

 

Netsales increased by 18% to $632.8 million during the three months ended June 30,2008 compared to the same period in 2007. The increase was primarily due to a25% increase in sales in the PCD segment for the three months ended June 30,2008 compared to the same period in 2007 primarily resulting from an increasednumber of units sold and higher average selling price. Multimedia Communicationsegment net sales increased by $10.6 million or 17%, for the three months endedJune 30, 2008 compared to the same period in 2007, mainly due to higherSet Top Box (“STB”) sales for the three months ended June 30, 2008.Handset sales decreased by $12.7 million, or 20%, in the second quarter of 2008due to both price and volume declines when compared to the second quarter of2007.  As we have been experiencing inrecent quarters, increased competition and a decline in PAS subscribers haveresulted in lower demand and decrease in average selling price for our PAShandsets.

 

*Six months ended June 30, 2008 and 2007*

 

Net sales increased by 20% to $1.2 billion during the six months ended June 30,2008 compared to the same period in 2007. The increase was primarily due to a36% increase in sales in the PCD segment during the six months ended June 30,2008 compared to the same period in 2007 primarily resulting from an increasednumber of units sold and higher average selling price.  Multimedia Communication segment salesincreased by $5.5 million, or 4% during the six months ended June 30, 2008compared to the same period in 2007, mainly due to increased STB sales,partially offset by the continued weakening demand for our PAS infrastructureproducts.  Broadband Infrastructuresegment net sales decreased by $3.3 million or 5% during the six months ended June 30,2008 compared to the same period in 2007. Due to the customer concentration inthis segment, revenues fluctuate based upon the magnitude and timing of revenuerecognition on certain contracts. Handset sales declined by $38.4 million, or 29% during the six monthsended June 30, 2008 due to both price and volume declines when compared tothe same period in 2007.  As we have beenexperiencing in recent quarters, increased competition and a decline in PASsubscribers have resulted in lower demand and decrease in average selling pricefor our handsets.

 

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Foradditional discussion see “Segment Reporting” section of this Item 2.

 

In 2008, we expect that new orders from PAS handsets and infrastructurewill continue to decline due to the China telecommunication industryrestructuring as well as increased pricing pressure. We expect our CDMA andTDSCDMA handsets will contribute more to our revenue and partially offset thedecline of PAS business.  We also plan tointroduce HSDPA (“High Speed Downlink Packet Access”) data cards supported byTDSCDMA networks and EVDO (“Evolution Data Only”) data cards supported by CDMA3G networks, which we expect to have relatively higher gross margin and averageselling price in mid-2009 to capitalize the data business in China.  However, we do not anticipate that thesesales will fully offset the decline in PAS handsets and infrastructure sales.We currently offer and have initial market acceptance of our IPTV products inChina, Japan, India, Taiwan and other geographic regions. We believe that theIPTV market presents a meaningful growth opportunity in these regions as wellas other regions where we have targeted to expand our IPTV offerings.

 

**GROSS PROFIT**

 
| ** **                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                    | ** ** | ** **                                          | ** ** | **Gross**                                         | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                    | ** ** | **2008**                                            | ** ** | **profit %**                                 | ** ** | **2007** | ** ** | **profit %** | ** ** | **2008** | ** ** | **profit %** | ** ** | **2007** | ** ** | **profit %** | ** ** |
| ** **                    | ** ** | **(in thousands)**                             | ** ** |
| ***Gross profit by Segment*** |       |                                                |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure      |       | $                                                   | 1,669      |                                              | 5          | % | $ | 10,105 |   | 26 | % | $ | 3,890 |   | 6 | % | $ | 14,314 |   | 22 | % |
| Multimedia Communication      |       | 28,818                                              |       | 39                                                | %          | 27,616 |   | 44 | % | 61,974 |   | 44 | % | 50,410 |   | 37 | % |
| PCD                           |       | 36,169                                              |       | 8                                                 | %          | 15,922 |   | 4 | % | 69,005 |   | 8 | % | 32,767 |   | 5 | % |
| Handsets                      |       | 6,781                                               |       | 14                                                | %          | 22,396 |   | 36 | % | 22,996 |   | 25 | % | 47,443 |   | 36 | % |
| Service                       |       | 4,794                                               |       | 30                                                | %          | 98 |   | 1 | % | 7,113 |   | 26 | % | 730 |   | 3 | % |
| Other                         |       | 3,717                                               |       | 43                                                | %          | 3,593 |   | 65 | % | 9,049 |   | 57 | % | 9,350 |   | 80 | % |
| Total                         |       | $                                                   | 81,948     |                                              | 13         | % | $ | 79,730 |   | 15 | % | $ | 174,027 |   | 14 | % | $ | 155,014 |   | 15 | % |

 

Costof sales consists primarily of material and labor costs, including stock-basedcompensation, associated with manufacturing, assembly and testing of products,costs associated with installation and customer training, warranty costs, feesto agents, inventory write-downs and overhead. Cost of sales also includes importtaxes and tariffs on components and assemblies. Some components and materialsused in our products are purchased from a single supplier or a limited group ofsuppliers and, in some cases, are subject to obtaining Chinese import permitsand approvals. We also rely on third party manufacturers to manufacture andassemble most of our CDMA handsets.

 

Ourgross profit has been affected by average selling prices, material costs,product mix, the impact of warranty charges and contract loss provisions aswell as inventory reserves and release of deferred revenues and related costpertaining to prior years. 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 in the future as a result of shiftsin product mix, stage of product life cycle, anticipated decreases in averageselling prices and our ability to reduce cost of sales.

 

*Three months ended June 30, 2008 and 2007*

 

Grossprofit was $81.9 million, or 13% of net sales for the three months ended June 30,2008, compared to $79.7 million, or 15% of net sales for the correspondingquarter of 2007. The overall gross profit increase in absolute dollars wasprimarily due to the increase in sales and gross profit in the PCD segmentpartially offset by the decrease in sales and gross 

 

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profitin the Broadband Infrastructure and Handsets segments. Gross profit in theBroadband Infrastructure segment decreased primarily due to a $7.3 millionprovision during the second quarter of 2008 for anticipated losses on aninfrastructure deployment contract that originated in 2006.

 

*Six months ended June 30, 2008 and 2007*

 

Gross profit was $174.0 million, or 14% of net sales for the sixmonths ended June 30, 2008, compared to $155.0 million, or 15% of netsales in the corresponding period of 2007. The overall gross profit increase inabsolute dollars was primarily due to an increase in sales and improved profitmargins in the PCD and Multimedia segments, partially offset by decrease insales and gross profit of Broadband Infrastructure and Handsets segments.However, overall gross profit as a percentage of sales decreasedslightly due primarily to increased sales of the PCD segment which had lowergross profit percentage.

 

Foradditional discussion see “Segment Reporting” section of this Item 2.

 

**OPERATING EXPENSES**

 

Thefollowing table summarizes our operating expenses:

 
| ** **                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                            | ** ** | **% of  net  sales**                         | ** ** | **2007** | ** ** | **% of  net  sales** | ** ** | **2008** | ** ** | **% of  net  sales** | ** ** | **2007** | ** ** | **% of  net  sales** | ** ** |
| ** **                          | ** ** | **(in thousands)**                             | ** ** |
| Selling, general and administrative |       | $                                                   | 72,010     |                                              | 11         | % | $ | 88,865 |   | 17 | % | $ | 151,754 |   | 12 | % | $ | 168,701 |   | 17 | % |
| Research and development            |       | 39,286                                              |       | 6                                                 | %          | 42,158 |   | 7 | % | 80,686 |   | 7 | % | 85,819 |   | 8 | % |
| Amortization of intangible assets   |       | 1,730                                               |       | 0                                                 | %          | 4,046 |   | 1 | % | 3,554 |   | 0 | % | 8,092 |   | 1 | % |
| Total operating expenses            |       | $                                                   | 113,026    |                                              | 17         | % | $ | 135,069 |   | 25 | % | $ | 235,994 |   | 19 | % | $ | 262,612 |   | 26 | % |

 

Selling,general and administrative expenses (“SG&A”) include compensation andbenefits, professional fees, sales commissions, provision for doubtful accountsreceivable and travel and entertainment costs. Research and development (“R&D”)expenses consist primarily of compensation and benefits of employees engaged inresearch, design and development activities, costs of parts for prototypes,equipment depreciation and third party development expenses. We believe thatcontinued and prudent investment in research and development is critical to ourlong-term success, and we will aggressively evaluate appropriate investmentlevels.  A portion of our costs are fixedand are difficult to quickly reduce in periods of lower sales.

 

*SELLING, GENERAL AND ADMINISTRATIVE*

 

*Three months ended June 30, 2008 and2007*

 

SG&Aexpenses decreased $16.9 million during the three months ended June 30,2008 compared to the same period in 2007. The decrease in SG&A expenses wasprimarily due to a $4.6 million decrease in the provision of doubtful accounts,a $7.3 million reduction in legal and accounting fees mainly due to reducedactivity in investigations and litigation, a $1.6 million reduction inpersonnel related expenses as we continued to streamline our operations and a$1.1 million decrease in expense related to software licenses.

