** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

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**FORM 10-Q**

 

| **(Mark  One)**                                                                                                                                                                                                       |   |                                                                                                |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------|
| **ý**                                                                                                                                                                                                            |   | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**   |
|                                                                                                                                                                                                                  |   |                                                                                                |
| **For the quarterly period ended  March 31, 2003**                                                                                                                                                                    |
|                                                                                                                                                                                                                  |   |                                                                                                |
| **OR**                                                                                                                                                                                                                |
|                                                                                                                                                                                                                  |   |                                                                                                |
| **o**                                                                                                                                                                                                                 |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                                                                                                                                                                                  |   |                                                                                                |
| **For the transition period  from                to               ** |
|                                                                                                                                                                                                                  |
| **COMMISSION  FILE NUMBER 000-29661**                                                                                                                                                                                 |

 

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

 

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

 

Indicate by check mark whether the Registrant is an accelerated filer(as defined in Rule 12b-2 of the Exchange Act of 1934).  Yes   ý  No   o

 

As of May 2, 2003 there were 100,342,383 shares of the Registrant’sCommon Stock outstanding, par value $0.00125.

 

 

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**TABLE OFCONTENTS**

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

 

2

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**PART I—FINANCIAL INFORMATION**

 

**ITEM 1—CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 

**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

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

 
|                                                                                                                                                            |   | **March 31,  2003** |      | **December 31,  2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------|------------------------|--------|
| **ASSETS**                                                                                                                                                      |   |                |      |                   |   |
| Current assets:                                                                                                                                                 |   |                |      |                   |   |
| Cash and cash  equivalents                                                                                                                                      |   | $                   | 562,141   |                   | $      | 231,944 |   |
| Short-term  investments                                                                                                                                         |   | 42,000              |      | 107,305                |   |
| Accounts  receivable, net of allowances for doubtful accounts of $34,464 and $26,250 at  March 31, 2003 and December 31, 2002, respectively                     |   | 255,267             |      | 222,050                |   |
| Inventories                                                                                                                                                     |   | 794,468             |      | 424,666                |   |
| Other current  assets                                                                                                                                           |   | 175,225             |      | 121,407                |   |
| Total current  assets                                                                                                                                           |   | 1,829,101           |      | 1,107,372              |   |
| Property, plant  and equipment, net                                                                                                                             |   | 106,880             |      | 98,511                 |   |
| Long-term  investments                                                                                                                                          |   | 25,651              |      | 35,360                 |   |
| Goodwill and  intangible assets, net                                                                                                                            |   | 55,379              |      | 49,820                 |   |
| Other long-term  assets                                                                                                                                         |   | 29,425              |      | 14,489                 |   |
| Total assets                                                                                                                                                    |   | $                   | 2,046,436 |                   | $      | 1,305,552 |   |
|                                                                                                                                                            |   |                |      |                   |   |
| **LIABILITIES AND STOCKHOLDERS'  EQUITY**                                                                                                                       |   |                |      |                   |   |
| Current  liabilities:                                                                                                                                           |   |                |      |                   |   |
| Accounts payable                                                                                                                                                |   | $                   | 476,885   |                   | $      | 256,980 |   |
| Income taxes  payable                                                                                                                                           |   | 18,925              |      | 13,003                 |   |
| Deferred revenue                                                                                                                                                |   | 257,207             |      | 164,247                |   |
| Other                                                                                                                                                           |   | 118,243             |      | 104,927                |   |
| Total current  liabilities                                                                                                                                      |   | 871,260             |      | 539,157                |   |
| Long-term debt                                                                                                                                                  |   | 402,500             |      | —                 |   |
| Total  liabilities                                                                                                                                              |   | 1,273,760           |      | 539,157                |   |
| Commitments and  contingencies (Note 14)                                                                                                                        |   |                |      |                   |   |
| Stockholders'  equity:                                                                                                                                          |   |                |      |                   |   |
| Common stock:  $0.00125 par value; authorized: 250,000,000 shares; issued and outstanding:  107,496,542 and 106,787,908 at March 31, 2003 and December 31, 2002 |   | 136                 |      | 135                    |   |
| Additional  paid-in capital                                                                                                                                     |   | 626,235             |      | 658,546                |   |
| Deferred stock  compensation                                                                                                                                    |   | (11,058             | )         | (11,766                | )      |
| Retained  earnings                                                                                                                                              |   | 157,863             |      | 120,520                |   |
| Receivable from  stockholders                                                                                                                                   |   | (282                | )         | (282                   | )      |
| Other comprehensive  income (loss)                                                                                                                              |   | (218                | )         | (758                   | )      |
| Total  stockholders' equity                                                                                                                                     |   | 772,676             |      | 766,395                |   |
| Total  liabilities and stockholders' equity                                                                                                                     |   | $                   | 2,046,436 |                   | $      | 1,305,552 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

3

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**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

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

 
|                                                        |   | **Three months ended** |    |
|-------------------------------------------------------------|--------|------------------------|---------|
|                                                        |   | **March 31,  2003**    |    | **March 31,  2002** |   |
| Net sales:                                                  |   |                   |    |   |   |
| Unrelated  parties                                          |   | $                      | 272,004 |   | $ | 173,731 |   |
| Related parties                                             |   | 58,516                 |    | 9,959 |   |
|                                                        |   | 330,520                |    | 183,690 |   |
|                                                        |   |                   |    |   |   |
| Cost of sales                                               |   | 217,835                |    | 118,048 |   |
| Gross profit                                                |   | 112,685                |    | 65,642 |   |
|                                                        |   |                   |    |   |   |
| Operating  expenses:                                        |   |                   |    |   |   |
| Selling, general  and administrative                        |   | 37,583                 |    | 23,686 |   |
| Research and development                                    |   | 26,812                 |    | 19,197 |   |
| In-process  research and development                        |   | 1,320                  |    | — |   |
| Amortization of  intangible assets                          |   | 695                    |    | 477 |   |
| Total operating  expenses                                   |   | 66,410                 |    | 43,360 |   |
|                                                        |   |                   |    |   |   |
| Operating income                                            |   | 46,275                 |    | 22,282 |   |
| Interest income                                             |   | 943                    |    | 1,574 |   |
| Interest expense                                            |   | (639                   | )       | (688 | ) |
| Other income,  net                                          |   | 4,186                  |    | 193 |   |
| Equity in (loss)  of affiliated companies                   |   | (975                   | )       | (793 | ) |
| Income before  income taxes and minority interest           |   | 49,790                 |    | 22,568 |   |
| Income tax  expense                                         |   | 12,447                 |    | 4,514 |   |
| Minority  interest in earnings of consolidated subsidiaries |   | —                 |    | (528 | ) |
|                                                        |   |                   |    |   |   |
| Net income                                                  |   | $                      | 37,343  |   | $ | 17,526 |   |
|                                                        |   |                   |    |   |   |
| Basic earnings  per share                                   |   | $                      | 0.35    |   | $ | 0.16 |   |
|                                                        |   |                   |    |   |   |
| Diluted earnings  per share                                 |   | $                      | 0.33    |   | $ | 0.15 |   |
|                                                        |   |                   |    |   |   |
| Weighted average  shares used in per-share calculation:     |   |                   |    |   |   |
| - Basic                                                     |   | 107,358                |    | 110,044 |   |
| - Diluted                                                   |   | 111,953                |    | 116,758 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

4

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**UTSTARCOM, INC.**

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

**(Inthousands)**

 

 
|                                                                           |   | **Three months ended** |    |
|--------------------------------------------------------------------------------|--------|------------------------|---------|
|                                                                           |   | **March 31, 2003**     |    | **March 31, 2002** |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                         |   |                   |    |   |   |
| Net income                                                                     |   | $                      | 37,343  |   | $ | 17,526 |   |
| Adjustments to  reconcile net income to net cash used in operating activities: |   |                   |    |   |   |
| Depreciation and  amortization                                                 |   | 7,910                  |    | 5,198 |   |
| Non-qualified  stock option exercise tax benefits                              |   | 1,449                  |    | 1,997 |   |
| Net loss on sale  of assets                                                    |   | 47                     |    | 180 |   |
| In-process  research and development costs                                     |   | 1,320                  |    | — |   |
| Amortization of  debt issuance                                                 |   | 201                    |    | — |   |
| Warrants  adjustment to fair value                                             |   | 80                     |    | 440 |   |
| Loss on sale of  investment                                                    |   | 80                     |    | — |   |
| Stock  compensation expense                                                    |   | 715                    |    | 1,346 |   |
| Allowance for  doubtful accounts                                               |   | 8,214                  |    | 3,046 |   |
| Inventory  reserve                                                             |   | 2,495                  |    | 1,655 |   |
| Equity in net  loss of affiliated companies                                    |   | 975                    |    | 793 |   |
| Minority  interest in earnings of consolidated subsidiary                      |   | —                 |    | 528 |   |
| Changes in  operating assets and liabilities:                                  |   |                   |    |   |   |
| Accounts  receivable                                                           |   | (41,431                | )       | (15,782 | ) |
| Inventories                                                                    |   | (372,297               | )       | (12,019 | ) |
| Other current  and non-current assets                                          |   | (55,314                | )       | (3,403 | ) |
| Accounts payable                                                               |   | 219,905                |    | (323 | ) |
| Income taxes  payable                                                          |   | 5,922                  |    | 1,751 |   |
| Deferred revenue                                                               |   | 92,960                 |    | (3,114 | ) |
| Other current  liabilities                                                     |   | 12,206                 |    | (4,038 | ) |
| Net cash used in  operating activities                                         |   | (77,220                | )       | (4,219 | ) |
|                                                                           |   |                   |    |   |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                         |   |                   |    |   |   |
| Additions to  property, plant and equipment, net                               |   | (15,169                | )       | (7,273 | ) |
| Investment in  affiliates, net of cash acquired                                |   | (3,074                 | )       | (12,848 | ) |
| Purchase of  businesses and intangible assets, net of cash acquired            |   | (1,292                 | )       | — |   |
| Purchase of  short-term investments                                            |   | (16,319                | )       | — |   |
| Sales of  short-term investments                                               |   | 91,876                 |    | 40,154 |   |
| Net cash  provided by investing activities                                     |   | 56,022                 |    | 20,033 |   |
|                                                                           |   |                   |    |   |   |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                         |   |                   |    |   |   |
| Issuance of  stock, net of expenses                                            |   | 4,026                  |    | 32,553 |   |
| Purchase of  calls options                                                     |   | (43,792                | )       | — |   |
| Proceeds from  borrowing, net of expenses                                      |   | 391,431                |    | 20,482 |   |
| Payments for  borrowing                                                        |   | —                 |    | (27,711 | ) |
| Proceeds from  stockholder notes                                               |   | —                 |    | (21 | ) |
| Net cash  provided by financing activities                                     |   | 351,665                |    | 25,303 |   |
| Effects of  exchange rates on cash                                             |   | (270                   | )       | (133 | ) |
| Net increase in  cash and cash equivalents                                     |   | 330,197                |    | 40,984 |   |
| Cash and cash  equivalents at beginning of period                              |   | 231,944                |    | 321,136 |   |
| Cash and cash  equivalents at end of period                                    |   | $                      | 562,141 |   | $ | 362,120 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

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**UTSTARCOM, INC.**

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

 

**1.****             BASIS OFPRESENTATION:**

 

The accompanying unaudited condensed consolidated financial statementsinclude the accounts of UTStarcom, Inc. (the “Company”) and itswholly-owned subsidiaries. All significant intercompany accounts andtransactions have been eliminated in the preparation of the condensedconsolidated financial statements. The minority interests in consolidatedsubsidiaries and equity in affiliated companies are shown separately in thecondensed consolidated financial statements. Investments in affiliatedcompanies are accounted for using the cost or equity method, as applicable.

 

The FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities”, (“FIN 46”) in January 2003. FIN 46 providesaccounting guidance for consolidation of variable interest entities (“VIE”),formerly referred to as special purpose entities. FIN 46 applies to public andprivate business enterprises that have a controlling interest or business orcontractual relationship with a VIE. FIN 46 requires consolidation of existingnon controlled affiliates if the VIE is unable to finance its operationswithout investor support, or where the other investors do not have exposure tothe significant risks and rewards of ownership. The Company expects this couldrequire consolidation of one of our non controlled affiliates under FIN 46,which is effective for the Company at the beginning of the interim period thatstarts July 1, 2003. The Company has a 90% ownership interest in UTStarcom(Chongqing) Co., Ltd., (“CUTS”) an affiliate incorporated in China thatassembles and manufactures handsets for our Personal Access System, or PAS,product line. The Company does not have control of the voting rights of CUTS;however, the Company is the primary beneficiary. Therefore, this affiliatewould be considered a VIE under FIN 46. The Company may be required toconsolidate the results of operations of this affiliate commencing July 1,2003. CUTS was formed in November 2002 and the results of operations of CUTSfor the three months ended March 31, 2003 were not material to our results ofoperations. The maximum exposure to loss assuming there is no furtherinvestment is $4.5 million at March 31, 2003.

 

On March 4, 2003, the Company entered into an agreement to purchasecertain assets and liabilities of the CommWorks division of 3Com Corporation,subject to regulatory approvals, the completion of the audit of the CommWorksdivision and other customary closing conditions, for $100.0 million in cash.CommWorks develops and deploys carrier-class, IP-based multi-service access andservice creation platforms for telecommunications service providers. If theCompany fails to close the acquisition by July 2, 2003 and all closingconditions have been satisfied, the Company will be required to pay 3Com Corporationa $10.0 million break-up fee. The transaction has been approved by the boardsof directors of both companies and does not require stockholder approval.

 

The accompanying financial data as of March 31, 2003 and for the threemonths ended March 31, 2003 and 2002 have been prepared by the Company, withoutaudit, pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles have been condensed or omitted pursuant to such rules andregulations. The December 31, 2002 balance sheet was derived from auditedfinancial statements, but does not include all disclosures required by generallyaccepted accounting principles. These condensed consolidated financialstatements should be read in conjunction with the Company’s auditedDecember 31, 2002 financial statements, including the notes thereto, andthe other information set forth in the Company’s Annual Report onForm 10-K.

 

In the opinion of management, the accompanying condensed consolidatedfinancial statements reflect all adjustments (consisting of only normalrecurring adjustments) considered necessary for a fair presentation of theCompany’s financial condition, the results of its operations and its cash flowsfor the periods indicated. The results of operations for the three months endedMarch 31, 2003 are not necessarily indicative of the operating results for thefull year.

 

**2.****             REVENUE RECOGNITION:**

 

Revenues fromsales of telecommunications equipment are recognized when persuasive evidenceof an arrangement exists, delivery of the product has occurred as evidenced bycustomer acceptance, the fee is fixed or determinable and collectability isreasonably assured. If the fee due from the customer is not fixed ordeterminable due to extended payment terms, revenue is recognized as paymentsbecome due from the customer, assuming all other criteria for revenuerecognition is met. Any payments received prior to revenue recognition arerecorded as deferred revenue. Shipping and handling costs are recorded asrevenues and costs of revenues.

 

Where multipleelements exist in an arrangement, the arrangement fee is allocated to thedifferent elements based upon verifiable objective evidence of the fair valueof the elements.  The Company’s multipleelement arrangements primarily involve the sale of PAS or iPAS equipment withhandsets, installation and training and the provision of such equipment todifferent locations for the same customer. Revenue is recognized as each element is earned, namely uponinstallation and acceptance of equipment or delivery of handsets, provided

 

6

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that the undeliveredelements are not deemed essential to the functionality of the deliveredelements and payment for the delivered elements is not contingent on deliveryof the further elements.

** **

**3.****             EARNINGS PER SHARE:**

 

Basic earnings per share is computed by dividing net income availableto common stockholders by the weighted average number of shares of theCompany’s common stock outstanding during the period. Diluted earnings pershare is determined in the same manner as basic earnings per share except thatthe number of shares is increased by potentially dilutive common sharesoutstanding during the period. Potentially dilutive common shares consist ofemployee stock options, warrants and convertible subordinated notes.

 

The following table presents the calculation of basic and dilutedearnings per share (in thousands, except per share data):

 
|                                      |   | **Three months ended  March 31** |   |
|-------------------------------------------|--------|----------------------------------|--------|
|                                      |   | **2003**                         |   | **2002** |   |
| Numerator:                                |   |                             |   |   |   |
| Net income                                |   | $                                | 37,343 |   | $ | 17,526 |   |
|                                      |   |                             |   |   |   |
| Denominator:                              |   |                             |   |   |   |
| Shares used to  compute basic EPS         |   | 107,358                          |   | 110,044 |   |
| Dilutive common  stock equivalent shares: |   |                             |   |   |   |
| Stock options                             |   | 4,567                            |   | 6,685 |   |
| Warrants                                  |   | 28                               |   | 29 |   |
| Shares used to  compute diluted EPS       |   | 111,953                          |   | 116,758 |   |
|                                      |   |                             |   |   |   |
| Basic earnings  per share                 |   | $                                | 0.35   |   | $ | 0.16 |   |
|                                      |   |                             |   |   |   |
| Diluted earnings  per share               |   | $                                | 0.33   |   | $ | 0.15 |   |

 

Certain potential shares related to employee stock options and warrantsoutstanding during the three months ended March 31, 2003 and 2002 were excludedin the diluted per share computations, since their exercise prices were greaterthan the average market price of the common shares during the period and,accordingly, their effect is anti-dilutive. For the three months ended March31, 2003, these shares totaled 5.6 million at a weighted average exerciseprice of $21.80 per share, compared to 0.5 million with a weighted averageexercise price of $28.16 per share for the corresponding period in 2002. Also,for the three months ended March 31, 2003, 16.9 million potential sharesoutstanding related to the convertible subordinated notes were excluded fromthe diluted per-share computations as the contingencies which would allow forconversion of the notes had not been met as of March 31, 2003, and 16.9 millionpotential shares outstanding related to a written call option were excludedfrom the diluted per share computation as their effect is anti-dilutive (seeNote 9).

 

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

 

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

 

The fair value of warrants, options or stock exchanged for services isexpensed over the period benefited. The warrants and options are valued usingthe Black-Scholes option pricing model.

 

7

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

 
|                                                                                                                                          |   | **Three months ended March 31,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|
|                                                                                                                                          |   | **2003**                         |   | **2002** |   |
| Net income, as  reported                                                                                                                      |   | $                                | 37,343 |   | $ | 17,526 |   |
|                                                                                                                                          |   |                             |   |   |   |
| Add: Stock-based  employee compensation expense included in reported net income, net of related  tax effects                                  |   | 499                              |   | 959 |   |
|                                                                                                                                          |   |                             |   |   |   |
| Deduct: Total  stock based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (6,315                           | )      | (4,857 | ) |
|                                                                                                                                          |   |                             |   |   |   |
| Proforma net  income                                                                                                                          |   | $                                | 31,527 |   | $ | 13,628 |   |
|                                                                                                                                          |   |                             |   |   |   |
| Basic - as  reported                                                                                                                          |   | $                                | 0.35   |   | $ | 0.16 |   |
| Basic - pro  forma                                                                                                                            |   | $                                | 0.29   |   | $ | 0.12 |   |
|                                                                                                                                          |   |                             |   |   |   |
| Diluted - as  reported                                                                                                                        |   | $                                | 0.33   |   | $ | 0.15 |   |
| Diluted - pro  forma                                                                                                                          |   | $                                | 0.29   |   | $ | 0.12 |   |

 

**5.****             COMPREHENSIVE INCOME:**

 

The reconciliation of net income to comprehensive income for the threemonths ended March 31, 2003 and 2002 is as follows (in thousands):

 
|                                          |   | **Three Months Ended  March 31** |       |
|-----------------------------------------------|--------|----------------------------------|------------|
|                                          |   | **2003**                         |       | **2002** |   |
|                                          |   |                             | ** ** |   | ** ** |
| Net income                                    |   | $                                | 37,343     |   | $ | 17,526 |   |
| Unrealized gains  (losses) on investments     |   | 574                              |       | (236 | ) |
| Change in  cumulative translation adjustments |   | (34                              | )          | (132 | ) |
| Total  comprehensive income                   |   | $                                | 37,883     |   | $ | 17,158 |   |

 

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

 

All of the Company’s short-term investments are classified as available-for-sale.At March 31, 2003, $144.1 million of available-for-sale securities wereincluded in cash equivalents and $42.0 million of available-for-salesecurities were included in short-term investments. At December 31, 2002,$105.0 million of available-for-sale securities were included in cashequivalents and $107.3 million of available-for-sale securities wereincluded in short-term investments. These available-for-sale securities consistof government-backed notes, commercial paper, floating rate corporate bonds andfixed income corporate bonds. These investments are recorded at fair value. Anyunrealized holding gains or losses are reported as a component of comprehensiveincome.

