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

 

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**UTSTARCOM, INC.**

(Exact name of Registrant 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).  Yes   ý  No   o

 

As of July 29, 2003 there were 102,914,907 shares of the Registrant’sCommon Stock outstanding, par value $0.00125.

 

 

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**TABLEOF CONTENTS**

 
| **PART I.**  | **FINANCIAL INFORMATION**                                                                                                      |   |
|--------------|--------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                           |   |
| Item 1.      | Condensed Consolidated Financial Statements                                                                                    | 3      |
|         |                                                                                                                           |   |
|         | Condensed Consolidated Balance Sheets as of  June 30, 2003 and December 31, 2002 (unaudited)                              | 3      |
|         |                                                                                                                           |   |
|         | Condensed Consolidated Statements of  Operations for the three and six month periods ended June 30, 2003 and 2002  (unaudited) | 4      |
|         |                                                                                                                           |   |
|         | Condensed Consolidated Statements of Cash  Flows for the six month periods ended June 30, 2003 and 2002 (unaudited)            | 5      |
|         |                                                                                                                           |   |
|         | Notes to Condensed Consolidated Financial  Statements (unaudited)                                                              | 6      |
|         |                                                                                                                           |   |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                    | 18     |
|         |                                                                                                                           |   |
| Item 3.      | Quantitative and Qualitative Disclosure  about Market Risk                                                                     | 49     |
|         |                                                                                                                           |   |
| Item 4.      | Controls  and Procedures                                                                                                       | 50     |
|         |                                                                                                                           |   |
| **PART II.** | **OTHER INFORMATION**                                                                                                          |   |
|         |                                                                                                                           |   |
| Item 1.      | Legal  proceedings                                                                                                             | 50     |
|         |                                                                                                                           |   |
| Item 2.      | Changes in Securities and Use of Proceeds                                                                                      | 50     |
|         |                                                                                                                           |   |
| Item 3.      | Defaults Upon Senior Securities                                                                                                | 50     |
|         |                                                                                                                           |   |
| Item 4.      | Submission of Matters to a Vote of Security  Holders                                                                           | 50     |
|         |                                                                                                                           |   |
| Item 5.      | Other Information                                                                                                              | 51     |
|         |                                                                                                                           |   |
| Item 6.      | Exhibits and Reports on Form 8-K                                                                                          | 52     |
|         |                                                                                                                           |   |
|         | Signatures                                                                                                                     | 53     |
|         |                                                                                                                           |   |
|         | Exhibit  Index                                                                                                                 | 54     |

 

2

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**PARTI—FINANCIAL INFORMATION**

 

**ITEM1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS(UNAUDITED)**

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

 

 
|                                                                                                                                                           |   | **June 30,  2003** |       | **December 31,  2002** |       |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|------------|------------------------|------------|
|                                                                                                                                                           |   |               | ** ** |                   | ** ** |
| **ASSETS**                                                                                                                                                     |   |               |       |                   |       |
| Current assets:                                                                                                                                                |   |               |       |                   |       |
| Cash and cash equivalents                                                                                                                                      |   | $                  | 275,978    |                   | $          | 231,944 |   |
| Short-term investments                                                                                                                                         |   | 5,282              |       | 107,305                |       |
| Accounts receivables, net of allowances for doubtful accounts of  $27,373 and $26,250 at June 30, 2003 and December 31, 2002, respectively                     |   | 195,016            |       | 221,215                |       |
| Accounts receivables, related parties                                                                                                                          |   | 68,170             |       | 835                    |       |
| Inventories                                                                                                                                                    |   | 1,099,044          |       | 424,666                |       |
| Prepaids                                                                                                                                                       |   | 139,418            |       | 47,220                 |       |
| Restricted cash                                                                                                                                                |   | 25,283             |       | 21,251                 |       |
| Other current assets                                                                                                                                           |   | 87,780             |       | 52,936                 |       |
| Total current assets                                                                                                                                           |   | 1,895,971          |       | 1,107,372              |       |
| Property, plant and equipment, net                                                                                                                             |   | 135,731            |       | 98,511                 |       |
| Long-term investments                                                                                                                                          |   | 24,697             |       | 35,360                 |       |
| Goodwill                                                                                                                                                       |   | 122,707            |       | 44,806                 |       |
| Intangible assets, net                                                                                                                                         |   | 26,347             |       | 5,014                  |       |
| Other long-term assets                                                                                                                                         |   | 26,138             |       | 14,489                 |       |
| Total assets                                                                                                                                                   |   | $                  | 2,231,591  |                   | $          | 1,305,552 |   |
|                                                                                                                                                           |   |               |       |                   |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                 |   |               |       |                   |       |
| Current liabilities:                                                                                                                                           |   |               |       |                   |       |
| Accounts payable                                                                                                                                               |   | 425,678            |       | 256,980                |       |
| Income taxes payable                                                                                                                                           |   | 4,881              |       | 13,003                 |       |
| Deferred revenue                                                                                                                                               |   | 545,343            |       | 164,247                |       |
| Other                                                                                                                                                          |   | 140,463            |       | 104,927                |       |
| Total current liabilities                                                                                                                                      |   | 1,116,365          |       | 539,157                |       |
| Long-term debt                                                                                                                                                 |   | 402,500            |       | —                 |       |
| Total liabilities                                                                                                                                              |   | 1,518,865          |       | 539,157                |       |
| Commitments and contingencies (Note 14)                                                                                                                        |   |               |       |                   |       |
| Stockholders’ equity:                                                                                                                                     |   |               |       |                   |       |
| Common stock: $0.00125 par value; authorized: 250,000,000 shares;  issued and outstanding: 101,923,611 and 106,787,908 at June 30, 2003 and  December 31, 2002 |   | 128                |       | 135                    |       |
| Additional paid-in capital                                                                                                                                     |   | 617,343            |       | 658,546                |       |
| Deferred stock compensation                                                                                                                                    |   | (9,133             | )          | (11,766                | )          |
| Retained earnings                                                                                                                                              |   | 104,282            |       | 120,520                |       |
| Receivable from stockholders                                                                                                                                   |   | (275               | )          | (282                   | )          |
| Accumulated other comprehensive income (loss)                                                                                                                  |   | 381                |       | (758                   | )          |
| Total stockholders’ equity                                                                                                                                |   | 712,726            |       | 766,395                |       |
| Total liabilities and stockholders’ equity                                                                                                                |   | $                  | 2,231,591  |                   | $          | 1,305,552 |   |

 

See accompanying notes to condensedconsolidated financial statements.

 

3

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**UTSTARCOM, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OFOPERATIONS (UNAUDITED)**

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

 
|                                                          |   | **Three  months ended** |    | **Six months  ended** |   |
|---------------------------------------------------------------|--------|-------------------------|---------|-----------------------|--------|
|                                                          |   | **June 30,  2003**      |    | **June 30,  2002**    |   | **June 30,  2003** |   | **June 30,  2002** |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Net sales                                                     |   |                    |    |                  |   |   |   |   |   |
| Unrelated parties                                             |   | $                       | 345,684 |                  | $      | 184,561 |   | $ | 617,687 |   | $ | 354,861 |   |
| Related parties                                               |   | 60,150                  |    | 46,947                |   | 118,667 |   | 60,337 |   |
|                                                          |   | 405,834                 |    | 231,508               |   | 736,354 |   | 415,198 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Cost of sales                                                 |   | 268,330                 |    | 145,596               |   | 486,165 |   | 263,644 |   |
| Gross profit                                                  |   | 137,504                 |    | 85,912                |   | 250,189 |   | 151,554 |   |
| Operating expenses:                                           |   |                    |    |                  |   |   |   |   |   |
| Selling, general and administrative                           |   | 34,963                  |    | 29,520                |   | 72,546 |   | 53,206 |   |
| Research and development                                      |   | 36,078                  |    | 21,370                |   | 62,890 |   | 40,567 |   |
| In-process research and development                           |   | 9,328                   |    | 670                   |   | 10,648 |   | 670 |   |
| Amortization of intangible assets                             |   | 1,483                   |    | 656                   |   | 2,178 |   | 1,133 |   |
| Total operating expenses                                      |   | 81,852                  |    | 52,216                |   | 148,262 |   | 95,576 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Operating income                                              |   | 55,652                  |    | 33,696                |   | 101,927 |   | 55,978 |   |
| Interest income                                               |   | 699                     |    | 1,454                 |   | 1,642 |   | 3,028 |   |
| Interest expense                                              |   | (2,210                  | )       | (447                  | )      | (2,849 | ) | (1,135 | ) |
| Other income (expenses) net                                   |   | 154                     |    | (1,744                | )      | 4,340 |   | (1,551 | ) |
| Equity in income (loss) of affiliated  companies              |   | (1,745                  | )       | (6                    | )      | (2,720 | ) | (799 | ) |
| Income before income taxes and minority  interest             |   | 52,550                  |    | 32,953                |   | 102,340 |   | 55,521 |   |
| Income tax expense                                            |   | 13,138                  |    | 6,590                 |   | 25,585 |   | 11,104 |   |
| Minority interest in (earnings) of  consolidated subsidiaries |   | —                  |    | (628                  | )      | — |   | (1,156 | ) |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Net income                                                    |   | $                       | 39,412  |                  | $      | 25,735 |   | $ | 76,755 |   | $ | 43,261 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Basic earnings per share                                      |   | $                       | 0.39    |                  | $      | 0.23 |   | $ | 0.74 |   | $ | 0.39 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Diluted earnings per share                                    |   | $                       | 0.33    |                  | $      | 0.22 |   | $ | 0.62 |   | $ | 0.37 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| Weighted average shares used in per-share  calculation:       |   |                    |    |                  |   |   |   |   |   |
| - Basic                                                       |   | 100,698                 |    | 111,549               |   | 104,009 |   | 110,806 |   |
|                                                          |   |                    |    |                  |   |   |   |   |   |
| - Diluted                                                     |   | 124,360                 |    | 117,343               |   | 126,409 |   | 117,074 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

4

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**UTSTARCOM, INC.**

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

**(In thousands)**

 
|                                                                                        |   | **Six months ended** |    |
|---------------------------------------------------------------------------------------------|--------|----------------------|---------|
|                                                                                        |   | **June 30, 2003**    |    | **June 30, 2002** |   |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                      |   |                 |    |   |   |
| Net income                                                                                  |   | $                    | 76,755  |   | $ | 43,261 |   |
| Adjustment to  reconcile net income to net cash provided by (used in) operating activities: |   |                 |    |   |   |
| Depreciation  and amortization                                                              |   | 17,729               |    | 10,063 |   |
| Non-qualified  stock option exercise tax benefits                                           |   | 8,231                |    | 3,031 |   |
| Net loss on  sale of assets                                                                 |   | 690                  |    | 251 |   |
| In-process  research and development costs                                                  |   | 10,648               |    | 670 |   |
| Amortization  of debt issuance                                                              |   | 777                  |    | — |   |
| Warrants  adjustment to fair value                                                          |   | (158                 | )       | — |   |
| Loss on sale  of investment                                                                 |   | 73                   |    | — |   |
| Impairment of  long-term investment                                                         |   | —               |    | 1,090 |   |
| Stock  compensation expense                                                                 |   | 3,074                |    | 1,858 |   |
| Allowance for  doubtful accounts                                                            |   | 1,123                |    | 6,985 |   |
| Inventory  reserve                                                                          |   | (8,105               | )       | 7,887 |   |
| Equity in loss  of affiliated companies                                                     |   | 2,720                |    | 799 |   |
| Minority  interest in earnings of consolidated subsidiary                                   |   | —               |    | 1,156 |   |
| Changes in  operating assets and liabilities:                                               |   |                 |    |   |   |
| Accounts  receivable                                                                        |   | (42,259              | )       | (42,862 | ) |
| Inventories                                                                                 |   | (659,929             | )       | (48,056 | ) |
| Other current  and non-current assets                                                       |   | (122,724             | )       | 9,680 |   |
| Accounts  payable                                                                           |   | 165,590              |    | 45,302 |   |
| Income taxes  payable                                                                       |   | (8,122               | )       | 4,709 |   |
| Deferred  revenue                                                                           |   | 371,428              |    | 22,055 |   |
| Other current  liabilities                                                                  |   | 26,525               |    | (1,011 | ) |
| Net cash  provided by (used in) operating activities                                        |   | (155,934             | )       | 66,868 |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                      |   |                 |    |   |   |
| Additions to  property, plant and equipment                                                 |   | (41,192              | )       | (21,563 | ) |
| Investment in  affiliates, net of cash acquired                                             |   | (1,000               | )       | (6,044 | ) |
| Repurchase of  stock                                                                        |   | (139,609             | )       | — |   |
| Purchase of  businesses, net of cash acquired                                               |   | (109,520             | )       | (17,705 | ) |
| Proceeds from  disposal of property                                                         |   | 21                   |    | 169 |   |
| Allocations to  restricted cash                                                             |   | (4,032               | )       | (13,879 | ) |
| Purchase of  short-term investments                                                         |   | (37,307              | )       | (49,174 | ) |
| Proceeds from  sale of short-term investments                                               |   | 150,278              |    | 70,564 |   |
| Net cash used  in investing activities                                                      |   | (182,361             | )       | (37,632 | ) |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                      |   |                 |    |   |   |
| Issuance of  stock, net of expenses                                                         |   | 34,959               |    | 35,697 |   |
| Purchase of  calls options                                                                  |   | (43,792              | )       | — |   |
| Proceeds from  borrowing                                                                    |   | 391,431              |    | 31,149 |   |
| Payments for  borrowing                                                                     |   | —               |    | (78,915 | ) |
| Proceeds from  stockholder notes                                                            |   | 7                    |    | 39 |   |
| Net cash  provided by (used in) financing activities                                        |   | 382,605              |    | (12,030 | ) |
| Effect of  exchange rate changes on cash                                                    |   | (276                 | )       | (141 | ) |
| Net increase  in cash and cash equivalents                                                  |   | 44,034               |    | 17,065 |   |
| Cash and cash  equivalents at beginning of period                                           |   | 231,944              |    | 321,136 |   |
| Cash and cash  equivalents at end of period                                                 |   | $                    | 275,978 |   | $ | 338,201 |   |

 

See accompanying notes to condensed consolidated financial statements.

 

5

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**UTSTARCOM, INC.**

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

 

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

 

Theaccompanying unaudited condensed consolidated financial statements include theaccounts of UTStarcom, Inc. (the “Company”) and its wholly-owned subsidiaries.All significant intercompany accounts and transactions have been eliminated inthe preparation of the condensed consolidated financial statements. Theminority interests in consolidated subsidiaries and equity in affiliatedcompanies are shown separately in the condensed consolidated financialstatements. Investments in affiliated companies are accounted for using thecost or equity method, as applicable. Certain previously reported amounts have been reclassified to conform tothe current presentation format.

 

The accompanying financial data as of June 30, 2003 and for the threeand six months ended June 30, 2003 and 2002 have been prepared by the Company,without audit, pursuant to the rules and regulations of the Securities andExchange Commission (“SEC”). Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations. The December 31, 2002 balance sheet was derivedfrom audited financial statements, but does not include all disclosuresrequired by generally accepted accounting principles. These condensedconsolidated financial statements should be read in conjunction with theCompany’s audited December 31, 2002 financial statements, including thenotes thereto, and the other information set forth in the Company’s AnnualReport on Form 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 and sixmonths ended June 30, 2003 are not necessarily indicative of the operatingresults for the full 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, if applicable, the fee is fixed or determinable andcollectibility is reasonably assured. If the fee due from the customer is notfixed or determinable due to extended payment terms, revenue is recognized aspayments become 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 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.