 

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S*ix months ended June 30, 2008and 2007*

 

SG&Aexpenses decreased $17.0 million during the six months ended June 30, 2008compared to the same period in 2007.  Thedecrease was primarily due to a $5.7 million decrease in legal and accountingfees mainly due to reduced activity in investigations and litigation, a $2.0million reduction in personnel related expenses as we continued to streamlineour operations, a $1.5 million savings from a reduction in the use of outsideservices, $1.1 million decrease in expense related to certain software licensesand a $1.7 million decrease in travel related expenses due to reduced travelactivity.

 

*RESEARCH AND DEVELOPMENT*

 

*Three months ended June 30, 2008 and2007*

 

R&Dexpenses decreased by $2.9 million during the three months ended June 30,2008 compared to the same period in 2007. The decrease in R&D expenses was mainly due to a $1.1 milliondecrease in personnel related expenses as we continued to streamline ouroperations.  In addition, a $1.4 milliongain was recognized from the sale of certain patents during the quarter whichwas recorded as a reduction of R&D expense.

 

*Six months ended June 30, 2008 and 2007*

 

R&D expenses decreased by $5.1 million during the six monthsended June 30, 2008 compared to the same period in 2007.  The decrease in R&D expenses was mainlydue to a $2.2 million decrease in personnel related expenses as we continued tostreamline our operations.  In addition, a$1.4 million gain was recognized from the sale of certain patents during 2008 which was recorded as a reduction of R&Dexpense.

 

*STOCK-BASED COMPENSATION EXPENSE*

 

Thefollowing table summarizes the stock-based compensation expense recognized inthe Company’s condensed consolidated statements of operations:

 
| ** **                          | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(in thousands)**                             | ** ** |
| Cost of net sales                   |       | $                                                   | 334        |                                              | $          | 119 |   | $ | 594 |   | $ | 243 |   |
| Selling, general and administrative |       | 4,029                                               |       | 1,159                                             |       | 8,026 |   | 2,864 |   |
| Research and development            |       | 686                                                 |       | 906                                               |       | 1,224 |   | 1,832 |   |
| Total                               |       | $                                                   | 5,049      |                                              | $          | 2,184 |   | $ | 9,844 |   | $ | 4,939 |   |

 

*Three and six months ended June 30, 2008 and 2007*

 

Theincrease in the level of stock-based compensation during the three and sixmonths ended June 30, 2008 was primarily due to the recognition of expensein 2008 for annual merit equity awards granted in November 2007 and February 2008,compared with the same period in 2007 when no awards were granted as we weredelinquent in the filing of our reports with the SEC.

 

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*AMORTIZATION OF INTANGIBLE ASSETS*

 

*Three and six months ended June 30, 2008 and 2007*

 

Amortization of intangible assets decreased by $2.3 millionin the three months ended June 30, 2008 compared to the same quarter lastyear, and by $4.5 millionin the six months ended June 30, 2008 compared to the same period lastyear. Amortization of intangible assetsdeclined primarily due to the impairment of intangible assets with a carryingvalue of $15.7 million in the fourth quarter of 2007, as well as due to thefact that several intangible assets became fully amortized during the precedingtwelve months.

 

*INTEREST INCOME*

 

*Three and six months ended June 30, 2008 and 2007*

 

Interest income was $1.3 million and $3.4 million for the three monthsended June 30, 2008 and 2007, respectively. Interest income was $4.1million and $8.3 million for the six months ended June 30, 2008 and 2007,respectively.  The decrease in interestincome for the three and six months ended June 30, 2008 compared to thesame period in 2007 was primarily due to the decrease in cash balancesavailable for investment, as we used $289.5 million to fully repay theprincipal and accrued interest on the convertible notes due on March 1,2008, and due to lower interest rates earned in the three and six months ended June 30,2008 as compared to the same periods in 2007.

 

*INTEREST EXPENSE*

 

*Three and six months ended June 30, 2008 and 2007*

 

Interest expense was $3.5 million and $7.3 million for the threemonths ended June 30, 2008 and 2007, respectively. Interest expense was$9.5 million and $14.0 million for the six months ended June 30, 2008and 2007, respectively. The decrease in interest expense for the threeand six months ended June 30, 2008 compared to the same period in 2007 wasprimarily attributable to the repayment of $274.6 million of convertiblesubordinated notes on March 1, 2008. Interest expense for the three monthsended June 30, 2008 included approximately $2.5 million of debt issuancecosts related to the $75 million secured revolving credit facility. For theperiod from January 1, 2008 through maturity on March 1, 2008, theconvertible subordinated notes had a stated interest rate of 10.875% inaccordance with the Second Supplemental Indenture.  As a result of the First SupplementalIndenture, our convertible subordinated notes’ stated interest rate was 7.625%per annum after January 9, 2007. Prior to January 9, 2007, our convertible subordinated notesaccrued interest at 7/8% per annum.

 

*OTHER INCOME (EXPENSE)*

 

*Three and six months ended June 30, 2008 and 2007*

 

Other expense was $0.9 million for the three months ended June 30,2008 as compared to other income, net of $0.2 million for the three monthsended June 30, 2007. Other income, net was income of $53.1 million and$4.1 million for the six months ended June 30, 2008 and 2007,respectively. Other income, net for the six months ended June 30,2008 was primarily due to a $32.4 million gain on the sale of the Gemdaleinvestment, a $7.3 million gain on the sale of the Infinera investment, an $8.2million gain on the liquidation of investment in a variable interest entity anda $4.1 million gain onforeign currency revaluation.  Otherincome (expense), net for the six months ended June 30, 2007 included a$2.8 million gain on the sale of our Immenstar investment and a $0.8 milliongain on foreign currency revaluation.

 

*INCOME TAX EXPENSE*

 

Incometax expense is based upon a blended effective tax rate based upon ourexpectation of the amount of income to be earned in each tax jurisdiction andis accounted under the liability method. Deferred income taxes are recognizedfor the differences between the tax bases of assets and liabilities and their financialstatement amounts based on enacted tax rates. Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be realized. We expect to maintain a full valuation allowance on ourremaining net deferred tax assets until an appropriate level of profitability 

 

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thatgenerates taxable income is sustained or until we are able to develop taxstrategies that would enable us to conclude that it is more likely than notthat a portion of our deferred tax assets will be realizable. Any reversal ofvaluation allowances will favorably impact our results of operations in the periodof the reversal.

 

Weadopted the provisions of FASB Interpretation No. 48, “Accounting forUncertainty in Income Taxes-an interpretation of FASB Statement No. 109”(FIN 48) on January 1, 2007. FIN 48 established criteria for recognizingor continuing to recognize only more-likely-than tax positions, which mayresult in income tax expense volatility in future periods. While we believethat we have adequately provided for all tax positions, amounts asserted bytaxing authorities could be greater than our accrued position. Accordingly,additional provisions on income tax related matters could be recorded in thefuture as revised estimates are made or the underlying matters are settled orotherwise resolved.

 

*Three months ended June 30, 2008 and 2007*

 

Incometax expense was $4.6 million and $3.3 million for the three months ended June 30,2008 and 2007, respectively.

 

*Sixmonths ended June 30, 2008 and 2007*

 

Incometax benefit was $0.4 million for the six months ended June 30, 2008compared to tax expense of $7.6 million for the six months ended June 30,2007. The China Corporate Income Tax Law (“CIT Law”) became effective on January 1,2008.  As a result of the enactment ofnew regulations during the first quarter of 2008 which address CIT Law, werecorded an income tax benefit of $11.7 million in the first quarter of 2008related to reversing a deferred tax liability on foreign withholding taxesrelated to the unremitted earnings of our subsidiaries which we determined tonot be permanently reinvested outside the United States.  We also have accrued $3.2 million of foreignwithholding taxes in the first quarter of 2008 related to the realized gain onthe sale of our investment in Gemdale.

 

Wehave not provided any tax benefit on any forecasted current year lossesincurred and tax credits generated in the United States and other countries,because we believe that it is more likely than not that the tax benefitassociated with these losses will not be realized. Also, we continue to accruetax expense in jurisdictions where we have been historically profitable.Estimates of the annual effective tax rate at the end of the interim periodsare based on evaluations of possible future events and transactions and may besubject to subsequent refinement or revision.

 

**SEGMENT REPORTING**

 

As noted previously, during the fourth quarter of 2007, the Companyannounced a new corporate organization to align the business units with itscorporate strategy.

 

Summarizedbelow are our segment sales revenue and gross profit figures for the three andsix months ended June 30, 2008 and 2007, respectively.

