**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 March 31, 2007** |
| ** **                                              |
| **OR**                                                  |
| ** **                                              |
| o                                                       |   | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                    |   | ** ** |
| **For the  transition period from to**                  |

 

**COMMISSIONFILE NUMBER 000-29661**

**UTSTARCOM, INC.**

(Exact name of registrant asspecified in its charter)

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

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d)of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past90 days.  Yes o No x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or non-accelerated filer (as defined in Rule 12b-2 ofthe Exchange Act).

Large Accelerated Filer x  Accelerated Filer o Non-Accelerated Filer o

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o No x

Asof September 30, 2007 there were 121,294,645 shares of the registrant’s commonstock outstanding, par value $0.00125.

 

----

**TABLE OFCONTENTS**
| PART I—FINANCIAL INFORMATION                                                                       | 12  |
|---------------------------------------------------------------------------------------------------------|-----|
| ITEM  1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                                | 12  |
| ITEM 2—MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 48  |
| ITEM  3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                                | 74  |
| ITEM 4—CONTROLS  AND PROCEDURES                                                                    | 76  |
| PART II—OTHER  INFORMATION                                                                         | 81  |
| ITEM 1—LEGAL  PROCEEDINGS                                                                          | 81  |
| ITEM  1A—RISK FACTORS                                                                              | 84  |
| ITEM  2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                | 102 |
| ITEM  3—DEFAULTS UPON SENIOR SECURITIES                                                            | 102 |
| ITEM  4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        | 103 |
| ITEM 5—OTHER  INFORMATION                                                                          | 103 |
| ITEM  6—EXHIBITS                                                                                   | 103 |
| SIGNATURES                                                                                              | 105 |

 

2

----

**EXPLANATORY NOTE**

**The Company was unable to file timelyits Form 10-Q for the quarterly period ended March 31, 2007 because we hadcommenced a voluntary review of historical stock option practices and theresults of that review were not known at the date the Form 10-Q filing wasdue.  Subsequent to that time, the AuditCommittee engaged independent counsel to conduct an investigation of sales inChina.  Information contained hereinabout the restatements of previously issued financial statements has been takenfrom the 2006 Annual Report on Form 10-K that was filed with the Securities andExchange Commission on October 10, 2007. The 2006 Annual Report containsadditional information about the restatements which is not included herein.**

Our consolidated financialstatements and related financial information included in this Quarterly Reporton Form 10-Q for accounting periods prior to the third quarter of 2006 havebeen restated, as described below.

***Summary***

In July 2007, the Company announced the Audit Committee of the Board ofDirectors (the “Audit Committee”) was conducting an independent investigationof historical sales with certain customers in China and stated that it couldnot rule out the possibility that the outcome of the investigation could impactrevenue recognized for certain of such contracts as recorded in previouslyissued financial statements. In September 2007, the Company announced theinvestigative phase of the Audit Committee’s investigation had been completed.After consultation with and upon the recommendation of management, the AuditCommittee determined revenue in the Company’s Western Region of China wasrecognized earlier than it should have been and that the financial statementsfor the affected periods should be restated. The Company also announced thatits previously issued financial statements for each of the fiscal years endedDecember 31 in the period 2000 through 2005, the financial statements for theinterim periods contained in the Quarterly Reports on Form 10-Q filed withrespect to each of these years, and the quarterly reports on Form 10-Q filedwith respect to each of the quarterly periods ended March 31 and June 30,2006 should not be relied upon. In thisQuarterly Report we have corrected for the effects of net sales and relatedcosts of net sales that were recorded earlier than they should have been andhave restated the financial statements for the three months ended March 31,2006. The net effect for the three months ended March 31, 2006 was to recognizepreviously deferred revenue and gross profit of $5.4 million and $1.4 million,respectively.

We also conducted a voluntary review of historical stock optionpractices under the direction of the Nominating and Corporate GovernanceCommittee of our Board of Directors (“Governance Committee”). This reviewconsidered all option grant awards made in the period from February 29, 2000,shortly before the initial public offering of our Common Stock, through August2006 for compliance with the various stock-based compensation accountingstandards applicable during this period as well as the rules of our stockoption plans. We found that in a number of instances we did not use the properdate as the measurement date in determining whether stock options had beenissued with exercise prices below the fair value of our common stock.Therefore, we have restated our previously issued financial statements for theyears ended December 31, 1998 through 2005 to account for an additional $25.5million of stock compensation expense that should have been recognized over theperiod together with an equal increase in additional paid-in capital torecognize the intrinsic value assigned to these issuances of equity securities.Related adjustments of payroll and income taxes resulted in an additional $0.5million of expense being recognized for the 1998 through 2005 period and totalstockholders’ equity being reduced by a total of $2.1 million at December 31,2005. During the first six months of 2006 an additional $1.2 million of stockcompensation expense was recognized, which reduces our previously reportedoperating results for this period.  Wehave restated the financial statements for the three months ended March 31,2006, and during that period incremental stock compensation expense totaling$0.7 million was recognized.

None of these restatements had any effect on any of ourcash balances, however cash equivalents were reduced at March 31, 2006 due tothe correction in classifications described below.

Additional information about these restatements andtheir effects on our financial statements is presented below as well as in theNotes to Consolidated Financial Statements.

***China Sales Investigation***

The Audit Committee engaged independent counselto conduct an investigation of sales in China following a determination by theInternal Audit group that allegations of improper activities in a sales officein the Western Region were credible. The allegations were made by a Companyemployee using the Company’s whistle blower program. The independent counselengaged the assistance of forensic accountants, and this group is collectivelyreferred to as the Investigating Team in the rest of this discussion.

3

----

In conducting its procedures, the InvestigatingTeam found instances where the customer contracts that evidenced thearrangement contained obligations for the Company to deliver software upgradeswhen and if made available for the equipment sold for no additionalconsideration and for an unspecified period that could extend over the term ofthe contract. This additional contract obligation is an element of “postcontract support.” In these cases, the Investigating Team found that thecontract documentation for the same transaction submitted by the sales officeto the Company’s China headquarters for accounting purposes and utilized by theCompany in determining the amount of revenue recognized did not includeevidence of such post contract support obligations.

Accounting standards governing revenuerecognition for system sales require all revenue to be deferred while there areundelivered elements under the arrangement unless the seller has establishedvendor specific objective evidence (“VSOE”) of fair value for such contractelements. Because these arrangements included such undelivered elements,revenue should be deferred based on the VSOE of the fair value of theunderlying elements. VSOE of fair value represents the price charged when thesame element is sold separately. Since the Company does not sell this elementseparately, it has not established VSOE for such undelivered elements, and assuch the revenue from such contracts is required to be deferred and recognizedover the period the Company is obligated to provide the post contract support.

The China sales investigation covered each of the seven years in theperiod ended December 31, 2006 and included: investigating approximately 1,200contracts in all of our five regions in China; reviews of the electronic filesof 45 employees; and formal interviews of 96 employees in China. Additionally,the China sales investigation included reviewing contract files, performingvarious financial analyses including comparison of payments received per ouraccounting records to the contract terms, and computer forensic procedureswhere destruction of electronic documents was suspected. In the aggregate, theInvestigating Team expended approximately 25,000 hours in conducting thisinvestigation, which commenced in February 2007 and was completed in September2007 when the independent counsel and forensic accountants presented theirfinal report to the Audit Committee. In July 2007, we announced the AuditCommittee was conducting an independent investigation of historical sales withcertain customers in China and we stated that we could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in our previously issuedfinancial statements.

Upon completion of the investigative phase of the independentinvestigation by the Audit Committee, our management:

·                  conducted follow-up procedures to attempt tolocate any additional relevant information to ensure the Company considered allavailable information and documents;

·                  evaluated the accounting for identified systemsales using the contract template and documentation found in the sales contractfiles from the Western Region offices. This included calculating the financialstatement effects of correcting the accounting for all system sales where thecontract template found at our sales offices contained post contract supportobligations to recognize revenue and cost of net sales over the estimatedperiod of post contract support;

·                  concluded that as a result of the existence ofthis undelivered post contract support obligation our previously issued financialstatements should be restated to defer system sales contract revenue and therelated cost of net sales over the estimated period of post contract supportwhen a contract contained unspecified software upgrade rights.

The Audit Committee concurred with management’s decisions.

4

----

The effect of correcting improperly recognized revenue and cost of netsales was to (reduce) increase previously reported net sales, gross profit andnet income by the following amounts (in thousands of dollars):
| Year ended  December 31, | ** ** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
|------------------------------------|------------|------------|--------------------|------------|-----------------------|------------|---------------------|------------|
| ** **                         | ** ** | ** ** | ** **         | ** ** | ** **            | ** ** | ** **          | ** ** |
|                               |       |       |               |       |                  |       |                |       |
| 2000                               |       |       | $                  | (12,408    | )                     | $          | (5,294              | )          | $ | (4,781 | ) |
| 2001                               |       |       | (17,154            | )          | (6,330                | )          | (5,779              | )          |
| 2002                               |       |       | (64,732            | )          | (22,924               | )          | (19,697             | )          |
| 2003                               |       |       | (21,060            | )          | (8,014                | )          | (6,382              | )          |
| Totals through December 31,  2003  |       |       | (115,354           | )          | (42,562               | )          | (36,639             | )          |
| 2004                               |       |       | (104,965           | )          | (27,241               | )          | (18,594             | )          |
| 2005                               |       |       | (58,232            | )          | (27,863               | )          | (42,433             | )          |
| 2000  - 2005 Total                 |       |       | (278,551           | )          | (97,666               | )          | (97,666             | )          |
| 2006  quarter ended                |       |       |               |       |                  |       |                |       |
| March  31                          |       |       | 5,410              |       | 1,360                 |       | 1,360               |       |
| June  30                           |       |       | 2,380              |       | (371                  | )          | (371                | )          |
| Total China Sales Restatement      |       |       | $                  | (270,761   | )                     | $          | (96,677             | )          | $ | (96,677 | ) |

 

The cumulative effect of all of the China sales restatement adjustmentsto our consolidated balance sheet as of December 31, 2003 resulted in adecrease in retained earnings of $36.6 million, an increase in deferred revenueof $115.4 million to account for previously recognized sales, an increase indeferred costs of $72.8 million to account for previously recognized costof net sales, and an increase in deferred tax assets and prepaid taxes of $5.9 million.In our consolidated balance sheet at March 31, 2007 the net reduction inpreviously recognized net sales is accounted for as deferred revenue, of which$36.5 million is classified as current and $233.3  million as non-current, and the related netreduction in cost of net sales of $172.9 million is accounted for as deferredcosts. These amounts are being recognized in our consolidated statements ofoperations over the estimated remaining period of post contract support.

Upon completing its investigation, the Audit Committeeconcluded that the conditions and practices relating to systems contractsprevalent in the Western Region resulted primarily from the failure to preventor detect instances of override related to controls in China over customeragreements, lack of proper management oversight, unclear record retentionpolicies and procedures relating to systems contracts, and inadequate employeetraining. The Investigating Team and the Audit Committee also concluded thatwith respect to four regions other than the Western Region there was noevidence of fraud or misconduct or reason to suspect such occurred. TheInvestigating Team and the Audit Committee also concluded that there was nocredible evidence of knowledge by senior management in China or the UnitedStates of the conditions and practices related to the Western Region of Chinathat were discovered in the investigation. The Audit Committee concluded thatlocal management in several of the sales offices in the Western Region of Chinadid not submit appropriate information to the Company’s senior management inChina and the United States. Therefore, in prior years, neither the Company’smanagement nor the Company’s independent registered accounting firm were ableto properly evaluate the effect of that information on revenue recognition. TheAudit Committee also concluded that certain members of management in China bearvarying degrees of responsibility for inadequate oversight of activities. As aresult, certain employees in China have either been terminated or placed onsuspension for failure to provide adequate oversight of activities.

We have restructured the management of the Western Region salesorganization and are working to identify and implement changes to our policiesand procedures and enhance employee training to improve internal controlconsciousness and lessen the possibility of accounting errors occurring in thefuture.

***Stock Option Accounting***

In November 2006, we announced we had commenced a voluntary review ofhistorical stock option practices under the leadership of the GovernanceCommittee following a preliminary review by management which identifiedpotential deficiencies and discrepancies in the documentation of stock optiongrants. The review considered all option grant awards made in the period fromFebruary 29, 2000, shortly before the initial public offering of our CommonStock, through August 2006 (“Review Period”) for compliance with the variousstock-based compensation accounting standards applicable during the ReviewPeriod as well as the rules of our stock option plans. The Governance Committeeengaged independent outside legal counsel to assist in the review who, in turn,engaged forensic accountants. (Separate law firms and separate forensic 

5

----

accountingfirms were engaged by the Audit Committee and the Governance Committee for theChina sales investigation and the stock option accounting review.) In the restof this discussion, this group collectively is referred to as the Stock OptionReview Team and their actions and activities are referred to as the StockOption Review. The Stock Option Review Team members spent over 11,000 hours inthis review, and the Governance Committee met with the Stock Option Review Teamon more than a dozen occasions to receive, discuss, and consider the StockOption Review Team’s information and findings.

At the time the review commenced, the Governance Committee consisted ofthree members of the Board of Directors, all of whom are independent directors.The Committee decided to delegate supervision of the review to Mr. Jeff Clarke,its Chairman, who joined our Board in 2005 and had not served on theCompensation Committee of the Board of Directors (“Compensation Committee”)during the period under review. The Governance Committee also consisted of twoother independent directors, Mr. Larry D. Horner and Mr. Thomas Toy, who alsoserve on the Board’s Compensation Committee. Mr. Allen Lenzmeier was appointedto the Governance Committee on April 27, 2007.

Review procedures included:

·                  interviews of individuals involved withgranting, advising, administering, or accounting for stock options, includingcurrent and former: management, members of the Board of Directors, employees,and non-employee professionals;

·                  review of relevant stock administration, humanresource, legal, and finance department files and records;

·                  review of stock option grant information inselect employee personnel files;

·                  review by at least 30 attorneys and 15 forensicaccountants of approximately 250,000 potentially relevant e-mails and documentsin electronic format selected through electronic discovery techniques from over1.8 million electronic documents processed;

·                  review of the electronic database of the Company’sstock option activity maintained by a third party along with communications toand from this service provider;

·                  reconciliation of grant activity from approvaldocuments executed by the Compensation Committee with the electronic database;

·                  reconciliation of stock option grant, exercise,and cancellation information from SEC filings with select employee personnelfiles and the electronic database;

·                  statistical and judgmental pattern analysis;

·                  follow-up on matters raising questions about theoption granting process and its history, conduct of those involved withgranting, advising, administering, or accounting for stock options, or theaccounting treatment for stock options; and

·                  follow-up on items or issues requested oridentified by management or the Company’s independent registered publicaccounting firm.

The Stock Option Review Team, management, and the Governance Committeedecided to group stock option grants into six award categories based ondifferences in what constituted substantive approval for each category underour stock option granting practices as well as giving consideration to the riskof intentional misstatement of the grant date. Guidance in a September 19, 2006letter publicly issued by the SEC’s Chief Accountant focuses on the conceptthat a measurement date under Accounting Principles Board Opinion No. 25 *Accounting for Stock Issued to Employees*(“APB 25”), theaccounting standard governing our stock option accounting through 2005, doesnot occur until the number of shares an individual employee is entitled toreceive and the exercise price is determined with finality (i.e., no longersubject to change). This is the date on which substantive approval occurred,and depending on a company’s facts and circumstances the guidance from the SECdiscussed above recognizes a company may determine that the measurement datefor some stock option grants may occur before all required granting actionshave occurred – such as final approval by the Compensation Committee. Thisalternative is available only when a review of all facts and circumstancessupports a conclusion that substantive approval occurs earlier than when allrequired granting actions have occurred and there is no evidence of fraudulentor manipulative conduct in the company’s option granting practices.

6

----

In determining the measurement date to be used, the Stock Option ReviewTeam, management, and the Governance Committee agreed to use the followingdefinitions as constituting the proper measurement date, and generally thesedates were used in testing the stated grant dates or establishing correctedmeasurement dates:
| **Discretionary Director and  Officer Grants** |       | The date of a Compensation Committee meeting where the grant was  approved or the date the final Compensation Committee signer approved the  grant when approval occurred through unanimous written consent documents  (“UWC”).                                                                                                                                                                                                                                                         |
|------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Automatic Director Grants**                  |       | The date specified in the relevant stock option plan.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Broadbase**                                  |       | The date the grantee list, including the allocation of shares to  individual grantees, was complete. Compensation Committee approval was  considered perfunctory due to delegation of authority to management.                                                                                                                                                                                                                                                                                    |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Acquisition**                                |       | The first Compensation Committee meeting following the acquisition,  provided grantees had received employment offer letters stating the number of  stock options to be granted before such date, because this was the date at  which the option exercise price was established. Compensation Committee  approval was considered perfunctory due to delegation of authority to  management.                                                                                                       |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **New Hire**                                   |       | The first scheduled Compensation Committee meeting following the first  day of employment, because this was the date at which the option exercise  price was established. The number of options was based on either grant  amounts specified in an employment offer letter or, in some cases, on a  matrix that assigned grant amounts based on position and level within the  Company. Compensation Committee approval was considered perfunctory due to  delegation of authority to management. |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Other Merit**                                |       | The date the grantee list, including the allocation of shares to  grantees, was substantially complete. Compensation Committee approval was  considered perfunctory due to delegation of authority to management.                                                                                                                                                                                                                                                                                 |

For 12 tested grant dates wherea corrected measurement date was required, the Stock Option Review Team andmanagement were unable to locate sufficient evidence to establish a correctedmeasurement date using our established criteria for the applicable option granttype. In these situations alternative available evidence was used to establishthe corrected measurement date.

During the period covered bythe Stock Option Review, we granted stock options on approximately 34 millionshares of our Common Stock at 197 grant dates. The review specifically examinedthe appropriateness of the stated grant date for approximately 90% of the stockoptions granted, including all stock option grants made to directors andofficers, all broadbase grants and all option grants made in connection withbusiness acquisitions.

The findings of this review aresummarized as follows:

 
| ** **                           | ** ** | ** **         | ** ** | ** **             | ** ** | ** **         | ** ** | **Measurement date changed** | ** ** |
|--------------------------------------|------------|--------------------|------------|------------------------|------------|--------------------|------------|----------------------------------------|------------|
| ** **                           | ** ** | ** **         | ** ** | ** **             | ** ** | ** **         | ** ** | **additional**                         | ** ** | **no additional** | ** ** |
| ** **                           | ** ** | **Number of** | ** ** | ** **             | ** ** | **No change** | ** ** | **compensation**                       | ** ** | **compensation** | ** ** |
| **Grant Type**                  | ** ** | **grants**         | ** ** | **Grants tested** | ** ** | **required**       | ** ** | **expense required**              | ** ** | **expense required(1)** | ** ** |
|                                 |       |               |       |                   |       |               |       |                                   |       |   |   |
| Discretionary Director & Officer |       | 16                 |       | 16                     |       | 8                  |       | 4                                      |       | 4 |   |
| Automatic Director                   |       | 5                  |       | 5                      |       | 5                  |       | —                                 |       | — |   |
| Broadbase                            |       | 8                  |       | 8                      |       | —             |       | 6                                      |       | 2 |   |
| Acquisition                          |       | 10                 |       | 10                     |       | 10                 |       | —                                 |       | — |   |
| New Hire                             |       | 166                |       | 48                     |       | 48                 |       | —                                 |       | — |   |
| Other Merit                          |       | 96                 |       | 41                     |       | 4                  |       | 21                                     |       | 16 |   |
| Total                                |       | 301                | (2)        | 128                    |       | 75                 |       | 31                                     |       | 22 |   |

 

----

(1) Under APB 25 there is no expense adjustment arising from using thecorrected measurement date for these grants because the amount the employeewould have to pay to exercise these stock option grants exceeded the quotedmarket price of our Common Stock at the corrected measurement date, andtherefore, these stock option grants contained no intrinsic value at thecorrected measurement date.

(2) The number of grants exceeds the number ofgrant dates because on certain grant dates more than one category of stockoption grants were approved.

7

----

In late January 2007 theGovernance Committee reported its interim findings concerning the use ofincorrect measurement dates in our stock option accounting under APB 25 to ourBoard of Directors. On February 1, 2007, the Audit Committee of the Board ofDirectors then concluded, in consultation with and upon the recommendation ofmanagement, that we should correct for errors in previously reported stock-basedcompensation expense through restatement of our previously issued financialstatements and that our previously issued financial statements for all periodsshould no longer be relied upon. We communicated this decision in a February 1,2007 public announcement.

A non-cash compensation charge, to be recognized as an expense over agrantee’s service period, arises under APB 25 if a stock option has intrinsicvalue at its measurement date. This intrinsic value is measured by the excess,if any, of the fair value at the date of grant of the underlying common stockover the stock option’s exercise price. Our practice has been to grant stockoptions with exercise prices equal to the closing price of our Common Stock ateach grant date, to use the grant date as the measurement date for stock-basedcompensation purposes, and as such previously we had determined the grantedstock options had no intrinsic value at their grant dates and no compensationexpense was recognized. However, APB 25 states the measurement date does notoccur until all essential actions necessary to grant the option are completed,including the final determination of both the number of shares to be granted toeach employee or director and the exercise price, and the option grant isapproved by those with requisite authority. This is reinforced by the September19, 2006 letter issued by the SEC’s Chief Accountant which focuses on the needfor the number of shares and exercise price of an award to an individual to befinalized to have a measurement date. This letter clarifies the SEC staff’sview that if it is possible that those terms could change, a measurement datehas not occurred, even if the award’s terms are not actually changed.

Based on the availableevidence, the review found that the number of shares an individual employee wasentitled to receive and/or the exercise price was not determined with finalityat the stated grant date on 53 tested grant dates, and we should have used alater date as the measurement date. The principal reasons for the stated grantdate not qualifying as the measurement date under APB 25 include:

·                  certain listings ofgrantees, below officer level, were incomplete and added to or modified bystock option administration personnel after the grant was approved by the CompensationCommittee;

·                  for certain grantswhere Compensation Committee approval was not considered perfunctory, the datea UWC document was sent to Compensation Committee members for approval was usedas the stated grant date for some discretionary officer and director grantsrather than the date the UWC was signed by all Compensation Committee membersand therefore became effective;

·                  the Stock OptionReview Team was unable to locate contemporaneous documentation of some directorand officer, broadbase, new hire, and other merit grants.

During the review the Companyalso discovered a stock option grant to a former officer that was modified in1998 in connection with his termination of employment. This change was neverincluded in the Company’s stock option grant records and the additionalcompensation expense resulting from the change in the option’s terms(approximately $1.2 million)  was notrecorded previously. This discovery is consistent with the Stock Option ReviewTeam’s finding that in certain instances there was a lack of formaldocumentation in the stock option granting process and/or expecteddocumentation is missing from the stock option administration files. Inaddition, the Stock Option Review Team found that, in many instances, there wasa lack of self-authenticating evidence to corroborate that cash exercises werecontemporaneous. As a result, the findings on the issue of backdating of cashexercises were inconclusive.

We restated our consolidated financial statements to recognizeadditional non-cash stock-based compensation expense arising from usingcorrected measurement dates for certain stock option grants made during theyears 2000 through 2005 and to reflect the modification of the 1998 grantdescribed above. Consistent with our historical accounting policy thisadditional stock-based compensation expense is being recognized on anaccelerated basis by treating each vesting tranche as a separate stock optiongrant (graded vesting).

Our accounting for stock-based compensation changed to a fair valuebased method in 2006 when, as required by accounting standards, we ceasedaccounting for stock-based compensation under the intrinsic value methodpursuant to APB 25 and began accounting for stock-based compensation underStatement of Financial Accounting Standards 123(R) *Share-BasedPayments*(“SFAS 123(R)”). Under this method all stock option grantshave a fair value determined using an option 

8

----

pricingmodel, and such fair value is used to recognize non-cash stock-basedcompensation expense. We restated our unaudited condensed consolidatedfinancial statement information for the first and second fiscal quarters of2006, included in Exhibit 99.1 in our Annual Report on Form 10-K for the yearended December 31, 2006 (and as reflected in our results for the three monthsended March 31, 2006 included in this Form 10-Q), to recognize changes innon-cash stock-based compensation expense that arose from a re-determination ofthe fair value of stock options granted in 2005 and prior where the Governance Committee’sreview resulted in a corrected measurement date. By January 1, 2006, of the17.9 million options granted in 2000 - 2005 where corrections were made to themeasurement dates in the Stock Option Review, 4.4 million options withcorrected measurement dates granted in 2000 and 2001 had fully vested.Therefore, the fair values of the outstanding and unvested portion of theremaining 13.5 million stock options granted in 2002-2005 with incorrectmeasurement dates were recalculated. We also recorded additional non-cashstock-based compensation expense in the first two quarters of 2006 arising fromcorrecting the measurement date for stock option grants to three individuals inthis period. We recognize stock compensation expense on a straight-line basis underSFAS 123(R).

Those stock option grants with corrected measurement dates have alsobeen restated using the fair value based measurement principles of Statement ofFinancial Accounting Standards 123 *Accounting for Stock-BasedCompensation*(“SFAS 123”) to present, in Note 2, “Restatement ofFinancial Statements” of Notes to Consolidated Financial Statements containedin Item 8 of the Company’s 2006 Annual Report, the pro forma effect onstock-based compensation expense, net income (loss), and earnings (loss) pershare amounts in 2004 and 2005 of using the fair value based method todetermine stock-based compensation expense rather than using APB 25’s intrinsicvalue method. Such disclosure is required in financial statements for periodsprior to the adoption of SFAS 123(R).

In addition to restating the consolidated financial statements inresponse to the Governance Committee’s findings, we recorded additionalnon-cash adjustments to account for the modification in 1998 of a stock optiongrant to a former officer in connection with his termination of employment andto record in the first two quarters of 2006 corrections relating to accountingfor performance related stock options and restricted stock grants, all of whichwere previously identified and considered immaterial.

Correcting the measurement date for previously granted stock options insome cases results in additional taxable income to employees on whichadditional payroll taxes are due from the employees as well as us. We haveprovided for all additional payroll taxes plus related penalties and interestarising from the restatement of stock-based compensation, including amountsotherwise payable by stock option recipients, and our restated financialstatements include an accrual in all affected years of approximately $1.5million for all estimated payroll tax related expenses.

The corrections for the stock option restatement were to increase(reduce) previously reported non-cash compensation expense, payroll taxes,income taxes and net income by the following amounts (in thousands of dollars):
|                                       | ** ** | **Non-cash stock** | ** ** | ** **             | ** ** | ** **            | ** ** | ** **          | ** ** |
|---------------------------------------|------------|-------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| **Year ended December 31,** | ** ** | **compensation**        | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
|                                  |       |                    |       |                   |       |                  |       |                |       |
| 1998                                  |       | $                       | 1,244      |                   | $          | —                |       | $                   | (448       | ) | $ | (796 | ) |
| 1999                                  |       | —                  |       | —                 |       | —                |       | —              |       |
| 2000                                  |       | 556                     |       | —                 |       | (104                  | )          | (452                | )          |
| 2001                                  |       | 4,870                   |       | —                 |       | (942                  | )          | (3,928              | )          |
| 2002                                  |       | 8,110                   |       | —                 |       | (1,550                | )          | (6,560              | )          |
| 2003                                  |       | 12,470                  |       | 900                    |       | (2,281                | )          | (11,089             | )          |
| Totals through December 31,  2003     |       | 27,250                  |       | 900                    |       | (5,325                | )          | (22,825             | )          |
| 2004                                  |       | (410                    | )          | 541                    |       | 250                   |       | (381                | )          |
| 2005                                  |       | (1,290                  | )          | 60                     |       | 4,083                 |       | (2,853              | )          |
| 2000-2005 Total                       |       | 25,550                  |       | 1,501                  |       | (992                  | )          | (26,059             | )          |
| 2006 quarter ended                    |       |                    |       |                   |       |                  |       |                |       |
| March 31                              |       | 662                     |       | 9                      |       | —                |       | (671                | )          |
| June 30                               |       | 504                     |       | 6                      |       | —                |       | (510)               |       |
|                                  |       | $                       | 26,716     |                   | $          | 1,516                 |       | $                   | (992)      |   | $ | (27,240) |   |

 

9

----

The Governance Committee’s review found 17.9 million stock options ofthe 28.8 million options granted on our Common Stock during 2000 through 2005had incorrect measurement dates. Using the corrected measurement dates, 7.6million stock options had exercise prices that exceeded the closing price ofour Common Stock and therefore had no intrinsic value to be accounted for underAPB 25, and 10.3 million stock options had intrinsic value because theirexercise prices were below the closing price of our Common Stock. These 10.3million stock options resulted in an increase in additional non-cashstock-based compensation expense of $24.3 million, and an additional $1.5million of payroll tax related expenses during 2000-2005 partially offset by$0.5 million of income tax benefit as shown in the above table. Of the 10.3 millionstock options resulting in additional non-cash stock-based compensationexpense, 2.0 million options were granted to officers and directors andresulted in $6.1 million of additional non-cash stock-based compensationexpense.

The total effect of the stock option restatement and the amounts for2006, as shown in the above table, have been reflected in the December 31, 2006financial statements as well as in the March 31, 2006 financial statements. Asa result of this restatement, net loss increased by $0.7 million for the threemonths ended March 31, 2006.

Upon completing its review, the Governance Committee concluded it foundno evidence of intent to manipulate the Company’s operating results orfinancial statements. A key finding of the Governance Committee was that therewere deficiencies with the process by which stock options were granted duringthe period from our initial public offering in 2000 through at least 2005,which resulted in accounting errors. The Governance Committee concluded thatcertain members of management bear varying degrees of responsibility for thedeficiencies in the process by which options were granted. The GovernanceCommittee’s review also concluded that none of the current or former employeesor directors of the Company engaged in intentional wrongdoing.

In determining the above restatement amounts, management used allreasonably available relevant information to form conclusions it believes arereasonable as to the most likely option granting actions that occurred, thedates when such actions occurred, and the determination of grant dates forfinancial accounting purposes based on when the requirements of the accountingstandards were met. In light of significant judgment used in establishingrevised measurement dates, alternative approaches to those used by the StockOption Review Team and management could have resulted in different compensationcharges than those recorded in the restatement. The Stock Option Review Teamand management considered various alternatives throughout the course of thereview and restatement, and management believes the adjustments to measurementdates used in our review of stock option grant accounting and restatement ofour financial statements were reasonable and appropriate in our circumstances.

10

----

***Summary of Restatement Amounts***

The following table presents the decrease in netearnings from the restatement for each restated year:
| **Year ended**               | ** ** | **Net income (loss),**     | ** ** | **Restatement adjustments** | ** ** | **Net income (loss),** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **December 31,**             | ** ** | **as previously reported** | ** ** | **China Sales**             | ** ** | **Stock Options**           | ** ** | **Total** | ** ** | **as restated** | ** ** |
| ** **                        | ** ** | ** **                           | ** ** | **(in thousands)**          | ** ** | ** **                       | ** ** |
| ** **                        | ** ** | ** **                           | ** ** | **(Decrease) Increase**          | ** ** | ** **                       | ** ** |
|                              |       |                                 |       |                             |       |                             |       |   |   |   |   |
| 1998                              |       |                                 |       | $                                | —     |                             | $          | (796 | ) | $ | (796 | ) |   |   |
| 1999                              |       |                                 |       | —                           |       | —                           |       | — |   |   |   |
| 2000                              |       |                                 |       | (4,781                           | )          | (452                             | )          | (5,233 | ) |   |   |
| 2001                              |       |                                 |       | (5,779                           | )          | (3,928                           | )          | (9,707 | ) |   |   |
| 2002                              |       | $                                    | 107,862    |                             | (19,697    | )                                | (6,560     | ) | (26,257 | ) | $ | 81,605 |   |
| 2003                              |       | $                                    | 209,856    |                             | (6,382     | )                                | (11,089    | ) | (17,471 | ) | $ | 192,385 |   |
| Totals through December 31,  2003 |       |                                 |       | (36,639                          | )          | (22,825                          | )          | (59,464 | ) |   |   |
| 2004                              |       | $                                    | 69,824     |                             | (18,594    | )                                | (381       | ) | (18,975 | ) | $ | 50,849 |   |
| 2005                              |       | $                                    | (487,359   | )                                | (42,433    | )                                | (2,853     | ) | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005 Total                 |       |                                 |       | (97,666                          | )          | (26,059                          | )          | (123,725 | ) |   |   |
| 2006 quarter ended                |       |                                 |       |                             |       |                             |       |   |   |   |   |
| March 31                          |       | $                                    | (10,635    | )                                | 1,360      |                             | (671       | ) | 689 |   | $ | (9,946 | ) |
| June 30                           |       | $                                    | (21,443    | )                                | (371       | )                                | (510       | ) | (881 | ) | $ | (22,324 | ) |
|                              |       |                                 |       | $                                | (96,677    | )                                | $          | (27,240 | ) | $ | (123,917 |   |   |   |

 

The cumulative effect onstockholders’ equity at December 31, 2003 from the above corrections was asfollows (in thousands):

| Increase (decrease) in paid-in capital and  deferred stock compensation: |   |    |    |
|--------------------------------------------------------------------------|--------|---------|---------|
|                                                                     |   |    |    |
| Values assigned to stock  options                                        |   | $       | 27,250  |   |
| Reduction of previously  recorded income tax benefits from stock options |   | (1,278  | )       |
|                                                                     |   |    |    |
| Net increase in paid-in  capital and deferred stock compensation         |   | 25,972  |    |
|                                                                     |   |    |    |
| (Increase) decrease in accumulated deficit:                              |   |    |    |
|                                                                     |   |    |    |
| Revenue and related cost of  sales deferral for China system sales       |   | (36,639 | )       |
| Additional non-cash  compensation expense from stock options             |   | (27,250 | )       |
| Payroll taxes for values  assigned to stock options                      |   | (900    | )       |
| Income tax benefit from  additional compensation and payroll tax expense |   | 5,325   |    |
|                                                                     |   |    |    |
| Net increase in accumulated  deficit                                     |   | (59,464 | )       |
|                                                                     |   |    |    |
| Net  decrease in stockholders' equity at December 31, 2003               |   | $       | (33,492 | ) |

 

In restating the previously issued financial statementsfor the investigations discussed above, we also corrected other previouslyreported amounts. We corrected the reporting of $8.7 million of net sales tocertain third party resellers and $1.8 million of associated cost of net salesfor the three months ended March 31, 2006 to classify these amounts as relatedparty net sales and related party cost of net sales classifications,respectively, because in 2006 we determined that sales to these entities were,in substance, sales to a significant shareholder, SOFTBANK CORP. Theclassification of the accounts receivable from these sales was similarlychanged to include them in accounts receivable from related parties in theMarch 31, 2006 consolidated balance sheet.  We also corrected our reporting of $6.2 million of time deposits atMarch 31, 2006 because they did not mature within three months. Formerlythe time deposits had been reported in error as cash equivalents, but now theseamounts are included in short-term investments in the balance sheet and in thestatement of cash flows for the March 2006 reporting period.

11

----

**PART I—FINANCIALINFORMATION**

**ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(In thousands,except share data)**
| ** **                                                                                                                                                | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                | ** ** | **2007**           | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                                                | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current assets:                                                                                                                                           |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                |       | $                  | 558,150    |                  | $          | 661,623 |   |
| Short-term  investments                                                                                                                                   |       | 14,768             |       | 9,546                 |       |
| Accounts  receivable, net of allowances for doubtful accounts of $48,264 and $53,894 at  March 31, 2007 and December 31, 2006, respectively               |       | 327,449            |       | 373,762               |       |
| Accounts  receivable, related parties, net of allowances for doubtful accounts of $0  and $19 at March 31, 2007 and December 31, 2006, respectively       |       | 25,487             |       | 32,318                |       |
| Notes receivable                                                                                                                                          |       | 6,161              |       | 5,060                 |       |
| Inventories                                                                                                                                               |       | 442,996            |       | 440,445               |       |
| Deferred costs                                                                                                                                            |       | 211,666            |       | 195,393               |       |
| Prepaids and  other current assets                                                                                                                        |       | 132,004            |       | 101,795               |       |
| Short-term  restricted cash and investments                                                                                                               |       | 5,620              |       | 16,666                |       |
| Total current assets                                                                                                                                      |       | $                  | 1,724,301  |                  | 1,836,608  |   |
| Property, plant and  equipment, net                                                                                                                       |       | 210,042            |       | 213,155               |       |
| Long-term investments                                                                                                                                     |       | 45,087             |       | 47,809                |       |
| Goodwill                                                                                                                                                  |       | 3,063              |       | 3,063                 |       |
| Intangible assets                                                                                                                                         |       | 52,397             |       | 56,443                |       |
| Long-term deferred  costs                                                                                                                                 |       | 172,895            |       | 176,649               |       |
| Other long-term assets                                                                                                                                    |       | 39,575             |       | 40,223                |       |
| Total assets                                                                                                                                              |       | $                  | 2,247,360  |                  | $          | 2,373,950 |   |
| ** **                                                                                                                                                |       |               |       |                  |       |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS' EQUITY**                                                                                              |       |               |       |                  |       |
| Current liabilities:                                                                                                                                      |       |               |       |                  |       |
| Accounts payable                                                                                                                                          |       | $                  | 265,519    |                  | $          | 304,869 |   |
| Short-term debt                                                                                                                                           |       | 378,416            |       | 102,758               |       |
| Income taxes  payable                                                                                                                                     |       | —             |       | 2,483                 |       |
| Customer  advances                                                                                                                                        |       | 312,363            |       | 265,812               |       |
| Deferred revenue                                                                                                                                          |       | 96,874             |       | 95,742                |       |
| Other current  liabilities                                                                                                                                |       | 191,807            |       | 271,400               |       |
| Total current  liabilities                                                                                                                                |       | 1,244,979          |       | 1,043,064             |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Long-term deferred  revenue                                                                                                                               |       | 251,369            |       | 261,014               |       |
| Long-term debt                                                                                                                                            |       | 521                |       | 275,161               |       |
| Other long-term  liabilities                                                                                                                              |       | 21,881             |       | 13,858                |       |
| Total  liabilities                                                                                                                                        |       | 1,518,750          |       | 1,593,097             |       |
|                                                                                                                                                      |       |               |       |                  |       |
| Commitments and contingencies  (Note 15)                                                                                                                  |       |               |       |                  |       |
| Minority interest in  consolidated subsidiaries                                                                                                           |       | 6,029              |       | 6,493                 |       |
| Stockholders’ equity:                                                                                                                                |       |               |       |                  |       |
| Common stock:  $0.00125 par value; 750,000,000 authorized shares; 121,299,113 issued and  121,294,645 outstanding at March 31, 2007 and December 31, 2006 |       | 152                |       | 152                   |       |
| Additional  paid-in capital                                                                                                                               |       | 1,208,349          |       | 1,205,592             |       |
| Accumulated  deficit                                                                                                                                      |       | (549,577           | )          | (494,244              | )          |
| Accumulated  other comprehensive income                                                                                                                   |       | 63,696             |       | 62,899                |       |
| Treasury stock:  4,468 shares held in treasury at March 31, 2007 and December 31, 2006                                                                    |       | (39                | )          | (39                   | )          |
| Total stockholders’  equity                                                                                                                          |       | 722,581            |       | 774,360               |       |
| Total  liabilities, minority interest and stockholders' equity                                                                                            |       | $                  | 2,247,360  |                  | $          | 2,373,950 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

12

----

**UTSTARCOM, INC.**

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

**(In thousands,except per share data)**
| ** **                                                | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| Net sales                                                 | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Unrelated party                                           |       | $                                                    | 462,574    |   | $ | 557,037 |   |
| Related party                                             |       | 13,328                                               |       | 44,944 |   |
|                                                      |       | 475,902                                              |       | 601,981 |   |
| Cost of net  sales                                        |       |                                                 |       |   |   |
| Unrelated party                                           |       | 390,539                                              |       | 461,585 |   |
| Related party                                             |       | 10,078                                               |       | 16,605 |   |
| Gross profit                                              |       | 75,285                                               |       | 123,791 |   |
| Operating  expenses:                                      |       |                                                 |       |   |   |
| Selling, general and administrative                       |       | 79,837                                               |       | 83,727 |   |
| Research and development                                  |       | 43,662                                               |       | 46,402 |   |
| Amortization of intangible assets                         |       | 4,046                                                |       | 4,925 |   |
| Total net  operating expenses                             |       | 127,545                                              |       | 135,054 |   |
|                                                      |       |                                                 |       |   |   |
| Operating loss                                            |       | (52,260                                              | )          | (11,263 | ) |
|                                                      |       |                                                 |       |   |   |
| Interest income                                           |       | 4,910                                                |       | 3,532 |   |
| Interest expense                                          |       | (6,725                                               | )          | (3,500 | ) |
| Other income,  net                                        |       | 3,970                                                |       | 3,568 |   |
|                                                      |       |                                                 |       |   |   |
| Loss before  income taxes and minority interest           |       | (50,105                                              | )          | (7,663 | ) |
| Income tax  expense                                       |       | (4,341                                               | )          | (2,839 | ) |
| Minority  interest in losses of consolidated subsidiaries |       | 464                                                  |       | 556 |   |
| Net loss                                                  |       | $                                                    | (53,982    | ) | $ | (9,946 | ) |
|                                                      |       |                                                 |       |   |   |
| Loss per share -  Basic                                   |       | $                                                    | (0.45      | ) | $ | (0.08 | ) |
| Loss per share -  Diluted                                 |       | $                                                    | (0.45      | ) | $ | (0.08 | ) |
|                                                      |       |                                                 |       |   |   |
| Weighted average  shares used in per-share calculation:   |       |                                                 |       |   |   |
| - Basic                                                   |       | 120,900                                              |       | 120,600 |   |
| - Diluted                                                 |       | 120,900                                              |       | 120,600 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

13

----

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

**(In thousands)**
| ** **                                                                                 | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                                                 | ** ** | **(Unaudited)**                                      | ** ** | **(As restated)** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                     | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Net loss                                                                                   |       | $                                                    | (53,982    | ) | $ | (9,946 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                                 |       |   |   |
| Depreciation and amortization                                                              |       | 14,744                                               |       | 17,476 |   |
| Net (gain) loss on sale of asset                                                           |       | (2,699                                               | )          | 4,708 |   |
| Stock-based compensation expense                                                           |       | 2,755                                                |       | 2,425 |   |
| (Recovery of) provision for doubtful accounts                                              |       | (5,281                                               | )          | 892 |   |
| (Recovery of) provision for deferred costs reserves                                        |       | (1,504                                               | )          | 795 |   |
| Other                                                                                      |       | 266                                                  |       | (578 | ) |
| Changes in operating assets and liabilities:                                               |       |                                                 |       |   |   |
| Accounts receivable                                                                        |       | 60,296                                               |       | 28,787 |   |
| Inventories                                                                                |       | (2,422                                               | )          | (4,337 | ) |
| Deferred costs                                                                             |       | (5,222                                               | )          | 3,248 |   |
| Other assets                                                                               |       | (31,433                                              | )          | (6,771 | ) |
| Accounts payable                                                                           |       | (41,324                                              | )          | 18,077 |   |
| Income taxes payable                                                                       |       | 5,969                                                |       | (2,020 | ) |
| Customer advances                                                                          |       | 44,298                                               |       | 43,097 |   |
| Deferred revenue                                                                           |       | (11,790                                              | )          | 8,789 |   |
| Other current liabilities                                                                  |       | (79,336                                              | )          | (50,970 | ) |
| Net cash provided by (used in) operating activities                                        |       | (106,665                                             | )          | 53,672 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                     |       |                                                 |       |   |   |
| Additions to property, plant and equipment                                                 |       | (5,221                                               | )          | (3,162 | ) |
| Proceeds from the disposition of an investment  interest                                   |       | 1,800                                                |       | — |   |
| Proceeds from the sale of semiconductor design  assets                                     |       | —                                               |       | 19,965 |   |
| Change in restricted cash and long-term investments                                        |       | 10,365                                               |       | (17,037 | ) |
| Purchase of short-term investments                                                         |       | (15,576                                              | )          | (17,041 | ) |
| Proceeds from sale of short-term investments                                               |       | 10,483                                               |       | 13,309 |   |
| Other                                                                                      |       | (70                                                  | )          | 499 |   |
| Net cash provided by (used in) investing activities                                        |       | 1,781                                                |       | (3,467 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                     |       |                                                 |       |   |   |
| Proceeds from borrowings                                                                   |       | 64,621                                               |       | 62,370 |   |
| Payments on borrowings                                                                     |       | (64,676                                              | )          | (89,948 | ) |
| Other                                                                                      |       | (654                                                 | )          | (3,184 | ) |
| Net cash used in financing activities                                                      |       | (709                                                 | )          | (30,762 | ) |
| Effect of  exchange rate changes on cash and cash equivalents                              |       | 2,120                                                |       | 2,374 |   |
| Net increase (decrease) in cash and cash equivalents                                       |       | (103,473                                             | )          | 21,817 |   |
| Cash and cash  equivalents at beginning of period                                          |       | 661,623                                              |       | 645,571 |   |
| Cash and cash  equivalents at end of period                                                |       | $                                                    | 558,150    |   | $ | 667,388 |   |
|                                                                                       |       |                                                 |       |   |   |
| Supplemental  disclosure of cash flow information:                                         |       |                                                 |       |   |   |
| Cash paid:                                                                                 |       |                                                 |       |   |   |
| Interest                                                                                   |       | $                                                    | 5,388      |   | $ | 2,511 |   |
| Income taxes                                                                               |       | $                                                    | 2,788      |   | $ | 3,801 |   |
| Non-cash  operating activity:                                                              |       |                                                 |       |   |   |
| Accounts receivable transferred to notes receivable                                        |       | $                                                    | 9,240      |   | $ | 8,977 |   |

 

See accompanying notes to thecondensed consolidated financial statements.

14

----

**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 interests inconsolidated subsidiaries is shown separately in the condensed consolidatedfinancial statements.

The accompanying unaudited condensed consolidatedfinancial statements as of March 31, 2007 and for the three months endedMarch 31, 2007 and 2006 have been prepared by the Company pursuant to therules 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, 2006 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, 2006 financialstatements, including the notes thereto, and the other information set forth inthe Company’s Annual Report on Form 10-K for the year endedDecember 31, 2006.

In the opinion of management, the accompanying unauditedcondensed 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 threemonths ended March 31, 2007 are not necessarily indicative of theoperating results for the full year.