 

**7.****             INVENTORIES:**

 

Inventories as of March 31, 2003 and December 31, 2002 consist ofthe following (in thousands):

 

8

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|            |   | **March 31, 2003** |    | **December 31, 2002** |   |
|-----------------|--------|--------------------|---------|-----------------------|--------|
|            |   |               |    |                  |   |
| Raw materials   |   | $                  | 125,347 |                  | $      | 84,715 |   |
| Work-in-process |   | 31,230             |    | 26,915                |   |
| Finished goods  |   | 637,891            |    | 313,036               |   |
|            |   | $                  | 794,468 |                  | $      | 424,666 |   |

 

**8.****             ACQUISITIONS:**

 

OnOctober 16, 2002, the Company acquired the assets and intellectualproperty of Shanghai Yi Yun Telecom Technology Co. Ltd. (“Shanghai YiYun”), a provider of synchronous digital hierarchy equipment.  The aggregate consideration paid by theCompany was $0.2 million of cash and 342,854 shares of restricted stockvalued at that time at $6.0 million. In connection with the acquisition, Shanghai Yi Yun and each ofthe stockholders that received the 342,854 shares of restricted stock executed anindemnity escrow agreement in favor of the Company and such shares ofrestricted stock were placed in escrow.  In addition, the Company issued514,290 shares of restricted stock valued at that time at $9.0 million tothe Shanghai Yi Yun employees that were hired by one of the Company’ssubsidiaries.  Such shares of restrictedstock vest over five years, with accelerated vesting upon the achievement ofspecified milestones.  The Company hastreated these 514,290shares of restricted stock as deferred compensation. 

 

Soon after theclosing of the acquisition, the two founders (the “Founders”) of Shanghai YiYun were criminally charged with infringing upon certain intellectual property owned bytheir former employer.  The purchaseagreement pursuant to which the Company acquired the assets of Shanghai Yi Yunis governed by the law of the People’s Republic of China (the “PRC”), and underPRC law, as advised by the Company’s PRC counsel, a contract may be rescindedif one party to the contract delays in performing its obligations orcommits other acts in breach of the contract so that the purpose of thecontract is frustrated.  In this case, since the Founders, who werehired by one of the Company’s subsidiaries following the closing of theacquisition, could not perform their obligations under the purchase agreementwhile they were detained on criminal charges of intellectual propertyinfringement and their failure to perform was determined tofrustrate the purpose of the purchase agreement, in December 2002, the Company’s PRC counsel advised theCompany that the purchase agreement could possibly be rescinded and the 342,854shares of restricted stock might not be released from escrow to thestockholders.  As of December 31, 2002, itwas not known when the Founders’ infringement cases would be heard or how theirinfringement cases would be resolved.

 

Furthermore, if any of the intellectual property acquired by theCompany in the acquisition was found to infringe on the intellectual propertyof the Founders’ former employer, the Company could assert a claim forindemnification under the indemnity

 

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escrowagreement and, depending on the damages incurred by the Company, up to all ofthe 342,854 shares ofrestricted stock would not bereleased from escrow to the stockholders. As of December 31, 2002, the Company was unable to determine if any ofthe intellectual property acquired in the acquisition was the subject of theinfringement charges.

 

Based on theuncertain status of the infringement charges against the Founders at December31, 2002, it was possible that under PRC law, the purchase agreement could havebeen rescinded.  Also, if it wasdetermined that the intellectual property acquired in the acquisition infringed on the intellectual property ofthe Founders’ former employer, the Company could file a claim forindemnification under the indemnity escrow agreement.  Therefore, because the outcome of the contingency was notdeterminable beyond a reasonable doubt and because of the possibility ofrescission, the Company did notrecord the acquisition as of December 31, 2002.

 

                Since December 31, 2002, theCompany has determined that the intellectual property acquired in theacquisition is not the subject of the infringement charges and does not believethat such intellectual property infringes on the intellectual property of theFounders’ former employer. Additionally, the Company recently has learned that the cases againstthe Founders were transferred from a local public security authority to anational public security authority, which the Company’s PRC counsel believes isin a more neutral position to resolve their cases.  Based on the transfer, the Company believes that the Founders’cases may be resolved in their favor in the future, thus eliminating a possiblerescission of the purchase agreement. Since the contingencies were determinable beyond a reasonable doubt asof March 31, 2003, the Company recorded the acquisition during the quarterended March 31, 2003. The amount of thepurchase price allocated to in-process research and development of$1.3 million, based on an appraisal by an independent valuationspecialist, was charged to the Company's results of operations, as no alternativefuture uses existed at the acquisition date. Goodwill of $2.8 million was recorded in connection with theacquisition and is expected to be deductible for tax purposes. The acquisitionwill enable the Company to enter the synchronous digital hierarchy transportmarket with internally developed products. The results of operations of Shanghai Yi Yun will be includedin the Company’s consolidated results of operations beginning April 1, 2003.

 

The followingrepresents the allocation of the purchase price for Shanghai Yi Yun:

 
|                                                                                                                |   | **(in  thousands)** |   |
|---------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|
| Fair value of  tangible net assets acquired                                                                         |   | $                   | 250    |   |
| Fair value of  identified intangible assets - technology                                                            |   | 1,870               |   |
| In-process  research and development                                                                                |   | 1,320               |   |
| Excess of costs  of acquiring Shangahi Yi Yun Telecom over fair value of identified net assets  acquired (goodwill) |   | 2,810               |   |
|                                                                                                                |   | $                   | 6,250  |   |

 

**9.****             DEBT:**

 

The following represents the outstanding long-term borrowings at March31, 2003 and December 31, 2002 (in thousands):

 
| **Note**                        |   | **Rate** |   | **Maturity**  |   | **March 31, 2003** |        | **December 31, 2002** |   |
|---------------------------------|--------|----------|--------|---------------|--------|--------------------|-------------|-----------------------|--------|
| Convertible  Subordinated Notes |   | 7/8      | %      | March 1, 2008 |   | $                  | 402,500,000 |                  | $      | — |   |
|                                 |        |          |        |               |        |                    |             |                       |        |  |  |

 

The Company hasunutilized borrowing facilities under lines of credit of $436.1 million as ofMarch 31, 2003. $239.2 million of these expire in 2003 and $196.9 million ofthese facilities expire between 2004 and 2010.

 

The Companycompleted an offering on March 12, 2003, of $402.5 million of convertiblesubordinated notes due March 1, 2008 to qualified buyers pursuant to Rule 144Aunder the Securities Act of 1933.  The notes bear interest at a rate of 0.875percent per annum and are convertible into the Company’s common stock at aconversion price of $23.79 per share and are subordinated to all present andfuture senior debt of the Company. Holders of the notes may convert their notesonly if: (i) the price of the Company’s common stock issuable upon conversionof a note reaches a specified threshold, (ii) specified corporate transactionsoccur, or (iii) the trading price for the notes falls below certain thresholds.  At the initial conversion price, each$1,000 principal amount of notes will be convertible into approximately 42.0345shares of our common stock. The Company has agreed to file a shelf registration statement with respect to the resaleof the notes and the common stock issuable upon the conversion of the noteswith the SEC within 120 days of the issuance of the notes.

 

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Concurrent with the issuance of the convertible notes, the Company hasentered into convertible bond hedge and call option transactions with respectto its common stock, the exposure for which is held by Banc of AmericaSecurities LLC and Credit Suisse First Boston LLC. Both the bond hedge and calloption transactions may be settled at the Company's option either in cash ornet shares and expire on March 1, 2008. The convertible bond hedge andcall option transactions are expected to reduce the potential dilution fromconversion of the notes. The options have been included in stockholders' equityin accordance with the guidance in Emerging Issues Task Force IssueNo. 00-19, “Accounting for Derivative Financial Instruments Indexed to,and Potentially Settled in, a Company's Own Stock.”

 

**10.****          WARRANTY OBLIGATIONS ANDOTHER GUARANTEES:**

 

Warrantyobligations are as follows (in thousands):

 
|                                              |   | **Three months ended  March 31** |       |
|---------------------------------------------------|--------|----------------------------------|------------|
|                                              |   | **2003**                         |       | **2002** |   |
|                                              |   |                             | ** ** |   | ** ** |
| Beginning of  period                              |   | $                                | 13,297     |   | $ | 6,721 |   |
| Accruals for  warranties issued during the period |   | 8,283                            |       | 2,293 |   |
| Adjustments to  accruals for changes in estimates |   | (4,552                           | )          | — |   |
| Settlements made  during the period               |   | (4,504                           | )          | (1,987 | ) |
| End of period                                     |   | $                                | 12,524     |   | $ | 7,027 |   |

 

Certain of theCompany’s sales contracts include provisions under which customers would beindemnified by the Company in the event of, among other things, a third-partyclaim against the customer for intellectual property rights infringementrelated to the Company’s products. There are no limitations on the maximumpotential future payments under these guarantees. The Company has accrued no amountsin relation to these provisions as no such claims have been made and theCompany believes it has valid, enforceable rights to the intellectual propertyembedded in its products.

 

The Company issuesstandby letters of credit primarily to support our international salesactivities outside of China. When the Company submits a bid for aninternational tender offer, oftentimes, the written “Request For Proposal” fromthe potential customer will include a requirement that the Company issue a bidbond/standby letter of credit to demonstrate its commitment through the bidprocess.  In addition, depending on thecontract, the Company may be required to issue standby letters of credit asguarantees for advance customer payments upon contract signing or performanceguarantees to protect customers from potential product delivery issues orperformance problems. The standby letters of credit usually expire six to ninemonths from date of issuance without being drawn by the beneficiary thereof.

 

**11.****          LONG-TERM INVESTMENTS:**

 

The Company’s investments are as follows (in thousands):

 
|                                         |   | **March 31,  2003** |   | **December 31,  2002** |   |
|----------------------------------------------|--------|---------------------|--------|------------------------|--------|
| Investment in  Softbank China                |   | $                   | 5,383  |                   | $      | 5,526 |   |
| Investment in  Cellon International          |   | 8,000               |   | 8,000                  |   |
| Investment in  China Telecom                 |   | 673                 |   | 9,106                  |   |
| Investment in  Joint Venture with Matsushita |   | 3,864               |   | 4,683                  |   |
| Investment in  others                        |   | 7,731               |   | 8,045                  |   |
| Total                                        |   | $                   | 25,651 |                   | $      | 35,360 |   |

 

The Company has invested $10.0 million inSoftbank China, an investment fund established by SOFTBANK CORP. focused oninvestments in Internet companies in China. This investment permits the Companyto participate in the anticipated growth of Internet-related businessesin China. SOFTBANK CORP. and its related companies are significant stockholdersof the Company. The Company's investment constitutes 10% of the funding forSoftbank China, with SOFTBANK CORP. contributing the remaining 90%. The fundhas a separate management team, and none of the Company's employees areemployed by the fund. Many of the fund's investments are and will be inprivately held companies, many of which are still in the start-up ordevelopment stages. These investments are inherently 

 

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risky as the market forthe technologies or products the companies have under development are typicallyin the early stages and may never materialize. The Company accounts for thisinvestment under the cost method and recorded losses of $0.1 million and$0.4 million due to a other than temporary decline in the carrying valueof this investment during the three months ended March 31, 2003 and 2002,respectively.

 

During the first quarter of fiscal 2002, the Company invested$2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliatedwith SOFTBANK CORP., is a significant stockholder of the Company. The fundfocuses on leveraged buyout investments in companies in Asia undergoing restructuringor bankruptcy procedures. The total fund offering is expected to be betweenapproximately $150.0 million and $226.0 million, with each investorcontributing a minimum of $0.8 million. The fund has a separate managementteam, and none of the Company’s employees are employed by the fund. The Companyaccounts for this investment under the equity method of accounting. The balancein this investment is $2.0 million at March 31, 2003.

 

The Company has also invested directly in a number of privatetechnology-based companies in the early stages of development. Theseinvestments are accounted for on the cost basis. The Company continuallyevaluates the carrying value of these investments for possible impairment basedon the achievement of business objectives and milestones, the financialcondition and prospects of these companies and other relevant factors. Duringthe three months ended March 31, 2003 and 2002, no impairment charge wasconsidered necessary, based upon a review of the carrying value of these investments.

 

In June 2002, the Company invested $1.0 million in GlobalAsia Partners L.P., with a commitment to invest up to a maximum of$5.0 million. The remaining amount is due at such times and in suchamounts as shall be specified in one or more future capital calls to be issuedby the general partner. The fund size is anticipated to be $100 millionand the fund was formed to make private equity investments in private orpre-IPO technology and telecommunications companies. The fund’s geographic focusis on technology investments in Asia, in particular India and China. TheCompany accounts for this investment under the equity method of accounting. Thebalance in this investment is $0.9 million at March 31, 2003.

 

                During2002, the Company purchased approximately 5.8 million shares of commonstock of InterWave Communications, Inc., a technology company listed onNASDAQ, for approximately $3.0 million. In addition, the Company receivedwarrants to purchase 2.0 million shares of InterWave's common stock at$0.21 cents per share, which were valued at $0.2 million at March 31, 2003,using the Black-Scholes option-pricing model. The Company recorded thechange in the carrying value of these securities of $0.2 million as ofMarch 31, 2003, in comprehensive income in equity. The Company recorded acharge of $0.1 million in the first quarter of 2003 to reflect the decline inthe fair value of the warrants.

 

In November 2002, the Company purchased approximately0.5 million shares of common stock of China Telecom in its initial publicoffering for approximately $10.0 million. In January 2003, the Companysold the majority of these shares realizing a loss of $0.1 million, andcurrently holds 37,500 shares. China Telecom is the leading provider ofwireline telephone, data and Internet and leased line services in four of themost economically developed regions of China, and its affiliates are customersof the Company. China Telecom is listed on the New York Stock Exchange.

 

**12.****          GOODWILL AND INTANGIBLEASSETS:**

 

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

 
|                           |   | **March 31, 2003** |   | **December 31, 2002** |   |
|--------------------------------|--------|--------------------|--------|-----------------------|--------|
|                           |   |               |   |                  |   |
| Goodwill                       |   | $                  | 47,641 |                  | $      | 44,806 |   |
| Purchased  technology          |   | 10,990             |   | 7,570                 |   |
| Less accumulated  amortization |   | (3,252             | )      | (2,556                | )      |
|                           |   | $                  | 55,379 |                  | $      | 49,820 |   |

 

Amortizationexpense for intangible assets was $0.7 million and $0.5 million forthe three months ended March 31, 2003 and 2002, respectively. Expectedamortization expense for the next five fiscal years, beginning the year endedDecember 31, 2004, is $2.9 million, $0.9 million, $0.1 million,$0.0 million and  $0.0 million,respectively.

 

Goodwill increased by $2.8 million and intangible assets increasedby $3.4 million during the three months ended March 31, 2003. This wasmainly attributable to goodwill and purchased technology that was recorded onthe acquisition of Shanghai Yi Yun

 

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in the first quarter of2003. The Company also purchased technology for $1.6 million in cash during thethree months ended March 31, 2003. The estimated useful life of purchasedtechnology is three years.

 

In July 2001, the FASB issued SFAS No. 142, “Goodwill andOther Intangible Assets.” SFAS No. 142 requires that goodwill andintangible assets with indefinite useful lives no longer be amortized, butinstead tested for impairment at least annually. SFAS No. 142 alsorequires that intangible assets with definite useful lives be amortized overtheir respective estimated useful lives to their estimated residual values, andreviewed for impairment in accordance with SFAS No. 144, “Accounting forthe Impairment or Disposal of Long-Lived Assets.”

 

The Company adopted SFAS No. 142 on January 1, 2002. SFASNo. 142 had the effect of eliminating amortization of goodwill commencingJanuary 1, 2002; however, impairment reviews may result in future periodicwrite-downs. The Company performs its annual impairment review in the fourthquarter of each year.

 

**13.****          SEGMENT REPORTING:**

 

The Company provides telecommunications equipment through an integratedsuite of network access systems, optical transmission products and subscriberterminal products. The Company primarily operates in two geographic areas,China and other regions. The chief operating decision makers evaluateperformance, make operating decisions, and allocate resources based onconsolidated financial data. Gross profit, operating income and income taxesare not allocated to specific individual departments within the organization.In accordance with SFAS No. 131 “Disclosures about Segments of anEnterprise and Related Information”, the Company is considered a singlereportable segment. Also the Company is required to disclose certaininformation about product revenues, information about geographic areas,information about major customers, and information about long-lived assets.

 

                Duringthe third quarter of 2002, the provincial-level telecommunicationsservice entity in the Zhejiang province of China began to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend in the Zhejiang province, the Company has grouped all customers inZhejiang province together and has treated these as one customer. At March 31,2003, the Company had approximately 19 such customers in Zhejiang province.Giving effect to this treatment, for the three months ended March 31, 2003,sales to BB Technologies Corporation (“BBTC”), Sichuan Chengdu PTT andHeilongjiang PTT accounted for 18%, 11% and 11% of our net sales, respectively.For the three months ended March 31, 2002, sales to Zhejiang province accountedfor 24% of our net sales and no other customer accounted for 10% or more of ourconsolidated net sales. Revenue attributable to Japan was primarily due tosales to BBTC. Sales to BBTC were $58.5 million for the three months endedMarch 31, 2003 and $10.0 million for the three months ended March 31,2002. 

 

Geographical area data and product data are as follows (in thousands):

 
|            |   | **Three Months Ended  March 31, 2003** |    | **Three Months Ended  March 31, 2002** |   |
|-----------------|--------|----------------------------------------|---------|----------------------------------------|--------|
|            |   |                                   |    |                                   |   |   |   |   |   |   |   |   |   |
|            |   | **Telecommunications  Equipment**      |    | **Subscriber  Handsets**               |   | **Total** |   | **Telecommunications  Equipment** |   | **Subscriber  Handsets** |   | **Total** |   |
| Net sales:      |   |                                   |    |                                   |   |   |   |   |   |   |   |   |   |
|            |   |                                   |    |                                   |   |   |   |   |   |   |   |   |   |
| China           |   | $                                      | 129,108 |                                   | $      | 139,821 |   | $ | 268,929 |   | $ | 97,625 |   | $ | 69,573 |   | $ | 167,198 |   |
| Japan           |   | 59,821                                 |    | —                                 |   | 59,821 |   | 13,729 |   | — |   |   | 13,729 |   |
| Other           |   | 1,632                                  |    | 138                                    |   | 1,770 |   | 2,763 |   | — |   | 2,763 |   |
| Total net sales |   | $                                      | 190,561 |                                   | $      | 139,959 |   | $ | 330,520 |   | $ | 114,117 |   | $ | 69,573 |   | $ | 183,690 |   |

 

Revenue attributable to the United States of America was insignificantduring the three months ended March 31, 2003 and 2002.

 

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

 

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|                     |   | **March 31,  2003** |       | **December 31,  2002** |       |
|--------------------------|--------|---------------------|------------|------------------------|------------|
|                     |   |                | ** ** |                   | ** ** |
| U.S.                     |   | $                   | 44,216     |                   | $          | 43,600 |   |
| Foreign                  |   | 118,043             |       | 104,731                |       |
| Total long-lived  assets |   | $                   | 162,259    |                   | $          | 148,331 |   |

 

**14.****          COMMITMENTS ANDCONTINGENCIES:**

 

*Litigation:*

 

On October 31, 2001, a complaint was filed in United StatesDistrict Court for the Southern District of New York against the Company, someof its directors and officers and various underwriters for its initial publicoffering. Substantially similar actions were filed concerning the initialpublic offerings for more than 300 different issuers, and the cases werecoordinated as *In re Initial Public OfferingSecurities Litigation*, 21 MC 92. In April 2002, a consolidatedamended complaint was filed in the matter against the Company, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604. Plaintiffs allegeviolations of the Securities Act of 1933 and the Securities Exchange Act of1934 through undisclosed improper underwriting practices concerning theallocation of IPO shares in exchange for excessive brokerage commissions,agreements to purchase shares at higher prices in the aftermarket, andmisleading analyst reports. Plaintiffs seek unspecified damages on behalf of apurported class of purchasers of the Company’s common stock betweenMarch 2, 2000 and December 6, 2000. The Company’s directors and officershave been dismissed without prejudice pursuant to a stipulation.  On February 19, 2003, the Court granted inpart and denied in part a motion to dismiss brought by defendants including theCompany. The order dismisses all claims against the Company except for a claimbrought under Section 11 of the Securities Act of 1933.  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.