 

***Broadband Infrastructure***

 
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 35,888     |                                              | $          | 38,237 |   | $ | 61,479 |   | $ | 64,781 |   |
| Gross profit                              |       | $                                                   | 1,669      |                                              | $          | 10,105 |   | $ | 3,890 |   | $ | 14,314 |   |
| Gross profit as a percentage of net sales |       | 5                                                   | %          | 26                                                | %          | 6 | % | 22 | % |

 

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Salesdecreased due to a decline in our IPDSLAM and CPE product line as Softbank inJapan completed its current phase of ADSL expansion. Softbank inJapan represented approximately 17% and 42% of total BroadbandInfrastructure sales during the three months ended June 30, 2008 and 2007,respectively, and 25% and 37% during the six months ended June 30, 2008and 2007, respectively. This decline was partially offset by higher salesin MSAN and Optical products.

 

Grossprofit decreased for the three and six months ended June 30, 2008 whencompared to corresponding periods in 2007, primarily due to a $7.3 millionprovision for anticipated losses during the second quarter of 2008 on aninfrastructure deployment contract that originated in 2006, as well as lowergross margin CPE sales which contributed $1.1 million and $1.3 million decreasein gross profit for the three and six months ended June 30, 2008,respectively, as compared to the same periods in 2007.

 

Wemay incur additional warranty expense as we introduce new products and may berequired to accrue additional contract losses for certain fixed price contractsas these contracts progress. Both events may have negative impacts on ourfuture gross profits, results of operations and financial position.

 

***Multimedia Communications***

*** ***
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 74,018     |                                              | $          | 63,439 |   | $ | 141,464 |   | $ | 135,994 |   |
| Gross profit                              |       | $                                                   | 28,818     |                                              | $          | 27,616 |   | $ | 61,974 |   | $ | 50,410 |   |
| Gross profit as a percentage of net sales |       | 39                                                  | %          | 44                                                | %          | 44 | % | 37 | % |

 

Duringthe three months ended June 30, 2008, Multimedia Communications sales increased by 17% or$10.6 million, of which $9.6 million was related to increased STB sales to acustomer in China.  The sales of our mainproduct lines, PAS system andSoftswitch, which comprised approximately 85% and 97% of our MultimediaCommunications segment sales for the second quarter of 2008 and 2007,respectively, increased by 2% during the second quarter of 2008.

 

Salesfor the six months ended June 30, 2008 increased 4% or $5.5 million.  The increase was mainly due to higher STBsales to a customer in China and Softswitch Sales during the period, partiallyoffset by lower 3G related product sales in 2008 as we exited this product linein 2007.

 

Thegross profit percentage decreased to 39% for the three months ended June 30,2008 from 44% for the corresponding period in 2007.  The decrease was primarily due to increasedsales of the lower gross margin STB product line during the period. The grossprofit percentage increased to 44% for the six months ended June 30, 2008from 37% for the corresponding period in 2007 primarily due to lower warrantyand inventory costs in the six months ended June 30, 2008 and $9.1 million3G product sales in 2007 with very low margin, offset in part by sales of lowermargin STB products in 2008.

 

We expect future PAS infrastructure spending to decline in 2008 asChina prepares for 3G launch. We expect the decline in PAS infrastructure neworders will continue and we plan to aggressively pursue opportunities for ourPacket PAS products (for broadband wireless data market based on PAStechnology), dual mode enterprise PAS products and Softswitch products inmultiple markets.  However, we do notanticipate that these sales will fully offset the anticipated decline in PASsales in 2008.

 

We believe that the IPTV market presents a meaningful growthopportunity. We currently offer and have initial market acceptance of our IPTVproducts in China, Japan, India, Taiwan and other geographic regions.

 

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***Personal Communication Devices (PCD)***

 
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 448,864    |                                              | $          | 357,797 |   | $ | 879,588 |   | $ | 646,127 |   |
| Gross profit                              |       | $                                                   | 36,169     |                                              | $          | 15,922 |   | $ | 69,005 |   | $ | 32,767 |   |
| Gross profit as a percentage of net sales |       | 8                                                   | %          | 4                                                 | %          | 8 | % | 5 | % |

 

Revenuefor the PCD segment increased 25% and 36% for the three and six months ended June 30,2008, respectively as compared to the same periods in 2007.  The increasewas primarily due to an increase in average selling price which resulted in improvedmargin, as well as an increase in units sold during the periods of productsourced from outside vendors and the change in product mix.  The overall average selling price increasedby approximately 13% and 28% and the number of units sold increased byapproximately 13% and 8%, for the three and six months ended June 30,2008, respectively as compared to the same periods in 2007.

 

Grossprofit as a percentage of sales increased to 8% for both the three and sixmonths ended June 30, 2008, compared to 4% and 5%, respectively for thecorresponding periods of 2007.  Theincrease in gross profit was primarily due to an increase in sales of highermargin products in 2008.

 

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***Handsets***

 
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 49,461     |                                              | $          | 62,177 |   | $ | 93,484 |   | $ | 131,896 |   |
| Gross profit                              |       | $                                                   | 6,781      |                                              | $          | 22,396 |   | $ | 22,996 |   | $ | 47,443 |   |
| Gross profit as a percentage of net sales |       | 14                                                  | %          | 36                                                | %          | 25 | % | 36 | % |

 

Netsales declined 20% and 29% for the three and six months ended June 30,2008, respectively, compared to the same periods in 2007.  The majority of our handset sales are inChina, where we have experienced a decline in volume and price for our PAShandsets.

 

The PAS handset units sold in China declined to 1.0million and 2.0 millionunits for the three and six months ended June 30, 2008, respectively,compared to 1.2 million and 2.5 million units in the comparable periods of2007.  The 21% and 20% volume decline forthree and six months periods, respectively, was primarily attributed to lowerdemand for our PAS handsets resulting from a decline in PAS subscribers asservice providers reduced marketing efforts for PAS handsets in anticipationfor next generation technology networks and the restructuring of Chinatelecommunication industry. The average selling price per unit in the PASproducts declined 8% and 13% during the three and six months ended June 30,2008, respectively, comparedwith the same periods in 2007 due to competitive pricing pressures andincreased sales through distributor channels. We have experienced such continuing pricing pressure in the Chinatelecommunications market since the latter part of 2003, which has drivenaverage unit selling prices lower. We expect a decline in PAS subscribers infuture periods.

 

Gross profit as a percentage of net sales for our Handsets segmentdecreased for both the three and six months ended June 30, 2008 comparedto the corresponding periods in 2007. The decrease was primarily due to losses from our GSM products as wereduced inventory of older models, cost related to cancelation of a CDMA modeland higher inventory cost of our PAS data card business, as well as continuedprice erosion and a decrease in demand of our PAS product line.

 

In 2008 and beyond, we expect a decline in PAS subscribers as the Chinatelecommunication industry reorganizes and prepares for 3G launch. Furthermore,we expect more price erosion and gross margin deterioration in PAS handsetsbecause of increasing competition and sales approach shifting from direct salesto carriers to selling through distributors. However, we expect our CDMA and TDSCDMA handsets willcontribute more to our revenue and partially offset the decline of PASbusiness. We also plan to introduce HSDPAdata card supported by TDSCDMA network and EVDO data card supported by CDMA 3Gnetwork, which we expect to have relatively higher gross margin and averageselling prices in mid 2009 to capitalize the data business in China.  In addition, we expect to continue to focus on product cost reduction efforts throughsupply chain improvements and R&D improvements, including outsourcing partof our product development.

 

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***Services***

 
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 15,884     |                                              | $          | 11,106 |   | $ | 26,975 |   | $ | 23,665 |   |
| Gross profit                              |       | $                                                   | 4,794      |                                              | $          | 98 |   | $ | 7,113 |   | $ | 730 |   |
| Gross profit as a percentage of net sales |       | 30                                                  | %          | 1                                                 | %          | 26 | % | 3 | % |

 

OurServices segment’s revenue from external customers increased by 43% and 14% forthe three and six months ended June 30, 2008, respectively, as compared tothe corresponding periods of last year. The increase was mainly due to the continued growth of our China servicesales.

 

Grossprofit increased from 1% for the three months ended June 30, 2007 to 30%for the corresponding period in 2008. Gross profit was 26% and 3% for the six months ended June 30, 2008and 2007, respectively.  The increase wasdue to a China service sales increase without a corresponding increase inassociated cost by utilizing excess capacity.