The Company reported net losses in each quarter in theperiod beginning April 1, 2005 and continuing through March 31, 2007, which hasresulted in an accumulated deficit of $549.6 million and total stockholders’equity being reduced to $722.6 million at March 31, 2007.  Additionally, at March 31, 2007, the Companyhad short-term debt in China under its lines of credit of $103.6 millionmaturing in 2007 and  convertiblesubordinated notes, outside of China, with a principal balance of $274.6million that matures in March 2008. On January 9, 2007 and July 26, 2007 the Companyand the holders of the convertible subordinated notes entered into twoagreements to prevent covenant defaults occurring from the Company’s inabilityto timely file required periodic reports containing financial statements withthe SEC.  As a result of theseagreements, convertible subordinated notes accrued interest at a rate of 7.625%per annum as of January 9, 2007 and the interest rated increased to 10.875%effective as of July 26, 2007. On October 15, 2007, the Company received anadditional notice of default asserting that a default had occurred under theIndenture (as amended by the First Supplemental Indenture and SecondSupplemental Indenture) with respect to the Notes.  The specific defaults referred to in thenotice of default were (i) the Company’s failure to file with the SEC andprovide copies to the Trustee of its Quarterly Reports on Form 10-Q for thefiscal quarter ended March 31, 2007 and June 30, 2007 and (ii) the Company’sfailure to deliver to the Trustee its officer’s certificate of compliancerequired by the Indenture. The notice of default provides that the Company has60 consecutive days from October 15, 2007 to cure the defaults before suchdefaults would constitute an “Event of Default” under the Indenture.  For additional information concerning theseagreements, see Note 25.

TheCompany’s cash and short-term investmentsaggregated $572.9 million (of which $414.6 million are held in China) at March31, 2007.

Creditfacilities in China at March 31, 2007 totaled $692.7 million, with $353.5million of this amount available for working capital purposes, of which theCompany had drawn $103.6 million in outstanding borrowings, and $339.2 millionwas available for use in support of letters of credit and corporate guarantees.These facilities expire primarily in November and December of 2007, and theCompany believes that based upon its recent financial performance and financialposition its lenders may reduce the total available credit when it negotiatesrenewals of these lines. 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. However, theCompany believes the amounts of credit its lenders may make available and theborrowings made under the renewed lines of credit will be sufficient to meetplanned uses of these credit facilities.

Tomeet liquidity needs outside of China, the Company’s subsidiaries in China havethe ability to transfer cash to the Company under China’s current exchangecontrol regulations.  The amount of cashavailable for transfer from the Company’s China subsidiaries is limited both bythe Company’s liquidity needs in China and by Chinese government requirementsthat the China subsidiaries retain adequate capital levels in China to protectcreditors and to have funds available for mandated employee benefits.  The Company believed the China subsidiariescould freely transfer at least $200 million to the Company as of December 31,2006, and during the nine months ended September 30, 2007 its Chinasubsidiaries have made such transfers totaling $150 million.

Althoughmanagement believes the Company has a sufficient amount of cash resources tofinance the Company’s anticipated working capital and capital expenditurerequirements for the next 12 months, the Company does not have enough

15

----

cash outside ofChina to repay the convertible notes due on March 1, 2008. Management’sliquidity plans include a partial or complete refinancing of the convertiblenotes, renewal of the lines of credit in China, transfers of more cash from itssubsidiaries in China to the extent necessary, and, if needed, liquidation of  certain investments and/or seeking newfinancing arrangements. The Company’s ability to maintain sufficient liquidityis also dependent on achieving projected sales and operating margin forecasts.

Ifadditional sources of liquidity were needed, the Company would consider newdebt or equity offerings or obtaining cash from asset sales, but there is noassurance that such transactions could be consummated on acceptable terms or atall. Failure to raise sufficient capital when needed could have a materialadverse effect on the business, results of operations and financial position ofthe Company.

**NOTE 2 - RESTATEMENT OF FINANCIAL STATEMENTS**

Theconsolidated financial statements for the three months ended March 31, 2006included herein have been restated.  Thereasons for the restatement are discussed below.

***China Sales Investigation***

The Audit Committee of the Company’s Board ofDirectors (“Audit Committee”) engaged independent counsel to conduct aninvestigation of sales in China following a determination by the Internal Auditgroup that allegations of improper activities in a sales office in the WesternRegion were credible. The allegations were made by a Company employee using theCompany’s whistle blower program. The independent counsel engaged theassistance of forensic accountants, and this group is collectively referred toas the Investigating Team in the rest of this discussion.

In conducting its procedures, the Investigating Teamfound instances where the customer contracts that evidenced thearrangement  contained obligations forthe Company to deliver software upgrades when and if made available for theequipment sold for no additional consideration and for an unspecified periodthat could extend over the term of the contract. This additional contractobligation is an element of “post contract support.”  In these cases, the Investigating Team foundthat the contract documentation for the same transaction submitted by the salesoffice to the Company’s China headquarters for accounting purposes and utilizedby the Company in determining the amount of revenue recognized did not includeevidence of such post contract support obligations.

Accounting standards governing revenue recognition forsystem sales require all revenue to be deferred while there are undeliveredelements under the arrangement unless the seller has established vendorspecific objective evidence (“VSOE”) of fair value for such contract elements.Because these arrangements included such undelivered elements, revenue shouldbe deferred based on the VSOE of the fair value of the underlying elements.VSOE of fair value represents the price charged when the same element is soldseparately.  Since the Company does notsell this element separately, it has not established VSOE for such undeliveredelements, and as such the revenue from such contracts is required to bedeferred and recognized over the period the Company is obligated to provide thepost contract support.

Uponcompletion of the investigative phase of the independent investigation by theAudit Committee, management:

·                  conductedfollow-up procedures to attempt to locate any additional relevant informationto ensure the China sales investigation considered all available informationand documents;

·                  evaluated theaccounting for identified system sales using the contract template anddocumentation found in the sales contract files from the Western Regionoffices. This included calculating the financial statement effects ofcorrecting the accounting for all system sales where the contract templatefound at the sales offices contained post contract support obligations torecognize revenue and cost of net sales over estimated period of post contractsupport;

·                  concluded thatas a result of this undelivered post contract support obligation the Company’spreviously issued financial statements should be restated to defer system salescontract revenue and the related cost of net sales over the estimated period ofpost contract support when a contract contained unspecified software upgraderights.

TheAudit Committee concurred with management’s decisions.

16

----

Theeffect of correcting improperly recognized revenue and cost of net sales was to(reduce) increase previously reported net sales, gross profit and net income bythe following amounts (in thousands of dollars):
|                                        | ** ** | ** **         | ** ** | ** **            | ** ** | ** **          | ** ** |
|----------------------------------------|------------|--------------------|------------|-----------------------|------------|---------------------|------------|
| **Year ended  December 31,** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
|                                   |       |               |       |                  |       |                |       |
| 2000                                   |       | $                  | (12,408    | )                     | $          | (5,294              | )          | $ | (4,781 | ) |
| 2001                                   |       | (17,154            | )          | (6,330                | )          | (5,779              | )          |
| 2002                                   |       | (64,732            | )          | (22,924               | )          | (19,697             | )          |
| 2003                                   |       | (21,060            | )          | (8,014                | )          | (6,382              | )          |
| Totals through December 31, 2003       |       | (115,354           | )          | (42,562               | )          | (36,639             | )          |
| 2004                                   |       | (104,965           | )          | (27,241               | )          | (18,594             | )          |
| 2005                                   |       | (58,232            | )          | (27,863               | )          | (42,433             | )          |
| 2000 - 2005 Total                      |       | $                  | (278,551   | )                     | $          | (97,666             | )          | $ | (97,666 | ) |
|                                   |       |               |       |                  |       |                |       |
| 2006 quarter ended                     |       |               |       |                  |       |                |       |
|                                   |       |               |       |                  |       |                |       |
| March 31                               |       | $                  | 5,410      |                  | $          | 1,360               |       | $ | 1,360 |   |

 

In our consolidatedbalance sheet at March 31, 2007 the net reduction in previously recognized netsales is accounted for as deferred revenue, of which $36.5 million isclassified as current and $233.3 million as non-current, and the related netreduction in cost of net sales of $172.9 million is accounted for as deferredcosts. These amounts will be recognized in our consolidated statements ofoperations over the estimated remaining period of post contract support.   Due to this restatement, we increased netsales, gross profit, and net income (in thousands) for the three month periodended March 31, 2006 as follows: $5,410, $1,360 and $1,360, respectively.  

 

*Audit Committee Findings*

Upon completingits investigation, the Audit Committee concluded that the conditions andpractices relating to systems contracts prevalent in the Western Regionresulted primarily from the failure to prevent or detect instances of overriderelated to controls in China over customer agreements, lack of propermanagement oversight, unclear record retention policies and procedures relatingto systems contracts, and inadequate employee training.  The Investigating Team and the AuditCommittee also concluded that with respect to four regions other than theWestern Region there was no evidence of fraud or misconduct or reason tosuspect such occurred. The Investigating Team and the Audit Committee alsoconcluded that there was no credible evidence of knowledge by senior managementin China or the United States of the conditions and practices related to theWestern Region of China that were discovered in the investigation. The AuditCommittee concluded that local management in several of the sales offices inthe Western Region of China did not submit appropriate information to theCompany's senior management in China and the United States. Therefore, in prioryears, neither the Company's management nor the Company's independentregistered accounting firm were able to properly evaluate the effect of thatinformation on revenue recognition. The Audit Committee also concluded thatcertain members of management in China bear varying degrees of responsibilityfor inadequate oversight of activities. As a result, certain employees in Chinahave either been terminated or placed on suspension for failure to provideadequate oversight of activities.

***GovernanceCommittee Review of Historical Stock Option Accounting***

In November 2006 theCompany announced it had commenced a voluntary review of historical stockoption practices under the leadership of the Nominating and CorporateGovernance Committee of the Company’s Board of Directors (“GovernanceCommittee”) following a preliminary review by management which identifiedpotential deficiencies and discrepancies in the documentation of stock optiongrants. The review considered all option grant awards made in the period fromFebruary 29, 2000, shortly before the initial public offering of the Company’sCommon Stock, through August 2006 (“Review Period”) for compliance with the variousstock-based compensation accounting standards applicable during the ReviewPeriod, the rules of the Company’s stock option plans, and the guidance onstock option accounting issued by the

17

----

SEC in the September 19,2006 letter which was to be considered applicable to periods prior as well assubsequent to its issuance. At the time the review commenced, the GovernanceCommittee consisted of three members of the Board of Directors, all of whom areindependent directors.  Mr. AllenLenzmeier was appointed to the Governance Committee on April 27, 2007.  The Governance Committee engaged independentoutside legal counsel to assist in the review who, in turn, engaged forensicaccounting experts (collectively referred to herein as the “Review Team”). 

The Review Team,management, and the Governance Committee decided to group stock option grantsinto six award categories based on differences in what constituted substantiveapproval for each category under the Company’s stock option granting practicesas well as giving consideration to the risk of intentional misstatement of thegrant date.  Guidance in the September19, 2006 letter on determining the date when substantive approval of a stockoption grant occurs recognizes that depending on a company’s facts and circumstancesa company may determine that the measurement date for some stock option grantsmay occur before all required granting actions have occurred – such as finalapproval by the Compensation Committee. This alternative is available only whena review of all facts and circumstances supports a conclusion that substantiveapproval occurs earlier than when all required granting actions have occurredand there is no evidence of fraudulent or manipulative conduct in the company’soption granting practices.

In determining themeasurement date to be used, the Review Team, management, and the GovernanceCommittee agreed to use the following definitions as constituting the propermeasurement date, and generally these dates were used in testing the statedgrant dates or establishing corrected measurement dates:
| **Discretionary Director and Officer Grants** |       | The date of a Compensation Committee meeting where  the grant was approved or the date the final Compensation Committee signer  approved the grant when approval occurred through unanimous written consent  documents (“UWC”).                                                                                                                                                                                                                                                        |
|-----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **Automatic  Director Grants**                |       | The date specified in the relevant stock option  plan.                                                                                                                                                                                                                                                                                                                                                                                                                                           |
| ** **                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **Broadbase**                                 |       | The date the grantee list, including the allocation  of shares to individual grantees, was complete. Compensation Committee  approval was considered perfunctory due to delegation of authority to  management.                                                                                                                                                                                                                                                                                  |
| ** **                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **Acquisition**                               |       | The first Compensation Committee meeting following  the acquisition, provided grantees had received employment offer letters  stating the number of stock options to be granted before such date because  this was the date at which the option exercise price was established.  Compensation Committee approval was considered perfunctory due to delegation  of authority to management.                                                                                                       |
| ** **                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **New  Hire**                                 |       | The first scheduled Compensation Committee meeting  following the first day of employment because this was the date at which the  option exercise price was established. The number of options was based on either  grant amounts specified in an employment offer letter or, in some cases, on a  matrix that assigned grant amounts based on position and level within the  Company. Compensation Committee approval was considered perfunctory due to  delegation of authority to management. |
| ** **                                    | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| **Other  Merit**                              |       | The date the grantee list, including the allocation  of shares to grantees, was substantially complete. Compensation Committee  approval was considered perfunctory due to delegation of authority to  management.                                                                                                                                                                                                                                                                               |

 

During the Review Period,the Company granted stock options on approximately 34 million shares of theCompany’s common stock at 197 grant dates. The review specifically examined theappropriateness of the stated grant date for approximately 90% of the stockoptions granted, including all stock option grants made to directors andofficers, all broadbase options and all option grants made in connection withbusiness acquisitions. The review included an extensive examination of theCompany’s historical stock option practices – including information from stockoption administration, human resource, legal, and accounting department filesand records as well as from e-mail communications, an electronic database ofthe Company’s stock option activity maintained by a third party, andinformation stored in Company hard drives and back-up tapes. The Review Teamalso conducted interviews of individuals involved with the granting, advising,

18

----

administering, oraccounting for stock options, including current and former: management, membersof the Board of Directors, employees, and non-employee professionals.

The findings ofthis review are summarized as follows:
|                                       | ** ** | ** **         | ** ** | ** **             | ** ** | ** **         | ** ** | **Measurement date changed** | ** ** |
|---------------------------------------|------------|--------------------|------------|------------------------|------------|--------------------|------------|----------------------------------------|------------|
| ** **                            | ** ** | ** **         | ** ** | ** **             | ** ** | ** **         | ** ** | **additional**                         | ** ** | **no additional** | ** ** |
| ** **                            | ** ** | **Number of** | ** ** | ** **             | ** ** | **No change** | ** ** | **compensation**                       | ** ** | **compensation** | ** ** |
| **Grant Type**                   | ** ** | **grants**         | ** ** | **Grants tested** | ** ** | **required**       | ** ** | **expense required**              | ** ** | **expense required(1)** | ** ** |
| ** **                            | ** ** | ** **         | ** ** | ** **             | ** ** | ** **         | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Discretionary  Director & Officer |       | 16                 |       | 16                     |       | 8                  |       | 4                                      |       | 4 |   |
| Automatic  Director                   |       | 5                  |       | 5                      |       | 5                  |       | —                                 |       | — |   |
| Broadbase                             |       | 8                  |       | 8                      |       | —             |       | 6                                      |       | 2 |   |
| Acquisition                           |       | 10                 |       | 10                     |       | 10                 |       | —                                 |       | — |   |
| New Hire                              |       | 166                |       | 48                     |       | 48                 |       | —                                 |       | — |   |
| Other Merit                           |       | 96                 |       | 41                     |       | 4                  |       | 21                                     |       | 16 |   |
| Total                                 |       | 301                | (2)        | 128                    |       | 75                 |       | 31                                     |       | 22 |   |

 

----

(1)  Under APB25 there is no expense adjustment arising from using the corrected measurementdate for these grants because the amount the employee  would have to pay to exercise these stockoption grants exceeded the quoted market price of the Company’s Common Stock atthe corrected measurement date, and therefore, these stock option grantscontained no intrinsic value at the corrected measurement date. 

(2)  The numberof grants exceeds the number of grant dates because on certain grant dates morethan one category of stock option grants were approved.

A non-cashcompensation charge, to be recognized as an expense over a grantee’s serviceperiod, arises under Accounting Principles Board Opinion No. 25 *Accounting for Stock Issued to Employees*(“APB 25”), theaccounting standard governing the Company’s stock option accounting through2005, if a stock option has intrinsic value at its measurement date. Thisintrinsic value is measured by the excess, if any, of the fair value at thedate of grant of the underlying common stock over the stock option’s exerciseprice. The Company’s practice has been to grant stock options with exerciseprices equal to the closing price of the underlying Company common stock ateach grant date, to use the grant date as the measurement date for stock-basedcompensation purposes, and as such previously the Company had determined thegranted stock options had no intrinsic value at their grant dates and nocompensation expense was recognized. However, APB 25 states the measurement date does not occur until allessential actions necessary to grant the option are completed, including thefinal determination of both the number of shares to be granted to each employeeor director and the exercise price, and the option grant is approved by thosewith requisite authority. A September 19, 2006 letter publicly issued by theSEC’s Chief Accountant focused companies registered with the SEC on the needfor the number of shares and exercise price of an award to an individual to befinalized to have a measurement date. This letter clarifies the SEC staff’sview that if it is possible that those terms could change, a measurement datehas not occurred, even if the award’s terms are not actually changed.

Based on availableevidence, the review found that the number of shares an individual employee wasentitled to receive and/or the exercise price for stock option grants was notdetermined with finality at the stated grant date at 53 tested grant dates, andthe Company should have used a later date as the measurement date. Theprincipal reasons for the stated grant date not qualifying as the measurementdate under APB 25 include:

·                  certainlistings of grantees, below officer level, were incomplete and added to ormodified by stock option administration personnel after the grant was approvedby the Compensation Committee;

·                  forcertain grants where Compensation Committee approval was not consideredperfunctory, the date a UWC document was sent to Compensation Committee membersfor approval was used as the stated grant date for some discretionary officerand director grants rather than the date the UWC was signed by all CompensationCommittee members and therefore became effective;

·                  theStock Option Review Team was unable to locate contemporaneous documentation ofsome director and officer, broadbase, new hire, and other merit grants.

A total of 17.9 million stock options weregranted at the 53 tested grant dates during 2000 through 2005 where theGovernance Committee’s review found the Company used incorrect measurementdates. Using the corrected measurement dates, 10.3 million stock options hadintrinsic value because their exercise prices were below the closing price ofthe Company’s Common Stock at the corrected measurement date, and 7.6 millionstock options had exercise prices that exceeded the closing price of theCompany’s Common Stock and therefore had no intrinsic value to be accounted forunder APB 25. These 10.3 million stock options resulted in an increase innon-cash stock-based compensation expense of $24.3 million during 2000 to2005.  Of the 10.3 million stock optionsresulting in additional non-cash stock-based compensations expense, 2.0 millionoptions were granted to officers and directors and resulted in $6.1 million ofadditional non-cash stock-based compensation expense.

19

----

In some cases, in correcting the measurementdate for previously granted stock options additional taxable income toemployees arises on which additional payroll taxes are due from the employee aswell as the Company. The Company has assumed responsibility for all additionalpayroll taxes plus related penalties and interest arising from the restatementof stock-based compensation, including amounts otherwise payable by stockoption recipients, and the Company’s restated financial statements include a$1.5 million accrual for this estimated expense.

Because theholders of stock options where corrections were made to the measurement dateswere not aware that improper measurement dates were used, the Company has takencertain actions and is contemplating taking additional actions to deal with theadverse personal income tax consequences that may be incurred by the holders ofstock options with corrected measurement dates. Adverse personal income taxconsequences arise from the exercise of stock options vesting afterDecember 31, 2004 where the corrected measurement dates cause them to havean exercise price below the fair market value of Company’s common stock at themeasurement date (“409A Affected Options”). Such an exercise would subject theoption holder to a penalty tax under IRC Section 409A (and, as applicable,similar penalty taxes under California and other state tax laws). The Companyhas evaluated its stock option exercises through December 31, 2006 anddetermined there were no exercises of 409A Affected Options; accordingly, nopenalty tax has been incurred by employees exercising stock options throughthat date. 

The Company isconsidering how to deal with exercises of 409A Affected Options that occur in2007 and beyond.  One alternative wouldbe to offer to amend all 409A Affected Options to change the exercise price tothe fair market price of the Company’s common stock on the corrected measurementdate. These amended options would not be subject to taxation under IRCSection 409A.  Under IRSregulations, option amendments had to be completed by December 31, 2006for anyone who was an executive officer or member of the Board of Directorswhen he or she received 409A Affected Options. Therefore, prior to December 31,2006 eight of the Company’s current and former executive officers and directorsexecuted an irrevocable Protective Amendment Election Form whereby any of theirstock options will be automatically amended to restate the exercise price tothe fair market value of the Company’s common stock at the correctedmeasurement date if in the future such stock options would otherwise bedetermined to be 409A Affected Options. A similar offer to amend all 409A Affected Options held by non-officeremployees is currently under consideration, but no decision has been reachedand such an offer cannot be made until the Company is current with its SECreporting obligations.

During the reviewthe Company also discovered a stock option grant to a former officer that wasmodified in 1998 in connection with his termination of employment that shouldhave resulted in additional compensation expense. This change was neverincluded in the Company’s stock option grant records and the additionalcompensation expense resulting from the change in the option’s terms  (approximately $1.2 million)  was not recorded previously. This discovery isconsistent with the Review Team’s finding that in certain instances there was alack of formal documentation in the stock option granting process and/orexpected documentation is missing from the stock option administration files.In addition, the Review Team found that, in many instances, there was a lack ofself-authenticating evidence to corroborate that cash exercises werecontemporaneous. As a result, the findings on the issue of backdating of cashexercises were inconclusive. 

The Company’saccounting for stock-based compensation changed to a fair value method in 2006when, as required by accounting standards, it ceased accounting for stock-basedcompensation under the intrinsic value method pursuant to APB 25 and beganaccounting for stock-based compensation pursuant to Statement of FinancialAccounting Standards 123(R) Share-Based Payments (“SFAS 123(R)”). Under thismethod all stock option grants have a fair value determined using an optionpricing model, and such fair value is used to recognize non-cash stock-basedcompensation expense. The Company recognizes stock compensation expense on astraight-line basis under SFAS 123(R).

The table belowshows the effects of correcting the consolidated financial statements for theGovernance Committee’s findings and the modification in 1998 of a stock optiongrant to a former officer in connection with his termination of employment.Consistent with its historical accounting policy, this additional stock-basedcompensation expense is being recognized on an accelerated basis by treatingeach vesting tranche as a separate stock option grant (graded vesting).  Additionally, the table gives effect tocorrections of the accounting for performance related stock options andrestricted stock grants in the first two quarters of 2006, all of which werepreviously identified and considered immaterial. The effects of correcting theerrors in the Company’s previous stock option accounting were to increase(reduce) previously reported non-cash compensation expense, payroll taxes,income taxes and net income by the following amounts (in thousands of dollars):

20

----

|                                        | ** ** | **Reduction (increase) in net income from** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Non-cash stock**                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Year ended  December 31,** | ** ** | **compensation**                                                     | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
|                                   |       |                                                                 |       |   |   |   |   |   |   |
| 1998                                   |       | $                                                                    | 1,244      |   | $ | — |   | $ | (448 | ) | $ | (796 | ) |
| 1999                                   |       | —                                                               |       | — |   | — |   | — |   |
| 2000                                   |       | 556                                                                  |       | — |   | (104 | ) | (452 | ) |
| 2001                                   |       | 4,870                                                                |       | — |   | (942 | ) | (3,928 | ) |
| 2002                                   |       | 8,110                                                                |       | — |   | (1,550 | ) | (6,560 | ) |
| 2003                                   |       | 12,470                                                               |       | 900 |   | (2,281 | ) | (11,089 | ) |
| Totals through December 31, 2003       |       | 27,250                                                               |       | 900 |   | (5,325 | ) | (22,825 | ) |
| 2004                                   |       | (410                                                                 | )          | 541 |   | 250 |   | (381 | ) |
| 2005                                   |       | (1,290                                                               | )          | 60 |   | 4,083 |   | (2,853 | ) |
| 2000-2005 Total                        |       | $                                                                    | 25,550     |   | $ | 1,501 |   | $ | (992 | ) | $ | (26,059 | ) |
| 2006 quarter ended                     |       |                                                                 |       |   |   |   |   |   |   |
| March 31                               |       | $                                                                    | 662        |   | $ | 9 |   | $ | — |   | $ | (671 | ) |

 

The followingtable shows the Company’s stock-based compensation expense as previouslyreported and the impact of the restatement (excluding payroll taxes) onstock-based compensation for periods prior to fiscal 2006, net of income tax:
|                                                                                          | ** ** | **Stock-Based Compensation Expense (Net of Tax)** | ** ** |
|------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                                                               | ** ** | **(in thousands)**                                                    | ** ** |
| **Year ended December 31,**                                               | ** ** | **As Reported**                                                       | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| 1998 (net of income tax benefit/(expense) of $118,  $448 and $566, respectively)         |       | $                                                                          | 294        |   | $ | 796 |   | $ | 1,090 |   |
| 1999 (net of income tax benefit/(expense) of $1,596,  $0 and $1,596, respectively)       |       | 3,957                                                                      |       | — |   | 3,957 |   |
| 2000 (net of income tax benefit/(expense) of $3,323,  $104 and $3,427, respectively)     |       | 8,238                                                                      |       | 452 |   | 8,690 |   |
| 2001 (net of income tax benefit/(expense) of $1,495,  $942 and $2,437, respectively)     |       | 3,706                                                                      |       | 3,928 |   | 7,634 |   |
| 2002 (net of income tax benefit/(expense) of $891,  $1,550 and $2,441, respectively)     |       | 2,209                                                                      |       | 6,560 |   | 8,769 |   |
| 2003 (net of income tax benefit/(expense) of $1,212,  $2,281 and $3,493, respectively)   |       | 3,071                                                                      |       | 10,189 |   | 13,260 |   |
| 2004 (net of income tax benefit/(expense) of $149,  ($250) and ($101), respectively)     |       | 370                                                                        |       | (160 | ) | 210 |   |
| 2005 (net of  income tax benefit/(expense) of $105, ($4,083) and ($3,978), respectively) |       | 2,154                                                                      |       | 2,793 |   | 4,947 |   |
|                                                                                          |            |                                                                            |            |  |  |  |  |  |  |  |

 

*Governance Committee Findings*

Upon completingits review, the Governance Committee concluded it found no evidence of intentto manipulate the Company’s operating results or financial statements. A keyfinding of the Governance Committee was that there were deficiencies with theprocess by which stock options were granted during the period from the Company’sinitial public offering in 2000 through at least 2005, which resulted inaccounting errors.  The GovernanceCommittee concluded that certain members of management bear varying degrees ofresponsibility for the deficiencies in the process by which options were granted.  The Governance Committee’s review alsoconcluded that none of the current or former employees or directors of theCompany engaged in intentional wrongdoing.

21

----

***Restatementand Impact on Financial Statements***

Thefollowing table presents the decrease in net income, by year, as a result ofrestating for the results of the China sales investigation and the historicalstock option accounting review:
| **Year ended**               | ** ** | **Net income (loss),**     | ** ** | **Restatement adjustments**               | ** ** | **Net income (loss),** | ** ** |
|-----------------------------------|------------|--------------------------------------|------------|------------------------------------------------|------------|----------------------------------|------------|
| **December 31,**             | ** ** | **as previously reported** | ** ** | **China Sales**                           | ** ** | **Stock Options**           | ** ** | **Total** | ** ** | **as restated** | ** ** |
| ** **                        | ** ** | ** **                           | ** ** | ** **                                     | ** ** | **(in thousands)**          | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | ** **                           | ** ** | **(Decrease)    Increase** | ** ** | ** **                       | ** ** |
|                              |       |                                 |       |                                           |       |                             |       |   |   |   |   |
| 1998                              |       |                                 |       | $                                              | —     |                             | $          | (796 | ) | $ | (796 | ) |   |   |
| 1999                              |       |                                 |       | —                                         |       | —                           |       | — |   |   |   |
| 2000                              |       |                                 |       | (4,781                                         | )          | (452                             | )          | (5,233 | ) |   |   |
| 2001                              |       |                                 |       | (5,779                                         | )          | (3,928                           | )          | (9,707 | ) |   |   |
| 2002                              |       | $                                    | 107,862    |                                           | (19,697    | )                                | (6,560     | ) | (26,257 | ) | $ | 81,605 |   |
| 2003                              |       | $                                    | 209,856    |                                           | (6,382     | )                                | (11,089    | ) | (17,471 | ) | $ | 192,385 |   |
| Totals through  December 31, 2003 |       |                                 |       | (36,639                                        | )          | (22,825                          | )          | (59,464 | ) |   |   |
| 2004                              |       | $                                    | 69,824     |                                           | (18,594    | )                                | (381       | ) | (18,975 | ) | $ | 50,849 |   |
| 2005                              |       | $                                    | (487,359   | )                                              | (42,433    | )                                | (2,853     | ) | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005  Total                |       |                                 |       | (97,666                                        | )          | (26,059                          | )          | (123,725 | ) |   |   |
| 2006 quarter  ended               |       |                                 |       |                                           |       |                             |       |   |   |   |   |
| March 31                          |       | $                                    | (10,635    | )                                              | 1,360      |                             | (671       | ) | 689 |   | $ | (9,946 | ) |
|                                   |            |                                      |            |                                                |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

Thecumulative effect of the restatements at December 31, 2003 was an increase toadditional paid-in capital and deferred stock-based compensation of $26.0million from $646.7 million to $672.7 million, and a decrease in retainedearnings of $59.5 million from $237.4 million to $177.9 million, and a decreasein total stockholders’ equity of $33.5 million from $887.7 million to $854.2million.

***OtherChanges***

Inrestating the previously issued financial statements for the investigationsdiscussed above, the Company also corrected other previously reported amounts.It corrected the reporting of $8.7 millionof net sales to certain third party resellers and $1.8 million of associatedcost of net sales for the three months ended March 31, 2006 to classify theseamounts as related party net sales and related party cost of net salesclassifications, respectively, because in 2006 the Company determined thatsales to these entities were, in substance, sales to a significant shareholder,SOFTBANK CORP. The classification of the accounts receivable from these saleswas similarly changed to include them in accounts receivable from relatedparties in the March 31, 2006 consolidated balance sheet.   The Company also corrected our reportingof $6.2 million of time deposits at March 31, 2006 because they did notmature within three months. Formerly the time deposits had been reported in erroras cash equivalents, but now these amounts are included in short-terminvestments in the balance sheet and in the statement of cash flows for theMarch 2006 reporting period.

22

----

***Restated Financial Information***

The following tables summarize the impact of therestatement adjustments on the condensed consolidated statement of operationsfor the three months ended March 31, 2006 and the condensed consolidatedstatement of cash flows for the three months ended March 31, 2006:

**UTSTARCOM, INC.**

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

**(In thousands, except per sharedata)**
| ** **                                                | ** ** | **Three months ended March 31, 2006** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                | ** ** | **As previously   reported**                         | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
|                                                      |       |                                                           |       |   |   |   |   |
| Net sales                                                 |       |                                                           |       |   |   |   |   |
| Unrelated party                                           |       | $                                                              | 560,361    |   | $ | (3,324 | ) | $ | 557,037 |   |
| Related party                                             |       | 36,210                                                         |       | 8,734 |   | 44,944 |   |
|                                                      |       | 596,571                                                        |       | 5,410 |   | 601,981 |   |
| Cost of net sales                                         |       |                                                           |       |   |   |   |   |
| Unrelated party                                           |       | 459,381                                                        |       | 2,204 |   | 461,585 |   |
| Related party                                             |       | 14,736                                                         |       | 1,869 |   | 16,605 |   |
| Gross profit                                              |       | 122,454                                                        |       | 1,337 |   | 123,791 |   |
| Operating expenses:                                       |       |                                                           |       |   |   |   |   |
| Selling, general  and administrative                      |       | 83,172                                                         |       | 555 |   | 83,727 |   |
| Research and  development                                 |       | 46,309                                                         |       | 93 |   | 46,402 |   |
| Amortization of  intangible assets                        |       | 4,925                                                          |       | — |   | 4,925 |   |
| Total operating  expenses                                 |       | 134,406                                                        |       | 648 |   | 135,054 |   |
|                                                      |       |                                                           |       |   |   |   |   |
| Operating loss                                            |       | (11,952                                                        | )          | 689 |   | (11,263 | ) |
|                                                      |       |                                                           |       |   |   |   |   |
| Interest income                                           |       | 3,532                                                          |       | — |   | 3,532 |   |
| Interest expense                                          |       | (3,500                                                         | )          | — |   | (3,500 | ) |
| Other income, net                                         |       | 3,568                                                          |       | — |   | 3,568 |   |
|                                                      |       |                                                           |       |   |   |   |   |
| Loss before income  taxes and minority interest           |       | (8,352                                                         | )          | 689 |   | (7,663 | ) |
| Income tax expense                                        |       | (2,839                                                         | )          | — |   | (2,839 | ) |
| Minority interest in  losses of consolidated subsidiaries |       | 556                                                            |       | — |   | 556 |   |
| Net loss                                                  |       | $                                                              | (10,635    | ) | $ | 689 |   | $ | (9,946 | ) |
|                                                      |       |                                                           |       |   |   |   |   |
| Loss per share - Basic                                    |       | $                                                              | (0.09      | ) | $ | 0.01 |   | $ | (0.08 | ) |
| Loss per share - Diluted                                  |       | $                                                              | (0.09      | ) | $ | 0.01 |   | $ | (0.08 | ) |

 

23

----

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**(in thousands)**
| ** **                                                                                 | ** ** | **Three Months Ended March 31, 2006** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                 | ** ** | **As   previously   reported**                       | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                     |       |                                                           |       |   |   |   |   |
| Net loss                                                                                   |       | $                                                              | (10,635    | ) | $ | 689 |   | $ | (9,946 | ) |
| Adjustments to  reconcile net loss to net cash provided by (used in) operating activities: |       |                                                           |       |   |   |   |   |
| Depreciation and  amortization                                                             |       | 17,476                                                         |       | — |   | 17,476 |   |
| Loss on sale of  assets                                                                    |       | 4,708                                                          |       | — |   | 4,708 |   |
| Stock-based  compensation expense                                                          |       | 1,769                                                          |       | 656 |   | 2,425 |   |
| Provision for  doubtful accounts                                                           |       | 892                                                            |       | — |   | 892 |   |
| Provision for  deferred costs                                                              |       | 795                                                            |       | — |   | 795 |   |
| Other                                                                                      |       | (578                                                           | )          | — |   | (578 | ) |
| Changes in  operating assets and liabilities:                                              |       |                                                           |       |   |   |   |   |
| Accounts  receivable                                                                       |       | 28,787                                                         |       | — |   | 28,787 |   |
| Inventories                                                                                |       | (4,337                                                         | )          | — |   | (4,337 | ) |
| Deferred costs                                                                             |       | (810                                                           | )          | 4,058 |   | 3,248 |   |
| Other assets                                                                               |       | (6,771                                                         | )          | — |   | (6,771 | ) |
| Accounts payable                                                                           |       | 18,077                                                         |       | — |   | 18,077 |   |
| Income taxes  payable                                                                      |       | (2,020                                                         | )          | — |   | (2,020 | ) |
| Customer  advances                                                                         |       | 43,097                                                         |       | — |   | 43,097 |   |
| Deferred revenue                                                                           |       | 14,207                                                         |       | (5,418 | ) | 8,789 |   |
| Other current  liabilities                                                                 |       | (50,985                                                        | )          | 15 |   | (50,970 | ) |
| Net cash provided by  operating activities                                                 |       | 53,672                                                         |       | — |   | 53,672 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                     |       |                                                           |       |   |   |   |   |
| Additions to  property, plant and equipment                                                |       | (3,162                                                         | )          | — |   | (3,162 | ) |
| Sale of business                                                                           |       | 19,965                                                         |       | — |   | 19,965 |   |
| Change in  restricted cash and long-term investments                                       |       | (17,037                                                        | )          | — |   | (17,037 | ) |
| Purchase of  short-term investments                                                        |       | (10,819                                                        | )          | (6,222 | ) | (17,041 | ) |
| Proceeds from  sale of short-term investments                                              |       | 13,309                                                         |       | — |   | 13,309 |   |
| Other                                                                                      |       | 499                                                            |       | — |   | 499 |   |
| Net cash provided by  (used in) investing activities                                       |       | 2,755                                                          |       | (6,222 | ) | (3,467 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                     |       |                                                           |       |   |   |   |   |
| Proceeds from  borrowings                                                                  |       | 62,370                                                         |       | — |   | 62,370 |   |
| Payments on  borrowings                                                                    |       | (89,948                                                        | )          | — |   | (89,948 | ) |
| Other                                                                                      |       | (3,184                                                         | )          | — |   | (3,184 | ) |
| Net cash used in  financing activities                                                     |       | (30,762                                                        | )          | — |   | (30,762 | ) |
|                                                                                       |       |                                                           |       |   |   |   |   |
| Effect of exchange rate  changes on cash and cash equivalents                              |       | 2,389                                                          |       | (15 | ) | 2,374 |   |
| Net increase in  cash and cash equivalents                                                 |       | 28,054                                                         |       | (6,237 | ) | 21,817 |   |
| Cash and cash  equivalents at beginning of period                                          |       | 645,571                                                        |       | — |   | 645,571 |   |
| Cash and cash  equivalents at end of period                                                |       | $                                                              | 673,625    |   | $ | (6,237 | ) | $ | 667,388 |   |
|                                                                                       |       |                                                           |       |   |   |   |   |
| Supplemental disclosure  of cash flow information:                                         |       |                                                           |       |   |   |   |   |
| Cash paid:                                                                                 |       |                                                           |       |   |   |   |   |
| Interest                                                                                   |       | $                                                              | 2,511      |   |   |   | $ | 2,511 |   |
| Income taxes                                                                               |       | $                                                              | 3,801      |   |   |   | $ | 3,801 |   |
| Non-cash operating  activities                                                             |       |                                                           |       |   |   |   |   |
| Accounts  receivable transferred to notes receivable                                       |       | $                                                              | 8,977      |   |   |   | $ | 8,977 |   |

 

24

----

**NOTE****3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

*Use of Estimates*

The preparation of consolidated financial statements inconformity with generally accepted accounting principles in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the consolidated financial statements andthe reported amounts of revenues and expenses during the reporting period.Estimates are used for revenue recognition, allowance for doubtful accounts andsales returns, tax valuation allowances, reserves for inventory, deferredcosts, accrued product warranty costs, provisions for contract losses, goodwilland other long-lived asset impairments, stock-based compensation, losscontingencies and restructuring expenses among others.  Actual resultscould differ from those estimates.

*Revenue Recognition*

Revenues from sales of telecommunications equipment andhandsets are recognized when persuasive evidence of an arrangement exists,delivery has occurred, the fee is fixed or determinable and collectibility isprobable.  If the payment due from thecustomer is not fixed or determinable due to extended payment terms, revenue isrecognized as payments become due and payable by the customer, assuming allother criteria for revenue recognition are met. Any payments received prior torevenue recognition are recorded as customer advances. Normal payment termsdiffer for various reasons amongst different customer regions, depending uponcommon business practices for customers within a region. Billing to customersfor shipping and handling are recorded as revenues and the associated costs arerecorded as costs of revenues. Any expected losses on contracts are recognizedwhen identified on an individual basis in accordance with the prevailingaccounting guidance for the respective contract.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the area of contracts with multiple deliverable elements(multiple element arrangements). Where multiple elements exist in anarrangement, the contract price is allocated to the different elements based uponand in proportion to verifiable objective evidence of the fair value of thevarious elements, as governed under Emerging Issues Task Force Issue (“EITF”)No. 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”and SEC Staff Accounting Bulletin No. 104 “Revenue Recognition.” Multipleelement arrangements primarily involve the sale of equipment, installation,training and post-contract support. Revenue is recognized as each element isearned, namely upon installation and acceptance of equipment or delivery ofhandsets, provided that the fair value of the undelivered element(s) has beendetermined, the delivered element(s) has stand-alone value, there is noright of return on delivered element(s), and the Company is in control of theundelivered element(s). For arrangements that include service elements,including promotional support and installation, for which verifiable objectiveevidence of the fair value does not exist, revenue is deferred until suchservices are deemed complete, or until the time the Company can establishverifiable objective evidence of the fair value.

Final acceptance is required for revenue recognition wheninstallation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and theCompany is entitled to the full payment. The Company does not recognize revenuebefore final acceptance is granted by the customer if acceptance is consideredsubstantive to the transaction.

Where multiple elements exist in an arrangement thatincludes software, and the software is considered more than incidental to theequipment or services in the arrangement, software and software relatedelements are recognized under the provisions of Statement of Position 97-2 “SoftwareRevenue Recognition,” as amended, and EITF No. 03-05, “Applicability ofSOP 97-2 to Non-Software Deliverables Containing More Than Incidental Software.”The Company allocates revenues to each element of software arrangements basedon vendor specific objective evidence (“VSOE”) of fair value. VSOE of fairvalue of each element is based on the price charged when the same element issold separately. The Company uses the residual method to recognize revenue whenan arrangement includes one or more elements to be delivered at a future dateand VSOE of the fair value of all the undelivered elements exists.  Under the residual method, the fair value ofthe undelivered elements is deferred and the remaining portion of the contractprice is recognized as revenue when all other revenue recognition criteria aremet. If VSOE of fair value of one or more undelivered elements does not exist,all revenue for delivered and undelivered elements is deferred until deliveryof all elements occurs or when VSOE of fair value of the undelivered elementscan be established.  In some cases theCompany has agreed to give software upgrade rights on a “when and if madeavailable” basis for equipment sold for no additional consideration and for anunspecified period which could extend over the term of the contract.  This additional contract obligation is anelement of “post contract support.”  TheCompany has not established VSOE for such contract element.  Accordingly, the revenues from such contractsare recognized ratably over the period during which the post contract supportis 

25

----

expected to be provided.  Theexpected period of support is generally the term of the contract.  In some cases where there is no statedcontractual term, revenue is recognized ratably over the estimated period ofsupport. The Company reviews assumptions regarding the estimated post contractsupport periods on a regular basis.  Ifthe Company determines that it is necessary to revise the Company’s estimatesof the support periods, the amount of revenue recognized over the life of thecontract would not be affected.  However,to the extent the new assumptions regarding the post contract support periodswere different than original assumptions, the contract revenues would berecognized over the remaining expected period of support.

Contract accounting is utilized for contracts thatinclude a requirement for significant software modification or customization;when utilized the Company generally accounts for such contracts using thecompleted contract method of accounting, whereby no revenue is recognized priorto the completion of the project, because for contracts involving uniquerequirements the Company is unable to make reasonably dependable estimates ofits progress towards meeting contractual requirements. In the event estimatedtotal project costs exceed estimated total project revenues, the entireestimated loss is charged to operations in the period in which the loss becomesprobable and can be reasonably estimated. The complexity of the estimationprocess and judgments about internal and external factors including laborutilization, changes to specifications and testing requirements, time requiredfor performance and resulting incurrence of contract penalties, and theperformance of subcontractors affect the estimation process.

The Company recognizes revenue for system integration,installation and training upon completion of performance and if all otherrevenue recognition criteria are met. Other service revenue, principallyrelated to maintenance and support contracts, is recognized ratably over themaintenance term. Revenues from services were less than 10% of revenues for allperiods present.

The Company also sells products through resellers.  Revenue is generally recognized when thestandard price protection period, which ranges from 30 to 90 days, haslapsed. If collectibility cannot be reasonably assured in a resellerarrangement, revenue is recognized upon sell through to the end customer andreceipt of cash. There may be additional obligations in reseller arrangementssuch as inventory rotation, or stock exchange rights on the product. As such,revenue is recognized in accordance with Statement of Financial AccountingStandards (“SFAS”) No. 48, “Revenue Recognition When Right of ReturnExists.” In most cases, the Company has developed reasonable estimates forstock exchanges based on historical experience with similar types of sales ofsimilar products.

The Company has sales agreements with certain wirelesscustomers that provide for a rebate of the selling price to such customers ifthe particular product is subsequently sold at a lower price to such customersor to a different customer. The rebate period extends for a relatively shortperiod of time. Historically, the amounts of such rebates paid to customershave not been material. The Company estimates the amount of the rebate basedupon the terms of each individual arrangement, historical experience and futureexpectations of price reductions and then records its estimate of the rebateamount at the time of the sale. The Company also enters into sales incentiveprograms, such as co-marketing arrangements, with certain wireless and handsetcustomers. The Company records the incurred incentive as a reduction of revenuewhen the sales revenue is recognized.

The assessment of collectibility is also a factor indetermining whether revenue should be recognized. The Company assessescollectibility based on a number of factors, including payment history and thecredit-worthiness of the customer. The Company does not requestcollateral from its customers. In international sales, the Company may requireletters of credit from its customers that can be drawn on demand if thecustomer defaults on its payment.  If theCompany determines that collection of a payment is not reasonably assured, theCompany defers revenue recognition until collection becomes reasonably assured,which is generally upon receipt of cash.

Occasionally, the Company enters into revenue sharingarrangements.  Under these arrangements,the Company collects payment only after its customer, the telecommunicationsservice provider, collects service revenues. When the Company enters a revenue sharing arrangement, the Company doesnot recognize revenue until collection is reasonably assured.

Because of the nature of doing business in China andother emerging markets, the Company’s billings and/or customer payments may notcorrelate with the contractual payment terms and the Company generally does notenforce contractual payment terms prior to final acceptance. Accordingly,accounts receivable are not recorded until the Company recognizes the relatedcustomer revenue. Advances from customers are recognized when the Company hascollected cash from the customer, prior to recognizing revenue. The Company hadcurrent deferred revenue of $96.9 million and $95.7 million, and long-termdeferred revenue of $251.4 million and $261.0 million, at March 31, 2007 andDecember 31, 2006, respectively.

26

----

*Inventories*

Inventories consist of product held at the Company’s manufacturingfacility and warehouses, as well as finished goods at customer sites for whichthe customer has taken possession, but based on specific contractual terms,title has not yet passed to the customer. The Company may ship inventory toexisting customers that require additional equipment to expand their existingnetworks prior to the signing of an expansion contract. Inventories are statedat the lower of cost or market value, net of write-downs for excess, slowmoving and obsolete inventory. With the exception of the handset inventory forour Personal Communications Division (“PCD”), which is based on weightedaverage cost, inventory cost is computed using standard cost, whichapproximates actual cost on a first-in, first-out basis. Inventoryis written down for estimated obsolescence or unmarketable inventory equal tothe difference between inventory cost and the estimated market value.

*Deferred costs*

Deferred costs consist of product shipped to the customerfor which the rights and obligations of ownership have passed to the customerbut revenue has not yet been recognized. All deferred costs are stated at cost.Management periodically assesses the recoverability of deferred costs andprovides reserves against deferred cost balances when recovery of deferredcosts is not probable. Recoverability is evaluated based on various factorsincluding the length of time the product has been held at the customer site, theviability of payment, including assessment of product demand if a revenuesharing arrangement exists and/or the evaluation if a related transaction willresult in a gross margin loss. In a loss situation for a transaction, thedeferred cost balance is adjusted for an impairment equal to the value of theexcess of cost over the amount of revenue that will be eventually recognizedfor the transaction.  Revenue and cost ofsales are recorded when final acceptance is received from the customer. Withgreater concentration of product at customer sites with specific or individualcustomer, the financial conditions of any specific or individual customer mayresult in increased concentration risk exposure for the Company’s inventory.

For any post contract support services where  the revenue is deferred, the entire relateddeferred direct costs are classified as a noncurrent asset, consistent with thedefinition of a current asset per Accounting Research Bulletin No. 43, “WorkingCapital: Current Assets and Current Liabilities.”