 

**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):

 

6

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|                                          |   | **Three Months Ended  June 30,** |   | **Six Months Ended  June 30,** |   |
|-----------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                          |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Numerator:                                    |   |                             |   |                           |   |   |   |   |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Basic earnings  per share                     |   |                             |   |                           |   |   |   |   |   |
| Net income                                    |   | $                                | 39,412 |                           | $      | 25,735 |   | $ | 76,755 |   | $ | 43,261 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Effect of  Dilutive Securities                |   |                             |   |                           |   |   |   |   |   |
| 7/8%  Convertible Subordinated Notes          |   | 1,092                            |   | —                         |   | 1,375 |   | — |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Diluted  earnings per share                   |   |                             |   |                           |   |   |   |   |   |
| Net income  adjusted for dilutive securities  |   | $                                | 40,504 |                           | $      | 25,735 |   | $ | 78,130 |   | $ | 43,261 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Denominator:                                  |   |                             |   |                           |   |   |   |   |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Shares used to  compute basic EPS             |   | 100,698                          |   | 111,549                        |   | 104,009 |   | 110,806 |   |
| Dilutive  common stock equivalent shares:     |   |                             |   |                           |   |   |   |   |   |
| Stock options                                 |   | 6,714                            |   | 5,766                          |   | 5,452 |   | 6,239 |   |
| Conversion of  convertible subordinated notes |   | 16,919                           |   | —                         |   | 16,919 |   | — |   |
| Warrants                                      |   | 29                               |   | 28                             |   | 29 |   | 29 |   |
| Shares used to  compute diluted EPS           |   | 124,360                          |   | 117,343                        |   | 126,409 |   | 117,074 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Basic earnings  per share                     |   | $                                | 0.39   |                           | $      | 0.23 |   | $ | 0.74 |   | $ | 0.39 |   |
|                                          |   |                             |   |                           |   |   |   |   |   |
| Diluted  earnings per share                   |   | $                                | 0.33   |                           | $      | 0.22 |   | $ | 0.62 |   | $ | 0.37 |   |

 

Certain potential shares related to employee stock options and warrantsoutstanding during the three and six months ended June 30, 2003 and 2002 wereexcluded in the diluted per share computations, since their exercise priceswere greater than the average market price of the common shares during theperiod and, accordingly, their effect is anti-dilutive. For the three monthsended June 30, 2003, these shares totaled 1.9 million at a weightedaverage exercise price of $28.67 per share, compared to 2.3 million with aweighted average exercise price of $24.24 per share for the correspondingperiod in 2002. For the six months ended June 30, 2003, these shares totaled3.2 million at a weighted average exercise price of $26.89 per share,compared to 1.0 million with a weighted average exercise price of $25.95per share for the corresponding period in 2002.

 

On June 30,2003, each of the Company’s 7/8% convertible subordinated notes outstandingfirst became eligible for conversion into shares of common stock.  Foreach $1,000 of aggregate principal amount of notes converted, the Company willdeliver approximately 42.0345 shares of common stock, if the Company’s stockprice exceeds a specified threshold. At June 30, 2003 the closing price of theCompany’s common stock exceeded the specified threshold, which had the effectof increasing the denominator for diluted earnings per share by 16.9 millionshares.

 

**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 granted or issued tonon-employees for services is expensed over the period benefited. The warrantsand options are valued using the Black-Scholes option pricing model.

 

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

 

7

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|                                                                                                                                          |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                                                          |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
| Net income, as  reported                                                                                                                      |   | $                                | 39,412 |                           | $      | 25,735 |   | $ | 76,755 |   | $ | 43,261 |   |
|                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Add:  Stock-based employee compensation expense included in reported net income,  net of related tax effects                                  |   | 1,681                            |   | 365                            |   | 2,181 |   | 1,324 |   |
|                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Deduct: Total  stock based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |   | (7,786                           | )      | (4,468                         | )      | (14,202 | ) | (9,325 | ) |
|                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Proforma net  income                                                                                                                          |   | $                                | 33,307 |                           | $      | 21,632 |   | $ | 64,734 |   | $ | 35,260 |   |
|                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Basic - as  reported                                                                                                                          |   | $                                | 0.39   |                           | $      | 0.23 |   | $ | 0.74 |   | $ | 0.39 |   |
| Basic - pro  forma                                                                                                                            |   | $                                | 0.33   |                           | $      | 0.19 |   | $ | 0.62 |   | $ | 0.32 |   |
|                                                                                                                                          |   |                             |   |                           |   |   |   |   |   |
| Diluted - as  reported                                                                                                                        |   | $                                | 0.33   |                           | $      | 0.22 |   | $ | 0.62 |   | $ | 0.37 |   |
| Diluted - pro  forma                                                                                                                          |   | $                                | 0.29   |                           | $      | 0.19 |   | $ | 0.54 |   | $ | 0.31 |   |

 

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

 

The reconciliation of net income to comprehensive income for the threeand six months ended June 30, 2003 and 2002 is as follows (in thousands):

 
|                                          |   | **Three Months Ended June 30** |   | **Six Months Ended June 30** |   |
|-----------------------------------------------|--------|--------------------------------|--------|------------------------------|--------|
|                                          |   | **2003**                       |   | **2002**                     |   | **2003** |   | **2002** |   |
| Net income                                    |   | $                              | 39,412 |                         | $      | 25,735 |   | $ | 76,755 |   | $ | 43,261 |   |
| Unrealized  gains (losses) on investments     |   | 609                            |   | 14                           |   | 1,183 |   | (221 | ) |
| Change in  cumulative translation adjustments |   | (10                            | )      | (9                           | )      | (44 | ) | (141 | ) |
|                                          |   |                           |   |                         |   |   |   |   |   |
| Total  comprehensive income                   |   | $                              | 40,011 |                         | $      | 25,740 |   | $ | 77,894 |   | $ | 42,899 |   |

 

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

 

All of the Company’s short-term investments are classified asavailable-for-sale. At June 30, 2003, $75.0 million of available-for-salesecurities were included in cash equivalents and $5.3 million ofavailable-for-sale securities were included in short-term investments. AtDecember 31, 2002, $105.0 million of available-for-sale securities wereincluded in cash equivalents and $107.3 million of available-for-salesecurities were included in short-term investments. These available-for-salesecurities consist of government-backed notes, commercial paper, floating ratecorporate bonds and fixed income corporate bonds. These investments arerecorded at fair value. Any unrealized holding gains or losses are reported asa component of comprehensive income.

 

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

 

Inventories as of June 30, 2003 and December 31, 2002 consist ofthe following (in thousands):

 

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|            |   | **June 30, 2003** |      | **December 31, 2002** |   |
|-----------------|--------|-------------------|-----------|-----------------------|--------|
|            |   |              |      |                  |   |
| Raw materials   |   | $                 | 156,561   |                  | $      | 84,715 |   |
| Work-in-process |   | 102,200           |      | 26,915                |   |
| Finished goods  |   | 840,283           |      | 313,036               |   |
|            |   | $                 | 1,099,044 |                  | $      | 424,666 |   |

 

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

 

During the three months ended June 30, 2003, the Company completedseveral acquisitions. On May 23, 2003, the Company completed its acquisitionfrom 3Com Corporation, a Delaware corporation, (“3Com”) of selected assets andliabilities from 3Com’s CommWorks division (“CommWorks”). The Company paid $100.0million in cash and incurred related transaction and other related costs of$9.3 million.  The Company funded the consideration for the acquisitionfrom cash on hand.

 

Selectedassets acquired included CommWork’s portfolio of carrier-focused voice and datanetworking products and customer support and professional services. Inaddition, the Company acquired or licensed all of the 3Com intellectualproperty used by CommWorks. CommWorks develops and deploys carrier-class,IP-based multi-service access and service creation platforms fortelecommunications service providers.

 

The amount of the purchase price allocated to in-process research anddevelopment (“IPR&D”) of $1.3 million, based on an appraisal by anindependent valuation specialist, was charged to the Company’s results ofoperations, as no alternative future uses existed at the acquisition date.Goodwill of $75.1 million was recorded in connection with the acquisitionand is expected to be deductible for tax purposes. The results of operations ofCommWorks are included in the Company’s consolidated results of operationsbeginning on May 23, 2003.

 

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

 

As of the date of the acquisition,CommWorks had two projects under development that qualified for in-processresearch and development (“IPR&D”), SLAP and High Density Voice (“HDV”)2.0.  SLAP is an IPR&D project inthe Wireless division of CommWorks.  Itis an interface that connects UTStarcom’s products with radio switchmanufacturers’ products in China in order to connect a cellular network to theInternet.  HDV 2.0 is an IPR&Dproject in the Wireline product line of CommWorks.  HDV 2.0 utilizes software technology to increase data capacity forVoice over Internet Protocol (“VoIP”) solutions.

 

There are significant risks associated with those technologies.  The technological risks stem from the factthat the new technologies are in an early stage of development.  As of the closing date, CommWork’s SLAPIPR&D project was approximately 60% complete and HDV 2.0 was approximately40% complete.  Therefore, there aresignificant risks associated with reaching the technological milestones on timeand on budget.  Commercial risks areassociated with the competitive nature of the telecommunications equipmentmarket.

 

Significant additional costs willbe required to complete the IPR&D projects.  The SLAP product is expected to be commercialized in September2003.  Remaining costs required tocomplete the project, are estimated to be $0.2 million.  The HDV 2.0 product is expected to be commercializedin December 2003.  Remaining costsrequired to complete the project are estimated to be $0.3 million.

 

The following table represents the preliminary allocation of thepurchase price for CommWorks. The allocation of the purchase price is basedupon a preliminary independent valuation. The estimated amounts for intangibleassets and goodwill may change based on revised assumptions of future revenuesfrom existing customers:

 

9

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|                                                                                                  |   | **(in thousands)** |    |
|-------------------------------------------------------------------------------------------------------|--------|--------------------|---------|
| Fair value of  tangible net assets                                                                    |   |               |    |
| Property,  plant and equipment                                                                        |   | $                  | 10,973  |   |
| Other tangible  assets                                                                                |   | 6,522              |    |
| Deferred  transition costs                                                                            |   | 6,588              |    |
| Fair value of  identified intangible assets                                                           |   | 9,250              |    |
| Existing  technology                                                                                  |   | 10,840             |    |
| In-process  research and development                                                                  |   | 1,260              |    |
| Liabilities  assumed                                                                                  |   | (11,193            | )       |
| Excess of  costs of acquiring CommWorks over fair value of identified net assets  acquired (goodwill) |   | 75,067             |    |
|                                                                                                  |   | $                  | 109,307 |   |

 

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

 
|                                                  |   | **Three  Months Ended  June 30,** |    | **Six Months  Ended  June 30,** |   |
|-------------------------------------------------------|--------|-----------------------------------|---------|---------------------------------|--------|
| **In thousands,  except per share data**              |   | **2003**                          |    | **2002**                        |   | **2003** |   | **2002** |   |
| Pro forma adjusted net revenue                        |   | $                                 | 418,483 |                            | $      | 275,119 |   | $ | 778,142 |   | $ | 514,570 |   |
| Pro  forma adjusted net income (loss)                 |   | $                                 | 25,302  |                            | $      | (15,855 | ) | $ | 51,808 |   | $ | (17,184 | ) |
| Pro forma adjusted basic  Earnings (loss) per share   |   | $                                 | 0.25    |                            | $      | (0.14 | ) | $ | 0.51 |   | $ | (0.16 | ) |
| Pro forma adjusted diluted  Earnings (loss) per share |   | $                                 | 0.21    |                            | $      | (0.14 | ) | $ | 0.43 |   | $ | (0.15 | ) |

 

The pro formaresults of operations include historical operations of the Company andCommWorks.  Certain non-recurringcharges were recorded by CommWorks and are included above including a $15.0million restructuring charge in both the first and second quarter of 2002 and a$15.0 and $6.1 million charge relating to goodwill impairment, which wasrecorded in the second quarter of 2002 and the first quarter of 2003,respectively.

 

On June 30,2003, the Company completed the acquisition of RollingStreams Systems, Ltd.(“RollingStreams”), a development-stage company, pursuant to a share exchangeagreement. RollingStreams designs streaming, end-to-endTV-over-Internet-Protocol (“TVoIP”) solutions for telecommunications operatorsand broadband service providers. The Company’s investment in RollingStreams was$0.4 million prior to the acquisition. The purchase consideration for all theoutstanding shares of RollingStreams, other than those already held by the Companyprior to the acquisition, was 301,074 shares of the Company’s common stock. Inaddition, the Company assumed all outstanding RollingStreams options, whichbecame options to purchase an aggregate of 12,742 shares of the Company’scommon stock, valued at $0.5 million. 164,115 of the 301,074 shares, valued at$5.8 million, were issued at the closing, 28,696 of which are held in escrowfor any undisclosed liabilities or contingencies incurred by RollingStreamsprior to the closing or for any breach of the share exchange agreement. Theseshares will be distributed to the former shareholders of RollingStreams withinten days of the six-month anniversary of the closing, after deducting anyclaims. Up to 147,592 of the 301,074 shares will be payable in the form of anearnout after an earnout period expiring 18 months after the closing, subjectto the achievement of certain revenue milestones during such earnout period.The amount of the purchase price allocated to in-process research anddevelopment was $6.2 million, based on an appraisal by an independent valuationspecialist. This amount was charged to the Company’s results of operations, asno alternative future uses existed at the acquisition date. The results ofoperations of RollingStreams will be included in the Company’s consolidatedresults of operations beginning on July 1, 2003.

 

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

 

10

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MediaSwitch is considered an IPR&D project because there aresignificant risks associated with the development of this technology.  These risks include technological andcommercial risks.  The technologicalrisks stem from the fact that the technology is 70% complete.  Therefore, there are significant risksassociated with reaching the technological milestones on time and onbudget.  Commercial risks are associatedwith the lack of market acceptance for the TVoIP concept.

 

In addition to the technologicaland commercial risks stated above, significant additional costs will berequired to complete the IPR&D project. MediaSwitch is expected to be commercialized in December 2003.  Remaining costs required to complete theproject are estimated to be $4.6 million. Remaining engineering tasks include the productization of the completesolution.  This involves adding newfeatures and functionalities and stabilizing the software code.

 

The following table represents the allocation of the purchase price forRollingStreams. The allocation of the purchase price is based upon anindependent valuation.

 
|                                       |   | **(in  thousands)** |   |
|--------------------------------------------|--------|---------------------|--------|
| Fair value of tangible net assets acquired |   | $                   | 86     |   |
| In-process research and development        |   | 6,171               |   |
| Investment                                 |   | (363                | )      |
| Deferred compensation                      |   | 434                 |   |
| Liabilities assumed                        |   | (36                 | )      |
|                                       |   | $                   | 6,292  |   |

 

On May 7,2003, the Company completed the purchase of all of the assets of XebeoCommunications, Inc. (“Xebeo”) for $2.4 million in cash. Xebeo develops andmanufacturers optical packet switches that enable telecommunications carriersto provide single fiber, multi-service access to customers. In addition, anamount up to $0.7 million may be payable based on future contingencies relatedto employment. The amount of the purchase price allocated to in-processresearch and development of $1.9 million, based on an appraisal by anindependent valuation specialist, was charged to the Company’s results ofoperations, as no alternative future uses existed at the acquisition date.

 

As of the date of the acquisition, Xebeo was focusing its resources on thedevelopment of its first product, MetroBridge, an optical packet switchingsolution, and was considered in the development stage.  There are significant risks associated withthe development of MetroBridge.  Theserisks include both technological and commercial risks; therefore, thedevelopment of MetroBridge is considered IPR&D. The technological risksstem from the fact that the development of MetroBridge requires highly complexsoftware for product development and testing. The development of MetroBridge was 60% complete as of the closingdate.  Technical flaws discovered in theremaining development period would delay the introduction of the product.  Therefore, there are significant risksassociated with reaching the technological milestones on time and onbudget.  The commercial risks areassociated with the competitive nature of the telecommunications equipmentmarket.  Furthermore, the commercialsuccess of MetroBridge is dependent upon the willingness of telecom carriers tocontinue to invest in new equipment and customer acceptance of the new featuresoffered by the product.

 

In addition to the technologicaland commercial risks stated above, significant additional costs are required tocomplete the development of MetroBridge, which is expected to be commercializedin November 2003.  Remaining costsrequired to complete the project are estimated to be $4.6 million.

 

The following table represents the allocation of the purchase price forXebeo. The allocation of the purchase price is based upon an independentvaluation.

 

11

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|                                   |   | **(in  thousands)** |   |
|----------------------------------------|--------|---------------------|--------|
| Fair value of tangible assets acquired |   | $                   | 769    |   |
| In-process research and development    |   | 1,897               |   |
| Liabilities assumed                    |   | (248                | )      |
|                                   |   | $                   | 2,418  |   |

 

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

 

The following represents the outstanding long-term borrowings at June30, 2003 and December 31, 2002 (in thousands):

 
| **Note**                       |   | **Rate** |   | **Maturity**  |   | **June 30, 2003** |    | **December 31, 2002** |   |
|--------------------------------|--------|----------|--------|---------------|--------|-------------------|---------|-----------------------|--------|
| Convertible Subordinated Notes |   | 7/8%     |   | March 1, 2008 |   | $                 | 402,500 |                  | $      | — |   |
|                                |        |          |        |               |        |                   |         |                       |        |  |  |

 

The Companyhas unutilized borrowing facilities under lines of credit of $523.8 million asof June 30, 2003. $140.1 million of these facilities expire in 2003 and $383.7million of these facilities expire between 2004 and 2010.