 

***Other***

*** ***
| ** **                                | ** ** | **Three months ended June 30,** | ** ** | **Six months ended June 30,** | ** ** |
|-------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                            | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                             | ** ** |
| Net sales                                 |       | $                                                   | 8,641      |                                              | $          | 5,489 |   | $ | 15,755 |   | $ | 11,683 |   |
| Gross profit                              |       | $                                                   | 3,717      |                                              | $          | 3,593 |   | $ | 9,049 |   | $ | 9,350 |   |
| Gross profit as a percentage of net sales |       | 43                                                  | %          | 65                                                | %          | 57 | % | 80 | % |

 

OurOther segment consists of Mobile Solutions and Custom Solutions businessunits.  The revenue increased by$3.2 million, or 57% for the three months ended June 30, 2008 ascompared to the same period in 2007.  Therevenue increased by $4.1 million, or 35% for the six months ended June 30,2008 as compared to the same period in 2007. The increase was primarily due to increased service revenues during theperiods.

 

Grossprofit percentage decreased to 43% and 57% for the three and six months ended June 30,2008, respectively, from 65% and 80% for the same periods in 2007.  The decrease was primarily related to therecognition of revenue of a higher margin contract in 2007. Increased overheadexpense related to dedicated supply chain support contributed to a lower grossprofit percentage in 2008.

 

**RELATED PARTY TRANSACTIONS**

 

For a description of related party transactions,see Note 16 to our Condensed Consolidated Financial Statements included under Part 1,Item 1 of this Quarterly Report on Form 10-Q.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

 

***Operating Activities***

 

*2008*

 

Netcash provided by operating activities for the six months ended June 30,2008 was $59.9 million. Cash flow generated from operations during the sixmonths ended June 30, 2008 is not indicative of future cash flows fromoperations. Operating cash was significantly impacted by changes in netoperating assets and liabilities providing net cash of $89.5 million, offsetpartially by adjusting net income for gains on sales of investments andliquidation of ownership interest in a variable interest entity, as well ascertain noncash charges, which resulted in a net use of cash of $29.7 million,as discussed below.

 

Operatingcash was negatively affected by the net loss of $13.4 million, adjusted forgains on sale of investments of $40.2 million, the $8.2 million gain onliquidation of ownership interest in a variable interest entity and non-cashcharges of $32.1 million, which resulted in a net use of cash of $29.7 million.The non-cash charges of $32.1 million included $19.9 million in depreciationand amortization of acquisition-related intangible assets, $9.8 million instock-based compensation expense, $2.7 million provision for doubtful accountsand a $9.1 million provision for deferred costs, partially offset by a benefitof $11.7 million resulting from a change in the China Corporate Income Tax Law.

 

Cashprovided by the net change in operating assets and liabilities totaled $89.5million and was primarily the result of management of working capital duringthe six months ended June 30, 2008, in part, necessitated by the repaymentof the convertible subordinated notes due March 1, 2008.  Operating cash was positively impacted bydecreases in accounts receivable of $65.1 million, decreases in deferred costsof $42.7 million and increases in accounts payable of $116.5 million, offsetpartially by an increase in inventory of $69.5 million, decreases in customeradvances of $16.5 million and decreases in other current liabilities of $40.0million.  The decrease in accountsreceivable was primarily due to strong customer collections in our PCD businesssegment.  The increase in inventory andaccounts payable was due to the high level of inventory purchasing related to asignificant customer project, as well as a management decision to forgo earlypayment discounts with a significant vendor.

 

*2007*

 

Net cash used in operating activities for the six months ended June 30,2007 was $149.3 million. Operating cash was negatively affected by the net lossof $115.7 million and changes in accounts payable and inventories offset bychanges in accounts receivable and customer advances, as discussed below.

 

During the first six months of 2007, accounts payable decreased $89.5million, due to our decision to change the timing of payments to vendors in thefirst quarter of 2007 to comply with vendor payment terms. In addition,inventories increased $19.4 million primarily due to inventory purchasesrelated to an infrastructure deployment contract that we entered into in thefourth quarter of 2006.

 

The cash used in operating activities was partially offset by areduction in accounts receivable of $84.7 million as a result of strong cashcollections and the high percentage of revenue in the first half of 2007 fromour PCD segment which generally has experienced a shorter collection period onrelated receivables. Customer advances increased by $27.1 million for the sixmonths ended June 30, 2007. Customer advances represents cash deposits wehave received from our customers for orders that have not yet received finalacceptance. Upon subsequent receipt of final acceptances and revenuerecognition, customer advances are reduced and revenue and cost of sales isrecorded. The reduction in other current liabilities is primarily due todecreases in compensation and warranty related accruals.

 

***Investing Activities***

 

*2008*

 

Net cash provided by investing activities for thesix months ended June 30, 2008 totaled $46.9 million. Cash of$66.6 million was received from the proceeds of the sale of short-terminvestments and $7.7 million was the net cash provided by the repayment of aloan by a variable interest entity. Cash outflows from investing activitiesincluded $10.8 million for the purchase of short-term and long-terminvestments, $10.3 million for the purchase of property, plant and equipmentand $6.5 million was the result of an increase in restricted cash.

 

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*2007*

 

Net cash used in investing activities for the six months ended June 30,2007 totaled $15.5 million. Cash of $15.3 million was received from thedisposition of long-term investments and proceeds from the sale of short-terminvestments, and $6.6 million was a decrease in restricted cash. Cashoutflows from investing activities included $21.7 million for the purchase ofshort-term investments as well as $15.4 million for the purchase ofproperty, plant and equipment.

 

***Financing Activities***

 

*2008*

 

Net cash used in financing activities was$299.7 million during the six months ended June 30, 2008, primarilydue to the repayment of the convertible subordinated notes of $274.6 million onMarch 1, 2008 and the net repayment of $21.4 million of other bank loans.

 

*2007*

 

Net cash provided by financing activities was $4.6 million,primarily consisting of a change in cash overdrafts for the six months ended June 30,2007.

 

***Liquidity***

 

We reported net losses of $195.6 million, $117.3 million and$532.6 million for the years ended December 31, 2007, 2006 and 2005,respectively. At December 31, 2007 we had an accumulated deficit of$691.2 million.  We used$218.2 million of cash in operations during the year ended December 31,2007, and at December 31, 2007 we had cash and cash equivalents of$437.4 million, of which $289.5 million was used to repay ourconvertible subordinated notes and the accrued interest thereon, that maturedin March 2008. These factors, as well as others discussed below, raisedsubstantial doubt as to our ability to continue as a going concern and ourindependent registered public accounting firm included an explanatory paragraphhighlighting this uncertainty in their “Report of Independent Registered PublicAccounting Firm” dated February 29, 2008 included in “Part II, Item8-Financial Statements and Supplementary Data” in our Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

We had an operating loss of $62.0 million and a net loss of $13.4 millionfor the six months ended June 30, 2008. Cash provided from operations was$59.9 million for the six months ended June 30, 2008, primarily the resultof management of working capital, in part, necessitated by the repayment of theconvertible subordinated notes due March 1, 2008.  During the six months ended June 30,2008, we also sold certain short-term investments for $66.6 million. At June 30,2008, we had cash and cash equivalents of $253.9 million in the aggregate tomeet our liquidity requirements of which $157.7 million was held by oursubsidiaries in China. Due to the limitations on converting Renminbi, we arelimited in our ability to engage in foreign currency hedging activities inChina. We cannot guarantee that fluctuations in foreign currency exchange ratesin the future will not have a material adverse effect on revenues frominternational sales and, correspondingly, on our business, financial condition,results of operations and cash flows.

 

In 2007 and through the first quarter of 2008, our China subsidiarieswere a significant source of cash for the Company. Our China subsidiariestransferred in aggregate $150 million of dividends during the year ended December 31,2007 and another $100 million in February 2008.  Going forward, however, the amount of cashavailable for transfer from the China subsidiaries is limited both by theliquidity needs of the subsidiaries in China and by Chinese-government mandatedrequirements including currency exchange controls on transfers of funds outsideof China.

 

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Currently,our primary sources of available credit are a series of credit facilities inChina.  At June 30, 2008, we had creditfacilities in China with a total of $153.8 million available for futureborrowings, of which an aggregate of $43.7 million remained available forgeneral working capital purposes and $110.1 million remained available in supportof letters of credit and corporate guarantees. The China facilities expire during the fourth quarter of 2008.

 

Ouravailable lines of credit in China are now significantly less than what hasbeen available to us historically. During the fourth quarter of 2007, creditfacilities in China in the aggregate amount of approximately$481.7 million matured or were extinguished. Our practice in China is todraw new loans under the credit facilities prior to either the maturity of ourborrowings or expiration of our facilities to ensure we maintain adequateliquidity to re-pay the existing borrowings at maturity, or to effectivelylengthen the credit facility period to the latest maturity date of theunderlying borrowings. We are currently in negotiations to renew some of thesecredit facilities. In order to renew these credit facilities we may need tocollateralize certain of our assets in China. However, we cannot be certainthat such additional lines of credit will be available to us on commerciallyreasonable terms or at all. Furthermore, each borrowing under the creditfacilities is subject to the bank’s current favorable opinion of the creditworthiness of the Company’s China subsidiaries, as well as the bank havingfunds available for lending and other Chinese banking regulations.

