Tableof Contents

 

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

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

 

**For the transition period from to**

 

**COMMISSION FILE NUMBER 000-29661**

 

**UTSTARCOM, INC.**

(Exact name ofregistrant as specified in its charter)

 

| **DELAWARE**                             | ** ** | **52-1782500**                       |
|------------------------------------------|------------|--------------------------------------|
| (State of Incorporation)                 |       | (I.R.S. Employer Identification No.) |
|                                     |       |                                 |
| **1275 HARBOR BAY PARKWAY**              | ** ** | ** **                           |
| **ALAMEDA, CALIFORNIA**                  | ** ** | **94502**                            |
| (Address of principal executive offices) |       | (zip code)                           |

 

Registrant’s telephone number, including area code:**(510) 864-8800**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company. See definitions of “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of the Exchange Act. (Check one):

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

 

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

 

Asof October 31, 2008 there were 126,199,705 shares of the registrant’scommon stock outstanding, par value $0.00125.

 

 

 

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**TABLE OF CONTENTS**

 
| PART I—FINANCIAL  INFORMATION                                                                  | 2  |
|----------------------------------------------------------------------------------------------------------|----|
| ITEM  1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)                                     | 2  |
| ITEM  2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS | 27 |
| ITEM  3—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS                                 | 46 |
| ITEM 4—CONTROLS AND  PROCEDURES                                                                     | 48 |
| PART II—OTHER  INFORMATION                                                                     | 50 |
| ITEM  1—LEGAL PROCEEDINGS                                                                           | 50 |
| ITEM  1A—RISK FACTORS                                                                               | 50 |
| ITEM 2—UNREGISTERED SALES OF EQUITY SECURITIES AND USE  OF PROCEEDS                                 | 52 |
| ITEM 3—DEFAULTS UPON SENIOR SECURITIES                                                              | 52 |
| ITEM 4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY  HOLDERS                                         | 53 |
| ITEM 5—OTHER INFORMATION                                                                            | 53 |
| ITEM 6—EXHIBITS                                                                                     | 54 |
| SIGNATURES                                                                                               | 55 |

 

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**PART I—FINANCIALINFORMATION**

 

**ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

**(Inthousands, except share data)**

 
| ** **                                                                                                                                                                                 | ** ** | **September 30,****2008** | ** ** | **December 31,****2007** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|-------------------------------|------------|
| **ASSETS**                                                                                                                                                                                 |       |                           |       |                          |       |
| Current assets:                                                                                                                                                                            |       |                           |       |                          |       |
| Cash and cash equivalents                                                                                                                                                                  |       | $                              | 328,969    |                          | $          | 437,449 |   |
| Short-term investments                                                                                                                                                                     |       | 1,593                          |       | 65,629                        |       |
| Accounts receivable, net of allowances for  doubtful accounts of $45,131 and $45,728 at September 30, 2008 and  December 31, 2007, respectively                                  |       | 141,429                        |       | 304,654                       |       |
| Accounts receivable, related parties                                                                                                                                                       |       | 10,543                         |       | 26,256                        |       |
| Notes receivable                                                                                                                                                                           |       | 14,859                         |       | 12,615                        |       |
| Inventories                                                                                                                                                                                |       | 195,407                        |       | 334,467                       |       |
| Deferred costs                                                                                                                                                                             |       | 142,307                        |       | 190,260                       |       |
| Deferred tax assets                                                                                                                                                                        |       | 1,157                          |       | 1,157                         |       |
| Restricted cash                                                                                                                                                                            |       | 18,535                         |       | 6,442                         |       |
| Prepaids and other current assets                                                                                                                                                          |       | 129,489                        |       | 114,037                       |       |
| Total current assets                                                                                                                                                                       |       | 984,288                        |       | 1,492,966                     |       |
| Property, plant and equipment, net                                                                                                                                                         |       | 203,411                        |       | 209,094                       |       |
| Long-term investments                                                                                                                                                                      |       | 13,500                         |       | 16,667                        |       |
| Intangible assets, net                                                                                                                                                                     |       | 5,193                          |       | 24,809                        |       |
| Long-term deferred costs                                                                                                                                                                   |       | 156,789                        |       | 164,766                       |       |
| Long-term deferred tax assets                                                                                                                                                              |       | 53,131                         |       | 46,277                        |       |
| Other long-term assets                                                                                                                                                                     |       | 24,827                         |       | 30,009                        |       |
| Total assets                                                                                                                                                                               |       | $                              | 1,441,139  |                          | $          | 1,984,588 |   |
|                                                                                                                                                                                       |       |                           |       |                          |       |
| **LIABILITIES, MINORITY INTEREST AND  STOCKHOLDERS’ EQUITY**                                                                                                                          |       |                           |       |                          |       |
| Current liabilities:                                                                                                                                                                       |       |                           |       |                          |       |
| Accounts payable                                                                                                                                                                           |       | $                              | 135,995    |                          | $          | 148,440 |   |
| Short-term debt                                                                                                                                                                            |       | —                         |       | 322,829                       |       |
| Income taxes payable                                                                                                                                                                       |       | 10,092                         |       | 1,174                         |       |
| Customer advances                                                                                                                                                                          |       | 179,065                        |       | 229,050                       |       |
| Deferred revenue                                                                                                                                                                           |       | 118,264                        |       | 100,502                       |       |
| Deferred tax liabilities                                                                                                                                                                   |       | 49,687                         |       | 53,922                        |       |
| Other current liabilities                                                                                                                                                                  |       | 170,559                        |       | 247,299                       |       |
| Total current liabilities                                                                                                                                                                  |       | 663,662                        |       | 1,103,216                     |       |
|                                                                                                                                                                                       |       |                           |       |                          |       |
| Long-term deferred revenue                                                                                                                                                                 |       | 219,597                        |       | 236,033                       |       |
| Long-term debt                                                                                                                                                                             |       | —                         |       | 333                           |       |
| Other long-term liabilities                                                                                                                                                                |       | 18,081                         |       | 23,325                        |       |
| Total liabilities                                                                                                                                                                          |       | 901,340                        |       | 1,362,907                     |       |
|                                                                                                                                                                                       |       |                           |       |                          |       |
| Commitments and contingencies (Note 14)                                                                                                                                                    |       |                           |       |                          |       |
| Minority interest in consolidated  subsidiaries                                                                                                                                            |       | 789                            |       | 3,705                         |       |
| Stockholders’ equity:                                                                                                                                                                 |       |                           |       |                          |       |
| Common stock: $0.00125 par value;  750,000,000 authorized shares; 126,199,705 and 123,467,204 issued and  outstanding at September 30, 2008 and December 31, 2007,  respectively |       | 153                            |       | 152                           |       |
| Additional paid-in capital                                                                                                                                                                 |       | 1,231,846                      |       | 1,216,691                     |       |
| Accumulated deficit                                                                                                                                                                        |       | (760,537                       | )          | (691,170                      | )          |
| Accumulated other comprehensive income                                                                                                                                                     |       | 67,548                         |       | 92,303                        |       |
| Total stockholders’ equity                                                                                                                                                            |       | 539,010                        |       | 617,976                       |       |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                                        |       | $                              | 1,441,139  |                          | $          | 1,984,588 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)**

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

 
| ** **                                                                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                 | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrelated party                                                            |       | $                                                        | 170,878    |                                                    | $          | 626,861 |   | $ | 1,368,461 |   | $ | 1,607,660 |   |
| Related party                                                              |       | 9,729                                                    |       | 19,633                                                  |       | 30,891 |   | 52,980 |   |
|                                                                       |       | 180,607                                                  |       | 646,494                                                 |       | 1,399,352 |   | 1,660,640 |   |
| Cost of net sales                                                          |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrelated party                                                            |       | 117,601                                                  |       | 567,389                                                 |       | 1,149,277 |   | 1,401,193 |   |
| Related party                                                              |       | 5,679                                                    |       | 14,672                                                  |       | 18,721 |   | 40,000 |   |
| Gross profit                                                               |       | 57,327                                                   |       | 64,433                                                  |       | 231,354 |   | 219,447 |   |
| Operating expenses (income):                                               |       |                                                     |       |                                                    |       |   |   |   |   |
| Selling, general and administrative                                        |       | 59,445                                                   |       | 74,297                                                  |       | 211,199 |   | 242,999 |   |
| Research and development                                                   |       | 35,971                                                   |       | 41,881                                                  |       | 116,657 |   | 127,700 |   |
| Amortization of intangible assets                                          |       | 279                                                      |       | 4,046                                                   |       | 3,833 |   | 12,137 |   |
| Net gain on divestitures                                                   |       | (3,455                                                   | )          | (4,271                                                  | )          | (3,455 | ) | (4,271 | ) |
| Total net operating expenses                                               |       | 92,240                                                   |       | 115,953                                                 |       | 328,234 |   | 378,565 |   |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating loss                                                             |       | (34,913                                                  | )          | (51,520                                                 | )          | (96,880 | ) | (159,118 | ) |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest income                                                            |       | 2,143                                                    |       | 3,029                                                   |       | 6,250 |   | 11,333 |   |
| Interest expense                                                           |       | (446                                                     | )          | (8,888                                                  | )          | (9,974 | ) | (22,934 | ) |
| Other income (expense), net                                                |       | (14,943                                                  | )          | 4,347                                                   |       | 38,107 |   | 8,476 |   |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Loss before income taxes and minority  interest                            |       | (48,159                                                  | )          | (53,032                                                 | )          | (62,497 | ) | (162,243 | ) |
| Income tax expense                                                         |       | (7,791                                                   | )          | (3,095                                                  | )          | (7,396 | ) | (10,735 | ) |
| Minority interest in losses of consolidated  subsidiaries                  |       | 6                                                        |       | 799                                                     |       | 526 |   | 1,961 |   |
| Net loss                                                                   |       | $                                                        | (55,944    | )                                                       | $          | (55,328 | ) | $ | (69,367 | ) | $ | (171,017 | ) |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Net loss per share - Basic and Diluted                                     |       | $                                                        | (0.45      | )                                                       | $          | (0.46 | ) | $ | (0.56 | ) | $ | (1.41 | ) |
|                                                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average shares used in per-share  calculation - Basic and Diluted |       | 123,884                                                  |       | 121,011                                                 |       | 123,036 |   | 120,965 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