 

*InvestmentCommitments:*

 

In June 2002, the Company invested $1.0 million in GlobalAsia Partners L.P. The fund size is anticipated to be $100 million and thefund was formed to make private equity investments in private or pre-IPOtechnology and telecommunications companies in Asia. The Company has acommitment to invest up to a maximum of $5.0 million. The remaining amountis due at such times and in such amounts as shall be specified in one or morefuture capital calls to be issued by the general partner.

 

**15.****          RELATED PARTYTRANSACTIONS:**

 

The Companyrecognized revenue of $58.5 million and $10.0 million during the threemonths ended March 31, 2003 and 2002, respectively, with respect to sales oftelecommunications equipment to BBTC, an affiliate of SOFTBANK CORP. SOFTBANKAmerica Inc., an entity affiliated with SOFTBANK CORP., is a significantstockholder of the Company. BBTC offers asynchronous digital subscriber line(“ADSL”) coverage throughout Japan, which is marketed under the name YAHOO. TheCompany provides ADSL technology to BBTC. The contract was competitively bidand the terms of this contract were on terms no more favorable than those withunrelated parties. Included in accounts receivable at March 31, 2003 is $58.7million related to this agreement. There were no amounts included in deferredrevenue in respect of this agreement at March 31, 2003. Included in accountsreceivable in respect of this agreement at December 31, 2002 was$0.8 million. There were no amounts included in deferred revenue inrespect of this agreement at December 31, 2002.

 

The Company has invested in Softbank China and Restructuring FundNo. 1, which are investment vehicles established by SOFTBANK CORP. and itsaffiliates. See Note 11. 

 

                OnAugust 29, 2002, the Company completed the repurchase of 6.0 millionshares of the Company's common stock for $72.9 million from it’s largestshareholder, SOFTBANK America Inc. As part of this transaction, SOFTBANK signeda voluntary "lock up" agreement stipulating that it would not sellany of the Company’s common stock within the next six months.

 

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This lock up agreement, whichended on March 1, 2003, coincided with the start of the Company’s"blackout period" in which insiders are not permitted to sell shares.The blackout period began March 1, 2003 and ended commencing at the closeof business on the second trading day following the public release of our firstquarter fiscal 2003 results on April 16, 2003. 

 

On February 21, 2003, the Company agreed to release SOFTBANK America,Inc. from its obligation under a lockup agreement dated August 29, 2002 not to,directly or indirectly, offer, pledge, sell or otherwise dispose of or transferits shares of the Company’s common stock prior to March 1, 2003 withoutobtaining the Company’s written consent. The release applied to 10 million of the shares of the Company’s commonstock held by SOFTBANK.

 

                OnMarch 7, 2003 the Company agreed to repurchase 8.0 million shares of theCompany’s common stock, beneficially owned by SOFTBANK America Inc., at apurchase price of $17.385 per share. The total cost of the repurchase, whichwas completed on April 5, 2003, was $139.6 million, including transaction fees.In connection with this repurchase transaction, SOFTBANK entered into anagreement with us not to offer, sell or otherwise dispose of the Company’scommon stock for a period of one year, subject to a number of exceptions. As ofApril 5, 2003, SOFTBANK beneficially owned approximately 14.7% of the Company’soutstanding common stock.       

 

**16.****          COUNTRY RISKS:**

 

                Approximately81% and 91% of the Company's net sales for the three months ended March 31,2003 and 2002, respectively, were made in China. Accordingly, the Company'sbusiness, financial condition and results of operations are likely to beinfluenced by the political, economic and legal environment in China and by thegeneral state of China's economy. The Company's operations in China are subjectto special considerations and significant risks not typically associated withcompanies in the United States. These include risks associated with, amongothers, the political, economic and legal environments and foreign currencyexchange. The Company's results may be adversely affected by, among otherthings, changes in the political, economic, competitive and social conditionsin China, including changes in governmental policies with respect to laws andregulations, changes in China's telecommunications industry and regulatoryrules and policies, anti-inflationary measures, currency conversion andremittance abroad, and rates and methods of taxation. 

 

Under China’s current regulatory structure, the communications productsthat the Company offers in China must meet government and industry standards, anda network access license for the equipment must be obtained. Without thelicense, the equipment is not allowed to be connected to publictelecommunications networks or sold in China. Moreover, the Company must ensurethat the quality of the telecommunications equipment for which it has obtaineda network access license is stable and reliable, and may not lower the qualityor performance of other installed licensed products. China’s State Council’sproduct quality supervision department, in concert with China’s Ministry ofInformation Industry, performs spot checks to track and supervise the qualityof licensed telecommunications equipment and publishes the results of such spotchecks.

 

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

 

Approximately 18%and 7% of the Company’s sales for the three months ended March 31, 2003 and2002, respectively, were made in Japan. Accordingly, the political, economicand legal environment and the general state of Japan’s economy may influencethe Company’s business, financial condition and results of operation.

 

**17.****          RECENT ACCOUNTINGPRONOUNCEMENTS:**

 

In November 2002, the Emerging Issues Task Force reached aconsensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”(“EITF No. 00-21”). This issue addresses how revenue arrangements with multipledeliverables should be divided

 

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into separate units of accounting and how the arrangement considerationshould be allocated to the identified separate accounting units. EITFNo. 00-21 is effective for fiscal periods beginning after June 15,2003. Where multiple elements exist in an arrangement, the arrangement fee isallocated to the different elements based upon verifiable objective evidence ofthe fair value of the elements. The Company has not yet determined the impactof adopting EITF No. 00-21 on our consolidated results of operations orfinancial position.

 

The FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities”, (“FIN 46”) in January 2003. FIN 46 providesaccounting guidance for consolidation of variable interest entities (“VIE”),formerly referred to as special purpose entities. FIN 46 applies to public andprivate business enterprises that have a controlling interest or business orcontractual relationship with a VIE. FIN 46 requires consolidation of existingnon controlled affiliates if the VIE is unable to finance its operationswithout investor support, or where the other investors do not have exposure tothe significant risks and rewards of ownership. The Company expects this couldrequire consolidation of one of our non-controlled affiliates under FIN 46,which is effective for the Company at the beginning of the interim period thatstarts July 1, 2003. The Company has a 90% ownership interest in UTStarcom(Chongqing) Co., Ltd., (“CUTS”) an affiliate incorporated in China thatassembles and manufactures handsets for our Personal Access System, or PAS,product line. The Company does not have control of the voting rights of CUTS;however, the Company is the primary beneficiary. Therefore, this affiliatewould be considered a VIE under FIN 46. The Company may be required toconsolidate the results of operations of this affiliate commencing July 1,2003. CUTS was formed in November 2002 and the results of operations of CUTSfor the three months ended March 31, 2003 were not material to our results ofoperations.  The maximum exposure toloss assuming there is no further investment is $4.5 million at March 31, 2003.

 

 

**ITEM 2—MANAGEMENT’S DISCUSSION ANDANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS**

 

**FORWARD-LOOKINGSTATEMENTS**

 

                This Report on Form 10-Q containsforward-looking statements within the meaning of the federal securities laws.These statements are based on information that is currently available tomanagement. We intend such forward-looking statements to be covered by the safeharbor provisions of the Private Securities Litigation Reform Act of 1995, andwe are including this statement for purposes of complying with thoseprovisions. The forward-looking statements include, without limitation, thoseconcerning the following: our expectations as to the nature of possible trends;the manner in which customers in Chinese provinces negotiate for the purchaseof our products; our expectation regarding continued growth in our business andoperations; our expectation that our PAS network access system will continue tobe allowed in China’s county-level cities and counties; our expectation thatthere will be no penalties or fines for our non-compliance with the licensingrequirements in China for our PAS system and other products; our expectationconcerning the anticipated cost and completion date of our new Hangzhoumanufacturing facility; our expectation that there will be fluctuations in ouroverall gross profit, gross margin, product mix, quarter to quarter results,customer base and selling prices; our plans for expanding the direct sales organizationand our selling and marketing campaigns and activities; our expectation that wemay use part of the net proceeds of our initial and follow on public offeringsto acquire or invest in complementary businesses, technologies or productofferings; our expectation that we may use the remaining net proceeds of ourconvertible subordinated notes offering for general corporate purposes,including research and development, expansion of our sales and marketingorganization and working capital; our expectation that there will be increasesin selling, marketing, research and development, general and administrativeexpenses; our expectation that we will continue to invest significantly inresearch and development; our expectation that we will fill the majority of ourcurrent backlog orders; our expectation regarding our future investments,particularly in Softbank China; our expectation that existing cash and cashequivalents will be sufficient to finance our operations for at least the next12 months; our expectations regarding the acquisition of the CommWorksdivision of 3Com Corporation, including accounting consequences such as theamortization of intangible assets and in process research and developmentwrite-offs; the impact of changes in general world and domestic economicconditions in light of the military conflict in Iraq; and the potential impactof the Severe Acute Respiratory Syndrome (“SARS”) on our operations and overallperformance. Additional forward-looking statements may be identified by thewords, “anticipate,” “expect,” “believe,” “intend,” “will” and similarexpressions, as they relate to us or our management. Investors are cautionedthat these forward-looking statements are inherently uncertain. Thesestatements are subject to risks and uncertainties that may cause actual resultsand events to differ materially. For a detailed discussion of these risks anduncertainties, see

 

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the “Factors Affecting Future Operating Results” section of this Form 10-Q.We do not guarantee future results and undertake no obligation to update theforward-looking statements to reflect events or circumstances occurring afterthe date of this Form 10-Q.

 

**OVERVIEW**

 

Incorporated in1991, UTStarcom designs, manufactures, and markets wireline and wirelessbroadband access and switching equipment that enables migration to nextgeneration IP-based networks. Our operations are conducted primarily by ourforeign subsidiaries that manufacture, distribute and support our products,principally in China. Our systems and products allow service providers to offercost-efficient and expandable voice, data and Internet access services. Becauseour systems are based on widely adopted international communications standards,service providers can easily integrate our systems into their existing networksand deploy our systems in new broadband, Internet Protocol and wireless networkrollouts.

 

We have derived most of our revenues from sales of telecommunicationsequipment to service providers in China. However, we continue to expand oursales to service providers in other growing communications markets outside ofChina, including Japan, Taiwan, Vietnam, India and Latin America. Our customersoften make a large initial purchase of our equipment followed by supplementalpurchases of enhancements and upgrades. As a result, our largestrevenue-producing customers typically vary from period to period. Theevaluation period for our products by potential customers may span a year ormore and our business generally depends on a relatively small number of largedeployments. We sell our products in China through a direct sales force.

 

                Approximately81% and 91% of our net sales for the three months ended March 31, 2003 and2002, respectively, were in China. Accordingly, our business, financialcondition and results of operations are likely to be influenced by thepolitical, economic and legal environment in China, and by the general state ofChina's economy. Our results may be adversely affected by, among other things,changes in the political, economic, competitive and social conditions in China,including changes in China’s governmental policies with respect to laws andregulations, changes in telecommunications industry and regulatory rules andpolicies, anti-inflationary measures, currency conversion and remittanceabroad, and rates and methods of taxation. We extend credit to our customers inChina without requiring collateral. We monitor our exposure for credit lossesand maintain allowances for doubtful accounts. 

 

We have historically considered local telecommunications serviceproviders serving municipalities and counties to be our primary customers inChina. Recently, however, the provincial-level telecommunications serviceentity in the Zhejiang province of China has begun to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend in the Zhejiang province, we have grouped all customers in Zhejiangprovince together and have treated these as one customer. Giving effect to thistreatment, for the three months ended March 31, 2003, sales to BB TechnologiesCorporation , Sichuan Chengdu PTT and Heilongjiang PTT accounted for 18%, 11%and 11% of our net sales, respectively. For the three months ended March 31, 2002,sales to Zhejiang province accounted for 24% of our net sales and no othercustomer accounted for 10% or more of our consolidated net sales. At March 31,2003, we have approximately nineteen customers in Zhejiang province.

 

                Whether this represents the beginning of a greatertrend throughout China towards increased consolidation of negotiations andpurchasing decisions into the control of provincial-level telecommunicationsservice entities is unclear. To our knowledge, no telecommunications service entitiesin the other Chinese provinces in which we operate have centralized thisprocess. However, the nature of negotiations in China is still evolving. If atrend toward consolidation of purchasing decisions into the control ofprovincial-level telecommunications service entities in China does emerge, itcould possibly take a variety of forms. For example, some provincial-leveltelecommunications service entities could simply coordinate purchase decisionsto be made by local telecommunications service providers, with local serviceproviders retaining ultimate control over purchasing decisions. In other cases,however, provincial-level entities could wield greater control over thedecision of whether or not to purchase our products. In any event, such a trendcould streamline the negotiation process within Chinese provinces, but it couldalso place downward pressure on the prices we can charge for our products. Wewill continue to monitor business practices in China closely, and to the extentthat any of these changes affect the manner in which our customers make theirdecisions about whether or not to purchase our products, we will re-evaluatewhat entities may best be described as our customers.

 

                UnderChina's current regulatory structure, the communications products that we offerin China must meet government and industry standards, and a network accesslicense for the equipment must be obtained. Without the license, the equipmentis not allowed to be connected to public telecommunications networks or sold inChina. Moreover, we must ensure that the quality of the telecommunicationsequipment for which we have obtained a network access license is stable andreliable, and may not lower the quality or performance of other installedlicensed products. China’s State Council’s quality supervision department, in concertwith China's Ministry of Information Industry, performs spot checks to track and supervise the quality of licensedtelecommunications equipment and publishes the results of such spot checks. 

 

The regulations implementing these requirements are not very detailed,have not been applied by a court and may be interpreted and enforced byregulatory authorities in a number of different ways. We have obtained therequired network access licenses for our AN-

 

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2000Bplatform.  We have also obtained aprobationary network access license for our mSwitch product, and after thetrial period, an official network access license will be issued if the trialdemonstrates that mSwitch satisfies all applicable government and industrystandards. We have applied for, but have not yet received, a network accesslicense for our PAS systems and handsets. Based upon conversations with theMinistry of Information Industry, we understand that our PAS systems andhandsets are considered to still be in the trial period and that sales of ourPAS systems and handsets may continue to be made by us during this trialperiod. However a license will ultimately be required. Network access licenseswill also be required for most additional products that we are selling or maysell in China, including our mSwitch platform. If we fail to obtain therequired licenses, we could be prohibited from making further sales of theunlicensed products, including our PAS systems and handsets, in China, whichwould substantially harm our business, financial condition and results ofoperations. Our counsel in China has advised us that China’s governmentalauthorities may interpret or apply the regulations with respect to whichlicenses are required and the ability to sell a product while a product is inthe trial period in a manner that is inconsistent with the information receivedby our counsel in China, either of which could have a material adverse effect onour business, financial condition and results of operations.

 

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

 

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

 

Revenues from sales of telecommunications equipmentare recognized when persuasive evidence of an arrangement exists, delivery ofthe product has occurred as evidenced by customer acceptance, the fee is fixedor determinable and collectability is reasonably assured. If the fee due fromthe customer is not fixed or determinable due to extended payment terms,revenue is recognized as payments become due from the customer, assuming allother criteria for revenue recognition is met. Any payments received prior torevenue recognition are recorded as deferred revenue. Shipping and handling costsare recorded as revenues and costs of revenues. 

 

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

 

                Cost of sales consists primarily of material costs,third party commissions, costs associated with manufacturing, assembly andtesting of products, costs associated with installation and customer trainingand overhead and warranty costs. Cost of sales also includes import taxes andtariffs on components and assemblies. Some components and materials used in ourproducts are purchased from a single supplier or a limited group of suppliersand, in some cases, are subject to our obtaining Chinese import permits andapprovals. We also rely on third party manufacturers in China to manufactureand assemble most of our handsets.

 

Our gross profit has been affected by product mix, average sellingprices and material costs. Our gross profit, as a percentage of net sales,varies among our product families. The gross profit, as a percentage of netsales, on our handsets is lower compared to our other products. We believe thatour handset sales in 2003 could represent up to approximately 35% to 45% of ournet sales. We expect that our overall gross profit, as a percentage of netsales, will fluctuate from period to period as a result of shifts in productmix, anticipated decreases in average selling prices and our ability to reducecost of sales.

 

Selling, general andadministrative expenses include compensation and benefits, professional fees,sales commissions, provision for doubtful accounts receivable and travel andentertainment costs. A large percentage of our costs are fixed and aredifficult to quickly reduce in periods of reduced sales. We intend to pursueaggressive selling and marketing campaigns and to expand our direct salesorganization, and, as a result, our sales and marketing expenses will increasein future periods. We also expect that in support of our continued growth,general and administrative expenses will continue to increase for theforeseeable future.

 

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

 

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                Amortizationof intangible assets consists primarily of the amortization of intangibleassets associated with acquisitions in China and outside of China and ouracquisitions of Stable Gain International Ltd., Issanni Communications,Inc. (“Issanni”) and Advanced Communication Devices Corporation (“ACD”). 

 

Consolidated equity in net income (loss) of affiliated companiescomprised our 51% share of the earnings from Guangdong UTStarcom, Ltd.(“GUTS”), our Guangdong manufacturing subsidiary, which we accounted for usingthe equity method prior to our acquisition of the remaining 49% ownershipinterest in GUTS in May 2002. We previously accounted for this under theequity method because we did not have voting control over significant matters.

 

Under current regulations in China, foreign investment enterprises thathave been accredited as technologically advanced enterprises are entitled toadditional tax incentives. These tax incentives vary in different locales andcould include preferential national enterprise income tax treatment at 50% ofthe usual rates for different periods of time. All of our active subsidiariesin China were accredited as technologically advanced enterprises. The taxholidays applicable to our wholly-owned subsidiaries UTStarcom China andUTStarcom Telecom Co., Ltd. (“HUTS”), which together accounted forapproximately 63.2% of our revenues for the three months ended March 31, 2003,expired at the end of 2002 and 2001, respectively. The tax holidays were notextended for the entities, and for 2003, the national enterprise tax rates wereincreased from 7.5% to 15%, and from 10% to 15%, respectively. During thefourth quarter of 2002, we formed a new entity, Hangzhou UTStarcomTelecom Co., Ltd., to manufacture and sell handsets. This entity willbenefit from a two year national enterprise income tax exemption from the firstprofit-making year and a 50% national enterprise income tax reduction in thefollowing three years. The Chinese government is considering the imposition ofa “unified” corporate income tax that would phase out, over time, thepreferential tax treatment to which foreign investment enterprises, such asUTStarcom, are currently entitled. We cannot be certain whether the governmentwill implement such a unified tax structure, or, if implemented, whether itwill adversely affect our financial results.

 

Minority interest in (earnings) loss of consolidated subsidiariesrepresented the share of earnings in HUTS, our Zhejiang manufacturing jointventure, attributable to our joint venture partner, prior to our acquisition ofthe remaining 12% ownership interest in HUTS in May 2002.

 

**RECENTDEVELOPMENTS**

 

                OnMarch 4, 2003, we entered into an agreement to purchase certain assets andliabilities of the CommWorks division of 3Com Corporation, subject toregulatory approvals, the completion of the audit of the CommWorks division andother customary closing conditions, for $100.0 million in cash. CommWorksdevelops and deploys carrier-class, IP-based multi-service access and servicecreation platforms for telecommunications service providers. If we fail toclose the acquisition by July 2, 2003 and all closing conditions have beensatisfied, we will be required to pay 3Com Corporation a $10.0 million break-upfee. The transaction has been approved by the board of directors of both companiesand does not require stockholder approval. 

 

                OnMarch 7, 2003, we agreed to repurchase 8.0 million shares of our common stock,beneficially owned by SOFTBANK America Inc., at a purchase price of $17.385 pershare. The total cost of the repurchase, which was completed on April 5, 2003,was $139.6 million including transaction fees. In connection with thisrepurchase transaction, SOFTBANK entered into an agreement with us not tooffer, sell or otherwise dispose of our common stock for a period of one year,subject to a number of exceptions. As of April 5, 2003, SOFTBANK beneficiallyowned approximately 14.7% of our outstanding common stock. 