*Stock-Based Compensation*

Prior to January 1, 2006, the Company accounted forshare-based payment awards under Accounting Principles Board Opinion No.25 Accounting for Stock Issued to Employees (“APB 25”), and provided the required pro forma disclosures under SFAS No. 123,“Accounting for Stock-Based Compensation” (“SFAS 123”).  In accordance with APB 25, non-cashcompensation expense was recognized for any options for which the exerciseprice was below the market price on the actual grant date, based on thedifference between the exercise price and the market price.  The expense was recognized ratably over theassociated service period, which was generally the option vesting term.

On January 1, 2006, the Company adopted SFASNo. 123 (revised 2004), “Share-Based Payment” (“SFAS 123(R)”),using the modified prospective transition method. Stock-basedcompensation expense recognized during the period is based on the value of theportion of share-based payment awards that is ultimately expected to vest.  Stock-based compensation expenserecognized in the consolidated statement of operations for the year endedDecember 31, 2006 included compensation expense for share-based paymentawards granted prior to, but not yet vested as of December 31, 2005 basedon the grant date fair value estimated in accordance with the pro formaprovisions of SFAS 123 and compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005 based on the grantdate fair value estimated in accordance with the provisions ofSFAS 123(R).  The Company used theBlack-Scholes option-pricing model (“Black-Scholes model”) method of valuationfor share-based awards granted on or prior to December 31, 2005, and continuesto use the Black-Scholes model for subsequent share-based payment awards.  On November 10, 2005, the FinancialAccounting Standards Board (“FASB”) issued FASB Staff Position No. FAS123(R)-3, “Transition Election Related to Accounting for Tax Effects ofShare-Based Payment Awards.”  The Companyadopted the alternative transition method provided in the FASB Staff Positionfor calculating the tax effects of stock-based compensation pursuant to SFAS123(R).  The alternative transitionmethod includes simplified methods for establishing the beginning balance ofthe additional paid-in-capital pool (“APIC pool”) related to the tax effects ofemployee stock-based compensation, and to determine the subsequent impact onthe APIC pool and consolidated statements of cash flows of the tax effects ofemployee stock-based compensation awards that are outstanding upon adoption ofSFAS 123(R).  The Company accountsfor utilization of windfall tax benefits based on tax law ordering andconsidered only the direct effects of stock-based compensation for purposes ofmeasuring the windfall at settlement of an award.

27

----

*Income Taxes*

The Company accounts for income taxes under the liability method, anddeferred income taxes are recognized for the differences between the tax basesof assets and liabilities and their financial statement amounts based onenacted tax rates. Valuation allowances are established when necessary toreduce deferred tax assets to the amount expected to be realized. The Companyis required to adjust its deferred tax asset and liabilities in the period whentax rates or the provisions of the income tax laws change.

In 2006, due to recent developments in its business, the Companydetermined that earnings from certain subsidiaries were not permanentlyreinvested outside the United States. The Company provides U.S. taxes onforeign undistributed earnings that are not considered to be permanentlyreinvested outside the United States. Under APB 23 “Accounting for IncomeTaxes—Special Areas,” deferred income taxes must be provided on the unremittedearnings of foreign subsidiaries unless such earnings could be deemed to bepermanently reinvested outside the United States. Prior to 2006, the Companyhad not provided for U.S. tax on any foreign unremitted earnings because theCompany did not intend to repatriate such earnings.

Asdescribed in Note 21, effective January 1, 2007, the Company adoptedFASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty inIncome Taxes, an interpretation of FASB Statement No. 109.”

**NOTE 4 - STOCK-BASED COMPENSATION**

The Company grants restricted stock awards to itsemployees under the 1997 and 2006 Plans. Such awards generally vest over a period of one to four years from thedate of grant.  The restricted stockawards have the voting rights of common stock and the shares underlying therestricted stock awards are considered issued and outstanding.  On February 28, 2006, the Company grantedrights to purchase 301,133 shares of restricted stock to executive officers ofthe Company which were allowed to lapse unexercised in March 2006.  In their place, on February 1, 2007, theCompensation Committee of the Board of Directors of the Company (“the Committee”)determined that certain executive officers, based on their level of performanceduring the Company’s 2006 fiscal year, were eligible to receive 203,000 sharesof common stock in the aggregate (“the Performance Stock”).  The Committee’s determination is subject tocompliance with applicable law, and the Committee will issue the PerformanceStock after the Company is in compliance with all SEC reportingrequirements.  The Performance Stock isincluded in the Company’s computation of stock-based compensation expense andwas $0.2 million for both of the three months ended March 31, 2007 and 2006.

In addition, on February 28, 2006, the Committee granted602,267 performance options under the 1997 and 2006 Plans.  On February 1, 2007, the Committeedetermined, based on each executive officer’s level of performance during theCompany’s 2006 fiscal year, that 406,000 shares underlying the previouslygranted performance options were earned as of February 28, 2007.  Each performance option has an exercise priceof $6.25 per share, which equals the closing price of the Company’s commonstock on the NASDAQ Stock Market on the date of grant, February 28, 2006.  The 196,267 performance options not declaredearned by the Committee were cancelled and returned to the Company.  The performance options are included in the Company’scomputation of stock-based compensation expense and were $0.5 million and $0.2million for the three months ended March 31, 2007 and 2006, respectively.

The total stock-based compensation cost recognizedin the condensed consolidated statement of operations was as follows:
|                                                               | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                                    | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                              | ** ** |
| Stock-based  compensation expense by type of award:           |       |                                                 |       |   |   |
| Employee stock options and stock purchase plans               |       | $                                                    | 1,619      |   | $ | 4,043 |   |
| Restricted stock                                              |       | 1,136                                                |       | 775 |   |
| Forfeitures related to disposal of a component of a  business |       | —                                               |       | (2,393 | ) |
| Total                                                         |       | $                                                    | 2,755      |   | $ | 2,425 |   |

 

For additional information regarding the Company’sstock-based compensation plans, see the Company’s Annual Report onForm 10-K for the year ended December 31, 2006.

28

----

**NOTE 5 - LOSS PER SHARE**

Basic earnings per share (“EPS”) is computed by dividingnet loss available to common stockholders by the weighted average number ofshares of the Company’s common stock outstanding during the period, whichexcludes unvested restricted shares. Diluted EPS presents the amount of netloss available to each share of common stock outstanding during the period pluseach share of common stock that would have been outstanding assuming theCompany had issued shares of common stock for all dilutive potential common sharesoutstanding during the period. The Company’s potential common shares includeemployee stock options, unvested restricted shares, a written call option,warrants, convertible subordinated notes and vested acquisition-relatedstock options.

The following is a summary of the calculation of basicand diluted EPS:
|                                                                 | ** ** | **Three months ended March 31,**              | ** ** |
|-----------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2007**                                                          | ** ** | **2006** | ** ** |
| ** **                                                      | ** ** | ** **                                                        | ** ** | **(As restated)** | ** ** |
| ** **                                                      | ** ** | **(in thousands except per share data)** | ** ** |
| **Numerator:**                                                  | ** ** | ** **                                                        | ** ** | ** ** | ** ** |
| Net loss for  basic EPS computation                             |       | $                                                                 | (53,982    | ) | $ | (9,946 | ) |
| Effect of  dilutive securities - convertible subordinated notes |       | —                                                            |       | — |   |
| Net loss  adjusted for dilutive securities                      |       | $                                                                 | (53,982    | ) | $ | (9,946 | ) |
|                                                            |       |                                                              |       |   |   |
| **Denominator:**                                                | ** ** | ** **                                                        | ** ** | ** ** | ** ** |
| Shares used to  compute basic EPS                               |       | 120,900                                                           |       | 120,600 |   |
| Dilutive common  stock equivalent shares                        |       | —                                                            |       | — |   |
| Shares used to  compute diluted EPS                             |       | 120,900                                                           |       | 120,600 |   |
|                                                            |       |                                                              |       |   |   |
| Loss per share - basic  and diluted                             |       | $                                                                 | (0.45      | ) | $ | (0.08 | ) |

 

For the three months ended March 31, 2007 and 2006, nopotential common shares were dilutive because of the net loss in each of theseperiods, and basic and dilutive EPS are the same.  The following table summarizes the totalpotential shares of common stock that were excluded from the diluted per sharecalculation, because to include them would have been anti-dilutive for theperiod.
|                                               | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                    | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                              | ** ** |
| Stock options                                 |       | 19,344                                               |       | 22,848 |   |
| Conversion of  convertible subordinated notes |       | 11,543                                               |       | 11,543 |   |
| Unvested  restricted shares                   |       | 635                                                  |       | 582 |   |
|                                          |       | 31,522                                               |       | 34,973 |   |

 

29

----

**NOTE 6 - COMPREHENSIVE LOSS**

The reconciliation of net loss to comprehensive loss forthe three months ended March 31, 2007 and 2006 is as follows:
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| ** **                             | ** ** | **(in thousands)**                              | ** ** |
| Net loss                               |       | $                                                    | (53,982    | ) | $ | (9,946 | ) |
| Unrealized gain (loss)  on investments |       | (3,869                                               | )          | 23 |   |
| Foreign currency  translation          |       | 4,666                                                |       | 1,764 |   |
| Total comprehensive loss               |       | $                                                    | (53,185    | ) | $ | (8,159 | ) |

 

**NOTE 7 - CASH, CASH EQUIVALENTS AND SHORT-TERMINVESTMENTS**

Cash and cash equivalents consist of instruments withmaturities of three months or less at the date of purchase. There were noavailable-for-sale securities included in cash and cash equivalents atMarch 31, 2007 or December 31, 2006. Short-term investments,consisting entirely of available-for-sale securities, were $14.8 million and$9.5 million at March 31, 2007 and December 31, 2006,respectively. The available-for-sale securities currently consist of bank timedeposits, but can consist of government-backed notes, commercial paper,floating rate corporate bonds and fixed income corporate bonds. Theseinvestments are recorded at fair value. Any unrealized holding gains or lossesare reported as a component of other comprehensive income. Realized gains andlosses are reported in earnings.

The Company accepts bank notes receivable with maturitydates of between three and six months from its customers in China in the normalcourse of business. The Company may discount these bank notes with bankinginstitutions in China. A sale of these notes is reflected as a reduction ofcash and cash equivalents or short-term investments and the proceeds of thesettlement of these notes are included in cash flows from operating activitiesin the consolidated statement of cash flows. There were no bank notes soldduring the three months ended March 31, 2007 and 2006.

**NOTE 8 - RESTRICTED CASH AND INVESTMENTS**

At March 31, 2007 the Company had short-termrestricted cash and investments of $5.6 million and long-term restricted cashof $17.2 million included in other long-term assets. At December 31,2006 the Company had short-term restricted cash and investments of$16.7 million and long-term restricted cash of $16.5 million includedin other long-term assets. These amounts primarily collateralize the Company’sissuances of standby and commercial letters of credit.

**NOTE 9 - ACCOUNTS AND NOTES RECEIVABLE**

The Company accepts bank notes and commercial notesreceivable from its customers in China in the normal course of business.  The notes are typically non-interest bearing,with maturity dates between three and six months.  Bank notes are included in short-terminvestments.  Commercial notes receivableavailable for sale were $6.2 million and $5.1 million at March 31, 2007and December 31, 2006, respectively. The Company may discount these notes with banking institutions inChina.  A sale of these notes isreflected as a reduction of notes receivable and the proceeds of the settlementof these notes are included in cash flows from operating activities in theconsolidated statement of cash flows. Any notes that have been sold are not included in the Company’sconsolidated balance sheets as the criteria for sale treatment established bySFAS No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishment of Liabilities” (“SFAS 140”), have been met. UnderSFAS 140, upon a transfer, the transferor or entity must de-recognizefinancial assets when control has been surrendered and the transferee obtainscontrol over the assets. In addition, the transferred assets have been isolatedfrom the transferor, beyond the reach of its creditors, and the transferee hasthe right, without conditions or constraints, to pledge or exchange the assetsit has received. There were no notes receivable sold during the three monthsended March 31, 2007 and 2006.

In August 2005, the Company entered into a CommittedReceivables Purchase Agreement (“Agreement”) with a commercial bank, wherebythe Company may sell up to $100.0 million of its eligible accountsreceivable, as defined in the Agreement. The Agreement contains provisions customary in transactions of thisnature including certain commitment fees. During the three months ended March 31, 2007, no receivables have been soldpursuant to provisions of the Agreement, and the Company recorded commitmentfees of $0.1 million.  In March2007, the Agreement was amended and restated to reflect that the purchase oftrade receivables shall be at the sole discretion of the commercial bank, withno associated commitment fees.

30

----

**NOTE 10 - INVENTORIES**

As of March 31, 2007 and December 31, 2006,total inventories consisted of the following:
|                   | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **        | ** ** | **(in thousands)** | ** ** |
|              |       |                    |       |                  |       |
| Raw materials     |       | $                       | 60,375     |                  | $          | 72,230 |   |
| Work-in-process   |       | 48,613                  |       | 43,542                |       |
| Finished goods    |       | 334,008                 |       | 324,673               |       |
| Total Inventories |       | $                       | 442,996    |                  | $          | 440,445 |   |

 

**NOTE 11 - GOODWILL AND INTANGIBLE ASSETS**

As of March 31, 2007 and December 31, 2006,goodwill was $3.1 million, the entire amount of which was allocated to theservices operating segment. As of March 31, 2007 and December 31,2006, intangible assets consisted of the following:
| ** **                    | ** ** | **March 31, 2007** | ** ** | **December 31, 2006** | ** ** |
|-------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                    | ** ** | **(in thousands)**      | ** ** |
| ** **                    | ** ** | **Gross**                    | ** ** | ** **                      | ** ** | **Net** | ** ** | **Gross** | ** ** | ** ** | ** ** | **Net** | ** ** |
| ** **                    | ** ** | **Carrying**                 | ** ** | **Accumulated**                 | ** ** | **Carrying** | ** ** | **Carrying** | ** ** | **Accumulated** | ** ** | **Carrying** | ** ** |
| ** **                    | ** ** | **Amount**                   | ** ** | **Amortization**                | ** ** | **Amount** | ** ** | **Amount** | ** ** | **Amortization** | ** ** | **Amount** | ** ** |
| Amortized intangible  assets: |       |                         |       |                            |       |   |   |   |   |   |   |   |   |
| Existing technology           |       | $                            | 39,530     |                            | $          | (29,329 | ) | $ | 10,201 |   | $ | 39,530 |   | $ | (27,824 | ) | $ | 11,706 |   |
| Customer relationships        |       | 57,220                       |       | (20,077                         | )          | 37,143 |   | 57,220 |   | (18,544 | ) | 38,676 |   |
| Trade names                   |       | 4,940                        |       | (4,162                          | )          | 778 |   | 4,940 |   | (3,829 | ) | 1,111 |   |
| Non-compete agreement         |       | 10,800                       |       | (6,525                          | )          | 4,275 |   | 10,800 |   | (5,850 | ) | 4,950 |   |
|                          |       | $                            | 112,490    |                            | $          | (60,093 | ) | $ | 52,397 |   | $ | 112,490 |   | $ | (56,047 | ) | $ | 56,443 |   |

 

Amortization expense was $4.0 million and$4.9 million for the three months ended March 31, 2007 and 2006,respectively. The estimated aggregate amortization expense for intangibles forthe remainder of 2007 and each of the next four years and thereafter is asfollows:
|                   | ** ** | **March 31, 2007** | ** ** |
|-------------------|------------|------------------------------|------------|
| ** **        | ** ** | **(in thousands)**      | ** ** |
| Remainder of 2007 |       | $                            | 11,915     |   |
| 2008              |       | 12,745                       |       |
| 2009              |       | 6,874                        |       |
| 2010              |       | 5,132                        |       |
| 2011              |       | 5,132                        |       |
| Thereafter        |       | 10,599                       |       |
|              |       | $                            | 52,397     |   |

 

31

----

**NOTE 12 - LONG-TERM INVESTMENTS**
|                            | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                 | ** ** | **(in thousands)** | ** ** |
| Gemdale                    |       | $                       | 29,061     |                  | $          | 32,781 |   |
| Global Asia Partners  L.P. |       | 1,700                   |       | 1,700                 |       |
| Fiberxon Ltd.              |       | 3,000                   |       | 3,000                 |       |
| ImmenStar                  |       | —                  |       | 2,000                 |       |
| Cortina                    |       | 3,013                   |       | —                |       |
| GCT SemiConductor          |       | 3,000                   |       | 3,000                 |       |
| Xalted Networks            |       | 3,302                   |       | 3,302                 |       |
| Infinera                   |       | 1,902                   |       | 1,902                 |       |
| Others                     |       | 109                     |       | 124                   |       |
| Total                      |       | $                       | 45,087     |                  | $          | 47,809 |   |

 

*Gemdale*

The negotiableGemdale shares are traded on the Shanghai Stock Exchange.  The 13.8 million negotiable shares aresubject to a transfer restriction through August 2007.  As of March 31, 2007 the Company had a 2%ownership interest in Gemdale.  Theinvestment is classified as equity securities available-for-sale and recordedat fair value.  An unrealized gain on theinvestment and related receivable totaling $27.8 million was recorded inaccumulated other comprehensive income as of March 31, 2007.

*Cortina Systems / ImmenStar*

In September 2004,the Company invested $2.0 million in Series A preferred stock of ImmenStar,Inc. (“ImmenStar”).  ImmenStar is adevelopment stage company that was designing a chip that can be used in theCompany’s product.  This investment wasaccounted for under the cost method. In February 2007, ImmenStar was acquiredby Cortina Systems, Inc., a privately owned company.  In exchange for the Company’s investment inImmenStar, the Company received 3.6 million shares of Series D Preferred Stockof Cortina Systems, Inc., $1.8 million cash in March 2007 and is entitled toreceive an additional 0.4 million shares of Series D Preferred Stock and $0.2million cash currently in escrow.  As aresult of the acquisition, the Company recorded a gain on investment of $2.8million, in other income, net, and owns 1.3% interest of Cortina Systems, Inc.on a fully diluted basis. The Company accounts for its investment in CortinaSystems, Inc. using the cost method.

**NOTE 13 - DEBT**

The following represents the outstanding borrowings atMarch 31, 2007 and December 31, 2006:
|                                                             | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                                                  | ** ** | **(in thousands)** | ** ** |
| Bank loans                                                  |       | $                       | 103,584    |                  | $          | 102,510 |   |
| Capital lease  obligations, at 4.7%-10.0%, due through 2011 |       | 753                     |       | 809                   |       |
| Convertible  subordinated notes, due March 1, 2008          |       | 274,600                 |       | 274,600               |       |
| Total Debt                                                  |       | $                       | 378,937    |                  | $          | 377,919 |   |
| Long-term debt                                              |       | 521                     |       | 275,161               |       |
| Short-term debt                                             |       | $                       | 378,416    |                  | $          | 102,758 |   |

 

At March 31, 2007, the Company had loans withvarious banks totaling $103.6 million with interest rates ranging from 5.51 %to 5.57 % per annum. These bank loans that are denominated in ChineseRenminbi mature during 2007 and the first quarter of 2008 and are included inshort-term debt. There are no significant covenants associated with theseloans.

32

----

The Company also had available credit facilities in Chinaat March 31, 2007 totaling $692.7 million, of which $353.5 million wasavailable for working capital purposes. The Company had drawn $103.6 million in outstanding borrowings as ofMarch 31, 2007, and $339.2 million was available for use in support of lettersof credit and corporate guarantees. These facilities expire primarily in 2007.

On March 12, 2003, the Company completed an offeringof $402.5 million of 7/8% convertible subordinated notes due March 1,2008 to qualified buyers pursuant to Rule 144A under the Securities Act of1933. The notes are convertible into the Company’s common stock at a conversionprice of $23.79 per share and are subordinated to all present and future seniordebt of the Company. Holders of the notes may convert their notes only if:(i) the price of the Company’s common stock issuable upon conversion of anote reaches a specified threshold, (ii) specified corporate transactionsoccur, or (iii) the trading price for the notes falls below certainthresholds. At the initial conversion price, each $1,000 principal amount ofnotes will be convertible into 42.0345 shares of common stock. Expensesassociated with the convertible subordinated notes issuance were$11.7 million and have been recorded in other long-term assets andare being amortized over the life of the notes.

The Company has entered into a convertible bond hedge anda call option transaction. The convertible bond hedge allows the Company topurchase 11.5 million shares of its common stock at $23.79 per share fromthe other party to the agreement. The written call option allows the holder topurchase 11.5 million shares of the Company’s common stock from theCompany at $32.025 per share. Both the bond hedge and call option transactionsmay be settled at the Company’s option either in cash or net shares and expireon March 1, 2008.

The Company recorded these instruments at cost, and theircarrying value at March 31, 2007 equaled their original cost as adjustedfor amendments related to the early extinguishment of debt. The convertiblebond hedge and call option transactions are expected to reduce the potentialdilution from conversion of the notes. The options have been included instockholders’ equity in accordance with the guidance in EITF No. 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.”

On November 15, 2006, the Company received a noticeasserting that its failure to timely file its Quarterly Report on Form 10-Q forthe period ended September 30, 2006 had caused a default under the provisionsof the indenture governing the convertible subordinated notes, which if notcured within 60 days, would cause an event of default.  The Company solicited and obtained therequisite consents from holders of the convertible subordinated notes due March2008 to a waiver effective January 9, 2007 of any default which may haveoccurred prior to such date due to the delay in filing and non-compliance withcertain covenants, and the Company and the Trustee entered into a FirstSupplemental Indenture, dated January 9, 2007, providing that any failure bythe Company to comply with certain covenants of the original indenture wouldnot result in a default or an event of default through May 31, 2007.  The First Supplemental Indenture provided foradditional interest at a rate of 6.75% per annum in special interest on thenotes from and after January 9, 2007 to the March 1, 2008 maturity date of thenotes, unless the notes are earlier repurchased or converted. Payments of thespecial interest were to be made in addition to and at the same time and in thesame manner as regularly scheduled payments of interest to holders entitled tosuch regularly scheduled payments of interest. As a result of the FirstSupplemental Indenture, the convertible subordinated notes accrued interest ata rate of 7.625% per annum as of January 9, 2007.  For information regarding the subsequentsolicitation of consents from the holders of the notes and the relatedamendments to the indenture governing the notes, see Note 25 entitled “SubsequentEvents” below.

**NOTE 14 - WARRANTY OBLIGATIONS AND OTHER GUARANTEES**

The Company provides a warranty on its equipment andhandset sales for a period generally ranging from one to three years from thetime of final acceptance. Very rarely, the Company has entered intoarrangements to provide limited warranty services for periods longer than threeyears. The longest of such warranty periods is ten years. The Company providesfor the expected cost of product warranties at the time that revenue isrecognized based on an assessment of past warranty experience.

33

----

Warranty obligations, included in other currentliabilities, are as follows:
|                                                  | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                       | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | ** **                                           | ** ** | **as restated** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                              | ** ** |
| Beginning of  period                             |       | $                                                    | 63,900     |   | $ | 76,719 |   |
| Accruals for warranties issued during the period |       | 3,297                                                |       | 8,949 |   |
| Settlements made during the period               |       | (9,886                                               | )          | (16,966 | ) |
| Balance at end  of period                        |       | $                                                    | 57,311     |   | $ | 68,702 |   |

 

During 2005, the Company recorded a special warrantycharge for equipment sold to Softbank during 2003 and 2004.  Since the agreement to repair these partsexceeds the Company’s normal warranty terms the Company recorded additionalspecial warranty charges of $11.7 million for certain asynchronous digitalsubscriber line (“ADSL”) products, $4.0 million primarily for NetRingequipment and $14.9 million for Gigabit Ethernet Passive Optical Network (“GEPON”)equipment.  The special warranty balancewas $15.2 million and $20.9 million at March 31, 2007 and 2006, respectively,and is included in the above amounts. These products are in the Company’s Broadband Infrastructure segment.

Certain of the Company’s sales contracts include provisionsunder which customers would be indemnified by the Company in the event of,among other things, a third-party claim against the customer forintellectual property rights infringement related to the Company’sproducts.  There are no limitations on themaximum potential future payments under these guarantees.  The Company has not accrued any amount inrelation to these provisions as no such claims have been made and the Companybelieves it has valid, enforceable rights to the intellectual property embeddedin its products.

**NOTE 15 - COMMITMENTS AND CONTINGENCIES**

*Leases*

The Company leases certain facilities undernon-cancelable operating leases that expire at various dates through 2013. Theminimum future lease payments under the leases at March 31, 2007 were asfollows:
|                               | ** ** | **March 31,**      | ** ** |
|-------------------------------|------------|-------------------------|------------|
| ** **                    | ** ** | **2007**                | ** ** |
| ** **                    | ** ** | **(in thousands)** | ** ** |
| 1 year                        |       | $                       | 14,189     |   |
| 2 year                        |       | 9,917                   |       |
| 3 year                        |       | 6,686                   |       |
| 4 year                        |       | 1,624                   |       |
| 5 year and after              |       | 1,447                   |       |
| Total minimum  lease payments |       | $                       | 33,863     |   |

 

Rent expense for the quarters ending March 31, 2007and 2006 was $4.8 million and $5.6 million, respectively.

*Contractual obligations and commercial commitments:*

34

----

As of March 31, 2007 theCompany’s obligations under contractual obligations and commercial commitmentsare as follows:
|                                 | ** ** | **Payments due by period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| ** **                      | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** |
| ** **                      | ** ** | **(in thousands)**                   | ** ** |
| Bank loans                      |       | $                                         | 103,584    |   | $ | 103,584 |   | $ | — |   | $ | — |   |
| Convertible  subordinated notes |       | $                                         | 274,600    |   | $ | 274,600 |   | $ | — |   | $ | — |   |
| Interest payable  on debt       |       | $                                         | 26,166     |   | $ | 26,166 |   | $ | — |   | $ | — |   |
| Letters of  credit              |       | $                                         | 45,965     |   | $ | 28,813 |   | $ | 17,152 |   | $ | — |   |
| Long-term purchase  obligations |       | $                                         | 6,182      |   | $ | 602 |   | $ | 5,580 |   | $ | — |   |

 

*Letters of credit*

The Company issues standby letters of credit primarily tosupport international sales activities outside of China.  When the Company submits a bid for a sale,often the potential customer will require that the Company issue a bid bond ora standby letter of credit to demonstrate its commitment through the bidprocess.  In addition, the Company may berequired to issue standby letters of credit as guarantees for advance customerpayments upon contract signing or performance guarantees.  The standby letters of credit usually expirewithout being drawn by the beneficiary thereof. Finally, the Company may issue commercial letters of credit in supportof purchase commitments.

*Long-term purchase obligations*

At March 31, 2007, long-term purchase obligations includenon-cancelable agreements to purchase components, primarily in connection withlast time buy agreements.  As of March31, 2007, total commitments under these agreements were approximately $6.2million.  Additionally, the Company hasagreed to purchase global data services from Verizon Communications, Inc. (“Verizon”).  At March 31, 2007, the remaining commitmentto Verizon under this agreement is approximately $0.9 million.  In connection with the sale of assets toMarvell Technology Group Ltd. (“Marvell”), the Company has agreed topurchase from Marvell certain chipsets that will be included in the Company’sPersonal Access Service and IP-based Personal Access Service (collectively “PAS”)handsets through 2011.  These chipsetswill be included in certain handset products designed and manufactured by theCompany.

*Intellectual property*

Certain sales contracts include provisions under whichcustomers would be indemnified by the Company in the event of, among otherthings, a third-party claim against the customer for intellectualproperty rights infringement related to the Company’s products. There are nolimitations on the maximum potential future payments under these guarantees.The Company has not accrued any amounts in relation to these provisions as nosuch claims have been made and the Company believes it has valid enforceable rightsto the intellectual property embedded in its products.

*Litigation*

*Securities Class Action Litigation*

Beginningin October 2004, several shareholder class actions alleging federalsecurities violations were filed against the Company and various officers anddirectors of the Company.  The actions have been consolidated in UnitedStates District Court for the Northern District of California under the 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 onJuly 26, 2005.  The First AmendedComplaint alleged violations of the Securities Exchange Act of 1934, and wasbrought on behalf of a putative class of shareholders who purchased our stockafter April 16, 2003 and before September 20, 2004.  On April 13, 2006, the lead plaintiffsfiled a Second Amended Complaint adding new allegations and extending the endof the class period to October 6, 2005. In addition to the Company defendants, the plaintiffs are also suingSoftbank.  Plaintiffs’ complaint seeksrecovery of damages in an unspecified amount.

OnJune 2, 2006, the Company and the individual defendants filed a motion todismiss the Second Amended Complaint.  OnMarch 21, 2007, the Court granted defendants’ motion and dismissed plaintiffs’Second Amended Complaint.  The Courtgranted plaintiffs leave to file a Third Amended Complaint, which plaintiffsfiled on May 25, 2007. On July 13, 2007, the Company and the individualdefendants filed a motion to dismiss and a motion to strike the Third AmendedComplaint.

On September 4, 2007, asecond shareholder class action complaint captioned *Peter Rudolph v. UTStarcom, et al.*, Case No. C-07-4578 SI,was filed in the United States District Court for the Northern District ofCalifornia against the 

35

----

Company and someof the Company’s current and former directors and officers. The complaintalleges violations of the Securities Exchange Act of 1934 through undisclosedimproper accounting practices concerning the Company’s historical equity awardgrants.  Plaintiff seeks unspecifieddamages on behalf of a purported class of purchasers of the Company’s commonstock between July 24, 2002 and September 4, 2007.

Due to the preliminary status ofthese lawsuits and uncertainties related to litigation, the Company is unableto evaluate the likelihood of either a favorable or unfavorable outcome.  Accordingly, the Company is unable at thistime to estimate the effects of these complaints on the Company’s financialposition, results of operations, or cash flows.

*GovernmentalInvestigations*

The Company has received notice of a formal inquiry bythe staff of the Securities & Exchange Commission (“SEC”) into certainaspects of the Company’s financial disclosures during prior reporting periodsand certain other issues.  In addition,in December 2005, the U.S. Embassy in Mongolia informed the Company that it hadforwarded to the Department of Justice (“DOJ”) allegations that an agent of theCompany’s Mongolia joint venture had offered payments to a Mongolian governmentofficial in possible violation of the Foreign Corrupt Practices Act (the “FCPA”).  The Company through our Audit Committee,authorized an independent investigation into possible violations of the FCPA,and the Company has  been in contact withthe DOJ and SEC regarding the investigation. The investigation has identified possible FCPA violations in Mongolia,Southeast Asia, India, and China, as well as possible violations of U.S.immigration laws. The DOJ has requested that the Company voluntarily producedocuments related to the investigation and the SEC has subpoenaed the Companyfor documents.  The Company has executed tolling agreements extending thestatute of limitations for the FCPA issues under investigation by the SEC andDOJ and the immigration issues under investigation by the DOJ.  At this time, the Company cannot predict whenany inquiry will be completed or what the outcome of any inquiry will be.

*Shareholder Litigation*

On November 17, 2006, a shareholderderivative complaint captioned *ErnestoEspinoza v. Ying Wu et al.*, Case No. RG06298775, was filed againstcertain of the Company’s current and former officers and directors in theSuperior Court of the County of Alameda, California.  The complaint alleges that the individualdefendants, among other things, breached their duties, were unjustly enriched,and violated the California Corporations Code in connection with the timing ofstock option grants.  The complaint namesthe Company as a nominal defendant and seeks unspecified monetary damagesagainst the individual defendants and various forms of injunctive relief.  On February 2, 2007, the Company and theindividual defendants filed demurrers against the complaint.  On April 11, 2007, the Court sustainedthe individual defendants’ demurrer, overruled the Company’s demurrer, orderedthe plaintiff to file an amended complaint, and ordered the Company to answerthe original complaint.  The plaintifffiled an amended complaint and the Company has filed an answer to the amendedcomplaint.  On August 21, 2007, theindividual defendants filed demurrers against the amended complaint.  The Court sustained the individual defendants’demurrers and ordered the plaintiff to file a second amended complaint.

Due to the preliminary status ofthis complaint and uncertainties related to litigation, the Company is unableto evaluate the likelihood of either a favorable or unfavorable outcome.  Accordingly, the Company is unable at thistime to estimate the effects of this complaint on the Company’s financialposition, results of operations, or cash flows.

*IPOAllocation*

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 filed concerning the initial publicofferings for more than 300 different issuers, and the cases were coordinatedas *In re Initial Public Offering SecuritiesLitigation*, 21 MC 92 for pretrial purposes.  In April 2002, a consolidated amendedcomplaint was filed in the matter against the Company, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604.  Plaintiffs allege violations of theSecurities Act of 1933 and the Securities Exchange Act of 1934 throughundisclosed improper underwriting practices concerning the allocation of IPOshares in exchange for excessive brokerage commissions, agreements to purchaseshares at higher prices in the aftermarket and misleading analyst reports.  Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock betweenMarch 2, 2000 and December 6, 2000. The Company’s directors and officers have been dismissed withoutprejudice pursuant to a stipulation.  OnFebruary 19, 2003, the Court granted in part and denied in part amotion to dismiss brought by defendants including the Company.  The order dismissed all claims against theCompany except for a claim brought under Section 11 of the Securities Actof 1933, which alleges that the registration statement filed in accordance withthe 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 forapproval.  The terms of the settlement,if approved, would have dismissed and released 

36

----

allclaims against the participating defendants (including the Company).  In August 2005, the Court preliminarilyapproved the settlement.  In December2006, the Court of Appeals for the Second Circuit reversed the Court’s October2004 order certifying a class in six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings.  The Company’s case is not one of the test cases. Because classcertification was a condition of the settlement, it was unlikely that thesettlement would receive final Court approval. On June 25, 2007, the Court entered an order terminating the proposedsettlement based on a stipulation among the parties to the settlement.  Plaintiffs have filed amended masterallegations and amended complaints in the six test cases.  It is unclear whether there will be any revisedor future settlement.  If the litigationproceeds, the Company believes that the Company has meritorious defenses andintend to defend the action vigorously. The total amount of the loss associated with the above litigation is notdeterminable at this time.  Therefore,the Company is unable to currently estimate the loss, if any, associated withthe litigation.

*Passave Litigation*

In November 2005, the Company filed suit in theSuperior Court of California, County of Santa Clara, against Passave, Inc.(“Passave”) for breaches of contract and warranties in connection with asemiconductor device sold by Passave, Ltd. (Passave’s wholly-­owned subsidiary) to the Company.The Company’s complaint alleges that the Passave device, known as the PAS5001M3chip, has exhibited certain operational malfunctions within some of ourFiber-to-the-Home product line, and has thereby caused damage to the Company.The parties entered into a settlement agreement, in favor of the Company datedAugust 7, 2007, and have since dismissed all claims with prejudice.

*UTStarcom, Inc. v. Starent Patent InfringementLitigations*

On February 16, 2005, the Company filed a suit againstStarent for patent infringement in the U.S. District Court for the NorthernDistrict of California.  In the Complaint,the Company asserts that Starent infringes UTStarcom patent U.S. Reg. No.  6,829,473 (“the ‘473 patent”) through Starent’sdevelopment and testing of a software upgrade for its customer’s installedST-16 Intelligent Mobile Gateways.  TheCompany seeks declaratory and injunctive relief.  Starent subsequently filed its answer andcounterclaims, denying the Company’s allegations and seeking a declaration thatthe patent-in-suit is not infringed, is invalid, and is unenforceable.  On June 16, 2005, the Company filed a motionto strike Starent’s affirmative defense and dismiss Starent’s counterclaimalleging inequitable conduct.  On July19, 2005, the parties stipulated that Starent would file an amended answer andcounterclaim by July 27, 2005 and that the Company  would withdraw the Company’s motion tostrike.  On August 10, 2005, the Companyresponded to Starent’s amended counterclaim filed on July 27, 2005.  In earlyDecember 2006, the Company filed a reissue application for the ‘473 patent withthe United States Patent and Trademark Office. Starent has also filed for reexamination of the ‘473 patent.  The reexamination and reissue are currentlycopending.  The litigation is still in apreliminary stage and its outcome cannot be predicted, although the Companybelieves the litigation has merit. Nonetheless, the Company believes that any adverse judgment on Starent’scounterclaims will not have a material adverse effect on the Company’sbusiness, financial condition, or results of operations.

On May 8, 2007,the Company filed an additional suit against Starent and sixteen individualdefendants (who were all former employees of 3Com’s CommWorks division whichthe Company acquired certain assets of in May of 2003) in the Northern Districtof Illinois.  The causes of actioninclude claims for patent infringement, misappropriation of trade secrets,intentional interference with business relations and prospective economicadvantage and declarations of ownership of certain patent rights.  In its Complaint, the Company asserts thatStarent infringes UTStarcom patents U. S. Reg. Nos. 7,173,905; 6,978,128;6,963,582; 6,975,900; and 6,684,256 through the manufacture, use, offer, forsale, and sale of Starent’s ST16 Intelligent Mobile Gateway and ST40 multimediacode platform, that the individual Defendants and Starent have misappropriatedvaluable Company trade secrets by improperly taking and using  the Company’s confidential and proprietaryinformation for the benefit of Starent, that the individual defendants andStarent have interfered with the Company’s business relations and prospectiveeconomic advantage by using the misappropriated information to obtain andenhance sales of Starent’s products, and that several of Starent’s patentapplications and one issued patent are based on information obtained by theformer employees while at the Company (CommWorks) and on that basis belong toUTStarcom.  The Company seekscompensatory damages, punitive damages and injunctive relief.  After the court denied the defendants motionto dismiss the misappropriation of trade secrets claims, on August 30, 2007, Starent answered the Company’s complaint, denyingthe Company’s allegations and asserting a number of affirmative defenses andcounterclaims, including non-infringement of the subject patents and allegedtortious interference with prospective economic advantage.  The Company has filed a motion to dismissmost of the counterclaims and the court has ordered appointment of a specialmaster to handle discovery, which is just beginning.  The Company believes that any adversejudgment on Starent’s counterclaims will not have a material adverse effect onthe Company’s business, financial condition or results of operations.

37

----

*Telemetrix, Inc. Arbitration*

On October 19, 2006, Telemetrix,Inc. (“Telemetrix”) filed a formal Request for Arbitration against the Companyto the World Intellectual Property Organization (“WIPO”) in Geneva,Switzerland.  The Request for Arbitrationsought unspecified damages arising from a contractbetween Telemetrix and Telos Technology, Inc., dated October 22, 2003.  The Company assumed Telos’ rights andobligations under this contract pursuant to the Company’spurchase of Telos’ assets on May 19, 2004.  Telemetrix alleged nine causes of action,including breach of contract, fraud, negligent misrepresentation, interferencewith contractual relations, and interference with prospective economicadvantage.  In December 2006, the Companyfiled a formal response to the Request for Arbitration, denying all material factualallegations asserted by Telemetrix.  Anarbitrator was selected by the parties, and, on August 2, 2007, the arbitrator granted a pleading motion in favor ofthe Company due to Telemetrix’s failure to allege sufficient facts in supportof 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, fraud,interference with contractual relations and interference with prospectiveeconomic advantage.  The previous hearingdate of December 11-13 has been vacated. No hearing date has been rescheduled. Discovery has begun.

*Telos Technology,Inc. Litigation*

On November 22, 2005, plaintiffs TelosTechnology, Inc., Telos Technology (Canada), Inc., Telos Technology(Bermuda) Ltd., and Telos Engineering Limited (collectively, the “TelosPlaintiffs”) filed a Complaint against the Company in the Superior Court ofCalifornia, County of Santa Clara. The Complaint alleges five causes of action,including breach of contract, breach of the implied covenant of good faith andfair dealing, fraudulent inducement, intentional misrepresentation andnegligent misrepresentation, all of which arise from the Asset PurchaseAgreement between the parties dated April 21, 2004. The Telos Plaintiffsassert that the Company breached the express and implied terms of the AssetPurchase Agreement and made representations to the Telos Plaintiffs duringnegotiations that it never intended to fulfill. The Telos Plaintiffs sought atleast $19 million in damages, unspecified punitive damages and attorneys’fees. The parties executed a settlement agreement in the amount of $4.5 millionon August 20, 2007 and the case was dismissed on September 26, 2007with prejudice.

*Other Litigation*

The Company is a party to other litigation matters andclaims that are normal in the course of operations, and while the results ofsuch litigation matters and claims cannot be predicted with certainty, theCompany believes that the final outcome of such matters will not have amaterial adverse impact on the Company’s financial position, results ofoperations or cash flows.

**NOTE 16 - SEGMENT REPORTING**

The Company has organized its business in a mannerconsistent with the chief operating decision makers’ view and management of thebusiness.  The Company offers productsand services through four operating units, (i) Network Solutions,(ii) PCD, (iii) Handsets and (iv) Services.  The Network Solutions operating unit providesits products and services through two reporting segments; BroadbandInfrastructure and Wireless Infrastructure. Each reporting segment and operating unit is responsible for managingits own performance.

The Company currently evaluates operating performance ofand allocates resources to the reporting segments based on segment grossprofit.  Cost of sales and directexpenses in relation to production are assigned to the reporting segments.  The accounting policies used in measuringsegment assets and operating performance are the same as those used bycorporate and are consistently applied across all segments.

Summarized below are the Company’s segment sales revenueand gross profit for the three months ended March 31, 2007 and 2006,respectively.

38

----

 
| ** **                  | ** **   | **Three months ended March 31,** | ** **   |
|-----------------------------|--------------|------------------------------------------------------|--------------|
| ** **                  | ** **   | ** **                                           | ** **   | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                  | ** **   | **2007**                                             | ** **   | **sales** | ** ** | **2006** | ** ** | **sales** | ** ** |
| ** **                  | ** **   | ** **                                           | ** **   | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                  | ** **   | **(in thousands)**                              | ** **   |
| ***Net  Sales by Segment*** | *** *** | *** ***                                         | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Broadband  Infrastructure   |         | $                                                    | 31,222       |   | 6 | % | $ | 57,251 |   | 10 | % |
| Wireless  Infrastructure    |         | 69,879                                               |         | 15 | % | 105,733 |   | 18 | % |
| Network Solutions           |         | 101,101                                              |         | 21 | % | 162,984 |   | 28 | % |
| PCD                         |         | 288,330                                              |         | 61 | % | 322,995 |   | 54 | % |
| Handsets                    |         | 69,719                                               |         | 15 | % | 99,034 |   | 16 | % |
| Services                    |         | 16,752                                               |         | 3 | % | 16,968 |   | 2 | % |
|                        |         | $                                                    | 475,902      |   | 100 | % | $ | 601,981 |   | 100 | % |

 
| ** **                     | ** **   | **Three months ended March 31,** | ** **   |
|--------------------------------|--------------|------------------------------------------------------|--------------|
| ** **                     | ** **   | ** **                                           | ** **   | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                     | ** **   | **2007**                                             | ** **   | **profit %** | ** ** | **2006** | ** ** | **profit %** | ** ** |
| ** **                     | ** **   | ** **                                           | ** **   | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                     | ** **   | **(in thousands)**                              | ** **   |
| ***Gross  profit by Segment*** | *** *** | *** ***                                         | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Broadband  Infrastructure      |         | $                                                    | 5,001        |   | 16 | % | $ | 23,086 |   | 40 | % |
| Wireless  Infrastructure       |         | 24,266                                               |         | 35 | % | 50,761 |   | 48 | % |
| Network Solutions              |         | 29,267                                               |         | 29 | % | 73,847 |   | 45 | % |
| PCD                            |         | 16,845                                               |         | 6 | % | 14,389 |   | 4 | % |
| Handsets                       |         | 25,048                                               |         | 36 | % | 31,613 |   | 32 | % |
| Services                       |         | 4,125                                                |         | 25 | % | 3,942 |   | 23 | % |
|                           |         | $                                                    | 75,285       |   | 16 | % | $ | 123,791 |   | 21 | % |

 

Assets by segment are as follows:
|                          | ** **   | **March 31,**      | ** **   | **December 31,** | ** **   |
|--------------------------|--------------|-------------------------|--------------|-----------------------|--------------|
| ** **               | ** **   | **2007**                | ** **   | **2006**              | ** **   |
| ** **               | ** **   | **(in thousands)** | ** **   |
| ***Long-lived  assets*** | *** *** | *** ***            | *** *** | *** ***          | *** *** |
| Broadband Infrastructure |         | $                       | 42,554       |                  | $            | 43,157 |   |
| Wireless Infrastructure  |         | 78,578                  |         | 79,691                |         |
| Network solutions        |         | 121,132                 |         | 122,848               |         |
| PCD                      |         | 2,208                   |         | 2,377                 |         |
| Handsets                 |         | 42,987                  |         | 43,596                |         |
| Services                 |         | 43,715                  |         | 44,334                |         |
|                     |         | $                       | 210,042      |                  | $            | 213,155 |   |

 

39

----

 
|                          | ** **   | **March 31,**      | ** **   | **December 31,** | ** **   |
|--------------------------|--------------|-------------------------|--------------|-----------------------|--------------|
| ** **               | ** **   | **2007**                | ** **   | **2006**              | ** **   |
| ** **               | ** **   | **(in thousands)** | ** **   |
| ***Total assets***  | *** *** | *** ***            | *** *** | *** ***          | *** *** |
| Broadband Infrastructure |         | $                       | 457,985      |                  | $            | 438,190 |   |
| Wireless Infrastructure  |         | 838,072                 |         | 909,450               |         |
| Network solutions        |         | 1,296,057               |         | 1,347,640             |         |
| PCD                      |         | 354,221                 |         | 414,295               |         |
| Handsets                 |         | 506,678                 |         | 505,693               |         |
| Services                 |         | 90,404                  |         | 106,322               |         |
|                     |         | $                       | 2,247,360    |                  | $            | 2,373,950 |   |

 

Net sales are attributed to a geographical area basedupon the location of the customer. Sales data by geographical area are asfollows:
|                            | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|
| ** **                 | ** ** | ** **                                           | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                 | ** ** | **2007**                                             | ** ** | **sales** | ** ** | **2006** | ** ** | **sales** | ** ** |
| ** **                 | ** ** | ** **                                           | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **(in thousands)**                              | ** ** |
| ***Net  Sales by region*** |       |                                                 |       |   |   |   |   |   |   |
| United States              |       | $                                                    | 293,169    |   | 62 | % | $ | 329,763 |   | 55 | % |
| China                      |       | 136,734                                              |       | 29 | % | 199,810 |   | 33 | % |
| Japan                      |       | 14,315                                               |       | 3 | % | 47,660 |   | 8 | % |
| Other                      |       | 31,684                                               |       | 6 | % | 24,748 |   | 4 | % |
| Net sales                  |       | $                                                    | 475,902    |   | 100 | % | $ | 601,981 |   | 100 | % |

 

Long-lived assets, consisting of property, plant andequipment by geographical area are as follows:
|                                    | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                         | ** ** | **(in thousands)** | ** ** |
| ***Long-lived  assets by region*** |       |                    |       |                  |       |
| U.S.                               |       | $                       | 14,161     |                  | $          | 14,354 |   |
| China                              |       | 188,593                 |       | 191,517               |       |
| Other                              |       | 7,288                   |       | 7,284                 |       |
| Total long-lived  assets           |       | $                       | 210,042    |                  | $          | 213,155 |   |

 

**NOTE 17 - TRANSACTIONS WITH RELATED PARTIES AND CERTAININVESTEES**

The following is a summary of the Company’s transactionswith related parties and certain investees:
|                                | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                     | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| ** **                     | ** ** | **(in thousands)**                              | ** ** |
| **Net  sales**                 | ** ** | ** **                                           | ** ** | ** ** | ** ** |
| Softbank                       |       | $                                                    | 11,535     |   | $ | 43,027 |   |
| Japan Telecom,  Ltd            |       | 1,581                                                |       | 1,790 |   |
| Total Softbank  and affiliates |       | 13,116                                               |       | 44,817 |   |
| ORG, Inc.                      |       | 212                                                  |       | 127 |   |
| Total                          |       | $                                                    | 13,328     |   | $ | 44,944 |   |

 

40

----

 
|                          | ** ** | **Accounts receivable** | ** ** | **Accounts payable** | ** ** |
|--------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **March 31,**           | ** ** | **December 31,**     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **               | ** ** | **2007**                     | ** ** | **2006**                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **               | ** ** | **(in thousands)**      | ** ** |
| Softbank and  affiliates |       | $                            | 24,451     |                      | $          | 29,941 |   | $ | 591 |   | $ | 535 |   |
| MDC Holding,  Ltd.       |       | 962                          |       | 1,300                     |       | — |   | — |   |
| Fiberxon, Ltd.           |       | 55                           |       | 44                        |       | 151 |   | 368 |   |
| ORG, Inc.                |       | 2                            |       | 1,025                     |       | — |   | — |   |
| GCT  Semiconductor, Inc. |       | —                       |       | —                    |       | 339 |   | 1,051 |   |
| Acoustek Int'l,  Inc.    |       | —                       |       | —                    |       | 51 |   | 51 |   |
| Cortina/Immenstar        |       | —                       |       | —                    |       | — |   | 345 |   |
| Other                    |       | 17                           |       | 8                         |       | 11 |   | 50 |   |
| Total                    |       | $                            | 25,487     |                      | $          | 32,318 |   | $ | 1,143 |   | $ | 2,400 |   |

 
|                          | ** ** | **Purchases**           | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **March 31,**      | ** ** | **March 31,** | ** ** |
| ** **               | ** ** | **2007**                | ** ** | **2006** | ** ** |
| ** **               | ** ** | ** **              | ** ** | **(As restated)** | ** ** |
| ** **               | ** ** | **(in thousands)** | ** ** |
| Softbank and  affiliates |       | $                       | 484        |   | $ | — |   |
| Fiberxon, Ltd.           |       | 1,803                   |       | 1,661 |   |
| GCT  Semiconductor, Inc. |       | 1,177                   |       | 2,285 |   |
| Cortina/Immenstar        |       | 13                      |       | 2,017 |   |
| Total                    |       | $                       | 3,477      |   | $ | 5,963 |   |

 

*Softbank and affiliates*

The Company recognized revenue with respect to sales oftelecommunications equipment to affiliates of Softbank, a significantstockholder of the Company. Softbank offers ADSL coverage throughout Japan,which is marketed under the name “YAHOO! BB.” The Company supports Softbank’sfiber-to-the-home service through sales of its carrier class GEPON product aswell as its multi-service optical transport product (“NetRingÔ“). In addition, the Company supports Softbank’s new internet protocoltelevision (“IPTV”), through sales of its RollingStreamÔ product. Included in revenue for the three months ended March 31,2006 is a fee of $17.0 million charged for the cancellation of orders forbroadband products.