 

On March 12, 2003, the Companycompleted an offering of $402.5 million of convertible subordinated notes dueMarch 1, 2008 to qualified buyers pursuant to Rule 144A under the SecuritiesAct of 1933.  The notes bear interest at a rate of 8.75% perannum and are convertible into the Company’s common stock at a conversion priceof $23.79 per share and are subordinated to all present and future senior debtof the Company. Holders of the notes may convert their notes only if: (i) theprice of the Company’s common stock issuable upon conversion of a note reachesa specified threshold, (ii) specified corporate transactions occur, 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 common stock.

 

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

 

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

 

Warrantyobligations are as follows (in thousands):

 
|                                              |   | **Three months ended  June 30,** |   | **Six months ended  June 30,** |   |
|---------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                              |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                              |   |                             |   |                           |   |   |   |   |   |
| Beginning of  period                              |   | $                                | 12,524 |                           | $      | 7,027 |   | $ | 13,297 |   | $ | 6,721 |   |
| Accruals for  warranties issued during the period |   | 8,427                            |   | 4,058                          |   | 16,710 |   | 6,351 |   |
| Adjustments to  accruals for changes in estimates |   | —                           |   | —                         |   | (4,552 | ) | — |   |
| Settlements  made during the period               |   | (4,523                           | )      | (2,191                         | )      | (9,027 | ) | (4,178 | ) |
| Balance at  June 30, 2003                         |   | $                                | 16,428 |                           | $      | 8,894 |   | $ | 16,428 |   | $ | 8,894 |   |

 

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 noamounts in relation to these provisions as no such claims have been made andthe Company believes it has valid, enforceable rights to the intellectualproperty embedded in its products.

 

12

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The Companyissues standby letters of credit primarily to support 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 long-term investments are as follows (in thousands):

 
|                                         |   | **June 30, 2003** |   | **December 31, 2002** |   |
|----------------------------------------------|--------|-------------------|--------|-----------------------|--------|
| Softbank China                               |   | $                 | 5,383  |                  | $      | 5,526 |   |
| Cellon  International                        |   | 8,000             |   | 8,000                 |   |
| Restructuring  Fund No. 1                    |   | 1,981             |   | 1,981                 |   |
| Global Asia  Partners L.P.                   |   | 1,882             |   | 882                   |   |
| Fiberxon Inc.                                |   | 2,000             |   | 2,000                 |   |
| InterWave  Communications International Ltd. |   | 2,060             |   | 1,546                 |   |
| China Telecom                                |   | —            |   | 9,106                 |   |
| Joint Venture  with Matsushita               |   | 2,119             |   | 4,683                 |   |
| Others                                       |   | 1,272             |   | 1,636                 |   |
|                                         |   |              |   |                  |   |
| Total                                        |   | $                 | 24,697 |                  | $      | 35,360 |   |

 

TheCompany has a $5.4 million investment in Softbank China, an investmentfund established by SOFTBANK CORP. focused on investments in Internet companiesin China. This investment permits the Company to participate in the anticipatedgrowth of Internet-related businesses in China. SOFTBANK CORP. and itsrelated companies are significant stockholders of the Company. The Company’sinvestment constitutes 10% of the funding for Softbank China, with SOFTBANKCORP. contributing the remaining 90%. The fund has a separate management team,and none of the Company’s employees are employed by the fund. Many of thefund’s investments are and will be in privately held companies, many of whichare still in the start-up or development stages. These investments areinherently risky as the market for the technologies or products the companieshave under development are typically in the early stages and may nevermaterialize. The Company accounts for this investment under the cost method andrecorded losses of $0.0 million and $0.1 million due to an other thantemporary decline in the carrying value of this investment during the three andsix months ended June 30, 2003, respectively, and recorded losses of$0.0 million and $0.4 million due to an other than temporary declinein the carrying value of this investment during the three and six months endedJune 30, 2002, respectively.

 

During the first quarter of fiscal 2002, the Company invested$2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliatedwith SOFTBANK CORP., is a significant stockholder of the Company. The fundfocuses on leveraged buyout investments in companies in Asia undergoingrestructuring or bankruptcy procedures. The total fund offering is expected tobe between approximately $150.0 million and $226.0 million, with eachinvestor contributing a minimum of $0.8 million. The fund has a separatemanagement team, and none of the Company’s employees are employed by the fund.The Company accounts for this investment under the equity method of accounting.The balance in this investment is $2.0 million at June 30, 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 and six months ended June 30, 2003, no impairment charge wasconsidered necessary, based upon a review of the carrying value of theseinvestments. During the three and six months ended June 30, 2002,impairment charges in respect of these private technology investments were$0.7.

 

In June 2002, the Company invested $1.0 million in Global AsiaPartners L.P., and an additional $1.0 million in June 2003, with a commitmentto invest up to a maximum of $5.0 million. The remaining amount is due atsuch times and in such amounts as shall be specified in one or more futurecapital calls to be issued by the general partner. The fund size is anticipatedto be $100 million and the fund was formed to make private equityinvestments in private or pre-IPO technology and telecommunications companies. 

 

13

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The fund’s geographic focus is on technologyinvestments in Asia, in particular India and China. The Company accounts forthis investment under the equity method of accounting. The balance in thisinvestment is $1.9 million at June 30, 2003.

 

During 2002, the Company purchased approximately 5.8 millionshares of common stock of InterWave Communications, Inc., a technologycompany listed on NASDAQ, for approximately $3.0 million. In addition, theCompany received warrants to purchase 2.0 million shares of InterWave’scommon stock at $0.21 cents per share, which were valued at $0.5 million atJune 30, 2003, using the Black-Scholes option-pricing model. The Companyrecorded the increase in the carrying value of these securities of $0.6 millionas of June 30, 2003, in comprehensive income in equity. The Company recordedincome of $0.2 million in the three months ended June 30, 2003 to reflect theincrease in the 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 $80,000. The Company soldthe remaining 37,500 shares during the three months ended June 30, 2003realizing a gain of $4,000.

 

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

 

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

 
|                          |   | **June 30, 2003** |    | **December 31, 2002** |   |
|-------------------------------|--------|-------------------|---------|-----------------------|--------|
|                          |   |              |    |                  |   |
| Goodwill                      |   | $                 | 135,530 |                  | $      | 57,629 |   |
| Less accumulated amortization |   | (12,823           | )       | (12,823               | )      |
|                          |   | $                 | 122,707 |                  | $      | 44,806 |   |
|                          |   |              |    |                  |   |
| Purchased technology          |   | $                 | 31,080  |                  | $      | 7,570 |   |
| Less accumulated amortization |   | (4,733            | )       | (2,556                | )      |
|                          |   | $                 | 26,347  |                  | $      | 5,014 |   |

 

Amortization expense for intangible assets was $1.5 million and$0.7 million for the three months ended June 30, 2003 and 2002,respectively, and was $2.2 million and $1.1 million for the six months endedJune 30, 2003 and 2002, respectively. Expected amortization expense for thenext five fiscal years, beginning the year ended December 31, 2004, is$8.5 million, $5.5 million, $3.9 million, $2.8 million and  $0.9 million, respectively.

 

Goodwill increased by $77.9 million and intangible assetsincreased by $23.5 million during the six months ended June 30, 2003. This wasmainly attributable to goodwill of $75.1 million and purchased technology of$20.1 million that was recorded on the acquisition of CommWorks in the secondquarter of 2003.  In addition, goodwillof $2.8 million and purchased technology of $1.9 million was recorded on theacquisition of Shanghai Yi Yun in the first quarter of 2003. The Company alsopurchased technology for $1.6 million in cash during the six months ended June30, 2003. The estimated useful life of purchased technology is from one to fiveyears.

 

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 or when changes in circumstances indicate a potentialimpairment.

 

**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 

 

14

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within the organization. In accordance with SFASNo. 131 “Disclosures about Segments of an Enterprise and RelatedInformation”, the Company is considered a single reportable segment. TheCompany is required to disclose certain information about product revenues,information about geographic areas, information about major customers, andinformation about long-lived assets.

 

During the third quarter of 2002, the provincial-leveltelecommunications service entity in the Zhejiang province of China began toconsolidate telecommunications purchasing decisions for that province. As aresult of this trend in the Zhejiang province, the Company has grouped alltelecommunications service entities in the Zhejiang province together and hastreated these as one customer. At June 30, 2003, the Company had approximately12 such telecommunications service entities in Zhejiang province. Giving effectto this treatment, for the three months ended June 30, 2003, sales to SoftbankBB Corporation (“SBBC”) and Zhejiang province accounted for 15% and 11% of netsales, respectively. For the three months ended June 30, 2002, sales toZhejiang province and SBBC accounted for 26% and 20% of net sales,respectively. For the six months ended June 30, 2003, sales to SBBC accountedfor 16% of net sales and no other customer accounted for 10% or more ofconsolidated net sales. For the six months ended June 30, 2002, sales toZhejiang province and SBBC accounted for 25% and 14% of net sales,respectively. Revenue attributable to Japan was primarily due to sales to SBBC.Sales to SBBC were $60.2 million for the three months ended June 30, 2003and $46.9 million for the three months ended June 30, 2002. Sales to SBBCwere $118.7 million for the six months ended June 30, 2003 and$56.9 million for the six months ended June 30, 2002.

 

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

 
|             |   | **Three Months Ended June 30, 2003** |    | **Three Months Ended June 30, 2002** |   |
|------------------|--------|--------------------------------------|---------|--------------------------------------|--------|
|             |   | **Telecommunications  Equipment**    |    | **Subscriber  Handsets**             |   | **Total** |   | **Telecommunications  Equipment** |   | **Subscriber  Handsets** |   | **Total** |   |
| Net sales:       |   |                                 |    |                                 |   |   |   |   |   |   |   |   |   |
| China            |   | $                                    | 147,276 |                                 | $      | 185,272 |   | $ | 332,548 |   | $ | 98,332 |   | $ | 83,760 |   | $ | 182,092 |   |
| Japan            |   | 60,546                               |    | —                               |   | 60,546 |   | 46,948 |   | — |   | 46,948 |   |
| Other            |   | 10,884                               |    | 1,856                                |   | 12,740 |   | 2,468 |   | — |   | 2,468 |   |
|             |   |                                 |    |                                 |   |   |   |   |   |   |   |   |   |
| Total net  sales |   | $                                    | 218,706 |                                 | $      | 187,128 |   | $ | 405,834 |   | $ | 147,748 |   | $ | 83,760 |   | $ | 231,508 |   |
|             |   |                                 |    |                                 |   |   |   |   |   |   |   |   |   |
|             |   | **Six Months Ended June 30, 2003**   |    | **Six Months Ended June 30, 2002**   |   |
|             |   | **Telecommunications  Equipment**    |    | **Subscriber  Handsets**             |   | **Total** |   | **Telecommunications  Equipment** |   | **Subscriber  Handsets** |   | **Total** |   |
| Net sales:       |   |                                 |    |                                 |   |   |   |   |   |   |   |   |   |
| China            |   | $                                    | 276,385 |                                 | $      | 325,093 |   | $ | 601,478 |   | $ | 195,957 |   | $ | 153,333 |   | $ | 349,290 |   |
| Japan            |   | 120,366                              |    | —                               |   | 120,366 |   | 60,677 |   | — |   | 60,677 |   |
| Other            |   | 12,515                               |    | 1,995                                |   | 14,510 |   | 5,231 |   | — |   | 5,231 |   |
|             |   |                                 |    |                                 |   |   |   |   |   |   |   |   |   |
| Total net  sales |   | $                                    | 409,266 |                                 | $      | 327,088 |   | $ | 736,354 |   | $ | 261,865 |   | $ | 153,333 |   | $ | 415,198 |   |

 

Revenue attributable to the United States of America was insignificantduring the three and six months ended June 30, 2003 and 2002.

 

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

 
|                     |   | **June 30,  2003** |    | **December 31,  2002** |   |
|--------------------------|--------|--------------------|---------|------------------------|--------|
| U.S.                     |   | $                  | 158,674 |                   | $      | 43,600 |   |
| Foreign                  |   | 126,111            |    | 104,731                |   |
| Total  long-lived assets |   | $                  | 284,785 |                   | $      | 148,331 |   |

 

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**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 public offering.Substantially similar actions were filed concerning the initial publicofferings for more than 300 different issuers, and the cases were coordinatedas *In re Initial Public Offering SecuritiesLitigation*, 21 MC 92. In April 2002, a consolidated amendedcomplaint was filed in the matter against the Company, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604. Plaintiffs 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 andofficers have 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.  A proposal has been made for the settlementand release of claims against the issuer defendants, including UTStarcom. Thesettlement is subject to a number of conditions, including approval of theproposed settling parties and the court. If the settlement does not occur, andlitigation against UTStarcom continues, UTStarcom believes it has meritoriousdefenses and intends to defend the case vigorously. The total amount of theloss associated with the above litigation is not determinable at this time.  Therefore we are unable to currentlyestimate the loss, if any, associated with the litigation.

 

*Investment Commitments:*

 

As of June 30, 2003, the Company had invested $2.0 million inGlobal Asia Partners L.P. 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 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 $60.2 million and $118.7 million during the threeand six months ended June 30, 2003, respectively, and $46.9 million and $56.9million during the three and six months ended June 30, 2002, respectively, withrespect to sales of telecommunications equipment to SBBC, an affiliate ofSOFTBANK CORP. SOFTBANK America Inc., an entity affiliated with SOFTBANKCORP., a significant stockholder of the Company. SBBC offers asynchronousdigital subscriber line (“ADSL”) coverage throughout Japan, which is marketedunder the name YAHOO. The Company provides ADSL technology to SBBC. Thecontract was competitively bid and the terms of this contract were on terms nomore favorable than those with unrelated parties. Included in accountsreceivable at June 30, 2003 is $68.2 million related to this agreement. Therewere no amounts included in deferred revenue in respect of this agreement atJune 30, 2003. Included in accounts receivable in respect of this agreement atDecember 31, 2002 was $0.8 million. There were no amounts included indeferred revenue in respect 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.

 

On April 5, 2003 the Company repurchased 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 was$139.6 million, including transaction fees. In connection with this repurchasetransaction, SOFTBANK entered into an agreement with the Company not to offer,sell or otherwise dispose of the Company’s common stock for a period of oneyear, subject to a number of exceptions. As of June 30,  2003, SOFTBANK beneficially ownedapproximately 14.4% of the Company’s outstanding common stock.

 

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

 

Approximately 82% and 79% of the Company’s net sales for the threemonths ended June 30, 2003 and 2002, respectively, and approximately 82% and84% of the Company’s net sales for the six months ended June 30, 2003 and 2002,respectively, were made in China. Accordingly, the Company’s business,financial condition and results of operations are likely to be influenced bythe political, economic and legal environment in China and by the general stateof China’s economy. The Company’s operations in China are subject to specialconsiderations and significant risks not typically associated with companies inthe United States. These include risks associated with, among others, thepolitical, economic and legal environments and foreign currency exchange. TheCompany’s results may be adversely affected by, among other things, changes inthe political, economic, competitive and social conditions in China, includingchanges in governmental policies with respect to laws and regulations, changesin China’s telecommunications industry and regulatory rules and policies,anti-inflationary measures, currency conversion and remittance abroad, andrates and methods of taxation.

 

Under China’s current regulatory structure, the communications productsthat the Company offers in China must meet government and industry standards,and a network access license for the equipment must be obtained. Without thelicense, the 

 

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equipment isnot allowed to be connected to public telecommunications networks or sold inChina. Moreover, the Company must ensure that the quality of thetelecommunications equipment for which it has obtained a network access licenseis stable and reliable, and may not lower the quality or performance of otherinstalled 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. The Company has obtainedthe required network access licenses for its AN-2000B platform. The Company hasalso obtained a probationary network access license for its mSwitch product,and after the trial period, an official network access license will be issuedif the trial demonstrates that mSwitch satisfies all applicable government andindustry standards. The Company applied for, but has not yet received, anetwork access license for its PAS systems and handsets. Based uponconversations with the Ministry of Information Industry, the Companyunderstands that its PAS systems and handsets are considered to still be in thetrial period and that sales of the Company’s PAS systems and handsets maycontinue to be made during this trial period, but a license will ultimately berequired. Network access licenses will also be required for most additionalproducts that the Company is selling or may sell in China, including themSwitch platform. If the Company fails to obtain the required licenses, theCompany could be prohibited from making further sales of the unlicensedproducts, including the PAS systems and handsets, in China, which wouldsubstantially harm its business, financial condition and results of operations.The Company’s counsel in China has advised that China’s governmentalauthorities may interpret or apply the regulations with respect to whichlicenses are required and the ability to sell a product while a product is inthe trial period in a manner that is inconsistent with the information receivedby such counsel in China, either of which could have a material adverse effecton the Company’s business, financial condition and results of operations.