 

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

**(In thousands)**

 
| ** **                                                                                       | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
|                                                                                             |       |                                                    |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                            | ** ** | ** **                                              | ** ** | ** ** | ** ** |
| Net loss                                                                                         |       | $                                                       | (69,367    | ) | $ | (171,017 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                     |       |                                                    |       |   |   |
| Depreciation and amortization                                                                    |       | 30,603                                                  |       | 45,009 |   |
| Gain on sale of investments and liquidation  of ownership interest in a variable interest entity |       | (48,375                                                 | )          | (6,127 | ) |
| Net gain on divestitures                                                                         |       | (3,455                                                  | )          | (4,271 | ) |
| Net (gain) loss on sale of fixed assets                                                          |       | (72                                                     | )          | 656 |   |
| Stock-based compensation expense                                                                 |       | 13,930                                                  |       | 6,970 |   |
| Impairment of long-term investments                                                              |       | 4,308                                                   |       | — |   |
| Provision for doubtful accounts                                                                  |       | 220                                                     |       | 291 |   |
| Provision for (recovery of) deferred costs                                                       |       | 12,797                                                  |       | (4,540 | ) |
| Deferred income taxes                                                                            |       | (7,921                                                  | )          | 1,926 |   |
| Other                                                                                            |       | (481                                                    | )          | (1,960 | ) |
| Changes in operating assets and  liabilities:                                                    |       |                                                    |       |   |   |
| Accounts receivable                                                                              |       | 60,894                                                  |       | 75,688 |   |
| Inventories                                                                                      |       | (85,822                                                 | )          | 63,828 |   |
| Deferred costs                                                                                   |       | 59,979                                                  |       | (26,442 | ) |
| Other assets                                                                                     |       | (5,729                                                  | )          | (20,170 | ) |
| Accounts payable                                                                                 |       | 80,316                                                  |       | (118,972 | ) |
| Income taxes payable                                                                             |       | 8,476                                                   |       | 7,100 |   |
| Customer advances                                                                                |       | (34,219                                                 | )          | 30,289 |   |
| Deferred revenue                                                                                 |       | (5,088                                                  | )          | (40,098 | ) |
| Other liabilities                                                                                |       | (42,866                                                 | )          | (31,515 | ) |
| Net cash used in operating activities                                                            |       | (31,872                                                 | )          | (193,355 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                            |       |                                                    |       |   |   |
| Additions to property, plant and equipment                                                       |       | (12,671                                                 | )          | (22,530 | ) |
| (Purchase of) proceeds from the disposition  of an investment interest                           |       | (3,841                                                  | )          | 3,334 |   |
| Proceeds from repayment of loan by a  variable interest entity                                   |       | 7,728                                                   |       | — |   |
| Net proceeds from divestitures                                                                   |       | 207,097                                                 |       | 4,271 |   |
| Change in restricted cash                                                                        |       | (10,380                                                 | )          | 7,273 |   |
| Purchase of short-term investments                                                               |       | (9,778                                                  | )          | (29,650 | ) |
| Proceeds from sale of short-term  investments                                                    |       | 67,284                                                  |       | 20,688 |   |
| Other                                                                                            |       | 245                                                     |       | (115 | ) |
| Net cash provided by (used in) investing  activities                                             |       | 245,684                                                 |       | (16,729 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                            |       |                                                    |       |   |   |
| Issuance (repurchase) of stock, net of  expenses                                                 |       | 1,150                                                   |       | (24 | ) |
| Proceeds from borrowings                                                                         |       | 50,000                                                  |       | 97,835 |   |
| Payments on borrowings                                                                           |       | (375,317                                                | )          | (64,790 | ) |
| Other                                                                                            |       | (9,057                                                  | )          | 6,052 |   |
| Net cash (used in) provided by financing  activities                                             |       | (333,224                                                | )          | 39,073 |   |
| Effect of exchange rate changes on cash and  cash equivalents                                    |       | 10,932                                                  |       | 18,938 |   |
| Net decrease in cash and cash equivalents                                                        |       | (108,480                                                | )          | (152,073 | ) |
| Cash and cash equivalents at beginning of  period                                                |       | 437,449                                                 |       | 661,623 |   |
| Cash and cash equivalents at end of period                                                       |       | $                                                       | 328,969    |   | $ | 509,550 |   |
|                                                                                             |       |                                                    |       |   |   |
| Supplemental disclosure of cash flow  information:                                               |       |                                                    |       |   |   |
| Non-cash operating activity:                                                                     |       |                                                    |       |   |   |
| Accounts receivable transferred to notes  receivable                                             |       | $                                                       | 18,487     |   | $ | 19,901 |   |

 

See accompanying notes to the condensedconsolidated financial statements.

 

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**UTSTARCOM, INC.**

 

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

 

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

 

The accompanying unaudited condensedconsolidated financial statements include the accounts of UTStarcom, Inc.(“Company”) and its wholly and majority owned subsidiaries. All significantintercompany accounts and transactions have been eliminated in the preparationof the condensed consolidated financial statements. The minority interest inconsolidated subsidiaries is shown separately in the condensed consolidatedfinancial statements.  The accounts ofUTStarcom Personal Communications LLC, a wholly-owned subsidiary of the Company(“PCD”) are included in the accompanying unaudited condensed consolidatedfinancial statements through the date of sale of PCD, July 1, 2008 (seeNote 3). Certain prior period amounts have been reclassified to conformto the current period presentation.

 

The accompanyingunaudited condensed consolidated financial statements as of September 30,2008 and for the three and nine months ended September 30, 2008 and 2007have been prepared by the Company pursuant to the rules and regulations ofthe Securities and Exchange Commission (“SEC”). Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. The December 31, 2007balance sheet was derived from audited financial statements, but does notinclude all disclosures required by generally accepted accounting principles.These condensed consolidated financial statements should be read in conjunctionwith the Company’s December 31, 2007 financial statements, including thenotes thereto, and the other information set forth in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2007. Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts of assets, liabilities,revenue, costs, expenses and gains and losses not affecting retained earnings thatare reported in the consolidated financial statements and accompanyingdisclosures.  Actual results may bedifferent.  See the Company’s 2007 AnnualReport for discussions of the Company’s critical accounting policies andestimates.

 

In the opinion of management,the accompanying unaudited condensed consolidated financial statements reflectall adjustments (consisting of only normal recurring adjustments) considerednecessary for a fair statement of the Company’s financial condition, theresults of its operations and its cash flows for the periods indicated. Theresults of operations for the three and nine months ended September 30,2008 are not necessarily indicative of the operating results for the full year.

 

The Company reported netlosses of $195.6 million, $117.3 million and $532.6 million forthe years ended December 31, 2007, 2006 and 2005, respectively. At December 31,2007, the Company’s accumulated deficit aggregated $691.2 million. Duringthe year ended December 31, 2007, the Company used $218.2 million ofcash in operations. At December 31, 2007, the Company had cash and cashequivalents of $437.4 million of which $289.5 million was used torepay the convertible subordinated notes due on March 1, 2008 (the “Notes”).This amount included a principal payment of $274.6 million and$14.9 million in accrued interest. At December 31, 2007,$322.4 million of the Company’s cash and cash equivalents was held by itssubsidiaries in China and China imposes currency exchange controls on transfersof funds outside of China. Additionally, the available lines of credit in Chinaare significantly less than what has been available to the Companyhistorically. These factors raised substantial doubt as to the Company’sability to continue as a going concern.

 

The Company had anoperating loss of $96.9 million and a net loss of $69.4 million for the ninemonths ended September 30, 2008. At September 30, 2008, the Companyhad an accumulated deficit of $760.5 million. Cash used in operations was $31.9 million during the nine months ended September 30,2008. In the third quarter of 2008, the Company completed the sale of PCD for atotal sale consideration of approximately $233.4 million (seeNote 3).  At September 30,2008, the Company had cash and cash equivalents of $329.0 million in theaggregate to meet the Company’s liquidity requirements of which $155.4 millionwas held by its subsidiaries in China and continues to be subject to currencyexchange controls on transfers of funds from China. Going forward, the amount ofcash available for transfer from the China subsidiaries is limited both by theliquidity needs of the subsidiaries in China and by Chinese-government mandatedrequirements including currency exchange controls on transfers of funds outsideof China.

 

Currently, the Company’sprimary sources of available credit are a series of credit facilities in Chinaand each borrowing under the credit facilities is subject to the bank’s thencurrent favorable opinion of the credit worthiness of the Company’s China

 

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subsidiaries, aswell as the bank having funds available for lending and other Chinese bankingregulations. Management cannot be certain that additional lines of credit willbe available to the Company on commercially reasonable terms or at all.