Sales to Softbank include a three year service period anda penalty clause if product failure rates exceed a certain level over a sevenyear period. As of March 31, 2007, the Company’s customer advance balancerelated to Softbank agreements was $0.5 million compared to no balance as ofDecember 31, 2006.  The current deferredrevenue balance related to Softbank was $9.3 million and $11.6 million as ofMarch 31, 2007 and December 31, 2006, respectively.  As of March 31, 2007, the Company’snoncurrent deferred revenue balance related to Softbank was $11.7 millioncompared to $11.5 million as of December 31, 2006.

During August 2004, the Company entered into severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiaryof Softbank. These agreements relate to the sale of *i*AN-8000 equipment with specified value and delivery dates,as well as an oral agreement which subsequently converted into specific servicecontracts to manage a sales promotional program for JT. The Company hasdetermined that the service activities revenue should be recorded net ofexpected promotional spending.

On July 17, 2003, the Company entered into aMezzanine Loan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate ofSoftbank. Under the terms of the agreement, the Company loaned BB Modem$10.1 million at an effective interest rate of 12.01% per annum, for thepurpose of investing in a portfolio of ADSL modems and associated modem rentalagreements, from Softbank. Softbank will continue to service such modems andmodem rental agreements. The Company’s loan was subordinated to certain seniorlenders of BB Modem, and repayments were paid to the Company over a 42-monthperiod through January 31, 2007, with a substantial portion of theprincipal amount of the loan schedule repaid during the last 16 months ofthis period. During the three months ended March 31, 2007 and 2006, theCompany recorded an immaterial 

41

----

amount and $0.2 million, respectively, in interest income withrespect to this loan. The loan receivable was fully settled at March 31,2007 compared to a balance of approximately $1.0 million as of December 31,2006 which was included in prepaid and other current assets.

As of March 31, 2007, Softbank beneficially ownedapproximately 12% of the Company’s outstanding stock.

*ORG, Inc.*

As of March 31, 2007, the Company has a 49% ownership inGlobal Asia Partners L.P. which in turn is a significant shareholder inORG, Inc., a reseller of infrastructure equipment for broadbandaccess.  In January 2005, the Companyentered into a reseller agreement with ORG, Inc., which was terminated inAugust 2006; however an immaterial amount of revenue for pre-August 2006deliveries was recognized in the three months ended March 31, 2007.

*MDC Holding, Ltd.*

The Company has an outstandingaccounts receivable balance with MDC Holding, Ltd. (“MDC”) related to a PASsystem purchase.  Certain employees ofthe Company were shareholders of MDC as of March 31, 2007.  MDC is in the business of providingvalue-added services, such as short message, voicemail or ring-tone servicesfor PAS telecom networks.

*Fiberxon, Ltd.*

The Company has an outstanding purchase commitment of animmaterial amount with Fiberxon, Ltd., in which the Company has a 7% ownershipinterest, to purchase component parts for optical networking products. TheCompany paid $0.1 million to Fiberxon, Ltd. for each of the three months endedMarch 31, 2007 and 2006.

*GCT Semiconductor, Inc.*

The Company has a 2% ownershipinterest in GCT Semiconductor, Inc., which designs, develops and marketsintegrated cost circuit products for the wireless communications industry.

*Acoustek Int’l, Inc.*

The Company has obtained consulting services fromAcoustek Int’l Inc. (“Acoustek”), which employed Minnie Huang, spouse ofWilliam Huang, the Company’s former Senior Vice President and Chief TechnologyOfficer.  Mr. Huang’s employment with theCompany terminated on December 31, 2006. The Company made no payments during the three months ended March 31,2007 compared to $0.1 million for the same period in 2006 to Acoustek forconsulting services.

*Cortina / Immenstar*

The Company has an outstanding purchasecommitment of approximately $1.8 million with Cortina Systems, Inc, in whichthe Company has a 1.3% ownership interest on a fully diluted basis, to purchasechips that are used in the Company’s product

*Xalted Networks, Inc.*

The Company has received purchase orders from XaltedNetworks (“Xalted”) totaling approximately $1.3 million in 2005 fortelecommunications equipment that is for product not typically sold by theCompany to other customers. The Company is charging a ten percent procurementfee to Xalted for obtaining and reselling these products. The equipment wasdelivered during 2005 but revenue has not been recognized as the revenuerecognition process had not been completed. As of March 31, 2007, theCompany’s customer advance balance related to Xalted was $1.3 million comparedto no balance as of December 31, 2006.

**NOTE 18 - RESTRUCTURING COSTS**

As of March 31, 2007 and December 31, 2006, therestructuring accrual, included within accrued liabilities in the condensedconsolidated balance sheet, was approximately $70,000 and $122,000,respectively.  The balance of theliability relates to non-cancelable lease payments for the New Jerseyfacility.  The Company expects theremaining accrual to be paid by the third quarter of 2007.

42

----

**NOTE 19 - OTHER INCOME**

Net other income was$4.0 million and $3.6 million for the three months endedMarch 31, 2007 and 2006, respectively. The balances were comprised of thefollowing:
|                                       | ** ** | **Three months ended March 31,** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|
| ** **                            | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)**                              | ** ** |
| Foreign exchange  gains               |       | $                                                    | 1,058      |   | $ | 2,814 |   |
| Gain on sale of  Immenstar investment |       | 2,813                                                |       | — |   |
| Chinese  government financial subsidy |       | 354                                                  |       | 536 |   |
| Other                                 |       | (255                                                 | )          | 218 |   |
| Total                                 |       | $                                                    | 3,970      |   | $ | 3,568 |   |

 

**NOTE 20 - CREDIT RISK AND CONCENTRATION**

The table below outlines theCompany’s sales to, and the accounts receivable balances from its largestcustomers:
|                     | ** ** | **For the three  months ended  March 31,** | ** ** | **March 31,**                  | ** ** |
|---------------------|------------|----------------------------------------------------------------|------------|-------------------------------------|------------|
| **2007**            | ** ** | **% of net  sales**                                  | ** ** | **% of  accounts  receivable** | ** ** |
| Verizon Wireless    |       | 15                                                             | %          | 1                                   | %          |
| T-Mobile USA,  Inc. |       | 13                                                             | %          | 13                                  | %          |
| Sprint Spectrum     |       | 11                                                             | %          | 5                                   | %          |
|                |       |                                                           |       |                                |       |
| **2006**            | ** ** | ** **                                                     | ** ** | ** **                          | ** ** |
| Verizon Wireless    |       | 16                                                             | %          | 1                                   | %          |
| Sprint Spectrum     |       | 13                                                             | %          | 7                                   | %          |

 

Approximately 18% and 33% of theCompany’s net sales during the three months ended March 31, 2007 and 2006,respectively, were to entities affiliated with the government of China.Accounts receivable balances from these China government affiliated entities orstate owned enterprises were $202.7 million and $170.4 million,respectively, as of March 31, 2007 and December 31, 2006. The Companyextends credit to its customers in China generally without requiringcollateral. In global sales outside of China, the Company often requiresletters of credit from its customers. The Company monitors its exposure forcredit losses and maintains allowances for doubtful accounts.

Approximately 27% and 33% of theCompany’s sales for the three months ended March 31, 2007 and 2006,respectively, were made in China. Accordingly, the political, economic andlegal environment, as well as the general state of China’s economy mayinfluence the Company’s business, financial condition and results ofoperations. The Company’s operations in China are subject to specialconsiderations and significant risks not typically associated with companies inthe United States. These include risks associated with, among others, thepolitical, economic and legal environments and foreign currency exchange. TheCompany’s results may be adversely affected by, among other things, changes inthe political, economic and social conditions in China, and by changes ingovernmental policies with respect to laws and regulations, changes in China’stelecommunications industry and regulatory rules and policies,anti-inflationary measures, currency conversion and remittance abroad, andrates and methods of taxation.

**NOTE 21 - INCOME TAX ASSETS ANDLIABILITIES**

In June 2006, the FASB issued FIN 48. Theinterpretation contains a two-step approach to recognizing and measuringuncertain tax positions accounted for in accordance with SFAS No. 109, “Accountingfor Income Taxes.” The first step is to evaluate the tax position forrecognition by determining if the weight of available evidence indicates thatit is more likely

43

----

than not that the position will besustained on audit, including resolution of related appeals or litigationprocesses, if any. The second step is to measure the tax benefit as the largestamount which is more than 50% likely of being realized upon ultimatesettlement.

TheCompany adopted the provisions of FIN 48 effective January 1, 2007. As a resultof the adoption of FIN 48, the Company recognized a $1.4 million increase inthe liability for unrecognized tax benefits which, as required, was accountedfor as a reduction to the January 1, 2007 balance of retained earnings.  As of January 1, 2007, the Company had $69.9 millionof liabilities for unrecognized tax benefits. If recognized, the portion ofliabilities for unrecognized tax benefits that would decrease the provision forincome taxes and increase the Company’s net income is $6.4 million. The impacton net income reflects the liabilities for unrecognized tax benefits net ofcertain deferred tax assets and the federal benefit of state income tax itemstotaling $63.5 million. The adoption resulted in a reclassification of taxliabilities totaling $6.4 million from current to non-current.  As of March 31, 2007, the Company’sliabilities for unrecognized tax benefits totaled $71.9 million and areincluded in other long-term liabilities, net of non-current deferred tax assetsand the federal tax benefit of state income tax items. If recognized, theportion of liabilities for unrecognized tax benefits that would decrease theprovision for income taxes and increase the Company’s net income is $6.7million. The total liabilities for unrecognized tax benefits, and increases forthe current period of these liabilities, relate primarily to the allocations ofrevenue and costs among our global operations.

The Company recognizes interest expense and penaltiesrelated to the above unrecognized tax benefits within income tax expense. TheCompany had accrued interest and penalties of approximately $2.2 million as ofJanuary 1, 2007 and approximately $2.4 million as of March 31, 2007.

TheCompany is subject to taxation in the U.S. federal jurisdiction and variousU.S. state and foreign jurisdictions. TheCompany’s income tax returns for the 2003, 2004, and 2005 tax years arecurrently under audit by the United States Internal Revenue Service. TheCompany is also under audit by the taxing authorities in China on a recurringbasis. The material jurisdictions that the Company is subject to examinationare in the United States and China.

In establishing its deferredincome tax assets and liabilities, the Company makes judgments andinterpretations based on the enacted tax laws and published tax guidanceapplicable to its operations as well as the amount and jurisdiction of futuretaxable income. The Company records deferred tax assets and liabilities andevaluates the need for valuation allowances to reduce the deferred tax assetsto realizable amounts. The Company will maintain a full valuation allowance onits net deferred tax assets in China, the United States, and other countriesuntil an appropriate level of profitability that generates taxable income issustained or until the Company is able to develop tax strategies that wouldenable it to conclude that it is more likely than not that a portion of itsdeferred tax assets will be realizable. Any reversal of valuation allowanceswill favorably impact our results of operations in the period of the reversal.

Income tax expense was$4.3 million and $2.8 million for the three months ended March 31, 2007and 2006, respectively. There are two primary reasons why the Company has tax expensewhile the Company has pretax losses. First, the Company has not provided anytax benefit on the 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. Second, the Company continues to accrue taxexpense in jurisdictions where the Company has 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.

**NOTE 22 - RECENT ACCOUNTINGPRONOUNCEMENTS**

In September 2006, the FASBissued SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”).  SFAS 157 defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles,and expands disclosures about fair value measurements.  The provisions of this standard apply to currentaccounting pronouncements that require or permit fair value measurements.  SFAS 157 becomes effective for the Company onJanuary 1, 2008.  Upon adoption, theprovisions of SFAS 157 are to be applied prospectively with limitedexceptions.  The Company iscurrently evaluating the effects of SFAS 157 on its consolidated financialstatements.

In February 2007, The FASB issuedSFAS No. 159, “The Fair Value Option for Financial Assets and FinancialLiabilities” (“SFAS 159”).  Thisstatement permits, but does not require, companies to report at fair value themajority 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.  SFAS 159becomes

44

----

effective for the Company on January 1, 2008. TheCompany is currently evaluating the effects of SFAS 159 on itsconsolidated financial statements.

**NOTE 23 - VARIABLE INTEREST ENTITY**

The FASB issued FASBInterpretation No. 46, “Consolidation of Variable Interest Entities”(“FIN 46”).  FIN 46 requires that if an entity is theprimary beneficiary of a variable interest entity (“VIE”), the assets,liabilities, and results of operations of the VIE should be included in theconsolidated financial statements of the entity.

During the fourth quarter of2005, the Company provided an interest free, $12.4 million loan to a partyin China as seed capital for a venture organized to participate in providingtechnical service, networking technology, and equipment to the emerging marketfor IPTV products in China.  The loan ispartially secured by an indirect ownership interest in the venture, is payablein 10 years and may be called early without penalty.  As a result of the foregoing, and the factthat the venture’s continuing viability is heavily dependent on the furtherprovision of network and terminal equipment by the Company, the Company hasdetermined that the venture is a VIE and that the Company is the primarybeneficiary of the venture.  Therefore,this venture is consolidated into the Company’s results as of March 31,2007.  This VIE had insignificant revenueduring the three months ended March 31, 2007 and March 31, 2006, and had a netloss of $1.5 million and $0.7 million, respectively during the sameperiod.  The consolidation of this VIErepresented $16.7 million and $17.2 million of the total assets ofthe Company as of March 31, 2007 and December 31, 2006.  The liabilities of the VIE consolidated by theCompany do not represent additional claims on the Company’s general assets;rather they represent claims against the specific assets of the VIE.  Likewise, the assets of the VIE consolidatedby the Company do not represent additional assets available to satisfy claimsagainst the Company’s general assets. The creditors’ of the VIE do not have recourse to the Company therebylimiting the liability risks associated with the Company’s variable interestsin the VIE.

In the first quarter of 2005, theCompany invested in an additional entity, which is considered a VIE where theCompany is the primary beneficiary and does not hold a majority votinginterest.  The company was established toinstall, develop and operate a PAS network in Mongolia.  The creditors of this VIE have no recourse tothe Company.  In December 2005, theU.S. Embassy in Mongolia informed the Company that it had forwarded to theDepartment of Justice allegations that an agent of the joint venture hadoffered payments to a Mongolian government official, in possible violation ofthe Foreign Corrupt Practices Act.  TheAudit Committee authorized an independent investigation into the matter.  As a result of the investigation, the Companywrote off $1.2 million of intangibles and established a $2.6 millionvalue added tax (“VAT”) liability at December 31, 2005.  The investigation is still ongoing.  The consolidation of this entity resulted ina $6.0 million increase in both total assets and total liabilities andequity as of December 31, 2005.  In thefirst quarter of 2006, the Company decided to terminate the joint venturearrangement and wrote off the remaining net assets, of approximately$4.7 million.  In November 2006, theBoard of Directors of the VIE approved dissolution of the joint venture.  As a result, the Company ceased to be theprimary beneficiary of this VIE and the asset and the liabilities of the VIEwere not consolidated as of December 31, 2006. The $2.6 million VAT liability was reversed accordingly as managementconcluded that it is remote that the Company would be required to pay such taxfor the joint venture.

**NOTE 24 – SALE OF ASSETS**

*Marvell Technology Group Ltd.*

In February 2006, the Company sold substantiallyall of the assets and selected liabilities of its semiconductor design businessdivision to Marvell Technology Group Ltd. (“Marvell”). The Companyreceived $35.4 million in cash, net of $0.6 million of transaction costs,and an additional $4.3 million in cash was paid by Marvell to the Companyin August 2007. Included in the cash received was $16.0 million earned bythe Company as a result of achieving certain defined milestones. The Companyreceived payment of this $16.0 million in October 2006. The assets soldinclude the assets related to the prior acquisition of Advanced CommunicationsDevices Corporation in 2001, and other system-on-chip semiconductors. Inconnection with the sale of assets, the Company has entered into a supplyagreement with Marvell.

In connection with the sale ofassets, the Company has entered into a supply agreement with Marvell topurchase chipsets for the Company’s handset products over the next five years.The value allocated to the supply agreement of $20.2 million is included inother current and long-term liabilities, and is being amortized in proportionto the quantities of chipsets purchased under the supply agreement over thenext five years. For the three months ended March 31, 2007, approximately$0.5 million has been amortized against cost of sales.

45

----

**NOTE 25 - SUBSEQUENT EVENTS**

*Notice of Default and SecondSupplemental Indenture*

On May 31, 2007, the Companyreceived a notice of default for the convertible subordinated notes assertingthat a default had occurred under the indenture, as amended by the FirstSupplemental Indenture (“the Indenture”) with respect to the Company’sconvertible subordinated notes due in March 2008.  The specific purported defaults referred toin the notice of default were (1) the Company’s failure to file its Quarterly Report on Form 10-Q for the fiscal quarterended September 30, 2006, its annual report on Form 10-K for the year endedDecember 31, 2006 and its Quarterly Report on Form 10-Q for the fiscal quarterended March 31, 2007 and (2) the Company’s failure to deliver to the Trusteethe officer’s certificate of compliance of the Company required by theIndenture.

Subsequently, the Companysolicited and obtained the requisite consents from the holders of the notes toa waiver, effective July 26, 2007, of any default which may have occurred priorto such date due to the delay in filing and non-compliance with certaincovenants, and the Company entered into a Second Supplemental Indenturewith the Trustee, dated July 26, 2007, after receiving consent from holders ofmore than 50% of the outstanding aggregate principal amount of the convertiblesubordinated notes in connection with the Company’s consent solicitationannounced July 19, 2007. The Second Supplemental Indenture provided that theconvertible subordinated notes accrue additional interest at a rate of (a)6.75% per annum in special interest from and after January 9, 2007 to andincluding July 25, 2007, and (b) 10% per annum in special interest from andafter July 26, 2007 to the date the notes are paid, prepaid, redeemed convertedor otherwise cease to be outstanding. The special interest rate provided by theSecond Supplemental Indenture represented an increase of 3.25% per annum overthe special interest rate of 6.75% provided by the First SupplementalIndenture.  As a result of the SecondSupplemental Indenture, the convertible subordinated notes now bear a statedinterest rate of 10.875%.  Payments ofspecial interest will be made in addition to, and at the same time and in thesame manner as, regularly scheduled payments of interest to holders entitled tosuch regularly scheduled payments of interest.

The Second Supplemental Indenture also provided that(i) during the period from and including July 26, 2007 to and including October15, 2007 (“Covenant Reversion Date”), any failure by the Company to comply withthe covenants contained in the original agreement related to the filing ofreports required to be filed with the SEC, and the furnishing of copies of theSEC reports and certain compliance certificates to the Trustee, will notconstitute a default, and that (ii) if, but for the Second SupplementalIndenture, a default would be deemed to have occurred as a result of a failureto comply with such covenants and such default remains uncured and iscontinuing as of the Covenant Reversion Date, such default will be deemed tohave occurred on the Covenant Reversion Date.

The Company filed its 2006 Annual Report on Form 10-Kand its Form 10-Q for the quarterly period ended September 30, 2006 with theSecurities and Exchange Commission on October 10, 2007.

On October 15, 2007, the Company received anadditional notice of default asserting that a default had occurred under theIndenture (as amended by the First Supplemental Indenture and the SecondSupplemental Indenture) with respect to the Notes.  The specific purported defaults referred toin the notice of default were (i) the Company’s failure to file with the SECand provide copies to the Trustee of its Quarterly Report on Form 10-Q for thefiscal quarter ended March 31, 2007 and its Quarterly Report on Form 10-Q forthe fiscal quarter ended June 30, 2007 and (ii) the Company’s failure todeliver to the Trustee the officer’s certificate of compliance of the Companyrequired by the Indenture.  The notice ofdefault provides that the Company has 60 consecutive days from October 15, 2007(the “Demand Date”) to cure the purported defaults before such defaults wouldconstitute an “Event of Default” under the Indenture.  The occurrence of an “Event of Default” underthe Indenture would afford the Trustee or holders of not less than 25% inaggregate principal amount of outstanding Notes the right to declare the fullprincipal amount of all outstanding Notes to be immediately due and payable. 

*Liquidationof Assets*

In the fourth quarter of 2006,the Company recorded a $13.5 million other-than-temporary impairment charge towrite down the Company’s investment in Cellon, and further recorded a writedown of a prepaid royalty balance of $3.0 million related to Cellon.  Based on the deterioration of Cellon’sfinancial condition, the Company determined that the carrying value of theinvestment was at an amount above the fair value of the investment, and thedecline was other-than temporary.  OnJune 18, 2007, a meeting of Cellon’s shareholders was held where a resolutionwas passed to place Cellon in voluntary liquidation.

*Infinera Initial Public Offering*

OnJune 7, 2007, Infinera Corporation (“Infinera”) closed on its initial publicoffering of 14,000,000 shares of common stock at a price of $13.00 per share.Infinera also announced that the underwriters of the offering exercised in fulltheir option to purchase an additional 2,100,000 shares of Infinera common stock,bringing the total initial public offering size to $209.3 million.  After the initial public offering, theCompany is entitled to convert its 669,643 shares of Series D and 2,500,000shares of Series E Preferred Stock into 792,410 shares of Infinera’s commonstock; subject to Rule 144 trading restrictions and 180 days lock up periodstarting June 2007 through December 2007.

As aresult of the initial public offering, the value of the Infinera shares ownedby the Company became readily determinable and the investment will beclassified as an equity security available-for-sale in accordance with SFAS No.115, “Accounting for Certain Investments in Debt and Equity Securities,” in thebalance sheet for the quarter ended June 30, 2007.  The closing price per share of Infineracommon stock on June 29, 2007 was $24.92 and the value of the Company’sinvestment was $19.7 million.  In thesecond quarter of 2007, the Company recorded an unrealized gain of $17.8million, in

46

----

othercomprehensive income, representing the difference between the fair value of theinvestment on June 29, 2007 and the initial investment amount of $1.9 million.

*Fiberxon merger with MRV Communications*

OnJuly 1, 2007, Fiberxon, an investment in which the Company has a 7% ownershipinterest, completed a merger with MRV Communications (“MRV”).  In exchange for the Company’s investment inFiberxon, the Company will receive approximately $1.5 million in cash, 1.5million shares of MRV common stock and deferred consideration of approximately$2.7 million.  The deferred considerationbecomes payable upon the completion of certain milestones and may be reduced bylegitimate claims of MRV for certain matters related to the merger.

47

----

**ITEM 2—MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**FORWARD-LOOKING STATEMENTS**

ThisQuarterly Report on Form 10-Q contains forward-looking statementswithin the meaning of the federal securities laws.  These statements are based on informationthat is currently available to management.  We intend such forward-lookingstatements to be covered by the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995, and we are including this statementfor purposes of complying with those provisions.  The forward-looking statements include,without limitation, those concerning the following: our expectations regardingour compliance with SEC reporting requirements and NASDAQ listing requirements;our expectations as to the nature of possible market trends; our expectationsregarding continued growth in our business and operations; our expectationsregarding fluctuations in gross profit; our plans regarding payment of cashdividends; our expectations regarding recognition of certain compensation costs;our plans regarding legal proceedings; our expectations regarding the effect oflegal proceedings and government inquiries; our expectations regarding thefunctionality, performance and features of our products; our expectationregarding Softbank’s continued service of certain modems and modem rentalagreements; our expectations regarding possible transition in our management;our plans and expectations regarding relationships with vendors and suppliers,including Marvell and Cellon; our expectations regarding the future source andcosts of chipsets; our plan to fulfill the purchase commitment under variousorders from our suppliers; our expectations regarding the exchange rate riskswith respect to accountable receivables and payables in Renminbi, Japanese Yenand Euros; our plans regarding the use of financial instruments to hedgeagainst certain foreign currency exchange rate risks; our plans regarding theuse of derivative financial instruments for speculative trading purposes; ourplans regarding the discounting of certain bank notes and commercial notes; ourexpectations regarding our ability to raise funds, including the impact of latefiling of our reports with the SEC on our ability to raise funds; ourexpectations regarding the availability of funding under the account receivablefinancing program with Citibank, N.A. and our plan to continue service theaccount receivable; our expectations regarding our investment in Global AsiaPartners L.P.; our expectations regarding our right to intellectual propertyembedded in our products; our expectations regarding our ability to protect ourintellectual property; our expectations regarding the effect of market risks onour operating results; our plans to implement measures to remediate materialweaknesses; our expectations regarding the effectiveness of remediationmeasures; our plans to continue to review internal controls; our expectationsregarding competition and the competitive advantages of our competitors; ourexpectations regarding consolidation of the telecommunications industry; ourexpectations regarding the development and introduction of new and moreadvanced products; our expectations regarding deployment of our products; ourplans to reinvest cost savings derived from and expectations regarding ourworkforce restructurings; our expectations regarding future workforcerestructurings; our expectation regarding the adoption of environmental, healthand safety laws by countries world-wide; our expectations regarding the effectof the Sarbanes-Oxley Act on our corporate governance and disclosurepractices; our expectation regarding the expenses associated with compliancewith the Sarbanes-Oxley Act; our expectations regarding the impact of therestatement of our consolidated financial statements; our expectationsregarding the maturation of the PAS market and corresponding decrease in PASsubscriber growth; our expectations regarding the long-term demand for our PASproducts; our expectations regarding our ability to offset the decline in PASsales through pursuing other products; our expectations regarding PAS systemspending; our plan to pursue opportunities for our wireless infrastructureproducts in multiple markets; our expectations regarding our investment in anddevelopment of the IPTV market; our expectations regarding product margins; ourexpectations regarding the impact of our initiatives on our revenue plan; ourexpectations regarding our annual effective tax rate; our expectationsregarding the likelihood to realize the tax benefits in the U.S. and othercountries; our expectations regarding the effect of the China Corporate IncomeTax Law on our future tax expenses; our expectations regarding valuationallowance on our net deferred tax assets and its impact; our expectationsregarding the reporting of net losses throughout 2007; our expectationsregarding our level of capital expenditures in China; our plans to maintainadequate liquidity levels through at least the next 12 months; our expectationsregarding the availability and sufficiency of credit lines from our existing lenders;our plans to issue new debt instruments, sell investments and assets; ourexpectations regarding refinancing of the convertible notes and access to cashin our China subsidiaries to meet our liquidity requirements outside of China;our expectations regarding interest rates; our expectations regardingsufficiency of cash resources; our expectations regarding our ability toreceive licenses for our products; our expectation that our business, financialcondition and results of operations will continue to be significantlyinfluenced by the political, economic, legal and social environment in Chinaand other international markets, including Japan, India and Europe; ourexpectations regarding the nature of political, economic and legal reform inChina; our expectations regarding the continued importance of the Chinesemarket for our technologies and development and the importance of sales inChina to our operating results; our expectations regarding future salesgenerated from China as a percentage of total sales; our expectations regardingthe impact of our receiving the license to sell GSM and CDMA handsets in Chinaon our ability to meet future market demands; our expectations regardingsubscriber growth in China; our expectations regarding global expansion ofsales outside of China; our plan to extend our supplier base by introducingmore models of our own design and expanding relationships with more

48

----

manufacturers; our plans to pursue opportunities to divest additionalnon-core assets; our expectation that research and development expenses will bestable; our expectations regarding future amortization expenses; ourexpectations regarding the impact of product defects or performance qualityissues; our expectations regarding the impact of international expansion on ourmanagement, operational, financial and other resources; our expectationsregarding the impact of legislation that restricts or prohibits the use ofwireless handsets while driving on our future sales; our expectations regardingimprovement to shorten days sales outstanding; our plans regarding improvementof our internal supply chain and inventory management processes; ourexpectations regarding the reliability of stock-based compensationvaluation models and the impact of SFAS 123R; and our expectationsregarding our ability to implement and enhance our administrativeinfrastructure. Additional forward-looking statements may be identifiedby the words “anticipate,” “expect,” “believe,” “intend,” “will,” “may,” andsimilar expressions, as they relate to us or our management, or by the words “designed,”“intended” and similar expressions, as they relate to our products andservices.  Investors are cautioned thatthese forward-looking statements are inherently uncertain.  These statements are subject to risks anduncertainties that may cause actual results and events to differmaterially.  For a detailed discussion ofthese risks and uncertainties, see Part II, Item 1A “Risk Factors” of thisForm 10-Q.  We do not guaranteefuture results and undertake no obligation to update the forward-lookingstatements to reflect events or circumstances occurring after the date of thisForm 10-Q.

**RESTATEMENTOF CONSOLIDATED FINANCIAL STATEMENTS**

Ourconsolidated financial statements and related financial information included inthis Quarterly Report on Form 10-Q for accounting periods prior to the thirdquarter of 2006 have been restated, as described below.

***Summary***

InJuly 2007, the Company announced the Audit Committee of the our Board of Directors (“Audit Committee”)was conducting an independent investigation of historical sales withcertain customers in China and stated that it could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in previously issuedfinancial statements. In September 2007, the Company announced theinvestigative phase of the Audit Committee’s investigation had been completed.After consultation with and upon the recommendation of management, the AuditCommittee determined revenue in the Company’s Western Region of China wasrecognized earlier than it should have been and that the financial statementsfor the affected periods should be restated. The Company also announced thatits previously issued financial statements for each of the fiscal years endedDecember 31 in the period 2000 through 2005, the financial statements for theinterim periods contained in the Quarterly Reports on Form 10-Q filed withrespect to each of these years, and the quarterly reports on Form 10-Q filedwith respect to each of the quarterly periods ended March 31 and June 30,2006 should not be relied upon. In this Annual Report we have corrected for the effects of net sales andrelated costs of net sales that were recorded earlier than they should havebeen and have restated the financial statements for the three months endedMarch 31, 2006.. The net effect for the three months ended March 31, 2006 wasto recognize previously deferred revenue and gross profit of $5.4 million and$1.4 million, respectively.

We alsoconducted a voluntary review of historical stock option practices underthe direction of the Nominating and Corporate Governance Committee of our Boardof Directors (“Governance Committee”). This review considered all option grantawards made in the period from February 29, 2000, shortly before the initialpublic offering of our Common Stock, through August 2006 for compliance withthe various stock-based compensation accounting standards applicable duringthis period as well as the rules of our stock option plans. We found that in anumber of instances we did not use the proper date as the measurement date indetermining whether stock options had been issued with exercise prices belowthe fair value of our common stock. Therefore, we have restated our previouslyissued financial statements for the years ended December 31, 1998 through 2005to account for an additional $25.5 million of stock compensation expense thatshould have been recognized over the period together with an equal increase inadditional paid-in capital to recognize the intrinsic value assigned to theseissuances of equity securities. Related adjustments of payroll and income taxesresulted in an additional $0.5 million of expense being recognized for the 1998through 2005 period and total stockholders’ equity being reduced by a total of$2.1 million at December 31, 2005. During the first six months of 2006 anadditional $1.2 million of stock compensation expense was recognized, whichreduced our previously reported operating results for this period. We haverestated the financial statements for the three months ended March 31, 2006,and during that period incremental stock compensation expense totaling $0.7million was recognized.

None of these restatements had any effect on any ofour cash balances, however cash equivalents were reduced at March 31, 2006 dueto the correction in classifications described below.

49

----

Additional information about these restatements andtheir effects on our financial statements is presented below as well as in theNotes to Condensed Consolidated Financial Statements.

***ChinaSales Investigation***

The Audit Committee engaged independent counsel toconduct an investigation of sales in China following a determination by theInternal Audit group that allegations of improper activities in a sales officein the Western Region were credible. The allegations were made by a Companyemployee using the Company’s whistle blower program. The independent counselengaged the assistance of forensic accountants, and this group is collectivelyreferred to as the Investigating Team in the rest of this discussion.

In conducting its procedures, the Investigating Teamfound instances where the customer contracts that evidenced the arrangementcontained obligations for the Company to deliver software upgrades when and ifmade available for the equipment sold for no additional consideration and foran unspecified period that could extend over the term of the contract. Thisadditional contract obligation is an element of “post contract support.” Inthese cases, the Investigating Team found that the contract documentation forthe same transaction submitted by the sales office to the Company’s Chinaheadquarters for accounting purposes and utilized by the Company in determiningthe amount of revenue recognized did not include evidence of such post contractsupport obligations.

Accounting standards governing revenue recognition forsystem sales require all revenue to be deferred while there are undeliveredelements under the arrangement unless the seller has established vendorspecific objective evidence (“VSOE”) of fair value for such contract elements.Because these arrangements included such undelivered elements, revenue shouldbe deferred based on the VSOE of the fair value of the underlying elements.VSOE of fair value represents the price charged when the same element is soldseparately. Since the Company does not sell this element separately, it has notestablished VSOE for such undelivered elements, and as such the revenue fromsuch contracts is required to be deferred and recognized over the period theCompany is obligated to provide the post contract support.

TheChina sales investigation covered each of the seven years in the period endedDecember 31, 2006 and included: investigating approximately 1,200 contracts in all of our five regionsin China; reviews of the electronic files of 45 employees; and formalinterviews of 96 employees in China. Additionally, the China salesinvestigation included reviewing contract files, performing various financialanalyses including comparison of payments received per our accounting recordsto the contract terms, and computer forensic procedures where destruction ofelectronic documents was suspected. In the aggregate, the Investigating Teamexpended approximately 25,000 hours in conducting this investigation, whichcommenced in February 2007 and was completed in September 2007 when theindependent counsel and forensic accountants presented their final report tothe Audit Committee. In July 2007, we announced the Audit Committee wasconducting an independent investigation of historical sales with certaincustomers in China and we stated that we could not rule out the possibilitythat the outcome of the investigation could impact revenue recognized forcertain of such contracts as recorded in our previously issued financialstatements.

Uponcompletion of the investigative phase of the independent investigation by theAudit Committee, our management:

·                  conductedfollow-up procedures to attempt to locate any additional relevant informationto ensure the China sales investigation considered all available informationand documents;

·                  evaluated theaccounting for identified system sales using the contract template anddocumentation found in the sales contract files from the Western Regionoffices. This included calculating the financial statement effects ofcorrecting the accounting for all system sales where the contract templatefound at our sales offices contained post contract support obligations torecognize revenue and cost of net sales over estimated period of post contractsupport;

·                  concluded thatas a result of the existence of this undelivered post contract supportobligation our previously issued financial statements should be restated todefer system sales contract revenue and the related cost of net sales over theestimated period of post contract support when a contract contained unspecifiedsoftware upgrade rights.

TheAudit Committee concurred with management’s decisions.

50

----

Theeffect of correcting improperly recognized revenue and cost of net sales was to(reduce) increase previously reported net sales, gross profit and net income bythe following amounts (in thousands of dollars):
|                                        | ** ** | ** **         | ** ** | ** **            | ** ** | ** **          | ** ** |
|----------------------------------------|------------|--------------------|------------|-----------------------|------------|---------------------|------------|
| **Year ended  December 31,** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
|                                   |       |               |       |                  |       |                |       |
| 2000                                   |       | $                  | (12,408    | )                     | $          | (5,294              | )          | $ | (4,781 | ) |
| 2001                                   |       | (17,154            | )          | (6,330                | )          | (5,779              | )          |
| 2002                                   |       | (64,732            | )          | (22,924               | )          | (19,697             | )          |
| 2003                                   |       | (21,060            | )          | (8,014                | )          | (6,382              | )          |
| Totals through December 31, 2003       |       | (115,354           | )          | (42,562               | )          | (36,639             | )          |
| 2004                                   |       | (104,965           | )          | (27,241               | )          | (18,594             | )          |
| 2005                                   |       | (58,232            | )          | (27,863               | )          | (42,433             | )          |
| 2000 - 2005 Total                      |       | (278,551           | )          | (97,666               | )          | (97,666             | )          |
| 2006 quarter ended                     |       |               |       |                  |       |                |       |
| March 31                               |       | 5,410              |       | 1,360                 |       | 1,360               |       |
| June 30                                |       | 2,380              |       | (371                  | )          | (371                | )          |
| Total China  Sales Restatement         |       | $                  | (270,761   | )                     | $          | (96,677             | )          | $ | (96,677 | ) |

 

Thecumulative effect of all of the China sales restatement adjustments to ourconsolidated balance sheet as of December 31, 2003 resulted in a decrease inretained earnings of $36.6 million, an increase in deferred revenue of $115.4million to account for previously recognized sales, an increase in deferredcosts of $72.8 million to account for previously recognized cost of net sales,and an increase in deferred tax assets and prepaid taxes of $5.9 million. Inour consolidated balance sheet at December 31, 2006, deferred revenue is $275.7million, of which $35.6 million is classified as current and $240.1 million asnon-current, and the deferred costs balance is $176.6 million. These amountswill be recognized in our consolidated statements of operations over theestimated remaining period of post contract support.

Due tothis restatement, we increased net sales, gross profit, and net income (inthousands) for the three month period ended March 31, 2006 as follows: $5,410,$1,360 and $1,360, respectively.  In ourconsolidated balance sheet at March 31, 2007 the net reduction in previouslyrecognized net sales is accounted for as deferred revenue, of which $36.5million is classified as current and $233.3 million as non-current, and therelated net reduction in cost of net sales of $172.9 million is accounted foras deferred costs. These amounts are being recognized in our consolidatedstatements of operations over the estimated remaining period of post contractsupport.

Uponcompleting its investigation, the Audit Committee concluded that the conditionsand practices relating to systems contracts prevalent in the Western Regionresulted primarily from the failure to prevent or detect instances of overriderelated to controls in China over customer agreements, lack of propermanagement oversight, unclear record retention policies and procedures relatingto systems contracts, and inadequate employee training.  The Investigating Team and the AuditCommittee also concluded that with respect to four regions other than theWestern Region there was no evidence of fraud or misconduct or reason tosuspect such occurred. The Investigating Team and the Audit Committee alsoconcluded that there was no credible evidence of knowledge by senior managementin China or the United States of the conditions and practices related to theWestern Region of China that were discovered in the investigation. The AuditCommittee concluded that local management in several of the sales offices inthe Western Region of China did not submit appropriate information to theCompany’s senior management in China and the United States. Therefore, in prioryears, neither the Company’s management nor the Company’s independent registeredaccounting firm were able to properly evaluate the effect of that informationon revenue recognition. The Audit Committee also concluded that certain membersof management in China bear varying degrees of responsibility for inadequateoversight of activities. As a result, certain employees in China have eitherbeen terminated or placed on suspension for failure to provide adequateoversight of activities.

Wehave restructured the management of the Western Region sales organization andare working to identify and implement changes to our policies and proceduresand enhance employee training to improve internal control consciousness andlessen the possibility of accounting errors occurring in the future.

51

----

***StockOption Accounting***

InNovember 2006, we announced we had commenced a voluntary review of historicalstock option practices under the leadership of the Governance Committeefollowing a preliminary review by management which identified potentialdeficiencies and discrepancies in the documentation of stock option grants. Thereview considered all option grant awards made in the period from February 29,2000, shortly before the initial public offering of our Common Stock, throughAugust 2006 (“Review Period”) for compliance with the various stock-based compensationaccounting standards applicable during the Review Period as well as the rulesof our stock option plans. The Governance Committee engaged independent outsidelegal counsel to assist in the review who, in turn, engaged forensicaccountants. (Separate law firms and separate forensic accounting firms wereengaged by the Audit Committee and the Governance Committee for the China salesinvestigation and the stock option accounting review.) In the rest of thisdiscussion, this group collectively is referred to as the Stock Option ReviewTeam and their actions and activities are referred to as the Stock OptionReview. The Stock Option Review Team members spent over 11,000 hours in thisreview, and the Governance Committee met with the Stock Option Review Team onmore than a dozen occasions to receive, discuss, and consider the Stock OptionReview Team’s information and findings.

At thetime the review commenced, the Governance Committee consisted of three membersof the Board of Directors, all of whom are independent directors. The Committeedecided to delegate supervision of the review to Mr. Jeff Clarke, its Chairman,who joined our Board in 2005 and had not served on the Compensation Committeeof the Board of Directors (“Compensation Committee”) during the period underreview. The Governance Committee also consisted of two other independentdirectors, Mr. Larry D. Horner and Mr. Thomas Toy, who also serve on the Board’sCompensation Committee.  Mr. AllenLenzmeier was appointed to the Governance Committee on April 27, 2007.

Reviewprocedures included:

·                  interviews ofindividuals involved with granting, advising, administering, or accounting forstock options, including current and former: management, members of the Board of Directors, employees, and non-employeeprofessionals;

·                  review ofrelevant stock administration, human resource, legal, and finance departmentfiles and records;

·                  review of stockoption grant information in select employee personnel files;

·                  review by atleast 30 attorneys and 15 forensic accountants of approximately 250,000potentially relevant e-mails and documents in electronic format selectedthrough electronic discovery techniques from over 1.8 million electronicdocuments processed;

·                  review of theelectronic database of the Company’s stock option activity maintained by athird party along with communications to and from this service provider;

·                  reconciliationof grant activity from approval documents executed by the CompensationCommittee with the electronic database;

·                  reconciliationof stock option grant, exercise, and cancellation information from SEC filingswith select employee personnel files and the electronic database;

·                  statistical andjudgmental pattern analysis;

·                  follow-up onmatters raising questions about the option granting process and its history,conduct of those involved with granting, advising, administering, or accountingfor stock options, or the accounting treatment for stock options; and

·                  follow-up onitems or issues requested or identified by management or the Company’sindependent registered public accounting firm.

TheStock Option Review Team, management, and the Governance Committee decided togroup stock option grants into six award categories based on differences inwhat constituted substantive approval for each category under our stock optiongranting practices as well as giving consideration to the risk of intentionalmisstatement of the grant date. Guidance in a September 19, 2006 letterpublicly issued by the SEC’s Chief Accountant focuses on the concept that ameasurement date under Accounting Principles Board Opinion No. 25 *Accounting for Stock Issued to Employees*(“APB 25”), theaccounting standard governing our stock option accounting through 2005, doesnot occur until the number of shares an individual employee is entitled toreceive and the exercise price is determined with finality (i.e., no longersubject to change). This is the date on which substantive approval occurred,and depending on a company’s facts and circumstances the guidance from the SECdiscussed above recognizes a company may determine that the measurement datefor some stock option grants may

52

----

occur before allrequired granting actions have occurred – such as final approval by theCompensation Committee. This alternative is available only when a review of allfacts and circumstances supports a conclusion that substantive approval occursearlier than when all required granting actions have occurred and there is noevidence of fraudulent or manipulative conduct in the company’s option grantingpractices.

In determining themeasurement date to be used, the Stock Option Review Team, management, and theGovernance Committee agreed to use the following definitions as constitutingthe proper measurement date, and generally these dates were used in testing thestated grant dates or establishing corrected measurement dates:

 
| **Discretionary Director and  Officer Grants** |       | The date of a Compensation Committee meeting where  the grant was approved or the date the final Compensation Committee signer  approved the grant when approval occurred through unanimous written consent  documents (“UWC”).                                                                                                                                                                                                                                                         |
|------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Automatic  Director Grants**                 |       | The date specified in the relevant stock option  plan.                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Broadbase**                                  |       | The date the grantee list, including the allocation  of shares to individual grantees, was complete. Compensation Committee  approval was considered perfunctory due to delegation of authority to  management.                                                                                                                                                                                                                                                                                   |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Acquisition**                                |       | The first Compensation Committee meeting following  the acquisition, provided grantees had received employment offer letters  stating the number of stock options to be granted before such date, because  this was the date at which the option exercise price was established.  Compensation Committee approval was considered perfunctory due to delegation  of authority to management.                                                                                                       |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **New  Hire**                                  |       | The first scheduled Compensation Committee meeting  following the first day of employment, because this was the date at which the  option exercise price was established. The number of options was based on  either grant amounts specified in an employment offer letter or, in some  cases, on a matrix that assigned grant amounts based on position and level  within the Company. Compensation Committee approval was considered perfunctory  due to delegation of authority to management. |
| ** **                                     | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| **Other  Merit**                               |       | The date the grantee list, including the allocation  of shares to grantees, was substantially complete. Compensation Committee  approval was considered perfunctory due to delegation of authority to  management.                                                                                                                                                                                                                                                                                |

 

For 12tested grant dates where a corrected measurement date was required, the StockOption Review Team and management were unable to locate sufficient evidence toestablish a corrected measurement date using our established criteria for theapplicable option grant type. In these situations alternative availableevidence was used to establish the corrected measurement date.