 

On March 21,2008, we entered into a credit agreement providing for a $75.0 million securedrevolving credit facility that was subject to an accounts receivable andinventory borrowing base formula and was used during the second quarter of 2008to fund the Company’s general working capital requirements.  During thequarter, we repaid all outstanding borrowings under this arrangement. On June 30,2008, in connection with the entry into an agreement for the sale of PCD weterminated the commitments under the credit agreement.

 

On August 1,2005, we entered into a 364-day $100.0 million committed receivablespurchase facility with a financial institution. On March 20, 2008, weterminated the commitments under this Amended and Restated Receivables PurchaseAgreement in connection with the $75.0 million credit agreement entered into onMarch 21, 2008.  No receivables were sold pursuant to thisarrangement and no premiums or penalties were incurred by us in connection withthe termination of this credit facility.

 

Management’s liquidity plans include divesting our noncore assets oroperations and obtaining loans from financial institutions. On June 30,2008, we entered into an agreement to sell UTStarcom Personal CommunicationsLLC, a wholly-owned subsidiary (“PCD”) for a total purchase consideration ofapproximately $240 million. The transaction closed on July 1, 2008. As aresult of this transaction, management believes we have sufficient liquidity tofinance our anticipated working capital and capital expenditure requirementsfor the next twelve months.  In an effortto further improve our profitability and cash flows, management continues tore-examine all aspects of our business. This review includes a focus on ourfixed cost base and improvements in the management of our working capital tobetter align with operations, market demand and current sales levels. However,if projected sales do not materialize, management may need to further reduceexpenses. In addition, we may require additional equity or debt financing. Iffuture funds are raised through issuance of stock or debt, these securitiescould have rights, privileges or preference senior to those of our common stockand debt covenants could impose restrictions on our operations. The sale ofadditional equity securities or debt financing could result in additionaldilution to our current shareholders. There can be no assurance that additionalfinancing, if required, will be available on terms satisfactory to us.

 

***Off-balancesheet arrangements***

 

At June 30, 2008, we do not have anyoff-balance sheet arrangements.

 

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***Contractual obligations and other commitments***

 

Our obligations under contractual obligations andcommercial commitments at June 30, 2008 were as follows:

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **                       | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| ** **                       | ** ** | **(in thousands)**                        | ** ** |
| **Contractual Obligations**      |       |                                      |       |   |   |   |   |   |   |   |   |
| Bank loans                       |       | $                                         | 29,158     |   | $ | 29,158 |   | $ | — |   | $ | — |   | $ | — |   |
| Lease obligations                |       | $                                         | 31,149     |   | $ | 14,582 |   | $ | 12,685 |   | $ | 3,396 |   | $ | 486 |   |
| **Other Commercial Commitments** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Letters of credit                |       | $                                         | 59,302     |   | $ | 43,481 |   | $ | 15,821 |   | $ | — |   | $ | — |   |
| Purchase commitments             |       | $                                         | 18,796     |   | $ | 16,422 |   | $ | 2,374 |   | $ | — |   | $ | — |   |

 

*Bank loans*

 

At June 30, 2008, we had loans with variousbanks totaling $29.2 million with interest rates ranging from 6.3% to 6.6%per annum. These bank loans mature during the 2008 and are included inshort-term debt.

 

*Operating leases*

 

We lease certain facilities under non-cancelableoperating leases that expire at various dates through 2013.

 

*Letters of credit*

 

We issue standby letters of credit primarily tosupport international sales activities outside of China. When we submit a bidfor a sale, often the potential customer will require that we issue a bid bondor a standby letter of credit to demonstrate our commitment through the bidprocess. In addition, we may be required to issue standby letters of credit asguarantees for advance customer payments upon contract signing or performanceguarantees. The standby letters of credit usually expire six to twelve monthsfrom date of issuance without being drawn by the beneficiary thereof.

 

*Purchase commitments*

 

We are obligated to purchase raw materials andwork-in-process inventory under various orders from various suppliers, all ofwhich should be fulfilled without adverse consequences material to ouroperations or financial condition. Purchase commitments exclude agreements thatare cancelable without penalty.  As of June 30,2008, total open commitments under these purchase orders extending beyond oneyear were approximately $2.4 million. Additionally, we have agreed to purchasefrom Marvell Semiconductors, Inc. certain chip-sets that will be includedin 50% to 100% of our PAS handsets, through 2011.

 

*Intellectual property*

 

Certain sales contracts include provisions underwhich customers would be indemnified by us in the event of, among other things,a third-party claim against the customer for intellectual property rightsinfringement related to our products. There are no limitations on the maximumpotential future payments under these guarantees. We have not accrued anyamounts in relation to these provisions as no such claims have been made and webelieve we have valid enforceable rights to the intellectual property embeddedin our products.

 

*Uncertain tax positions*

 

EffectiveJanuary 1, 2007, we adopted the provisions of FIN 48.  As of June 30,2008, we had $82.8 million of gross unrecognized tax benefits. If recognized,the portion of gross unrecognized tax benefits that would decrease theprovision for income taxes and increase our net income is $9.1 million. Theimpact on net income reflects the gross unrecognized tax benefits net ofcertain deferred tax assets and the federal tax benefit of state income taxitems totaling $73.7 million. We havenot included these amounts in the table of contractual obligations andcommercial commitments because of the difficulty in making reasonably reliableestimates of the timing of cash settlements with the respective taxingauthorities.

 

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*ThirdParty Commissions*

 

TheCompany records accruals for commissions payable to third parties in the normalcourse of business.  Such commissions are recorded based on the terms ofthe contracts between the Company and the third parties and paid pursuant tosuch contracts.  Consistent with our accounting policies, thesecommissions are recorded as operating expense in the period in which theliability is incurred.  As of June 30, 2008, approximately $7 millionof such accrued commissions had not been claimed by the third parties for morethan three years.  Management has performed, and continues to perform,follow-up procedures with respect to these accrued commissions. Upon completionof such follow-up procedures, if the accrued commissions have not been claimedand the statute of limitations, if any, has expired or a reasonable period oftime has elapsed, the Company will reverse such accruals. Such reversals willbe recorded in the Statement of Operations during the period managementdetermines that such accruals are no longer necessary. During the three and sixmonths ended June 30, 2008 and 2007, no significant accruals related tothird party commissions were reversed.

 

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**ITEM 3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

Weare exposed to the impact of interest rate changes, changes in foreign currencyexchange rates and changes in the stock market.

 

***Interest Rate Risk***

 

Ourexposure to market risk for changes in interest rates relates primarily to ourinvestment portfolio. The fair value of our investment portfolio would not besignificantly affected by either a 10% increase or decrease in interest ratesdue mainly to the short term nature of most of our investment portfolio.However, our interest income can be sensitive to changes in the general levelof U.S and China interest rates since the majority of our funds are invested ininstruments with maturities of less than one year. In a declining interest rateenvironment, as short term investments mature, reinvestment occurs at lessfavorable market rates. Given the short term nature of certain investments,anticipated declining interest rates will negatively impact our investmentincome.

 

Wemaintain an investment portfolio of various holdings, types and maturities. Wedo not use derivative financial instruments. We place our cash investments ininstruments that meet high credit quality standards, as specified in ourinvestment policy guidelines. Our policy is to limit the risk of principal lossand to ensure the safety of invested funds by generally attempting to limitmarket risk. Funds in excess of current operating requirements are mostlyinvested in government-backed notes, commercial paper, floating rate corporatebonds and fixed income corporate bonds. In accordance with our investmentpolicy, all short-term investments are invested in “investment grade” rated securitieswith minimum A or better ratings. Currently, most of our short-term investmentshave AA or better ratings.

 

Ourcash and cash equivalents are not subject to significant interest rate risk dueto the short maturities of these instruments. As of June 30, 2008 thecarrying value of our cash and cash equivalents approximated fair value.

 

Thetable below represents carrying amounts and related weighted-average interestrates of our investment portfolio at June 30, 2008:

 
| ** **                   | ** ** | **(in thousands, except** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **interest rates)**            | ** ** |
| Cash and cash equivalents    |       | $                                   | 253,901    |   |
| Average interest rate        |       | 1.58                                | %          |
|                         |       |                                |       |
| Restricted cash - short-term |       | $                                   | 17,394     |   |
| Average interest rate        |       | 1.83                                | %          |
|                         |       |                                |       |
| Short-term investments       |       | $                                   | 889        |   |
| Average interest rate        |       | 1.49                                | %          |
|                         |       |                                |       |
| Restricted cash - long-term  |       | $                                   | 15,821     |   |
| Average interest rate        |       | 2.28                                | %          |
|                         |       |                                |       |
| Total investment securities  |       | $                                   | 288,005    |   |
| Average interest rate        |       | 1.63                                | %          |

 

***Equity Investment Risk***

 

Ourinvestment portfolio includes equity investments in publicly traded companies,the values of which are subject to market price volatility.  Economic events could adversely affect thepublic equities market and general economic conditions may worsen.  Should the fair value of our publicly tradedequity investments decline below their cost basis in a manner deemed to beother-than-temporary, our earnings may be adversely affected.  We have also invested in several privatelyheld companies as 

 

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wellas investment funds which invest primarily in privately held companies, many ofwhich can still be considered in the start-up or development stages.  These investments are inherently risky, asthe market for the technologies or products they have under development aretypically in the early stages and may never materialize.