 

On March 12, 2003 we sold $402.5 million of convertible subordinated notes due in2008 to qualified institutional buyers pursuant to Rule 144A under theSecurities Act of 1933, as amended. The notes bear interest at a rate of 0.875percent per annum, are convertible into UTStarcom common stock at a conversionprice of $23.79 per share and are subordinated to all present and future seniordebt of UTStarcom. Holders of the notes may convert their notes only if: (i)the price of our common stock issuable upon conversion of a note reaches aspecified threshold, (ii) specified corporate transactions occur, or (iii) thetrading price for the notes falls below certain thresholds.  At the initial conversion price, each $1,000principal amount of notes will  beconvertible into approximately 42.0345 shares of our common stock. We usedapproximately $139.6 million of the net proceeds in the second quarter torepurchase 8 million of our shares beneficially owned by SOFTBANK America Inc.as described above. We also used approximately $43.8 million of the netproceeds to enter into convertible bond hedge and call option transactions withrespect to our common stock to reduce the potential dilution from conversion ofthe notes. We intend to use the balance of the net proceeds for generalcorporate purposes, including research and development, expansion of our salesand marketing organization and working capital.  From time to time we may evaluate opportunities to acquire orinvest in complementary businesses, technologies or products, and may use aportion of the net proceeds to enter into these types of transactions. 

 

**CRITICALACCOUNTING POLICIES**

 

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

 

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

 

**RevenueRecognition, Allowances for Doubtful Accounts and Product Warranty**

 

We recognize revenue from sales of telecommunications equipment whenpersuasive evidence of an arrangement exists, delivery of the product hasoccurred, the fee is fixed or determinable and collectability is reasonablyassured. For transactions where we have yet to obtain customer acceptance,revenue is deferred until the terms of acceptance are satisfied. A salesreserve is established based on historical trends in sales returns. If actualfuture sales returns do not reflect the historical data, our revenue could beaffected. Historically, the level of sales returns and our collection historyhave been within our expectations.

 

We also maintain allowances for doubtful accounts based on ourassessment of the collectability of our accounts receivable. We continuallymonitor collections from our customers and maintain allowances for doubtfulaccounts based upon the age of outstanding invoices and any specific customercollection issues. Historically, doubtful accounts or credit losses have beenwithin our expectations, and our doubtful account allowances have beenadequate.

 

We provide a warranty on our equipment and handset sales for a periodgenerally ranging from twelve to eighteen months. We provide for the expectedcost of product warranties at the time that we recognize revenue, based on ourassessment of past warranty experience. We continually monitor the level of ourwarranty expenses. If, however, there were a material adverse change in ourproduct failure rates, an additional warranty provision would be required.Historically, our warranty experience has been within our expectations.

 

**Inventories**

 

                Ourinventories are stated at the lower of cost or net realizable value, net ofwrite-downs for excess, slow moving and obsolete inventory. Inventorywrite-downs are based on our assumptions about future market conditionsand customer demand. We continually monitor our inventory valuation.Historically, the level of inventory write-downs, our inventory turnoverand obsolescence experience have been within our expectations. 

 

**Researchand Development and Software Development Costs**

 

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

 

**DeferredIncome Taxes**

 

We recognize deferred income taxes as the difference between the taxbases of assets and liabilities and their financial statement amounts based onenacted tax rates. Management judgment is required in the assessment of therecoverability of our deferred tax assets based on our assessment of projectedtaxable income. Numerous factors could affect our results of operations in thefuture. If there were a significant decline in our future operating results, ourassessment of the recoverability of our deferred tax assets would need to berevised, and any such adjustment to our deferred tax assets would be charged toincome in that period.

 

**Goodwilland Intangibles**

 

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

 

**Long-TermInvestments**

 

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

 

**RELATEDPARTY TRANSACTIONS**

 

We recognizedrevenue of $58.5 million and $10.0 million during the three months endedMarch 31, 2003 and 2002, respectively, with respect to sales oftelecommunications equipment to BBTC, an affiliate of SOFTBANK CORP. SOFTBANKAmerica Inc., an entity affiliated with SOFTBANK CORP., is a significantstockholder of ours. BBTC offers asynchronous digital subscriber line (“ADSL”)coverage throughout Japan, which is marketed under the name YAHOO. We provideADSL technology to BBTC. The contract was competitively bid and the terms ofthis contract were on terms no more favorable than those with unrelatedparties. Included in accounts receivable at March 31, 2003 is $58.7 millionrelated to this agreement. There were no amounts included in deferred revenuein respect of this agreement at March 31, 2003. Included in accounts receivablein respect of this agreement at December 31, 2002 was $0.8 million.There were no amounts included in deferred revenue in respect of this agreementat December 31, 2002.

 

We invested$10.0 million in Softbank China, an investment fund established bySOFTBANK CORP. focused on investments in Internet companies in China. Thisinvestment permits us to participate in the anticipated growth of Internet-relatedbusinesses in China. SOFTBANK CORP. and its related companies are significantstockholders of ours. Our investment constitutes 10% of the funding forSoftbank China, with SOFTBANK CORP. contributing the remaining 90%. The fundhas a separate management team, and none of our employees are employed by thefund. Many of the fund's investments are and will be in privately heldcompanies, many of which are still in the start-up or development stages. Theseinvestments are inherently risky as the market for the technologies or productsthe companies have under development are typically in the early stages and maynever materialize. We account for this investment under the cost method andrecorded losses of $0.1 million and $0.4 million due to a other thantemporary decline in the carrying value of this investment during the threemonths ended March 31, 2003 and 2002, respectively. 

 

During the first quarter of fiscal 2002, we invested $2.0 millionin Restructuring Fund No. 1, a venture capital investment limitedpartnership established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANKCORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., isa significant stockholder of ours. The fund focuses on leveraged buyoutinvestments in companies in Asia undergoing restructuring or bankruptcyprocedures. The total fund offering is expected to be between approximately$150.0 million and $226.0 million, with each investor contributing aminimum of $0.8 million. The fund has a separate management team, and noneof our employees are employed by the fund. We account for this investment underthe equity method of accounting. The balance in this investment is$2.0 million at March 31, 2003.

 

                OnAugust 29, 2002, we completed the repurchase of $6.0 million shares of ourcommon stock for $72.9 million from our largest shareholder, SOFTBANKAmerica Inc. As part of this transaction, SOFTBANK signed a voluntary"lock up" agreement stipulating that it would not sell any of ourcommon stock within the next six months. This lock up agreement, which ended onMarch 1, 2003, coincided with the start of our "blackout period"in which insiders are not permitted to sell shares. The blackout period beganMarch 1, 2003 and ended commencing at the close of business on the secondtrading day following the public release of our first quarter fiscal 2003results on April 16, 2003. 

 

On February 21, 2003, we agreed to release SOFTBANK America Inc. fromits obligation under a lockup agreement dated August 29, 2002 not to, directlyor indirectly, offer, pledge, sell or otherwise dispose of or transfer itsshares of our common stock prior to March 1, 2003 without obtaining our writtenconsent.  The release applied to 10million of the shares of our common stock held by SOFTBANK.

 

                OnMarch 7, 2003, we agreed to repurchase 8.0 million shares of our common stock,beneficially owned by SOFTBANK America Inc., at a purchase price of $17.385 pershare. The total cost of the repurchase, which was completed on April 5, 2003,was $139.6 million including transaction fees. In connection with thisrepurchase transaction, SOFTBANK entered into an agreement with us not tooffer, sell or otherwise dispose of our common stock for a period of one year,subject to a number of exceptions. As of April 5, 2003, SOFTBANK beneficiallyowned approximately 14.7% of our outstanding common stock.           

 

 

**RESULTSOF OPERATIONS**

 

**THREEMONTHS ENDED MARCH 31, 2003 AND MARCH 31, 2002**

 

NET INCOME

 

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For the three months ended March 31, 2003, net income increased 113% to$37.3 million as compared to net income of $17.5 million for thethree months ended March 31, 2002. The increase in net income was mainly aresult of the higher growth in our gross profit, which increased by 72%, ascompared to the growth in operating expenses, which increased by 53%. We willcontinue to focus our efforts on the efficient management of our operatingexpenses, including continued cost reduction, manufacturing efficiencies andthe redesign of our products for our PAS systems.

 

NET SALES

 

Our net sales increased 80% to $330.5 million for the three monthsended March 31, 2003 from $183.7 million for the corresponding period in2002. Sales of telecommunications equipment for the three months ended March31, 2003 were $190.6 million, an increase of $76.4 million or 67% ascompared to the three months ended March 31, 2002. Sales of subscriber handsetsfor the three months ended March 31, 2003 were $139.9 million, an increaseof $70.4 million or 101%, as compared to the three months ended March 31,2002. In particular, sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment,PAS handsets and other products were $124.5 million, $65.7 million, $140.0million and $0.3 million, respectively, and represented 38%, 20%, 42% and 0% ofour net sales for the three months ended March 31, 2003, respectively. Sales ofPAS/iPAS equipment, AN-2000/IP-DSLAM equipment, PAS handsets and other productswere $93.2 million, $16.5 million, $69.6 million and $4.4 million,respectively, and represented 51%, 9%, 38% and 2% of our net sales for thethree months ended March 31, 2002, respectively. Our mSwitch products areincluded with our iPAS product offering. We do not expect the percentage ofrevenues attributed to these products to change significantly in the nearfuture.  In particular, we expect that,in 2003, sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment and PAShandsets will represent approximately 40-45%, 20-25% and 35-40% of our netsales, respectively. 

 

Sales of iPAS/PAS equipment and sales of subscriber handsets increaseddue to the continued growth in spending on telecommunications infrastructure inChina, which accounted for 81% and 91% of our net sales for the three monthsended March 31, 2003 and 2002, respectively. International sales oftelecommunication equipment increased to $61.6 million for the threemonths ended March 31, 2003 as compared to $16.5 million for the threemonths ended March 31, 2002, primarily driven by sales of IP-DSLAM equipment toBBTC in Japan to support its ADSL rollout. Sales in Japan for the three monthsended March 31, 2003 and 2002, accounted for 18% and 7% of our net sales,respectively. For the three months ended March 31, 2003, sales to BBTC, SichuanChengdu PTT and Heilongjiang PTT accounted for 18%, 11% and 11% of our netsales, respectively.  During 2002, theprovincial-level telecommunications service entity in the Zhejiang province ofChina began to consolidate telecommunications purchasing decisions for thatprovince. As a result of this trend in the Zhejiang province, we have groupedall customers in Zhejiang province together and have treated these as onecustomer. At March 31, 2003, we had approximately 19 such customers in Zhejiangprovince. For the three months ended March 31, 2002, sales to Zhejiang provinceaccounted for 24% of our net sales.

 

COST OF GOODS SOLD

 

During the three months ended March 31, 2003, our cost of goods sold asa percentage of sales increased to 65.9% from 64.3 % in the correspondingperiod.  This increase can be primarilyattributed to the fact that a higher proportion of our sales are lower marginhandsets, which comprised 42% and 38% of our sales for the three months endedMarch 31, 2003 and 2002, respectively.

 

GROSS PROFIT

 

Gross profit increased by 72% to $112.7 million for the threemonths ended March 31, 2003 from $65.6 million for the correspondingperiod in 2002. Gross profit, as a percentage of net sales, was 34% for thethree months ended March 31, 2003 and 36% for the three months ended March 31,2002. Gross profit, as a percentage of net sales, decreased primarily due to ahigher level of lower margin handset sales, which comprised 42% and 38% of oursales for the three months ended March 31, 2003 and 2002, respectively. Webelieve our lower margin handset sales will increase somewhat during futureperiods. In addition, we believe that there will be continued competitivemarket pricing pressures on our other products in line with current trends inthe industry. However, we believe that cost efficiencies arising from thecontinued cost reduction, manufacturing efficiencies and redesign of ourproducts for our PAS systems will partially offset the impact of these factorson our gross profit as a percentage of net sales.

 

SELLING, GENERAL AND ADMINISTRATIVE

 

                Selling, general and administrative expensesincreased 59% to $37.6 million for the three months ended March 31, 2003from $23.7 million for the corresponding period in 2002. The increase inselling, general and administrative expenses was primarily due to increasedsales and administrative personnel and related expenses, including salescommissions, associated with the growth in net sales and the expansion of ouroverall level of business activities. Selling and administrative headcountincreased to 1,810 employees at March 31, 2003 as compared to 1,125 employeesat March 31, 2002. Selling, general and administrative expenses as a percentageof net sales were 11% and 13% for the three months ended March 31, 2003 and2002, respectively. We expect our selling, general and administrative expensesto increase in absolute dollar amounts in future periods as sales and marketingactivities increase and we incur additional

 

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expenses relatedto the anticipated growth of our business and operations.

 

RESEARCH AND DEVELOPMENT

 

Research and development expenses increased 40% to $26.8 millionfor the three months ended March 31, 2003 from $19.2 million for thecorresponding period in 2002. The increase in research and development expenseswas primarily due to the hiring of additional technical personnel, increasedprototype expenses and licensing fees to support our research and developmentefforts. Research and development headcount increased to 1,440 employees atMarch 31, 2003 as compared to 1,058 employees at March 31, 2002. As apercentage of net sales, research and development expenses were 8% and 11% forthe three months ended March 31, 2003 and 2002, respectively. We expect ourresearch and development expenses to increase in absolute dollar amounts infuture periods as we expand our research and development organization tosupport new product development.

 

IN-PROCESS RESEARCH AND DEVELOPMENT COSTS

 

                In-processresearch and development costs of $1.3 million during the three months endedMarch 31, 2003 resulted from our acquisition of  ShanghaiYi Yun and was based on an appraisal by an independent valuation specialist. 

 

AMORTIZATION OF INTANGIBLE ASSETS

 

Amortization of intangible assets was $0.7 million for the threemonths ended March 31, 2003 and $0.5 million for the three months endedMarch 31, 2002. The increase in amortization expense is mainly due toadditional amortization of intangibles recorded upon our acquisition of Issanniin April 2002.

 

INTEREST INCOME (EXPENSE), NET

 

Net interest income was $0.3 million for the three months endedMarch 31, 2003 and $0.9 million for the corresponding period in 2002. Thedecrease was primarily due to lower balances in cash and cash equivalents onaverage during the three months ended March 31, 2003 as compared to 2002. Inaddition, average interest rates on deposits decreased from 1.5% to 1.0%.

 

OTHER INCOME (EXPENSE), NET

 

Other income (expense), net was $4.2 million of income for the threemonths ended March 31, 2003 and $0.2 million of income for the correspondingperiod in 2002. The current quarter’s other income (expense), net was primarilydue to a reinvestment incentive payment received in China of $3.9 million.

 

EQUITY IN LOSS OF AFFILIATED COMPANIES

 

Consolidated equity in the net loss of affiliated companies was$1.0 million for the three months ended March 31, 2003 and$0.8 million for the corresponding period in 2002. The current quarter’s equityincome (loss) was primarily due to our share of losses relating to a jointventure agreement we entered into on July 5, 2002 with MatsushitaCommunication Industrial Co., Ltd., and Matsushita Electric IndustrialCo., Ltd., to jointly design, develop, manufacture and selltelecommunication products. We have a 49% ownership interest in this jointventure company.  The equity loss for2002 is in respect of losses at our Guangdong manufacturing subsidiary. In May 2002,we acquired the remaining 49% ownership interest in GUTS, which is now awholly-owned subsidiary. Its results of operations are included in ourconsolidated financial statements beginning June 1, 2002. Prior to May2002, GUTS was accounted for using the equity method of accounting.

 

INCOME TAX EXPENSE

 

Income tax expense was $12.4 million for the three months endedMarch 31, 2003 and $4.5 million for the corresponding period in 2002. Theincrease in income tax expense was due to our increasing income. The effectivetax rate was 25% and 20% for the three months ended March 31, 2003 and 2002,respectively. The increase in our effective tax rate is due primarily to theexpiration of certain tax holidays in China and the fact that more of ourrevenue will be attributed to higher tax rate jurisdictions as we expand ourbusiness globally. The future rate may vary due to a variety of factors,including, but not limited to, the relevant income contribution by domestic andforeign operations, changes in statutory tax rates, the amount of tax exempt interestincome generated during the year, the ability to utilize foreign tax creditsand non-deductible items relating to acquisitions, or other non-recurringcharges. We will continue to monitor the effective tax rate on a quarterlybasis.

 

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MINORITY INTEREST IN (EARNINGS) OF CONSOLIDATEDSUBSIDIARIES

 

Minority interest in earnings of consolidated subsidiaries was$0.0 million for the three months ended March 31, 2003 and$0.5 million for the corresponding period in 2002. The decrease is due tothe acquisition of the remaining 12% ownership interest in HUTS in May 2002.HUTS is now a wholly-owned subsidiary of UTStarcom.

 

**LIQUIDITYAND CAPITAL RESOURCES**

 

At March 31, 2003we had lines of credit totaling $436.1 million available for futureborrowings.  We have not guaranteed anydebt not included in the consolidated balance sheet. At March 31, 2003, we hadworking capital of $957.9 million, including $562.1 million in cash and cashequivalents and $42.0 million of short-term investments.

 

Net cash used in operations for the three months endedMarch 31, 2003 of $77.2 million was primarily due to an increase ininventories, accounts receivable and other current and non-current assets of$372.3 million, $41.4 million and $55.3 million, respectively.  This was partially offset by net income of$37.3 million, adjusted for non-cash charges including depreciation andamortization expense of $7.9 million and allowance for doubtful accounts of$8.2 million, as well as growth in accounts payable of $219.9 million, otheraccrued liabilities of $12.2 million, deferred revenue of $93.0 million andincome taxes payable of $5.9 million. Net cash used in operations for the threemonths ended March 31, 2002 of $4.2 million was primarily due to net income of$17.5 million, adjusted for depreciation and amortization expense of $5.2million, amortization of deferred stock compensation expense of $1.3 million,non-qualified stock option exercise tax benefits of $2.0 million, inventoryreserve of $1.7 million, allowance for doubtful accounts of $3.0 million and anincrease in income taxes payable of $1.8 million. This was more than offset byan increase in inventories, accounts receivable and other current andnon-current assets of $12.0 million, $15.8 million and $3.4 million,respectively, and decreases in deferred revenue and other current liabilitiesof $3.1 million and $4.0 million, respectively.

 

Net cash provided by investing activities for thethree months ended March 31, 2003 of $56.0 million was primarily due to netsales of short-term investments of $75.6 million offset by purchases ofproperty, plant and equipment of $15.2 million. Net cash provided by investingactivities for the three months ended March 31, 2002 of $20.0 million wasprimarily due to sales of short-term investments of $40.2 million, partiallyoffset by purchases of plant, property and equipment of $7.3 million andinvestment in affiliates of $12.8 million.

 

Net cashprovided by financing activities for the three months ended March 31, 2003 of$351.7 million was primarily due to the offering of convertible subordinatednotes of $391.4 million and proceeds from the exercise of stock options of $4.0million, offset by purchases of call options for $43.8 million. Net cashprovided by financing activities for the three months ended March 31, 2002 of$25.3 million was primarily due to net proceeds of $28.9 million from theexercise of the over-allotment option by our underwriters in connection withthe public offering of our common stock in February 2002 and $3.6 million fromthe issuance of common stock through the exercise of stock options.  This was offset by net payments of $7.2million on borrowings under our lines of credit. 

 

We completed anoffering on March 12, 2003 of $402.5 million of convertible subordinated notesdue in 2008 to qualified buyers pursuant to Rule 144A under the Securities Actof 1933. We used $43.8 million of the net proceeds in the second quarter toenter into convertible bond hedge and call option transactions with respect toour common stock to reduce the potential dilution from conversion of thenotes.  We used $139.6 million of thenet proceeds in the second quarter to repurchase 8 million of our shares ofcommon stock beneficially owned by SOFTBANK America, Inc., pursuant to anagreement we entered into on March 7, 2003. On March 4, 2003, we entered intoan agreement to purchase certain assets and liabilities of the CommWorksdivision  of 3Com Corporation for $100.0million in cash, subject to regulatory approvals, the completion of the auditof the CommWorks division and other customary closing conditions. Theacquisition is expected to close by the end of June 2003. If the Company failsto close the acquisition by July 2, 2003 and all closing conditions have beensatisfied, the Company will be required to pay 3Com a $10.0 million break-upfee. The transaction has been approved by the boards of directors of bothcompanies and does not require stockholder approval.