During the period coveredby the Stock Option Review, we granted stock options on approximately 34million shares of our Common Stock at 197 grant dates. The review specificallyexamined the appropriateness of the stated grant date for approximately 90% ofthe stock options granted, including all stock option grants made to directorsand officers, all broadbase grants and all option grants made in connectionwith business acquisitions.

53

----

Thefindings of this review are summarized as follows:
|                                       | ** ** | ** **                 | ** ** | ** **             | ** ** | ** **                   | ** ** | **Measurement date changed**              | ** ** |
|---------------------------------------|------------|----------------------------|------------|------------------------|------------|------------------------------|------------|-----------------------------------------------------|------------|
| **Grant Type**                   | ** ** | **Number of  grants** | ** ** | **Grants tested** | ** ** | **No change  required** | ** ** | **additional  compensation  expense required** | ** ** | **no additional  compensation  expense required(1)** | ** ** |
|                                  |       |                       | ** ** |                   |       |                         |       |                                                |       |   |   |
| Discretionary  Director & Officer |       | 16                         | ** ** | 16                     |       | 8                            |       | 4                                                   |       | 4 |   |
| Automatic  Director                   |       | 5                          | ** ** | 5                      |       | 5                            |       | —                                              |       | — |   |
| Broadbase                             |       | 8                          | ** ** | 8                      |       | —                       |       | 6                                                   |       | 2 |   |
| Acquisition                           |       | 10                         | ** ** | 10                     |       | 10                           |       | —                                              |       | — |   |
| New Hire                              |       | 166                        | ** ** | 48                     |       | 48                           |       | —                                              |       | — |   |
| Other Merit                           |       | 96                         | ** ** | 41                     |       | 4                            |       | 21                                                  |       | 16 |   |
| Total                                 |       | 301                        | **(2**)    | 128                    |       | 75                           |       | 31                                                  |       | 22 |   |

 

----

(1)         Under APB 25 there is no expense adjustment arising from using thecorrected measurement date for these grants because the amount the employeewould have to pay to exercise these stock option grants exceeded the quotedmarket price of our Common Stock at the corrected measurement date, andtherefore, these stock option grants contained no intrinsic value at thecorrected measurement date.

(2)         The number of grants exceeds the number of grant dates because oncertain grant dates more than one category of stock option grants wereapproved.

Inlate January 2007 the Governance Committee reported its interim findingsconcerning the use of incorrect measurement dates in our stock optionaccounting under APB 25 to our Board of Directors. On February 1, 2007, theAudit Committee of the Board of Directors then concluded, in consultation withand upon the recommendation of management, that we should correct for errors inpreviously reported stock-based compensation expense through restatement of ourpreviously issued financial statements and that our previously issued financialstatements for all periods should no longer be relied upon. We communicatedthis decision in a February 1, 2007 public announcement.

Anon-cash compensation charge, to be recognized as an expense over a grantee’sservice period, arises under APB 25 if a stock option has intrinsic value atits measurement date. This intrinsic value is measured by the excess, if any,of the fair value at the date of grant of the underlying common stock over thestock option’s exercise price. Our practice has been to grant stock optionswith exercise prices equal to the closing price of our Common Stock at eachgrant date, to use the grant date as the measurement date for stock-basedcompensation purposes, and as such previously we had determined the grantedstock options had no intrinsic value at their grant dates and no compensationexpense was recognized. However, APB 25 states the measurement date does notoccur until all essential actions necessary to grant the option are completed,including the final determination of both the number of shares to be granted toeach employee or director and the exercise price, and the option grant isapproved by those with requisite authority. This is reinforced by the September19, 2006 letter issued by the SEC’s Chief Accountant which focuses on the needfor the number of shares and exercise price of an award to an individual to befinalized to have a measurement date. This letter clarifies the SEC staff’sview that if it is possible that those terms could change, a measurement datehas not occurred, even if the award’s terms are not actually changed.

Basedon the available evidence, the review found that the number of shares anindividual employee was entitled to receive and/or the exercise price was notdetermined with finality at the stated grant date on 53 tested grant dates, andwe should have used a later date as the measurement date. The principal reasonsfor the stated grant date not qualifying as the measurement date under APB 25include:

·                  certainlistings of grantees, below officer level, were incomplete and added to ormodified by stock option administration personnel after the grant was approvedby the Compensation Committee;

·                  forcertain grants where Compensation Committee approval was not consideredperfunctory, the date a UWC document was sent to Compensation Committee membersfor approval was used as the stated grant date for some discretionary officerand director grants rather than the date the UWC was signed by all CompensationCommittee members and therefore became effective;

·                  theStock Option Review Team was unable to locate contemporaneous documentation ofsome director and officer, broadbase, new hire, and other merit grants.

During the review theCompany also discovered a stock option grant to a former officer that wasmodified in 1998 in connection with his termination of employment. This changewas never included in the Company’s stock option grant records and theadditional compensation expense resulting from the change in the option’sterms  (approximately $1.2 million)  was not recorded previously. This discoveryis consistent with the Stock Option Review Team’s finding that in certaininstances there was a lack of formal documentation in the stock option grantingprocess and/or expected documentation is missing from the stock optionadministration files. In addition, the Stock Option Review Team found that, inmany instances, there was a lack of self-authenticating evidence to corroboratethat cash exercises were contemporaneous. As a result, the findings on theissue of backdating of cash exercises were inconclusive.

54

----

We restated ourconsolidated financial statements to recognize additional non-cash stock-basedcompensation expense arising from using corrected measurement dates for certainstock option grants made during the years 2000 through 2005 and to reflect the modificationof the 1998 grant described above. Consistent with our historical accountingpolicy this additional stock-based compensation expense is being recognized onan accelerated basis by treating each vesting tranche as a separate stockoption grant (graded vesting).

Our accounting forstock-based compensation changed to a fair value based method in 2006 when, asrequired by accounting standards, we ceased accounting for stock-basedcompensation under the intrinsic value method pursuant to APB 25 and beganaccounting for stock-based compensation under Statement of Financial AccountingStandards 123(R) *Share-Based Payments*(“SFAS123(R)”). Under this method all stock option grants have a fair valuedetermined using an option pricing model, and such fair value is used torecognize non-cash stock-based compensation expense. We restated our unauditedcondensed consolidated financial statement information for the first and secondfiscal quarters of 2006,included in Exhibit 99.1 in our Annual Report on Form 10-Kfor the year ended December 31, 2006 (and as reflected in our results for thethree months ended March 31, 2006 included in this Form 10-Q), to recognizechanges in non-cash stock-based compensation expense that arose from are-determination of the fair value of stock options granted in 2005 and priorwhere the Governance Committee’s review resulted in a corrected measurementdate. By January 1, 2006, of the 17.9 million options granted in 2000 — 2005where corrections were made to the measurement dates in the Stock OptionReview, 4.4 million options with corrected measurement dates granted in 2000and 2001 had fully vested. Therefore, the fair values of the outstanding andunvested portion of the remaining 13.5 million stock options granted in2002-2005 with incorrect measurement dates were recalculated. We also recordedadditional non-cash stock-based compensation expense in the first two quartersof 2006 arising from correcting the measurement date for stock option grants tothree individuals in this period. We recognize stock compensation expense on astraight-line basis under SFAS 123(R).

Those stock optiongrants with corrected measurement dates have also been restated using the fairvalue based measurement principles of Statement of Financial AccountingStandards 123 *Accounting for Stock-Based Compensation*(“SFAS123”) to present, in Note 2, “Restatement of Financial Statements” of Notes toConsolidated Financial Statements contained in Item 8 of this Annual Report,the pro forma effect on stock-based compensation expense, net income (loss),and earnings (loss) per share amounts in 2004 and 2005 of using the fair valuebased method to determine stock-based compensation expense rather than usingAPB 25’s intrinsic value method. Such disclosure is required in financialstatements for periods prior to the adoption of SFAS 123(R).

In addition torestating the consolidated financial statements in response to the GovernanceCommittee’s findings, we recorded additional non-cash adjustments to accountfor the modification in 1998 of a stock option grant to a former officer inconnection with his termination of employment and to record in the first twoquarters of 2006 corrections relating to accounting for performance relatedstock options and restricted stock grants, all of which were previouslyidentified and considered immaterial.

Correcting themeasurement date for previously granted stock options in some cases results inadditional taxable income to employees on which additional payroll taxes aredue from the employees as well as us. We have provided for all additionalpayroll taxes plus related penalties and interest arising from the restatementof stock-based compensation, including amounts otherwise payable by stockoption recipients, and our restated financial statements include an accrual inall affected years of approximately $1.5 million for all estimated payroll taxrelated expenses.

55

----

The correctionsfor the stock option restatement were to increase (reduce) previously reportednon-cash compensation expense, payroll taxes, income taxes and net income bythe following amounts (in thousands of dollars):
|                                        | ** ** | **Reduction (increase) in net income from** | ** ** |
|----------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Non-cash stock**                                              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Year ended  December 31,** | ** ** | **compensation**                                                     | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
|                                   |       |                                                                 |       |   |   |   |   |   |   |
| 1998                                   |       | $                                                                    | 1,244      |   | $ | — |   | $ | (448 | ) | $ | (796 | ) |
| 1999                                   |       | —                                                               |       | — |   | — |   | — |   |
| 2000                                   |       | 556                                                                  |       | — |   | (104 | ) | (452 | ) |
| 2001                                   |       | 4,870                                                                |       | — |   | (942 | ) | (3,928 | ) |
| 2002                                   |       | 8,110                                                                |       | — |   | (1,550 | ) | (6,560 | ) |
| 2003                                   |       | 12,470                                                               |       | 900 |   | (2,281 | ) | (11,089 | ) |
| Totals through December 31, 2003       |       | 27,250                                                               |       | 900 |   | (5,325 | ) | (22,825 | ) |
| 2004                                   |       | (410                                                                 | )          | 541 |   | 250 |   | (381 | ) |
| 2005                                   |       | (1,290                                                               | )          | 60 |   | 4,083 |   | (2,853 | ) |
| 2000 -2005 Total                       |       | $                                                                    | 25,550     |   | $ | 1,501 |   | $ | (992 | ) | $ | (26,059 | ) |
| 2006 quarter ended                     |       |                                                                 |       |   |   |   |   |   |   |
| March 31                               |       | 662                                                                  |       | 9 |   | — |   | (671 | ) |
| June 30                                |       | 504                                                                  |       | 6 |   | — |   | (510 | ) |
|                                   |       | $                                                                    | 26,716     |   | $ | 1,516 |   | $ | (992 | ) | $ | (27,240 | ) |

 

The GovernanceCommittee’s review found 17.9 million stock options of the 28.8 million optionsgranted on our Common Stock during 2000 through 2005 had incorrect measurementdates. Using the corrected measurement dates, 7.6 million stock options hadexercise prices that exceeded the closing price of our Common Stock andtherefore had no intrinsic value to be accounted for under APB 25, and 10.3million stock options had intrinsic value because their exercise prices werebelow the closing price of our Common Stock. These 10.3 million stock optionsresulted in an increase in additional non-cash stock-based compensation expenseof $24.3 million, and an additional $1.5 million of payroll tax relatedexpenses during 2000-2005 partially offset by $0.5 million of income taxbenefit as shown in the above table. Of the 10.3 million stock optionsresulting in additional non-cash stock-based compensation expense, 2.0 millionoptions were granted to officers and directors and resulted in $6.1 million ofadditional non-cash stock-based compensation expense.

The total effectof the stock option restatement and the amounts for 2006, as shown in the abovetable, have been reflected in the December 31, 2006 financial statements, aswell as in the March 31, 2006 financial statements. As a result of thisrestatement, net loss increased by $0.7 million for the three months endedMarch 31, 2006.

Upon completingits review, the Governance Committee concluded it found no evidence of intentto manipulate the Company’s operating results or financial statements. A keyfinding of the Governance Committee was that there were deficiencies with theprocess by which stock options were granted during the period from our initialpublic offering in 2000 through at least 2005, which resulted in accountingerrors. The Governance Committee concluded that certain members of managementbear varying degrees of responsibility for the deficiencies in the process bywhich options were granted. The Governance Committee’s review also concludedthat none of the current or former employees or directors of the Companyengaged in intentional wrongdoing.

In determining theabove restatement amounts, management used all reasonably available relevantinformation to form conclusions it believes are reasonable as to the mostlikely option granting actions that occurred, the dates when such actionsoccurred, and the determination of grant dates for financial accountingpurposes based on when the requirements of the accounting standards were met.In light of significant judgment used in establishing revised measurementdates, alternative approaches to those used by the Stock Option Review Team andmanagement could have resulted in different compensation charges than those recordedin the restatement. The Stock Option Review Team and management consideredvarious alternatives throughout the course of the review and restatement, andmanagement believes the approaches used were the most appropriate in thecircumstances, and the choices of measurement dates used in our review of stockoption grant accounting and restatement of our financial statements werereasonable and appropriate in our circumstances.

56

----

***Summaryof Restatement Amounts***

Thefollowing table presents the decrease in net earnings from the restatement foreach restated year:
|                                            | ** ** | **Net income (loss),**     | ** ** | **Restatement adjustments** | ** ** | **Net income (loss),** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **Year ended December 31,** | ** ** | **as previously reported** | ** ** | **China Sales**             | ** ** | **Stock Options**           | ** ** | **Total** | ** ** | **as restated** | ** ** |
| ** **                                 | ** ** | ** **                           | ** ** | **(in thousands)**          | ** ** | ** **                       | ** ** |
| ** **                                 | ** ** | ** **                           | ** ** | **(Decrease) Increase**     | ** ** | ** **                       | ** ** |
|                                       |       |                                 |       |                             |       |                             |       |   |   |   |   |
| 1998                                       |       |                                 |       | $                                | —     |                             | $          | (796) |   | $ | (796) |   |   |   |
| 1999                                       |       |                                 |       | —                           |       | —                           |       | — |   |   |   |
| 2000                                       |       |                                 |       | (4,781                           | )          | (452                             | )          | (5,233 | ) |   |   |
| 2001                                       |       |                                 |       | (5,779                           | )          | (3,928                           | )          | (9,707 | ) |   |   |
| 2002                                       |       | $                                    | 107,862    |                             | (19,697    | )                                | (6,560     | ) | (26,257 | ) | $ | 81,605 |   |
| 2003                                       |       | $                                    | 209,856    |                             | (6,382     | )                                | (11,089    | ) | (17,471 | ) | $ | 192,385 |   |
| Totals through December 31, 2003           |       |                                 |       | (36,639                          | )          | (22,825                          | )          | (59,464 | ) |   |   |
| 2004                                       |       | $                                    | 69,824     |                             | (18,594    | )                                | (381       | ) | (18,975 | ) | $ | 50,849 |   |
| 2005                                       |       | $                                    | (487,359   | )                                | (42,433    | )                                | (2,853     | ) | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005 Total                          |       |                                 |       | (97,666                          | )          | (26,059                          | )          | (123,725 | ) |   |   |
| 2006 quarter ended                         |       |                                 |       |                             |       |                             |       |   |   |   |   |
| March 31                                   |       | $                                    | (10,635    | )                                | 1,360      |                             | (671       | ) | 689 |   | $ | (9,946 | ) |
| June 30                                    |       | $                                    | (21,443    | )                                | (371       | )                                | (510       | ) | (881 | ) | $ | (22,324 | ) |
|                                       |       |                                 |       | $                                | (96,677    | )                                | $          | (27,240 | ) | $ | (123,917 | ) |   |   |

 

The cumulative effect on stockholders’ equity atDecember 31, 2003 from the above corrections was as follows (in thousands):
| Increase (decrease) in  paid-in capital and deferred stock compensation:       |   |    |    |
|--------------------------------------------------------------------------------|--------|---------|---------|
|                                                                           |   |    |    |
|  Values assigned to stock options                                         |   | $       | 27,250  |   |
|  Reduction of previously recorded income tax  benefits from stock options |   | (1,278  | )       |
|                                                                           |   |    |    |
|  Net increase in paid-in capital and deferred  stock compensation         |   | 25,972  |    |
|                                                                           |   |    |    |
| (Increase)  decrease in accumulated deficit:                                   |   |    |    |
|                                                                           |   |    |    |
|  Revenue and related cost of sales deferral  for China system sales       |   | (36,639 | )       |
|  Additional non-cash compensation expense  from stock options             |   | (27,250 | )       |
|  Payroll taxes for values assigned to stock  options                      |   | (900    | )       |
|  Income tax benefit from additional  compensation and payroll tax expense |   | 5,325   |    |
|                                                                           |   |    |    |
|  Net increase in accumulated deficit                                      |   | (59,464 | )       |
|                                                                           |   |    |    |
| Net decrease in  stockholders’ equity at December 31, 2003                |   | $       | (33,492 | ) |

 

Inrestating the previously issued financial statements for the investigationsdiscussed above, we also corrected other previously reported amounts. We corrected the reporting of $8.7 million of netsales to certain third party resellers and $1.8 million of associated cost ofnet sales for the three months ended March 31, 2006 to classify these amountsas related party net sales and related party cost of net sales classifications,respectively, because in 2006 we determined that sales to these entities 

57

----

were, in substance, sales to a significant shareholder, SOFTBANK CORP.The classification of the accounts receivable from these sales was similarlychanged to include them in accounts receivable from related parties in theMarch 31, 2006 consolidated balance sheet. We also corrected our reporting of $6.2 million of time depositsat March 31, 2006 because they did not mature within three months.Formerly the time deposits had been reported in error as cash equivalents, butnow these amounts are included in short-term investments in the balance sheetand in the statement of cash flows for the March 2006 reporting period.

**ALL AMOUNTS IN THE FOLLOWINGSECTIONS OF THIS MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS, EXCEPT THOSE IDENTIFIED “AS PREVIOUSLY REPORTED” INTABLES WITHIN THE QUARTERLY DATA (UNAUDITED), AS RESTATED CAPTION, REFLECT THEEFFECTS OF THE RESTATEMENT OF OUR FINANCIAL STATEMENTS TO CORRECT OUR REVENUERECOGNITION FOR CERTAIN SALES CONTRACTS IN CHINA AND OUR HISTORICAL STOCKOPTION ACCOUNTING, AND THE CORRECTION OF THE CLASSIFICATION OF A TIME DEPOSITFROM CASH TO SHORT-TERM INVESTMENTS IN THE FIRST TWO QUARTERS OF 2006.**

**Late SEC Filings and NASDAQDelisting Proceedings**

As a result of the Nominating and Corporate Governance’sCommittee’s review of our historical stock option accounting and the resultingrestatements, we did not timely file our Quarterly Report on Form 10-Q for thequarter ended September 30, 2006 (“Q3 2006 Form 10-Q”), our Annual Report onForm 10-K for the fiscal year ended December 31, 2006 (“2006 Form 10-K”), andour Quarterly Report on Form 10-Q for the quarter ended March 31, 2007 (“Q12007 Form 10-Q”) with the Securities and Exchange Commission.  Inaddition, as a result of the Audit Committee’s review of certain historicalsales contracts in China, we did not timely file our Quarterly Report on Form10-Q for the quarter ended June 30, 2007 (“Q2 2007 Form 10-Q”) with theSecurities and Exchange Commission.

In connection with our failure to timely file ourperiodic reports, we received four NASDAQ Staff Determination letters, datedNovember 15, 2006, March 7, 2007, May 16, 2007 and August 13, 2007,respectively, stating that, as a result of each of these non-timely filings, wewere not in compliance with the requirements of Marketplace Rule 4310(c)(14)and, therefore, our stock was subject to delisting from the NASDAQ StockMarket. We appealed the November 15, 2006 determination to the NASDAQ ListingQualifications Panel (the “Panel”) and were granted a conditional extension toour request for continued listing until April 16, 2007. On April 17, 2007, thePanel extended the deadline for filing our Q3 2006 Form 10-Q to May 14,2007.  The Panel also extended the deadline for filing our 2006 Form 10-Kuntil July 16, 2007.

On May 2, 2007, we asked the NASDAQ Listing andHearing Review Council (“Listing Council”) to review the April 17, 2007decision of the Panel.  On May 14, 2007, the Listing Council called thePanel’s decision for review and requested that we provide an update on ourefforts to file our delinquent filings.  We have continued and continue tocomply with that request.  In addition, the Listing Council stayed thePanel’s decision that required us to file our Quarterly Report on Form 10-Q forthe third quarter of 2006 Form 10-Q by May 14, 2007, and to file our AnnualReport Form 10-K for 2006 by July 16, 2007.  On August 23, 2007, theListing Council granted the Company an extension until October 22, 2007 to fileour delinquent periodic reports and restatements. On October 10, 2007, wefiled our Quarterly Report on Form 10-Q for the third quarter of 2006 and ourAnnual Report on Form 10-K for 2006.  As of the date of the filing of thisQuarterly Report on Form 10-Q for the first quarter of 2007, we will have oneperiodic report still outstanding, our Quarterly Report on Form 10-Q for thesecond quarter of 2007.  We expect to be able to complete the filing ofthis outstanding  report as soon aspracticable.

**EXECUTIVE SUMMARY**

We design, manufacture and sell telecommunicationsinfrastructure, handsets and customer premise equipment and provide servicesassociated with their installation, operation, and maintenance.  Our products are sold primarily totelecommunications service providers or operators.  We sell an extensive range of products thatare designed to enable voice, data and video services for our operatorcustomers and consumers around the world. While historically the vast majority of our sales have been to serviceproviders in China, we have expanded our focus to build a global presence andcurrently sell our products in several other established and emerging growthmarkets, which include North America, Japan, India, Central and Latin America,Europe, the Middle East, Africa and Southeast and North Asia.

58

----

We differentiate ourselves with products designed toreduce network complexity, integrate high performance capabilities and allow asimple transition to next generation networks. We design our products to facilitate cost-effective and efficientdeployment, maintenance and upgrades.

As of March 31, 2007, the Company was structured acrossfour key operating units:

1.               Network Solutions: Our Network Solutions operating unit provides its products and servicesthrough two reporting segments; Wireless Infrastructure and BroadbandInfrastructure.  Our WirelessInfrastructure segment designs, builds and sells software and hardware productsthat enable end users, or subscribers, to send and receive voice and datacommunication in either a fixed or mobile environment by using wirelessdevices.  Our Broadband Infrastructuresegment designs, builds and sells software and hardware products that enableend users to access high-speed, cost effective fixed data, voice and mediacommunication;

2.               Personal Communications Division: Our PersonalCommunications Division (“PCD”) markets, sells and supports handsets other thanPAS handsets for markets other than China. Most of our handset sales prior to 2006 were designed and built by othermanufacturers, but beginning in 2006 and beyond future sales will include moreproducts built by our Handsets segment;

3.               Handsets: Our Handsets segment designs, builds andsells consumer devices that allow customers to access wireless services.  Revenues from worldwide PAS handsets and allhandset revenues within China are included in this segment; and

4.               Services: Our Services segment provides serviceand support for Wireless Infrastructure and Broadband Infrastructure customersin the areas of planning, deployment, operations and ongoing maintenance.

Our products within each of these categories, excludingservices, 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, InternetProtocol and wireless network rollouts. Our products are also designed forquick and cost-effective transition to future network technologies, enablingour customers to make the best use of their existing infrastructure.

We  monitor our key business indicators on aregular basis, including net new bookings, collections, revenues, grossmargins, operating expenses, inventory and inventory turns, days salesoutstanding, cash flow from operations and cash balances. The inventory turnsand days sales outstanding for the handsets and PCD segments are different fromthe Network Solutions operating unit and tend to fluctuate because ofseasonality effects. Net new bookings and booking margins are good indicatorsof the health of the business and the aging distribution of accounts receivableindicates how well we are performing on our cash collections.

Our largest market for the three months ended March 31,2007 and the year ended December 31, 2006 was the United States ofAmerica, representing 62% and 55% of sales, respectively. Prior to 2005, themajority of our sales were to service providers in China. This shift in marketconcentration and revenue is due to the combination of China’s continuedslow-down in its economy since the fourth quarter of 2004 and our ability tocapture growth opportunities internationally as well as the incremental salescontributed by PCD subsequent to its acquisition in November 2004.

Our gross profit as a percentage of sales in both our PCDand handset product lines have improved despite the decline in sales prices asa result of improved product cost management. However, we expect gross profit as a percentage of sales to declineduring the remainder of the year as cost reduction measures are not likely tokeep pace with price reductions.  Westrive to develop products with more advanced features and to enhance thefeatures of our existing products, which, we believe, will enable us to offerour customers more advanced products at higher average selling prices thanotherwise would be possible in the future.

China has been one of our largest markets and we believethat it will continue to be an important market for our current and futuretechnologies and development for the foreseeable future. However, we have alsoexperienced a maturation of our PAS market in China resulting in our need tohave a more diversified product and customer base. The number of competitorsfor communications access and switching systems and handsets in China has grownin line with China’s telecommunications market expansion.  This growth has led to competitive pricingpressure, causing average selling prices to decrease during the three monthsended March 31, 2007 relative to those in the comparative period in 2006.

59

----

We strive to develop products with more advanced featuresand to enhance the features of our existing products, which, we believe, willenable us to offer our customers more advanced products at higher averageselling prices than otherwise would be possible in the future.

Over the past few years, we have undertaken a significantglobalization program and we intend to continue to expand our global salesoutside of China in the current year.  Aswe expand, we will continue to improve our internal supply chain and inventorymanagement processes to ensure timely deliveries. We use subscriber growthstatistics to gauge future inventory purchasing requirements as well asforecast our anticipated revenue growth. We will also continue to implement and enhance our administrativeinfrastructure to assist with our growth and globalization transformation.

On October 2, 2007, our Board of Directors approved arestructuring plan (the “Plan”) to reduce operating costs, which includes aworldwide reduction in force of approximately 11% of the Company’s headcount,or approximately 700 employees.  Theworkforce reduction will be based primarily in the United States and China and,to a lesser degree, other international locations.  Management expects the Plan to be completedin the fourth quarter of fiscal year 2007. We expect to incur a restructuring charge in connection with the Plan ofapproximately $10 million, comprised largely of cash payments associated withone-time severance benefits, with the majority of the charge to be taken in thefourth quarter of 2007.  In addition, weexpect to realize cost savings in salary and compensation related expenses ofapproximately $21 million on an annualized basis.

We will continue our efforts to evaluate certainoperations and will actively pursue opportunities to divest additional non-coreassets and may incur additional costs associated with future actions to furtheralign our business operations and streamline our business processes.

**KEY TRANSACTIONS**

***Marvell Technology Group Ltd.***

In February 2006, we sold substantially all of theassets and selected liabilities of our semiconductor design business division,including the assets related to the prior acquisition of AdvancedCommunications Devices Corporation, to Marvell. We received $20.0 million in cash in February 2006 and anadditional $4.3 million in cash in August 2007. We received anadditional payment of $16.0 million from Marvell in October 2006 as a result ofachieving certain defined milestones.

In connection with the sale of assets, we have enteredinto a supply agreement with Marvell to purchase chipsets for our handsetproducts over the next five years. The value allocated to the supply agreementof $20.2 million is included in other current and long-term liabilities, and isbeing amortized in proportion to the quantities of chipsets purchased under thesupply agreement over the next five years. For the three months endedMarch 31, 2007, approximately $0.5 million amortized against cost ofsales.

60

----

**TRANSACTIONS WITH RELATED PARTIES AND OTHER INFORMATION**

The following is a summary of the Company’s transactionswith related parties and other information:
|                                | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| ** **                     | ** ** | ** **                                           | ** ** | **(As restated)** | ** ** |
| **Net sales**             | ** ** | **(in thousands)**                              | ** ** |
| Softbank                       |       | $                                                    | 11,535     |   | $ | 43,027 |   |
| Japan Telecom,  Ltd            |       | 1,581                                                |       | 1,790 |   |
| Total Softbank  and affiliates |       | 13,116                                               |       | 44,817 |   |
| ORG, Inc.                      |       | 212                                                  |       | 127 |   |
| Total                          |       | $                                                    | 13,328     |   | $ | 44,944 |   |

 

 
|                          | ** ** | **Accounts receivable** | ** ** | **Accounts payable** | ** ** |
|--------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **March 31,**           | ** ** | **December 31,**     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
| ** **               | ** ** | **2007**                     | ** ** | **2006**                  | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **               | ** ** | **(in thousands)**      | ** ** |
| Softbank and  affiliates |       | $                            | 24,451     |                      | $          | 29,941 |   | $ | 591 |   | $ | 535 |   |
| MDC Holding,  Ltd.       |       | 962                          |       | 1,300                     |       | — |   | — |   |
| Fiberxon, Ltd.           |       | 55                           |       | 44                        |       | 151 |   | 368 |   |
| ORG, Inc.                |       | 2                            |       | 1,025                     |       | — |   | — |   |
| GCT  Semiconductor, Inc. |       | —                       |       | —                    |       | 339 |   | 1,051 |   |
| Acoustek Int'l,  Inc.    |       | —                       |       | —                    |       | 51 |   | 51 |   |
| Cortina/Immenstar        |       | —                       |       | —                    |       | — |   | 345 |   |
| Other                    |       | 17                           |       | 8                         |       | 11 |   | 50 |   |
| Total                    |       | $                            | 25,487     |                      | $          | 32,318 |   | $ | 1,143 |   | $ | 2,400 |   |

 

|                          | ** ** | **March 31,**      | ** ** | **March 31,**     | ** ** |
|--------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **               | ** ** | **2007**                | ** ** | **2006**               | ** ** |
| ** **               | ** ** | ** **              | ** ** | **(As restated)** | ** ** |
| ** **               | ** ** | **(in thousands)** | ** ** |
| Softbank and  affiliates |       | $                       | 484        |                   | $          | — |   |
| Fiberxon, Ltd.           |       | 1,803                   |       | 1,661                  |       |
| GCT Semiconductor,  Inc. |       | 1,177                   |       | 2,285                  |       |
| Cortina/Immenstar        |       | 13                      |       | 2,017                  |       |
| Total                    |       | $                       | 3,477      |                   | $          | 5,963 |   |

 

***Softbank and affiliates***

We recognize revenue with respect to sales oftelecommunications equipment to affiliates of SOFTBANK CORP. (“Softbank”), asignificant stockholder of the Company. Softbank offers asynchronous digitalsubscriber line (“ADSL”) coverage throughout Japan, which is marketed under thename “YAHOO! BB.” We support Softbank’s fiber-to-the-home service through salesof our carrier class Gigabit Ethernet Passive Optical Network (“GEPON”) productas well as our multi-service optical transport product (“NetRingTM“). In addition, we support Softbank’s new IPTV,through sales of our RollingStreamTMproduct. Included in revenue for the three months ended March 31, 2006 isa fee of $17.0 million charged for the cancellation of orders forbroadband products.

Sales to Softbank include a three-year service period anda penalty clause if product failure rates exceed a certain level over aseven-year period. As of March 31, 2007, our customer advance balance relatedto Softbank agreements was $0.5 million compared to no balance as of December31, 2006.  The current deferred revenuebalance related to Softbank was $9.3 million and $11.6 million as of March 31,2007 and December 31, 2006, respectively. As of March 31, 2007, our noncurrent deferred revenue balance related toSoftbank was $11.7 million compared to $11.5 million as of December 31, 2006.

During August 2004, we entered into severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiaryof Softbank. These agreements relate to the sale of *i*AN-8000 equipment with specified value and delivery dates,as well as an oral agreement which subsequently converted into specific servicecontracts to manage a sales promotional program for JT. We  have determined that the service activitiesrevenue should be recorded net of expected promotional spending.

On July 17, 2003, we entered into a Mezzanine LoanAgreement with BB Modem Rental PLC (“BB Modem”), an affiliate of Softbank.Under the terms of the agreement, we loaned BB Modem $10.1 million at aneffective interest rate of 12.01% per annum, for the purpose of investing in aportfolio of ADSL modems and associated modem rental agreements, from Softbank.Softbank will continue to service such modems and modem rental agreements. Ourloan was subordinated to certain senior lenders of BB Modem, and repaymentswere paid to us over a 42-month period through January 31, 2007, with asubstantial portion of the principal amount of the loan schedule repaid duringthe last 16 months of this period. During the three months endedMarch 31, 2007 and 2006, we recorded an immaterial amount and$0.2 million, respectively, in interest income with respect to this loan.The loan receivable was fully settled at March 31, 2007 compared to abalance of approximately $1.0 million as of December 31, 2006 which wasincluded in prepaid and other current assets.

61

----

As of March 31, 2007, Softbank beneficially ownedapproximately 12% of our outstanding stock.

***ORG, Inc.***

We have a 49% ownership in Global Asia Partners L.P.which in turn is a significant shareholder in ORG, Inc., a reseller ofinfrastructure equipment for broadband access. In January 2005, we entered into a reseller agreement with ORG, Inc.,which was terminated in August 2006; however an immaterial amount of revenuefor pre-August 2006 deliveries were recognized in the three months ended March31, 2007.

***MDC Holding, Ltd.***

We have an outstandingaccounts receivable balance with MDC Holding, Inc. (“MDC”) related to a PASsystem purchase, in which certain of our employees were shareholders ofMDC.  MDC is in the business of providingvalue-added services, such as short message, voicemail or ring-tone servicesfor PAS telecom networks.

***Fiberxon, Ltd.***

We have an outstanding purchase commitment of animmaterial amount with Fiberxon, Ltd., in which we have a 7% ownershipinterest, to purchase component parts for optical networking products. We paid$0.1 million to Fiberxon, Ltd. for each of the three months ended March 31,2007 and 2006.

***GCTSemiconductor, Inc.***

We have a 2% ownershipinterest in GCT Semiconductor, Inc., which designs, develops and marketsintegrated cost circuit products for the wireless communications industry.

***Acoustek Int’l, Inc.***

We have obtained consulting services from Acoustek Int’lInc. (“Acoustek”), which employed Minnie Huang, spouse of William Huang, ourformer Senior Vice President and Chief Technology Officer.  Mr. Huang’s employment with the Companyterminated on December 31, 2006.  We madeno payments during the three months ended March 31, 2007 compared to $0.1million for the same period in 2006 to Acoustek for consulting services.

***Cortina /Immenstar***

We have an outstanding purchase commitmentwith Cortina Systems, Inc, in which the Company has a 1.3% ownership intereston a fully diluted basis, to purchase chips that are used in our product.

***Xalted Networks, Inc****.*

We received purchase orders from Xalted Networks(Xalted”) totaling approximately $1.3 million in 2005 fortelecommunications equipment that is for product not typically sold by us toother customers. We are charging a ten percent procurement fee to Xalted forobtaining and reselling these products. The equipment was delivered during 2005but revenue has not been recognized as the revenue recognition process had notbeen completed. As of March 31, 2007, our customer advance balance relatedto Xalted was $1.3 million compared to no balance as of December 31, 2006.

**RESULTS OF OPERATIONS**

As mentioned in the Executive Summary, we manage ourbusiness based principally upon product families of four operating units, (i)Network Solutions, which includes the Broadband Infrastructure and WirelessInfrastructure reporting segments, (ii) PCD, (iii) Handsets, and(iv) Services. A summary of the financial results of each of the segmentsare as follows:

62

----

***Net sales***
|                             | ** **   | **Three months ended March 31,** | ** **   |
|-----------------------------|--------------|------------------------------------------------------|--------------|
| ** **                  | ** **   | ** **                                           | ** **   | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                  | ** **   | **2007**                                             | ** **   | **sales** | ** ** | **2006** | ** ** | **sales** | ** ** |
| ** **                  | ** **   | ** **                                           | ** **   | ** ** | ** ** | **as restated** | ** ** | ** ** | ** ** |
| ** **                  | ** **   | **(in thousands)**                              | ** **   |
| ***Net  Sales by Segment*** | *** *** | *** ***                                         | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| Broadband  Infrastructure   |         | $                                                    | 31,222       |   | 6 | % | $ | 57,251 |   | 10 | % |
| Wireless  Infrastructure    |         | 69,879                                               |         | 15 | % | 105,733 |   | 18 | % |
| Network Solutions           |         | 101,101                                              |         | 21 | % | 162,984 |   | 28 | % |
| PCD                         |         | 288,330                                              |         | 61 | % | 322,995 |   | 54 | % |
| Handsets                    |         | 69,719                                               |         | 15 | % | 99,034 |   | 16 | % |
| Services                    |         | 16,752                                               |         | 3 | % | 16,968 |   | 2 | % |
| Net sales                   |         | $                                                    | 475,902      |   | 100 | % | $ | 601,981 |   | 100 | % |

 
|                            | ** **   | **Three months ended March 31,** | ** **   |
|----------------------------|--------------|------------------------------------------------------|--------------|
| ** **                 | ** **   | ** **                                           | ** **   | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                 | ** **   | **2007**                                             | ** **   | **sales** | ** ** | **2006** | ** ** | **sales** | ** ** |
| ** **                 | ** **   | ** **                                           | ** **   | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                 | ** **   | **(in thousands)**                              | ** **   |
| ***Net  Sales by region*** | *** *** | *** ***                                         | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** | *** *** |
| United States              |         | $                                                    | 293,169      |   | 62 | % | $ | 329,763 |   | 55 | % |
| China                      |         | 136,734                                              |         | 29 | % | 199,810 |   | 33 | % |
| Japan                      |         | 14,315                                               |         | 3 | % | 47,660 |   | 8 | % |
| Other                      |         | 31,684                                               |         | 6 | % | 24,748 |   | 4 | % |
| Net sales                  |         | $                                                    | 475,902      |   | 100 | % | $ | 601,981 |   | 100 | % |

 

*Three months ended March 31, 2007 and 2006*

Net sales decreased by 21% to $475.9 million duringthe quarter ended March 31, 2007 compared to the same period in 2006. Thedecrease is primarily due to a decrease in sales in the Wireless Infrastructureand Broadband Infrastructure segments by 38% for the three months endedMarch 31, 2007 compared to the three months ended March 31, 2006.Broadband Infrastructure net sales decreased by $26.0 million, or 45%, for thethree months ended March 31, 2007 compared to the same period in 2006.  Higher Broadband Infrastructure segment salesduring the three months ended March 31, 2006 included order cancellation feesof $22.6 million, primarily for the GEPON and Netring products.  In addition, due to the customerconcentration in this segment, revenues fluctuate based upon the magnitude andtiming of revenue recognition on certain contracts.   Wireless Infrastructure net sales decreasedby $35.9 million, or 34%, for the three months ended March 31, 2007 compared tothe same period in 2006, mainly due to the continued weakening demand for ourPAS products.  Handset sales declined by$29.3 million, or 30%, in the first quarter of 2007 due to both price andvolume declines when compared to the first quarter of 2006.  As we have been experiencing in recentquarters, increased competition and lower net subscriber growth of PAS haveresulted in lower demand and average selling price for our handsets.

Net sales of PCD decreased during the three months endedMarch 31, 2007 as compared to the same period in 2006, primarily due to adecline in the overall average selling price. Net sales for our Services segment remained relatively stable during thefirst three months of 2007.  For additionaldiscussion see “Segment Reporting” section of this Item 2.

63

----

***Gross profit***
|                                | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------|------------|------------------------------------------------------|------------|
| ** **                     | ** ** | ** **                                           | ** ** | **Gross** | ** ** | ** ** | ** ** | **Gross** | ** ** |
| ** **                     | ** ** | **2007**                                             | ** ** | **profit %** | ** ** | **2006** | ** ** | **profit %** | ** ** |
| ** **                     | ** ** | ** **                                           | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | **(in thousands)**                              | ** ** |
| ***Gross  profit by Segment*** |       |                                                 | ** ** | ** ** |   |   |   |   |   |
| Broadband  Infrastructure      |       | $                                                    | 5,001      |   | 16 | % | $ | 23,086 |   | 40 | % |
| Wireless  Infrastructure       |       | 24,266                                               |       | 35 | % | 50,761 |   | 48 | % |
| Network Solutions              |       | 29,267                                               |       | 29 | % | 73,847 |   | 45 | % |
| PCD                            |       | 16,845                                               |       | 6 | % | 14,389 |   | 4 | % |
| Handsets                       |       | 25,048                                               |       | 36 | % | 31,613 |   | 32 | % |
| Services                       |       | 4,125                                                |       | 25 | % | 3,942 |   | 23 | % |
| Gross Profit                   |       | $                                                    | 75,285     |   | 16 | % | $ | 123,791 |   | 21 | % |

 

Cost of sales consists primarily of material and laborcosts, including stock-based compensation, associated with manufacturing,assembly and testing of products, costs associated with installation andcustomer training, warranty costs, fees to agents, inventory provision andoverhead. Cost of sales also includes import taxes and tariffs on componentsand assemblies. Some components and materials used in our products arepurchased from a single supplier or a limited group of suppliers and, in somecases, are subject to obtaining Chinese import permits and approvals. We alsorely on third party manufacturers to manufacture and assemble most of our CDMAhandsets.

Our gross profit has been affected by average sellingprices, material costs, product mix, the impact of warranty charges andcontract loss provisions as well as inventory reserves and release of deferredrevenues and related cost pertaining to prior years. Our gross profit, as apercentage of net sales, varies among our product families. We expect that ouroverall gross profit, as a percentage of net sales, will fluctuate from periodto period as a result of shifts in product mix, stage of product life cycle,anticipated decreases in average selling prices and our ability to reduce costof sales.

*Three months ended March 31, 2007 and 2006*

Gross profit was $75.3 million, or 16% of net sales,in the three months ended March 31, 2007, compared to $123.8 million,or 21% of net sales, in the corresponding quarter of 2006. The overall grossprofit decrease is due to a decline in sales and lower gross profit as apercentage of sales in the Wireless Infrastructure and Broadband Infrastructuresegments. Gross profit percentages improved in the PCD, Handset and Servicessegments, primarily due to a change in the product mix to higher gross marginproducts.  For additional discussion see“Segment Reporting” section of this Item 2.

***Operating expenses***

The following table summarizes our operating expenses:
|                                      | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| ** **                           | ** ** | ** **                                           | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **                           | ** ** | **2007**                                             | ** ** | **sales** | ** ** | **2006** | ** ** | **sales** | ** ** |
| ** **                           | ** ** | ** **                                           | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **(in thousands)**                              | ** ** |
| Selling, general  and administrative |       | $                                                    | 79,837     |   | 17 | % | $ | 83,727 |   | 14 | % |
| Research and  development            |       | 43,662                                               |       | 9 | % | 46,402 |   | 8 | % |
| Amortization of  intangible assets   |       | 4,046                                                |       | 1 | % | 4,925 |   | 1 | % |
| Total operating  expenses            |       | $                                                    | 127,545    |   | 27 | % | $ | 135,054 |   | 23 | % |

 

Selling, general and administrative expenses (“SG&A”)include compensation and benefits, professional fees, sales commissions,provision for doubtful accounts receivable and travel and entertainment costs.Research and development (“R&D”) expenses consist primarily of compensationand benefits of employees engaged in research, design and developmentactivities, costs of parts for prototypes, equipment depreciation and thirdparty development expenses. We believe that continued and prudent investment inresearch and development is critical to our long-term success, and we willaggressively evaluate appropriate investment levels.  A portion of our costs are fixed and aredifficult to quickly reduce in periods of lower sales.

64

----

*Selling, general and administrative*

*Three months ended March 31, 2007 and 2006*

SG&A expenses decreased $3.9 million butincreased by 3 percentage points as a percentage of net sales during the threemonths ended March 31, 2007 compared to the same period in 2006. Thedecrease in SG&A expenses was primarily due to a $6.1 million decreasein our provision for doubtful accounts compared to the same period in2006.  Days sales outstanding was67 days at March 31, 2007 as compared to 74 days atMarch 31, 2006. The shorter days sales outstanding and resultant decreasein provision for doubtful accounts is the result of improved cash collectionsin the first quarter of 2007 relative to the comparable period in 2006.  This was offset by higher labor relatedexpenses as well as external accounting and legal expenses.

In the first quarter of 2006, the Company decided toterminate the Mongolian joint venture arrangement and wrote off the remainingnet assets, of approximately $4.7 million. SG&A expense for the three months ended March 31, 2006 includedone-time charges related to the write off of these assets.

*Research and development*

*Three months ended March 31, 2007 and 2006*

R&D expenses decreased by $2.7 million butincreased by 1 percentage points as a percentage of net sales during the threemonths ended March 31, 2007 compared to the same period in 2006. Theabsolute decrease in R&D expenses is mainly attributed to a $2.3 milliondecrease in consulting expenses.

*Amortization of intangible assets*

*Three months ended March 31, 2007 and 2006*

Amortization of intangible assets decreased by$0.9 million in the three months ended March 31, 2007 compared to thesame quarter last year. Amortization of intangible assets declined as severalintangible assets became fully amortized during the preceding twelve months.

***Interest income***

*Three months ended March 31, 2007 and 2006*

Interest income was $4.9 million and$3.5 million for the three months ended March 31, 2007 and 2006,respectively. Interest income increased primarily due to a change in ourinvestment mix which was more heavily weighted toward short-term and long-terminvestments during the three months ended March 31, 2007 as compared tothe same period in 2006.

***Interest expense***

*Three months ended March 31, 2007 and 2006*

Interest expense was $6.7 million and$3.5 million for the three months ended March 31, 2007 and 2006,respectively. The increase in interest expense for the three months endedMarch 31, 2007 compared to the same period in 2006 was primarilyattributable to the incremental interest expense of $4.2 million resulting fromthe First Supplemental Indenture.  As a resultof the First Supplemental Indenture, our convertible subordinated notes’ statedinterest rate increased to 7.625% per annum after January 9, 2007 to the March1, 2008 maturity date.  Prior to January9, 2007, our convertible subordinated notes accrued interest at 7/8% per annum.

***Other income***

*Three months ended March 31, 2007 and 2006*

Net other income was $4.0 million and$3.6 million for the three months ended March 31, 2007 and 2006,respectively. Net other income for the three months ended March 31, 2007was primarily due to a $2.8 million gain on the sale of the Immenstarinvestment and a $1.1 million gain on foreign currency revaluation.  Net other income for the three months endedMarch 31, 2006 was primarily due to a $2.8 million gain on foreigncurrency revaluation and a $0.5 million financial subsidy from the localChinese government.

65

----

***Income tax expense***

Income tax expense is based upon a blended effective taxrate based upon our expectation of the amount of income to be earned in eachtax jurisdiction and is accounted under the liability method. Deferred incometaxes are recognized for the differences between the tax bases of assets andliabilities and their financial statement amounts based on enacted tax rates.Valuation allowances are established when necessary to reduce deferred tax assetsto the amount expected to be realized. We will maintain a full valuationallowance on our net deferred tax assets in China, the United States, and othercountries until an appropriate level of profitability that generates taxableincome is sustained or until we are able to develop tax strategies that wouldenable us to conclude that it is more likely than not that a portion of ourdeferred tax assets will be realizable. Any reversal of valuation allowanceswill favorably impact our results of operations in the period of the reversal.