 

Primarily as a result ofthe success in executing on management’s strategy of divesting the Company’snon-core businesses, at September 30, 2008, the Company had cash and cashequivalents  of $329.0 million ascompared to $253.9 million at June 30, 2008.  Although management believes the Company nowhas sufficient liquidity to finance its anticipated working capital and capitalexpenditure requirements for the next twelve months, in an effort to furtherimprove the Company’s profitability and cash flows, management has intensifiedits focus on the Company’s fixed cost base to better align with operations,market demand and projected sales levels. If projected sales do not materialize, management may need to furtherreduce expenses. In addition, the Company may require additional equity or debtfinancing. If future funds are raised through issuance of stock or debt, thesesecurities could have rights, privileges or preference senior to those of theCompany’s common stock and debt covenants could impose restrictions on theCompany’s operations. The sale of additional equity securities or debtfinancing could result in additional dilution to the Company’s currentshareholders. There can be no assurance that additional financing, if required,will be available on terms satisfactory to the Company or at all.

 

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

 

*Adoptionof New Accounting Standards*

 

In September 2006, the Financial Accounting Standards Board (“FASB”)issued Statement of Financial Accounting Standards No. 157, “Fair ValueMeasurements,” (“SFAS 157”). SFAS 157 defines fair value, establishesa framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. Theprovisions of this standard apply to current accounting pronouncements thatrequire or permit fair value measurements. Upon adoption, the provisions of SFAS 157are to be applied prospectively with limited exceptions.  Effective January 1, 2008, the Companyadopted the measurement and disclosure requirements of SFAS 157 as it relatesto financial assets and financial liabilities measured at fair value on arecurring basis. In October 2008, the FASB issued FASB Staff Position FAS157-3, “Determining the Fair Value of a Financial Asset When the Market forThat Asset Is Not Active” (“FSP 157-3”), which clarified the application ofFAS 157. FSP 157-3 demonstrated how the fair value of a financialasset is determined when the market for that financial asset is inactive.FSP 157-3 was effective upon issuance, including prior periods for whichfinancial statements had not been issued. The adoption of SFAS No. 157 forthese financial assets and financial liabilities did not have a material impacton the Company’s financial condition or results of operations in the first ninemonths of 2008. The new disclosures required by SFAS 157 are included in Note7.

 

In February 2008, the FASB issued FASB Staff Position No. 157-2,“Effective Date of FASB Statement No. 157”(“FSP 157-2”), which delays the effective date of SFAS 157 fornon-financial assets and non-financial liabilities except those recorded ordisclosed at fair value on a recurring basis.  Therefore, the Companyhas delayed application of SFAS 157 to those non-financial assets andnon-financial liabilities until January 1, 2009.  The Company iscurrently evaluating the impact of SFAS 157 on those non-financial assetsand non-financial liabilities on the Company’s financial position and resultsof operations.  While the Company does not expect the adoption of thisstatement to have a material impact on its consolidated financial statements insubsequent reporting periods, the Company continues to monitor any additionalimplementation guidance that is issued that addresses the fair valuemeasurements for non-financial assets and non-financial liabilities notdisclosed at fair value in the consolidated financial statement on at least anannual basis.

 

In February 2007,the FASB issued Statement of Financial Accounting Standard No. 159, “TheFair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”).This statement permits, but does not require, companies to report at fair valuethe majority of recognized financial assets, financial liabilities and firmcommitments. Under this standard, unrealized gains and losses on items forwhich the fair value option is elected are reported in earnings at each subsequentreporting date. The Company adopted SFAS 159 during the first quarter of 2008.The Company has chosen not to elect the fair value option for any items thatare not already required to be measured at fair value in accordance withaccounting principles generally accepted in the United States. As such, theadoption of SFAS 159 did not have an impact on the Company’s financial positionor results of operations.

 

*StandardsIssued But Not Yet Effective*

 

In December 2007,the FASB issued Statement No. 141 (revised), “Business Combinations” (“SFAS 141(R)”).The standard changes the accounting for business combinations including themeasurement of acquirer shares issued in consideration for a businesscombination, the recognition of contingent consideration, the accounting forpreacquisition gain and loss contingencies, the recognition of capitalizedin-process research and development, the accounting for acquisition-relatedrestructuring cost accruals, the

 

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treatment ofacquisition related transaction costs and the recognition of changes in theacquirer’s income tax valuation allowance. SFAS 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  The Company will assess the impact of SFAS 141(R) ifand when a future acquisition occurs.

 

In December 2007,the FASB issued Statement No. 160, “Non-controlling Interests inConsolidated Financial Statements, an amendment of ARB No. 51” (“SFAS 160”).The standard changes the accounting for non-controlling (minority) interests inconsolidated financial statements including the requirements to classifynon-controlling interests as a component of consolidated stockholders’ equity,and the elimination of “minority interest” accounting in results of operationswith earnings attributable to non-controlling interests reported as part ofconsolidated earnings. Additionally, SFAS 160 revises the accounting forboth increases and decreases in a parent’s controlling ownership interest.SFAS 160 is effective for fiscal years beginning after December 15,2008, with early adoption prohibited. The Company is currently evaluating theimpact of the pending adoption of SFAS 160 on its consolidated financialstatements.

 

In March 2008, theFASB issued Statement No. 161, “Disclosuresabout Derivative Instruments and Hedging Activities” (“SFAS 161”),which amends and expands the disclosure requirements of FASB Statement No. 133,“Accounting for Derivative Instrumentsand Hedging Activities”  (“SFAS 133”),with the intent to provide users of financial statements with an enhancedunderstanding of:  (a) how and why an entity uses derivativeinstruments; (b) how derivative instruments and related hedged items areaccounted for under SFAS 133 and its related interpretations; and (c) howderivative instruments and related hedged items affect an entity’s financialposition, financial performance and cash flows.  SFAS 161 requiresqualitative disclosures about objectives and strategies for using derivatives,quantitative disclosures about fair value amounts of and gains and losses onderivative instruments and disclosures about credit-risk-related contingentfeatures in derivative instruments.  This statement applies to allentities and all derivative instruments.  SFAS 161 is effective forfinancial statements issued for fiscal years and interim periods beginningafter November 15, 2008.  Since SFAS 161 only provides for additionaldisclosure requirements, there will be no impact on the Company’s financialposition or results of operations upon adoption.

 

In April 2008, theFASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination of theUseful Life of Intangible Assets.” FSP 142-3 amends the factors an entityshould consider in developing renewal or extension assumptions used indetermining the useful life of recognized intangible assets under FASBStatement No. 142, “Goodwill and Other Intangible Assets.” This newguidance applies prospectively to intangible assets that are acquiredindividually or with a group of other assets in business combinations and assetacquisitions. FSP 142-3 is effective for financial statements issued for fiscalyears and interim periods beginning after December 15, 2008. Earlyadoption is prohibited. The Company will assess the impact of FSP 142-3 if andwhen it acquires intangible assets in the future.

 

In May 2008, theFASB issued FASB Staff Position No. APB 14-1, “Accounting for ConvertibleDebt Instruments that May be Settled in Cash Upon Conversion (“APB 14-1”).APB 14-1 requires that the liability and equity components of convertible debtinstruments that may be settled in cash upon conversion (including partial cashsettlement) be separately accounted for in a manner that reflects an issuer’snonconvertible debt borrowing rate. The resulting debt discount is amortizedover the period the convertible debt is expected to be outstanding asadditional non-cash interest expense. APB 14-1 is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. Retrospective application to allperiods presented is required except for instruments that were not outstandingduring any of the periods that will be presented in the annual financialstatements for the period of adoption but were outstanding during an earlierperiod. Since the Company does not have any debt securities, the Company doesnot anticipate the adoption of APB 14-1 to have any impact on its financialcondition, results of operations and cash flows.

 

**NOTE****3 – DIVESTITURES**

 

*2008*

 

Beginning in the fourthquarter of 2007, the Company launched a number of initiatives, includingpotential divestitures of non-core assets, to focus on its core growthtechnologies, including IPTV, IP-based softswitch and broadband devices.  During the third quarter of 2008, the Companycompleted its divestitures of UTStarcom Personal Communications LLC and MobileSolutions Business Unit.

 

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*UTStarcom Personal Communications LLC (PCD)*

 

On July 1, 2008, theCompany completed the sale of UTStarcom Personal Communications LLC, awholly-owned subsidiary of the Company (“PCD”), to an entity controlled by AIGGlobal Investment Group and certain other investors. The total saleconsideration to the Company of approximately $233.4 million was basedprimarily on the working capital of PCD as of the closing of the transaction,subject to certain adjustments.  Duringthe quarter ended September 30, 2008, the Company recorded net cashproceeds of $212.2 million from the sale of PCD, which was represented by thetotal sale consideration of $233.4 million, less $8.2 million of transactioncosts and $13.0 million held in escrow.  At September 30, 2008, theCompany recorded an additional $1.8 million of transaction costs which had beenincurred but not yet paid. The $13.0 million held in escrow consists of $3.0million expected to be received by the Company upon settlement of workingcapital adjustments and $10.0 million to be held for a period of one year tosecure indemnification claims made by the purchaser, if any, and is included inprepaids and other current assets in the condensed consolidated balance sheetat September 30, 2008. The Company also invested $1.6 million in equitysecurities representing approximately a 2.5% interest in the newly formedentity, Personal Communications Devices, LLC (“New PCD”).  Pursuant to the terms of the divestitureagreement, the Company may be entitled to receive up to an additional $50million earnout payment in 2011 based on the achievement of cumulative earningslevels of New PCD through December 31, 2010. Previously, PCD was areportable segment of the Company.