 

In 2001, we purchased the rights to use 49 acres of land located inZhejiang Science and Technology Industry Garden of Hangzhou Hi-tech IndustryDevelopment Zone. As of March 31, 2003, we have completed the foundation andgroundwork and have commenced construction of the building. We expect thatconstruction of the new facility will be completed in 2003 or 2004 at aprojected cost of approximately $95.6 million. Capital expenditures forthe facility were $38.6 million in 2002 and $5.2 million in the threemonths ended March 31, 2003.

 

Our principal commitments at March 31, 2003 consist of obligationsunder operating leases and a commitment to invest up to an additional$4.0 million in one of our investments. We lease certain of our facilitiesunder non-cancelable operating leases, which expire at various dates through2007. We did not have any borrowings under our lines of credit at March 31,2003.

 

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

 

Our China sales are generally denominated in local currency. Due to thelimitations on converting Renminbi, we are limited in our ability to engage incurrency hedging activities in China. Sales outside China are generallydenominated in US dollars. We cannot guarantee that fluctuations in currencyexchange rates in the future will not have a material adverse effect onrevenues from international sales and, correspondingly, on our business,financial condition and results of operations. We have contracts negotiated inJapanese Yen and a multi-currency bank account in Japanese Yen for purchasingportions of our inventories and supplies. The balance of this Japanese Yenaccount March 31, 2003 was approximately $122.2 million. As of March 31,2003 and December 31, 2002, we were not engaged in any hedging activities anddid not hold any derivative financial instruments in respect of these JapaneseYen purchases.

 

We believe that our existing cash and cash equivalents, short-terminvestments and cash from operations will be sufficient to finance ouroperations through at least the next 12 months. As of March 31, 2003, wehad cash, restricted cash and investments, of $612.5 million and lines ofcredit totaling $436.1 million available for future borrowings. $239.2 millionof these expire in 2003 and $196.9 million of these facilities expire between2004 and 2010. However, in the event that our current cash balances, futurecash flows from operations and current lines of credit are not sufficient tomeet our obligations or strategic needs or in the event that market conditionsare favorable, we would consider raising additional funds in the capital orequity markets. If additional financing is needed, there can be no assurancethat such financing will be available to us on commercially reasonable terms,or at all.

 

**CONTRACTUALOBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS**

 

Our obligations under contractual obligations and commercialcommitments are primarily with regards to leasing arrangements, standby lettersof credit and convertible subordinated notes and are as follows (in thousands):

 
|                            |   | **March 31, 2003**         |    |
|---------------------------------|--------|----------------------------|---------|
|                            |   | **Payments Due by Period** |    |
|                            |   | **Total**                  |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   |
| *Contractual  Obligations*      |   |                       |    |   |   |   |   |   |   |
| Operating leases                |   | $                          | 12,234  |   | $ | 6,312 |   | $ | 4,713 |   | $ | 1,209 |   |
| Convertible  Subordinated Notes |   | $                          | 402,500 |   | $ | — |   | $ | — |   | $ | 402,500 |   |
| *Other  Commercial Commitments* |   |                       |    |   |   |   |   |   |   |
| Standby letters  of credit      |   | $                          | 8,382   |   | $ | 8,382 |   | $ | — |   | $ | — |   |

 

We issue standbyletters of credit primarily to support our international sales activitiesoutside of China. When we submit a bid for an international tender offer,oftentimes, the written “Request For Proposal” from the potential customer willinclude a requirement that we issue a bid bond/standby letter of credit todemonstrate our commitment through the bid process.  In addition, depending on the contract, we may be required toissue standby letters of credit as guarantees for advance customer paymentsupon

 

 

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contract signing or performance guarantees to protect customers frompotential product delivery issues or performance problems. The standby lettersof credit usually expire six to nine months from date of issuance without beingdrawn by the beneficiary thereof.

 

**RECENTACCOUNTING PRONOUNCEMENTS**

 

In November 2002, the Emerging Issues Task Force reached aconsensus on Issue No. 00-21, “Revenue Arrangements with MultipleDeliverables” (“EITF No. 00-21”). This issue addresses how revenue arrangementswith multiple deliverables should be divided into separate units of accountingand how the arrangement consideration should be allocated to the identifiedseparate accounting units. EITF No. 00-21 is effective for fiscal periodsbeginning after June 15, 2003. Where multiple elements exist in anarrangement, the arrangement fee is allocated to the different elements basedupon verifiable objective evidence of the fair value of the elements We havenot yet determined the impact of adopting EITF No. 00-21 on ourconsolidated results of operations or financial position.

 

The FinancialAccounting Standards Board issued Interpretation No. 46, “Consolidation ofVariable Interest Entities”, (“FIN 46”) in January 2003. FIN 46 providesaccounting guidance for consolidation of variable interest entities (“VIE”),formerly referred to as special purpose entities. FIN 46 applies to public andprivate business enterprises that have a controlling interest or business orcontractual relationship with a VIE. FIN 46 requires consolidation of existingnon controlled affiliates if the VIE is unable to finance its operationswithout investor support, or where the other investors do not have exposure tothe significant risks and rewards of

 

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ownership. We expect thiscould require consolidation of one of our non-controlled affiliates under FIN46, which is effective for us at the beginning of the interim period thatstarts July 1, 2003. We have a 90% ownership interest in UTStarcom (Chongqing)Co., Ltd. (“CUTS”), an affiliate incorporated in China, that assembles andmanufactures handsets for our Personal Access System, or PAS, product line. Wedo not have control of the voting rights of CUTS; however, we are the primarybeneficiary. Therefore, this affiliate would be considered a VIE under FIN 46.We may be required to consolidate the results of operations of this affiliatecommencing July 1, 2003. CUTS was formed in November 2002 and the results ofoperations of CUTS for the three months ended March 31, 2003 were not materialto our results of operations.  Themaximum exposure to loss assuming there is no further investment is $4.5million at March 31, 2003.

 

**FACTORSAFFECTING FUTURE OPERATING RESULTS**

 

**RISKSRELATING TO OUR COMPANY**

 

**OURFUTURE PRODUCT SALES ARE UNPREDICTABLE, OUR OPERATING RESULTS ARE LIKELY TOFLUCTUATE FROM QUARTER TO QUARTER, AND IF WE FAIL TO MEET THE EXPECTATIONS OFSECURITIES ANALYSTS OR INVESTORS, OUR STOCK PRICE COULD DECLINE SIGNIFICANTLY**

 

Our quarterly and annual operating results have fluctuated in the pastand are likely to fluctuate in the future due to a variety of factors, some ofwhich are outside of our control. As a result, period-to-period comparisons ofour operating results are not necessarily meaningful or indicative of futureperformance. Furthermore, it is likely that in some future quarters ouroperating results will fall below the expectations of securities analysts orinvestors. If this occurs, the trading price of our common stock could decline.

 

Factors that may affect our future operating results include:

 

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

 

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

 

•                                          theevolving and unpredictable nature of the economic, regulatory, competitive andpolitical environments in China and other countries in which we market or planto market our products;

 

•                                          pricereductions by our competitors;

 

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

 

•                                          changesin our customers’ subscriber growth rate;

 

•                                          currencyfluctuations;

 

•                                          marketacceptance of our products and product enhancements;

 

•                                          thelengthy and unpredictable sales cycles associated with sales of our productscombined with the impact of this variability on our suppliers’ ability toprovide us with components on a timely basis;

 

•                                          theimpact on operations and demand, particularly in the Far East, of the SARSoutbreak;

 

•                                          theimpact of changes in general world and domestic economic conditions in light ofthe military conflict in Iraq;

 

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

 

•                                          thedecline in business activity we typically experience during the Lunar New Year,which leads to decreased sales during our first fiscal quarter.

 

The limited performance history of some of our products, our limitedforecasting experience and processes and the emerging nature of our targetmarkets make forecasting our future sales and operating results difficult. Ourexpense levels are based, in part, on our expectations regarding future sales,and these expenses are largely fixed, particularly in the short term. Inaddition, to enable us to promptly fill orders, we maintain inventories offinished goods, components and raw materials. As a result, we commit toconsiderable costs in

 

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advance ofanticipated sales. In the past, a substantial portion of our sales in eachquarter resulted from orders received and shipped in that quarter, and we haveoperated with a limited backlog of unfilled orders. Accordingly, we may not beable to reduce our costs in a timely manner to compensate for any unexpectedshortfall between forecasted and actual sales. Any significant shortfall of salesmay require us to maintain higher levels of inventories of finished goods,components and raw materials than we require, thereby increasing our risk ofinventory obsolescence and corresponding inventory write-downs and write-offs.

 

**COMPETITIONIN OUR MARKETS MAY LEAD TO REDUCED PRICES, REVENUES AND MARKET SHARE**

 

We are increasingly facing intense competition in our target markets,especially from domestic companies in China. We believe that our strongestcompetition in the future may come from these companies, many of which operateunder lower cost structures and more favorable governmental policies and havemuch larger sales forces than we do. Furthermore, other companies not presentlyoffering competing products may also enter our target markets, particularlywith the reduction of trade restrictions as a result of China’s admission tothe World Trade Organization, or WTO. Many of our competitors havesignificantly greater financial, technical, product development, sales,marketing and other resources than we do. As a result, our competitors may beable to respond more quickly to new or emerging technologies and changes inservice provider requirements. Our competitors may also be able to devotegreater resources than we can to the development, promotion and sale of newproducts. These competitors may also be able to offer significant financingarrangements to service providers, in some cases facilitated by governmentpolicies, which is a competitive advantage in selling systems to serviceproviders with limited financial and currency resources. Increased competitionis likely to result in price reductions, reduced gross profit as a percentageof net sales and loss of market share, any one of which could materially harmour business, financial condition and results of operations.

 

Moreover, current and potential competitors have established or mayestablish cooperative relationships among themselves or with third parties,including Telecommunications Administrations, Telecommunications Bureaus andother local organizations, to increase the ability of their products to addressthe needs of prospective customers in our target markets. Accordingly,alliances among competitors or between competitors and third parties may emergeand rapidly acquire significant market share. To remain competitive, we believethat we must continue to partner with Telecommunications Administrations andother local organizations, maintain a high level of investment in research anddevelopment and in sales and marketing, and manufacture and deliver products toservice providers on a timely basis and without significant defects. If we failto meet any of these objectives, our business, financial condition and resultsof operations could be harmed.

 

The introduction of inexpensive wireless telephone service or othercompetitive services in China may also have an adverse impact on sales of ourPAS systems and handsets in China. We may not be able to compete successfullyagainst current or future competitors, and competitive pressures in the futuremay materially adversely affect our business, financial condition and resultsof operations.

 

**OURBUSINESS MAY SUFFER IF WE ARE UNABLE TO COLLECT PAYMENTS FROM OUR CUSTOMERS ONA TIMELY BASIS**

 

Our customers often must make a significant commitment of capital topurchase our products. As a result, any downturn in a customer’s business thataffects the customer’s ability to pay us could harm our financial condition.Moreover, accounts receivable collection cycles historically tend to be muchlonger in China than in other markets. The failure of any of our customers tomake timely payments could require us to write-off accounts receivable orincrease our accounts receivable reserves, either of which could adverselyaffect our financial condition.

 

**THE PENDINGACQUISITION OF THE COMMWORKS DIVISION OF 3COM CORPORATION MAY NOT BECONSUMMATED**

 

On March 4, 2003, we entered into an agreement to purchase certainassets and liabilities of the CommWorks division of 3Com Corporation for $100.0million in cash.  The transaction isexpected to close by the end of June 2003. However, the consummation of the acquisition is subject to regulatoryapprovals, the completion of the audit of the CommWorks division, and othercustomary closing conditions.  If wefail to close the acquisition by July 2, 2003 and all closing conditions havebeen satisfied, we will be required to pay to 3Com Corporation a $10.0 millionbreak-up fee.  We expect the transactionto result in approximately $20.0 million to $30.0 million of intangible assetsto be amortized over four years and also expect to incur a one-time charge,estimated at $8.0 million to $12.0 million, associated with the write-off ofin-process research and development in the quarter in which the transactioncloses.  The foregoing amounts representour current estimates but are subject to change following the completion of anasset valuation.  We cannot assure youthat the acquisition will ever be consummated.

 

**COMMWORKSHAS EXPERIENCED SEQUENTIALLY DECLINING ANNUAL REVENUE AND SUBSTANTIAL OPERATINGLOSSES**

 

Based on information provided by 3Com Corporation in its publicfilings, CommWorks has experienced sequentially declining annual revenue forthe past several years and has experienced substantial operating losses duringthese periods.  There can be noassurance that CommWorks will not continue to do so following its acquisitionby us.  For SEC reporting purposes,CommWorks has been treated as a separate segment by 3Com Corporation; however,CommWorks is not a separate legal entity. Since CommWorks does not operate as a separate legal entity, completehistorical financial statements for CommWorks have not yet been prepared.  The audited financial statements, whenprepared, may differ significantly from the information reported by 3ComCorporation in its financial statements. Furthermore, historical results of the CommWorks operations may not beindicative of the results to be expected from those operations as they areintegrated into our business.

 

**OURACQUISITION OF COMMWORKS COULD BE DIFFICULT TO INTEGRATE, MAY DISRUPT OURBUSINESS AND COULD HARM OUR OPERATING RESULTS**

 

Even if the transaction is consummated, our management and financialcontrols, personnel, computer systems and other corporate support systems maynot be adequate to manage the increase in the size and scope of our operationsas a result of the completed acquisition. In addition, we may not be able to generate revenue from the CommWorksoperations consistent with historical results. We may not be able to realize the synergies that we expect will resultfrom the addition of the CommWorks assets to our business.  Although our acquisition of CommWorks isstructured as the acquisition of selected assets and liabilities, we cannotassure you that we will not assume or become subject to, as a result of theacquisition, liabilities that have an adverse impact on our financial positionor results of operations.  We alsoexpect that CommWorks will need a significant working capital investment fromus and/or an available debt facility. If additional financing is needed to fund the CommWorks operations, wecannot assure you that such financing will be available to us on commerciallyreasonable terms, or at all.

 

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**OURMARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE EFFECTIVELY, WEMUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE**

 

The emerging market for communications equipment in developingcountries is characterized by rapid technological developments, frequent newproduct introductions and evolving industry and regulatory standards. Oursuccess will depend in large part on our ability to enhance our network accessand switching technologies and develop and introduce new products and productenhancements that anticipate changing service provider requirements andtechnological developments. 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 timely develop andintroduce new products or enhancements to existing products that effectivelyrespond to technological change, our business, financial condition and resultsof operations could be materially adversely affected. From time to time, ourcompetitors or we may announce new products or product enhancements,technologies or services that have the potential to replace or shorten the lifecycles of our products and that may cause customers to defer purchasing ourexisting products, resulting in inventory obsolescence. Future technologicaladvances in the communications industry may diminish or inhibit marketacceptance of our existing or future products or render our products obsolete.

 

Even if we are able to develop and introduce new products, they may notgain market acceptance. Market acceptance of our products will depend onvarious factors including:

 

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•                                          ourability to obtain necessary approvals from regulatory organizations;

 

•                                          theperceived advantages of the new products over competing products;

 

•                                          ourability to attract customers who have existing relationships with ourcompetitors;

 

•                                          productcost relative to performance; and

 

•                                          thelevel of customer service available to support new products.

 

Specifically, sales of PAS, our wireless access system, will depend inpart upon consumer acceptance of the mobility limitations of this servicerelative to other wireless service systems, such as GSM or CDMA. If ourexisting or new products fail to achieve market acceptance for any reason, ourbusiness could be seriously harmed.

 

**OURBUSINESS WILL SUFFER IF WE ARE UNABLE TO DELIVER QUALITY PRODUCTS ON A TIMELYAND COST EFFECTIVE BASIS**

 

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

 

We contract with third parties in China to undertake high volumemanufacturing and assembly of our handsets. In addition, we sometimes use thirdparties for high volume assembly of circuit boards. We do not have anylong-term contracts with these third party manufacturers, and in the event thatthese manufacturers are unable or unwilling to continue to manufacture ourproducts, we may be unable to secure alternative manufacturers or couldexperience delays in qualifying new manufacturers.

 

**WEDEPEND ON SOME SOLE SOURCE AND OTHER KEY SUPPLIERS FOR HANDSETS, BASE STATIONS,COMPONENTS AND MATERIALS USED IN OUR PRODUCTS, AND IF THESE SUPPLIERS FAIL TOPROVIDE US WITH ADEQUATE SUPPLIES OF HIGH QUALITY PRODUCTS AT COMPETITIVEPRICES, OUR COMPETITIVE POSITION, REPUTATION AND BUSINESS COULD BE HARMED**

 

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

 

Our ability to source a sufficient quantity of high quality componentsused in our products may be limited by China’s import restrictions and duties.We require a significant number of imported components to manufacture ourproducts in China. Imported electronic components and other imported goods usedin the operation of our business are subject to a variety of permitrequirements, approval procedures, import duties and registration requirements.Non-payment of required import duties could subject us to penalties and finesand could adversely affect our ability to manufacture and sell our products inChina. In addition, import duties increase the cost of our products and maymake them less competitive.

 

In particular, components of our PAS system include the handset used bysubscribers to make and receive mobile telephone calls and the base stationunit. Our inability to obtain a sufficient number of high quality componentsand assemblies for handsets and base stations could severely harm our business.From time to time, there has been a worldwide shortage of handsets, and therecurrently exists a shortage of low-priced handsets, which we have found to bepopular with many consumers in China. We have only used third parties toassemble and manufacture handsets in China for us for a limited period of time.These manufacturers may be unable to produce adequate quantities ofhigh-quality handsets to meet the demand of our customers. In addition, we maybe unable to obtain adequate quantities of base stations and may be unable tofind alternative sources on favorable terms, in a timely manner, or at all. Ourinability to obtain or to develop alternative sources if and as required couldresult in delays or reductions in manufacturing or product shipments.

 

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**IF WEARE UNABLE TO EXPAND OUR DIRECT SALES OPERATION IN CHINA AND INDIRECTDISTRIBUTION CHANNELS ELSEWHERE OR SUCCESSFULLY MANAGE OUR EXPANDED SALESORGANIZATION, OUR OPERATING RESULTS MAY SUFFER**

 

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

 

**WEEXPECT AVERAGE SELLING PRICES OF OUR PRODUCTS TO DECREASE WHICH MAY REDUCE OURREVENUES AND OUR GROSS MARGIN AS A PERCENTAGE OF NET SALES, AND, AS A RESULT,WE MUST INTRODUCE NEW PRODUCTS AND REDUCE OUR COSTS IN ORDER TO MAINTAINPROFITABILITY**

 

The average selling prices for communications access and switchingsystems and subscriber terminal products, such as handsets, in China have beendeclining as a result of a number of factors, including:

 

•                                          increasedcompetition;

 

•                                          aggressiveprice reductions by competitors; and

 

•                                          rapidtechnological change.

 

We anticipate that average selling prices of our products will decreasein the future in response to product introductions by us or our competitors orother factors, including price pressures from customers. Therefore, we mustcontinue to develop and introduce new products and enhancements to existingproducts that incorporate features that can be sold at higher average sellingprices. Failure to do so could cause our revenues and gross profit, as apercentage of net sales, to decline.

 

Our cost reduction efforts may not allow us to keep pace withcompetitive pricing pressures or lead to improved gross profit, as a percentageof net sales. In order to be competitive, we must continually reduce the costof manufacturing our products through design and engineering changes. We maynot be successful in these efforts or delivering our products to market in atimely manner. Any redesign may not result in sufficient cost reductions toallow us to reduce the prices of our products to remain competitive or toimprove or maintain our gross profit, as a percentage of net sales.

 

**SHIFTSIN OUR PRODUCT MIX MAY RESULT IN DECLINES IN GROSS PROFIT, AS A PERCENTAGE OFNET SALES**

 

Our gross profit, as a percentage of net sales, varies among ourproduct groups. Our gross profit, as a percentage of net sales, is generallyhigher on our access network system products and is significantly lower on ourhandsets. We also anticipate that the gross profit, as a percentage of netsales, may be lower for our newly developed products due to start-up costs andmay improve as unit volumes increase and efficiencies can be realized. Ouroverall gross profit, as a percentage of net sales, has fluctuated from periodto period as a result of shifts in product mix, the introduction of newproducts, decreases in average selling prices for older products and ourability to reduce manufacturing costs.