*Three months ended March 31, 2007 and 2006*

Income tax expense was $4.3 million and $2.8 millionfor the three months ended March 31, 2007 and 2006, respectively.  There are two primary reasons why the Companyhas tax expense while the Company has pretax losses. First, we have notprovided any tax benefit on the forecasted current year losses incurred and taxcredits generated in the United States and other countries, because managementbelieves that it is more likely than not that the tax benefit associated withthese losses will not be realized. Second, we continue to accrue tax expense injurisdictions where we have been historically profitable. Estimates of theannual 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.

Weadopted the provisions of Financial Accounting Standards Board (“FASB”)Interpretation No. 48, “Accounting for Uncertainty in Income Taxes-aninterpretation of FASB Statement No. 109” (“FIN 48”) on January 1, 2007. As aresult of the implementation of FIN 48, the Company recognized a $1.4 millionincrease in the liability for unrecognized tax benefits which, as required, wasaccounted for as a reduction to the January 1, 2007 balance of retainedearnings.  FIN 48 established criteriafor recognizing or continuing to recognize only more-likely-than tax positions,which may result in income tax expense volatility in future periods. While webelieve that we have adequately provided for all tax positions, amountsasserted by taxing authorities could be greater than our accrued position.Accordingly, additional provisions on income tax related matters could berecorded in the future as revised estimates are made or the underlying mattersare settled or otherwise resolved.

**SEGMENT REPORTING**

We offer products and services through four operatingunits, namely Network Solutions, PCD, Handsets and Services.  The Network Solutions operating unit providesits products and services through two reporting segments; BroadbandInfrastructure and Wireless Infrastructure. Each reporting segment and operating unit is responsible for managingits own performance.

We currently evaluate operating performance of andallocate resources to the reporting segments based on segment gross profit.Cost of sales and direct expenses in relation to production are assigned to thereporting segments. The accounting policies used in measuring segment assetsand operating performance are the same as those used by corporate and areconsistently applied across all segments.

Summarized below are our segment sales revenue and grossprofit for the three months ended March 31, 2007 and 2006, respectively.

***Network Solutions***

*Broadband Infrastructure*
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | **as restated** | ** ** |
| ** **                             | ** ** | **(in thousands)**                         | ** ** |
| Sales                                  |       | $                                               | 31,222     |   | $ | 57,251 |   |
| Gross profit                           |       | $                                               | 5,001      |   | $ | 23,086 |   |
| Gross profit as  a percentage of sales |       | 16                                              | %          | 40 | % |

 

66

----

Our largest Broadband Infrastructure customer is Softbank in Japan,representing approximately 30% and 74% of total broadband sales during thethree months ended March 31, 2007 and 2006, respectively.   Due to the customer concentration in thissegment, revenues fluctuate based upon the magnitude and timing of revenuerecognition on certain contracts.

Gross profit decreased in the first quarter of 2007 when compared to thesame period in 2006, primarily due to revenue recorded for the cancellationcompensation fees in 2006 of $22.6 million; this revenue had no associatedcost of sales related to it.  This caused a one-time increase in bothsales and gross profit in the first three months of 2006, when compared to thesame period in 2007.  The overall reduction in gross profit during 2007was partially offset by $4.8 million of RollingStreamTM  revenue which has a higher gross profitmargin.

We currently offer and have initial market acceptance of ourRollingStreamTM IPTV products inChina, Japan and other geographic regions.  We believe that the IPTVmarket presents a meaningful growth opportunity in these regions as well asother regions we have targeted to expand our IPTV offerings, including India.

*Wireless Infrastructure*
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | **as restated** | ** ** |
| ** **                             | ** ** | **(in thousands)**                         | ** ** |
| Sales                                  |       | $                                               | 69,879     |   | $ | 105,733 |   |
| Gross profit                           |       | $                                               | 24,266     |   | $ | 50,761 |   |
| Gross profit as  a percentage of sales |       | 35                                              | %          | 48 | % |

 

 During the threemonths ended March 31, 2007, PAS systems sales declined 41% and nowcomprise approximately 79% of our Wireless Infrastructure sales compared to 88%during the same period in 2006. Wireless sales declined in China by 40%, andwere offset by marginal increases in other regions.  The decrease in PAS systems sales is primarilya result of our customers in China transitioning from new system installationsto system expansions as PAS systems reach product maturity and China readiesfor 3G launch.

The gross profit as a percentage of sales decreased by 13percentage points in the three months ended March 31, 2007, as compared tothe corresponding quarter in 2006 due to a number of factors, including:(i) decrease of PAS infrastructure margin, and (ii) lower voice anddata networks software sales which have higher margin.

We expect future PAS infrastructure spending to declinefurther as China readies for 3G launch. We plan to aggressively pursueopportunities for our Packet PAS products (for broadband wireless data marketbased on PAS technology), high end PAS products including dual mode, CDMAproducts and Softswitch products in multiple markets; though we do notanticipate that these sales will fully offset the decline in PAS sales.

***PCD***
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | **as restated** | ** ** |
| ** **                             | ** ** | **(in thousands)**                         | ** ** |
| Sales                                  |       | $                                               | 288,330    |   | $ | 322,995 |   |
| Gross profit                           |       | $                                               | 16,845     |   | $ | 14,389 |   |
| Gross profit as  a percentage of sales |       | 6                                               | %          | 4 | % |

 

Revenue for the PCD segment decreased 11% during thethree months ended March 31, 2007 as compared to the same period in2006.  Although the number of units soldduring the first three months of 2007 increased by 256,000 units, the declinein the overall average selling price of 22% resulted in a $34.7 milliondecrease to revenue for the three months ended March 31, 2007 as compared tothe same period in 2006.

Historically, PCD has relied upon a limited number ofmanufacturers to supply its handset products. During the three months endedMarch 31, 2007, sales of UTStarcom branded devices accounted for 51% ofthe total units sold, compared to 16%

67

----

of the total units sold for the three months ended March 31, 2006.  We have focused on increasing our sales ofUTStarcom branded devices as we earn a higher gross margin on these handsets.

Gross profit as a percentage of sales increased to 6% forthe three months ended March 31, 2007 compared to 4% for the three months endedMarch 31, 2006.  The increase in grossprofit is mainly attributable to the product mix including more UTStarcomproducts with higher gross margins.  Asthe percentage of UTStarcom designed and manufactured products increases, weexpect the PCD margin to increase in the future.

***Handsets***
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | **as restated** | ** ** |
| ** **                             | ** ** | **(in thousands)**                         | ** ** |
| Sales                                  |       | $                                               | 69,719     |   | $ | 99,034 |   |
| Gross profit                           |       | $                                               | 25,048     |   | $ | 31,613 |   |
| Gross profit as  a percentage of sales |       | 36                                              | %          | 32 | % |

 

Net sales declined 30% for the three months ended March 31, 2007compared to the same period in 2006. Nearly all our handset sales are in China, where we have experienced adecline in volume and price for our PAS handsets.  The PAS handset units sold declined to 1.3 million compared to 2.0 million inthe comparable period last year. The 35% volume decline was primarilyattributed to lower demand for our PAS handsets resulting from slowersubscriber growth as service providers reduced the marketing efforts for PAShandsets in anticipation for next generation technology networks.

The average selling price perunit in the PAS products declined 5%due to competitive pricing pressures. We have also experienced continuingpricing pressure in the China telecommunications market since the latterpart 2003, which has driven average unit selling prices lower. We expectto see cumulative PAS subscriber growth at lower rates in future periods.

Gross profit as a percentage of sales for our handsetssegment increased from 32% to 36%  in thethree months ended March 31, 2007, as compared to the corresponding periodin 2006. The improvement in the gross profit percentage primarily relates toshifting most of our products to the use of chip-sets with greaterfunctionality in PAS handsets that reduce the overall component costs of eachunit.

***Services***
|                                        | ** ** | **Three months ended March 31,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------|------------|
| ** **                             | ** ** | **2007**                                        | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                      | ** ** | **as restated** | ** ** |
| ** **                             | ** ** | **(in thousands)**                         | ** ** |
| Sales                                  |       | $                                               | 16,752     |   | $ | 16,968 |   |
| Gross profit                           |       | $                                               | 4,125      |   | $ | 3,942 |   |
| Gross profit as  a percentage of sales |       | 25                                              | %          | 23 | % |

 

Our Services segment’s revenue from external customersremained relatively stable in the three months ended March 31, 2007 ascompared to the corresponding quarter last year.

Duringthe first quarter of 2007, revenues of $1.4 million from WirelessInfrastructure and $0.2 million from Broadband Infrastructure in Chinawere allocated to the Services segment. The allocation was made on certain completed contracts for which theservice element was not separately priced. The allocated amount for the threemonths ended March 31, 2006 was $2.6 million from Wireless Infrastructure and$0.1 million from Broadband Infrastructure. The lower allocated amount of $1.1 million in the first three months of2007, when compared to the same period in 2006, was due to a renewal delay ofcertain service contracts and a net loss in our China Services segment.

68

----

**LIQUIDITY AND CAPITAL RESOURCES**

***Operating Activities***

*2007*

Net cash used in operating activities for the threemonths ended March 31, 2007 was $106.7 million. Operating cash wasnegatively affected by the net loss of $54.0 million and changes in other assets,inventories, payables and other current liabilities offset by changes inaccounts receivable and customer advances, as discussed below.

During the first three months of 2007, inventoriesincreased $2.4 million primarily due to inventory purchases related to a largeinfrastructure deployment contract that we entered into in the fourth quarterof 2006, and increases in other assets of $31.4 million primarily due toadvances to our suppliers and the prepayment of taxes and insurance.  In addition, accounts payable decreased $41.3million, due to our decision to change the timing of payments to vendors in thefirst quarter of 2007 to comply with shorter vendor payment terms.  Other current liabilities decreased $79.3million in the first three months of 2007, due primarily to payments of bonusesand commissions earned in the prior year and warranty settlements.

The cash used in operating activities was partiallyoffset by a reduction in accounts receivable of $60.3 million as a result ofstrong cash collections and the high percentage of revenue in the first quarterof 2007 from our PCD segment which generally has experienced a shortercollection period on related receivables.

Customer advances increased by $44.3 million at March 31,2007.  Customer advances represents cashdeposits we have received from our customers for orders that have not yetreceived final acceptance.  Uponsubsequent receipt of final acceptances and revenue recognition, customeradvances are reduced and revenue and cost of sales is recorded.

*2006*

Net cash provided by operating activities for the threemonths ended March 31, 2006 was $53.7 million. Operating cash wasaffected by changes in deferred costs, customer advances, accounts receivable,and accounts payable and offset by the net loss as well as changes in othercurrent liabilities and inventory.

Customer advances increased by $43.1 million for thethree months ended March 31, 2006. Customer advances represent cashdeposits we have received from our customers for orders that have not yetreceived final acceptance. Upon subsequent receipt of final acceptances andrevenue recognition, customer advances are reduced and revenue and cost ofsales is recorded. Deferred costs decreased by $3.2 million from December31, 2005 to March 31, 2006 due to a net increase in cost of sales recognitionresulting from customer acceptances during this three month timeframe..

The $28.8 million decrease in accounts receivablewas attributable to a decline in sales preceding the end of the March 31,2006 quarter as compared to sales in the preceding quarter. Partiallyoffsetting this is a lengthening of days sales outstanding to 74 days atMarch 31, 2006 as compared to 66 days at December 31, 2005.

Accounts payable increased by $18.1 million andinventory increased by $4.3 million primarily due to handset unitinventory purchases in China partially offset by lower inventory purchases byPCD.  Other current liabilities decreasedby $51.0 million, primarily as a result of a decrease in taxes payable ofapproximately $14.2 million, a decrease in compensation related costs ofapproximately $8.8 million, a decrease in accrued expenses, such aswarranty, royalty and legal, of approximately $13.9 million, and adecrease of approximately $14.1 million in other liabilities.

***Investing Activities***

*2007*

Net cash provided by investing activities for the threemonths ended March 31, 2007 totaled $1.8 million. Cash of$12.3 million was received from the disposition of an investment interestand proceeds from the sale of short-term investments, and $10.4 million was theresult of a decrease in restricted cash. Cash outflows from investing activities included $15.6 million for thepurchase of short-term investments as well as $5.2 million for the purchase ofproperty, plant and equipment.

*2006*

Net cash used in investing activities for the threemonths ended March 31, 2006 totaled $3.5 million. Cash outflows frominvesting activities included an increase in restricted cash of$17.0 million as well as $17.0 million used to purchase short-term investments.  Cash of $20.0 million was received fromthe sale of the semiconductor design assets to Marvell, and $13.3 millionwas received from the net sale of short-term investments.

69

----

***Financing Activities***

*2007*

Net cash used in financing activities was$0.7 million, primarily consisting of a change in cash overdrafts for thethree months ended March 31, 2007.

*2006*

Net cash used in financing activities was$30.8 million, primarily consisting of a net repayment of short-termborrowings in excess of new borrowing of $27.6 million for the three monthsended March 31, 2006.

***Liquidity***

We reported net losses in each quarter in the periodbeginning April 1, 2005 and continuing through March 31, 2007, which haveresulted in an accumulated deficit of $549.6 million and total stockholders’equity being reduced to $722.6 million at March 31, 2007. Additionally, atMarch 31, 2007, we had short-term debt in China under lines of credit to ourChina subsidiaries of $103.6 million maturing in 2007 and the first quarter of2008, and short-term debt outside of China in the form of 7/8% convertiblesubordinated notes with a principal balance of $274.6 million that matures inMarch 2008.

Our working capital was $479.3 million and$855.0 million at March 31, 2007 and 2006, respectively, and includedcash on hand of $558.1 million and $667.4 million and short terminvestments of $14.8 million in and $17.1 million, respectively in 2007and 2006.  Planned capital expendituresinclude an increase in the level of our capital expenditures in China in 2007by approximately $40 million to support wire line telephone carriers in Chinawho utilize our products and services to provide television service to theircustomers using the IPTV protocol.

Creditfacilities in China at March 31, 2007 totaled $692.7 million, with $353.5million of this amount available for working capital purposes, of which we haddrawn $103.6 million in outstanding borrowings, with interest rates rangingfrom 5.51% to 5.57%, and $339.2 million was available for use in support ofletters of credit and corporate guarantees. These facilities expire primarily in November and Decemberof 2007.  We believe that based upon ourrecent financial performance and financial position our lenders may reduce thetotal available credit when it negotiates renewals of these lines. Furthermore,each borrowing under the credit facilities is subject to the bank’s currentfavorable opinion of the credit worthiness of the Company’s China subsidiaries,as well as the bank having funds available for lending and other Chinesebanking regulations. However, we believe the amounts of credit our lenders maymake available and the borrowings made under the renewed lines of credit willbe sufficient to meet planned uses of these credit facilities.

As of September 30, 2007 our outstanding borrowings underthe credit facilities in China totaled $140.1 million, with interest rates ofup to 6.67%, with varying maturity dates through September 2008. The Company’spractice in China is to draw new loans under the credit facilities prior toeither the maturity of our borrowings or expiration of our facilities to ensurewe maintain adequate liquidity to re-pay the existing borrowings at maturity,or to effectively lengthen the credit facility period to the latest maturitydate of the underlying borrowings.

Of ourtotal cash and short-term investments at March 31, 2007 of $572.9 million, a total of $414.6 million was heldin China. To meet liquidity needs outside of China, our subsidiaries inChina have the ability to transfer cash to the Company in the United Statesunder China’s current exchange control regulations. The amount of cashavailable for transfer from the China subsidiaries is limited both by liquidityneeds of the subsidiaries in China and by Chinese government requirements thatthe China subsidiaries retain adequate capital levels in China to protectcreditors and to have funds available for mandated employee benefits. Duringthe nine months ended September 30, 2007 our China subsidiaries have made suchtransfers of funds out of China to the Company totaling $150 million.

Althoughmanagement believes we now have a sufficient amount of cash resources tofinance our anticipated working capital and capital expenditure requirementsfor the next 12 months, we do not have enough cash outside of China to repaythe convertible notes due on March 1, 2008. Management’s liquidity plansinclude a partial or complete refinancing of the convertible notes, renewal ofthe lines of credit in China, transfers of more cash from its subsidiaries inChina to the extent necessary, and, if needed, liquidation of certaininvestments and/or seeking new financing arrangements. Our ability to maintainsufficient liquidity is also dependent on achieving projected sales andoperating margin forecasts.

70

----

The convertible notes were issued in March 2003 whenwe completed an offering of $402.5 million of 7/8% convertiblesubordinated notes due March 1, 2008 to qualified institutional buyers.The notes are convertible into our common stock at a conversion price of $23.79per share and are subordinated to all of our present and future senior debt.Concurrent with the issuance of the convertible notes, we entered into aconvertible bond hedge and a call option transaction with respect to our commonstock. Both the bond hedge and call option transactions may be settled at ouroption either in cash or net shares and expire on March 1, 2008. During2005, we completed exchanges of approximately 5.0 million shares of ourcommon stock and approximately $57.1 million in cash for$127.9 million aggregate principal amount of outstanding notes. As aresult of the early extinguishment, we also amended the convertible bond hedgeand call option transactions to reflect the change in principal amount of theunderlying notes.

If anevent of default were to occur and be continuing, the Trustee or the holders ofat least 25% in aggregate principal amount of the notes then outstanding coulddeclare all unpaid principal and accrued interest on the Notes then outstandingto be immediately due and payable. Therefore as a result of our inability totimely file our Quarterly Report on Form 10-Q for the period ended September30, 2006, because the independent review by the Governance Committee of theCompany’s historic stock option accounting was not completed, after receiving apurported notice of default from the trustee for the notes (the “Trustee”)asserting that the delay in filing and a failure to comply with certaincovenants had caused a default under the indenture, we solicited and receivedthe requisite consents from the holders of the notes to a waiver of anydefaults which may have occurred to and including January 9, 2007, caused by adelay in filing certain reports required to be filed pursuant to the ExchangeAct (the “SEC Reports”) with the Securities and Exchange Commission (the “SEC”)and entered into a First Supplemental Indenture with the Trustee, dated January9, 2007, which provided that any failure by us to comply with certainprovisions of the original agreement will not result in a default or an eventof default through May 31, 2007. After receiving a notice of default from theTrustee asserting that our inability to timely file SEC Reports and comply withcertain covenants as of May 31, 2007 had caused a default under the indenture,we solicited and received the requisite consents from the holders of the notesto a waiver of any defaults which may have occurred to and including July 26,2007 and entered into a Second Supplemental Indenture with the Trustee, afterreceiving consent from holders of more than 50% of the outstanding aggregateprincipal amount of the convertible subordinated notes in connection with ourconsent solicitation announced July 19, 2007. The Second Supplemental Indentureprovides that (i) during the period from and including July 26, 2007 to and includingOctober 15, 2007 (“Covenant Reversion Date”), any failure by us to comply withthe covenants contained in the original indenture agreement related to therequired filing of reports with the SEC, and the furnishing of copies of theSEC reports and certain compliance certificates to the Trustee, will notconstitute a default, and that (ii) if, but for the Second SupplementalIndenture, a default would be deemed to have occurred as a result of a failureto comply with such covenants and such default remains uncured and iscontinuing as of the Covenant Reversion Date, such default will be deemed tohave occurred on the Covenant Reversion Date. On October 15, 2007, we receivedan additional notice of default from the Trustee asserting that a default hadoccurred under the Indenture (as amended by the First Supplemental Indentureand the Second Supplemental Indenture) with respect to the Notes.  The specific purported defaults referred toin the notice of default were (i) our failure to file with the SEC and providecopies to the Trustee of our Quarterly Report on Form 10-Q for the fiscalquarter ending March 31, 2007 and our Quarterly Report on Form 10-Q for thefiscal quarter ending June 30, 2007 and (ii) our failure to deliver to theTrustee our officer’s certificate of compliance required by the Indenture.  The notice of default provides that we have60 consecutive days from October 15, 2007 to cure the purported defaults beforesuch defaults would constitute an “Event of Default” under the Indenture.  The occurrence of an “Event of Default” underthe Indenture would afford the Trustee or holders of not less than 25% inaggregate principal amount of the Notes the right to declare the full principalamount of all outstanding Notes to be immediately due and payable. We cannot becertain that we will be able to file all required reports with the SEC by theDemand Date. Furthermore, we cannot be certain that consents from holders ofthe Notes necessary for an additional waiver of its obligations to comply withthe Indenture covenants within the required period can be obtained onreasonable terms or at all. 

Underthe Second Supplemental Indenture, the convertible subordinated notes accrue anadditional 6.75% per annum in special interest from and after January 9, 2007to and including July 25, 2007, and an additional 10% per annum in specialinterest from and after July 26, 2007 to the date the notes are paid, prepaid,redeemed, converted or otherwise cease to be outstanding. The special interestrate accruing on the notes after July 26, 2007 represents an increase of 3.25%per annum over the previous special interest rate of 6.75% per annum providedby the First Supplemental Indenture. As a result of the Second SupplementalIndenture, the convertible subordinated notes now bear a stated interest rateof 10.875%. Accordingly, we will have $22.0million of additional annual interest expense in 2007 while the convertiblesubordinated notes are outstanding. Payments of special interest will bemade in addition to, and at the same time and in the same manner as, regularlyscheduled payments of interest to holders entitled to such regularly scheduledpayments of interest.

Ifadditional sources of liquidity were needed, the Company would consider newdebt or equity offerings or obtaining cash from asset sales, but there is noassurance that such transactions could be consummated on acceptable terms or atall. Failure to raise sufficient capital when needed could have a materialadverse effect on the business, results of operations and financial position ofthe Company.

Our China sales are generally denominated in localcurrency, and we accept commercial notes receivable with maturity dates ofbetween three and six months from our customers in China in the normalcourse of business. Notes receivable available for sale was $6.2 millionand $5.1 million at March 31, 2007 and December 31, 2006, respectively. Wemay discount these notes with banking institutions in China. Any notes thathave been sold are not included in our consolidated balance sheets as thecriteria for sale treatment established by Statement of Financial AccountingStandards No. 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishment of Liabilities” (“SFAS 140”) have been met.

71

----

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. We have contracts negotiated in JapaneseYen and we maintain bank accounts in Japanese Yen for purchasing portions ofour inventories and supplies. The balance of these Japanese Yen accounts atMarch 31, 2007 was approximately $15.4 million.

On August 1, 2005, we entered into a 364-day$100.0 million committed receivables purchase facility with a financialinstitution. In March 2007, the agreement was amended and restated to reflectthat the purchase of trade receivables shall be at the sole discretion of thefinancial institution. The agreement was also extended to the earlier of(i) March 28, 2008 or (ii) upon 90 days written notice by thefinancial institution. Pursuant to the terms of the receivable purchasefacility, we may sell certain receivables arising from the sale oftelecommunications equipment to this financial institution. No receivables hadbeen sold pursuant to this arrangement.

We have not guaranteed any debt that is not included inthe consolidated balance sheet.

***Income taxes***

Certain subsidiaries and jointventures located in China enjoy tax benefits in China which are generallyavailable to foreign investment enterprises, including full exemption fromnational enterprise income tax for two years starting from the first profit-makingyear and/or a 50% reduction in national income tax rate for the following threeyears. In addition, local enterprise income tax is often waived or reducedduring this tax holiday/incentive period. Under current regulations in China,foreign investment enterprises that have been accredited as technologicallyadvanced enterprises are entitled to additional tax incentives. These taxincentives vary in different locales and could include preferential nationalenterprise income tax treatment at 50% of the usual rates for different periodsof time. The tax holidays discussed above are applicable or potentiallyapplicable to UTStarcom Chongqing Telecom Co. Ltd. (“CUTS”), UTStarcomTelecom Co., Ltd. (“HUTS”), Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”) andUTStarcom China Co., Ltd. (“UTSC”), our active subsidiaries in China, as thoseentities may qualify as accredited technologically advanced enterprises.

On March 16, 2007, China’s top legislature, theNational People’s Congress, passed the China Corporate Income Tax Law (“CIT Law”).  CIT Law will be effective on January 1,2008.  Under the CIT Law, China’s dualtax system for domestic enterprises and foreign investment enterprises (“FIEs”)would be effectively replaced by a unified system.  The new law establishes a tax rate of 25% formost enterprises and a reduced tax rate of 15% for certain qualified hightechnology enterprises.

Prior to this change in tax law, certain subsidiariesand joint ventures located in China enjoy tax benefits in China which aregenerally available to FIEs.  The taxholidays/incentives for FIEs were applicable or potentially applicable to CUTS,HUTS, HSTC and UTSC, our active subsidiaries in China, as those entities mayqualify as accredited technologically advanced enterprises.

CIT Law targets certain industries for the reduced 15%tax rate for certain qualified high technology enterprises.  For FIEs established before the promulgationof the new law who currently enjoy lower tax rates, any increase in their taxrates would be gradually phased in over five years.  Significant regulations regarding theinterpretation and implementation of the new tax law are still pending.  There is potential risk that our subsidiariesmay not qualify for the reduced 15% tax rate. Therefore, the new law may have an adverse impact on our future tax expensein China.

Moreover,the Chinese central government may review and audit tax benefits granted bylocal or provincial authorities and could determine to disallow such benefits.Certain of our subsidiaries and joint ventures located in China enjoy taxbenefits in China that are generally available to foreign investment enterprises.If these tax benefits are reduced, disallowed or repealed due to changes in taxlaws or determination by the Chinese government, our business could suffer.

We adopted the provisions of FIN 48 on January 1,2007. As a result of the implementation of FIN 48, the Company recognized a$1.4 million increase in the liability for unrecognized tax benefits which, asrequired, was accounted for as a reduction to the January 1, 2007 balance ofretained earnings.  FIN 48 providesa comprehensive model for the recognition, measurement and disclosure infinancial statements of uncertain income tax positions that a company has takenor expects to take on a tax return. Under FIN 48, a company can recognizethe benefit of an income tax position only if it is more likely than not(greater than 50%) that the tax position will be sustained upon taxexamination, based solely on the technical merits of the tax position.Otherwise, no benefit can be recognized. The tax benefits recognized aremeasured based on the largest benefit that has a greater than fifty percentlikelihood of being realized upon ultimate settlement. Additionally, companiesare

72

----

requiredto accrue interest and related penalties, if applicable, on all tax exposuresfor which reserves have been established consistent with jurisdictional taxlaws. While we believe that we have adequately provided for all tax positions,amounts asserted by taxing authorities could be greater than our accruedposition. Accordingly, additional provisions on income tax related matterscould be recorded in the future as revised estimates are made or the underlyingmatters are settled or otherwise resolved.

***Off-balance sheet arrangements***

On August 1, 2005, we entered into a 364-daycommitted receivables purchase facility with Citibank, N.A., which provides forthe sale of up to $100.0 million of trade accounts receivable of our PCDsegment. On March 30, 2007, the agreement was amended and restated to reflectthat the purchase of trade receivables shall be at the sole discretion of Citibank,N.A.  Sales of the accounts receivablesto Citibank, N.A. under this program will result in a reduction of totalaccounts receivable in our consolidated balance sheet. The remaining accountsreceivables not sold to Citibank, N.A. will be carried at their net realizablevalue, including an allowance for doubtful accounts. We have not sold anyreceivables pursuant to this facility during 2006 or the first three months of2007. We believe that available funding under our accounts receivable financingprogram provides us increased flexibility to manage working capitalrequirements, and that there are sufficient trade accounts receivable tosupport the U.S. financing programs. Under the program, we will continue toservice the accounts receivable.

At March 31, 2007, we have no other off balance sheetarrangements.

***Contractual obligations and other commitments***

Our obligations under contractual obligations andcommercial commitments at March 31, 2007 were as follows:
| ** **                        | ** ** | **Payments due by period** | ** ** |
|-----------------------------------|------------|-------------------------------------------|------------|
| ** **                        | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                        | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** |
| ** **                        | ** ** | **(in thousands)**                   | ** ** |
| **Contractual  Obligations**      | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Bank loans                        |       | $                                         | 103,584    |   | $ | 103,584 |   | $ | — |   | $ | — |   |
| Convertible subordinated notes    |       | $                                         | 274,600    |   | $ | 274,600 |   | $ | — |   | $ | — |   |
| Interest payable on debt          |       | $                                         | 26,166     |   | $ | 26,166 |   | $ | — |   | $ | — |   |
| Lease obligations                 |       | $                                         | 33,863     |   | $ | 14,189 |   | $ | 16,603 |   | $ | 3,071 |   |
| **Other  Commercial Commitments** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Letters of credit                 |       | $                                         | 45,965     |   | $ | 28,813 |   | $ | 17,152 |   | $ | — |   |
| Purchase  commitments             |       | $                                         | 106,469    |   | $ | 100,889 |   | $ | 5,580 |   | $ | — |   |

 

*Bank loans*

At March 31, 2007, we had loans with various bankstotaling $103.6 million with interest rates ranging from 5.51% to 5.57 %per annum. These bank loans mature during the fourth quarter of 2007 and thefirst quarter of 2008, and are included in short-term debt.

*Convertible subordinatednotes*

Our convertible subordinated notes, due March 1,2008, are convertible into our common stock at a conversion price of $23.79 pershare and are subordinated to all our present and future senior debt. Theprincipal is due only at maturity of the notes.

Effective January 9, 2007, the Company and the holders ofthe remaining $274.6 million of convertible subordinated notes entered into aFirst Supplemental Indenture, providing that any failure by us to comply withcertain provisions of the original agreement will not result in a default or anevent of default thru May 31, 2007. The convertible subordinated notesaccrue an additional 6.75% per annum in special interest from and after January9, 2007 to the March 1, 2008 maturity date of the notes, unless the notes areearlier repurchased or converted. On July 26, 2007, we entered into aSecond Supplemental Indenture providing that the convertible subordinated noteswill accrue an additional 10% per annum in special interest from and after July26, 2007 to the March 31, 2008 maturity date of the notes unless the notes areearlier repurchased or converted.  Thespecial interest rate represents an increase of 3.25% per annum over theprevious special interest rate of 6.75% per

73

----

annum in the FirstSupplemental Indenture.  As a result ofthe Second Supplemental Indenture, the convertible subordinated notes now beara stated interest rate of 10.875%.  Interest is payable semiannually on March 1and September 1, and payments of the special interest are made in addition toand at the same time and in the same manner as regularly scheduled payments ofinterest to holders entitled to such regularly scheduled payments ofinterest.  For more information regardingthe notice of default on May 31, 2007, the Company’s Second SupplementalIndenture and the notice of default on October 15, 2007, see the “Liquidity”section of this Item 2.

*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 to supportinternational sales activities outside of China. When we submit a bid for asale, often the potential customer will require that we issue a bid bond or astandby letter of credit to demonstrate our commitment through the bid process.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 ofMarch 31, 2007 total open commitments under these purchase ordersextending beyond one year were approximately $5.6 million. Additionally,we have agreed to purchase from Marvell certain chip-sets that will be includedin 50% to 100% of our PAS handsets, through 2011.

*Intellectual property*

Certain sales contracts include provisions under whichcustomers would be indemnified by us in the event of, among other things, athird-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.

*Income Tax Obligations*

EffectiveJanuary 1, 2007, the Company adopted the provisions of FIN 48. As of March 31,2007, the liability for uncertain tax positions, net of federal impacts on state tax issues, was $71.9 million, ofwhich none is expected to be paid within one year. Included in the $71.9million is approximately $6.7 million which has not yet reduced income taxpayments, and, therefore, has been netted against non-current deferred taxassets. For the remaining liability, the Company is unable to make a reasonablyreliable estimate when cash settlement with a taxing authority may occur.

**RECENT ACCOUNTING PRONOUNCEMENTS**

See Note 22, “RecentAccounting Pronouncements,” in the Notes to Condensed Consolidated FinancialStatements in Item 1 of this Quarterly Report for a full description of recentaccounting pronouncements, including the expected dates of adoption andestimated effects on results of operations and financial condition, which isincorporated herein by reference.

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

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

***Interest Rate Risk***

Our exposure to market risk for changes in interest ratesrelates primarily to our investment portfolio. The fair value of our investment portfolio would not be significantlyaffected by either a 10% increase or decrease in interest rates due mainly tothe short-term nature of most of our investment portfolio.  However, our interest income can be sensitiveto changes in the general level of U.S. interest rates since the majority ofour funds are invested in instruments with maturities less than one year.  Our policy is to ensure the safety ofinvested funds by generally attempting to limit market risk.  Funds in excess of current operatingrequirements are mostly invested in government-backed notes, commercialpaper, floating rate corporate bonds, fixed income corporate bonds andtax-exempt instruments.  In accordancewith our investment policy, all short-term investments are invested in “investmentgrade” rated securities with minimum A or better ratings.  Currently, most of our short-term investmentshave AA or better ratings.

74

----

The table below represents carrying amounts and relatedweighted-average interest rates of our investment portfolio at March 31,2007:
|                               | ** ** | **(in thousands, except** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|
| ** **                    | ** ** | **interest rates)**            | ** ** |
| Cash and cash  equivalents    |       | $                                   | 558,150    |   |
| Average interest  rate        |       | 2.18                                | %          |
|                          |       |                                |       |
| Restricted cash  - short-term |       | $                                   | 5,620      |   |
| Average interest  rate        |       | 4.52                                | %          |
|                          |       |                                |       |
| Short-term  investments       |       | $                                   | 14,768     |   |
| Average interest  rate        |       | 1.73                                | %          |
|                          |       |                                |       |
| Restricted cash  - long-term  |       | $                                   | 17,152     |   |
| Average interest  rate        |       | 4.95                                | %          |
|                          |       |                                |       |
| Total investment  securities  |       | $                                   | 595,690    |   |
| Average interest rate         |       | 2.27                                | %          |

 

***Equity Investment Risk***

Our investment portfolio includes equity investments inpublicly traded companies, the values of which are subject to market pricevolatility.  Economic events couldadversely affect the public equities market and general economic conditions mayworsen.  Should the fair value of ourpublicly traded equity investments decline below their cost basis in a mannerdeemed to be other-than-temporary, our earnings may be adversely affected.  We have also invested in several privatelyheld companies as well as investment funds which invest primarily in privatelyheld companies, many of which can still be considered in the start-up ordevelopment stages.  These investmentsare inherently risky, as the market for the technologies or products they haveunder development are typically in the early stages and may never materialize.

***Foreign Exchange Rate Risk***

We are exposed to foreign currency exchange rate riskbecause most of our sales in China are denominated in Renminbi and portions ofour accounts receivable and payable are denominated in Japanese Yen.  Due to the limitations on convertingRenminbi, we are limited in our ability to engage in foreign currency hedgingactivities in China.  Although the impactof currency fluctuations of Renminbi to date has been slight, fluctuations incurrency exchange rates in the future may have a material adverse effect on ourresults of operations.  The balance ofcash and short-term investment balance held in China was $414.6 million atMarch 31, 2007.  In July 2005, Chinauncoupled the Renminbi from the U.S. dollar and let it float in a narrow bandagainst a basket of foreign currencies. The move revalued the Renminbi by 2.1% against the U.S. dollar.  Additionally, during 2006 and the first threemonths of 2007 we made significant sales in both Japanese Yen and inEuros.  We maintain Japanese Yen bankaccounts for purchasing portions of our inventories and supplies.

Our revenues, earnings and cash flows are subject tofluctuations due to changes in foreign currency exchange rates.  We may hedge currency exposures associatedwith certain assets and liabilities denominated in nonfunctional currencies andcertain anticipated nonfunctional currency transactions using forward foreigncurrency exchange rate contracts.  We havenot hedged any such transactions, and due to the limitations on convertingRenminbi, we are limited in our ability to engage in currency hedgingactivities in China.  As a globalconcern, we face exposure to adverse movements in foreign currency exchangerates.

We have performed a sensitivity analysis as of March 31,2007, using a modeling technique that measures the change in the fair valuesarising from a hypothetical 10% positive or adverse movement in the levels offoreign currency exchange rates relative to the U.S. Dollar, with all othervariables held constant.  The analysiscovers all of our foreign currency contracts offset by the underlyingexposures.  The foreign currency exchangerates used were based on market rates in effect at March 31, 2007.  The sensitivity analysis indicated that ahypothetical 10% movement in foreign currency exchange rates would result in again or loss in the fair values of our foreign exchange financial instrumentsof $3.5 million at March 31, 2007.

75

----

**ITEM 4—CONTROLS AND PROCEDURES**

**Evaluation of Disclosure Controls and Procedures**

UTStarcom, Inc. (“UTStarcom” or the “Company”)maintains disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the reports the Company files orsubmits under the Securities Exchange Act of 1934, as amended (“Exchange Act”),is recorded, processed, summarized and reported within the time periodsspecified in the Securities and Exchange Commission’s (“SEC”) rules and forms,and that such information is accumulated and communicated to the Company’smanagement, including its chief executive officer (“CEO”) and chief financialofficer (“CFO”), as appropriate, to allow timely decisions regarding requiredfinancial disclosure.

In connection with the preparation of this QuarterlyReport on Form 10-Q (“Form 10-Q”), the Company carried out an evaluationas of March 31, 2007 under the supervision and with the participation ofthe Company’s management, including the CEO and CFO, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures, assuch term is defined in Rules 13a-15(e) and 15d-15(e) under the ExchangeAct. Based upon this evaluation, management concluded that as of March 31,2007 the Company’s disclosure controls and procedures were not effectivebecause of the material weaknesses described in “Management’s Annual Report onInternal Control over Financial Reporting,” included in “ITEM 9A**—**CONTROLSAND PROCEDURES” in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2006 (the “Item 9A in the 2006 Annual Report”),which have not yet been fully remediated. Investors are directed to Item9A in the 2006 Annual Report for the description of these weaknesses.

A “material weakness” is a control deficiency in internalcontrol over financial reporting, or a combination of deficiencies in internalcontrol over financial reporting, that results in more than a remote likelihoodthat a material misstatement of the annual or interim consolidated financialstatements will not be prevented or detected. To address these materialweaknesses in internal control over financial reporting noted above, theCompany performed additional analyses and other procedures (as furtherdescribed below under “Management’s Planned Remediation Initiatives and InterimMeasures”) to ensure that the Company’s consolidated financial statements areprepared in accordance with generally accepted accounting principles in theUnited States (“GAAP”). Accordingly, the Company’s management believes that theconsolidated financial statements included in this Form 10-Q fairly present inall material respects the Company’s financial condition, results of operationsand cash flows for the periods presented and that this Form 10-Q does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodscovered by this report.

**Management’s Planned Remediation Initiatives andInterim Measures**

The Company plans to make necessary changes andimprovements to the overall design of its control environment to address thematerial weaknesses in internal control over financial reporting described inItem 9A in the 2006 Annual Report  Inparticular, the Company has implemented during 2006 and the first quarter of2007, and plans to continue to implement during 2007, the specific measuresdescribed below.  In addition, inconnection with the March 31, 2007 quarter-end reporting process, the Companyhas undertaken additional measures described under the subheading “InterimMeasures” below to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of the Company’s consolidated financialstatements included in this Form 10-Q and to ensure that material informationrelating to the Company and its consolidated subsidiaries was made known tomanagement in connection with the preparation of this Form 10-Q.

***Remediation Initiatives***

1.             To remediate the material weakness described in Item 9Ain the 2006 Annual Report, in “1.*The Company did notmaintain an effective control environment*,” the Company has implemented or plans to implement themeasures described below, and will continue to evaluate and may in the futureimplement additional measures. These measures include the following:

a)             *Effective financial reportingprocess, including policies and procedures*—In the fourth quarter of 2006, the Company’s finance departmentcommenced an initiative to update its finance and accounting policies andprocedures. Through this initiative, which was ongoing through the first ninemonths of 2007 and will be ongoing through the rest of 2007, the Company’sfinancial policies and procedures will be reviewed for completeness, accuracyand adequacy, updated and brought current, and standardized globally asnecessary and appropriate. A communication plan will also be developed toensure updated policies and procedures are publicized and understood, andappropriate employees are trained in their application, as necessary. TheCompany expects this initiative will form the foundation for the process tomaintain and keep current its finance and accounting policies and procedures ona go-forward basis. In addition, starting in the fourth quarter of 2006, theCompany commenced internal audits of, and in the remainder of 2007 and 2008plans to continue to expand and increase the scope of its efforts to monitor,controls at the Company’s decentralized and remote operations globally, throughreviews and audits of employee compliance with applicable policies andprocedures at business units, subsidiaries and other locations.

76

----

b)            *Non-compliance withestablished policies and procedures intended to ensure compliance with laws andregulations*—During the secondquarter of 2006, the Company launched a formal investigation at the directionof the Audit Committee of the Company’s Board of Directors (“Audit Committee”)to review alleged violations of the FCPA; refer to “*GovernmentalInvestigations*” under “ITEM3—LEGAL PROCEEDINGS” for additional information. Throughout the courseof this investigation, the Company took 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 addition, in the third and fourthquarters of 2006 and 2007 to date, the Company provided training to personnelin offices in various regions including North America, Europe, and China and,in the remainder of 2007 and in 2008, plans to continue to provide training andexpand its coverage of personnel employed in other regions and countries. Inaddition, 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.

c)             In addition to the specific measures describedabove to address this material weakness in the control environment, the Company’splanned remediation measures include the following:

i.              In November, 2006, the Company hired an assistantcontroller and a shared services manager at its U.S. headquarters whoseresponsibilities include overseeing the corporate accounting and SEC externalfinancial reporting functions. In the first quarter of 2007, the Company hireda vice president of financial operations and a vice president of financialplanning and analysis to provide additional finance personnel at its U.S.headquarters. These personnel have appropriate qualifications, considerabletechnical experience and training in areas including accounting and SECreporting, and in the utilization of the Oracle financial system modules. TheCompany believes the addition of these personnel improves and strengthens thecapabilities of this function.

ii.             In April 2007, the Company created the position ofand hired a new chief ethics officer, to provide focused executive leadershipin the area of corporate ethics and integrity.

iii.            The Company retained and intends to continue toretain the services of outside consultants with relevant accounting experience,skills and knowledge in the application of GAAP, working under the supervisionand direction of the Company’s management, to supplement the Company’s existingcorporate accounting and external financial reporting personnel.

iv.            The Company will continue to hire, and hasallocated resources to hire, additional finance personnel as needs arise and toreplace departures, in the areas of compliance, corporate accounting, externalfinancial reporting, internal audit, revenue accounting and tax, with relevantaccounting experience, skills and knowledge in the application of GAAP.

v.             In the first quarter of 2007, the Companyimplemented a new “management by objectives” system which is being usedglobally to capture corporate and executive management goals and articulatethem throughout the organization, and to cascade and align each employee’sgoals to support corporate objectives. The goal setting, monitoring andevaluation process will incorporate capturing employee’s training and developmentrequirements, including training to stay current with the application of GAAPand the Company’s code of business conduct and ethics.

vi.            During 2007 to date, the Company’s CFO, withassistance from senior financial staff and outside consultants, reviewed and inthe remainder of 2007 will continue to review and adapt the overall design ofthe Company’s financial reporting organization and structure, including theroles and responsibilities of each functional group within the Company.

2.             In addition to the remediation measures describedabove, the Company has implemented or plans to implement the measures describedbelow, and will continue to evaluate and may in the future implement additionalmeasures.

a)             Toremediate the material weaknesses described in Item 9A in the 2006 AnnualReport in section 2. a) over “*instances of overriderelated to controls in China over customer agreements*,” the Company’s planned remediation measures areintended to address material weakness in China that has the potential ofmisstating these balances in the financial statements in future financialperiods. These measures include the following:

77

----

i.                                          Inthe period from January to May 2007, the Company effected personnel changes inthe sales force in China’s western sales region, as well as certain associatedsales offices. The Company believes that these changes will enable effectivemanagement of the China western sales region’s sales operations and enhancecompliance with the Company’s policies and procedures, including the Company’sCode of Business Conduct and Ethics.

ii.                                       TheCompany plans to revise its policies and procedures related to entering intosales contracts, document retention, as well the Code of Business Conduct andEthics to provide for details around the standards for entering into salesagreements and breaches to the Code of Business Conduct and Ethics.

iii.                                    TheCompany plans to implement mandatory training to employees in China’s salesorganization around control consciousness and ongoing training to Sales, ContractManagement and Finance in China around the Company’s policies and procedures,including revenue recognition.

iv.                                   TheCompany plans to review and make improvements to the sales databases to capturerelevant contract information and current status information.

v.                                      TheCompany plans to establish a process around organizing visits by businessoperations and the regional sales managers to the various sales offices inChina to enhance the awareness and compliance with the Company’s polices andprocedures.

b)                                     To remediate the material weaknesses described inItem 9A in the 2006 Annual Report in section 2. b) over “*inventory,including finished goods at customer sites, inventory reserves and deferredcosts accounts and associated cost of sales,*” section 2. c) over “*inventory reserves for losses on customer contracts and associated costof sales*,” and section 2. d) over “*accountingfor warranty reserves and associated cost of sales*”, the Company’splanned remediation measures are intended to address material weaknesses at itsU.S. headquarters that have the potential of misstating these balances in thefinancial statements in future financial periods. These measures include thefollowing:

i.              In November 2006, the Company hired an assistantcontroller and a shared services manager at its U.S. headquarters whoseresponsibilities include overseeing the international cost accounting function.These personnel have considerable experience and training in cost accountingand utilization of the relevant Oracle financial system modules. The Companybelieves the addition of these personnel improves and strengthens thecapabilities for the manual analyses and management review required of thisfunction.

ii.             The Company plans in the remainder of 2007, toenhance its processes and procedures related to properly tracking andconfirming inventory movements to ensure the proper classification ofinventory, including finished goods at customer sites, and deferred costs (andassociated accounts such as purchase price variances), and to ensure thecompleteness and accuracy of the recording of the cost of sales when revenue isrecognized. The revised processes will include involving and obtaining detailedand timely input from business unit, operations and sales operations personnelto enhance the information available for finance to analyze these accounts. Newreports have been developed and reports and procedures will continue to beenhanced as necessary to facilitate the accuracy of accounting for theseprocesses. In addition, finance management has placed increased attention onreviewing in detail the accounting in this area.

c)             To remediate the material weaknesses described inItem 9A in the 2006 Annual Report in section 2. e) over “*accountingfor and disclosure of stock-based compensation expense,*” the Company’splanned remediation measures are intended to address material weaknesses thathave the potential of misstating these balances in the financial statements infuture financial periods. These measures include the following:

i.              In November 2006, the Company announced avoluntary review of its historical equity award grant practices under thedirection of the nominating and corporate governance committee of the board ofdirectors. Upon this announcement, theCompany immediately suspended granting of equity awards and no new equityawards have been granted through the date of filing of this Form 10-Q.

ii.             Further, inNovember 2006, the Company migrated to a new vendor’s system for stock optionsand equity awards administration, selectedin part for its improved processes, systems and controls.

iii.            In April 2007,the Company’s compensation committee of the board of directors approved anequity award grant policy and procedures (“Awards Policy”). Under this AwardsPolicy, the Company has adopted the following equity awards grant processes:

78

----

·              Equity awards will be made only ongrant dates pre-determined in accordance with the Awards Policy.

·              The awards committee (a committee asdefined in the Awards Policy consisting of human resources, legal and financepersonnel, duly formed and authorized by the compensation committee, withspecific, limited authority to approve certain grants of equity awards) willensure completeness and accuracy of the final equity awards grant list.