 

***Foreign Exchange Rate Risk***

 

Asa multinational company, we conduct our business in a wide variety ofcurrencies and are therefore subject to market risk for changes in foreignexchange rates.  We expect to continue toexpand our business globally and, as such, expect that an increasing proportionof our business may be denominated in currencies other than U.S. Dollars.  As a result, fluctuations in foreigncurrencies may have a material impact on our business, results of operationsand financial condition.

 

Historically,the majority of our foreign-currency denominated sales have been made in China,denominated in Renminbi.  Additionally,during 2006 and 2007 we made significant sales in Japanese Yen, Euros, IndianRupees and Canadian Dollars.  Due toChina’s currency exchange control regulations, we are limited in our ability toconvert and repatriate Renminbi, as well as in our ability to engage in foreigncurrency hedging activities in China. The balance of our cash and short-term investments held in China was$165.1 million at June 30, 2008. Since China un-pegged the Renminbi from the U.S. Dollar in July, 2005,through June 30, 2008, the Renminbi has strengthened by more than 15%versus the U.S. Dollar.  However, it isuncertain what further adjustments may be made in the future.

 

Wemay manage foreign currency exposures using forward and option contracts tohedge and thus minimize exposure to the risk of the eventual net cash inflowsand outflows resulting from foreign currency denominated transactions withcustomers, suppliers, and non-U.S. subsidiaries, however, we are not currentlyhedging any such transactions.  As ourforeign currency balances are not currently hedged, any significant revaluationof our foreign currency exposures may materially and adversely affect ourbusiness, results of operation and financial condition.  We do not enter into foreign exchange forwardor option contracts for trading purposes.

 

Givenour exposure to international markets, we regularly monitor all of our materialforeign currency exposures.  We usesensitivity analysis to measure our foreign currency risk by computing thepotential decrease in cash flows that may result from adverse or beneficialchanges in foreign exchange rates, relative to the functional currency with allother variables held constant.  Theanalysis covers all of our underlying exposures for foreign currencydenominated financial instruments.  Theforeign currency exchange rates used were based on market rates in effect at June 30,2008.  The sensitivity analysis indicatedthat a hypothetical 10% adverse or beneficial movement in exchange rates wouldhave resulted in a loss or gain in the fair values of our foreign currencydenominated financial instruments of $4.2 million at June 30, 2008.

 

**ITEM 4—CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

UTStarcom, Inc.(“UTStarcom” or the “Company”) maintains disclosure controls and proceduresthat are designed to ensure that information required to be disclosed in thereports the Company files or submits under the Securities Exchange Act of 1934,as amended (“Exchange Act”), is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’s (“SEC”)rules and forms, and that such information is accumulated and communicatedto the Company’s management, including its chief executive officer (“CEO”) andchief financial officer (“CFO”), as appropriate, to allow timely decisionsregarding required financial disclosure.

 

Inconnection with the preparation of this Quarterly Report on Form 10-Q (“Form 10-Q”),the Company carried out an evaluation as of June 30, 2008 under thesupervision and with the participation of the Company’s management, includingthe CEO and CFO, of the effectiveness of the design and operation of theCompany’s disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act. Based upon this evaluation, managementconcluded that as of June 30, 2008 the Company’s disclosure controls andprocedures were not effective because of the material weaknesses described in “Management’sAnnual Report on Internal Control over Financial Reporting,” included in “Part II,Item 9A - Controls and Procedures” (“Item 9A”) in the Company’s Annual Reporton Form 10-K for the fiscal year ended December 31, 2007, which havenot yet been remediated. Investors are directed to Item 9A in the 2007 AnnualReport for the description of these weaknesses.

 

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A“material weakness” is a deficiency, or a combination of deficiencies, ininternal control over financial reporting, such that there is a reasonablepossibility that a material misstatement of the Company’s annual or interimfinancial statements will not be prevented or detected on a timely basis. Toaddress these material weaknesses in internal control over financial reportingnoted above, the Company performed additional analyses and other procedures (asfurther described below under “Management’s Planned Remediation Initiatives andInterim Measures”) to ensure that the Company’s consolidated financialstatements are prepared in accordance with generally accepted accountingprinciples in the United States (“GAAP”). Accordingly, the Company’s managementbelieves that the consolidated financial statements included in this Form 10-Qfairly present in all material respects the Company’s financial condition,results of operations and cash flows for the periods presented and that this Form 10-Qdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the periods covered by this report.

 

**Management’s Planned Remediation Initiatives and InterimMeasures**

 

TheCompany plans to make necessary changes and improvements to the overall designof its control environment to address the material weaknesses in internalcontrol over financial reporting described in Item 9A in the 2007 AnnualReport. In particular, the Company has implemented during 2007 and the firstand second quarters of 2008, and plans to continue to implement during theremainder of 2008, the specific measures described below.  In addition, in connection with the June 30,2008 quarter-end reporting process, the Company has undertaken additionalmeasures described under the subheading “Interim Measures” below to providereasonable assurance regarding the reliability of financial reporting and thepreparation of the Company’s consolidated financial statements included in thisForm 10-Q and to ensure that material information relating to the Companyand its consolidated subsidiaries was made known to management in connectionwith the preparation of this Form 10-Q.

 

***Remediation Initiatives***

 

1.                                       To remediate the material weakness described in Item 9Ain the 2007 Annual Report, in “*The Company failed toprevent or detect non-compliance with established policies and proceduresintended to ensure compliance with laws and regulations,”* theCompany launched a formal investigation at the direction of the Audit Committeeof the Company’s Board of Directors (“Audit Committee”) to review allegedviolations of the FCPA during the second quarter of 2006; refer to “*Governmental Investigations*” under “Part II,Item 1-Legal Proceedings” for additional information. Throughout the course ofthis investigation, the Company has taken and plans to continue to take allappropriate actions including changes to its training, processes and proceduresrelated to its code of business conduct and ethics, its payment controlsparticularly in outlying regions, and its due diligence evaluation of businesspartnerships. Upon conclusion of this investigation, the Company will reviewand, as necessary, further enhance its procedures to reduce the risk of ongoingcontrol deficiencies in this area. In the third and fourth quarters of 2007 andthe first and second quarters of 2008, the Company provided training topersonnel in offices in various regions including North America, Europe, Chinaand India and, in the remainder of 2008, plans to continue to provide trainingand expand its coverage to personnel employed in other regions and countries.In addition, the Company’s internal audit staff commenced audits and plans tocontinue to expand and increase the scope of the Company’s efforts to monitorcontrols at company operations globally, through reviews and audits of employeecompliance with applicable policies and procedures at business units,subsidiaries and other locations.

 

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2.                                       To remediate the material weaknessesdescribed in Item 9A in the 2007 Annual Report over “*appropriatelymatching of costs of sales with revenue and recording the reserves for losseson customer contracts and the associated cost of sale,*” the Company’s plannedremediation measures are intended to address material weaknesses at its U.S.headquarters that have the potential of misstating these balances in thefinancial statements in future financial periods. These measures include thefollowing:

 

i.        TheCompany effected changes in the overall design and structure of its financialreporting organization, in the months of September and October of2007.  These changes have enabled, andare expected to continue to foster, improvements in the flow of informationbetween various groups within finance, and enhancements in various processesincluding the review of the sales contracts’ gross margins to ensure propermatching of cost to revenue, and identification of loss contracts as well asthe review of the accuracy and adequacy of existing reserves for losses oncustomer contracts.

 

ii.         Inthe first and second quarters of 2008, the Company enhanced, and in the remainderof 2008, the Company plans to continue enhancing, its processes and proceduresto ensure the completeness and accuracy of the recording of the cost of saleswhen revenue is recognized, and the accuracy and adequacy of recording of thereserves for losses on customer contracts. The revised processes includedinvolving and obtaining detailed and timely input from business units,operations and sales operations personnel to enhance the information availablefor finance to analyze these accounts. Additional analytical processes were putin place to ensure the accuracy of the recording of the cost of sales whenrevenue is recognized. In addition, finance management has placed increased attentionon reviewing in detail the accounting in this area.