 

**SERVICEPROVIDERS SOMETIMES EVALUATE OUR PRODUCTS FOR LONG AND UNPREDICTABLE PERIODSWHICH CAUSES THE TIMING OF PURCHASES AND OUR RESULTS OF OPERATIONS TO BEUNPREDICTABLE**

 

The period of time between our initial contact with a service providerand the receipt of an actual purchase order may span a year or more. Duringthis time, service providers may subject our products to an extensive andlengthy evaluation process before making a purchase. The length of thesequalification processes may vary substantially by product and service provider,making our results of operations unpredictable. We may incur substantial salesand marketing expenses and expend significant management effort during thisprocess, which ultimately may not result in a sale. These qualificationprocesses often make it difficult to obtain new customers, as service providersare reluctant to expend the resources necessary to qualify a new supplier ifthey have one or more existing qualified sources.

 

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**OURMULTI-NATIONAL OPERATIONS SUBJECT US TO VARIOUS ECONOMIC, POLITICAL, REGULATORYAND LEGAL RISKS**

 

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

 

•                                          difficultiesin designing products that are compatible with varying internationalcommunications standards;

 

•                                          longeraccounts receivable collection periods and greater difficulty in accountsreceivable collection;

 

•                                          unexpectedchanges in regulatory requirements or the regulatory environment;

 

•                                          changesin governmental control or influence over our customers;

 

•                                          changesto import and export regulations, including quotas, tariffs and other tradebarriers;

 

•                                          delaysor difficulties in obtaining export and import licenses;

 

•                                          potentialforeign exchange controls and repatriation controls on foreign earnings;

 

•                                          exchangerate fluctuations and currency conversion restrictions;

 

•                                          theburdens of complying with a variety of foreign laws and regulations;

 

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

 

•                                          reducedprotection for intellectual property rights in some countries;

 

•                                          potentiallyadverse tax consequences; and

 

•                                          politicaland economic instability.

 

Multi-national companies are required to establish intercompany pricingfor transactions between their separate legal entities operating in differenttaxing jurisdictions. These intercompany transactions are subject to audit bytaxing authorities in the jurisdictions in which multi-national companiesoperate. An additional tax liability may be incurred if it is determined thatintercompany pricing was not done at arm’s length. We believe we haveadequately estimated and recorded our liability arising from intercompanypricing, but an additional tax liability may result from audits of ourintercompany pricing policies.

 

In markets outside of China, we rely on a number of original equipmentmanufacturers, or OEMs, and third-party distributors and agents to market andsell our network access products. If these OEMs, distributors or agents fail toprovide the support and effort necessary to service developing marketseffectively, our ability to maintain or expand our operations outside of Chinawill be negatively impacted. We may not successfully compete in these markets,our products may not be accepted and we may not successfully overcome the risksassociated with international operations.

 

Moreover, in less developed markets we may face additional risks, suchas inconsistent infrastructure support, unstable political and economicenvironments, and lack of a secure environment for our personnel, facilitiesand equipment. We have in the past experienced cases of vandalism and armedtheft of our equipment that had been or was being installed in the field. Ifdisruptions for any of these reasons become too severe in any particularmarket, it may become necessary for us to terminate contracts and withdraw fromthat market and suffer the associated costs and lost revenue.

 

Due to the multi-national nature of our business and operations, we aresubject to regulation in multiple governmental jurisdictions. Furthermore, as aresult of the heavily regulated nature of the markets in which we operate, weare continually subject to the risk of governmental investigations regardingour compliance with the rules and regulations of such jurisdictions. Should webecome subject to any such investigations, there may be significant andunanticipated expenses, and risks such as the distraction of our key employeesand disruptions to our operations. Such expenses and risks may result even inthe event that such investigations are decided in our favor and no instances ofnon-compliance are found.

 

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**WE ARESUBJECT TO RISKS RELATING TO CURRENCY EXCHANGE RATE FLUCTUATIONS**

 

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

 

**OURFAILURE TO MEET INTERNATIONAL AND GOVERNMENTAL PRODUCT STANDARDS COULD BEDETRIMENTAL TO OUR BUSINESS**

 

Many of our products are required to comply with numerous governmentregulations and standards, which vary by market. As standards for productscontinue to evolve, we will need to modify our products or develop and supportnew versions of our products to meet emerging industry standards, comply withgovernment regulations and satisfy the requirements necessary to obtainapprovals. Our inability to obtain regulatory approval and meet establishedstandards could delay or prevent our entrance into or force our departure fromparticular markets.

 

**OURRECENT GROWTH HAS STRAINED OUR RESOURCES, AND IF WE ARE UNABLE TO MANAGE ANDSUSTAIN OUR GROWTH, OUR OPERATING RESULTS WILL BE NEGATIVELY AFFECTED**

 

We have recently experienced a period of rapid growth and anticipatethat we must continue to expand our operations to address potential marketopportunities. If we fail to implement or improve systems or controls or tomanage any future growth and expansion effectively, our business could suffer.

 

Our expansion has placed and will continue to place a significantstrain on our management, operational, financial and other resources. To manageour growth effectively, we will need to take various actions, including:

 

•                                          enhancingmanagement information systems and forecasting procedures;

 

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

 

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

 

•                                          expanding,training and managing our employee base; and

 

•                                          expandingour finance, administrative and operations staff.

 

**WE MAYNOT BE ABLE TO SUSTAIN PROFITABILITY**

 

We may not be able to remain profitable in future periods. Weanticipate continuing to incur significant sales and marketing, research anddevelopment and general and administrative expenses and, as a result, we willneed to generate higher revenues to remain profitable. Numerous factors couldnegatively impact our results of operations, including a decrease in sales,price pressures and significant fixed costs. Our past results should not berelied on as an indication of our future performance.

 

**OURSUCCESS IS DEPENDENT ON CONTINUING TO HIRE AND RETAIN QUALIFIED PERSONNEL, ANDIF WE ARE NOT SUCCESSFUL IN ATTRACTING AND RETAINING THESE PERSONNEL, OURBUSINESS WOULD BE HARMED**

 

The success of our business depends in significant part upon thecontinued contributions of key technical and senior management personnel, manyof whom would be difficult to replace. In particular, our success depends inlarge part on the knowledge, expertise and services of Hong Liang Lu, ourChairman of the Board, President and Chief Executive Officer, and Ying Wu, ourExecutive Vice President and Chief Executive Officer of China Operations. Theloss of any key employee, the failure of any key employee to performsatisfactorily in his or her current position or our failure to attract andretain other key technical and senior management employees could have asignificant negative impact on our operations.

 

To effectively manage our recent growth as well as any future growth,we will need to recruit, train, assimilate, motivate and retain qualifiedemployees. Competition for qualified employees is intense, and the process ofrecruiting personnel with the combination of skills and attributes required toexecute our business strategy can be difficult, time-consuming and expensive.We are actively searching for research and development engineers and sales andmarketing personnel, who are in short supply. Additionally, we have a need forand have experienced difficulty in finding qualified accounting personnelknowledgeable in U.S. and China accounting standards who are resident in China.If we fail to attract, hire, assimilate or retain qualified personnel, ourbusiness would be harmed.

 

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Competitors and others have in the past and may in the future attemptto recruit our employees. In addition, companies in the telecommunicationsindustry whose employees accept positions with competitors frequently claimthat the competitors have engaged in unfair hiring practices. We may be thesubject of these types of claims in the future as we seek to hire qualifiedpersonnel. Some of these claims may result in material litigation anddisruption to our operations. We could incur substantial costs in defendingourselves against these claims, regardless of their merit.

 

**ANYACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OURBUSINESS, DILUTE OUR STOCKHOLDERS AND HARM OUR OPERATING RESULTS**

 

                Wemay acquire other businesses, products and technologies. For example, on March4, 2003, we entered into an agreement to purchase certain assets andliabilities of the CommWorks division of 3Com Corporation, subject toregulatory approvals, the completion of the audit of the CommWorks division andother customary closing conditions, for $100.0 million in cash.  In addition, during 2002 we acquiredIssanni, a remote access server and local access technology company and assetsand intellectual property of Shanghai Yi Yun, a provider of synchronous digitalhierarchy transmission equipment. Any anticipated benefits of an acquisitionmay not be realized. We have in the past and will continue to evaluateacquisition prospects that would complement our existing product offerings,augment our market coverage, enhance our technological capabilities, or thatmay otherwise offer growth opportunities. Acquisitions may result in dilutiveissuances of equity securities, use of our cash resources, the incurrence ofdebt and the amortization of expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including difficulties in theassimilation of operations, technologies, products and personnel of theacquired company, diversion of management's attention from other businessconcerns, risks of entering markets in which we have no direct or limited priorexperience, and the potential loss of key employees of the acquired company. 

 

**WE MAY BE UNABLETO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY WHICH COULD SUBSTANTIALLY HARMOUR BUSINESS**

 

                Werely on a combination of patents, copyrights, trademarks, trade secret laws andcontractual obligations to protect our technology. We have applied for patentsin the United States, three of which have been issued. We have also filedpatent applications in other countries. Additional patents may not be issuedfrom our pending patent applications and our issued patents may not be upheld.In addition, we have, from time to time, chosen to abandon previously filedapplications. Moreover, we have not yet obtained, and may not be able toobtain, patents in China on our products or the technology that we use tomanufacture our products. Our subsidiaries and joint ventures in China relyupon our trademarks, technology and know-how to manufacture and sell ourproducts. We cannot guarantee that these and other intellectual propertyprotection measures will be sufficient to prevent misappropriation of ourtechnology or that our competitors will not independently develop technologiesthat are substantially equivalent or superior to ours. In addition, the legalsystems of many foreign countries, including China, do not protect intellectualproperty rights to the same extent as the legal system of the United States.

 

**WE MAY BESUBJECT TO CLAIMS THAT WE INFRINGE THE INTELLECTUAL PROPERTY OF OTHERS, WHICHCOULD SUBSTANTIALLY HARM OUR BUSINESS**

 

                Theindustry in which we compete is moving towards aggressive assertion, licensing,and litigation of patents and other intellectual property rights.  From time to time, we have become aware ofthe possibility or have been notified that we may be infringing certain patentsor other intellectual property rights of others.  Regardless of their merit, responding to such claims could betime consuming, divert management’s attention and resources and cause us toincur significant expenses.    

 

                Wemay, in the future, become subject to litigation to defend against claimedinfringements of the rights of others or to determine the scope and validity ofthe proprietary rights of others. Future litigation may also be necessary toenforce and protect our trade secrets and other intellectual property rights.Any intellectual property litigation or threatened intellectual propertylitigation could be costly, and adverse determinations or settlements couldresult in the loss of our proprietary rights, subject us to significantliabilities, require us to seek licenses from or pay royalties to third partieswhich 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 or the markets in which we compete. 

 

                Inthe event that there is a successful claim of infringement against us and wefail to develop non-infringing technology or license the propriety rights oncommercially reasonable terms and conditions, our business, results ofoperations or financial condition could be materially and adversely impacted.

 

**BUSINESSINTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS**

 

Our operations are vulnerable to interruption by fire, earthquake,power loss, telecommunications failure and other events beyond our control. Wedo not have a detailed disaster recovery plan. Our headquarters facility in theState of California was subject to electrical blackouts as a consequence of ashortage of available electrical power. In the event these blackouts resume,they could disrupt the operations at our headquarters. In addition, we do notcarry sufficient business interruption insurance to compensate us for lossesthat may occur and any losses or damages incurred by us could have a materialadverse effect on our business.

 

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**WE AREEXPOSED TO FLUCTUATIONS IN THE VALUES OF OUR PORTFOLIO INVESTMENTS**

 

We maintain an investment portfolio of various holdings, types, andmaturities. Part of this portfolio includes equity investments in publiclytraded companies, the value of which are subject to market price volatility.Recent events have adversely affected the public equities market and generaleconomic conditions may continue to worsen. Should the fair value of ourpublicly traded equity investments decline below their cost basis in a mannerdeemed to be other-than-temporary, it may become necessary for us to take animpairment charge.

We have also invested in several privately held companies as well asinvestment funds which invest primarily in privately held companies, many ofwhich can still be considered in the start-up or development stages. Theseinvestments are inherently risky, as the market for the technologies orproducts they have under development are typically in the early stages and maynever materialize. We could lose our entire initial investment in these companiesand investment funds.

 

**IF WESEEK TO SECURE ADDITIONAL FINANCING WE MAY NOT BE ABLE TO DO SO. IF WE ARE ABLETO SECURE ADDITIONAL FINANCING OUR STOCKHOLDERS MAY EXPERIENCE DILUTION OFTHEIR OWNERSHIP INTEREST OR WE MAY BE SUBJECT TO LIMITATIONS ON OUR OPERATIONS.**

 

We currently anticipate that our available cash resources, whichinclude existing cash and cash equivalents, short-term investments and cashfrom operations, will be sufficient to meet our anticipated needs for workingcapital and capital expenditure during the next 12 months. If we are unable togenerate sufficient cash flows from operations to meet our anticipated needsfor working capital and capital expenditures, we may need to raise additionalfunds to develop new or enhanced products, respond to competitive pressures,take advantage of acquisition opportunities or raise capital for strategicpurposes. If we raise additional funds through the issuance of equitysecurities, our stockholders may experience dilution of their ownership interest,and the newly issued securities may have rights superior to those of commonstock. If we raise additional funds by issuing debt, we may be subject tolimitations on our operations.

 

**WE HAVEBEEN NAMED AS A DEFENDANT IN SECURITIES LITIGATION**

 

We, and various underwriters for our initial public offering aredefendants in a putative shareholder class action. The complaint allegesundisclosed improper underwriting practices concerning the allocation of IPOshares, in violation of the federal securities laws. Similar complaints havebeen filed concerning the IPOs of more than 300 companies, and the litigationhas been coordinated in federal court for the Southern District of New York as *In re Initial Public Offering Securities Litigation*,21 MC 92. We believe we have meritorious defenses to the claims against us andintend to defend the litigation vigorously. However, as litigation is by itsnature uncertain, an unfavorable resolution of the lawsuit could have amaterial adverse effect on our business, results of operations, or financialcondition.

 

**RISKSRELATING TO THE STRUCTURE AND REGULATION OF CHINA’STELECOMMUNICATIONS INDUSTRY**

 

**CHINA’STELECOMMUNICATIONS INDUSTRY IS SUBJECT TO EXTENSIVE GOVERNMENT REGULATION**

 

China’s telecommunications industry is heavily regulated by theMinistry of Information Industry. The Ministry of Information Industry hasbroad discretion and authority to regulate all aspects of thetelecommunications and information technology industry in China, includingmanaging spectrum bandwidths, setting network equipment specifications andstandards and drafting laws and regulations related to the electronics andtelecommunications industries. Additionally, the Ministry of InformationIndustry can unilaterally, or in concert with other relevant authorities,decide what types of equipment may be connected to the nationaltelecommunications networks, the forms and types of services that may beoffered to the public, the rates that are charged to subscribers for thoseservices and the content of material available in China over the Internet. Ifthe Ministry of Information Industry sets standards with which we are unable tocomply or which render our products noncompetitive, our ability to sellproducts in China may be limited, resulting in substantial harm to ouroperations.

 

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

 

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**CHINA’STELECOMMUNICATIONS REGULATORY FRAMEWORK IS IN THE PROCESS OF BEING DEVELOPED,WHICH HAS LED TO UNCERTAINTIES REGARDING HOW TO CONDUCT OUR BUSINESS IN CHINA**

 

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

China’s telecommunications regulatory framework is in the process ofbeing developed. In September 2000, China’s State Council issued the Telecommunications Regulations of thePeople’s Republic of China, known as the Telecom Regulations. The TelecomRegulations cover telecommunications services and market regulations, pricing,interconnection and connection, as well as telecommunications construction andsecurity issues. In May 2001, China’s Ministry of Information Industryissued the Administrative Measures of Network Access Licenses to implement theTelecom Regulations. Regulations in this area often require subjectiveinterpretation and, given the relative infancy of the Telecom Regulations andthe implementing regulations, we do not know how the regulations will beinterpreted or enforced. As a result, our attempts to comply with theseregulations may be deemed insufficient by the appropriate regulatory agencies,which could subject us to penalties that adversely affect our business.

 

**OURBUSINESS MAY SUFFER AS A RESULT OF THE RECENT RESTRUCTURING OF CHINA TELECOM**

 

In February 1999, China’s State Council approved a restructuringplan for the China Telecom system, under which the telecommunicationsoperations of the China Telecom system were separated along four businesslines: fixed line, mobile, paging and satellite communications services.Following the announcement, we observed a reduction in orders from our maincustomers in China, the local telecommunications companies (the“Telecommunications Companies”), which we attributed to the uncertaintiessurrounding the restructuring and the ultimate impact the restructuring wouldhave on the Telecommunications Companies.

 

Effective in May 2002, China Telecom was split into two entitiesby region, northern and southern. The 10 northern provinces, municipalities andautonomous regions of China Telecom were merged with China Netcom Co. Ltd.and China Jitong Network Communications Co. Ltd. to form a newcompany known as China Netcom (“China Netcom”). The remaining 21 provinces,municipalities and autonomous regions now constitute the southern entity, andhave kept the name of China Telecom (the “New China Telecom”). China Netcom inherited30% of the old China Telecom’s national backbone network, with the rest goingto the New China Telecom. As this change is very recent, we cannot be certainwhat impact the restructuring of China Telecom will have on our businessoperations. However, we may experience another decline in orders and relatedrevenues similar to that which we experienced following the 1999 restructuring,resulting from uncertainty among our Telecommunications Company customersassociated with the restructuring. Additionally, China Telecom completed itsinitial public offering in November 2002, and is now a publicly listed on theNew York Stock Exchange. Moreover, following any restructuring, China Netcom,the New China Telecom or any other entity that may replace it as a result ofany subsequent restructuring may restrict or prohibit the sales of ourproducts, which could cause substantial harm to our business.

 

**WE DONOT HAVE SOME OF THE LICENSES WE ARE REQUIRED TO HAVE TO SELL OUR NETWORKACCESS PRODUCTS IN CHINA**

 

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

 

The regulations implementing these requirements are not very detailed,have not been applied by a court and may be interpreted and enforced byregulatory authorities in a number of different ways. We have obtained therequired network access licenses for our AN-2000B platform. . We have alsoobtained a probationary network access license for our mSwitch product, andafter the trial period, an official network access license will be issued ifthe trial demonstrates that mSwitch satisfies all the applicable government andindustry standards. We have applied for, but have not yet received, a networkaccess license for our PAS systems and handsets. Based upon conversations withChina’s Ministry of Information Industry, we understand that our PAS systemsand handsets are considered to still be in the trial period and that sales ofour PAS systems and handsets may continue to be made by us during this trialperiod, but a license will ultimately be required. Network access licenses willalso be required for most additional products that we are selling or may sellin China, including our mSwitch platform. If we fail to obtain the requiredlicenses, we could be prohibited from making further sales of the 

 

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unlicensed products, including our PAS systems and handsets, in China,which would substantially harm our business, financial condition and results ofoperations. Our counsel in China has advised us that China’s governmentalauthorities may interpret or apply the regulations with respect to whichlicenses are required and the ability to sell a product while a product is inthe trial period in a manner that is inconsistent with the information receivedby our counsel in China, either of which could have a material adverse effecton our business, financial condition and results of operations.

 

**WE AREREQUIRED TO REGISTER THE SOFTWARE INCORPORATED IN OUR PRODUCTS IN ACCORDANCEWITH RELEVANT CHINESE REGULATIONS**

 

In October 2000, the Ministry of Information Industry issuedregulations which prohibit the production and sale of software products, orproducts incorporating software, in China unless the software is registeredwith the government. We have accomplished the necessary registration withregards to the software incorporated in our AN-2000, PAS and mSwitch products.However, additional registration is required for software incorporated inadditional products that we are selling or may sell in China. Based upon verbaladvice received from the Ministry of Information Industry, we believe that wewill be able to sell products incorporating our software while any of ourapplications for registration may be pending. However, the Chinese governmentmay interpret or apply the regulations in such a way as to prohibit sales ofproducts incorporating our unregistered software prior to registration. If thegovernment prohibits sales pending registration, or if we fail in our effortsto register any software required to be registered, we could be prohibited frommaking further sales of products incorporating our unregistered software inChina, which could substantially harm our business and financial condition.