·              All equity awards will be approvedmonthly, at a meeting of the awards committee, the compensation committee orthe board of directors, as applicable.

·              Internal audit will conduct periodic review of theaccounting records and equity awards grant process.

iv.            Relevantpersonnel at the Company will be provided training in the equity awardsgranting and accounting process.

v.             In April 2007, the Company created the position ofand hired a new chief ethics officer, to provide focused executive leadershipin the area of corporate ethics and integrity.

vi.            During the remainder of 2007, the Company willupdate its record retention policy to specify retention of equity awardrecords.

d)            To remediate the material weaknesses described inItem 9A in the 2006 Annual Report in section 2. f) over “*its processto ensure the complete, accurate and timely preparation and review of itsconsolidated financial statements in accordance with GAAP*”, theCompany’s planned remediation measures are intended to address materialweaknesses at its U.S. headquarters that have the potential of preventing thecomplete, accurate and timely preparation and review of the Company’sconsolidated financial statements in future financial periods. In addition tothe measures described above, these measures include the following:

i.              During the fourth quarter of 2006 and 2007 todate, the Company implemented and in the remainder of 2007 and in 2008, theCompany plans to continue to enhance and improve month and quarter-end closingprocedures within its corporate accounting function to standardize itsprocesses for financial review to ensure that reviewers at its U.S.headquarters analyze and monitor financial information in a consistent andthorough manner. In addition, the Company implemented and plans to continue toimprove new and enhanced procedures within its corporate accounting function toensure that non-routine transactions are identified and escalated to seniorfinancial management during the close process to help ensure proper accountingtreatment.

ii.             During the fourth quarter of 2006 and 2007 todate, the Company implemented and in the remainder of 2007 and in 2008, theCompany plans to continue to enhance and improve the documentation and reviewof required information associated with the preparation of its quarterly andannual filings under the Exchange Act.

***Interim Measures***

Management has not yet implemented and/or tested all ofthe measures described above under the heading “*Remediation Initiatives.*” Nevertheless, management believes the measures identifiedabove (to the extent these have been implemented), together with other measuresundertaken by the Company in connection with preparation of the consolidatedfinancial statements included in this Form 10-Q and described below,address the material weaknesses in internal control over financial reportingdescribed in Item 9A in the 2006 Annual Report and that remain materialweaknesses as of March 31, 2007. These other measures include the following:

1.             The Company retained on an interim basisoutside consultants with relevant accounting experience, skills and knowledge,working under the supervision and direction of the Company’s management, toassist with its review in a number of areas including inventory and reserves,equity award pricing and accounting, and SEC external financial reporting.

2.             The Company implemented and performed anumber of additional detailed procedures and a comprehensive review of itsaccounting in various areas, including:

a)             Inventory cycle counts at a majority of its International inventory locations.

b)            Reconciliation of inventories at customersites to outstanding customer contracts as of quarter end and consideration andanalysis of this inventory for recoverability and potential impairment.

79

----

c)             Review of contract analysis reports andconsolidated revenue schedules from the first quarter of 2007 to determine theproper recording and classification of inventory and deferred costs and therelated cost of goods sold (including associated accounts such as purchaseprice variance).

d)            Analysis of the backlog report, gross marginreport and contract analysis report, enhanced discussions with business unit,operations and sales and services personnel to enhance the informationavailable for finance to analyze, and thorough review of related sales and costinformation to determine the reserves for losses on customer contracts andassociated cost of sales.

e)             Analysis of actual cost reports associatedwith specific warranty reserves, and discussions with business unit, operationsand sales and services personnel to enhance the information available forfinance to analyze and determine the adequacy of liability reserves forwarranty and associated cost of sales.

f)             A variety of manual review procedures, suchas an extensive review of journal entry postings into the Oracle system, athorough review of account reconciliations, and a detailed review at its U.S.headquarters of trial balances including those issued from decentralizedlocations, to ensure the completeness and accuracy of the underlying financialinformation used to generate the consolidated financial statements included inthis Form 10-Q.

3.             As part of theinvestigation of historical sales in China**,**the AuditCommittee retained independent outside counsel and forensic accountants toconduct an investigation of sales in China. The investigation was expanded toconsider sales contracts entered into in the period 2000 to 2006 in China,beyond the Western Region in order to provide adequate coverage percentage ofthe value of sales contracts entered into during the period. The investigationencompassed different procedures depending on the contract type, date andregion in which the contracts were executed. In addition, the accounting andreporting process for the consolidated financial statements for the quarterended March 31, 2007 was extended, thereby allowing the Company time to conductadditional procedures and analyses, to assess the adequacy and accuracy of therelated balances, and to make additional adjustments and disclosures asnecessary to ensure the accuracy of financial reporting.  Additionally, the Company conducted a reviewof a portion of contracts recognized in revenue during the quarter ended March31, 2007, from the Western Region in China, for compliance with revenuerecognition criteria. As part of this review, the Company matched the contractcopies at the China headquarters, regional office and the relevant salesoffice, and analyzed them for terms that might affect revenue recognition. 

***Management’s Conclusion***

Management believes the remediation measures describedunder “Management’s Planned RemediationInitiatives and Interim Measures” above will strengthen the Company’sinternal control over financial reporting and remediate the material weaknessesidentified in “Management’s Annual Report on Internal Control over FinancialReporting.” However, management has not yet implemented all of these measuresand/or tested them.  Management believesthat the interim measures described under “Management’s Planned RemediationInitiatives and Interim Measures” above provide reasonable assurance regardingthe reliability of financial reporting and the preparation of the Company’sfinancial statements included in this Form 10-Q and has discussed this with theCompany’s Audit Committee.

The Company is committed to continuing to improve itsinternal control processes and will continue to diligently and vigorouslyreview its disclosure controls and procedures and its internal control overfinancial reporting in order to ensure compliance with the requirements ofSection 404 of the Sarbanes-Oxley Act of 2002. However, any controlsystem, regardless of how well designed, operated and evaluated, can provideonly reasonable, not absolute, assurance that its objectives will be met. Asmanagement continues to evaluate and work to improve the Company’s internalcontrol over financial reporting, it may determine to take additional oralternate measures to address control deficiencies, and it may determine not tocomplete certain of the measures described under “Management’s Planned Remediation Initiatives and Interim Measures”above.

**Changes in Internal Control over Financial Reporting**

The discussion above under “Management’s Planned Remediation Initiatives and Interim Measures”includes a description of thematerial changes to the Company’s internal control over financial reportingduring the first quarter of 2007 and subsequent to March 31, 2007 thatmaterially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

80

----

**PART II—OTHERINFORMATION**

**ITEM 1—LEGAL PROCEEDINGS**

*Securities Class Action Litigation*

Beginning in October 2004, several shareholder classactions alleging federal securities violations were filed against us andvarious officers and directors of our Company.  The actions have beenconsolidated in United States District Court for the Northern District ofCalifornia under the caption*In reUTStarcom, Inc. Securities Litigation*, Master File No.C-04-4908-JW(PVT).  The lead plaintiffsin the case filed a First Amended Consolidated Complaint on July 26,2005.  The First Amended Complaintalleged violations of the Securities Exchange Act of 1934, and was brought onbehalf of a putative class of shareholders who purchased our stock afterApril 16, 2003 and before September 20, 2004.  On April 13, 2006, the lead plaintiffsfiled a Second Amended Complaint adding new allegations and extending the endof the class period to October 6, 2005. In addition to the Company defendants, theplaintiffs are also suing Softbank. Plaintiffs’ complaint seeks recovery of damages in an unspecifiedamount.

On June 2, 2006, we and the individual defendants filed amotion to dismiss the Second Amended Complaint. On March 21, 2007, the Court granted defendants’ motion and dismissedplaintiffs’ Second Amended Complaint. The Court granted plaintiffs leave to file a Third Amended Complaint,which plaintiffs filed on May 25, 2007. On July 13, 2007, we and the individualdefendants filed a motion to dismiss and a motion to strike the Third AmendedComplaint.

OnSeptember 4, 2007, a second shareholder class action complaint captioned *Peter Rudolph v. UTStarcom, et al.*, CaseNo. C-07-4578 SI, was filed in the United States District Court for theNorthern District of California against us and some of our current and formerdirectors and officers. The complaint alleges violations of the SecuritiesExchange Act of 1934 through undisclosed improper accounting practicesconcerning our historical equity award grants. Plaintiff seeks unspecified damages on behalf of a purported class ofpurchasers of our common stock between July 24, 2002 and September 4, 2007.

Due to the preliminary status of these lawsuits anduncertainties related to litigation, we are unable to evaluate the likelihoodof either a favorable or unfavorable outcome. Accordingly, we areunableat this time to estimate the effects of these complaints on ourfinancial position, results of operations, or cashflows.

*Governmental Investigations*

In September2005, we have receivednotice of a formal inquiry by the staff of the Securities & ExchangeCommission (“SEC”) into certain aspects of our financial disclosures during prior reporting periods and certainother issues.  In addition, in December2005, the U.S. Embassy in Mongolia informed us that it had forwarded to theDepartment of Justice (“DOJ”) allegations that an agent of our Mongolia jointventure had offered payments to a Mongolian government official in possibleviolation of the Foreign Corrupt Practices Act (the “FCPA”).  We, through our Audit Committee, authorizedan independent investigation into possible violations of the FCPA, and we havebeen in contact with the DOJ and SEC regarding the investigation.  The investigation has identified possibleFCPA violations in Mongolia, Southeast Asia, India, and China, as well aspossible violations of U.S. immigration laws. The DOJ has requested that we voluntarily produce documents related tothe investigation and the SEC has subpoenaed us for documents.  We haveexecuted tolling agreements extending the statute of limitations for the FCPAissues under investigation by the SEC and DOJ and the immigrationissues under investigation by the DOJ. At this time, we cannot predict when any inquiry will be completed orwhat the outcome of any inquiry will be.

*Shareholder Litigation*

On November 17, 2006, a shareholder derivative complaintcaptioned *Ernesto Espinoza v. Ying Wu et al.*,Case No. RG06298775, was filed against certain of our current and former officersand directors in the Superior Court of the County of Alameda, California.  The complaint alleges that the individualdefendants, among other things, breached their duties, were unjustly enriched,and violated the California Corporations Code in connection with the timing ofstock option grants.  The complaint namesus as a nominal defendant and seeks unspecified monetary damages against theindividual defendants and various forms of injunctive relief.  On February 2, 2007, we and the individualdefendants filed demurrers against the complaint.  On April 11, 2007, the Court sustainedthe individual defendants’ demurrer, overruled our demurrer, ordered theplaintiff to file an amended complaint, and ordered us to answer the originalcomplaint.  The plaintiff filed anamended complaint and we havefiled an answer to the amended complaint. On August 21, 2007, the individual defendants filed demurrers againstthe amended complaint.  The Courtsustained the individual defendants’ demurrers and ordered the plaintiff tofile a second amended complaint.

Due to the preliminary status of this complaint anduncertainties related to litigation, we are unable to evaluate the likelihoodof either a favorable or unfavorable outcome. Accordingly, we are unable at this time to estimate the effects of thiscomplaint on our financial position, results of operations, or cash flows.

81

----

*IPO Allocation*

On October 31, 2001, a complaint was filed in UnitedStates District Court for the Southern District of New York against us, some ofourdirectors and officers and variousunderwriters for our initial public offering. Substantially similar actions were filed concerning the initial publicofferings for more than 300 different issuers, and the cases were coordinatedas *In re Initial Public Offering SecuritiesLitigation*, 21 MC 92 for pretrial purposes.  In April 2002, a consolidated amendedcomplaint was filed in the matter against us, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604.  Plaintiffs allege violations of theSecurities Act of 1933 and the Securities Exchange Act of 1934 throughundisclosed improper underwriting practices concerning the allocation of IPOshares in exchange for excessive brokerage commissions, agreements to purchaseshares at higher prices in the aftermarket and misleading analyst reports.  Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of our common stock between March 2,2000 and December 6, 2000.  Ourdirectors and officers have been dismissed without prejudice pursuant to astipulation.  On February 19, 2003,the Court granted in part and denied in part a motion to dismiss broughtby defendants including us.  The orderdismissed all claims against us except for a claim brought underSection 11 of the Securities Act of 1933, which alleges that theregistration statement filed in accordance with the IPO was misleading.  In June 2004, a stipulation ofsettlement and release of claims against the issuer defendants, including us,was submitted to the court for approval. The terms of the settlement, if approved, would have dismissed andreleased all claims against the participating defendants (including us).  In August 2005, the Court preliminarilyapproved the settlement.  In December2006, the Court of Appeals for the Second Circuit reversed the Court’s October2004 order certifying a class in six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings.  Our case isnot one of the test cases. Because class certification was a condition of thesettlement, it was unlikely that the settlement would receive final Courtapproval.  On June 25, 2007, the Courtentered an order terminating the proposed settlement based on a stipulationamong the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaintsin the six test cases.  It is unclearwhether there will be any revised or future settlement.  If the litigation proceeds, we believe thatwe have meritorious defenses and intend to defend the action vigorously.  The total amount of the loss associated withthe above litigation is not determinable at this time.  Therefore, we are unable to currentlyestimate the loss, if any, associated with the litigation.

*Passave Litigation*

In November 2005,the Company filed suit in the Superior Court of California, County of SantaClara, against Passave, Inc. (“Passave”) for breaches of contract andwarranties in connection with a semiconductor device sold by Passave, Ltd.(Passave’s wholly-­ownedsubsidiary) to the Company. The Company’s complaint alleges that the Passavedevice, known as the PAS5001M3 chip, has exhibited certain operationalmalfunctions within some of our Fiber-to-the-Home product line, and has therebycaused damage to the Company. The parties entered into a settlement agreement,in favor of the Company dated August 7, 2007, and have since dismissed allclaims with prejudice.

*UTStarcom, Inc. v. Starent Patent InfringementLitigations*

On February 16, 2005, wefiled a suit against Starent for patent infringement in the U.S. District Courtfor the Northern District of California. In the Complaint, we assert that Starent infringes UTStarcom patent U.S.Reg. No.  6,829,473 (“the ’473 patent”)through Starent’s development and testing of a software upgrade for itscustomer’s installed ST-16 Intelligent Mobile Gateways.  We seek declaratory and injunctiverelief.  Starent subsequently filed itsanswer and counterclaims, denying our allegations and seeking a declarationthat the patent-in-suit is not infringed, is invalid, and isunenforceable.  On June 16, 2005, wefiled a motion to strike Starent’s affirmative defense and dismiss Starent’scounterclaim alleging inequitable conduct. On July 19, 2005, the parties stipulated that Starent would file anamended answer and counterclaim by July 27, 2005 and that we would withdraw ourmotion to strike.  On August 10, 2005, weresponded to Starent’s amended counterclaim filed on July 27, 2005.  In earlyDecember 2006, we filed a reissue application for the ‘473 patent with theUnited States Patent and Trademark Office. Starent has also filed for reexamination of the ’473 patent. The reexamination and reissue are currently copending.  The litigation is still in a preliminarystage and its outcome cannot be predicted, although we believe the litigationhas merit.  Nonetheless, we believe thatany adverse judgment on Starent’s counterclaims will not have a materialadverse effect on our business, financial condition, or results of operations.

82

----

On May8, 2007, we filed an additional suit against Starent and sixteen individualdefendants (who were all former employees of 3Com’s CommWorks division which weacquired certain assets of in May of 2003) in the Northern District ofIllinois.  The causes of action includeclaims for patent infringement, misappropriation of trade secrets, intentionalinterference with business relations and prospective economic advantage anddeclarations of ownership of certain patent rights.  In its Complaint, we assert that Starentinfringes UTStarcom patents U. S. Reg. Nos. 7,173,905; 6,978,128; 6,963,582;6,975,900; and 6,684,256 through the manufacture, use, offer, for sale, andsale of Starent’s ST16 Intelligent Mobile Gateway and ST40 multimedia codeplatform, that the individual Defendants and Starent have misappropriatedvaluable Company trade secrets by improperly taking and using our confidentialand proprietary information for the benefit of Starent, that the individualdefendants and Starent have interfered with our business relations andprospective economic advantage by using the misappropriated information toobtain and enhance sales of Starent’s products, and that several of Starent’spatent applications and one issued patent are based on information obtained bythe former employees while at the Company (CommWorks) and on that basis belongto UTStarcom.  We seek compensatorydamages, punitive damages and injunctive relief.  After the court denied the defendants motionto dismiss the misappropriation of trade secrets claims, on August 30, 2007, Starent answered our complaint, denying ourallegations and asserting a number of affirmative defenses and counterclaims,including non-infringement of the subject patents and alleged tortiousinterference with prospective economic advantage.  We have filed a motion to dismiss most of thecounterclaims and the court has ordered appointment of a special master tohandle discovery, which is just beginning. We believe that any adverse judgment on Starent’s counterclaims will nothave a material adverse effect on our business, financial condition or resultsof operations.

*Telemetrix, Inc. Arbitration*

On October 19, 2006, Telemetrix, Inc. (“Telemetrix”)filed a formal Request for Arbitration against us to the World IntellectualProperty Organization (“WIPO”) in Geneva, Switzerland.  The Request for Arbitration sought unspecified damages arising from a contractbetween Telemetrix and Telos Technology, Inc., dated October 22, 2003.  We assumed Telos’ rights and obligationsunder this contract pursuant to ourpurchaseof Telos’ assets on May 19, 2004. Telemetrix alleged nine causes of action, including breach of contract,fraud, negligent misrepresentation, interference with contractual relations,and interference with prospective economic advantage.  In December 2006, we filed a formal responseto the Request for Arbitration, denying all material factual allegationsasserted by Telemetrix.  An arbitrator was selected by the parties, and, on August 2, 2007, the arbitrator granted a pleading motion in favor of usdue to Telemetrix’s failure to allege sufficient facts in support of a majorityof its causes of action.  On August 17,2007, Telemetrix filed an Amended Statement of Claim, alleging six causes ofaction, including breach of contract, fraud, interference with contractualrelations and interference with prospective economic advantage.  The previous hearing date of December 11-13has been vacated.  No hearing date hasbeen rescheduled.  Discovery has begun.

*Telos Technology, Inc.Litigation*

On November 22,2005, plaintiffs Telos Technology, Inc., Telos Technology(Canada), Inc., Telos Technology (Bermuda) Ltd., and TelosEngineering Limited (collectively, the “Telos Plaintiffs”) filed a Complaintagainst the Company in the Superior Court of California, County of Santa Clara.The Complaint alleges five causes of action, including breach of contract,breach of the implied covenant of good faith and fair dealing, fraudulentinducement, intentional misrepresentation and negligent misrepresentation, allof which arise from the Asset Purchase Agreement between the parties datedApril 21, 2004. The Telos Plaintiffs assert that the Company breached theexpress and implied terms of the Asset Purchase Agreement and maderepresentations to the Telos Plaintiffs during negotiations that it neverintended to fulfill. The Telos Plaintiffs sought at least $19 million indamages, unspecified punitive damages and attorneys’ fees. The parties executeda settlement agreement in the amount of $4.5 million on August 20, 2007and the case was dismissed on September 26, 2007 with prejudice.

*Other Litigation*

We area party to other litigation matters and claims that are normal in the course ofoperations, and while the results of such litigation matters and claims cannotbe predicted with certainty, we believe that the final outcome of such matterswill not have a material adverse impact on our financial position or results ofoperations.

83

----

**ITEM 1A—RISK FACTORS**

**FACTORS AFFECTING FUTURE OPERATING RESULTS**

**RISKS RELATED TO OUR COMPANY**

*The restatement of our consolidated financial statementsfollowing the**Nominating and CorporateGovernance Committee’s and management’s review of our past stock optiongranting practices and the Audit Committee’s and management’s review of certainsales in China has resulted in expanded litigation and regulatory proceedingsand may result in future litigation which could harm our financial results*

Our review of ourhistoric option granting practices and certain sales in China has required usto incur substantial expenses for legal, accounting, tax and other professionalservices, has diverted our management’s attention from our business, and couldin the future harm our business, financial condition, results of operations andcash flows.

The Audit Committee of our Board of Directors(“Audit Committee”) engaged independent counsel to conduct an investigation ofsales in China. The independent counsel engaged forensic accountants.The China sales investigation, which commenced in February 2007 and wascompleted in September 2007, covered each of the seven years in the periodended December 31, 2006.  As a result ofthe review, management concluded and recommended to the Audit Committee thatour previously issued financial statements should be restated to defer thesystem sales contract revenue and the related cost of net sales for certainsales arrangements in one region of China found to contain post-contractsupport obligations and recognize such amounts in our consolidated statementsof operations over the estimated period of post-contract support. The AuditCommittee concurred with management’s recommendation.

In November 2006we announced that the Nominating and Corporate Governance Committee of ourBoard of Directors (“Governance Committee”), comprised of independentdirectors, was conducting a voluntary review, with the assistance ofindependent legal counsel and forensic accounting experts (the “Option GrantReview Team”), of our historic option granting practices, the timing of optiongrants and related accounting matters. The review considered all optiongrant awards made in the period from February 29, 2000, shortly before theinitial public offering of our Common Stock, through August 2006 for compliancewith the various stock-based compensation accounting standards applicable aswell as the rules of our stock option plans. Upon completion of the review,management concluded the adjustments to correct errors in stock optionaccounting in our previously issued financial statements for the years endedDecember 31, 1998 and 2000 through 2005, and the quarterly periods of 2005, aswell as in the quarterly periods ended March 31 and June 30, 2006 that arereflected in our consolidated financial statement information included inExhibit 99.1 in our Annual Report on Form 10-K for the year ended December 31,2006 should be made.

In determining therestatement adjustments in connection with the review of our historical optiongranting practices, management used all reasonably available relevantinformation to form conclusions it believes are reasonable as to the mostlikely option granting actions that occurred, the dates when such actionsoccurred, and the determination of grant dates for financial accountingpurposes based on when the requirements of the accounting standards were met.The Option Grant Review Team and management considered various alternativesthroughout the course of the review and restatement; management believesthe  adjustments to measurement datesused in our restatement of our financial statements are reasonable andappropriate in our circumstances.

Our restatement ofpreviously issued financial statements to correct revenue recognition forcertain sales in China and for the effects of past stock options grantingpractices has exposed us to greater risks associated with litigation andregulatory proceedings. We have voluntarily provided information about theconduct of our independent investigation and review, the findings of thereviews, and our conclusions to the staff of the Securities and ExchangeCommission (“SEC”), and are cooperating, and will continue to cooperate fullywith the SEC. In addition, as described in Part II, Item 1, “LegalProceedings,” of this Form 10-Q, several derivative complaints have been filedagainst certain of our current and formerofficers and directors pertaining to allegations relating to stockoption grants. However, our judgments may be challenged in legal proceedings orregulatory reviews, and we could be subject to adverse findings that couldrequire us to again restate our financial statements, to pay damages orpenalties, or have other remedies imposed upon us that could harm our business,financial condition, results of operations and cash flows.  We may also be exposed to legal proceedingsin connection with the results of our investigation of certain sales inChina.  We cannot guarantee that newlawsuits related to the matters resulting in the restatements will not befiled, and we cannot predict the outcome of any current or potential futurelitigation or regulatory proceeding against the Company or our current andformer directors or officers.

*The matters relating to the Audit Committee’s investigationof revenue recognition in China, the Governance Committee’s review of our paststock option granting practice, and the restatement of our consolidatedfinancial statements may otherwise adversely impact our business.*

84

----

As a result of ourdelayed filing of our Quarterly Reports on Form 10-Q for the quarters endedSeptember 30, 2006, March 31, 2007 and June 30, 2007, as well as our Form 10-Kfor the fiscal year ended December 31, 2006, we will be ineligible to registerour securities on Form S-3 for sale by us or resale by others until we havebeen current in our SEC filings for 12 calendar months.  We may use Form S-1 to raise capital, butdoing so could increase transaction costs and the time required to completesuch transactions.

Employees who wereawarded options at a discount from fair market value and were totally orpartially unvested as of December 31, 2004, may be subject to a penaltytax under Internal Revenue Code Section 409A (“Section 409A”) andcorresponding states taxes upon exercise of these stock options. We areconsidering certain actions, which we believe would be in the best interests ofour stockholders and employees that might substantially reduce or eliminate thefederal and state penalty taxes. However, there is no guarantee that we will besuccessful in developing effective measures to address employees’ adverse taxconsequences, and any such measures may cause us to incur additional cash ornoncash compensation expense. Furthermore, such measures, or the failure ofsuch measures, may require the Company to incur substantial expenses for legal,accounting, tax and other professional services and may divert management’sattention from our business, which could in the future harm our business,financial condition, results of operations and cash flows.

*Our future product sales are unpredictable and, as aresult, our operating results are likely to fluctuate from quarter to quarter.*

Our quarterly and annual operating results havefluctuated in the past and are likely to fluctuate in the future due to a varietyof factors, some of which are outside of our control.  Factors that may affect our future operatingresults include:

·             the timing and size of the orders for ourproducts;

·             consumer acceptance of new products we mayintroduce to market;

·             changes in the growth rate of customer purchasesof communications services;

·             the lengthy and unpredictable sales cyclesassociated with sales of our products;

·             revenue recognition, which is based primarily oncustomer acceptance of delivered products, is unpredictable;

·             cancellation, deferment or delay in implementationof large contracts;

·             quality issues resulting from the design ormanufacture of the products, or from the software used in the product;

·             cash collection cycles in China and other emergingmarkets;

·             reliance on product, software and componentsuppliers who may constitute a sole source of supply or may have going concernissues;

·             the decline in business activity we typicallyexperience during the Chinese Lunar New Year, which leads to decreased salesand collections during our first fiscal quarter;

·             issues that might arise from the integration ofacquired entities or the inability to achieve expected results from suchacquisitions; and

·             shifts in our product mix or market focus.

As a result of these and other factors, period-to-periodcomparisons of our operating results are not necessarily meaningful orindicative of future performance.  Inaddition, the factors noted above may make it difficult for us to forecast andprovide in a timely manner public guidance (including updates to priorguidance) related to our projected financial performance.  Furthermore, it is possible that in somefuture quarters our operating results will fall below the expectations of securitiesanalysts or investors.  If this occurs,the trading price of our common stock could decline.

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

We have experienced intense competition in the pastyears, and we believe that we will continue to face intense competition fromboth domestic and international companies in our target markets, many of whichmay operate under lower cost 

85

----

structures or may be given preferential treatment by applicablegovernmental regulators and policies and have much larger sales forces than wedo.  Additionally, other companies notpresently offering competing products may also enter our target markets.  Many of our competitors have significantlygreater financial, technical, product development, sales, marketing and otherresources than we do.  As a result, ourcompetitors may be able to respond more quickly to new or emerging technologiesand changes in service provider requirements. Our competitors may also be able to devote greater resources than we canto the development, promotion and sale of new products.  These competitors may be able to offersignificant financing arrangements to service providers, which may give them acompetitive advantage in selling systems to service providers with limitedfinancial resources.  In many of thedeveloping markets in which we operate or intend to operate, relationships withlocal governmental telecommunications agencies are important to establish andmaintain.  In many such markets, ourcompetitors may have or be able to establish better relationships with localgovernmental telecommunications agencies than we have, which could result intheir ability to influence governmental policy formation and interpretation totheir advantage.  Additionally, ourcompetitors might have better relationships with their third party suppliersand obtain component parts at a reduced rate, allowing them to offer their endproducts at reduced prices.  Moreover,the telecommunications and data transmission industries have experiencedsignificant consolidation, and we expect this trend to continue.  If we have fewer significant customers, wemay be more reliant on such large customers and our bargaining position andprofit margins may suffer.  Increasedcompetition is likely to result in price reductions, reduced gross profit as apercentage of net sales and loss of market share, any one of which couldmaterially harm our business, cash flows and financial condition, includingpotential impairment in value of our tangible and intangible assets andgoodwill if extended losses were incurred.

*We have**incurred net losses in the past and will need to renew our lines ofcredit in China, refinance our convertible subordinated notes, and transfercash from our subsidiaries in China to have sufficient cash resources and liquidity.Our ability to accomplish these actions is not assured, and our ability toraise funds for other purposes is uncertain.*

At March 31, 2007, we had cash and short-term investments of $572.9million to meet our liquidity requirements of which $414.6 million was held byour subsidiaries in China. China imposes currency exchange controls ontransfers of funds outside of China; such controls limit transfers ofapproximately $200 million of our net assets outside of China without firstobtaining the consent of the Chinese government. While we believed the Chinasubsidiaries could freely transfer at least $200 million as of March 31, 2007,the amount of cash available for transfer from the China subsidiaries islimited both by the liquidity needs of the subsidiaries in China and by theChinese government requirements that the China subsidiaries retain adequatecapital levels in China to protect creditors and to have funds available formandated employee benefits.  Additionally,available credit facilities in China at March 31, 2007 totaled$692.7 million, of which $353.5 million was available for working capitalpurposes and $339.2 million was available for use in support of letters ofcredit and corporate guarantees. These credit facilities expire principally inNovember and December 2007, and we had borrowed $103.6 million at March 31,2007 under the working capital portion of the available credit lines and suchborrowings increased to $140.1 million at September 30, 2007. We also haveoutstanding long-term debt outside of China in the form of our convertiblesubordinated notes with a principal balance of $274.6 million that mature inMarch 2008 (the “Notes”).

During the ninemonths ended September 30, 2007 our China subsidiaries made transfers of fundsout of China to the Company totaling $150 million. Although we believe theCompany now has sufficient amount of cash resources to finance the Company’santicipated working capital and capital expenditure requirements for the next12 months, we do not have enough cash outside of China to repay the convertiblenotes maturing in March 2008, and we expect our recent financial performance and financial position will cause the lenders toreduce the total available credit facilities when we negotiate renewals of thelines of credit in China in late 2007. Management’s liquidity plans include a partial or complete refinancingof the convertible notes, renewal of the lines of credit in China, transfers ofadditional cash from its subsidiaries in China to the extent necessary, and, ifneeded, liquidation of certain investments and/or seeking new financingarrangements.  In addition, it may benecessary for us to make significant changes to our business plan to maintainadequate liquidity for at least the next 12 months in the event of variousmatters, such as:

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

·                  changes in China’s currency exchange controlregulations that could limit our ability to access cash in China to meetliquidity requirements outside of China; and

·                  inability to achieve planned operating resultsthat could increase liquidity requirements beyond those considered in our financialplans.

We may desire to raise additional funds for purposes notpresently included in our financial plans such as to develop new or enhancedproducts, respond to competitive pressures, take advantage of acquisitionopportunities or raise capital for strategic purposes. There is no assurancethat additional financing for these or other purposes would be available onacceptable 

86

----

terms or at all. If we raise additional funds through the issuance ofequity securities, our stockholders will experience dilution of their ownershipinterest, and the newly issued securities may have rights superior to those ofcommon stock.  If we raise additionalfunds by issuing debt, our ability to meet our debt service obligations will bedependent upon our future performance, which will be subject to financial,business and other factors affecting our operations, many of which are beyondour control, we may be subject to limitations on our operations, and ourleverage may increase.  The degree towhich we are leveraged could materially and adversely affect our ability toobtain financing for working capital, acquisitions or other purposes and couldmake us more vulnerable to industry downturns and competitive pressures.

*Our ability to meet our obligations under the terms ofour outstanding convertible notes and to continue operations may be compromisedif we are unable to transfer funds from our China operations as needed.*

Duringthe nine months ended September 30, 2007 our China subsidiaries made transfersof funds out of China to the Company totaling $150 million.  Although we believe the Company now hassufficient amount of cash resources to finance the Company’s anticipatedworking capital and capital expenditure requirements for the next 12 months, we do not have enough cash outside ofChina to also repay the convertible notes, aggregating $274.6 million andmaturing on March 1, 2008.  Because we are limitedby the Chinese government’s imposition of currency controls on transfer offunds outside of China, it may be time-consuming, difficult and /or expensivefor us to transfer funds from China to repay the Notes.  As a result, if an Event of Default on theNotes were to occur, we may not have sufficient cash resources to repay theNotes and to continue operations without seeking new financingarrangements.  We cannot be certain thatadditional financing for these purposes would be available on acceptable termsor at all, and if such financing is not available, our business could beseriously harmed.  See the riskfactor entitled “*We face a variety of risksrelated to our convertible subordinated notes”*for a furtherdescription of our obligations under the Notes, our recent consent solicitationof the noteholders and our compliance with certain covenants under the Indenture.

*Sales in China have historically accounted for amaterial portion of our total sales, and our business, financial condition andresults of operations are to a significant degree subject to economic,political and social events, and the performance of our senior managementteam  in China.*

Approximately $785.5 million, or 32%,$870.6 million, or 30%, and $2,028.2 million, or 79%, of our netsales for fiscal years 2006, 2005 and 2004, respectively, occurred inChina.  While we have expanded into othermarkets, we have made substantial investments in China and, therefore, ourbusiness, financial condition and results of operations are to a significantdegree subject to economic, political, legal and social developments and otherevents in China.  In addition, we havehad significant changes within our senior management team in China recently,and our current senior management team as a whole does not have the same degreeof experience in China as our senior management team had in the past. (See therisk factor entitled “*Our success isdependent on continuing to hire and retain qualified personnel, including forsenior management positions, and if we are not successful in attracting andretaining these personnel and in managing key employee turnover, our businesswill suffer”)*.  If our currentsenior management in China cannot maintain and /or establish key relationshipswith customers, governmental entities and others in China, our business inChina may decline significantly. If our business in China declines, ourfinancial condition and results of operations may be significantly harmed.

*The average selling prices of our products maydecrease, which may reduce our revenues and our gross profit.  As a result, we must introduce new productsand reduce our costs in order to maintain profitability.*

The average selling prices for communications access andswitching systems and handsets have historically declined as a result of anumber of factors, including:

·             increased competition;

·             aggressive price reductions by competitors;

·             rapid technological change; and

·             constant change in customer buying behavior andmarket trends.

The average selling prices of our products may continueto decrease in the future in response to product introductions by us or ourcompetitors or other factors, including price pressures from customers.  Certain of our products, including wirelesshandsets, have historically had low gross profit margins, and any furtherdeterioration of our profit margins on such products could result in losses withrespect to such products.  Therefore, wemust continue to develop, source and introduce new products 

87

----

and enhancements to existing products that incorporate features that canbe sold at higher average selling prices. Failure to do so or the failure of consumers or our direct customers toaccept such new products could cause our revenues and gross profit to decline.

Our cost reduction efforts initiated in 2005 and oursubsequent efforts in the remainder of 2007 and early 2008 may not allow us tokeep pace with competitive pricing pressures or lead to improved gross profit,as a percentage of net sales.  In orderto be competitive, we must continually reduce the cost of manufacturing ourproducts through design and engineering changes.  We may not be successful in these efforts orin delivering our products to market in a timely manner.  In addition, any redesign may not result insufficient cost reductions to allow us to reduce the prices of our products toremain competitive or to improve or maintain our gross profit, as a percentageof net sales, which would cause our financial results to suffer.

*Our market is subject to rapid technological change,and to compete effectively, we must continually introduce new products andproduct enhancements that achieve market acceptance.*

The market for communications equipment is characterizedby rapid technological developments, frequent new product introductions,changes in consumer preferences and evolving industry and regulatorystandards.  Our success will depend inlarge part on our ability to enhance our technologies and develop and introducenew products and product enhancements that anticipate changing service providerrequirements, technological developments and evolving consumer preferences.  We may need to make substantial capitalexpenditures and incur significant research and development costs to developand introduce new products and enhancements. If we fail to develop and introduce new products or enhancements to existingproducts that effectively respond to technological change on a timely basis,our business, financial condition and results of operations could be materiallyadversely affected.  Certain of ourproducts, including wireless handsets, have a short product life.  Moreover, from time to time, our competitorsor we may announce new products or product enhancements, technologies orservices that have the potential to replace or shorten the life cycles of ourproducts and that may cause customers to defer purchasing our existingproducts, resulting in charges for inventory obsolescence reserves.  Future technological advances in thecommunications industry may diminish or inhibit market acceptance of ourexisting or future products or render our products obsolete.  Even if we are able to develop and introducenew products, they may not gain market acceptance.  Market acceptance of our products will dependon various factors, including:

·             our ability to obtain necessary approvals fromregulatory organizations within the countries in which we operate and for anynew technologies that we introduce;

·             the length of time it takes service providers toevaluate our products, causing the timing of purchases to be unpredictable;

·             the compatibility of our products with legacytechnologies and standards existing in previously deployed network equipment;

·             our ability to attract customers who may havepre-existing relationships with our competitors;

·             product pricing relative to performance;

·             the level of customer service available to supportnew products; and

·             the timing of new product introductions meetingdemand patterns.

If our products fail to obtain market acceptance in atimely manner, our business and results of operations could suffer.

*We depend on some sole source and key suppliers forhandsets, base stations, components and materials used in our products.  If we cannot secure adequate supplies of highquality products at competitive prices or in a timely manner from thesesuppliers or sources, or if the suppliers successfully market their products directlyto our customers, our competitive position, reputation and business could beharmed.*

We have contracts with a limited group of suppliers topurchase some components and materials used in our products.  If any supplier is unwilling or unable toprovide us with high-quality components and materials in the quantitiesrequired and at the costs specified by us, we may not be able to findalternative sources on favorable terms, in a timely manner, or at all.  Further, a supplier could market its productsdirectly to our customers.  Thepossibility of a supplier marketing its own products would create directcompetition and may affect our ability to obtain adequate supplies.  Our inability to obtain or to develop 

88

----

alternative sources if and as required could result in delays orreductions in manufacturing or product shipments.  From time to time, there could be shortagesof certain products or components. Moreover, our suppliers may supply us with inferior qualityproducts.  If an inferior productsupplied by a third party is embedded in our end product and causes a problem,it might be difficult to identify the source of the problem as being due to thecomponent parts.  If any of these eventsoccur, our competitive position, reputation and business could suffer.

Our ability to source a sufficient quantity ofhigh-quality, cost-effective components used in our products may also belimited by import restrictions and duties in the foreign countries in which wemanufacture our products.  We require asignificant number of imported components to manufacture our products, andimported electronic components and other imported goods used in the operationof our business may be limited by a variety of permit requirements, approvalprocedures, patent infringement claims, import duties and licensingrequirements.  As an example, a recentcourt case between a third party and one of our suppliers involved a patentdispute potentially restricting the importation of handsets into the U.S.  While this case has been resolved in thesupplier’s favor at the trial court level, our supply of products could beaffected by similar cases in the future. Moreover, import duties on such components increase the cost of ourproducts and may make them less competitive.

*Product defects or performance quality issues couldcause us to lose customers and revenue or to incur unexpected expenses.*

Many of our products are highly complex and may have qualitydeficiencies resulting from the design or manufacture of such product, or fromthe software or components used in the product. For example, during 2005 we recorded warranty charges of$70.6 million, including special warranty charges of $11.7 millionfor certain asynchronous digital subscriber line (“ADSL”) products,$4.0 million for NetRingTM equipment and $14.9 million for GEPONequipment sold to SBBC, an affiliate of SOFTBANK CORP and SOFTBANKAmerica Inc., during 2003 and 2004. Often these issues are identified prior to the shipment of the productsand may cause delays in market acceptance of our products, delays in shippingproducts to customers, or the cancellation of orders.  In other cases, we may identify the qualityissues after the shipment of products. In such cases, we may incur unexpected expenses and diversion ofresources to replace defective products or correct problems.  Such pre-shipment and post-shipment qualityissues could result in delays in the recognition of revenue, loss of revenue orfuture orders, and damage to our reputation and customer relationships.  In addition, we may be required to paydamages for failed performance under certain customer contracts, and mayreceive claims from customers related to the performance of our products.  Such pre-shipment and post-shipment quality issuescould result in delays in the recognition of revenue, loss of revenue or futureorders, and damage to our reputation and customer relationships.  In addition, we may be required to paydamages for failed performance under certain customer contracts and may receiveclaims from customers related to the performance of our products.

*Our global diversification strategy and growth hasstrained our resources, adversely affected our reported gross margins, and ifwe are unable to manage this growth, our future operating results will befurther negatively affected.*

Over the last four years we have experienced a rapidexpansion of our international operations and anticipate that we must continueto transform our operations to address market demands and potential marketopportunities globally.

Competition in international markets for new serviceprovider customers and for new infrastructure deployments is particularlyintense and increasingly focused on price. To meet competitive offerings we mayaccept contracts with low profitability or even enter into contracts withanticipated losses if we believe it is necessary to establish a relationshipwith a customer or a presence in a market that we consider important to ourinternational expansion strategy. We believe these decisions will facilitatethe development of our international business, but we can provide no assurancethat they will. Accepting a contract with an anticipated loss requires us torecognize a provision for the entire loss in the period in which it becomesevident rather than in later periods in which contract performance occurs.Accepting contracts with low gross margins adversely affects our reportedresults when the revenues from such contracts are recognized; in some casesrevenue recognition must be deferred until all revenue recognition criteriahave been met, and this would result in recognizing the adverse effects of lowgross margin contracts in periods subsequent to when contract performanceoccurred.

Our transformation to a global focus will place asignificant strain on our management, operational, financial and otherresources.  To manage this transformationeffectively, we will need to take various actions, including:

·             enhancing management information systems,including forecasting procedures;

·             further developing our operating, administrative,financial and accounting systems and controls;

·             managing our working capital and sources offinancing;

89

----

·             maintaining close coordination among ourengineering, accounting, finance, marketing, sales and operationsorganizations;

·             retaining, training and managing our employeebase;

·             enhancing human resource operations and improvingemployee hiring and training programs;

·             reorganizing our business structure to moreeffectively allocate and utilize our internal resources;

·             improving and sustaining our supply chaincapability; and

·             managing both our direct and indirect saleschannels in a cost-efficient and competitive manner.

If we fail to implement or improve systems or controls orto manage any future growth and transformation effectively, our business couldsuffer.

*Any failure by us to execute planned cost reductionssuccessfully could result in total costs and expenses that are greater thanexpected.*

From time to time we have undertaken restructuring plansto bring operational expenses to appropriate levels for each of our businesses,while simultaneously implementing extensive new company-wide expense-controlprograms.  For example, in 2005, weannounced workforce restructurings. These programs resulted in the termination of approximately 1,595employees worldwide through December 31, 2005.  We anticipate making further workforcereductions and taking additional rebalancing actions in the future.  In October 2007, our Board ofDirectors approved a restructuring plan which includes a worldwide reduction inforce of approximately 11% of the Company’s headcount, or approximately 700employees.  We expect cost savings from planned restructuring activities to be usedto offset market forces or to be reinvested in our businesses to strengthen ourcompetitiveness, but we cannot be certain that we will be successful in theseefforts.  Significant risks associatedwith these actions and other workforce management issues that may impair ourability to achieve anticipated cost reductions or may otherwise harm ourbusiness include delays in implementation of anticipated workforce reductionsin highly regulated locations outside of the United States, particularly inEurope and Asia, redundancies among restructuring programs, decreases inemployee morale and the failure to meet operational targets due to the loss ofemployees, particularly sales employees.

*Our success is dependent on continuing to hire andretain qualified personnel, including for senior management positions, and ifwe are not successful in attracting and retaining these personnel and inmanaging key employee turnover, our business will suffer.*

The success of our business depends in significant partupon the continued contributions of key technical and senior managementpersonnel, many of whom would be difficult to replace.  In particular, our success depends in largepart on the knowledge, expertise and services of Hong Liang Lu, our ChiefExecutive Officer, Peter Blackmore, our President and Chief Operating Officer,Francis P. Barton, Executive Vice President and Chief Financial Officer andPhilip Christopher, President and Chief Executive Officer of our PersonalCommunications Division.  The loss of anykey employee, the failure of any key employee to perform satisfactorily in hisor her current position or our failure to attract and retain other keytechnical and senior management employees could have a significant negativeimpact on our operations.  We have hadsignificant changes within our senior management team recently, and our currentsenior management team as a whole does not have the same degree of experiencein China as our senior management  had inthe past.  If our current seniormanagement cannot maintain and/or establish key relationships with customers,governmental entities and others in China, our business in China may declinesignificantly and our financial condition and results of operations may besignificantly harmed.

Notwithstanding our workforce restructurings, toeffectively manage our operations, we will need to recruit, train, assimilate,motivate and retain qualified employees both locally and internationally.  Competition for qualified employees isintense, and the process of recruiting personnel in all fields, including technology,research and development, sales and marketing, administration and managementwith the combination of skills and attributes required to execute our businessstrategy can be difficult, time-consuming and expensive.  As we grow globally, we must implement hiringand training processes that are capable of quickly deploying qualified localresidents to knowledgeably support our products and services.  Alternatively, if there is an insufficientnumber of qualified local residents available, we might incur substantial costsimporting expatriates to service new global markets.  For example, we have historically experienceddifficulty finding qualified accounting personnel knowledgeable in both U.S.and Chinese accounting standards who are Chinese residents.  If we fail to attract, hire, 

90

----

assimilate or retain qualified personnel, our business would beharmed.  Competitors and others have inthe past, and may in the future, attempt to recruit our employees.  In addition, companies in thetelecommunications industry whose employees accept positions with competitorsfrequently claim that the competitors have engaged in unfair hiringpractices.  We may be the subject ofthese types of claims in the future as we seek to hire qualifiedpersonnel.  Some of these claims mayresult in material litigation and disruption to our operations.  We could incur substantial costs in defendingourselves against these claims, regardless of their merit.

*Any acquisitions and divestitures that we undertakecould be difficult to integrate, disrupt our business, dilute our stockholdersand harm our operating results.*

We have acquired and divested certain businesses,products and technologies.  Anticipatedbenefits of these acquisitions and divestitures may not be realized.  We have in the past and will continue toevaluate acquisition prospects that would complement our existing productofferings, augment our market coverage, enhance our technological capabilities,or that may otherwise offer growth opportunities.  Acquisitions may result in dilutive issuancesof equity securities, use of our cash resources, the incurrence of debt and theamortization of expenses related to intangible assets.  In addition, acquisitions involve numerousrisks, including difficulties in the assimilation of operations, technologies,products and personnel of the acquired company, diversion of management’sattention from other business concerns, risks of entering markets in which wehave no direct or limited prior experience, the potential loss of key employeesof the acquired company, unanticipated costs and, in the case of theacquisition of financially troubled businesses, challenges as to the validityof such acquisitions from third party creditors of such businesses. Forexample, in the fourth quarter 2004, we encountered difficulties in integratingHyundai Syscomm, Inc. (“HSI”) legacy operations into our operations anddetermined to abandon a substantial amount of HSI’s legacy operations.  As a result, in the fourth quarter 2004, wewrote off the entire goodwill and intangibles associated with HSI.