 

Approximately15% and 20% of the Company’s sales for the three months ended June 30, 2003 and2002, respectively, and approximately 16% and 15% of the Company’s sales forthe six months ended June 30, 2003 and 2002, respectively, were made in Japan.Accordingly, the political, economic and legal environment and the generalstate of Japan’s economy may influence the Company’s business, financialcondition 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 MultipleDeliverables” (“EITF No. 00-21”). This issue addresses how revenue arrangementswith multiple deliverables should be divided into separate units of accountingand how the arrangement consideration should be allocated to the identifiedseparate accounting units. EITF No. 00-21 is effective for fiscal periodsbeginning after June 15, 2003. Where multiple elements exist in anarrangement, the arrangement fee is allocated to the different elements basedupon verifiable objective evidence of the fair value of the elements. TheCompany does not expect that the adoption of EITF No. 00-21 will have asignificant impact on consolidated results of operations and financialposition.

 

In January2003, the Financial Accounting Standards Board issued Interpretation No. 46,“Consolidation of Variable Interest Entities” (“FIN 46”). 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 and six months ended June 30, 2003 were not material to itsresults of operations.  The maximumexposure to loss assuming there is no further investment is $4.5 million atJune 30, 2003. The Company has not yet determined the impact of adopting FIN 46on its consolidated financial statements.

 

In April 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 149  “Amendmentof Statement 133 on Derivative Instruments and Hedging Activities” (“SFAS149”). This statement amends SFAS 133 to provide clarification on the financialaccounting and reporting of derivative instruments and hedging activities. TheCompany does not expect the adoption of SFAS 149, which will be effective forcontracts entered into or modified after June 30, 2003, to have a materialeffect on its financial condition or results of operations.

 

In May 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150 

 

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establishes standards for howan issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of these instruments were previouslyclassified as equity. The guidance in SFAS 150 is generally effective for allfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003. As the Company does not have any of these financialinstruments, the adoption of FAS 150 is not expected to have any impact on theCompany’s consolidated financial statements.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

This Report onForm 10-Q contains forward-looking statements within the meaning of thefederal securities laws. These statements are based on information that iscurrently available to management. We intend such forward-looking statements tobe covered by the safe harbor provisions of the Private Securities LitigationReform Act of 1995, and we are including this statement for purposes ofcomplying with those provisions. The forward-looking statements include,without limitation, those concerning the following: our expectations as to thenature of possible trends; the manner in which customers in Chinese provincesnegotiate for the purchase of our products; our expectation regarding continuedgrowth in our business and operations; our expectation that our PAS networkaccess system will continue to be allowed in China’s county-level cities andcounties; our expectation that there will be no penalties or fines for ournon-compliance with the licensing requirements in China for our PAS system andother products; our expectation concerning the anticipated cost and completiondate of our new Hangzhou manufacturing facility; our expectation that therewill be fluctuations in our overall gross profit, gross margin, product mix,quarter to quarter results, customer base and selling prices; our plans forexpanding the direct sales organization and our selling and marketing campaignsand activities; our expectation that we may use part of the net proceeds of ourinitial and follow on public offerings to acquire or invest in complementarybusinesses, technologies or product offerings; our expectation that we may usethe remaining net proceeds of our convertible subordinated notes offering forgeneral corporate purposes, including research and development, expansion ofour sales and marketing organization and working capital; our expectation thatthere will be increases in selling, marketing, research and development,general and administrative expenses; our expectation that we will continue toinvest significantly in research and development; our expectation that we willfill the majority of our current backlog orders; our expectation regarding ourfuture investments, particularly in Softbank China; our expectation thatexisting cash and cash equivalents will be sufficient to finance our operationsfor at least the next 12 months; and the impact of changes in generalworld and domestic economic conditions in light of the military conflict inIraq. Additional forward-looking statements may be identified by the words,“anticipate,” “expect,” “believe,” “intend,” “will” and similar expressions, asthey relate to us or our management. Investors are cautioned that theseforward-looking statements are inherently uncertain. These statements aresubject to risks and uncertainties that may cause actual results and events todiffer materially. For a detailed discussion of these risks and uncertainties,see 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**

 

Incorporatedin 1991, UTStarcom designs, manufactures, and markets wireline and wirelessbroadband access and switching equipment that enables migration to nextgeneration IP-based networks. Our operations are conducted primarily by ourforeign subsidiaries that manufacture, distribute and support our products, principallyin 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.

 

Approximately 82% of our net sales for both the three and six monthsended June 30, 2003 and approximately 79% and 84% of our net sales,respectively, for the three and six months ended June 30, 2002 were madein China. Accordingly, our business, financial condition and results ofoperations are likely to be influenced by the political, economic and legalenvironment in China, and by the general state of China’s economy. Our resultsmay be adversely affected by, among other things, changes in the political,economic, competitive and social conditions in China, including changes inChina’s governmental policies with respect to laws and regulations, 

 

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changes intelecommunications industry and regulatory rules and policies,anti-inflationary measures, currency conversion and remittance abroad, andrates and methods of taxation. We extend credit to our customers in Chinawithout requiring collateral. We monitor our exposure for credit losses andmaintain 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 telecommunications serviceentities in Zhejiang province together and have treated these as one customer.Giving effect to this treatment, for the three months ended June 30, 2003,sales to Softbank BB Corporation and Zhejiang province accounted for 15% and11% of our net sales, respectively. For the three months ended June 30, 2002,sales to Zhejiang province and Softbank BB Corporation accounted for 26% and20% of our net sales, respectively. For the six months ended June 30, 2003,sales to Softbank BB Corporation accounted for 16% of our net sales and noother customer accounted for 10% or more of our consolidated net sales. For thesix months ended June 30, 2002, sales to Zhejiang province and Softbank BBCorporation accounted for 25% and 14% of our net sales, respectively. At June30, 2003, we have approximately 12 telecommunications service entities inZhejiang province.

 

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

 

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

 

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

 

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

 

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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.

 

Revenuesfrom sales of telecommunications equipment are recognized when persuasiveevidence of an arrangement exists, delivery of the product has occurred asevidenced by customer acceptance, the fee is fixed or determinable andcollectability is reasonably assured. If the fee due from the customer is notfixed or determinable 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.  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 salesconsists primarily of material costs, third party commissions, costs associatedwith manufacturing, assembly and testing of products, costs associated withinstallation and customer training and overhead and warranty costs. Cost ofsales also includes import taxes and tariffs on components and assemblies. Somecomponents and materials used in our products are purchased from a singlesupplier or a limited group of suppliers and, in some cases, are subject to ourobtaining Chinese import permits and approvals. We also rely on third partymanufacturers in China to manufacture and assemble most of our handsets.

 

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 45% to 50% 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 and administrative expenses include compensation andbenefits, professional fees, sales commissions, provision for doubtful accountsreceivable and travel and entertainment costs. A large percentage of our costsare fixed and are difficult to quickly reduce in periods of reduced sales. Weintend to pursue aggressive selling and marketing campaigns and to expand ourdirect sales organization, and, as a result, our sales and marketing expenseswill increase in future periods. We also expect that in support of ourcontinued growth, general and administrative expenses will continue to increasefor the foreseeable future.

 

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

 

The equity loss for the current year is primarily due to our share oflosses relating to a joint venture agreement we entered into on July 5, 2002with Matsushita Communication Industrial Co., Ltd., and Matsushita ElectricIndustrial Co., Ltd., to jointly design, develop, manufacture and selltelecommunications products. We have a 49% ownership interest in this jointventure company. The equity loss for 2002 is in respect of losses at ourGuangdong manufacturing subsidiary. In May 2002, we acquired the remaining 49%ownership interest in GUTS, which is now a wholly-owned subsidiary. Its resultsof operations are included in our consolidated financial statements beginningJune 1, 2002. Prior to May 2002, GUTS was accounted for using the equity methodof accounting.

 

Under current regulations in China, foreign investment enterprises thathave been accredited as technologically advanced enterprises are entitled toadditional tax incentives. These tax incentives vary in different locales andcould include preferential national enterprise income tax treatment at 50% ofthe usual rates for different periods of time. All of our active subsidiariesin China were accredited as technologically advanced enterprises. The taxholidays applicable to our wholly-owned subsidiaries UTStarcom China andUTStarcom Telecom Co., Ltd. (“HUTS”), which together accounted forapproximately 53.9% of our revenues for the six months ended June 30, 2003,expired at the end of 2002 and 2001, respectively. The tax holidays were notextended for the entities, and for 2003, the national enterprise tax rates wereincreased from 7.5% to 15%, and from 10% to 15%, respectively. During thefourth quarter of 2002, we formed a new entity, Hangzhou UTStarcomTelecom Co., Ltd., to manufacture and sell handsets. This entity willbenefit from a two year national enterprise income tax exemption from the firstprofit-making year and a 50% national enterprise income tax reduction in thefollowing three years. The Chinese government is considering the imposition ofa “unified” corporate income tax that would phase out, over time, thepreferential tax treatment to which foreign investment enterprises, such as 

 

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UTStarcom, arecurrently entitled. We cannot be certain whether the government will implementsuch a unified tax structure, or, if implemented, whether it will adverselyaffect 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.

 

**CRITICAL ACCOUNTING POLICIES**

 

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

 

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

 

**Revenue Recognition, Allowances for DoubtfulAccounts 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**

 

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

 

**Research and Development and SoftwareDevelopment Costs**

 

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

 

**Deferred Income Taxes**

 

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

 

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**Goodwill and Intangibles**

 

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

 

**Long-Term Investments**

 

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

 

**RELATED PARTY TRANSACTIONS**

 

We recognizedrevenue of $60.2 million and $118.7 million during the three and sixmonths ended June 30, 2003, respectively, and $46.9 million and $56.9 millionduring the three and six months ended June 30, 2002, respectively, with respectto sales of telecommunications equipment to SBBC, an affiliate of SOFTBANKCORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., isa significant stockholder of ours. SBBC offers asynchronous digital subscriberline (“ADSL”) coverage throughout Japan, which is marketed under the name“YAHOO! BB”. We provide ADSL technology to SBBC. The contract was competitivelybid and the terms of this contract were on terms no more favorable than thosewith unrelated parties. Included in accounts receivable at June 30, 2003 is$68.2 million related to this agreement. There were no amounts included indeferred revenue in respect of this agreement at June 30, 2003. Included inaccounts receivable 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.

 

During 2000, we invested $10.0 million in Softbank China, aninvestment fund established by SOFTBANK CORP. focused on investments inInternet companies in China. This investment permits us to participate in theanticipated growth of Internet-related businesses in China. SOFTBANK CORP. andits related companies are significant stockholders of ours. Our investmentconstitutes 10% of the funding for Softbank China, with SOFTBANK CORP.contributing the remaining 90%. The fund has a separate management team, andnone of our employees are employed by the fund. Many of the fund’s investmentsare and will be in privately held companies, many of which are still in thestart-up or development stages. These investments are inherently risky as themarket for the technologies or products the companies have under developmentare typically in the early stages and may never materialize. We account forthis investment under the cost method and recorded losses of $0.0 millionand $0.1 million due to a other than temporary decline in the carryingvalue of this investment during the three and six months ended June 30, 2003,respectively, and recorded losses of $0.0 million and $0.4 milliondue to a other than temporary decline in the carrying value of this investmentduring the three and six months ended June 30, 2002, respectively.

 

During the first quarter of fiscal 2002, we invested $2.0 millionin Restructuring Fund No. 1, a venture capital investment limitedpartnership established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANKCORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., isa significant stockholder of ours. The fund focuses on leveraged buyoutinvestments in companies in Asia undergoing restructuring or 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 June 30, 2003.

 

On April 5, 2003, we repurchased 8.0 million shares of our common stockbeneficially owned by SOFTBANK America Inc., at a purchase price of $17.385 pershare. The total cost of the repurchase was $139.6 million includingtransaction fees. In connection with this repurchase transaction, SOFTBANKentered into an agreement with us not to offer, sell or otherwise dispose ofour common stock for a period of one year, subject to a number of exceptions.As of June 30, 2003, SOFTBANK beneficially owned approximately 14.4% of ouroutstanding common stock.

 

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**RESULTS OF OPERATIONS**

 

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

 

NET INCOME

 

For the three months ended June 30, 2003, net income increased 53% to$39.4 million as compared to net income of $25.7 million for the threemonths ended June 30, 2002. The increase in net income was partly attributableto the higher growth in our gross profit, which increased by 60%, as comparedto the growth in operating expenses, which increased by 57%. We will continueto focus our efforts on the efficient management of our operating expenses,including continued cost reduction, manufacturing efficiencies and the redesignof our products for our PAS systems.

 

NET SALES

 

Our net sales increased 75% to $405.8 million for the three monthsended June 30, 2003 from $231.5 million for the corresponding period in 2002.Sales of telecommunications equipment for the three months ended June 30, 2003were $218.7 million, an increase of $71.0 million or 48% as comparedto the three months ended June 30, 2002. Sales of subscriber handsets for thethree months ended June 30, 2003 were $187.1 million, an increase of$103.4 million or 123%, as compared to the three months ended June 30, 2002. Inparticular, sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment, PAShandsets and other products were $140.0 million, $75.3 million, $187.1 millionand $3.4 million, respectively, and represented 34%, 19%, 46% and 1% of our netsales for the three months ended June 30, 2003, respectively. Sales of PAS/iPASequipment, AN-2000/IP-DSLAM equipment, PAS handsets and other products were$93.9 million, $51.2 million, $83.7 million and $2.7 million, respectively, andrepresented 41%, 22%, 36% and 1% of our net sales for the three months endedJune 30, 2002, respectively. Our mSwitch products are included with our iPASproduct offering. We do not expect the percentage of revenues attributed tothese products to change significantly in the near future.  In particular, we expect that, in 2003,sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment and PAS handsets willrepresent approximately 35%, 20% and 45% of our net sales, respectively.

 

Sales of iPAS/PAS equipment and sales of subscriber handsets increaseddue to the continued growth in spending on telecommunications infrastructure inChina, which accounted for 82% and 79% of our net sales for the three monthsended June 30, 2003 and 2002, respectively. International sales oftelecommunication equipment increased to $73.3 million for the threemonths ended June 30, 2003 as compared to $49.4 million for the threemonths ended June 30, 2002, primarily driven by sales of IP-DSLAM equipment toSBBC in Japan to support its ADSL rollout. Sales in Japan for the three monthsended June 30, 2003 and 2002 accounted for 15% and 20% of our net sales,respectively. During 2002, the provincial-level telecommunications serviceentity in the Zhejiang province of China began to consolidatetelecommunications purchasing decisions for that province. As a result of thistrend in the Zhejiang province, we have grouped all telecommunications serviceentities in Zhejiang province together and have treated these as one customer.For the three months ended June 30, 2003, sales to SBBC and Zhejiang provinceaccounted for 15% and 11% of our net sales, respectively. For the three monthsended June 30, 2002, sales to Zhejiang province and SBBC accounted for 26% and20% of our net sales, respectively. At June 30, 2003, we had approximately 12telecommunications service entities in Zhejiang province.

 

COST OF GOODSSOLD

 

During the three months ended June 30, 2003, our cost of goods sold as apercentage of sales increased to 66% from 63% in the corresponding period.  This increase can be primarily attributed tothe fact that a higher proportion of our sales are lower margin handsets, whichcomprised 46% and 36% of our sales for the three months ended June 30, 2003 and2002, respectively.

 

GROSS PROFIT

 

Gross profit increased by 60% to $137.5 million for the three monthsended June 30, 2003 from $85.9 million for the corresponding period in2002. Gross profit, as a percentage of net sales, was 34% for the three monthsended June 30, 2003 and 37% for the three months ended June 30, 2002. Grossprofit, as a percentage of net sales, decreased primarily due to a higher levelof lower margin handset sales, which comprised 46% and 36% of our sales for thethree months ended June 30, 2003 and 2002, respectively. We believe our lowermargin handset sales will increase somewhat during future periods. In addition,we believe that there will be continued competitive market pricing pressures onour other products in line with current trends in the industry. However, webelieve that cost efficiencies arising from the continued cost reduction,manufacturing efficiencies and redesign of our products for our PAS systemswill partially offset the impact of these factors on our gross profit as apercentage of net sales.