 

**MOST OFOUR CUSTOMERS IN CHINA HAVE HISTORICALLY BEEN PART OF THE CHINA TELECOM SYSTEMAND UNDER CHINA TELECOM’S ULTIMATE CONTROL; FOLLOWING THE RECENT RESTRUCTURINGOF CHINA TELECOM, MOST OF OUR CUSTOMERS IN CHINA ARE NOW PART OF THE NEW CHINATELECOM OR CHINA NETCOM, AND ARE SUBJECT TO THEIR ULTIMATE CONTROL**

 

Our main customers in China are the local Telecommunications Companies(formerly known as Telecommunications Bureaus) which historically operatedunder China Telecom, China’s state-owned fixed line operator, and were subjectto its ultimate control. Following the recent restructuring of China Telecom,the Telecommunications Companies now operate under the ultimate control ofeither the New China Telecom or China Netcom. China Telecom completed itsinitial public offering in November 2002, and is listed on the New YorkStock Exchange. Policy statements may be issued and decisions may be made byNew China Telecom and China Netcom, which govern the equipment purchasingdecisions of most of our customers in China. For example, in late 1999, ChinaTelecom prohibited all Telecommunications Companies from purchasing PHSsystems, such as our PAS systems, for implementation in large cities, evenbefore these sales were prohibited by China’s Ministry of Information Industry.As most of our sales are generated from our operations in China, any decisionsby the New China Telecom or China Netcom restricting or prohibiting the salesor deployment of our products could cause significant harm to our business.

 

**OURCUSTOMER BASE IN CHINA COULD EFFECTIVELY BECOME INCREASINGLY CONCENTRATED IFMORE PURCHASING DECISIONS ARE COORDINATED OR MADE BY PROVINCIAL OR GREATERREGIONAL TELECOMMUNICATIONS SERVICE ENTITIES RATHER THAN BY LOCALTELECOMMUNICATIONS SERVICE PROVIDERS**

 

We have historically considered local telecommunications serviceproviders serving municipalities and counties to be our primary customers inChina. Recently, however, the provincial-level telecommunications serviceentity in the Zhejiang province of China has begun to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend in the Zhejiang province, we have grouped all customers in Zhejiangprovince together and have treated these as one customer for the three monthsended March 31, 2003 and the comparative periods presented. For the threemonths ended March 31, 2003, sales to Zhejiang province did not account for 10%or more of our consolidated net sales. For the three months ended March 31,2002, sales to Zhejiang province accounted for 24% of our net sales. At March31, 2003, we have approximately nineteen customers in Zhejiang province.

 

                Whetherthis represents the beginning of a greater trend throughout China towardsincreased consolidation of negotiations and purchasing decisions into thecontrol of provincial-level telecommunications service entities isunclear. If an increasing number of purchasing decisions and negotiations arecontrolled on a larger regional level in China by provincial-leveltelecommunications service entities, this would effectively result in aconcentration of our customer base. Our financial results may increasinglydepend in significant part upon the success of a few major customers and  our ability to meet their future capitalequipment needs. Although the composition of the group comprising our largestcustomers may vary from period to period, the loss of a significant customer orany reduction in orders by any significant customer, including reductions dueto market, economic or competitive conditions in the telecommunicationsindustry, may have a material adverse effect on our business, financialcondition and results of operations. In addition to the business risksassociated with dependence on major customers, significant customerconcentration may also result in significant concentrations of accounts receivable.Significant and concentrated receivables would expose us to additional risks,including the risk of default by one or more customers representing asignificant portion of our total receivables. If we are required to takeadditional accounts receivable reserves, our business, financial condition andresults of operations would be materially adversely affected. 

 

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**OURABILITY TO SELL OUR PAS WIRELESS SYSTEMS AND HANDSETS COULD BE SIGNIFICANTLYIMPAIRED IF THE NEW CHINA TELECOM OR CHINA NETCOM ARE GRANTED, OR IF THEYOTHERWISE ACQUIRE, MOBILE LICENSES ALLOWING THE NEW CHINA TELECOM OR CHINANETCOM TO DELIVER CELLULAR SERVICES**

 

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

 

**CHANGESIN TELECOMMUNICATIONS RATES OR PRICING POLICIES MAY RESULT IN DECREASED DEMANDFOR OUR PRODUCTS**

 

In November 2000, China’s Ministry of Information Industryannounced significant changes in rates for telecommunications services inChina. While long distance, international, leased line and Internet connectionfees were cut by up to 70%, the rates for local telephone services, whichinclude certain types of wireless access services such as those offered overour PAS systems and handsets, were increased, from approximately $0.01 perminute to approximately $0.02 per minute. The increase in rates may result in areduced demand by end users for wireless services delivered over our PAS systemand a corresponding decline in demand for our products. In addition, mobileoperators are offering price incentive plans that could impact demand for ourproducts. Additionally, China’s Ministry of Information Industry may implementfuture rate changes for wireline or wireless services in China or changetelecommunications pricing policies, including allowing carriers to set pricesbased on market conditions, any of which may lead to reduced demand for oursystems and products and result in a material adverse effect on our business orresults of operations.

 

**RISKSRELATING TO CONDUCTING OPERATIONS IN CHINA**

 

**SALES INCHINA HAVE ACCOUNTED FOR MOST OF OUR SALES, AND THEREFORE, OUR BUSINESS,FINANCIAL CONDITION AND RESULTS OF OPERATIONS ARE TO A SIGNIFICANT DEGREESUBJECT TO ECONOMIC, POLITICAL AND SOCIAL EVENTS IN CHINA**

 

Approximately $268.9 million, or 81.4% and $167.2 million or91.0%, of our net sales in the three months ending March 31, 2003 and 2002,respectively occurred in China. Additionally, a substantial portion of ourfixed assets are located in China. Of our total fixed assets, approximately96.8% and 87.8%, as of March 31, 2003 and December 31, 2002, respectively,were in China. We expect to make further investments in China in the future.Therefore, our business, financial condition and results of operations are to asignificant degree subject to economic, political, social and other events,such as the SARS outbreak, in China.

 

**DEVALUATIONIN THE VALUE OF THE RENMINBI AND FLUCTUATIONS IN EXCHANGE RATES COULD ADVERSELYAFFECT OUR FINANCIAL RESULTS**

 

Exchange rate fluctuations could have a substantial negative impact onour financial condition and results of operations. We purchase substantiallyall of our materials in the United States and Japan and a significant portionof our cost of goods sold is incurred in U.S. dollars and Japanese yen. Asignificant portion of our operating expenses is incurred in U.S. dollars. Atthe same time, most of our sales are denominated in Renminbi. The value of theRenminbi is fixed by China’s national government and is subject to changes inChina’s governmental policies and to international economic and politicaldevelopments. China may choose to devalue the Renminbi against the U.S. dollar.Additionally, China’s government has considered from time to time whether topartially or fully abandon the official exchange rate for Renminbi to the U.S.dollar. The abandonment of this official exchange rate policy may lead to sharpdepreciation of the Renminbi against the U.S. dollar and other foreigncurrencies and to significantly more volatility in the Renminbi exchange ratein the future, both of which would adversely affect our financial results andmake our future results more subject to fluctuation.

 

In the past, financial markets in many Asian countries have experiencedsevere volatility and, as a result, some Asian currencies have experiencedsignificant devaluation from time to time. The devaluation of some Asiancurrencies may have the effect of rendering exports from China more expensiveand less competitive and therefore place pressure on China’s government todevalue the Renminbi. Any devaluation of the Renminbi could result in anincrease in volatility of Asian currency and capital markets. Future volatilityof Asian financial markets could have an adverse impact on our ability toexpand our product sales into Asian markets outside of China. Moreover, 

 

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due to the limitations on the convertibility of Renminbi, we arelimited in our ability to engage in currency hedging activities in China and donot currently engage in currency hedging activities with respect tointernational sales outside of China.

 

**CURRENCYRESTRICTIONS IN CHINA MAY LIMIT THE ABILITY OF OUR SUBSIDIARIES AND JOINTVENTURES IN CHINA TO OBTAIN AND REMIT FOREIGN CURRENCY NECESSARY FOR THEPURCHASE OF IMPORTED COMPONENTS AND MAY LIMIT OUR ABILITY TO OBTAIN AND REMITFOREIGN CURRENCY IN EXCHANGE FOR RENMINBI EARNINGS**

 

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

 

**CHINASUBJECTS FOREIGN INVESTORS IN THE TELECOMMUNICATIONS INDUSTRY TO OWNERSHIP ANDGEOGRAPHIC LIMITATIONS**

 

China’s government and its agencies, including China’s Ministry ofInformation Industry and China’s State Council, regulate foreign investment inthe telecommunications industry through the promulgation of various laws andregulations and the issuance of various administrative orders and decisions.Currently, foreign investors may engage in such activities only in accordancewith certain ownership and geographic limitations. China may promulgate newlaws or regulations, or issue administrative or judicial decisions orinterpretations, which would further restrict or bar foreigners from engagingin telecommunications-related activities. The promulgation of laws orregulations or the issuance of administrative orders or judicial decisions orinterpretations restricting or prohibiting telecommunications activities byforeigners could have a substantial impact on our ongoing operations.

 

**GOVERNMENTALPOLICIES IN CHINA COULD IMPACT OUR BUSINESS**

 

Since 1978, China’s government has been and is expected to continuereforming its economic and political systems. These reforms have resulted inand are expected to continue to result in significant economic and socialdevelopment in China. Many of the reforms are unprecedented or experimental andmay be subject to change or readjustment due to a number of political, economicand social factors. We believe that the basic principles underlying thepolitical and economic reforms will continue to be implemented and provide theframework for China’s political and economic system. New reforms or thereadjustment of previously implemented reforms could have a significantnegative effect on our operations. Changes in China’s political, economic andsocial conditions and governmental policies which could have a substantialimpact on our business include:

 

•                                          newlaws and regulations or the interpretation of those laws and regulations;

 

•                                          theintroduction of measures to control inflation or stimulate growth;

 

•                                          changesin the rate or method of taxation;

 

•                                          theimposition of additional restrictions on currency conversion and remittancesabroad; and

 

•                                          anyactions which limit our ability to develop, manufacture, import or sell ourproducts in China, or to finance and operate our business in China.

 

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**ECONOMICPOLICIES IN CHINA COULD IMPACT OUR BUSINESS**

 

The economy of China differs from the economies of most countriesbelonging to the Organization for Economic Cooperation and Development invarious respects such as structure, government involvement, level ofdevelopment, growth rate, capital reinvestment, allocation of resources,self-sufficiency, rate of inflation and balance of payments position. In thepast, the economy of China has been primarily a planned economy subject to one-and five-year state plans adopted by central government authorities and largelyimplemented by provincial and local authorities, which set production anddevelopment targets.

 

Since 1978, increasing emphasis had been placed on decentralization andthe utilization of market forces in the development of China’s economy.Economic reform measures adopted by China’s government may be inconsistent orineffectual, and we may not in all cases be able to capitalize on any reforms.Further, these measures may be adjusted or modified in ways which could resultin economic liberalization measures that are inconsistent from time to time orfrom industry to industry or across different regions of the country. China’seconomy has experienced significant growth in the past decade. This growth,however, has been accompanied by imbalances in China’s economy and has resultedin significant fluctuations in general price levels, including periods ofinflation. China’s government has implemented policies from time to time toincrease or restrain the rate of economic growth, control periods of inflationor otherwise regulate economic expansion. While we may be able to benefit fromthe effects of some of these policies, these policies and other measures takenby China’s government to regulate the economy could also have a significantnegative impact on economic conditions in China with a resulting negativeimpact on our business.

 

**CHINA’SENTRY INTO THE WORLD TRADE ORGANIZATION CREATES UNCERTAINTY AS TO THE FUTUREECONOMIC AND BUSINESS ENVIRONMENTS IN CHINA**

China’s entry into the WTO was approved in September 2001. Entryinto the WTO will require China to further reduce tariffs and eliminatenon-tariff barriers, which include quotas, licenses and other restrictions by2005 at the latest. While China’s entry into the WTO and the related relaxationof trade restrictions may lead to increased foreign investment, it may alsolead to increased competition in China’s markets from international companies.China’s entry into the WTO could have a negative impact on China’s economy witha resulting negative impact on our business.

 

**IF TAXBENEFITS AVAILABLE TO OUR SUBSIDIARIES LOCATED IN CHINA ARE REDUCED ORREPEALED, OUR BUSINESS COULD SUFFER**

 

Our subsidiariesand joint ventures located in China enjoy tax benefits in China which aregenerally available to foreign investment enterprises, including full exemptionfrom national 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. All of our active subsidiaries in China were accredited astechnologically advanced enterprises. The tax holidays applicable to ourwholly-owned subsidiaries, UTStarcom China and HUTS, which together accountedfor approximately 63.2% of our revenues in the first quarter of 2003, expiredat the end of 2002 and 2001, respectively. The tax holidays were not extendedfor the entities, and for 2003, the national enterprise tax rates wereincreased from 7.5% to 15% and from 10% to 15%, respectively, which couldnegatively impact our financial condition and results of operations. During thefourth quarter of 2002, we formed a new entity, Hangzhou UTStarcom Telecom Co.,Ltd., to manufacture and sell handsets. This entity will benefit from atwo-year national enterprise income tax exemption from the first profit-makingyear, and a 50% national enterprise income tax reduction in the following threeyears. The Chinese government is considering the imposition of “unified”corporate income tax that would phase out, over time, the preferential taxtreatment to which foreign investment enterprises, such as UTStarcom, arecurrently entitled. While it is not certain whether the government willimplement such a unified tax structure or whether, if implemented, UTStarcomwill be grandfathered into the new tax structure, if the new tax structure isimplemented, it will adversely affect our financial condition.

 

**CHINA’SLEGAL SYSTEM EMBODIES UNCERTAINTIES THAT COULD NEGATIVELY IMPACT OUR BUSINESS**

 

China has a civil law system. Decided court cases do not have bindinglegal effect on future decisions. Since 1979, many new laws and regulationscovering general economic matters have been promulgated in China. Despite thisactivity to develop the legal system, China’s system of laws is not yetcomplete. Even where adequate law exists in China, enforcement of existing lawsor contracts based on existing law may be uncertain and sporadic and it may bedifficult to obtain swift and equitable enforcement, or to obtain enforcementof a judgment by a court of another jurisdiction. The relative inexperience ofChina’s judiciary in many cases creates additional uncertainty as to theoutcome of any litigation. Further, interpretation of statutes and regulationsmay be subject to government policies reflecting domestic 

 

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political changes. Moreover, 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.

 

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

 

**NEWMANUFACTURING FACILITY**

 

We have purchased the rights to use 49 acres of land located inZhejiang Science and Technology Industry Garden of Hangzhou Hi-tech IndustryDevelopment Zone. As of March 31, 2003, we have completed the foundation andgroundwork and have commenced construction of the building. We expect thatconstruction of the new facility will be completed in 2003 or 2004 at aprojected cost of approximately $95.6 million. Capital expenditures forthe facility were $38.6 million in 2002 and $5.2 million in the threemonths ended March 31, 2003. If we are unable to complete the construction on atimely basis our business may be harmed.

 

**IF THE OUTBREAK OF SEVERE ACUTERESPIRATORY SYNDROME (SARS) IN CHINA AND OTHER MARKETS IN WHICH WE OPERATECONTINUES AND EXPANDS, OUR BUSINESS COULD SUFFER**

 

The recent outbreak of SARS in parts of China, where we conduct themajority of our business, and other markets in which we operate has thepotential to harm business conditions and slow economic growth in such markets.The expected level of economic growth for this year in markets affected by SARShas declined, and slower growth could result in less demand for our products inthese markets. Moreover, if the SARS outbreak leads to quarantines and closuresthat disrupt our manufacturing operations or distribution channels, ourbusiness could suffer. We cannot yet assess the full potential impact that theSARS outbreak may have on our business and will continue to monitor conditionsin China and other affected markets carefully.

 

**RISKSRELATING TO OUR STOCK PERFORMANCE AND CONVERTIBLE DEBT SECURITIES**

 

 

**OURSTOCK PRICE IS HIGHLY VOLATILE**

 

The trading price of our common stock has fluctuated significantlysince our initial public offering in March 2000. Our stock price could besubject to wide fluctuations in the future in response to many events orfactors, including those discussed in the preceding risk factors relating toour operations, as well as:

 

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

 

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

 

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

 

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

 

•                                          theoperating and stock price performance of other comparable companies; and

 

•                                          newsand commentary emanating from the media, securities analysts, and governmentbodies in China relating to UTStarcom and to the industry in general.

 

General market conditions and domestic or international macroeconomicfactors unrelated to our performance may also affect our stock price. For thesereasons, investors should not rely on recent trends to predict future stockprices or financial results. In addition, following periods of volatility in acompany’s securities, securities class action litigation against a company issometimes instituted. This type of litigation could result in substantial costsand the diversion of management time and resources.

 

 

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**SOFTBANKCORP. AND ITS RELATED ENTITIES, INCLUDING SOFTBANK AMERICA INC., HASSIGNIFICANT INFLUENCE OVER OUR MANAGEMENT AND AFFAIRS, WHICH IT COULD EXERCISEAGAINST YOUR BEST INTERESTS**

 

                SOFTBANKCORP. and its related entities, including SOFTBANK America Inc.,beneficially owned 14.7% of our outstanding stock as of April 5, 2003. As aresult, SOFTBANK CORP. and its related entities, including SOFTBANKAmerica Inc., have the ability to exercise influence over all matterssubmitted to our stockholders for approval and exert significant influence overour management and affairs. This concentration of ownership may delay orprevent a change of control or discourage a potential acquirer from making atender offer or otherwise attempting to obtain control of our company, whichcould decrease the market price of our common stock. Matters that could requirestockholder approval include: 

 

•                                          electionand removal of directors;

 

•                                          mergeror consolidation of our company; and

 

•                                          saleof all or substantially all of our assets.

 

                                Theinterests of SOFTBANK America Inc. may not always coincide with ourinterests. SOFTBANK America Inc., acting through its designees on ourboard of directors and through its ownership of voting securities, will havethe ability to exercise significant influence over our actions irrespective ofthe desires of our other stockholders or directors. 

 

                OnMarch 7, 2003 we agreed to repurchase 8.0 million shares of our common stock,beneficially owned by SOFTBANK America Inc., at a purchase price of $17.385 pershare. The total cost of the repurchase, which was completed on April 5, 2003,was $139.6 million including transaction fees. In connection with thisrepurchase transaction, SOFTBANK entered into an agreement with us not tooffer, sell or otherwise dispose of our common stock for a period of one year,subject to a number of exceptions.

 

**DELAWARELAW AND OUR CHARTER DOCUMENTS CONTAIN PROVISIONS THAT COULD DISCOURAGE ORPREVENT A POTENTIAL TAKEOVER, EVEN IF THE TRANSACTION WOULD BENEFIT OURSTOCKHOLDERS**

 

Other companies may seek to acquire or merge with us. An acquisition ormerger of our company could result in benefits to our stockholders, includingan increase in the value of our common stock. Some provisions of ourCertificate of Incorporation and Bylaws, as well as provisions of Delaware law,may discourage, delay or prevent a merger or acquisition that a stockholder mayconsider favorable. These provisions include:

 

•                                          authorizingthe board of directors to issue additional preferred stock;

 

•                                          prohibitingcumulative voting in the election of directors;

 

•                                          limitingthe persons who may call special meetings of stockholders;

 

•                                          prohibitingstockholder action by written consent;

 

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

 

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

 

**THE CONVERTIBLE DEBT SECURITIES RANKBELOW OUR SENIOR DEBT AND LIABILITIES OF OUR SUBSIDIARIES, AND WE MAY BE UNABLETO REPAY OUR OBLIGATIONS UNDER THE NOTES**

 

The convertibledebt securities (the “notes”) are unsecured and subordinated in right ofpayment in full to all of our existing and future senior debt.  Because the notes are subordinated to oursenior debt, in the event of (i) our liquidation or insolvency, (ii) a paymentdefault on our designated senior debt, (iii) a covenant default on ourdesignated senior debt, or (iv) acceleration of the notes due to an event ofdefault, we will make payments on the notes only after our senior debt has beenpaid in full.  After paying our seniordebt in full, we may not have sufficient assets remaining to pay any or allamounts due on the notes.