 

The Company recorded a$0.5 million loss on sale of PCD net assets during the third quarter of2008.  The following table summarizes thecomponents of the loss on sale (in thousands):

 

| Purchase price                      |   | $        | 233,442 |   |
|-------------------------------------|--------|----------|---------|--------|
| Less:                               |   |     |    |
| Accounts receivable, net            |   | (121,979 | )       |
| Inventories                         |   | (205,367 | )       |
| Prepaids and other assets           |   | (8,885   | )       |
| Property, plant and equipment, net  |   | (1,539   | )       |
| Intangible assets, net              |   | (15,783  | )       |
| Accounts payable                    |   | 89,628   |    |
| Other liabilities                   |   | 39,999   |    |
| Estimated transaction related costs |   | (9,980   | )       |
| Loss on sale, net of tax            |   | $        | (464    | )      |
|                                     |        |          |         |        |  |

 

Concurrent with theclosing of the transaction, the Company entered into a three-year supplyagreement with New PCD whereby the Company intends to supply handset productsto New PCD.  Due to the ongoing directcash flows pursuant to the supply agreement, the sale of the PCD assets did notmeet the criteria for presentation as a discontinued operation under SFAS 144, “Accountingfor the Impairment or Disposal of Long-Lived Assets,” (“SFAS 144”).

 

*MobileSolutions Business Unit*

 

On July 31, 2008 theCompany completed the divestiture of its Mobile Solutions Business Unit (“MSBU”)to a global private equity firm. During the third quarter of 2008, the Companyrecorded a net gain on divestiture of $3.9 million.  This gain resulted from transferring netliabilities of approximately $9.0 million, netted against cash payments made bythe Company of approximately $5.1 million, including transaction related costsof $0.3 million. The net liability primarily consisted of deferred revenue andother liabilities totaling $27.8 million offset by deferred costs and otherassets of approximately $18.8 million. Previously, MSBU was reported as part ofthe Company’s Other segment.  Concurrent with the closing of thetransaction, the Company entered into a manufacturing agreement whereby theCompany will continue to develop and manufacture wireless IP-based products forsale to the divested entity. Due to the ongoing direct cash flows pursuant tothe manufacturing agreement, the sale of the MSBU assets did not meet thecriteria for presentation as a discontinued operation under SFAS 144.

 

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*2007*

 

*Marvell Technology Group Ltd.*

 

In February 2006, the Company sold substantially all of the assetsand selected liabilities of its semiconductor design business division toMarvell Technology Group Ltd. (“Marvell”). The assets sold included theassets related to the prior acquisition of Advanced Communications DevicesCorporation in 2001, and other system-on-chip semiconductors. The Companyreceived $35.4 million in cash, net of $0.6 million of transactioncosts. Included in the cash received was $16.0 million earned by theCompany as a result of achieving certain defined milestones. The Companyreceived payment of this $16.0 million in October 2006. Uponsatisfaction of certain escrow conditions, the Company received an additional$4.3 million in cash in August 2007 which was recorded in thecondensed consolidated statement of operations as gain on divestiture in thequarter ended September 30, 2007. In connection with the sale of assets,the Company entered into a supply agreement with Marvell to purchase chipsetsfor the Company’s handset products over the next five years. The value allocatedto the supply agreement of $20.2 million is included in other current andlong-term liabilities, and is being amortized in proportion to the quantitiesof chipsets purchased under the supply agreement over five years. As of September 30,2008, approximately $8.1 million has been amortized against cost of sales,including $0.8 million and $5.1 million amortized against cost of sales duringthe three and nine months ended September 30, 2008, respectively.

 

**NOTE 4 - STOCK-BASED COMPENSATION**

 

During the three and ninemonths ended September 30, 2008, the Company granted equity awardsincluding restricted stock, restricted stock units, stock options and ESPPshares. Such awards generally vest over a period of one to four years from thedate of grant.  Restricted stock has thevoting rights of common stock and the shares underlying restricted stock areissued and outstanding.

 

In November 2007,the Compensation Committee granted 962,249 shares of performance-basedrestricted stock units to certain senior executive officers.  On February 26, 2008, the Committeedetermined, based on the Company’s and each executive officer’s level ofperformance during the Company’s 2007 fiscal year, that 783,324 sharesunderlying the previously granted performance-based restricted stock units hadbeen earned, with 50% vesting immediately and 50% vesting on February 28,2009.  Each performance-based restrictedstock unit has a fair value of $2.99 per share, which equals the closing priceof the Company’s common stock on the NASDAQ Stock Market on the measurementdate of February 26, 2008.  In February 2008,the Compensation Committee also granted an additional 1,073,333performance-based awards to certain senior executive officers, subject to theattainment of goals determined by the Compensation Committee. During the thirdquarter of 2008, 233,333 of these contingently issuable shares were forfeitedas a result of employee terminations. The Company may be subject to variable levels of expense relatedprimarily to the varying levels of performance, as well as for fluctuations inthe Company’s stock price as these awards are “marked to market” at eachreporting period prior to the date of the Compensation Committee’sdetermination on performance.

 

The total stock-basedcompensation expense recognized in the condensed consolidated statements ofoperations is as follows:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| Cost of net sales                   |       | $                                                        | 182        |                                                    | $          | 119 |   | $ | 776 |   | $ | 362 |   |
| Selling, general and administrative |       | 3,154                                                    |       | 1,007                                                   |       | 11,180 |   | 3,871 |   |
| Research and development            |       | 750                                                      |       | 905                                                     |       | 1,974 |   | 2,737 |   |
| Total                               |       | $                                                        | 4,086      |                                                    | $          | 2,031 |   | $ | 13,930 |   | $ | 6,970 |   |

 

The fair value of eachoption award is estimated on the date of grant using the Black-Scholes-Mertonoption valuation model and the weighted average assumptions in the followingtable. The expected term of options granted is derived from historical data onemployee exercise and post-vesting employment termination behavior. The riskfree interest rate is based on the zero coupon U.S. Treasury securities with anequivalent remaining term. Expected volatility is based on the historicalvolatility of the Company’s stock. The weighted-average per share fair value ofstock options granted and the assumptions used, are as follows:

 
| ** **                                       | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                 | ** ** | **2007 (1)**                                       | ** ** | **2008** | ** ** | **2007 (1)** | ** ** |
| ** **                                       | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted-average per share fair value of  grants |       | $                                                        | 1.57       |                                                    | —     |   | $ | 1.53 |   | — |   |
| Expected remaining term in years                 |       | 2.7                                                      |       | —                                                  |       | 3.7 |   | — |   |
| Weighted average risk-free interest rate         |       | 2.2                                                      | %          | —                                                  |       | 2.3 | % | — |   |
| Expected dividend rate                           |       | 0.00                                                     | %          | —                                                  |       | 0.00 | % | — |   |
| Volatility                                       |       | 71                                                       | %          | —                                                  |       | 66 | % | — |   |
|                                                  |            |                                                          |            |                                                         |            |  |  |  |  |  |  |

 

(1) No stock optionswere granted during the three and nine months ended September 30, 2007.

 

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Option activity as of September 30,2008 and changes during the nine months ended September 30, 2008 are asfollows:

 

| ** **                                    | ** ** | **Number of  shares  outstanding  (in thousands)** | ** ** | **Weighted  average  exercise  price** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------------------------|------------|----------------------------------------|------------|
| Options outstanding, January 1, 2008     |       | 17,647                                                       |       | $                                      | 13.91      |   |
| Options granted                               |       | 854                                                          |       | 3.15                                   |       |
| Options exercised                             |       | (62                                                          | )          | 2.05                                   |       |
| Options forfeited or expired (2)              |       | (4,644                                                       | )          | 15.36                                  |       |
|                                          |       |                                                         |       |                                   |       |
| Options outstanding, September 30,  2008 |       | 13,795                                                       |       | $                                      | 12.81      |   |

 

The fair value of eachrestricted stock or restricted stock unit award is determined based on thequoted price of the Company’s common stock on the date of grant. Nonvestedrestricted stock and restricted stock units as of September 30, 2008, andchanges during the nine months ended September 30, 2008, are as follows:

 

| ** **                           | ** ** | **Shares  (in thousands)** | ** ** | **Weighted average  grant date fair value** | ** ** |
|--------------------------------------|------------|---------------------------------|------------|-----------------------------------------------------------------|------------|
| Nonvested at January 1, 2008    |       | 6,370                           |       | $                                                               | 3.09       |   |
| Granted                              |       | 5,758                           |       | 2.96                                                            |       |
| Vested                               |       | (2,513                          | )          | 3.02                                                            |       |
| Forfeited (2)                        |       | (2,873                          | )          | 3.06                                                            |       |
| Nonvested at September 30, 2008 |       | 6,742                           |       | $                                                               | 3.02       |   |

 

(2) Includes 1.0million options forfeited and 0.3 million restricted stock or restricted stockunit awards forfeited by employees terminated in connection with thedivestiture of PCD.