 

SELLING,GENERAL AND ADMINISTRATIVE

 

Selling,general and administrative expenses increased 18% to $35.0 million for thethree months ended June 30, 2003 from $29.5 million for the correspondingperiod in 2002. The increase in absolute dollars in selling, general andadministrative expenses was primarily due to increased sales and administrativepersonnel and related expenses, including sales commissions, associated with 

 

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the growth in net sales and theexpansion of our overall level of business activities. Selling andadministrative headcount increased to 2,160 employees at June 30, 2003 ascompared to 1,236 employees at June 30, 2002. Selling, general andadministrative expenses as a percentage of net sales were 9% and 13% for thethree months ended June 30, 2003 and 2002, respectively. The decrease inselling, general and administrative expenses as a percentage of net sales wasmainly due to significant cash collections in China that reduced therequirement for allowance for doubtful debts as compared with previous periods.In addition, due to the SARS outbreak in China, our travel to Asia wascurtailed for a number of months, with a resulting reduction in travelexpenses. We expect our selling, general and administrative expenses toincrease in absolute dollar amounts and to return to our previous percentage ofnet sales level in future periods as sales and marketing activities increaseand we incur additional expenses related to the anticipated growth of ourbusiness and operations.

 

RESEARCH ANDDEVELOPMENT

 

Research and development expenses increased 69% to $36.1 million for thethree months ended June 30, 2003 from $21.4 million for the correspondingperiod in 2002. The increase in research and development expenses was primarilydue to the hiring of additional technical personnel, our recent acquisitions ofCommWorks and increased prototype expenses and licensing fees to support ourresearch and development efforts. Research and development headcount increasedto 1,924 employees at June 30, 2003 as compared to 1,159 employees at June 30,2002. As a percentage of net sales, research and development expenses were 9%for both the three months ended June 30, 2003 and the corresponding period in2002. We expect our research and development expenses to increase in absolutedollar amounts in future periods as we expand our research and developmentorganization to support new product development.

 

IN-PROCESSRESEARCH AND DEVELOPMENT COSTS

 

In-processresearch and development costs increased to $9.4 million during the threemonths ended June 30, 2003 from $0.7 million in the corresponding period in2002. Of the charge for the three months ended June 30, 2003, $1.3 million wasdue to our acquisition of CommWorks, a former division of 3Com, and two smalleracquisitions, RollingStreams and Xebeo, accounted for $6.2 million and $1.9million, respectively, and were based on appraisals by an independent valuationspecialist.

 

On May 23,2003, the Company completed its acquisition of CommWorks.  CommWorks develops and deployscarrier-class, IP-based multi-service access and service creation platforms fortelecommunications service providers.

 

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

 

As of the date of the acquisition,CommWorks had two projects under development that qualified for in-processresearch and development (“IPR&D”), SLAP and High Density Voice (“HDV”)2.0.  SLAP is an IPR&D project inthe Wireless division of CommWorks.  Itis an interface that connects UTStarcom’s products with radio switchmanufacturers’ products in China in order to connect a cellular network to theInternet.  HDV 2.0 is an IPR&Dproject in the Wireline product line of CommWorks.  SLAP utilizes software technology to increase data capacity forVoice over Internet Protocol (“VoIP”) solutions.

 

There are significant risks associated with those technologies.  The technological risks stem from the factthat the new technologies are in an early stage of development.  As of the closing date, CommWork’s SLAPIPR&D project was approximately 60% complete and HDV 2.0 was approximately40% complete.  Therefore there aresignificant risks associated with reaching the technological milestones on timeand on budget.  Commercial risks areassociated with the competitive nature of the telecommunications equipmentmarket.

 

In addition to the technologicaland commercial risks stated above, significant additional costs will berequired to complete the IPR&D projects. The SLAP product is expected to be commercialized in September2003.  Remaining costs required tocomplete the project, are estimated to be $0.2 million.  The HDV 2.0 product is expected to becommercialized in December 2003. Remaining costs required to complete the project, are estimated to be$0.3 million.

 

On June 30,2003, the Company completed the acquisition of RollingStreams adevelopment-stage company. RollingStreams designs streaming, end-to-end TVoIPsolutions for telecom operators and broadband service providers.

 

As of the dateof the acquisition, the Company had one project under development thatqualified for in-process research and development, MediaSwitch. MediaSwitch isan end-to-end solution designed for telecom operators and broadband serviceproviders to 

 

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deliver broadcast quality TVand on-demand entertainment services over Internet Protocol networks.

 

MediaSwitch isconsidered an IPR&D project because there are significant risks associatedwith the development of this technology. These risks include technological and commercial risks.  The technological risks stem from the factthat the technology is 70% complete. Therefore, there are significant risks associated with reaching thetechnological milestones on time and on budget.  Commercial risks are associated with the lack of marketacceptance for the TVoIP concept.

 

In addition to the technological and commercial risksstated above, significant additional costs will be required to complete theIPR&D project.  MediaSwitch isexpected to be commercialized in December 2003.  Remaining costs required to complete the project, are estimatedto be $4.6 million.  Remainingengineering tasks include the productization of the complete solution.  This involves adding new features andfunctionalities and stabilizing the software code.

 

On May 7, 2003, the Company completed the purchase of all of the assetsof Xebeo.  Xebeo develops and manufacturersoptical packet switches that enable telecommunications carriers to providesingle fiber, multi-service access to customers.

 

As of the date ofthe acquisition, the Xebeo was focusing its resources on the development of itsfirst product, MetroBridge, an optical packet switching solution, and wasconsidered in the development stage.

 

There aresignificant risks associated with the development of MetroBridge.  These risks include both technological andcommercial risks; therefore the development of MetroBridge is consideredIPR&D. The technological risks stem from the fact that the development ofMetroBridge requires highly complex software for product development andtesting.  The development of MetroBridgewas 60% complete as of the closing date. Technical flaws discovered in the remaining development period woulddelay the introduction of the product. Therefore there are significant risks associated with reaching thetechnological milestones on time and on budget.  The commercial risks are associated with the competitive natureof the telecommunications equipment market. Furthermore, the commercial success of MetroBridge is dependent upon thewillingness of telecom carriers to continue to invest in new equipment andcustomer acceptance of the new features offered by the product.

 

In addition to the technological and commercial risksstated above, significant additional costs are required to complete thedevelopment of MetroBridge, which is expected to be commercialized in November2003.  Remaining costs required tocomplete the project are estimated to be $4.6 million.

 

AMORTIZATIONOF INTANGIBLE ASSETS

 

Amortization of intangible assets was $1.5 million for the threemonths ended June 30, 2003 and $0.7 million for the three months endedJune 30, 2002. The increase in amortization expense was mainly due toadditional amortization of intangibles recorded upon our acquisition ofCommWorks in May 2003. We recorded intangibles of $20.1 million in connection with our acquisition of CommWorks based on apreliminary purchase price allocation. The estimated useful lives ofthese purchased intangibles are from one to five years.  Expected amortization expense for the nextfive years, beginning the year ended December 31, 2004, is $8.5 million, $5.5million, $3.9 million, $2.8 million and $0.9 million, respectively.

 

INTERESTINCOME (EXPENSE), NET

 

Net interest income (expense) was $(1.5) million for the threemonths ended June 30, 2003 and $1.0 million for the corresponding periodin 2002. The increase was primarily due to interest expense and amortization ofdebt issuance costs relating to $402.5 million of convertible subordinatednotes that we issued in March 2003.  Inaddition, there were lower balances in cash and cash equivalents on averageduring the three months ended June 30, 2003 as compared to 2002.

 

OTHER INCOME(EXPENSE), NET

 

Other income (expense), net was $0.2 million of income for the threemonths ended June 30, 2003 and $(1.7) million of income for the correspondingperiod in 2002. The current quarter’s other income (expense), net was primarilydue to a tax refund received in China of $2.6 million.

 

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EQUITY IN LOSSOF AFFILIATED COMPANIES

 

Consolidated equity in the net loss of affiliated companies was$1.7 million for the three months ended June 30, 2003 and$0.0 million for the corresponding period in 2002. The current quarter’sequity 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.

 

INCOME TAXEXPENSE

 

Income tax expense was $13.1 million for the three months endedJune 30, 2003 and $6.6 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 June 30, 2003 and 2002,respectively. The increase in our effective tax rate was due primarily to theexpiration of certain tax holidays in China and the fact that more of ourrevenue has become subject to higher tax rate jurisdictions as we expand ourbusiness globally. The future rate may vary due to a variety of factors,including, but not limited to, the relevant income contribution by domestic andforeign operations, changes in statutory tax rates, the amount of tax exemptinterest income generated during the year, the ability to utilize foreign taxcredits and non-deductible items relating to acquisitions, or othernon-recurring charges. We will continue to monitor the effective tax rate on aquarterly basis.

 

MINORITYINTEREST IN (EARNINGS) OF CONSOLIDATED SUBSIDIARIES

 

Minority interest in earnings of consolidated subsidiaries was$0.0 million for the three months ended June 30, 2003 and$0.6 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.

 

**SIX MONTHS ENDED JUNE30, 2003 AND JUNE 30, 2002**

 

NET INCOME

 

For the six months ended June 30, 2003, wereported net income of $76.8 million as compared to net income of$43.3 million for the six months ended June 30, 2002. Theincrease in net income was partly attributable to the higher growth in ourgross profit, which increased by 65%, as compared to the growth in operatingexpenses, which increased by 55%. We will continue to focus our efforts on theefficient management of our operating expenses, including continued costreduction, manufacturing efficiencies and the redesign of our products for ourPAS systems.

 

NET SALES

 

Our net sales increased 77% to$736.4 million for the six months ended June 30, 2003 from$415.2 million for the corresponding period in 2002. Sales oftelecommunications equipment for the six months ended June 30, 2003 were$409.3 million, an increase of $147.4 million or 56%, as compared tothe six months ended June 30, 2002. Sales of subscriber handsets for the sixmonths ended June 30, 2003 were $327.1 million, an increase of$173.8 million or 113%, as compared to the six months ended June 30, 2002.In particular, sales of PAS/iPAS equipment, AN-2000/IP-DSLAMequipment, PAS handsets and other products were $264.5 million, $141.0 million,$327.1 million and $3.8 million, respectively, and represented 36%, 19%, 44%and 1% of our net sales for the six months ended June 30, 2003, respectively.Sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment, PAS handsets and otherproducts were $187.1 million, $67.8 million, $153.3 million and $7.0 million,respectively, and represented 45%, 16%, 37% and 2% of our net sales for the sixmonths ended June 30, 2002, respectively. Our mSwitch products are includedwith our iPAS product offering. We do not expect the percentage of revenuesattributed to these products to change significantly in the near future.  In particular, we expect that, in 2003,sales of PAS/iPAS equipment, AN-2000/IP-DSLAM equipment and PAS handsets willrepresent approximately 35%, 20% and 45% of our net sales, respectively.

 

Sales of iPAS/PAS equipment and sales ofsubscriber handsets increased due to the continued growth in spending ontelecommunications infrastructure in China, which accounted for 82% and 84% ofour net sales for the six months ended June 30, 2003 and 2002, respectively.Sales of telecommunication equipment also increased due to a $69.0 millionincrease in international sales, primarily driven by the sale of equipment toSBBC in Japan to support its ADSL rollout. Sales in Japan for thesix months ended June 30, 2003 and 2002, accounted for 16% and 15% of our netsales, respectively. For the six months ended June 30, 2003, sales to SBBCaccounted for 16% of our net sales and no other customer accounted for 10% ormore of our consolidated net sales. For the six months ended June 30, 2002,sales to Zhejiang province and SBBC accounted for 25% and 14% of our net sales,respectively.

 

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GROSS PROFIT

 

Gross profit increased 65% to$250.2 million for the six months ended June 30, 2003 from$151.6 million for the corresponding period in 2002. Gross profit, as apercentage of net sales, was 34% for the six months ended June 30, 2003 ascompared to 37% for the six months ended June 30, 2002. The decrease in grossprofit, as a percentage of net sales, was primarily due to higher sales of ourlower margin handsets. Handset sales comprised 44% of sales for the six monthsended June 30, 2003 compared to 37% for the corresponding period in 2002.

 

SELLING, GENERAL AND ADMINISTRATIVE

 

Selling, general and administrative expenses increased 36% to$72.5 million for the six months ended June 30, 2003 from$53.2 million for the corresponding period in 2002. Selling, general andadministrative expenses as a percentage of net sales was 10% and 13% for thesix months ended June 30, 2003 and 2002, respectively. The increase in selling,general and administrative expenses in absolute dollars was primarily due toincreased sales and administrative personnel and related expenses, includingsales commissions, associated with the growth in net sales and the expansion ofour overall level of business activities. Selling and administrativeheadcount increased to 2,160 employees at June 30, 2003 as compared to 1,236employees at June 30, 2002. The decrease in selling, general and administrativeexpenses as a percentage of net sales was mainly due to significant cashcollections in China that reduced the requirement for allowance for doubtfuldebts as compared with previous periods. In addition, due to the SARS outbreakin China, our travel to Asia was curtailed for a number of months, with aresulting reduction in travel expenses. We expect our selling, general andadministrative expenses to increase in absolute dollar amounts and to return toour previous percentage of net sales level, in future periods as sales andmarketing activities increase and we incur additional expenses related to theanticipated growth of our business and operations.

 

RESEARCH AND DEVELOPMENT

 

Research and development expenses increased55% to $62.9 million for the six months ended June 30, 2003 from$40.6 million for the corresponding period in 2002. The increase inresearch and development expenses was primarily due to the hiring of additionaltechnical personnel, increased prototype expenses and licensing fees to supportour research and development efforts. Research and developmentheadcount increased to 1,924 employees at June 30, 2003 as compared to 1,159employees at June 30, 2002. As a percentageof net sales, research and development expenses were 9% and 10% for the sixmonths ended June 30, 2003 and 2002, respectively. We expect our research anddevelopment expenses to increase in absolute dollar amounts in future periodsas we expand our research and development organization to support new productdevelopment.

 

IN-PROCESSRESEARCH AND DEVELOPMENT COSTS

 

In-process research and development expense was $10.7 million forthe six months ended June 30, 2003, and $0.7 million for the correspondingperiod in 2002. The charge for the six months ended June 30, 2003, resultedfrom our acquisition of CommWorks, a former division of 3Com, and three smalleracquisitions: RollingStreams, Xebeo and Shanghai Yi Yun TelecomTechnology Co. Ltd., which accountedfor $1.3 million, $6.2 million, $1.9 million and $1.3 million, respectively,and were based on appraisals by an independent valuation specialist. The charge for the six months ended June 30, 2002arose from our acquisition of Issanni Communications, Inc. on April 19,2002 and was based on an appraisal by an independent valuationspecialist.

 

On May 23,2003, the Company completed its acquisition of CommWorks.  CommWorks develops and deployscarrier-class, IP-based multi-service access and service creation platforms fortelecommunications service providers.

 

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

 

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

 

There aresignificant risks associated with those technologies.  The technological risks stem from the fact that the newtechnologies are in an early stage of development.  As of the closing date, CommWork’s SLAP IPR&D project wasapproximately 60% complete and HDV 2.0 was approximately 40% complete.  Therefore there are significant risksassociated with reaching the technological 

 

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milestones on time and onbudget.  Commercial risks are associatedwith the competitive nature of the telecommunications equipment market.

 

In addition to the technological and commercial risksstated above, significant additional costs will be required to complete theIPR&D projects.  The SLAP product isexpected to be commercialized in September 2003.  Remaining costs required to complete the project, are estimatedto be $0.2 million.  The HDV 2.0 productis expected to be commercialized in December 2003.  Remaining costs required to complete the project, are estimatedto be $0.3 million.

 

On June 30, 2003, the Company completed the acquisition of RollingStreams a development-stage company.RollingStreams designs streaming, end-to-end TvoIP solutions for telecomoperators and broadband service providers.

 

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

 

MediaSwitch isconsidered an IPR&D project because there are significant risks associatedwith the development of this technology. These risks include technological and commercial risks.  The technological risks stem from the factthat the technology is 70% complete. Therefore, there are significant risks associated with reaching the technologicalmilestones on time and on budget. Commercial risks are associated with the lack of market acceptance forthe TVoIP concept.

 

In addition to the technological and commercial risksstated above, significant additional costs will be required to complete theIPR&D project.  MediaSwitch isexpected to be commercialized in December 2003.  Remaining costs required to complete the project, are estimatedto be $4.6 million.  Remainingengineering tasks include the productization of the complete solution.  This involves adding new features andfunctionalities and stabilizing the software code.