*We may be unable to adequately protect the loss ormisappropriation of our intellectual property, which could substantially harmour business.*

We rely on a combination of patents, copyrights,trademarks, trade secret laws and contractual obligations to protect ourtechnology.  We have applied for patentsin the United States and internationally. Additional patents may not be issued from our pending patentapplications, and our issued patents may not be upheld.  In addition, we have, from time to time,chosen to abandon previously filed patent and trademark applications.  Moreover, we may face difficulties inregistering our existing trademarks in new jurisdictions in which we operate,and we may be forced to abandon or change product or service trademarks becauseof the unavailability of our existing trademarks or because of oppositionsfiled or legal challenges to our trademark filings.  We cannot guarantee that the intellectualproperty protection measures that we have taken will be sufficient to preventmisappropriation of our technology or trademarks or that our competitors willnot independently develop technologies that are substantially equivalent orsuperior to ours.  In addition, the legalsystems of many foreign countries do not protect or honor intellectual propertyrights to the same extent as the legal system of the United States.  For example, in China, the legal system ingeneral, and the intellectual property regime in particular, are still in the developmentstage.  It may be very difficult,time-consuming and costly for us to attempt to enforce our intellectualproperty rights in these jurisdictions.

*We may be subject to claims that we infringe theintellectual property rights of others, which could substantially harm ourbusiness.*

The industry in which we compete is moving towardsaggressive assertion, licensing, and litigation of patents and otherintellectual property rights.  From timeto time, we have become aware of the possibility or have been notified that wemay be infringing certain patents or other intellectual property rights ofothers.  Regardless of their merit,responding to such claims could be time consuming, divert management’sattention and resources and cause us to incur significant expenses.  In addition, although some of our suppliercontracts provide for indemnification from the supplier with respect to lossesor expenses incurred in connection with any infringement claim, certain contractswith our key suppliers do not provide for such protection.  Moreover, certain of our sales contractsprovide that we must indemnify our customers against claims by third partiesfor intellectual property rights infringement related to our products.  There are no limitations on the maximum potentialfuture payments under these guarantees. Therefore, we may incur substantial costs related to any infringementclaim, which may substantially harm our results of operations and financialcondition.

We have been and may in the future become subject tolitigation to defend against claimed infringements of the rights of others orto determine the scope and validity of the proprietary rights of others.  Future litigation may also be necessary toenforce and protect our patents, trade secrets and other intellectual propertyrights.  Any intellectual propertylitigation or threatened intellectual property litigation could be costly, andadverse determinations or settlements could result in the loss of ourproprietary rights, subject us to significant liabilities, require us to seeklicenses from or pay royalties to third parties which 

91

----

may not be available on commercially reasonable terms, if at all, and/orprevent us from manufacturing or selling our products, which could causedisruptions to our operations.

In the event that there is a successful claim ofinfringement against us and we fail to develop non-infringing technology orlicense the proprietary rights on commercially reasonable terms and conditions,our business, results of operations and financial condition could be materiallyand adversely impacted.

*Our multinational operations subject us to variouseconomic, political, regulatory and legal risks.*

We market and sell our products globally, with asignificant portion of our sales made in China. The expansion of our existing multinational operations and entry intonew markets will require significant management attention and financialresources.  Multinational operations aresubject to a variety of risks, such as:

·             the burden of complying with a variety of foreignlaws and regulations;

·             the burden of complying with United States lawsand regulations for foreign operations, including the Foreign Corrupt PracticesAct;

·             difficulty complying with continually evolving andchanging global product and communications standards and regulations for bothour end products and their component technology;

·             market acceptance of our new products, includinglonger product acceptance periods in new markets into which we enter;

·             reliance on local original equipment manufacturers(“OEMs”), third party distributors and agents to effectively market and sellour products;

·             unusual contract terms required by customers indeveloping markets;

·             changes in local governmental control or influenceover our customers;

·             changes to import and export regulations,including quotas, tariffs, licensing restrictions and other trade barriers;

·             the burden of compliance with complex and varyingtaxation requirements of multiple jurisdictions;

·             evolving and unpredictable nature of the economic,regulatory, competitive and political environments;

·             reduced protection for intellectual propertyrights in some countries;

·             unproven business operation models developed oroperated in specific countries or regions;

·             longer accounts receivable collection periods; and

·             difficulties and costs of staffing, monitoring andmanaging multinational operations, including but not limited to internalcontrols and compliance.

*We do business in markets that are not fullydeveloped, which subjects us to various economic, political, regulatory andlegal risks unique to developing economies.*

Less developed markets present additional risks, such asthe following:

·             customers that may be unable to pay for ourproducts in a timely manner or at all;

·             new and unproven markets for our products and thetelecommunications services that our products enable;

·             lack of a large, highly trained workforce;

92

----

·             difficulty in controlling local operations fromour headquarters;

·             variable ethical standards and an increased potentialfor fraud;

·             unstable political and economic environments; and

·             lack of a secure environment for our personnel,facilities and equipment.

In particular, these factors create the potential forphysical loss of inventory and misappropriation of operating assets.  We have in the past experienced cases ofvandalism and armed theft of our equipment that had been or was being installedin the field.  If disruptions for any ofthese reasons become too severe in any particular market, it may become necessaryfor us to terminate contracts and withdraw from that market and suffer theassociated costs and lost revenue.

*Our wireless handset products are subject to a widerange of environmental, health and safety laws, and may expose us to potentialhealth and environmental liability claims.*

Our handset products are subject to a wide range ofenvironmental, health and safety laws, including laws relating to the use,disposal and clean up of, and human exposure to hazardous substances.  In the United States, these laws oftenrequire parties to fund remedial action regardless of fault.  Factors such as the discovery of additionalcontaminants, the extent of remediation and compliance expenses, and theimposition of additional clean up obligations could cause us to incursubstantial costs relating to remediation activities.  Compliance with existing or futureenvironmental, health and safety laws could also cause us to incur substantialcosts relating to such compliance, including the expense of modifying productdesigns and manufacturing processes.  Inaddition, restrictions on the use of certain materials in our facilities orproducts in the future could have a negative impact on our operations.

Additionally, there have been claims made alleging a linkbetween the use of wireless handsets and the development or aggravation ofcertain cancers, including brain cancer. The scientific community is divided onwhether there is a risk from wireless handset use, and if so, the magnitude ofthe risk.  Even if there is no link establishedbetween wireless handset use and cancer, the negative publicity and possiblelitigation could have a material adverse effect on our business.  In the past, several plaintiffs’ groups havebrought class actions against wireless handset manufacturers and distributors,alleging that wireless handsets have caused cancer.  To date, we have not been named in any ofthese actions and none of these actions has been successful.  In the future we could incur substantialcosts in defending ourselves against similar claims, regardless of theirmerit.  Also, claims may be successful inthe future and may have a material adverse effect on our business.

Furthermore, there have been claims made alleging a linkbetween the use of Bluetooth enabled mobile phone handsets and noise-inducedhearing loss.  To date, we have not beennamed in any of these actions.  In thefuture we could incur substantial costs in defending ourselves against similarclaims, regardless of their merit.  Also,claims may be successful in the future and may have a material adverse effecton our business.

*We are subject to a wide range of environmental,health and safety laws and efforts to comply with such laws may be costly andmay adversely impact our financial performance.*

Our operations and the products we manufacture and/orsell are subject to a wide range of global environmental, health and safetylaws.  Compliance with existing or futureenvironmental, health and safety laws could subject us to future costs,liabilities, impact our production capabilities, constrict our ability to sell,expand or acquire facilities and generally impact our financialperformance.  Some of these laws relateto the use, disposal, clean up of, and exposure to hazardous substances.  In the United States, laws often requireparties to fund remedial studies or action regardless of fault.  Over the last several years, the EuropeanUnion (the “EU”) countries have enacted environmental laws regulatingelectronic products.  For example,beginning July 1, 2006, our products have been subject to laws thatmandate the recycling of waste in electronic products sold in the EU and thatlimit or prohibit the use of certain substances in electronic products.  Other countries outside of Europe areexpected to adopt similar laws.  We mayincur additional expenses to comply with these laws.

*Currency rate fluctuations and exchange controls mayadversely affect our cash flow and operating results.*

Because a significant percentage of our sales are made inforeign countries and denominated in local currency, we are exposed to marketrisk for changes in foreign exchange rates on our foreign currency denominatedaccounts and notes receivable balances. Historically, the majority of our sales have been made in China anddenominated in Renminbi.  Prior toJuly 2005, the impact of currency fluctuations of Renminbi wereinsignificant as it was fixed to the U.S. dollar.  However, in July 2005, China 

93

----

uncoupled the Renminbi from the U.S. dollar and let it float in a narrowband against a basket of foreign currencies. The move revalued the Renminbi by 2.1% against the U.S. dollar; however,it is uncertain what further adjustments may be made in the future.  The Renminbi-U.S. dollar exchange rate couldfloat, and the Renminbi could appreciate relative to the U.S. dollar.  For example, the Renminbi-U.S. dollarexchange rate was 8.28 to the U.S. dollar prior to the float of the Renminbi inJuly 2005 and 7.74 Renminbi to the U.S. dollar at March 31, 2007.  Any significant revaluation of the Renminbimay materially and adversely affect our cash flows, revenues, operating resultsand financial position.

Outside of China, our primary foreign currency exposureshave related to non-dollar denominated sales and purchases in Japan, Europe andCanada.  Additionally, we have exposuresto emerging market currencies, which can have extreme currency volatility.  We have experienced material adverse impactson our results of operations from fluctuations in currency exchange rates andmay continue to do so in the future.

We may, from time to time, enter into foreign exchangeforward contracts to minimize the short-term impact of foreign currencyfluctuations on certain foreign currency receivables and payables.  Our attempts to hedge against these risks maynot be successful, resulting in an adverse impact on our results ofoperations.  Moreover, some of theforeign countries in which we do business might impose currency restrictionsthat may limit the ability of our subsidiaries and joint ventures in suchcountries to obtain and remit foreign currency necessary for the purchase ofimported components and may limit our ability to obtain and remit foreigncurrency in exchange for foreign earnings. For example, China employs currency controls restricting Renminbi conversion,limiting our ability to engage in currency hedging activities in China.  Various foreign exchange controls may alsomake it difficult for us to repatriate earnings, which could have a materialadverse effect on our ability to conduct business globally.

*Business interruptions could adversely affect ourbusiness.*

Our operations are vulnerable to interruption by fire,earthquake, power loss, telecommunications failure, external interference withour information technology systems, incidents of terrorism and other eventsbeyond our control.  For example, ourHangzhou manufacturing facility’s ability to produce sufficient products isdependent upon a continuous power supply. However, the Hangzhou facility has in the past been subject to powershortages, which has affected our ability to produce and ship sufficientproducts.  Also, our operations inAlameda, California are located in an area prone to earthquakes.  We do not have a detailed disaster recoveryplan, and the occurrence of any events like these that disrupt our businesscould harm our business and operating results.

*We may suffer losses with respect to equipment held atcustomer sites, which could harm our business.*

We face the risk of loss relating to our equipment heldat customer sites.  In some cases, ourequipment held at customer sites is under contract, pending final acceptance bythe customer.  We generally do not holdtitle or risk of loss on such equipment, as title and risk of loss aretypically transferred to the customer upon delivery of our equipment.  However, we do not recognize revenue andaccounts receivable with respect to the sale of such equipment until we obtainacceptance from the customer.  If we donot obtain final acceptance, we may not be able to collect the contract priceand recover this equipment or its associated costs.  In other cases, particularly in China, wheregovernmental approval is required to finalize certain contracts, inventory notunder contract may be held at customer sites. We hold title and risk of loss on this inventory until the contracts arefinalized and, as such, are subject to any losses incurred resulting from anydamage to or loss of this inventory.

If our contract negotiations fail or if the government ofChina otherwise delays approving contracts, we may not recover or receivepayment for this inventory.  Moreover,our insurance may not cover all losses incurred if our inventory at customersites not under contract is damaged prior to contract finalization.  If we incur a loss relating to inventory forany of the above reasons, our financial condition, cash flows, and operatingresults could be harmed.

*Restrictions on the use of handsets while drivingcould affect our future growth.*

Several foreign governments and U.S. state and localgovernments have adopted or are considering adopting legislation that wouldrestrict or prohibit the use of wireless handsets while driving.  Widespread legislation that restricts orprohibits the use of wireless handsets while driving could negatively affectour future growth.

94

----

*We have been named as a defendant in securitieslitigation and other lawsuits, as well as lawsuits in the ordinary course ofbusiness.*

Currently, we are a defendant in securities litigationclass action lawsuits, as well as other lawsuits.  Additionally, from time to time we areplaintiffs or defendants in other lawsuits including lawsuits in the ordinarycourse of our business.  The pursuit ordefense of these lawsuits may divert our management’s attention, and we mayincur significant expenses in pursuing or defending these lawsuits.  In addition, we may be required to payjudgments or settlements that could have a material adverse effect on ourresults of operations, financial condition and liquidity.

*We face risks related to pending governmentalinquiries.*

In September 2005, we received notice of a formal inquiryby the staff of the Securities & Exchange Commission (“SEC”) intocertain aspects of our financial disclosures during prior reporting periods andcertain other issues.  In addition, inDecember 2005, the U.S. Embassy in Mongolia informed us that it hadforwarded to the Department of Justice (“DOJ”) allegations that an agent of ourMongolia joint venture had offered payments to a Mongolian government officialin possible violation of the Foreign Corrupt Practices Act (the “FCPA”).  We, through our Audit Committee, authorizedan independent investigation into possible violations of the FCPA, and we havebeen in contact with the DOJ and SEC regarding the investigation.  The investigation has identified possibleFCPA violations in Mongolia, Southeast Asia, India and China, as well aspossible violations of U.S. immigration laws. The DOJ has requested that the Company voluntarily produce documents relatedto the investigation and the SEC has subpoenaed the Company fordocuments.  The Company has executed tolling agreements extending thestatute of limitations for the FCPA issues under investigation by the SEC andthe DOJ and the immigration issues under investigation by the DOJ.  At this time, we cannot predict when anyinquiry will be completed or what the outcome of any inquiry will be.  These inquiries could harm relationships withexisting customers and our ability to obtain new customers and partners.  If the SEC or the DOJ makes a determinationthat we have violated federal laws, we may face sanctions including, but notlimited to, fines, disgorgement and an injunction.  Additionally, such a determination by the SECor the DOJ could adversely affect our business, results of operations,financial position and cash flow, and ultimately our stock price.

We have also been in communication with the SEC regardingour voluntary review of our historical option grant awards grant practices andour review of certain historical sales contracts in China.  Although we have now completed both of thosevoluntary reviews, it is possible that the SEC may question the findings of ourreviews or initiate its own review into related matters.

It is possible that the findings and outcome of any ofthese inquiries may affect other lawsuits that are pending.  These inquiries could divert managementattention and resources, which could harm our business.

*Failure to achieve and maintain effective internalcontrols in accordance with Section 404 of the Sarbanes-Oxley Act of2002 could have a material adverse effect on our business and stock price.*

Section 404 of the Sarbanes-Oxley Act of 2002(“Sarbanes-Oxley Act”) requires that we establish and maintain anadequate internal control structure and procedures for financial reporting andinclude a report of management on our internal control over financialreporting.  Our annual report onForm 10-K must contain an assessment by management of the effectiveness ofour internal control over financial reporting and must include disclosure ofany material weaknesses in internal control over financial reporting that wehave identified.  In addition, ourindependent registered public accounting firm must attest to and report onmanagement’s assessment of the effectiveness of our internal control overfinancial reporting.

We have identified material weaknesses in our internalcontrol over financial reporting.  See “PartI Item 4 — Controls and Procedures—Management’s Report on Internal Control OverFinancial Reporting.”  As of the date ofthis quarterly report on Form 10-Q, we are still in the process ofimplementing remedial measures related to the material weaknesses identified in2004 through 2006.  If our efforts toremediate the weaknesses we identified are not successful, our business andoperating results could be harmed and the reliability of our financialstatements could be impaired, which could adversely affect our stockprice.  The requirements ofSection 404 of the Sarbanes-Oxley Act are ongoing and also apply tofuture years.  We expect that ourinternal control over financial reporting will continue to evolve as wecontinue in our efforts to transform our business.  Although we are committed to continue toimprove our internal control processes and we will continue to diligently andvigorously review our internal control over financial reporting in order toensure compliance with the Section 404 requirements, any control system,regardless of how well designed, operated and evaluated, can provide onlyreasonable, not absolute, assurance that its objectives will be met.  In addition, successful remediation of thenoted control deficiencies is dependent on the Company’s ability to hire andretain qualified personnel.  Therefore,we cannot be certain that in the future additional material weaknesses orsignificant deficiencies will not exist or otherwise be discovered.

95

----

**RISKS RELATED TO CONDUCTING BUSINESS IN CHINA**

*China’s governmental and regulatory reforms may impactour ability to do business in China.*

Since 1978, the Chinese government has been in a state ofevolution and reform.  The reforms haveresulted in and are expected to continue to result in significant economic andsocial development in China.  Many of thereforms are unprecedented or experimental and may be subject to change orreadjustment due to a variety of political, economic and social factors.  Multiple government bodies are involved inregulating and administering affairs in the telecommunications and informationtechnology industries, among which the Ministry of Information Industry (“MII”),the National Development and Reform Commission (“NDRC”), the State-ownedAssets Supervision and Administration Commission (“SASAC”) and the StateAdministration of Radio, Film and Television (“SARFT”) play the leadingroles.  These government agencies havebroad discretion and authority over all aspects of the telecommunications andinformation technology industry in China, including but not limited to, settingthe telecommunications tariff structure, granting carrier licenses andfrequencies, approving equipment and products, granting product licenses,approving of the form and content of transmitted data, specifying technologicalstandards as well as appointing carrier executives, all of which may impact ourability to do business in China.

Any of the following changes in China’s political andeconomic conditions and governmental policies could have a substantial impacton our business:

·             the promulgation of new laws and regulations andthe interpretation of those laws and regulations;

·             inconsistent enforcement and application of thetelecommunications industry’s rules and regulations by the Chinese governmentbetween foreign and domestic companies;

·             the restructuring of telecommunications carriersin China, including policy making governing 3G network infrastructure andlicensing;

·             restrictions on IPTV license grants, which couldlimit the potential market for our products;

·             the introduction of measures to control inflationor stimulate growth;

·             the introduction of new guidelines for tariffs andservice rates, which affect our ability to competitively price our products andservices;

·             changes in the rate or method of taxation;

·             the imposition of laws, rules or regulationsaffecting the direct or indirect nationalization of assets controlled bynon-governmental persons or entities;

·             the imposition of additional restrictions oncurrency conversion and remittances abroad; or

·             any actions that limit our ability to develop,manufacture, import or sell our products in China, or to finance and operateour business in China.

In addition to modifying the existing telecommunicationsregulatory framework, the Chinese government is currently preparing a draft ofa standard, national telecommunications law (“Telecommunications Law”) toprovide a uniform regulatory framework for the telecommunicationsindustry.  Currently a draft of the lawhas been finished and delivered to the National People’s Congress fordiscussion.  We do not yet know the finalnature or scope of the regulations that would be created if theTelecommunications Law is passed. Accordingly, we cannot predict whether it will have a positive ornegative effect on us or on some or all aspects of our business.

Under China’s current regulatory structure, the communicationsproducts that we offer in China must meet government and industrystandards.  In addition, a network accesslicense for the equipment must be obtained. Without a license, telecommunications equipment is not allowed to beconnected to public telecommunications networks or sold in China.  Moreover, we must ensure that the quality ofthe telecommunications equipment for which we have obtained a network accesslicense is stable and reliable, and will not negatively affect the quality orperformance of other installed licensed products.

96

----

*China’s changing economic environment may impact ourability to do business in China.*

Since 1978, the Chinese government has been reforming theeconomic system in China to increase the emphasis placed on decentralizationand the utilization of market forces in the development of China’seconomy.  These reforms have resulted insignificant economic growth.  However,any economic reform policies or measures in China may from time to time bemodified or revised by the Chinese government. While we may be able to benefit from the effects of some of thesepolicies, these policies and other measures taken by the Chinese government toregulate the economy could also have a significant negative impact on economicconditions in China, which would result in a negative impact on our business.

*China’s entry into the World Trade Organization andrelaxation of trade restrictions have led to increased foreign investment inChina’s telecommunications industry and may lead to increased competition inour markets which may have an adverse impact on our business.*

China’s economic environment has been changing as aresult of China’s entry, in December of 2001, into the World Trade Organization(“WTO”).  Foreign investment in thetelecommunications sector is regulated by the “Provisions on Administration ofForeign Invested Telecommunications Enterprises” promulgated by the StateCouncil in December 2001 and effective as of January 1, 2002.  The provisions brought foreign equity limitsinto conformity with China’s WTO commitments, allowing foreign investors to ownequity generally up to 49% for basic telecom services enterprises and up to 50%for value-added telecom services enterprises. Furthermore, China is gradually introducing a market oriented pricingmechanism for telecommunication services. On July 13, 2005, China’s Ministry of Information Industry (“MII”)and National Development and Reform Commission (“NDRC”) approved the launch ofplan-based pricing for fixed-line telephone service by China’s two fixed-lineoperators, China Telecom and China Netcom. In August 2005, MII and NDRC endorsed a “Circular on the Changes inAdministration of Telecom Service Pricing,” which became effective onOctober 1, 2005 and further relaxed the pricing administration on certaintelecom services.   As China graduallyrelaxes such legal provisions, international telecommunication service vendorsmay seize this opportunity to adjust their China strategy, increasing theirinvestment in China and converting some of their joint-ventures intofully-owned enterprises.

As the existing international vendors increase theirinvestment in China, and more vendors enter the China market, the competitionin the telecommunication equipment market may increase, and as a result, ourbusiness may suffer. If China’s entry into the WTO results in increasedcompetition or has a negative impact on China’s economy, our business couldsuffer. In addition, although China is increasingly according foreign companiesand foreign investment enterprises established in China the same rights andprivileges as Chinese domestic companies as a result of its admission into theWTO, special laws, administrative rules and regulations governing foreigncompanies and foreign investment enterprises in China may still place foreigncompanies at a disadvantage in relation to Chinese domestic companies and mayadversely affect our competitive position.

*Uncertainties with respect to the Chinese legal systemmay adversely affect us.*

We conduct our business in China primarily through ourwholly owned subsidiaries incorporated in China. Our subsidiaries are generallysubject to laws and regulations applicable to foreign investment in China.Accordingly, our business might be affected by China’s developing legal system.Since 1978, many new laws and regulations covering general economic mattershave been promulgated in China, and government policies and internal rulespromulgated by governmental agencies may not be published in time, or at all.As a result, we may operate our business in violation of new rules and policieswithout having any knowledge of their existence. In addition, there areuncertainties regarding the interpretation and enforcement of laws, rules andpolicies in China. Governmental authorities have broad discretion in theinterpretation and enforcement of the laws, regulations and rules. The Chineselegal system is based on written statutes, and prior court decisions havelimited precedential value. Because many laws and regulations are relativelynew and the Chinese legal system is still evolving, the interpretations of manylaws, regulations and rules are not always uniform. Moreover, the relativeinexperience of China’s judiciary in many cases creates additional uncertaintyas to the outcome of any litigation, and the interpretation of statutes andregulations may be subject to government policies reflecting domestic politicalchanges. Finally, enforcement of existing laws or contracts based on existinglaw may be uncertain and sporadic, and it may be difficult to obtain swift andequitable enforcement, or to obtain enforcement of a judgment by a court ofanother jurisdiction. Any litigation in China may be protracted and result insubstantial costs and diversion of resources and management’s attention.

*If tax benefits available to our subsidiaries locatedin China are reduced or repealed, our business could suffer.*

On March 16, 2007, China’s top legislature, theNational People’s Congress, passed the China Corporate Income Tax Law (“CIT Law”). CIT Law will be effective on January 1,2008.  Under the CIT Law, China’s dualtax system for 

97

----

domesticenterprises and foreign investment enterprises (“FIEs”) would be effectivelyreplaced by a unified system.  The newlaw establishes a tax rate of 25% for most enterprises and a reduced tax rateof 15% for certain qualified high technology enterprises.

Prior to this change in tax law, certain subsidiariesand joint ventures located in China enjoyed tax benefits in China which aregenerally available to FIEs.   The taxholidays/incentives for FIEs were applicable or potentially applicable toUTStarcom ChongQing Telecom Co. Ltd. (“CUTS”), UTStarcom Telecom Co., Ltd. (“HUTS”),Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”) and UTStarcom China Co., Ltd. (“UTSC”),our active subsidiaries in China, because these entities may qualify asaccredited technologically advanced enterprises.

CIT Law targets certain industries for the reduced 15%tax rate for certain qualified high technology enterprises.    For FIEs established before thepromulgation of the new law who currently enjoy lower tax rates, any increasein their tax rates would be gradually phased in over five years.  Significant regulations regarding theinterpretation and implementation of the new tax law are still pending.  There is potential risk that our subsidiariesmay not qualify for the reduced 15% tax rate. Therefore, the new law may have an adverse impact on our future taxexpense in China.

Moreover, the Chinese central government may review and audit taxbenefits granted by local or provincial authorities and could determine todisallow such benefits. Certain of our subsidiaries and joint ventures locatedin China enjoy tax benefits in China that are generally available to foreigninvestment enterprises. If these tax benefits are reduced, disallowed orrepealed due to changes in tax laws or determination by the Chinese government,our business could suffer.

*Our ability to continue successful deployment of PAS systemand sales of PAS handsets are limited by certain factors, including thefollowing:*

*Maturing PAS market and increased competition in handsetsand tariffs.*

The market for PAS exceeded 96 million users as ofthe end of fiscal year 2006 and is available in most of the provincesthroughout China. We believe the PAS market has matured. For example, duringfiscal year 2005, net sales of the PAS/iPAS system and the wirelessinfrastructure market declined significantly as compared to fiscal year2004.  This decline continued throughfiscal year 2006, and the first quarter of 2007. If additional handsetcompetitors enter the market, or if competitors decide to further reducepricing, our sales of PAS handsets may be adversely impacted.

Furthermore, competition from mobile operators, such asChina Mobile and China Unicom, has increased in cities where PAS is deployed.Mobile operators offering special promotional pricing or incentives tocustomers, such as free incoming calls or free mobile-to-mobile calls, haveharmed the ability of our customers, China Telecom and China Netcom, to competeeffectively. The continued use of such incentive programs by mobile operatorsmay adversely impact China Telecom and China Netcom’s ability to increase PASsubscriptions. Due to our relationships with China Telecom and China Netcom,reduced subscription growth at these carriers may have a material adverseeffect on our pricing and harm our business or results of operations.

*Our PAS system and handsets sales may experience a sharpdecline if China Telecom or China Netcom obtain licenses allowing them todeliver mobile services.*

China’s media sources have widely reported that the MII may grant 3Gmobile licenses to China Telecom or China Netcom, or to both in 2007. If ChinaTelecom or China Netcom obtains 3G mobile licenses, they may re-allocatecapital expenditures to construct 3G networks, and as a consequence, maysignificantly reduce capital expenditures relating to PAS networks that utilizeour existing products. In addition, it is possible that current PAS frequency bandsutilized by PAS networks may be reallocated for use by 3G networks, resultingin the restriction of or shutting down of PAS networks. If this were to occur,we could lose current and potential future customers of our products, and ourfinancial condition and results of operations could be significantly harmed.

*We only have trial licenses for the PAS system andhandsets in China.*

We only have trial licenses for our PAS systems andhandsets. We have applied for, but have not yet received, a final officialnetwork access license for our PAS systems and handsets. Based uponcommunication with the MII, we understand that our PAS systems and handsets areconsidered to still be in the trial period and sales of our PAS systems andhandsets may 

98

----

continue to be made by us during this trial period, but that licenseswill ultimately be required. If we fail to obtain the required licenses, wecould be prohibited from making further sales of the unlicensed products,including our PAS systems and handsets, in China, which would substantiallyharm our business, financial condition and results of operations. Theregulations implementing these requirements are not very detailed, have notbeen applied by a court and may be interpreted and enforced by regulatoryauthorities in a number of different ways. Our external legal counsel in Chinahas advised us that China’s governmental authorities may interpret or apply theregulations with respect to which licenses are required and the ability to sella product while a product is in the trial period in a manner that isinconsistent with the information received by our legal counsel in China, andeither of these conditions could have a material adverse effect on ourbusiness, financial condition and results of operations.

*Increasing centralization of purchasing decision-makingby carriers may lead to customer concentration and affect the results of ourbusiness.*

Most Chinese carriers have three levels of operations:the central headquarters level, the provincial level and the local city/countylevel. Both central and provincial levels are independent legal persons andhave their own corporate mandate. The purchasing decision-making processmay take various forms for different projects and may also differ significantlyfrom carrier to carrier. In the case of PAS systems, we negotiate and enterinto all China Netcom contracts with the provincial operators. However, thecentral headquarters of China Telecom has chosen to exert its influence in thepurchasing decision-making process by negotiating contractual terms, suchas purchase price, payment terms, and acceptance clauses at the central level.The provincial operator then further negotiates the contract based on theguidelines provided by the headquarters. We enter into final contracts with theprovincial operator. However, if this trend of centralized decision-makingexpands to unified purchasing, resulting in the negotiation and execution ofcontracts at the central headquarter level, there may be a concentration ofcustomers which could have a significant impact on our business. If ChinaNetcom follows China Telecom and exerts the headquarters’ influence in pricenegotiation, it may give downward pressure to the margin of our PAS systemproducts to China Netcom.

*Television over the internet is a new business inChina and laws regulating the business have not been fully developed and may beunpredictable. Unfavorable regulation of the industry may adversely affect ourIPTV operations in China and negatively impact our business.*

Broadcasting television over the internet has onlyrecently begun in China. The State Administration of Radio, Film and Television(SARFT), the central government’s regulatory body, issued a measure inJuly 2004 to regulate the broadcasting of audio-visual programsthrough the information network, which includes our Internet Protocoltelevision (IPTV) business. SARFT categorized the information network into themobile telecommunication network, fixed communications network, microwavecommunication network, cable television network, satellite or othermetropolitan area network, wide area network, local area network and otherinformation networks categories. The receiving terminal equipment includescomputers, television sets, mobile phones and other electronic products. Whileregulating the IPTV business, SARFT is encouraging development in China of thedigital television business, a business that may be competitive with IPTV inthe target market. The digital television and IPTV target complementary marketsand it is not clear the extent of support SARFT will provide for IPTV insetting regulations. For example, the Guangzhou Administration of Radio, Film,and Television, the municipal regulatory body in the city of Guangzhou, issueda notice to stop all IPTV business in Guangzhou on December 25, 2005.  The Zhejiang Administration of Radio, Film,and Television, the local regulatory body in the province of Zhejiang, issued asimilar notice on January 10, 2006. In both instances, SARFT had notformally endorsed the launch of commercial IPTV services in those localities.Because the IPTV industry relates to both television and telecom sectors, itmay be subject to regulation by different governmental authorities, includingthe Ministry of Information Industry (MII). At the end of 2005, an official of MII declared that MII and SARFT wouldjointly administer the IPTV industry in the coming years. However, due to alack of uniform regulation on the development of the IPTV industry, we cannotpredict that our IPTV business will operate smoothly in China. Our business maysuffer if the law or policy in China does not encourage the IPTV industry.

*We currently do not have a license to engage in theIPTV operator service business in China and development of our IPTV businessdepends upon the cooperation of IPTV license holder(s) and network operators.If we are unable to work cooperatively with license holder(s) and networkoperators, our business may suffer.*

Under the measures issued by SARFT in July 2004,entities intending to engage in the IPTV operator service business shouldobtain a license from SARFT and foreign investment enterprises are prohibitedfrom engaging in the IPTV operator service business. In practice, SARFT onlygrants such licenses to state-owned companies. Since we are the technicalservice and equipment provider in this field, our business development willdepend on the cooperation of license holders and network operators. Ourbusiness may suffer if we fail to cooperate with license holders or networkoperators, or if the license holder(s) we’re cooperating with lose theirlicenses.

99

----

**RISKS RELATED TO OUR STOCK PERFORMANCE AND CONVERTIBLEDEBT SECURITIES**

*Our stock price is highly volatile.*

The trading price of our common stock has fluctuatedsignificantly since our initial public offering in March of 2000. Our stockprice could be subject to wide fluctuations in the future in response to manyevents or factors, including those discussed in the preceding risk factorsrelating to our operations, as well as:

·             actual or anticipated fluctuations in operatingresults, actual or anticipated gross profit as a percentage of net sales,levels of inventory, our actual or anticipated rate of growth and our actual oranticipated earnings per share;

·             changes in expectations as to future financialperformance or changes in financial estimates or buy/sell recommendations ofsecurities analysts;

·             changes in governmental regulations or policies inChina;

·             our, or a competitor’s, announcement of newproducts, services or technological innovations;

·             the operating and stock price performance of othercomparable companies; and

·             news and commentary emanating from the media,securities analysts or government bodies in China relating to us and to theindustry in general.

General market conditions and domestic or internationalmacroeconomic factors unrelated to our performance may also affect our stockprice. For these reasons, investors should not rely on recent trends to predictfuture stock prices or financial results. In addition, following periods ofvolatility in a company’s securities, securities class action litigationagainst a company is sometimes instituted. We have experienced substantialcosts and the diversion of management’s time and resources on this type oflitigation and may do so in the future.

In addition, public announcements by China Telecom, ChinaNetcom, China Mobile, and China Unicom each of which exert significantinfluence over many of our major customers in China, may contribute tovolatility in the price of our stock. The price of our stock may react to suchannouncements.

*SOFTBANK CORP. with its related entities, includingSOFTBANK America Inc., has significant influence over our management andaffairs, which it could exercise against the best interests of ourstockholders.*

SOFTBANK CORP. and its related entities, includingSOFTBANK America Inc. (collectively, “SOFTBANK”), beneficially ownedapproximately 12% of our outstanding stock as of March 31, 2007.  As a result, SOFTBANK has the ability toinfluence all matters submitted to our stockholders for approval, as well asour management and affairs. Matters that could require stockholder approvalinclude:

·             election and removal of directors;

·             our merger or consolidation with or into anotherentity; and

·             sale of all or substantially all of our assets.

This concentration of ownership may delay or prevent achange of control or discourage a potential acquirer from making a tender offeror otherwise attempting to obtain control of us, which could decrease themarket price of our common stock.

*Delaware law and our charter documents contain provisionsthat could discourage or prevent a potential takeover, even if the transactionwould benefit our stockholders.*

Other companies may seek to acquire or merge with us. Ouracquisition or merger could result in benefits to our stockholders, includingan increase in the value of our common stock. Some provisions of ourCertificate of Incorporation and 

100

----

Bylaws, as well as provisions of Delaware law, may discourage, delay orprevent a merger or acquisition that a stockholder may consider favorable. Theseprovisions include:

·             authorizing the board of directors to issueadditional preferred stock;

·             prohibiting cumulative voting in the election ofdirectors;

·             limiting the persons who may call special meetingsof stockholders;

·             prohibiting stockholder action by written consent;

·             creating a classified board of directors pursuantto which our directors are elected for staggered three year terms; and

·             establishing advance notice requirements fornominations for election to the board of directors and for proposing mattersthat can be acted on by stockholders at stockholder meetings.

W*e**face avariety of risks related to ourconvertible subordinated notes.*

We face a variety of risks with respect to ourconvertible subordinated notes due in 2008 (“Notes”), including the following:

·                                          we have significantly increased our leverage as aresult of the sale of the Notes which could have an adverse impact on ourability to obtain additional financing for working capital;

·                                          we may be limited in our ability to purchase theNotes in the event of a change in control, either for cash or stock, whichcould result in our defaulting on the Notes at the time of the change incontrol, and purchases for stock would be subject to market risk; and

·                                          hedging transactions related to the Notes and ourcommon stock and other transactions, as well as changes in interest rates andour creditworthiness, may affect the value of our common stock.

In addition, we are subject to various covenants pursuant to the termsof the indenture governing the Notes (the “Indenture”). Should we fail tocomply with certain covenants in the Indenture, including covenants requiringus to file certain reports required to be filed pursuant to the Exchange Act(the “SEC Reports”) with the Securities and Exchange Commission (the “SEC”) andto provide the Trustee for the notes (the “Trustee”) with copies of suchreports and certain certificates regarding our compliance with our obligationsunder the Indenture, the Trustee or the holders of 25% of the aggregate principalamount of the Notes outstanding (the “25% Holders”) could accelerate thematurity of the Notes and the Notes could become immediately due andpayable.  In the past, there have beendelays in filing such reports: For example, as of November 9, 2006 andcontinuing through the date hereof there has been a delay in the filing of ourQuarterly Report on Form 10-Q for the quarter ended September 30, 2006 (the “2006Q3 Form 10-Q”), our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2006 (the “2006 Form 10-K”), our Quarterly Report on Form 10-Q forthe quarter ended March 31, 2007 (the “2007 Q1 Form 10-Q”), and ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2007 (the “2007 Q2Form 10-Q,” and together with the 2006 Q3 Form 10-Q, the 2006 Form 10-K, andthe 2007 Q1 Form 10-Q, the “Delayed Reports”). We received a notice from the Trusteeon May 31, 2007, asserting that our failure to file the 2006 Q3 Form 10-Q, the2006 Form 10-K and the 2007 Q-1 Form 10-Q had resulted in a default under theIndenture, and that if we failed to file such reports within 60 days, an eventof default would arise under the Indenture.

In July 2007, we sought and obtained the requisite consents from holdersof the Notes to certain amendments to the Indenture, which provide that (i) anyfailure by us to file SEC Reports with the SEC and provide copies of suchreports and certain certificates to the Trustee prior to 5:30 p.m. New YorkCity time on October 15, 2007 (the “Expiration Date”) will not cause a defaultunder the Indenture, (ii) any such failure continuing after the Expiration Datewould cause a default under the Indenture, which would be deemed to haveoccurred as of the Expiration Date, and (iii) we will pay additional intereston the Notes of (a) 6.75% annually from January 9, 2007 to and including July25, 2007, and (b) 10.0% annually from and including July 26, 2007 to the datethe Notes are paid, prepaid, converted, redeemed or otherwise cease to beoutstanding (in each case, in addition to interest of 7/8% annually, asprovided by the Indenture, without regard to any amendments). Although we havenow filed our Q3 2006 Form 10Q, our 2006 Form 10K and this Q1 2007 Form 10Q, wehave not yet filed our Q2 2007 Form 10Q and delivered copies of such report andcertain certificates to the Trustee. As a result, on October 15, 2007, wereceived a notice from the Trustee asserting that our failure to file our Q12007 Form 10-Q and our Q2 2007 Form 10-Q had resulted in a default under theIndenture, as amended by the First and Second Supplemental Indentures, and thatif we failed to file such reports within 60 days of October 15, 2007, an eventof default would arise under the Indenture. The Company cannot be certain thatit will be able to file all required reports with the SEC by the Demand Date.Furthermore, the Company cannot be certain that consents from holders of theNotes necessary for an additional waiver of its obligations to comply with theIndenture covenants within the required period can be obtained on reasonableterms or at all.

101

----

Ifan event of default were to occur, the Trustee or the 25% Holders would havethe right to accelerate the maturity of the Notes and declare all unpaidprincipal and accrued interest on the Notes then outstanding to be immediatelydue and payable, as described above. No assurance can be given that we would beable to obtain the requisite consents of the Holders to a further amendment tothe Indenture, providing for a waiver of compliance with covenants in theIndenture relating to the filing of our Q2 2007 Form 10Q, on acceptable termsor at all.  If an event of default underthe Indenture were to occur, and the maturity of the Notes were accelerated, andall unpaid principal and accrued interest is declared immediately due andpayable, our business would be seriously harmed.  If we have not filed the Q2 2007 Form10Q, our ability to raise additional capital may be limited, and specifically,we would not be able to refinance indebtedness under the Notes from theproceeds of an issuance of new convertible notes.  In addition, if we areable to raise capital to refinance indebtedness under the Notes by issuing newconvertible notes, the terms of such notes may be significantly less favorablethan the terms of the Notes, and may cause greater dilution to holders of ourcommon stock.

*Our failure to timely file periodic reports with theSecurities and Exchange Commission could result in the delisting of our commonstock from the NASDAQ Stock Market.*

As a result of our failure to timely file ourQuarterly Report on Form 10-Q for the period ended September 30, 2006 (“Q3 2006Form 10-Q”), our Annual Report on Form 10-K for the year ended December 31,2006, our Quarterly Report on Form 10-Q for the period ended March 31, 2007 (“Q12007 Form 10-Q”) and our Quarterly Report on Form 10-Q for the period endedJune 30, 2007 (“Q2 2007 Form 10-Q”), we have not been in full compliance withNASDAQ Marketplace Rule 4310(c)(14), which requires us to make, on a timely basis,all filings with the Securities and Exchange Commission required by theSecurities Exchange Act of 1934. Although we have now filed our Q3 2006 10-Q, 2006 Form 10-K and this Q12007 Form 10-Q, we have not yet filed our Q2 2007 Form 10-Q and thus continuenot to be in full compliance with this rule. We are required to comply withNASDAQ Marketplace Rule 4310(c)(14) as a condition for our common stock tocontinue to be listed on the NASDAQ Stock Market.

In connection with our failure to timely file ourperiodic reports, we received four NASDAQ Staff Determination letters, datedNovember 15, 2006, March 7, 2007, May 16, 2007 and August 13, 2007,respectively, stating that, as a result of each of these non-timely filings, wewere not in compliance with the requirements of Marketplace Rule 4310(c)(14)and, therefore, that our stock was subject to delisting from the NASDAQ StockMarket. We appealed the November 15, 2006 determination to the NASDAQ ListingQualifications Panels (the “Panel”) and were granted a conditional extension toour request for continued listing until April 16, 2007. On April 17, 2007 thePanel extended the deadline for filing our Q3 2006 Form 10-Q  to May 14, 2007.  The Panel alsoextended the deadline for filing our 2006 Form 10-K until July 16, 2007. On May 2, 2007, we asked the NASDAQ Listing and Hearing Review Council (“ListingCouncil”) to review the April 17, 2007 decision of the Panel.  On May 14,2007, the Listing Council called the Panel’s decision for review and requestedthat we provide an update on our efforts to file our delinquent filings. We have continued and continue to comply with that request.  In addition,the Listing Council stayed the Panel’s decision that required us to file our Q32006 Form 10-Q by May 14, 2007, and to file our 2006 Form 10-K by July 16,2007.  On August 23, 2007, the Listing Council granted the Company anextension until October 22, 2007 to file our delinquent periodic reports andrestatements.  As stated above, we havenow filed our Q3 2006 Form 10Q, 2006 Form 10K and this Q1 2007 Form 10Q.  However, we can provide no assurances that wewill be able to file our Q2 2007 Form 10Q by October 22, 2007.

If we are unable to maintain compliance with theconditions for continued listing required by NASDAQ, then our shares of commonstock may be subject to delisting from the NASDAQ Stock Market. If our sharesof common stock are delisted from the NASDAQ Stock Market, they may not beeligible to trade on any national securities exchange or the over-the countermarket. If our common stock is no longer traded through a market system, theliquidity of our common stock may be greatly reduced, which could negativelyaffect its price. In addition, we may be unable to obtain future equityfinancing, or use our common stock as consideration for mergers or otherbusiness combinations. A delisting from the NASDAQ Stock Market may also haveother negative implications, including the potential loss of confidence bysuppliers, customers and employees, the loss of institutional investorinterest, and fewer business development opportunities.

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

None

**ITEM 3—DEFAULTS UPON SENIOR SECURITIES**

None

102

----

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

None

**ITEM 5—OTHER INFORMATION**

None

**ITEM 6—EXHIBITS**
| Exhibit  Number | ** ** | **EXHIBIT DESCRIPTION**                                                                                                                                                                                                                                                                                                                        | ** ** |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **      | ** ** | ** **                                                                                                                                                                                                                                                                                                                                     | ** ** |
| 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             |       | First Amended and Restated Bylaws of  UTStarcom, Inc., as amended on July 13, 2007 (incorporated by reference  to Exhibit 3.2 of the Annual Report on Form 10-K filed with the SEC on  October 10, 2007)                                                                                                                                  |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 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)                                                                                                                                                   |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.4             |       | Convertible Subordinated Notes Indenture dated as of  March 12, 2003 between UTStarcom, Inc. and U.S. Bank National  Association, including the form of the 7¤8% Convertible Subordinated  Notes due 2008. (incorporated by reference to Exhibit 4.4 of Quarterly Report  on Form 10-Q filed with the SEC on May 12, 2003) |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.5             |       | First Supplemental Indenture, dated January 9, 2007,  by and between the Company and U.S. Bank National Association. (incorporated by reference to Exhibit 99.2 of  Current Report on Form 8-K filed with the SEC on January 10, 2007)                                                                                                         |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.6             |       | Underwriting Agreement, dated January 8, 2004  between the Company and Bank of America Securities LLC, as amended on  January 14, 2004. (incorporated by reference to Exhibit 4.7 of Form 10-K  filed with the SEC on April 15, 2005)                                                                                           |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.7             |       | Consent Solicitation Statement dated December 22,  2006 related to the Company’s 7/8% Convertible Subordinated Notes due 2008  (incorporated by reference to Exhibit 99.2 of Current Report on Form 8-K  filed with the SEC on December 22, 2006)                                                                                         |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.8             |       | Amended Letter of Consent related to the Company’s  7/8% Convertible Subordinated Notes due 2008 (incorporated by reference to  Exhibit 99.3 of Current Report on Form 8-K filed with the SEC on January 8,  2007)                                                                                                                        |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.9             |       | Supplemental Consent Solicitation Statement dated  January 8, 2007 related to the Company’s 7/8% Convertible Subordinated Notes  due 2008 (incorporated by reference to Exhibit 99.2 of Current Report on Form  8-K filed with the SEC on January 8, 2007)                                                                                |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.10            |       | Second Consent Solicitation Statement dated July 19,  2007 relating to the Company’s Convertible Subordinated Notes due 2008  (incorporated by reference to Exhibit 99.2 to the Form 8-K filed with the SEC  on July 19, 2007)                                                                                                            |       |
|            |       |                                                                                                                                                                                                                                                                                                                                           |       |
| 4.11            |       | Letter of Consent relating to the Company’s  Convertible Subordinated Notes due 2008 (incorporated by reference to Exhibit  99.3 to the Form 8-K filed with the SEC on July 19, 2007)                                                                                                                                                     |       |

 

103

----

 
| 4.12   |   | Second Supplemental Indenture, dated July 26, 2007,  by and between the Company and U.S. Bank National Association (incorporated  by reference to Exhibit 99.1 to the Form 8-K filed with the SEC on July 30,  2007) |   |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|   |   |                                                                                                                                                                                                                 |   |
| 10.1++ |   | Amended and Restated Committed Receivables Purchase  Agreement dated March 30, 2007 between UTStarcom Personal Communications LLC  and Citibank N.A.                                                                 |   |
|   |   |                                                                                                                                                                                                                 |   |
| 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.                                                                          |   |

 

----

++                 Portions of this exhibit have been omittedpursuant to a request for confidential treatment filed with the Securities andExchange Commission

104

----

**SIGNATURES**

Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.
|                              |   |   | UTSTARCOM, INC. |
|------------------------------|--------|--------|----------------------|
|                         |   |   |                 |
| Date: October 17,  2007 |   |   | By:                  | /s/ FRANCIS P.  BARTON |
|                         |   |   |                 | Francis P. Barton * * |
|                         |   |   |                 | *Executive Vice President and Chief Financial  Officer* |
|                         |   |   |                 | *(Principal Financial Officer)* |

 

105

----