 

At September 30,2008, there was approximately $25.4 million of total unrecognized compensationcost, related to non-vested stock options, restricted stock and restricted stockunits, adjusted for forfeitures, which is expected to be recognized over aweighted average period of 2.2 years. During the third quarter of 2008, theCompany modified the terms of outstanding equity awards of an executive officerwhich included 0.9 million shares of nonvested restricted stock and 0.4 millionshares of vested stock options. The modification included accelerated vestingof unvested share awards and provided for a one-year period for the exercise ofall the outstanding vested stock options effective upon the executive officer’sretirement on August 31, 2008. The total incremental compensation costrecognized, net of forfeitures, in the third quarter of 2008 as a result ofthis equity award modification was approximately $1.5 million. For additionalinformation regarding the Company’s stock-based compensation plans, see theCompany’s Annual Report on Form 10-K for the year ended December 31,2007.

 

Tender offer

 

On October 1, 2008, the Company completed a tender offer toexchange certain outstanding employee stock options to purchase shares of theCompany’s common stock. Eligible for exchange were outstanding options, vestedor unvested, held by current employees (excluding directors and executiveofficers) and granted under the Company’s 1997 Stock Plan with an exerciseprice greater than or equal to $6.00 per share, which included options with anexercise price less than the fair market value of the Company’s common stock onthe date of grant.  Subject to the termsand conditions of the tender offer, the Company accepted for exchange andcancelled options to purchase an aggregate of 6,072,818 shares with a weightedaverage exercise price of $14.15 per share, and issued new options to purchasean aggregate of 1,983,920 shares with an exercise price of $3.24 per share, theclosing stock price of the Company’s common stock on October 1, 2008. Thenew options were granted under the Company’s 2006 Equity

 

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Incentive Plan and generally vest over two years. The incrementalcompensation expense resulting from the completion of the tender offer did nothave a material impact on the Company’s consolidated financial position,results of operations and cash flows.

 

**NOTE****5 - LOSS PER SHARE**

 

Basic earnings per share(“EPS”) is computed by dividing net loss available to common stockholders bythe weighted average number of shares of the Company’s common stock outstandingduring the period, which excludes nonvested restricted stock. Diluted EPSpresents the amount of net loss available to each share of common stockoutstanding during the period plus each share of common stock that would havebeen outstanding assuming the Company had issued shares of common stock for alldilutive potential common shares outstanding during the period. The Company’spotentially dilutive common shares include convertible subordinated notes priorto their maturity, outstanding stock options, nonvested restricted stock,restricted stock units and Employee Stock Purchase Plan (“ESPP”) shares.

 

The following is asummary of the calculation of basic and diluted loss per share:

 
| ** **                             | ** ** | **Three months ended September 30,**          | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                             | ** ** | **2008**                                                          | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                             | ** ** | **(in thousands except per share data)** | ** ** |
| ***Numerator***                        |       |                                                              |       |                                                    |       |   |   |   |   |
| Net loss                               |       | $                                                                 | (55,944    | )                                                       | $          | (55,328 | ) | $ | (69,367 | ) | $ | (171,017 | ) |
|                                   |       |                                                              |       |                                                    |       |   |   |   |   |
| ***Denominator***                      |       |                                                              |       |                                                    |       |   |   |   |   |
| Weighted-average shares outstanding    |       | 123,884                                                           |       | 121,011                                                 |       | 123,036 |   | 120,965 |   |
|                                   |       |                                                              |       |                                                    |       |   |   |   |   |
| Net loss per share - basic and diluted |       | $                                                                 | (0.45      | )                                                       | $          | (0.46 | ) | $ | (0.56 | ) | $ | (1.41 | ) |

 

For the three and ninemonths ended September 30, 2008 and 2007, no potential common shares weredilutive because of the net loss in each of these periods.  The following table summarizes the totalpotential shares of common stock that were excluded from the diluted per sharecalculation:

 
| ** **                                             | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                             | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                                  | ** ** |
| Stock options and ESPP shares                          |       | 16,298                                                   |       | 17,983                                                  |       | 16,780 |   | 18,658 |   |
| Assumed conversion of convertible  subordinated notes  |       | —                                                   |       | 11,543                                                  |       | 2,528 |   | 11,543 |   |
| Nonvested restricted stock and restricted  stock units |       | 8,544                                                    |       | 481                                                     |       | 8,835 |   | 543 |   |
|                                                   |       | 24,842                                                   |       | 30,007                                                  |       | 28,143 |   | 30,744 |   |

 

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**NOTE 6 - COMPREHENSIVE LOSS**

 

The reconciliation of netloss to comprehensive loss for the three and nine months ended September 30,2008 and 2007 is as follows:

 
| ** **                                                           | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                           | ** ** | **(in thousands)**                                  | ** ** |
| Net loss                                                             |       | $                                                        | (55,944    | )                                                       | $          | (55,328 | ) | $ | (69,367 | ) | $ | (171,017 | ) |
| Unrealized (loss) gain on  available-for-sale securities, net of tax |       | (30                                                      | )          | 23,799                                                  |       | (1,753 | ) | 72,071 |   |
| Realization of previously unrealized gains,  net of tax              |       | 25                                                       |       | —                                                  |       | (38,277 | ) | — |   |
| Realization of foreign currency translation  upon divestiture of PCD |       | (1,540                                                   | )          | —                                                  |       | (1,540 | ) | — |   |
| Foreign currency translation                                         |       | 4,544                                                    |       | 7,835                                                   |       | 16,815 |   | 19,742 |   |
| Total comprehensive loss                                             |       | $                                                        | (52,945    | )                                                       | $          | (23,694 | ) | $ | (94,122 | ) | $ | (79,204 | ) |

 

The components ofaccumulated other comprehensive income reported in the condensed consolidatedbalance sheets are as follows:

 
| ** **                                                           | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                           | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                                                           | ** ** | **(in thousands)** | ** ** |
| Unrealized (loss) gain on  available-for-sale securities, net of tax |       | $                       | (2,704     | )                     | $          | 35,949 |   |
| Foreign currency translation                                         |       | 70,252                  |       | 56,354                |       |
| Accumulated other comprehensive income                               |       | $                       | 67,548     |                  | $          | 92,303 |   |

 

**NOTE 7 - CASH, CASH EQUIVALENTS, INVESTMENTS AND FAIR VALUEMEASUREMENTS**

 

Cash and cashequivalents, consisting primarily of bank deposits and money market funds, arerecorded at cost which approximates fair value because of the short-term natureof these instruments. Short-term investments, consisting of bank notes andavailable-for-sale securities, were $1.6 million and $65.6 million at September 30,2008 and December 31, 2007, respectively. Short-term investments decreased at September 30, 2008 from December 31,2007 primarily due to the sale of investments with a carrying value of $42.4million at December 31, 2007.  Theavailable-for-sale securities investments are recorded at fair value (seebelow).  Any unrealized holding gains orlosses are reported as a component of other comprehensive income, net ofrelated income tax effects. Realized gains and losses are reported inearnings.  At September 30, 2008,the long-term investments included $2.7 million of unrealized holding losswhich was recorded in accumulated other comprehensive income. There was nounrealized holding gain or loss in short-term investments.  At December 31, 2007, the long-term andshort-term investments included $1.0 million of unrealized holding lossand $36.9 million of unrealized holding gain, respectively.

 

The Company accepts banknotes receivable with maturity dates of between three and six months from itscustomers in China in the normal course of business.  The Company may discount these bank noteswith banking institutions in China. There were no bank notes sold during thethree months ended September 30, 2008. The Company sold $30.5 million of bank notes, and recorded costs of $0.4million as a result of discounting the notes, during the nine months ended September 30,2008.  There were no bank notes soldduring the three and nine months ended September 30, 2007.

 

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The following table showsthe break-down of the Company’s total investments at September 30, 2008and December 31, 2007:

 

|                         | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                         | ** ** | **(in thousands)**      | ** ** |
| Equity Securities:           | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Gemdale Company, Ltd         |       | $                            | —     |                        | $          | 30,595 |   |
| Infinera                     |       | —                       |       | 11,759                      |       |
| Global Asia Partners L.P.    |       | —                       |       | 2,113                       |       |
| Cortina                      |       | 3,348                        |       | 3,013                       |       |
| MRV                          |       | 1,778                        |       | 3,523                       |       |
| GCT SemiConductor, Inc. |       | 3,000                        |       | 3,000                       |       |
| Xalted Networks              |       | 3,302                        |       | 3,302                       |       |
| FITEL                        |       | —                       |       | 123                         |       |
| New PCD                      |       | 1,600                        |       | —                      |       |
| Other                        |       | 472                          |       | 1,593                       |       |
| Total Equity Securities      |       | 13,500                       |       | 59,021                      |       |
| Bank notes                   |       | 1,593                        |       | 23,275                      |       |
| Total investments            |       | $                            | 15,093     |                        | $          | 82,296 |   |
|                         |       |                         |       |                        |       |
| Short-term investments       |       | $                            | 1,593      |                        | $          | 65,629 |   |
| Long-term investments        |       | $                            | 13,500     |                        | $          | 16,667 |   |
|                              |            |                              |            |                             |            |  |  |  |  |

* *

*Gemdale*

 

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

 

*Infinera*

 

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

 

*Global Asia Partners L.P.*

 

Global Asia Partners L.P. (“GAP”) is aventure capital fund formed to make private equity investments in private andpre-IPO technology and telecommunications companies in Asia. Between June 2002and April 2005, the Company invested a total of $2.6 million in thefund. As of September 30, 2008 and December 31, 2007, the Companyowned 49% of the fund’s outstanding partnership units and the investment isaccounted for under the equity method. Earnings in the equity interest in GAP were $0.1 million and $0.4million for the nine months ended September 30, 2008 and 2007,respectively.  No earnings in the equityinterest in GAP were recognized for both the three months ended September 30,2008 and 2007.