 

On May 7, 2003, the Company completed the purchase of all of the assetsof Xebeo.  Xebeo develops and manufacturersoptical packet switches that enable telecommunications carriers to providesingle fiber, multi-service access to customers.

 

As of the date ofthe acquisition, the Xebeo was focusing its resources on the development of itsfirst product, MetroBridge, an optical packet switching solution, and wasconsidered in the development stage.

 

There aresignificant risks associated with the development of MetroBridge.  These risks include both technological andcommercial risks; therefore the development of MetroBridge is consideredIPR&D. The technological risks stem from the fact that the development ofMetroBridge requires highly complex software for product development andtesting.  The development of MetroBridgewas 60% complete as of the closing date. Technical flaws discovered in the remaining development period woulddelay the introduction of the product. Therefore there are significant risks associated with reaching thetechnological milestones on time and on budget.  The commercial risks are associated with the competitive natureof the telecommunications equipment market. Furthermore, the commercial success of MetroBridge is dependent upon thewillingness of telecom carriers to continue to invest in new equipment andcustomer acceptance of the new features offered by the product.

 

In addition to the technological and commercial risksstated above, significant additional costs are required to complete thedevelopment of MetroBridge, which is expected to be commercialized in November2003.  Remaining costs required tocomplete the project are estimated to be $4.6 million.

 

Shanghai Yi Yun Telecom Technology Co. Ltd. is aprovider of synchronous digital hierarchy (“SDH”) equipment.   As of the date of the acquisition, Yi Yunhad two projects under development that qualified for in-process R&D, SDHtransport systems that multiplex and transport data.  The products are expected to be utilized by telecommunicationcarriers for deployment in regional, international, national, provincial andmetropolitan area backbone networks.

 

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There aresignificant risks associated with the development of these products.  These risks include both technological andcommercial risks.  The technologicalrisks stem from the fact that some of the new technologies are in an early stageof development.  Therefore there aresignificant risks associated with reaching the technological milestones on timeand on budget.  Commercial risks areassociated with the competitive nature of the telecommunications equipmentmarket.

 

In addition tothe technological and commercial risks stated above, significant additional costswill be required to complete the IPR&D projects.  The products are expected to be commercialized by December2003.  Remaining costs required tocomplete the projects, are estimated to be $0.7 million.

 

AMORTIZATION OF INTANGIBLE ASSETS

 

Amortization of intangible assets increasedto $2.2 million for the six months ended June 30, 2003 from $1.1 millionfor the corresponding period in 2002. The increase in amortization ofintangible assets was primarily due to additional intangibles recorded in connectionwith our acquisition of CommWorks. The estimated useful lives ofthese purchased intangibles are from one to five years.

 

INTEREST INCOME (EXPENSE), NET

 

Net interest expense was $(1.2) millionfor the six months ended June 30, 2003 and net interest income was$1.9 million for the corresponding period in 2002. Theincrease was primarily due to interest expense and amortization of debtissuance costs relating to $402.5 million of convertible subordinated notesthat we issued in March 2003.  Inaddition, there were lower balances in cash and cash equivalents on averageduring the six months ended June 30, 2003 as compared to 2002.

 

OTHER INCOME (EXPENSE) NET

 

Other income net was $4.3 million forthe six months ended June 30, 2003 and other expense net was $(1.6) million forthe corresponding period in 2002. The increase in other incomenet was primarily due to a reinvestment incentive payment received in China of$3.9 million and a tax refund received in China of $2.6 million.

 

EQUITY IN LOSS OF AFFILIATED COMPANIES

 

Consolidated equity in net loss of affiliatedcompanies was $2.7 million for the six months ended June 30, 2003 and$0.8 million for the corresponding period in 2002. Theequity loss for the six months ended June 30, 2003 was primarily due to our shareof losses relating to a joint venture agreement we entered into on July 5,2002 with Matsushita Communication Industrial Co., Ltd., and MatsushitaElectric Industrial Co., Ltd., to jointly design, develop, manufacture andsell telecommunication products. We have a 49% ownership interest in this jointventure company.

 

INCOME TAX EXPENSE

 

Income tax expense was $25.6 million forthe six months ended June 30, 2003 and $11.1 million for the correspondingperiod in 2002. The effective tax rate was 25% and 20% for the six months endedJune 30, 2003 and 2002, respectively. The increase in oureffective tax rate was due primarily to the expiration of certain tax holidaysin China and the fact that more of our revenue has become subject to higher taxrate jurisdictions as we expand our business globally. The future rate may varydue to a variety of factors, including, but not limited to, the relevant incomecontribution by domestic and foreign operations, changes in statutory taxrates, the amount of tax exempt interest income generated during the year, theability to utilize foreign tax credits and non-deductible items relating toacquisitions, or other non-recurring charges. We will continue to monitor theeffective tax rate on a quarterly basis.

 

MINORITY INTEREST IN (EARNINGS) OFCONSOLIDATED SUBSIDIARIES

 

Minority interest in earnings of consolidatedsubsidiaries was $0.0 million for the six months ended June 30, 2003 and$1.2 million for the corresponding period in 2002. The decrease is due tothe acquisition of the remaining 12% ownership interest in HUTS during the sixmonths ended June 30, 2002. HUTS is now a wholly-owned subsidiary.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

At June 30,2003, we had lines of credit totaling $523.8 million available for future borrowings.  We have not guaranteed any debt not includedin the consolidated balance sheet. At June 30, 2003, we had working capital of$779.6 million, including $276.0 million in cash and cash equivalents and $5.3million of short-term investments.

 

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Net cash usedin operations for the six months ended June 30, 2003 of $155.9 million wasprimarily due to an increase in inventories, accounts receivable and othercurrent and non-current assets of $659.9 million, $42.3 million and $122.7million, respectively, as well as a decrease in taxes payable of $8.1million.  This was partially offset bynet income of $76.8 million, adjusted for non-cash charges including depreciationand amortization expense of $17.7 million, in-process research and developmentcosts of $10.6 million, amortization of deferred stock compensation expense of$3.1 million, non-qualified stock option exercise tax benefits of $8.2 million,as well as growth in accounts payable of $165.6 million, other accruedliabilities of $26.5 million, and deferred revenue of $371.4 million. Net cashprovided by operations for the six months ended June 30, 2002 of $66.9 millionwas primarily due to net income of $43.3 million, adjusted for depreciation andamortization expense of $10.1 million, amortization of deferred stockcompensation expense of $1.9 million, non-qualified stock option exercise taxbenefits of $3.0 million, inventory reserve of $7.9 million, allowance fordoubtful accounts of $7.0 million an increase in accounts payable of $45.3million, deferred revenue of $22.1 million, income taxes payable of $4.7million, other current and non-current assets of $9.7 million, and a long-terminvestment impairment charge of $1.1 million. This was offset by an increase ininventories and accounts receivable of $48.1 million and $42.9 million,respectively.

 

Net cash usedin investing activities for the six months ended June 30, 2003 of $182.4million was primarily due to repurchase of shares from Softbank of $139.6million, business acquisitions of $109.5 million, purchases of property, plantand equipment of $41.2 million, allocations to restricted cash of $4.0 millionand investment in affiliates of $1.0 million, offset by net sales of short-terminvestments of $113.0 million. Net cash used in investing activities for thesix months ended June 30, 2002 of $37.6 million was primarily due to purchasesof plant, property and equipment of $21.6 million, business acquisitions of$17.7 million, allocations to restricted cash of $13.9 million and investmentin affiliates of $6.0 million, offset by net sales of short-term investments of$21.4 million.

 

Net cash providedby financing activities for the six months ended June 30, 2003 of $382.6million was primarily due to the offering of convertible subordinated noteswith net proceeds of $391.4 million and proceeds from the exercise of stockoptions of $35.0 million, offset by purchases of call options for $43.8million. Net cash used by financing activities for the six months ended June30, 2002 of $12.0 million was primarily due to net payments of $47.8 million onborrowings under our lines of credit. This was offset by $35.7 million inproceeds from the sale of common stock in connection with the Softbank resaleand the issuance of common stock through the exercise of stock options.

 

On May 23, 2003, we completed the acquisition from 3Com Corporation, aDelaware corporation, (“3Com”) of selected assets and liabilities from 3Com’sCommWorks division (“CommWorks”). We paid $100 million in cash, relatedtransaction costs of $4.6 million and related transition costs of $4.7 million,such consideration was determined through negotiations between the Company and3Com.  We funded the consideration for the acquisition from cash on hand.

 

We completedan offering on March 12, 2003 of $402.5 million of convertible subordinatednotes due in 2008 to qualified buyers pursuant to Rule 144A under theSecurities Act of 1933. We used $43.8 million of the net proceeds in the secondquarter 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 used $139.6 million ofthe net proceeds in the second quarter to repurchase 8.0 million of our sharesof common stock beneficially owned by SOFTBANK America, Inc., pursuant to anagreement we entered into on March 7, 2003. On May 23, 2003, the Companycompleted its acquisition from 3Com Corporation, a Delaware corporation,(“3Com”) of selected assets and liabilities from 3Com’s CommWorks division(“CommWorks”). The Company paid $100.0 million in cash and incurred relatedtransaction and other related costs of $9.3 million.

 

In 2001, wepurchased the rights to use 49 acres of land located in Zhejiang Science andTechnology Industry Garden of Hangzhou Hi-tech Industry Development Zone. As ofJune 30, 2003, we had completed the foundation and groundwork of a facility tobe located there and have commenced construction of the building, which includesthe infrastructure and outer-wall construction. We expect that construction ofthe new facility will be completed in early 2004 at a projected cost ofapproximately $95.6 million. We revised the expected completion date ofthat facility from late 2003 to early 2004, due to a slow down in constructionduring the first quarter of fiscal 2003resulting from the SARS outbreak andinclement weather. Capital expenditures for the facility were$38.6 million in 2002 and $8.0 million and $12.5 million in the threeand six months ended June 30, 2003, respectively.

 

Our principal commitments at June 30, 2003 consist of obligations underoperating leases and a commitment to invest up to an additional$3.0 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 June 30,2003.

 

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 

 

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cannotguarantee that fluctuations in currency exchange rates in the future will nothave a material adverse effect on revenues from international sales and,correspondingly, on our business, financial condition and results ofoperations. We have contracts negotiated in Japanese Yen and a multi-currencybank account in Japanese Yen for purchasing portions of our inventories andsupplies. The balance of this Japanese Yen account as of June 30, 2003 wasapproximately $14.3 million. As of June 30, 2003 and December 31, 2002, we werenot engaged in any hedging activities and did not hold any derivative financialinstruments in respect of these Japanese Yen purchases.

 

We believe that our existing cash and cash equivalents, short-terminvestments and cash from operations will be sufficient to finance ouroperations through at least the next 12 months. As of June 30, 2003, wehad cash, restricted cash and investments, of $291.2 million and lines ofcredit totaling $523.8 million available for future borrowings. $140.1 millionof these facilities expire in 2003 and $383.7 million of these facilitiesexpire between 2004 and 2010. However, in the event that our current cashbalances, anticipated future cash flows from operations and current lines ofcredit are not sufficient to meet our obligations or strategic needs or in theevent that market conditions are favorable, we would consider raisingadditional funds in the capital or equity markets. If additional financing isneeded, there can be no assurance that such financing will be available to uson commercially reasonable terms, or at all.

 

**CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIALCOMMITMENTS**

 

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):

 
|                            |   | **June 30,  2003**          |    |
|---------------------------------|--------|-----------------------------|---------|
|                            |   | **Payments  Due by Period** |    |
|                            |   | **Total**                   |    | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   |
| *Contractual  Obligations*      |   |                        |    |   |   |   |   |   |   |
| Convertible subordinated  notes |   | $                           | 402,500 |   | $ | — |   | $ | — |   | $ | 402,500 |   |
| Operating leases                |   | $                           | 19,076  |   | $ | 7,478 |   | $ | 10,952 |   | $ | 646 |   |
| *Other  Commercial Commitments* |   |                        |    |   |   |   |   |   |   |
| Standby letters of credit       |   | $                           | 9,910   |   | $ | 9,504 |   | $ | 406 |   | $ | — |   |

 

Certain sales contracts include provisions under which customers wouldbe indemnified by us in the event of, among other things, a third-party claimagainst the customer for intellectual property rights infringement related toour products. There are no limitations on the maximum potential future paymentsunder these guarantees. We have not accrued any amounts in relation to theseprovisions as no such claims have been made and we believes we have valid,enforceable rights to the intellectual property embedded in our products.

 

We issue standby letters of credit primarily to support ourinternational sales activities outside of China. When we submit a bid for aninternational tender offer, oftentimes, the written “Request For Proposal” fromthe potential customer will include a requirement that we issue a bidbond/standby letter of credit to demonstrate our commitment through the bidprocess.  In addition, depending on thecontract, we may be required to issue standby letters of credit as guaranteesfor advance customer payments upon contract signing or performance guaranteesto protect customers from potential product delivery issues or performanceproblems. The standby letters of credit usually expire six to nine months fromdate of issuance without being drawn by the beneficiary thereof.

 

**RECENT ACCOUNTING 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 do notexpect that the adoption of EITF No. 00-21 will have a significant impacton our consolidated results of operations and financial position.

 

In January2003, the Financial Accounting Standards Board issued Interpretation No. 46,“Consolidation of Variable Interest Entities,” (“FIN 46”). FIN 46 providesaccounting guidance for consolidation of variable interest entities (“VIE”),formerly referred to 

 

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as special purpose entities.FIN 46 applies to public and private business enterprises that have acontrolling interest or business or contractual relationship with a VIE. FIN 46requires consolidation of existing non controlled affiliates if the VIE isunable to finance its operations without investor support, or where the otherinvestors do not have exposure to the significant risks and rewards ofownership. We expect this could require consolidation of one of ournon-controlled affiliates under FIN 46, which is effective for us at thebeginning of the interim period that starts July 1, 2003. We have a 90%ownership interest in UTStarcom (Chongqing) Co., Ltd. (“CUTS”), an affiliateincorporated in China that assembles and manufactures handsets for our PersonalAccess System, or PAS, product line. We do not have control of the votingrights of CUTS; however, we are the primary beneficiary. Therefore, thisaffiliate would be considered a VIE under FIN 46. We 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 and six months ended June 30, 2003 were not material to ourresults of operations.  The maximumexposure to loss assuming there is no further investment is $4.5 million atJune 30, 2003. The Company has not yet determined the impact of adopting FIN 46on its consolidated financial statements.

 

In April 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 149, “Amendment of Statement 133 on DerivativeInstruments and Hedging Activities”(“SFAS 149”).  This statement amends SFAS 133 to provide clarification on thefinancial accounting and reporting of derivative instruments and hedgingactivities. We do not expect the adoption of SFAS No. 149, which will beeffective for contracts entered into or modified after June 30, 2003, to have amaterial effect on our financial condition or results of operations.

 

In May 2003,the Financial Accounting Standards Board issued Statement of FinancialAccounting Standards No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity” (“SFAS 150”). SFAS 150establishes standards for how an issuer classifies and measures certainfinancial instruments with characteristics of both liabilities and equity. Itrequires that an issuer classify a financial instrument that is within itsscope as a liability (or an asset in some circumstances). Many of theseinstruments were previously classified as equity. The guidance in SFAS 150 isgenerally effective for all financial instruments entered into or modifiedafter May 31, 2003, and otherwise is effective at the beginning of the firstinterim period beginning after June 15, 2003. As the Company does not have anyof these financial instruments, the adoption of FAS 150 is not expected to haveany impact on the Company’s consolidated financial statements.

 

**RISKS RELATED TO OUR COMPANY**

 

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

 

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

 

Factors thatmay affect our future operating results include:

 

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

 

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

 

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

 

•                  price reductionsby our competitors;

 

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

 

•                  changes in ourcustomers’ subscriber growth rate;

 

•                  currencyfluctuations;

 

•                  marketacceptance of our products and product enhancements;

 

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

 

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

 

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

 

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

 

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

 

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

 

We areincreasingly facing intense competition in our target markets, especially fromdomestic companies in China. We believe that our strongest competition in thefuture may come from these companies, many of which operate under lower coststructures and more favorable governmental policies and have much larger salesforces than we do. Furthermore, other companies not presently offeringcompeting products may also enter our target markets, particularly with thereduction of trade restrictions as a result of China’s admission to the WorldTrade Organization, or WTO. Many of our competitors have significantly greaterfinancial, technical, product development, sales, marketing and other resourcesthan we do. As a result, our competitors may be able to respond more quickly tonew or emerging technologies and changes in service provider requirements. Ourcompetitors may also be able to devote greater resources than we can to thedevelopment, promotion and sale of new products. These competitors may also beable to offer significant financing arrangements to service providers, in somecases facilitated by government policies, which is a competitive advantage inselling systems to service providers with limited financial and currencyresources. Increased competition is likely to result in price reductions,reduced gross profit as a percentage of net sales and loss of market share, anyone of which could materially harm our business, financial condition andresults of operations.