 

3.                                       To remediate the material weaknessesdescribed in Item 9A in the 2007 Annual Report over “*its process to**ensure the complete andaccurate preparation and review of its consolidated financial statements anddisclosures in accordance with GAAP,*” the Company’s plannedremediation measures are intended to address material weaknesses at its U.S.headquarters that have the potential of misstating these balances in thefinancial statements in future financial periods. These measures include thefollowing:

 

i.         During2007 and the first and second quarters of 2008 the Company enhanced, and in theremainder of 2008 the Company plans to continue enhancing, the month andquarter-end closing procedures within its corporate accounting function tostandardize its processes for financial review to ensure that reviewers at itsU.S. headquarters analyze and monitor financial information in a consistent andthorough manner. The enhanced procedures included timely communication with theCompany’s remote locations to ensure the completeness and accuracy of the closeprocesses.

 

ii.         During2007 and the first and second quarters of 2008 the Company implemented, and inthe remainder of 2008 the Company plans to continue enhancing and improving thedocumentation and review of required information associated with thepreparation of its quarterly and annual filings under the Exchange Act.Additional reviews were put in place to ensure the accuracy of the financialstatements in the quarterly and annual filings, and procedures were added toensure the completeness of the reviews of the quarterly and annual filings.

 

***Interim Measures***

 

Managementhas not yet implemented and/or tested all of the measures described above underthe heading “*Remediation Initiatives.*” Nevertheless, management believesthe measures identified above (to the extent these have been implemented),together with other measures undertaken by the Company in connection withpreparation of the consolidated financial statements included in this Form 10-Qand described below, address the material weaknesses in internal control overfinancial reporting described in Item 9A in the 2007 Annual Report and thatremain material weaknesses as of June 30, 2008. These other measuresinclude the following:

 

1.            The Company retainedon an interim basis outside consultants with relevant accounting experience,skills and knowledge, working under the supervision and direction of theCompany’s management, to assist with its review in a number of areas includingSEC external financial reporting.

 

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2.            The Companyimplemented and performed a number of additional detailed procedures and acomprehensive review of its accounting in various areas, including:

 

a)                                 Analysisof the backlog report, gross margin report and contract analysis report,enhanced discussions with business unit, finance personnel in variouslocations, operations and sales and services personnel to enhance theinformation available for finance to analyze, and thorough review of relatedsales and cost information to determine the reserves for losses on customercontracts and associated cost of sales.

 

b)                                Avariety of manual review procedures, such as an extensive review of journalentry postings into the Oracle system, a thorough review of accountreconciliations, and a detailed review at its U.S. headquarters of trialbalances including those issued from decentralized locations, to ensure thecompleteness and accuracy of the underlying financial information used togenerate the financial statements.

 

***Management’s Conclusion***

 

Managementbelieves the remediation measures described under “Management’s Planned Remediation Initiatives and Interim Measures”above will strengthen the Company’s internal control over financial reportingand remediate the material weaknesses identified in “Management’s Annual Reporton Internal Control over Financial Reporting.” However, management has not yetimplemented all of these measures and/or tested them.  Management believes that the interim measuresdescribed under “Management’s Planned Remediation Initiatives and InterimMeasures” above provide reasonable assurance regarding the reliability offinancial reporting and the preparation of the Company’s financial statementsincluded in this Form 10-Q and has discussed this with the Company’s AuditCommittee.

 

TheCompany is committed to continuing to improve its internal control processesand will continue to diligently and vigorously review its disclosure controlsand procedures and its internal control over financial reporting in order toensure compliance with the requirements of Section 404 of theSarbanes-Oxley Act of 2002. However, any control system, regardless of how welldesigned, operated and evaluated, can provide only reasonable, not absolute,assurance that its objectives will be met. As management continues to evaluateand work to improve the Company’s internal control over financial reporting, itmay determine to take additional or alternate measures to address controldeficiencies, and it may determine not to complete certain of the measuresdescribed under “Management’s PlannedRemediation Initiatives and Interim Measures” above.

 

**Changes in Internal Control over Financial Reporting**

 

Duringthe second quarter of 2008 the Company continued its implementation of anupgrade to its enterprise resource planning (“ERP”) system. The Company willcontinue to enhance its ERP system through the remainder of 2008 and beyond.The Company has modified and will continue modifying the design anddocumentation of internal controls processes and procedures relating to theupgraded system as appropriate and necessary to supplement and complementexisting internal controls over financial reporting.

 

Thediscussion in this section and in the “Management’sPlanned Remediation Initiatives and Interim Measures” section includes a description of the materialchanges to the Company’s internal control over financial reporting during thesecond quarter of 2008 that materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

**PART II—OTHERINFORMATION**

 

**ITEM 1—LEGAL PROCEEDINGS**

 

For a description of litigation and governmentalinvestigations, see Note 14 to our Condensed Consolidated Financial Statementsincluded under Part 1, Item 1 of this Quarterly Report on Form 10-Q.

 

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**ITEM 1A—RISK FACTORS**

 

For a description of risk factors that could materially affect ourbusiness, financial condition and future operating results, see “Part II,Item 1A – Risk Factors” of our Quarterly Report on Form 10-Q for thefiscal quarter ended March 31, 2008, which superseded thedescription of risk factors previously disclosed in “Part I, Item 1A- Risk Factors” of our Annual Report on Form 10-K for the fiscal yearended December 31, 2007.  Thedescriptions below include material changes to the respective risk factor aspreviously disclosed in our Quarterly Report on Form 10-Q for the fiscalquarter ended March 31, 2008. Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially and adversely affect ourbusiness, financial condition or future operating results.

 

**FACTORS AFFECTING FUTURE OPERATING RESULTS**

 

**RISKS RELATED TO OUR COMPANY**

 

*We continue to experience operating losses and do not havesufficient liquidity to execute our business plan or to continue our operationswithout obtaining additional funding. Our ability to obtain additional fundingis not assured.*

 

Pleaserefer to Management’s Discussion and Analysis of “Liquidity and CapitalResources” included under Part I, Item 2 of this Quarterly Report on Form 10-Qfor a discussion of the factors that raise doubt as to our ability to continueas a going concern, including, among other things, our continuing operatinglosses, generally declining amount of cash and cash equivalents, and reducedand expiring credit facilities.  Thisuncertainty as to our ability to continue as a going concern caused ourindependent registered public accounting firm to include an explanatoryparagraph highlighting this uncertainty in their “Report of IndependentRegistered Public Accounting Firm” dated February 29, 2008 included in “Part II,Item 8-Financial Statements and Supplementary Data” in our Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

Asa result of the sale of PCD on July 1, 2008 (see Note 22 to our CondensedConsolidated Financial Statements included under Part I, Item 1 of thisQuarterly Report on Form 10-Q), management believes the Company now hassufficient liquidity to finance its working capital and capital expenditurerequirements for the next twelve months.

 

Managementwill continue to implement its liquidity plans, which include divesting othernoncore assets or operations and obtaining loans from financial institutions.If we cannot successfully implement our liquidity plans, it may be necessaryfor us to make significant changes to our business plan in order to maintainadequate liquidity beyond the next twelve months. In addition, variousother matters may impact our liquidity such as:

 

·                     changes in financial market conditions or ourbusiness condition that could limit our access to existing credit facilities ormake new financings more costly or even unfeasible;

 

·                     inability to achieve planned operatingresults that could increase liquidity requirements beyond those considered inour business plan; and

 

·                     changes inChina’s currency exchange control regulations that could limit our ability toaccess cash in China to meet liquidity requirements for our operations in Chinaor elsewhere.

 

Althoughmanagement has developed liquidity plans, we may have difficulty maintainingexisting relationships, or developing new relationships, with suppliers or vendorsas a result of our financial condition. Our suppliers or vendors could chooseto provide supplies or services to us on more stringent payment terms thanthose currently in place, such as by requiring advance payment or payment upondelivery of such supplies or services, which would have an adverse impact onour short-term cash flows. As a result, our ability to retain currentcustomers, attract new customers and maintain contracts that are critical toour operations may be adversely affected.

 

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Thus,our ability to continue as a going concern beyond the next twelve months anduntil we generate sustained profits and/or positive cash flows from operationsis subject to our ability to successfully divest noncore assets or operationsand/or obtain loans from financial institutions. Our continuing operatinglosses increase the difficulty of our meeting such goals and our efforts tocontinue as a going concern may not prove successful.

 

*We may not realize the anticipated benefits of anydivestitures that we undertake.*

 

Asdiscussed in Note 22 to our CondensedConsolidated Financial Statements included under Part 1, Item 1 of thisQuarterly Report on Form 10-Q, we divested one of our noncore operations(and the assets associated with this operation) in July 2008. There is noassurance that the anticipated benefits of this divestiture, includingwithout limitation the receipt of any earnout payment based on the achievementof cumulative earnings levels by PCD, and any other divestitures we mayundertake in the future will be realized.