 

During the quarter, the Company’s review ofthis investment included, but was not limited to, a review of GAP’s cashposition, recent financing activities, financing needs, earnings/revenueoutlook, operational performance, management/ownership changes, andcompetition. Based on this review, the Company determined that the carryingvalue of the investment exceeded the fair value of the investment, and thedecline was other-than-temporary. As a result, during the third quarter of2008, the Company recorded a $2.2 million write-down in the value of thisinvestment in other income (expense), net.

 

*MRV*

 

On July 1, 2007,Fiberxon, an investment in which the Company had a 7% ownership interest,completed a merger with MRV Communications (“MRV”), which is a publicly-tradedcompany in an active market. In exchange for the Company’s interest inFiberxon, the Company was entitled to receive $1.5 million in cash,1,519,365 shares of MRV common stock valued at approximately $4.5 millionand deferred consideration of approximately $2.7 million. The deferredconsideration becomes payable upon the completion of certain milestones and maybe reduced by legitimate claims of MRV for certain matters related to themerger. In the third quarter of 2007, the Company received cash considerationof $1.5 million and 1,519,365 shares of MRV common stock and recognized again on investment of $2.9 million. During the three and nine months endedSeptember 30, 2008, the Company recorded an unrealized loss of less than$0.1 million and $1.8 million, respectively, in other comprehensive income,representing the change in fair value of the investment during the period.  The accumulated unrealized loss at September 30,2008 was $2.7 million, representing the difference between the fair value ofthe investment on September 30, 2008 and the initial amount recorded of$4.5 million when the MRV shares were received in 2007.  Because the Company has the ability andintent to hold this investment until a recovery of

 

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fair value, theCompany does not consider this investment to be other-than-temporarilyimpaired. At September 30, 2008, MRV is the only investment accounted forunder SFAS 115, “Accounting for Certain Investments in Debt and EquitySecurities”.

 

*FITEL*

 

First InternationalTelecom Corporation (“FITEL”), which was a publicly-traded company in an activemarket in Taiwan, is a provider of telecommunications and data transmissionservices in Taiwan and Hong Kong, providing mobile paging, mobile data andwireless services.  The Company invested$0.1 million in July 2003 and $2.0 million in March 2008 inFITEL.  As of September 30, 2008 andDecember 31, 2007, the Company had less than 2% of ownership interest inFITEL.  During 2007, FITEL wasvoluntarily temporarily delisted from the publicly-traded market for raisingfunds through a private placement for developing its new WiMAX business.  Prior to the delisting, the investment wasaccounted for under SFAS 115.  During thethird quarter of 2008, FITELfiled a petition for reorganization under Taiwanese law.  As a result of the filing, managementre-evaluated the carrying value of this investment, including reviewingFITEL’s cash position, recent financing activities, financing needs,earnings/revenue outlook, operational performance, management/ownershipchanges, and competition. Based on this review, the Company recorded a $2.1million write-down in the value of this investment in other income (expense),net.

 

*New PCD*

 

In connection with thedivestiture of PCD, the Company invested $1.6 million in shares of common stockrepresenting approximately a 2.5% ownership interest of New PCD.  The investment is accounted for under thecost method.

 

**Fair Value Measurements**

 

As discussed in Note 2,effective January 1, 2008, the Company adopted SFAS 157 as it relatesto financial assets and liabilities that are being measured and reported atfair value on a recurring basis.  Although the adoption of SFAS 157did not materially impact its financial condition, results of operations, orcash flows, the Company is now required to provide additional disclosures aspart of its financial statements.  In accordance with FSP 157-2, theCompany deferred adoption of SFAS 157 as it relates to non-financial assets andliabilities measured at fair value on a nonrecurring basis.

 

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

 

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

 

**NOTE 8 - RESTRICTED CASH**

 

At September 30,2008, the Company had short-term restricted cash of $18.5 million, and hadlong-term restricted cash of $18.5 million included in other long-term assets.At December 31, 2007 the Company had short-term restricted cash of$6.4 million, and had long-term restricted cash of $20.2 millionincluded in other long-term assets. These amounts primarily collateralize theCompany’s issuances of standby and commercial letters of credit.

 

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**NOTE 9 - NOTES RECEIVABLE AND RECEIVABLES PURCHASE AGREEMENT**

 

Commercial notesreceivable available for sale were $14.9 million and $12.6 million at September 30,2008 and December 31, 2007, respectively. The Company may discount thesecommercial notes with banking institutions in China. A sale of these notes isreflected as a reduction of notes receivable and the proceeds of the settlementof these notes are included in cash flows from operating activities in theconsolidated statement of cash flows. There were no commercial notes receivablesold during the three and nine months ended September 30, 2008 and 2007.

 

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

 

**NOTE****10 - INVENTORIES**

 

As of September 30,2008 and December 31, 2007, total inventories consisted of the following:

 

| ** **        | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|-------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **        | ** ** | **(in thousands)**      | ** ** |
| Raw materials     |       | $                            | 28,915     |                        | $          | 34,413 |   |
| Work-in-process   |       | 34,353                       |       | 35,853                      |       |
| Finished goods    |       | 132,139                      |       | 264,201                     |       |
| Total Inventories |       | $                            | 195,407    |                        | $          | 334,467 |   |

 

**NOTE 11 - INTANGIBLE ASSETS**

 

As of September 30,2008 and December 31, 2007, intangible assets consisted of the following:

 
| ** **                         | ** ** | **September 30, 2008** | ** ** | **December 31, 2007** | ** ** |
|------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                         | ** ** | **(in thousands)**          | ** ** | ** **                      | ** ** |
| ** **                         | ** ** | **Gross  Carrying****Amount**    | ** ** | **Accumulated****Amortization** | ** ** | **Net  Carrying****Amount** | ** ** | **Gross  Carrying****Amount** | ** ** | **Impairment****Charges** | ** ** | **Accumulated****Amortization** | ** ** | **Net  Carrying****Amount** | ** ** |
| ***Amortized intangible assets:*** |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Existing technology                |       | $                                | —     |                            | $          | — |   | $ | — |   | $ | 39,530 |   | $ | (5,214 | ) | $ | (33,843 | ) | $ | 473 |   |
| Customer relationships             |       | 11,128                           |       | (5,935                          | )          | 5,193 |   | 57,220 |   | (10,458 | ) | (24,676 | ) | 22,086 |   |
| Trade names                        |       | —                           |       | —                          |       | — |   | 4,940 |   | — |   | (4,940 | ) | — |   |
| Non-compete agreement              |       | —                           |       | —                          |       | — |   | 10,800 |   | — |   | (8,550 | ) | 2,250 |   |
|                               |       | $                                | 11,128     |                            | $          | (5,935 | ) | $ | 5,193 |   | $ | 112,490 |   | $ | (15,672 | ) | $ | (72,009 | ) | $ | 24,809 |   |

 

Amortization expense was$0.3 million and $4.0 million for the three months ended September 30,2008 and 2007, respectively, and was $3.8 million and $12.1 million for thenine months ended September 30, 2008 and 2007, respectively. In the fourthquarter of 2007, the Company determined that the undiscounted cash flows werenot sufficient to recover the carrying value of the customer relationships andtechnology intangible assets within the Other segment and recorded anintangible asset impairment charge of $15.7 million.  During the third quarter of 2008, the Companydivested intangibles with a net carrying amount of approximately $15.8 millionin connection with the sale of PCD (see Note 3).

 

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The estimated aggregateamortization expense for intangibles for the remainder of 2008 and each of thenext four years and thereafter is as follows:

 

| ** **        | ** ** | **(in thousands)** | ** ** |
|-------------------|------------|-------------------------|------------|
| Remainder of 2008 |       | $                       | 278        |   |
| 2009              |       | 1,113                   |       |
| 2010              |       | 1,113                   |       |
| 2011              |       | 1,113                   |       |
| 2012              |       | 1,113                   |       |
| Thereafter        |       | 463                     |       |
|              |       | $                       | 5,193      |   |

 

**NOTE 12 - DEBT**

 

The following representsthe outstanding borrowings at September 30, 2008 and December 31,2007:

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

 

At September 30,2008, the Company had no bank loans outstanding. At September 30, 2008,the Company had credit facilities in China totaling $428.6 million, ofwhich $191.5 million was for working capital purposes and the remaining $237.1 millionwas for use in support of letters of credit and corporate guarantees. Theseavailable credit facilities include a new credit facility in China providing$265.1 million in additional borrowing availability which was entered intoduring the third quarter of 2008.  Thisfacility requires collateralization for working capital draws in excess of$29.5 million and/or non-working capital draws in excess of $44.2 million. Asof September 30, 2008, $389.8 million of the total credit facilitiesremained available. Approximately $163.5 million of these facilities expireduring the fourth quarter of 2008 and approximately $265.1 million of thesefacilities expire in the third quarter of 2009. As of September 30, 2008,the Company had not guaranteed any debt not included in the condensedconsolidated balance sheet.