 

Moreover,current and potential competitors have established or may establish cooperativerelationships among themselves or with third parties, including TelecommunicationsAdministrations, Telecommunications Bureaus and other local organizations, toincrease the ability of their products to address the needs of prospectivecustomers in our target markets. Accordingly, alliances among competitors orbetween competitors and third parties may emerge and rapidly acquiresignificant market share. To remain competitive, we believe that we mustcontinue to partner with Telecommunications Administrations and other localorganizations, maintain a high level of investment in research and developmentand in sales and marketing, and manufacture and deliver products to serviceproviders on a timely basis and without significant defects. If we fail to meetany of these objectives, our business, financial condition and results of operationscould be harmed.

 

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

 

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

 

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

 

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

 

In May 2003, wecompleted our acquisition of certain assets of 3Com Corporation’s CommWorksdivision (“CommWorks”). However, our management and financial controls,personnel, computer systems and other corporate support systems may not beadequate to manage the increase in the size and scope of our operations as aresult of the completed acquisition. In addition, we may not be able togenerate revenue from the CommWorks operations consistent with historicalresults. We may not be able to realize the synergies that we expect will resultfrom the addition of the CommWorks assets to our business. Although ouracquisition of CommWorks is structured as the acquisition of selected assetsand liabilities, we cannot assure you that we will not assume or become subjectto, as a result of the acquisition, liabilities that have an adverse impact onour financial position or results of operations. We also expect that CommWorkswill need a significant working capital investment from us and/or an availabledebt facility. If additional financing is needed to fund the CommWorksoperations, we cannot assure you that such financing will be available to us oncommercially reasonable terms, or at all.

 

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

 

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

 

The emergingmarket for communications equipment in developing countries is characterized byrapid technological developments, frequent new product introductions andevolving industry and regulatory standards. Our success will depend in largepart on our ability to enhance our network access and switching technologiesand develop and introduce new products and product enhancements that anticipatechanging service provider requirements and technological developments. We mayneed to make substantial capital expenditures and incur significant researchand development costs to develop and introduce new products and enhancements.If we fail to timely develop and introduce new products or enhancements to existingproducts that effectively respond to technological change, our business,financial condition and results of operations could be materially adverselyaffected. From time to time, our competitors or we may announce new products orproduct enhancements, technologies or services that have the potential toreplace or shorten the life cycles of our products and that may cause customersto defer purchasing our existing products, resulting in inventory obsolescence.Future technological advances in the communications industry may diminish orinhibit market acceptance of our existing or future products or render ourproducts obsolete.

 

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

 

•                       our abilityto obtain necessary approvals from regulatory organizations;

 

•                       theperceived advantages of the new products over competing products;

 

•                       our abilityto attract customers who have existing relationships with our competitors;

 

•                       productcost relative to performance; and

 

•                       the levelof customer service available to support new products.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

In particular,components of our PAS system include the handset used by subscribers to make andreceive mobile telephone calls and the base station unit. Our inability toobtain a sufficient number of high quality components and assemblies forhandsets and base stations could severely harm our business. From time to time,there has been a worldwide shortage of handsets, and there currently exists ashortage of low-priced handsets, which we have found to be popular with manyconsumers in China. We have only used third parties to assemble and manufacturehandsets in China for us for a limited period of time. These manufacturers maybe unable to produce adequate quantities of high-quality handsets to meet thedemand of our customers. In addition, we may be unable to obtain adequatequantities of base stations and may be unable to find alternative sources onfavorable terms, in a timely manner, or at all. Our inability to obtain or todevelop alternative sources if and as required could result in delays orreductions in manufacturing or product shipments.

 

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

 

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

 

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

 

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

 

•                  increasedcompetition;

 

•                  aggressive pricereductions by competitors; and

 

•                  rapidtechnological change.

 

We anticipatethat average selling prices of our products will decrease in the future inresponse to product introductions by us or 

 

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our competitors or otherfactors, including price pressures from customers. Therefore, we must continueto develop and introduce new products and enhancements to existing productsthat incorporate features that can be sold at higher average selling prices.Failure to do so could cause our revenues and gross profit, as a percentage ofnet sales, to decline.

 

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

 

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

 

Our grossprofit, as a percentage of net sales, varies among our product groups. Ourgross profit, as a percentage of net sales, is generally higher on our accessnetwork system products and is lower on our handsets. We also anticipate thatthe gross profit, as a percentage of net sales, may be lower for our newlydeveloped products due to start-up costs and may improve as unit volumesincrease and efficiencies can be realized. Our overall gross profit, as apercentage of net sales, has fluctuated from period to period as a result ofshifts in product mix, the introduction of new products, decreases in averageselling prices for older products and our ability to reduce manufacturingcosts.

 

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

 

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

 

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

 

We market and sellour products in China and other markets, including Taiwan, Japan, Vietnam,India and Latin America. The expansion of our existing multi-nationaloperations and entry into additional international markets will requiresignificant management attention and financial resources. Multi-nationaloperations are subject to inherent risks, including:

 

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

 

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

 

•                  unexpectedchanges in regulatory requirements or the regulatory environment;

 

•                  changes ingovernmental control or influence over our customers;

 

•                  changes toimport and export regulations, including quotas, tariffs and other tradebarriers;

 

•                  delays ordifficulties in obtaining export and import licenses;

 

•                  potentialforeign exchange controls and repatriation controls on foreign earnings;

 

•                  exchange ratefluctuations and currency conversion restrictions;

 

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

 

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

 

•                  reducedprotection for intellectual property rights in some countries;

 

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•                  potentiallyadverse tax consequences; and

 

•                  political andeconomic instability.

 

Multi-nationalcompanies are required to establish intercompany pricing for transactionsbetween their separate legal entities operating in different taxingjurisdictions. These intercompany transactions are subject to audit by taxingauthorities in the jurisdictions in which multi-national companies operate. Anadditional tax liability may be incurred if it is determined that intercompanypricing was not done at arm’s length. We believe we have adequately estimatedand recorded our liability arising from intercompany pricing, but an additionaltax liability may result from audits of our intercompany pricing policies.

 

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

 

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

 

Due to themulti-national nature of our business and operations, we are subject toregulation in multiple governmental jurisdictions. Furthermore, as a result ofthe heavily regulated nature of the markets in which we operate, we arecontinually subject to the risk of governmental investigations regarding ourcompliance 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.

 

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

 

We are exposedto foreign exchange rate risk because our sales to China are denominated inRenminbi and portions of our accounts payable are denominated in Japanese Yen.Due to the limitations on converting Renminbi, we are limited in our ability toengage in currency hedging activities in China. Although the impact of currencyfluctuations of Renminbi to date has been insignificant, fluctuations incurrency exchange rates in the future may have a material adverse effect on ourresults of operations.

 

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

 

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

 

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

 

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

 

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

 

•                  enhancingmanagement information systems and forecasting procedures;

 

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

 

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

 

•                  expanding,training and managing our employee base; and

 

•                  expanding ourfinance, administrative and operations staff.

 

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

 

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

 

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

 

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

 

To effectivelymanage our recent growth as well as any future growth, we will need to recruit,train, assimilate, motivate and retain qualified employees. Competition forqualified employees is intense, and the process of recruiting personnel withthe combination of skills and attributes required to execute our businessstrategy can be difficult, time-consuming and expensive. We are activelysearching for research and development engineers and sales and marketingpersonnel, who are in short supply. Additionally, we have a need for and haveexperienced difficulty in finding qualified accounting personnel knowledgeablein U.S. and China accounting standards who are resident in China. If we fail toattract, hire, assimilate or retain qualified personnel, our business would beharmed.

 

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

 

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

 

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

 

**Wemay be unable to adequately protect our intellectual property, which couldsubstantially harm our business.**

 

We rely on acombination 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 

 

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subsidiaries and joint venturesin China rely upon our trademarks, technology and know-how to manufacture andsell our products. We cannot guarantee that these and other intellectualproperty protection measures will be sufficient to prevent misappropriation ofour technology or that our competitors will not independently developtechnologies that are substantially equivalent or superior to ours. Inaddition, the legal systems of many foreign countries, including China, do notprotect intellectual property rights to the same extent as the legal system ofthe United States.

 

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

 

The industryin which we compete is moving towards aggressive assertion, licensing, andlitigation of patents and other intellectual property rights. From time totime, we have become aware of the possibility or have been notified that we maybe infringing certain patents or other intellectual property rights of others.Regardless of their merit, responding to such claims could be time consuming,divert management’s attention and resources and cause us to incur significantexpenses. In addition, although some of our supplier contracts provide forindemnification from the supplier with respect to losses or expenses incurredin connection with any infringement claim, some of our contracts do not providefor such protection. Therefore, we may incur substantial costs related to anyinfringement claim, which may substantially harm our results of operations orfinancial condition.

 

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

 

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

 

**Businessinterruptions could adversely affect our business.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

We, andvarious underwriters for our initial public offering are defendants in aputative shareholder class action. The complaint alleges undisclosed improperunderwriting practices concerning the allocation of IPO shares, in violation ofthe federal securities laws. Similar complaints have been filed concerning theIPOs of more than 300 companies, and the litigation has been coordinated infederal 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. A proposal has been made for thesettlement and release of claims against the issuer defendants, includingUTStarcom. The settlement is subject to a number of conditions, including approvalof the proposed settling parties and the court. If the settlement does notoccur, and litigation against UTStarcom continues, UTStarcom believes it hasmeritorious defenses and intends to defend the case vigorously.

 

**RISKS RELATING TO THE STRUCTURE ANDREGULATION OF**

**CHINA’S TELECOMMUNICATIONS INDUSTRY**

 

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

 

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

 

At the end ofMay 2000, we became aware of an internal notice, circulated within theMinistry of Information Industry, announcing a review of PHS-basedtelecommunications equipment for future installation into China’stelecommunications infrastructure. The Ministry of Information Industry requestedservice 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.

 

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

 

China does notyet have a national telecommunications law. However, to provide a uniformregulatory framework for the telecommunication industry, the Chinese governmentis currently preparing a draft of such a law (the “Telecommunication Law”). Ifand when the Telecommunication Law is adopted by the National People’s Congressor its standing committee, it is expected to provide a new regulatory frameworkfor telecommunications regulation in China. We do not yet know the final natureor scope of the regulation that would be created if the Telecommunications Lawis passed. Accordingly, we cannot predict whether it will have a positive ornegative effect on us or on some or all aspects of our business.

 

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

 

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the appropriate regulatoryagencies, which could subject us to penalties that adversely affect ourbusiness.

 

**Ourbusiness may suffer as a result of the recent restructuring of China Telecom.**

 

InFebruary 1999, China’s State Council approved a restructuring plan for theChina Telecom system, under which the telecommunications operations of theChina Telecom system were separated along four business lines: fixed line,mobile, paging and satellite communications services. Following theannouncement, we observed a reduction in orders from our main customers inChina, the local telecommunications companies (the “TelecommunicationsCompanies”), which we attributed to the uncertainties surrounding therestructuring and the ultimate impact the restructuring would have on theTelecommunications Companies.

 

Effective inMay 2002, China Telecom was split into two entities by region, northernand southern. The 10 northern provinces, municipalities and autonomous regionsof China Telecom were merged with China Netcom Co. Ltd. and China JitongNetwork Communications Co. Ltd. to form a new company known as ChinaNetcom (“China Netcom”). The remaining 21 provinces, municipalities andautonomous regions now constitute the southern entity, and have kept the nameof China Telecom (the “New China Telecom”). China Netcom inherited 30% of theold China Telecom’s national backbone network, with the rest going to the NewChina Telecom. As this change is very recent, we cannot be certain what impactthe restructuring of China Telecom will have on our business operations.However, we may experience another decline in orders and related revenues similarto that which we experienced following the 1999 restructuring, resulting fromuncertainty among our Telecommunications Company customers associated with therestructuring. Additionally, China Telecom completed its initial publicoffering in November 2002, and is now publicly listed on the New YorkStock Exchange. Moreover, following any restructuring, China Netcom, the NewChina Telecom or any other entity that may replace it as a result of anysubsequent restructuring may restrict or prohibit the sales of our products,which could cause substantial harm to our business.

 

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

 

Under China’scurrent regulatory structure, the communications products that we offer inChina must meet government and industry standards, and a network access licensefor the equipment must be obtained. Without the license, the equipment is notallowed to be connected to public telecommunications networks or sold in China.Moreover, we must ensure that the quality of the telecommunications equipmentfor which we have obtained a network access license is stable and reliable, andmay not lower the quality or performance of other installed licensed products.China’s State Council’s product quality supervision department, in concert withChina’s Ministry of Information Industry, performs spot checks to track andsupervise the quality of licensed telecommunications equipment and publishesthe results of such spot checks.

 

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

 

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

 

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

 

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

 

Our maincustomers in China are the local Telecommunications Companies (formerly knownas Telecommunications Bureaus), which historically operated under ChinaTelecom, China’s state-owned fixed line operator, and were subject to itsultimate control. Following the recent restructuring of China Telecom, theTelecommunications Companies now operate under the ultimate control of eitherthe New China Telecom or China Netcom. China Telecom completed its initialpublic offering in November 2002, and is listed on the New York StockExchange. Policy statements may be issued and decisions may be made by NewChina Telecom and China Netcom, which govern the equipment purchasing decisionsof most of our customers in China. For example, in late 1999, China Telecomprohibited all Telecommunications Companies from purchasing PHS systems, suchas our PAS systems, for implementation in large cities, even before these saleswere prohibited by China’s Ministry of Information Industry. As most of oursales are generated from our operations in China, any decisions by the NewChina Telecom or China Netcom restricting or prohibiting the sales ordeployment 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 havehistorically considered local telecommunications service providers servingmunicipalities and counties to be our primary customers in China. Recently,however, the provincial-level telecommunications service entity in the Zhejiangprovince of China has begun to consolidate telecommunications purchasingdecisions for that province. As a result of this trend in the Zhejiangprovince, we have grouped all telecommunications service entities in Zhejiangprovince together and have treated these as one customer for the three and sixmonths ended June 30, 2003 and the comparative periods presented. For the three months ended June 30, 2003, sales toSoftbank BB Corporation (“SBBC”) and Zhejiang province accounted for 15% and11% of our net sales, respectively. For the three months ended June 30, 2002,sales to Zhejiang province and SBBC accounted for 26% and 20% of our net sales,respectively. For the six months ended June 30, 2003, sales to SBBCaccounted for 16% of our net sales and no other customer accounted for 10% ormore of our consolidated net sales. For the six months ended June 30, 2002,sales to Zhejiang province and SBBC accounted for 25% and 14% of our net sales,respectively. At June 30, 2003, we have approximately 12 telecommunicationsservice entities in Zhejiang province.

 

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

 

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

 

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

 

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**Changesin telecommunications rates or pricing policies may result in decreased demand forour products.**

 

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

 

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

 

The officialtariffs and per-minute usage rates charged to mobile users in China aregenerally set by the Ministry of Information Industry and the National Developmentand Reform Commission, and are usually adhered to by mobile operators. However,from time to time, certain mobile operators such as China Mobile and ChinaUnicom have offered special promotional pricing or incentives to customers,such as free incoming calls or free mobile-to-mobile calls. The continued useof such incentive programs by mobile operators may adversely impact thecompetitiveness and pricing of our PAS Systems and related products and theirrollout by New China Telecom and China Netcom. Such incentive programs maycontinue or be expanded in the future. We cannot be certain as to what impactsuch incentive programs may have on our financial condition. However, it ispossible that the continuation or expansion of such programs may have amaterial adverse effect on our business or results of operations.