 

The notes are obligations exclusively ofUTStarcom.  Since substantially all ofUTStarcom’s operations are conducted through subsidiaries, our cash flow andour ability to service our debt, including the notes, is dependent upon theearnings of our subsidiaries and 

 

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the distribution of those earnings to us. Our subsidiaries are separatelegal entities and have no obligation to make any payments on the notes or makeany funds available for payment on the notes, whether by dividends, loans orother payments.  The payment ofdividends and the making of loans and advances to us by our subsidiaries may besubject to statutory or contractual restrictions and are dependent upon theearnings of our subsidiaries. Our subsidiaries do not guarantee the payment ofthe notes. Our right to receive assets of any of our subsidiaries upon theirliquidation or reorganization, and your right to participate in these assets,are effectively subordinated to the claims of that subsidiary’s creditors.  Consequently, the notes will be effectivelysubordinated to all liabilities, including trade payables, of any of oursubsidiaries and any subsidiaries that we may in the future acquire orestablish, except to the extent that we are recognized as a creditor of suchsubsidiary, in which case our claims would still be subordinate to any securityinterests in the assets of such subsidiary and any debt of such subsidiarysenior to that held by us.

 

As of  March 31,2003, (i) we had no senior debt outstanding, and (ii) our subsidiaries had nooutstanding indebtedness and approximately $379.5 million of other liabilities,including trade payables, but excluding intercompany liabilities, as to whichthe notes would have been effectively subordinated. Neither we nor oursubsidiaries are prohibited or limited from incurring debt or acting asguarantors of debt for others in whom we or our subsidiaries may have aninterest under the indenture. Our ability to pay our obligations on the notescould be adversely affected by our or our subsidiaries’ incurrence ofadditional indebtedness or other liabilities. We and our subsidiaries may from time to time incur additionalindebtedness and other liabilities, including senior debt.  

 

**WE MAY BE LIMITED IN OUR ABILITY TOPURCHASE THE NOTES IN THE EVENT OF A CHANGE IN CONTROL**

 

Our ability to purchase the notes upon the occurrenceof a change in control is subject to limitations.  We may not have sufficient financial resources or the ability toarrange financing to pay the purchase price for all the notes delivered byholders seeking to exercise their purchase right.  Although we may elect, subject to satisfaction of certainconditions, to pay the purchase price for the notes in common stock, ourability to purchase the notes in cash may be limited or prohibited by the termsof any future borrowing arrangements existing at the time of a change incontrol.  Any failure by us to purchasethe notes upon a change in control would result in an event of default underthe indenture, whether or not the purchase is permitted by the subordinationprovisions of the indenture.  Any suchdefault may, in turn, cause a default under our senior debt. Moreover, theoccurrence of a change in control could result in an event of default under theterms of our then existing senior debt. As a result, any purchase of the notes may be prohibited until thesenior debt is paid in full.

 

In the event we elect to pay the purchase price incommon stock, our common stock will be valued at a price determined prior tothe applicable repurchase date, therefore, holders of the notes bear the marketrisk that our common stock will decline in value between the date the price iscalculated and the purchase date.

 

**ABSENCE OF A TRADING MARKET FOR THENOTES**

 

The notes are a new issue of securities with no establishedtrading market.  The initial purchasersof the notes have advised us that they currently intend to make a market in thenotes.  However, the initial purchasersare not obligated to make a market in the notes and any market making by theinitial purchasers may be discontinued at any time at the sole discretion ofthe initial purchasers without notice. We cannot assure you that a market for the notes will develop andcontinue upon completion of the offering or that the market price of the noteswill not decline. Various factors, such as changes in prevailing interest ratesor changes in perceptions of our creditworthiness could cause the market priceof the notes to fluctuate significantly. The trading price of the notes will also be significantly affected bythe market price of our common stock, which could be subject to widefluctuations in response to a variety of factors.  The notes will not be listed on any securities exchange or quotedon the Nasdaq National Market and will only be traded on the over-the-countermarket.

 

The notes and the common stock to be issued uponconversion of the notes have not been registered under the Securities Act of1933 and are not transferable except upon satisfaction of certain conditions.Although we have agreed to use our reasonable efforts to have declaredeffective a shelf registration statement covering the notes and the commonstock issuable upon conversion of the notes within 210 days after the firstdate on which the notes were originally issued, we may not be able to have theregistration statement declared effective within that time period, if at all.

 

**WE HAVE SIGNIFICANTLY INCREASED OURLEVERAGE AS A RESULT OF THE SALE OF THE NOTES**

 

In connection with the sale of the notes, we haveincurred $402.5 million of indebtedness. As a result of this indebtedness, our principal and interest paymentobligations have increased substantially. The degree to which we are leveraged could materially and adverselyaffect our ability to obtain financing for working capital, acquisitions orother purposes and could make us more vulnerable to industry downturns andcompetitive pressures. 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.

 

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**Hedging transactions and other transactions may affect thevalue of the notes AND OF OUR COMMON STOCK**

 

We have entered into convertible bond hedge and calloption transactions with respect to our common stock, the exposure for which isheld by Banc of America Securities LLC and Credit Suisse First Boston LLC.  The convertible bond hedge and call optiontransactions are expected to reduce the potential dilution from conversion ofthe notes.  In connection with thesehedging arrangements, Banc of America Securities LLC and Credit Suisse FirstBoston LLC have taken and will take positions in our common stock in secondarymarket transactions and/or have entered or will enter into various derivativetransactions after the pricing of the notes. Such hedging arrangements could increase the price of our common stock.  Banc of America Securities LLC and CreditSuisse First Boston LLC are likely to modify their hedge positions from time totime prior to conversion or maturity of the notes by purchasing and sellingshares of our common stock, other securities of the Company or otherinstruments they may wish to use in connection with such hedging.  We cannot assure you that such activity willnot adversely affect the market price of our common stock.

** **

**THE NOTES MAY NOT BE RATED OR MAYRECEIVE A LOWER RATING THAN ANTICIPATED**

 

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

 

**ITEM3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS**

 

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

 

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

 

The table below represents carrying amounts and relatedweighted-average interest rates of maturity of interest bearing instruments inour investment portfolio at March 31, 2003:

 
| **(In thousands, except interest  rates)** |   |    |    |
|--------------------------------------------|--------|---------|---------|
|                                       |   |    |    |
| Cash and cash  equivalents                 |   | $       | 562,141 |   |
| Average interest  rate                     |   | 1.0     | %       |
| Short-term  investments                    |   | 42,000  |    |
| Average interest  rate                     |   | 1.7     | %       |
| Total investment  securities               |   | 604,141 |    |
| Average interest  rate                     |   | 1.0     | %       |
|                                            |        |         |         |  |

 

Part of our investment portfolio has recently includedequity investments in publicly traded companies, the value of which are subjectto market price volatility. Recent events have adversely affected the publicequities market and general economic conditions may continue to worsen. Shouldthe fair value of our publicly traded equity investments decline below theircost basis in a manner deemed to be other-than-temporary, it may becomenecessary for us to take an impairment charge. We have also invested in severalprivately held companies as well as investment funds which invest primarily inprivately held companies, many of which can still be considered in the start-upor development stages. These investments are inherently risky, as the marketfor the technologies or products they have under development are typically inthe early stages and may never materialize. We could lose our entire initialinvestment in these companies and investment funds. 

 

*Foreign Exchange Rate Risk.*  We are exposed to foreign exchange rate riskbecause most of our sales in China are denominated in Renminbi and portions ofour accounts payable are denominated in Japanese Yen. Due to the limitations onconverting Renminbi, we

 

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are limited in our ability to engage in currency hedging activities inChina. Although the impact of currency fluctuations of Renminbi to date hasbeen insignificant, fluctuations in currency exchange rates in the future mayhave a material adverse effect on our results of operations. We have amulti-currency bank account in Japanese Yen for purchasing portions of ourinventories and supplies. The balance of this Japanese Yen account as of March31, 2003 is approximately $122.2 million.

 

*CreditRisk.* The Company completed an offering on March 12, 2003, of$402.5 million of convertible subordinated notes due March 1, 2008. Concurrentwith the issuance of the convertible notes, the Company has entered intoconvertible bond hedge and call option transactions with respect to its commonstock, the exposure for which is held by Banc of America Securities LLC andCredit Suisse First Boston LLC. Both the bond hedge and call optiontransactions may be settled at the Company's option either in cash or netshares and expire on March 1, 2008.  The convertible bond hedge and calloption transactions are expected to reduce the potential dilution fromconversion of the notes. Subject to the movement in the share price of ourcommon stock, we could be exposed to credit risk in the settlement of theseoptions in our favor. Based on a review of the possible net settlements and thecredit strength of Banc of America Securities LLC and its affiliates and CreditSuisse First Boston LLC and its affiliates, we believe that we do not have amaterial exposure to credit risk arising from these option transactions.

 

**ITEM 4—CONTROLS AND PROCEDURES**

 

(a)                                  *Evaluation of disclosure controls and procedures*.Our chief executive officer and our chief financial officer, after evaluatingthe effectiveness of our disclosure controls and procedures (as defined inRules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934 (the“Exchange Act”)) as of a date (the “Evaluation Date”) within 90 days before thefiling date of this quarterly report on Form 10-Q, have concluded that as ofthe Evaluation Date, our disclosure controls and procedures are effective toensure that information that we are required to disclose in reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms.

 

(b)                                 *Changes in internal controls.* There wereno significant changes in our internal controls or in other factors that couldsignificantly affect our disclosure controls and procedures subsequent to theEvaluation Date.

 

During the first quarter of fiscal year 2003, ourAudit Committee pre-approved the retention of PricewaterhouseCoopers, LLC, ouroutside auditor, to evaluate certain accounting matters and to conductfinancial and accounting due diligence in connection with our acquisition ofthe CommWorks division of 3Com Corporation.

 

**PARTII—OTHER INFORMATION**

 

**ITEM1—LEGAL PROCEEDINGS**

 

On October 31, 2001, acomplaint was filed in United States District Court for the Southern Districtof New York against the Company, some of its directors and officers and variousunderwriters for its initial public offering. Substantially similar actionswere filed concerning the initial public offerings for more than 300 differentissuers, and the cases were coordinated as *Inre Initial Public Offering Securities Litigation*, 21 MC 92. In April2002, a consolidated amended complaint was filed in the matter against theCompany, captioned *In re UTStarcom, InitialPublic Offering Securities Litigation*, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarket,and misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock between March2, 2000 and December 6, 2000. The Company’s directors and officers have beendismissed without prejudice pursuant to a stipulation.  On February 19, 2003, the Court granted inpart and denied in part a motion to dismiss brought by defendants including theCompany. The order dismisses all claims against the Company except for a claimbrought under Section 11 of the Securities Act of 1933.  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.

 

 

**ITEM2—CHANGES IN SECURITIES AND USE OF PROCEEDS**

 

We completed our initial public offering (“IPO”) on March 3, 2000pursuant to a Registration Statement on Form S-1 (FileNo. 333-93069). In the IPO, we sold an aggregate of 11,500,000 shares ofcommon stock (including an over-allotment option of 1,500,000 shares) at $18.00per share.

 

The managing underwriters of our initial public offering were MerrillLynch & Co., Banc of America Securities LLC, U.S. Bancorp PiperJaffray, Merrill Lynch Japan Inc. and E-TRADE Securities Co., Ltd.The sale of the shares of common stock generated aggregate gross proceeds ofapproximately $207.0 million. The aggregate net proceeds was approximately$189.4 million, after deducting underwriting discounts and commissions ofapproximately $14.5 million and expenses of the offering of approximately$3.1 million. None of such amounts were direct or indirect payments to ourdirectors or officers or their associates, to persons owning 10 percent ormore of any class of our equity securities or to our affiliates.

 

We completed a follow-on public offering on August 3, 2001pursuant to a Registration Statement on Form S-3 (FileNo. 333-63356). A total of 10,350,000 shares of common stock (includingthe underwriters’ over-allotment) were registered. We sold an aggregate of7,400,000 shares of common stock, which included the underwriters’over-allotment, at a price to the public of $20.00 per share. Selling 

 

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stockholders soldan additional 2,950,000 shares of common stock in the offering.

 

The managing underwriter of our follow on public offering was MerrillLynch & Co. Salomon Smith Barney, Banc of America Securities LLC, HSBCSecurities (USA) Inc., and U.S. Bancorp Piper Jaffray served asco-managers of our offering. The sale of the shares of common stock generatedaggregate gross proceeds of approximately $148.0 million. The aggregatenet proceeds that we received was approximately $139.9 million, afterdeducting underwriting discounts and commissions of approximately$7.3 million and expenses of the offering of approximately$1.0 million. None of such amounts were direct or indirect payments to ourdirectors or officers or their associates, to persons owning 10 percent ormore of any class of our equity securities or to our affiliates. The aggregategross proceeds for the selling stockholders was approximately$59.0 million.

 

On February 28, 2002, we sold 1,500,000 shares of common stockupon exercise of the underwriter’s over-allotment option in connection with theresale public offering of 10,000,000 shares of our common stock by SOFTBANKAmerica Inc., one of our stockholders, at a price to the public of $20.25per share, pursuant to a Registration Statement on Form S-3 (FileNo. 333-82458). A total of 11,500,000 shares of common stock wereregistered.

 

The joint book-running managers of this public offering were MerrillLynch & Co. and Credit Suisse First Boston Corporation. Salomon SmithBarney, Banc of America Securities LLC, U.S. Bancorp Piper Jaffray and HSBCSecurities (USA) Inc., served as co-managers of our offering. Theaggregate net proceeds we received was approximately $28.9 million, afterdeducting underwriting discounts and commissions and related expenses of$1.5 million. None of such amounts were direct or indirect payments to ourdirectors or officers or their associates, to persons owning 10 percent ormore of any class of our equity securities or to our affiliates. We did notreceive any proceeds from the offering of the shares of our common stock bySOFTBANK America Inc. The aggregate gross proceeds for SOFTBANKAmerica Inc. was approximately $202.5 million.

 

We expect to use the net proceeds from these offerings for generalcorporate purposes, including research and development, expansion of our salesand marketing organization and working capital and capital expenditures. Theamounts actually expended for such purposes may vary significantly and willdepend on a number of factors, including our future revenues and cash generatedby operations and the other factors described under “Factors Affecting FutureOperating Results”. Accordingly, we retain broad discretion in the allocationof the net proceeds of the offerings. A portion of the net proceeds may also beused to acquire or invest in complementary businesses, technologies or productofferings. As of April 24, 2003, we have used a portion of the net proceedsfrom the offerings described above for general corporate purposes, includingresearch and development, expansion of our sales and marketing organization,working capital and capital expenditures, and the buy back of our shares fromSOFTBANK America Inc., one of our stockholders.

 

                OnMarch 12, 2003, we issued $402.5 million of 0.875% convertible subordinatednotes due in 2008 to qualified buyers pursuant to Rule 144A under theSecurities Act of 1933. The underwriters for this offering were Banc of AmericaSecurities LLC, Credit Suisse First Boston LLC and Merrill Lynch, Pierce,Fenner & Smith Incorporated.  Thenotes are convertible into our common stock at the option of the holder at anytime prior to maturity at a conversion price of $23.79 per share. We usedapproximately $43.8 million of the net proceeds to enter into convertible bondhedge and call option transactions with respect to our common stock to reducethe potential dilution from conversion of the notes, and we used approximately$139.6 million of the net proceeds in the second quarter, to repurchase 8million of our shares beneficially owned by SOFTBANK America, Inc., pursuant toan agreement we entered into on March 7, 2003. We intend to use the balance of the net proceeds for general corporatepurposes, including research and development, expansion of our sales andmarketing organization and working capital. 

 

**ITEM 5—OTHER INFORMATION**

 

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

 

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**ITEM 6—EXHIBITS AND REPORTS ON FORM8-K**

 

(a)                                  Exhibits:

 
| **NUMBER**       |   | **EXHIBIT  DESCRIPTION**                                                                                                                                                                                  |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                      |
|  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. |
| 10.88            |   | Registration Rights Agreement between UTStarcom,  Inc. and the Initial Purchasers named therein dated as of March 12, 2003.                                                                               |
| 10.89            |   | Asset Purchase Agreement dated as of March 4, 2003  between UTStarcom, Inc. and 3Com Corporation.                                                                                                         |
| 10.90*           |   | Equipment Purchase Agreement dated as of February 4,  2003 between UTStarcom, Inc. and Tata Teleservices Limited.                                                                                         |
|   99.1 |   | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                        |
|   99.2 |   | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                        |

 

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*                                         Certaininformation in this Exhibit has been omitted and filed separately with the SEC.Confidential treatment has been requested with respect to the omitted portions.

 

(b)                                 Reportson Form 8-K:

 

 

1.                On March 7, 2003,UTStarcom filed with the SEC a Report on Form 8-K (dated March 6, 2003) inconnection with its pending acquisition of the CommWorks division of 3ComCorporation and its repurchase of 8,000,000 shares of common stock fromSOFTBANK America Inc.

 

2.                On March 7, 2003,UTStarcom filed with the SEC a Report on Form 8-K (dated March 7, 2003) inconnection with its convertible subordinated notes offering.

 

3.                On April 23, 2003,UTStarcom furnished to the SEC a Report on Form 8-K (dated April 16, 2003) inconnection with its announcement of financial results for the fiscal quarterending March 31, 2003.

 

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**UTSTARCOM, INC.**

 

**SIGNATURES**

 

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

 
| Date:  May 9,  2003 | UTSTARCOM, INC.                                    |
|--------------------------|----------------------------------------------------|
|                     | (Registrant)                                       |
|                     |                                               |
|                     | BY:                                                |
|                     |                                               |
|                     |                                               |
|                     | /s/ Hong  Liang Lu                                 |
|                     | Hong Liang Lu                                      |
|                     | *President, Chief Executive Officer  and Director* |
|                     |                                               |
|                     |                                               |
|                     | /s/ Michael  J. Sophie                             |
|                     | Michael J. Sophie                                  |
|                     | *Chief Financial Officer and  Assistant Secretary* |

 

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**CERTIFICATION**

 

I, Hong Liang Lu, certify that:

 

1.             I have reviewed thisquarterly report on Form 10-Q of UTStarcom, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on myknowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(the “Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  May 9,  2003 |                                   |
|--------------------------|----------------------------------------|
|                     | /s/ Hong  Liang Lu                     |
|                     | Hong Liang Lu*Chief Executive Officer* |

 

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**CERTIFICATION**

 

I, Michael J. Sophie, certify that:

 

1.             I have reviewed thisquarterly report on Form 10-Q of UTStarcom, Inc.;

 

2.             Based on myknowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Based on my knowledge,the financial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4.             The registrant’sother certifying officers and I are responsible for establishing andmaintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report(the “Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

5.             The registrant’sother certifying officers and I have disclosed, based on our most recentevaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.             The registrant’sother certifying officers and I have indicated in this quarterly report whetheror not there were significant changes in internal controls or in other factorsthat could significantly affect internal controls subsequent to the date of ourmost recent evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 
| Date:  May 9,  2003 |                      |
|--------------------------|---------------------------|
|                     | /s/ Michael  J. Sophie    |
|                     | Michael J. Sophie         |
|                     | *Chief Financial Officer* |

 

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**UTSTARCOM, INC.**

**EXHIBIT INDEX**

 
| **NUMBER**       |   | **EXHIBIT  DESCRIPTION**                                                                                                                                                                                  |
|------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|  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. |
| 10.88            |   | Registration Rights Agreement between UTStarcom,  Inc. and the Initial Purchasers named therein dated as of March 12, 2003.                                                                               |
| 10.89            |   | Asset Purchase Agreement dated as of March 4, 2003  between UTStarcom, Inc. and 3Com Corporation.                                                                                                         |
| 10.90*           |   | Equipment Purchase Agreement dated as of February 4,  2003 between UTStarcom, Inc. and Tata Teleservices Limited.                                                                                         |
|   99.1 |   | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                        |
|   99.2 |   | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of  the Sarbanes-Oxley Act of 2002                                        |
|             |   |                                                                                                                                                                                                      |

 

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*                                         Certaininformation in this Exhibit has been omitted and filed separately with the SEC.Confidential treatment has been requested with respect to the omitted portions.

 

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