 

**RISKS RELATED TO CONDUCTINGBUSINESS IN CHINA**

 

*Recent PRC regulations relatingto offshore investment activities by PRC residents and employee stock optionsgranted by overseas-listed companies may increase our administrativeburden.  If our shareholders who are PRC residents, or our PRC employeeswho are granted or exercise stock options, fail to make any requiredregistrations or filings, we may be unable to distribute profits and may becomesubject to liability under PRC laws.*

 

The State Administration of Foreign Exchange (“SAFE”)has promulgated regulations that require PRC residents and PRC corporateentities to register with local branches of SAFE in connection with theirdirect or indirect offshore investment activities.  Under the SAFEregulations, PRC residents who make, or have previously made, direct orindirect investments in offshore companies will be required to register thoseinvestments.  In addition, any PRC resident who is a direct or indirectshareholder of an offshore company is required to file or update theregistration with the local branch of SAFE with respect to that offshorecompany any material change involving its round-trip investment, capitalvariation, such as an increase or decrease in capital, transfer or swap ofshares, merger, division, long-term equity or debt investment or creation ofany security interest.  If any PRC shareholder fails to make the requiredSAFE registration or file or update the registration, the PRC subsidiaries ofthat offshore parent company may be prohibited from distributing their profitsand the proceeds from any reduction in capital, share transfer or liquidationto their offshore parent company, and the offshore parent company may also beprohibited from injecting additional capital into its PRC subsidiaries. Moreover, failure to comply with the various SAFE registration requirements describedabove could result in liability under PRC laws for evasion of applicableforeign exchange restrictions.

 

We cannot provide any assurances that all of ourshareholders who are PRC residents will make or obtain any applicableregistrations or approvals required by these SAFE regulations.  Thefailure or inability of our PRC resident shareholders to comply with theregistration procedures set forth therein may subject us to fines and legalsanctions, restrict our cross-border investment activities, or limit our PRCsubsidiaries’ ability to distribute dividends or obtainforeign-exchange-denominated loans to our company.

 

On March 28, 2007, SAFE promulgated a stockoption rule under which PRC citizens who are granted stock options by anoverseas publicly-listed company are required to register with SAFE andcomplete certain other procedures.  We and our PRC employees who have beengranted stock options are subject to this stock option rule.  If we or ourPRC employees holding options fail to comply with these regulations, we or ouremployees may be subject to fines and legal sanctions.

 

**ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

None

 

**ITEM 3—DEFAULTS UPON SENIOR SECURITIES**

 

None

 

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

 

Weheld our annual meeting of stockholders on June 27, 2008.  At the meeting, our stockholders voted on thefollowing three proposals, casting their votes as follows:

 

(i) To elect two Class II directors to serve for a term expiring on the dateon which the annual meeting of stockholders is held in the year 2011.

 
| **Nominee**     | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-----------------|------------|------------|------------|--------------|------------|
| Larry D. Horner |       | 96,232,932 |       | 6,444,005    |       |
| Allen Lenzmeier |       | 96,276,155 |       | 6,400,782    |       |

 

Therewere no broker non-votes on this matter. As a result, Messrs. Horner andLenzmeier were re-elected as directors of the Company. Other directors whoseterms of office continued after the meeting were as follows:

 
| **Class I (Term Expiring 2010)**   | ** ** | ** ** | ** ** |
|--------------------------------------------------------|------------|------------|------------|
|                                                   |       |       |       |
| Thomas J. Toy                                          |       |       |       |
| Bruce J. Ryan                                          |       |       |       |
|                                                   |       |       |       |
| **Class III (Term Expiring 2009)** |       |       |       |
|                                                   |       |       |       |
| Francis P. Barton                                      |       |       |       |
| Jeff Clarke                                            |       |       |       |
| Hong Liang Lu                                          |       |       |       |

 

EffectiveJuly 1, 2008, Peter Blackmore, the Company’s Chief Executive Officer andPresident, was appointed by the Board of Directors as a Class II directorof the Company.

 

(ii) To ratify and approve the appointment of PricewaterhouseCoopers LLP as theCompany’s independent registered public accounting firm for the fiscal yearending December 31, 2008.

 
| **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|-------------|------------|-------------|------------|-------------|------------|
| 101,188,694 |       | 1,185,828   |       | 302,415     |       |

 

Therewere no broker non-votes on this matter.

 

(iii)   To approve a stock option exchange programfor employees (excluding executive officers and directors), pursuant to whicheligible employees will be offered the opportunity to exchange their eligibleoptions to purchase shares of common stock outstanding under the Company’sexisting equity incentive plans for a smaller number of new options at a lowerexercise price.

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-  votes** | ** ** |
|------------|------------|-------------|------------|-------------|------------|-----------------------------|------------|
| 49,972,749 |       | 6,082,393   |       | 1,915,162   |       | 44,706,633                  |       |

 

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**ITEM 5—OTHER INFORMATION**

 

Aspreviously disclosed on Form 8-K filed with the SEC on March 25,2008, on March 21, 2008, UTStarcom Personal Communications LLC (the “Borrower”),a wholly-owned subsidiary of UTStarcom, Inc. (the “Company”), entered intoa credit agreement (the “Credit Agreement”) with Wells Fargo Foothill, LLC, aDelaware limited liability company (the “Lender”), providing for a $75.0million secured revolving credit facility that was subject to an accountsreceivable and inventory borrowing base formula.  On June 30, 2008,in connection with the entry into a merger agreement for the sale of theBorrower to AIG Global Investment Group as disclosed on Form 8-K filedwith the SEC on July 7, 2008, the Borrower terminated the commitmentsunder the Credit Agreement.  A description of the material terms of theCredit Agreement can be found under Item 1.01 in the Form 8-K filed by theCompany on March 25, 2008 and such description is incorporated herein byreference.  There were no amounts outstanding at the time of terminationof the commitments and no premiums or penalties were incurred by the Borrowerin connection with the termination of the Credit Agreement.

 

**ITEM 6—EXHIBITS**

** **
| **Exhibit  Number** | ** ** | **EXHIBIT DESCRIPTION**                                                                                                                                                                                                                                                                                                                              |
|---------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1                 |       | Merger  Agreement, dated as of June 30, 2008, by and among UTStarcom, Inc.,  UTStarcom Personal Communications Devices LLC, Personal Communications  Devices, LLC and Personal Communications Devices Holdings, LLC(incorporated by reference to  Exhibit 2.1 of Current Report on Form 8-K filed with the SEC on  July 7, 2008) |
| 3.1                 |       | Thirteenth  Amended and Restated Certificate of Incorporation of UTStarcom, Inc., as  amended (incorporated by reference to Exhibit 3.1 of Current Report on  Form 8-K filed with the SEC on December 12, 2003)                                                                                                                       |
| 3.2                 |       | Second  Amended and Restated Bylaws of UTStarcom, Inc., effective June 28,  2008 (incorporated by reference to Exhibit 3.1 of Current Report on  Form 8-K filed with the SEC on April 14, 2008)                                                                                                                                  |
| 4.1                 |       | See  exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and  Bylaws defining the rights of holders of Common Stock.                                                                                                                                                                                                                  |
| 4.2                 |       | Specimen  Common Stock Certificate (incorporated by reference to Exhibit 4.1 of  Form S-1/A filed with the SEC on February 7, 2000)                                                                                                                                                                                                        |
| 4.3                 |       | Third  Amended and Restated Registration Rights Agreement dated December 14,  1999 (incorporated by reference to Exhibit 4.2 of Form S-1 filed  with the SEC on December 20, 1999)                                                                                                                                                    |
| 10.1*               |       | Vice  President Change in Control and Involuntary Termination Severance Pay Plan as  amended and restated April 25, 2008 (incorporated by reference to  Exhibit 10.1 to Current Report on Form 8-K filed with the SEC on  May 1, 2008)                                                                                                |
| 10.2*               |       | 2006  Equity Incentive Plan as amended June 27, 2008                                                                                                                                                                                                                                                                                                 |
| 10.3*               |       | Separation  Agreement and Release (California) by and between Ying Wu and  UTStarcom, Inc. dated July 25, 2008                                                                                                                                                                                                                                  |
| 10.4*               |       | Separation  Agreement and Release (China) by and between Ying Wu and UTStarcom (China)  Co., Ltd., dated July 25, 2008                                                                                                                                                                                                                               |
| 31.1                |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) or  Rule 15d-14(a) promulgated under the Securities Exchange Act of  1934, as amended                                                                                                                                                                        |
| 31.2                |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) or  Rule 15d-14(a) promulgated under the Securities Exchange Act of  1934, as amended                                                                                                                                                                        |
| 32.1                |       | Certifications  of the Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                |

 

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*                                         Management contract, plan or arrangement

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|                            | UTSTARCOM, INC. |
|----------------------------|----------------------|
|                       |                 |
| Date: August 11, 2008 | By:                  | /s/ FRANCIS P. BARTON |
|                       |                 | Francis P. Barton |
| * *                   |                 | *Executive Vice President and Chief Financial  Officer* |
| * *                   | * *             | *(Principal Financial Officer)* |

 

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