 

**RISKS RELATING TO CONDUCTING OPERATIONS INCHINA**

 

**Salesin China 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$332.5 million, or 81.9% and $182.1 million or 78.7%, of our netsales in the three months ending June 30, 2003 and 2002, respectively, andapproximately $601.5 million, or 81.7% and $349.3 million or 84.1%, of ournet sales in the six months ending June 30, 2003 and 2002, respectively,occurred in China. Additionally, a substantial portion of our fixed assets islocated in China. Of our total fixed assets, approximately 76.3% and 87.8%, asof June 30, 2003 and December 31, 2002, respectively, were in China. Weexpect to make further investments in China in the future. Therefore, ourbusiness, financial condition and results of operations are to a significant degreesubject to economic, political, social and other events in China.

 

**Devaluationin the value of the Renminbi and fluctuations in exchange rates could adverselyaffect our financial results.**

 

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

 

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

 

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

 

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

 

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

 

China’sgovernment and its agencies, including China’s Ministry of Information Industryand China’s State Council, regulate foreign investment in thetelecommunications industry through the promulgation of various laws andregulations and the issuance of various administrative orders and decisions.Currently, foreign investors may engage in such activities only in accordancewith certain ownership and geographic limitations. China may promulgate newlaws or regulations, or issue administrative or judicial decisions orinterpretations, which would further restrict 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 continue reforming its economicand political systems. These reforms have resulted in and are expected tocontinue to result in significant economic and social development in China.Many of the reforms are unprecedented or experimental and may be subject tochange or readjustment due to a number of political, economic and socialfactors. We believe that the basic principles underlying the political andeconomic reforms will continue to be implemented and provide the framework forChina’s political and economic system. New reforms or the readjustment ofpreviously implemented reforms could have a significant negative effect on ouroperations. Changes in China’s political, economic and social conditions andgovernmental policies, which could have a substantial impact on our business,include:

 

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

 

•                  the introductionof measures to control inflation or stimulate growth;

 

•                  changes in therate or method of taxation;

 

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

 

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

 

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

 

The economy ofChina differs from the economies of most countries belonging to theOrganization for Economic Cooperation and Development in various respects suchas structure, government involvement, level of development, growth rate,capital reinvestment, allocation of resources, self-sufficiency, rate ofinflation and balance of payments position. In the past, the economy of

 

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China has been primarily aplanned economy subject to one- and five-year state plans adopted by centralgovernment authorities and largely implemented by provincial and localauthorities, which set production and development targets.

 

Since 1978,increasing emphasis had been placed on decentralization and the utilization ofmarket forces in the development of China’s economy. Economic reform measuresadopted by China’s government may be inconsistent or ineffectual, and we maynot in all cases be able to capitalize on any reforms. Further, these measuresmay be adjusted or modified in ways, which could result in economic liberalizationmeasures that are inconsistent from time to time or from industry to industryor across different regions of the country. China’s economy has experiencedsignificant growth in the past decade. This growth, however, has beenaccompanied by imbalances in China’s economy and has resulted in significantfluctuations in general price levels, including periods of inflation. China’sgovernment has implemented policies from time to time to increase or restrainthe rate of economic growth, control periods of inflation or otherwise regulateeconomic expansion. While we may be able to benefit from the effects of some ofthese policies, these policies and other measures taken by China’s governmentto regulate the economy could also have a significant negative impact oneconomic conditions in China with a resulting negative impact on our business.

 

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

 

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

 

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

 

Oursubsidiaries and joint ventures located in China enjoy tax benefits in Chinawhich are generally available to foreign investment enterprises, including fullexemption from national enterprise income tax for two years starting from thefirst profit-making year and/or a 50% reduction in national income tax rate forthe following three years. In addition, local enterprise income tax is oftenwaived or reduced during this tax holiday/incentive period. Under currentregulations in China, foreign investment enterprises that have been accreditedas technologically advanced enterprises are entitled to additional tax incentives.These tax incentives vary in different locales and could include preferentialnational enterprise income tax treatment at 50% of the usual rates fordifferent periods of time. All of our active subsidiaries in China wereaccredited as technologically advanced enterprises. The tax holidays applicableto our wholly-owned subsidiaries, UTStarcom China and HUTS, which togetheraccounted for approximately 53.9% of our revenues in the six months ended June30, 2003, expired at the end of 2002 and 2001, respectively. The tax holidayswere not extended for the entities, and for 2003, the national enterprise taxrates were increased from 7.5% to 15% and from 10% to 15%, respectively, whichcould negatively impact our financial condition and results of operations.During the fourth 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 of“unified” corporate income tax that would phase out, over time, thepreferential tax treatment to which foreign investment enterprises, such asUTStarcom, are currently entitled. While it is not certain whether thegovernment will implement such a unified tax structure or whether, ifimplemented, UTStarcom will be grandfathered into the new tax structure, if thenew tax structure is implemented, it will adversely affect our financialcondition.

 

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

 

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

 

China hasadopted a broad range of related laws, administrative rules and regulationsthat govern the conduct and operations of foreign investment enterprises andrestrict the ability of foreign companies to conduct business in China. Theselaws, rules and regulations provide some incentives to encourage the flow ofinvestment into China, but also subject foreign companies, and foreigninvestment enterprises, including our subsidiaries in China, to a set ofrestrictions that may not always apply to domestic companies in China. As aresult of its admission into the WTO, China is increasingly according foreigncompanies and foreign investment

 

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enterprises established inChina the same rights and privileges as Chinese domestic companies. Thesespecial laws, administrative rules and regulations governing foreign companiesand foreign investment 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.**

 

In 2001, wepurchased the rights to use 49 acres of land located in Zhejiang Science andTechnology Industry Garden of Hangzhou Hi-tech Industry Development Zone. As ofJune 30, 2003, we have completed the foundation and groundwork of a facility tobe located there and have commenced construction of the building, whichincludes the infrastructure and outer-wall construction. We expect thatconstruction of the new facility will be completed in early 2004 at a projectedcost of approximately $95.6 million. We revised the expected completiondate of that facility from late 2003 to early 2004, due to a slow down inconstruction during the first quarter of fiscal 2003 resulting from the SARSoutbreak and inclement weather. Capital expenditures for the facility were$38.6 million in 2002 and $8.0 million and $12.5 million in the threeand six months ended June 30, 2003, respectively. If we are unable to completethe construction on a timely basis our business may be harmed.

 

**RISKS RELATING TO OUR STOCK PERFORMANCE AND**

**CONVERTIBLE DEBT SECURITIES**

 

On March 12,2003 we sold $402.5 million of convertible subordinated notes (referred to as“the notes” in the following risk factors) due in 2008 to qualifiedinstitutional buyers pursuant to Rule 144A under the Securities Act of 1933, asamended. The notes bear interest at a rate of 0.875 percent per annum, areconvertible into UTStarcom common stock at a conversion price of $23.79 pershare and are subordinated to all present and future senior debt of UTStarcom.Holders of the notes may convert their notes only if: (i) the price of ourcommon stock issuable upon conversion of a note reaches a specified threshold,(ii) specified corporate transactions occur, or (iii) the trading price for thenotes falls below certain thresholds. At the initial conversion price, each$1,000 principal amount of notes will be convertible into approximately 42.0345shares of our common stock.

 

**Ourstock price is highly volatile.**

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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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.**

 

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

 

•                  election andremoval of directors;

 

•                  merger orconsolidation of our company; and

 

•                  sale of all orsubstantially all of our assets.

 

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

 

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

 

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

 

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

 

•                  authorizing theboard of directors to issue additional preferred stock;

 

•                  prohibitingcumulative voting in the election of directors;

 

•                  limiting thepersons who may call special meetings of stockholders;

 

•                  prohibitingstockholder action by written consent;

 

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

 

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

 

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

 

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

 

The notes areobligations exclusively of UTStarcom. Since substantially all of UTStarcom’soperations are conducted through subsidiaries, our cash flow and our ability toservice our debt, including the notes, is dependent upon the earnings of oursubsidiaries

 

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and the distribution of thoseearnings to us. Our subsidiaries are separate legal entities and have noobligation to make any payments on the notes or make any funds available forpayment on the notes, whether by dividends, loans or other payments. Thepayment of dividends and the making of loans and advances to us by oursubsidiaries may be subject to statutory or contractual restrictions and aredependent upon the earnings of our subsidiaries. Our subsidiaries do notguarantee the payment of the notes. Our right to receive assets of any of oursubsidiaries upon their liquidation or reorganization, and your right toparticipate in these assets, are effectively subordinated to the claims of thatsubsidiary’s creditors. Consequently, the notes will be effectivelysubordinated to all liabilities, including trade payables, of any of our subsidiariesand any subsidiaries that we may in the future acquire or establish, except tothe extent that we are recognized as a creditor of such subsidiary, in whichcase our claims would still be subordinate to any security interests in theassets of such subsidiary and any debt of such subsidiary senior to that heldby us.

 

As of June 30,2003, (i) we had no senior debt outstanding, and (ii) oursubsidiaries had no outstanding indebtedness and approximately$405.8 million of other liabilities, including trade payables, butexcluding intercompany liabilities, as to which the notes would have beeneffectively subordinated.

 

Neither we nor our subsidiariesare prohibited or limited from incurring debt or acting as guarantors of debtfor others in whom we or our subsidiaries may have an interest under theindenture. Our ability to pay our obligations on the notes could be adverselyaffected by our or our subsidiaries’ incurrence of additional indebtedness orother liabilities. We and our subsidiaries may from time to time incuradditional indebtedness and other liabilities, including senior debt.

 

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

 

Our ability topurchase the notes upon the occurrence of a change in control is subject tolimitations. We may not have sufficient financial resources or the ability toarrange financing to pay the purchase price for all the notes delivered byholders seeking to exercise their purchase right. Although we may elect,subject to satisfaction of certain conditions, to pay the purchase price forthe notes in common stock, our ability to purchase the notes in cash may belimited or prohibited by the terms of any future borrowing arrangementsexisting at the time of a change in control. Any failure by us to purchase thenotes upon a change in control would result in an event of default under theindenture, whether or not the purchase is permitted by the subordinationprovisions of the indenture. Any such default may, in turn, cause a defaultunder our senior debt. Moreover, the occurrence of a change in control couldresult in an event of default under the terms of our then existing senior debt.As a result, any purchase of the notes may be prohibited until the senior debtis paid in full.

 

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

 

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

 

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

 

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

 

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

 

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

 

We haveentered into convertible bond hedge and call option transactions with respectto our common stock, the exposure for which is held by Banc of AmericaSecurities LLC and Credit Suisse First Boston LLC. The convertible bond hedgeand call option transactions are expected to reduce the potential dilution fromconversion of the notes. In connection with these hedging arrangements,

 

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Banc of America Securities LLCand Credit Suisse First Boston LLC have taken and/or will take positions in ourcommon stock in secondary market transactions and/or have entered and/or willenter into various derivative transactions after the pricing of the notes. Suchhedging arrangements could increase the price of our common stock. Banc ofAmerica Securities LLC and Credit Suisse First Boston LLC are likely to modifytheir hedge positions from time to time prior to conversion or maturity of thenotes by purchasing and selling shares of our common stock, other securities ofthe Company or other instruments they may wish to use in connection with suchhedging. We cannot assure you that such activity will not adversely affect themarket price of our common stock.

 

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

 

We believe itis unlikely that the notes will be rated. However, if one or more ratingagencies rates the notes and assigns the 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 QUALITATIVEDISCLOSURES ABOUT MARKET RISKS**

 

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

 

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

 

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

 
| **(in thousands except interest rates)** |   |   |    |
|------------------------------------------|--------|--------|---------|
|                                     |   |   |    |
| Cash and equivalents                     |   | $      | 275,978 |   |
| Average interest rates                   |   | 1.1    | %       |
| Short-term investments                   |   | $      | 5,282   |   |
| Average interest rates                   |   | 1.4    | %       |
| Total investment securities              |   | $      | 281,260 |   |
| Average interest rate                    |   | 1.1    | %       |

 

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

 

*Foreign Exchange Rate Risk.*  We are exposed to foreign exchange rate riskbecause most of our sales in China are denominated in Renminbi and portions ofour accounts payable are denominated in Japanese Yen. Due to the limitations onconverting Renminbi, we are limited in our ability to engage in currencyhedging activities in China. Although the impact of currency fluctuations ofRenminbi to date has been insignificant, fluctuations in currency exchangerates in the future may have a material adverse effect on our results ofoperations. We have a multi-currency bank account in Japanese Yen forpurchasing portions of our inventories and supplies. The balance of thisJapanese Yen account as of June 30, 2003 is approximately $14.3 million.

 

*Credit Risk.* TheCompany completed an offering on March 12, 2003, of $402.5 million ofconvertible subordinated notes

 

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due March 1,2008. 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 andcall option transactions may be settled at the Company’s option either in cashor net 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. Subject to the movement in the share price of our commonstock, we could be exposed to credit risk in the settlement of these options inour favor. Based on a review of the possible net settlements and the creditstrength of Banc of America Securities LLC and its affiliates and Credit SuisseFirst Boston LLC and its affiliates, we believe that we do not have a materialexposure 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.

 

**PARTII****—OTHERINFORMATION**

 

**ITEM1****—LEGALPROCEEDINGS**

 

On October 31, 2001, a complaint was filed in United States DistrictCourt for the Southern District of New York against the Company, some of itsdirectors 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 were coordinatedas *In re Initial Public Offering SecuritiesLitigation*, 21 MC 92. In April 2002, a consolidated amendedcomplaint was filed in the matter against the Company, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604. Plaintiffs 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 between March 2,2000 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.  A proposal has been made for the settlementand release of claims against the issuer defendants, including UTStarcom. Thesettlement is subject to a number of conditions, including approval of theproposed settling parties and the court. If the settlement does not occur, andlitigation against UTStarcom continues, UTStarcom believes it has meritoriousdefenses and intends to defend the case vigorously. The total amount of theloss associated with the above litigation is not determinable at thistime.  Therefore we are unable tocurrently estimate the loss if any associated with the litigation.

 

**ITEM2—CHANGES IN SECURITIES AND USE OFPROCEEDS**

 

[None.]

 

**ITEM 3 – DEFAULTS UPON SENIOR SECURITIES**

 

[None.]

 

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

 

On May 9,2003, the Annual Meeting of Stockholders of the Company was held in Oakland,California.

 

An election ofClass III directors was held with the following individuals being elected tothe Board of Directors of the Company as Class III directors:

 

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| **Name**       |   | **Votes For** |   | **Votes Withhold** |   |
|----------------|--------|---------------|--------|--------------------|--------|
| Hong  Liang Lu |   | 76,665,663    |   | 14,582,567         |   |
| Masayoshi Son  |   | 70,573,483    |   | 20,674,747         |   |

 

The currentClass I and Class II directors with unexpired terms are as follows:

 

***Continuing Class IDirectors:***

Thomas J. Toy

Ying Wu

 

***Continuing Class IIDirectors:***

Larry D.Horner

Betsy S.Atkins

 

Thestockholders ratified the appointment of PricewaterhouseCoopers LLP as theCompany’s independent public accountants to audit the financial statements ofthe Company for the fiscal year ending December 31, 2003. There were 88,820,136votes cast for the appointment, 2,403,462 votes cast against the appointmentand 24,632 abstentions.

 

**ITEM 5—OTHERINFORMATION**

 

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—EXHIBITSAND REPORTS ON FORM 8-K**

 

(a)                                  Exhibits:

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

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(b)                                 Reports onForm 8-K:

 

1.               Report on Form 8-K dated April 16, 2003,filed on April 23, 2003 under “Item 9. FD Disclosure” containing UTStarcom.Inc.’s press release dated April 16, 2003 with respect to announcing itsfinancial results for the fiscal quarter ended March 31, 2003.

 

2.               Report on Form 8-K dated May 23,2003,filed on June 4, 2003 under “Item 2. Acquisition or Disposition of Assets”and “Item 7. Financial Statements and Exhibits.” With respect to UTStarcom.Inc.’s acquisition of 3Com Corporation and certain assets of 3Com’s CommWorks.

 

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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:  August 4, 2003 | UTSTARCOM,  INC.                                                                 |
|----------------------------|----------------------------------------------------------------------------------|
|                       | (Registrant)                                                                     |
|                       |                                                                             |
|                       | BY:                                                                              |
|                       |                                                                             |
|                       |                                                                             |
|                       | /s/ Hong Liang Lu                                                                |
|                       | Hong Liang  Lu                                                                   |
|                       | *President, Chief Executive Officer and Director  (principal executive officer)* |
|                       |                                                                             |
|                       |                                                                             |
|                       | /s/ Michael J. Sophie                                                            |
|                       | Michael J.  Sophie                                                               |
|                       | *Chief Financial Officer and Assistant Secretary  (principal financial officer)* |

 

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**UTStarcom, Inc**

 

**EXHIBITINDEX**

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

 

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