 

On March 21,2008, the Company entered into a credit agreement providing for a $75.0 millionsecured revolving credit facility that was subject to an accounts receivableand inventory borrowing base formula and was used during the second quarter of2008 to fund the Company’s general working capital requirements.  Duringthe second quarter, the Company repaid all outstanding borrowings under thiscredit agreement. On June 30, 2008, in connection with the entry into anagreement for the sale of PCD (see Note 3), the Company terminated thecommitments under the credit agreement. Upon termination of the creditagreement, the Company expensed the remaining unamortized debt issuance costsof approximately $1.1 million.

 

On March 12, 2003,the Company completed an offering of $402.5 million of 7/8% convertible subordinated notes due March 1,2008 to qualified buyers pursuant to Rule 144A under the Securities Act of1933.  In 2007, the Company and holdersof the remaining $274.6 million of convertible subordinated notes enteredinto two supplemental indentures waiving certain provisions of the originalagreement and providing for an increase in the interest rate. The notes wereconvertible into the Company’s common stock, under certain conditions, at a conversionprice of $23.79 per share and were subordinated to all present and futuresenior debt of the Company.  On March 3,2008, the Company repaid the convertible subordinated notes of $289.5 millionwhich included a principal payment of $274.6 million and the accrued interestof $14.9 million.

 

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

 

The Company provides awarranty on its equipment and handset sales for a period generally ranging fromone to two years from the time of final acceptance. At times, the Company hasentered into arrangements to provide limited warranty services for periodslonger than two years. The Company provides for the expected cost of productwarranties at the time that revenue is recognized based on an assessment of pastwarranty experience and when specific circumstances dictate. From time to time,the Company may be subject to additional costs related to non-standard warrantyclaims from its customers. If and when this occurs, the Company estimatesadditional accruals based on historical experience, communication with itscustomers and various assumptions

 

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that the Companybelieves to be reasonable under the circumstances. Such additional warrantyaccruals are recorded in the period in which the additional costs areidentified.

 

Warranty obligations,included in other current liabilities, are as follows:

 
| ** **                                        | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                        | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                        | ** ** | **(in thousands)**                                  | ** ** |
| Balance at beginning of period *                  |       | $                                                        | 35,580     |                                                    | $          | 56,124 |   | $ | 52,734 |   | $ | 66,408 |   |
| Accruals for warranties issued during the  period |       | 4,234                                                    |       | 11,466                                                  |       | 15,821 |   | 25,508 |   |
| Settlements made during the period                |       | (5,060                                                   | )          | (11,790                                                 | )          | (23,677 | ) | (36,116 | ) |
| Warranty obligations divested upon sale of  PCD   |       | —                                                   |       | —                                                  |       | (10,124 | ) | — |   |
| Balance at end of period                          |       | $                                                        | 34,754     |                                                    | $          | 55,800 |   | $ | 34,754 |   | $ | 55,800 |   |

 

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* The balance at thebeginning of the three months ended September 30, 2008 excludes warrantyobligations relating to PCD as such amounts were classified as held for sale asof June 30, 2008.

 

Certain of the Company’ssales contracts include provisions under which customers would be indemnifiedby the Company in the event of, among other things, a third-party claim againstthe customer for intellectual property rights infringement related to theCompany’s products.  There are nolimitations on the maximum potential future payments under theseguarantees.  The Company has not accruedany amount in relation to these provisions as no such claims have developedinto assertable claims and the Company believes it has defensible rights to theintellectual property embedded in its products.

 

**NOTE 14 - COMMITMENTS AND CONTINGENCIES**

 

***Litigation***

 

*Securities Class Action Litigation*

 

Beginning in October 2004,several shareholder class action lawsuits alleging federal securitiesviolations were filed against the Company and various officers and directors ofthe Company. The actions have been consolidated in United States District Courtfor the Northern District of California under the caption *In re UTStarcom, Inc. Securities Litigation*,Master File No. C-04-4908-JW (PVT). The lead plaintiffs in the case fileda First Amended Consolidated Complaint on July 26, 2005. The First AmendedComplaint alleged violations of the Securities Exchange Act of 1934, and wasbrought on behalf of a putative class of shareholders who purchased the Company’sstock after April 16, 2003 and before September 20, 2004. On April 13,2006, the lead plaintiffs filed a Second Amended Complaint adding newallegations and extending the end of the class period to October 6, 2005.In addition to the Company defendants, the plaintiffs are also suing Softbank.Plaintiffs’ complaint seeks recovery of damages in an unspecified amount.

 

On June 2, 2006, theCompany and the individual defendants filed a motion to dismiss the SecondAmended Complaint. On March 21, 2007, the Court granted defendants’ motionand dismissed plaintiffs’ Second Amended Complaint. The Court grantedplaintiffs leave to file a Third Amended Complaint, which plaintiffs filedon May 25, 2007. On July 13, 2007, the Company and the individualdefendants filed a motion to dismiss and a motion to strike the Third AmendedComplaint. On March 14, 2008, the Court granted defendants’ motion anddismissed plaintiffs’ Third Amended Complaint. The Court granted plaintiffs leave to file a Fourth Amended Complaint,which plaintiffs filed on May 14, 2008. On June 13, 2008, consistent with the Court’s March 14, 2008dismissal order, the Company and the individual defendants filed objections tothe form and content of the Fourth Amended Complaint.  On July 24, 2008, the Court overruledthe objections. On September 8, 2008, the Company and the individualdefendants filed a motion to dismiss and a motion to strike certain allegationsfrom the Fourth Amended Complaint.

 

On September 4,2007, a second shareholder class action complaint captioned *Peter Rudolph v. UTStarcom, et al.*, Case No. C-07-4578SI, was filed in the United States District Court for the Northern District ofCalifornia against the Company and some of its current and former directors andofficers. The complaint alleges violations of the Securities Exchange Act of1934 through undisclosed improper accounting practices concerning the Company’shistorical equity award grants. Plaintiff seeks unspecified damages on behalfof a purported class of purchasers of the Company’s common stock between July 24,2002 and September 4, 2007. On December 14, 2007, the Court appointedJames R. Bartholomew lead plaintiff. On January 25, 2008, the leadplaintiff filed an

 

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amendedcomplaint.  On April 14, 2008, theCourt granted defendants’ motion to dismiss the amended complaint.  The Court granted the lead plaintiff leave tofile a second amended complaint no later than May 16, 2008 which was filedby the lead plaintiff on May 16, 2008. On June 6, 2008, defendants filed a motion to dismiss the secondamended complaint. On August 21, 2008, the Court granted in part anddenied in part the motion to dismiss.

 

Due to the preliminarystatus of these lawsuits and uncertainties related to litigation, management isunable to evaluate the likelihood of either a favorable or unfavorable outcome.Accordingly, management is unable at this time to estimate the effects of thesecomplaints on the Company’s financial position, results of operations, or cashflows.

 

*Governmental Investigations*

 

On May 1, 2008, theU.S. Securities and Exchange Commission (the “SEC”) announced a finalsettlement agreement with the Company in connection with an investigationcommenced by the SEC in September 2005. The investigation involved the Company’s financial disclosures duringprior reporting periods, historic option grant awards practices, certainhistorical sales contracts in China and other matters. Without admitting ordenying the allegations in the SEC’s complaint, the Company consented to apermanent injunction against any future violations of certain books-and-recordsand internal control provisions of the federal securities laws. No monetarypenalties were assessed against the Company. In connection with the same investigation, Mr. Lu, the Company’sChief Executive Officer at the time of the settlement and the current Chairmanof the Board of Directors, individually entered into a settlement agreementwith the SEC. Without admitting or denying the allegations in the SEC’scomplaint, Mr. Lu agreed to pay a civil penalty of $100,000 and consentedto a permanent injunction on similar terms as the Company.

 

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

 

*Shareholder Derivative Litigation*

 

On November 17,2006, a shareholder derivative complaint captioned *Ernesto Espinoza v. Ying Wu et al.*, Case No. RG06298775,was filed against certain of the Company’s current and former officers anddirectors in the Superior Court of the County of Alameda, California. Thecomplaint alleges that the individual defendants, among other things, breachedtheir duties, were unjustly enriched, and violated the California CorporationsCode in connection with the timing of stock option grants. The complaint namesthe Company as a nominal defendant and seeks unspecified monetary damagesagainst the individual defendants and various forms of injunctive relief. On February 2,2007, the Company and the individual defendants filed demurrers against thecomplaint. On April 11, 2007, the Court sustained the individualdefendants’ demurrer, overruled the Company’s demurrer, ordered the plaintiffto file an amended complaint, and ordered the Company to answer the originalcomplaint. The plaintiff filed an amended complaint and the Company has filedan answer to the amended complaint. On August 21, 2007, the individualdefendants filed demurrers against the amended complaint. The Court sustainedthe individual defendants’ demurrers and ordered the plaintiff to file asecond amended complaint.  On September 26,2008, plaintiff filed his second amended complaint.

 

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Due to the preliminary status of this complaint anduncertainties related to litigation, management of the Company is unable toevaluate the likelihood of either a favorable or unfavorable outcome.Accordingly, management of the Company is unable at this time to estimate theeffects of this complaint on the Company’s financial position, results ofoperations, or cash flows.

 

*IPO Allocation*

 

On October 31, 2001, a complaint was filed inUnited States District Court for the Southern District of New York against theCompany, some of the Company’s directors and officers and various underwritersfor the Company’s initial public offering. Substantially similar actions werefiled concerning the initial public offerings for more than 300 differentissuers, and the cases were coordinated as *Inre Initial Public Offering Securities Litigation*, 21 MC 92 forpretrial purposes. In April 2002, a consolidated amended complaint was filedin the matter against the Company, captioned *Inre UTStarcom, Initial Public Offering Securities Litigation*, CivilAction No. 01-CV-9604. Plaintiffs allege violations of the Securities Actof 1933 and the Securities Exchange Act of 1934 through undisclosed improperunderwriting practices concerning the allocation of IPO shares in exchange forexcessive brokerage commissions, agreements to purchase shares at higher pricesin the aftermarket and misleading analyst reports. Plaintiffs seek unspecified damageson behalf of a purported class of purchasers of the Company’s common stockbetween March 2, 2000 and December 6, 2000. The Company’s directorsand officers have been dismissed without prejudice pursuant to a stipulation.On February 19, 2003, the Court granted in part and denied in part amotion to dismiss the claims brought by defendants including the Company. Theorder dismissed all claims against the Company except for a claim brought underSection 11 of the Securities Act of 1933, which alleges that theregistration statement filed in accordance with the IPO was misleading. In June 2004,a stipulation of settlement and release of claims against the issuerdefendants, including the Company, was submitted to the court for approval. Theterms of the settlement, if approved, would have dismissed and released allclaims against the participating defendants (including the Company). In August 2005,the Court preliminarily approved the settlement. In December 2006, theCourt of Appeals for the Second Circuit reversed the Court’s October 2004order certifying a class in six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings. TheCompany’s case is not one of the test cases. Because class certification was acondition of the settlement, it was unlikely that the settlement would receivefinal Court approval. On June 25, 2007, the Court entered an orderterminating the proposed settlement based on a stipulation among the parties tothe settlement. Plaintiffs have filed amended master allegations and amendedcomplaints in the six test cases. On March 26, 2008, the Court largelydenied the defendants’ motion to dismiss the amended complaints.  It is unclear whether there will be anyrevised or future settlement. If the litigation proceeds, management of theCompany believes that the Company has meritorious defenses and management ofthe Company intends to defend the action vigorously. The total amount of theloss associated with the above litigation is not determinable at this time.Therefore, management of the Company is unable to currently estimate the loss,if any, associated with the litigation.

 

*UTStarcom, Inc. v. Starent Patent InfringementLitigations*

 

On February 16, 2005, the Company filed a suitagainst Starent for patent infringement in the U.S. District Court for theNorthern District of California. In the Complaint, the Company asserted thatStarent infringes UTStarcom patent U.S. Reg. No. 6,829,473 (“the ‘473patent”) through Starent’s development and testing of a software upgrade forits customer’s installed ST-16 Intelligent Mobile Gateways. The Company seeksdeclaratory and injunctive relief. Starent subsequently filed its answer andcounterclaims, and the Company then filed a motion to dismiss Starent’scounterclaim. On July 19, 2005, the parties stipulated that Starent wouldfile an amended answer and counterclaim and the Company then responded toStarent’s amended counterclaim. In early December 2006, the Company fileda reissue application for the ‘473 patent with the United States Patent andTrademark Office. Starent has also filed for reexamination of the ‘473 patent.The reexamination and reissue are currently co-pending. The litigation is stillin a preliminary stage, and is stayed pending the outcome of the reissue. Thelitigation and its outcome cannot be predicted, although management of theCompany believes the litigation has merit. Nonetheless, management of theCompany believes that any adverse judgment on Starent’s counterclaims will not havea material adverse effect on the Company’s business, financial condition,results of operations or cash flows.

 

On May 8,2007, the Company filed an additional suit against Starent and sixteenindividual defendants (who were all former employees of 3Com’s CommWorksdivision, of which the Company acquired certain assets in May of 2003) in theNorthern District of Illinois.  Thecauses of action include claims for patent infringement, misappropriation oftrade secrets, intentional interference with business relations and prospectiveeconomic advantage and declarations of ownership of certain patent rights.  The Company seeks compensatory damages,punitive damages and injunctive relief. After the court denied the defendant’s motion to dismiss the misappropriationof trade secrets claims, on August 30, 2007, Defendants answered the Company’scomplaint, denying the Company’s allegations and asserting a number ofaffirmative defenses and counterclaims. The Company filed an Amended Complaint to allege additional relatedcauses of action.  Starent moved todismiss certain causes of action of the Amended Complaint.  On May 30, 2008, the Company amended itscomplaint to remove from suit U.S. patent 6,978,128, and to add additionalfactual allegations relating to all 

 

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defendants in the case.  On July 23, 2008, the Court dismissed theCompany’s trade secret and contract-based counts.  The Company asked the Court to clarify thatruling and filed a motion for leave to file a Fourth Amended Complaintcontaining the trade secret and contract-based counts.  After initially granting Defendants’ motionto strike that complaint, the Court reconsidered its order and granted theCompany leave to file it.  The FourthAmended Complaint has been filed. Defendants have moved to dismiss various counts of that Complaint.  The Company is opposing that motion.  The Company has moved to dismiss certain ofStarent’s counterclaims and Starent is opposing that motion.  Discovery and motion practice is ongoing andthe Court has appointed a special master to handle discovery and issues relatedto identification of the trade secrets. The Company believes that any adverse judgment on Starent’scounterclaims will not have a material adverse effect on the Company’sbusiness, financial condition, results of operations of cash flows.

 

*Telemetrix, Inc. Arbitration*

 

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

 

*Other Litigation*

 

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

 

***Uncertain Tax Positions***

 

Effective January 1, 2007, the Company adoptedthe provisions of FASB Interpretation No. 48 (“FIN 48”).  As of September 30,2008, the Company had $84.3 million of gross unrecognized tax benefits. Ifrecognized, the portion of gross unrecognized tax benefits that would decreasethe provision for income taxes and increase the Company’s net income is $9.3million. The impact on net income reflects the gross unrecognized tax benefitsnet of certain deferred tax assets and the federal tax benefit of state incometax items totaling $75.0 million.

*** ***

***Letters of credit***

 

The Company issues standby letters of credit primarilyto support international sales activities outside of China.  When the Company submits a bid for a sale,often the potential customer will require that the Company issue a bid bond ora standby letter of credit to demonstrate its commitment through the bidprocess.  In addition, the Company may berequired to issue standby letters of credit as guarantees for advance customerpayments upon contract signing or performance guarantees.  The standby letters of credit usually expirewithout being drawn by the beneficiary thereof. Finally, the Company may issue commercial letters of credit in supportof purchase commitments.  As of September 30,2008 the Company had outstanding letters of credit approximating $69.7 million.

 

**NOTE 15 - SEGMENT REPORTING**

 

During the fourth quarter of 2007, the Companyannounced a new organization structure to align the business units with itscorporate strategy. This new organization structure changed the reportingsegments on which the Company measures performance and allocates resources.Effective October 1, 2007, the new reporting segments were as follows:

 

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

 

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

 

·                  Personal Communications Division(PCD)—Focused on distribution of mobile handsets, mainly in the UnitedStates.  On July 1, 2008 the Companysold PCD to New PCD (see Note 3).

 

·                  Handsets—Focused on mobilephone business with continued focus on the PAS and CDMA handset market, as wellas data cards markets.  Handset sales toNew PCD, which commenced after the July 1, 2008 sale of PCD, are included inthis segment.

 

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

 

·                  Other—includes Mobile Solutions whichfocused on development, sales and services for the IPCDMA market; and CustomSolutions which focused on customized telecommunication solutions. On July 31,2008, the Company divested its Mobile Solutions Business Unit (see Note 3).

 

The Company’s management makes financial decisionsbased on information it receives from its internal management system andcurrently evaluates the operating performance of and allocates resources to thereporting segments based on segment revenue and gross profit. Cost of sales anddirect expenses in relation to production are assigned to the reportingsegments.  The accounting policies usedin measuring segment assets and operating performance are the same as thoseused at the consolidated level.

 

Summarized below are the Company’s segment net sales,gross profit and segment margin for the three and nine months ended September 30,2008 and 2007 based on the current reporting segment structure.  The Company has reclassified its previouslyreported segment information for the three and nine months endedSeptember 30, 2007 to conform to the current segment presentation.

 

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| ** **                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                                 | ** ** | **% of net  sales**                           | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of net  sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                  | ** ** |
| ***Net Sales by Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure   |       | $                                                        | 31,112     |                                                    | 17         | % | $ | 40,892 |   | 6 | % | $ | 92,591 |   | 7 | % | $ | 105,673 |   | 6 | % |
| Multimedia Communication   |       | 57,787                                                   |       | 32                                                      | %          | 58,289 |   | 9 | % | 199,251 |   | 14 | % | 194,283 |   | 12 | % |
| PCD                        |       | —                                                   |       | —                                                  |       | 458,301 |   | 71 | % | 879,588 |   | 63 | % | 1,104,428 |   | 67 | % |
| Handsets                   |       | 71,906                                                   |       | 40                                                      | %          | 59,254 |   | 9 | % | 165,390 |   | 12 | % | 191,150 |   | 11 | % |
| Services                   |       | 14,197                                                   |       | 8                                                       | %          | 14,655 |   | 2 | % | 41,172 |   | 3 | % | 38,320 |   | 2 | % |
| Other                      |       | 5,605                                                    |       | 3                                                       | %          | 15,103 |   | 3 | % | 21,360 |   | 1 | % | 26,786 |   | 2 | % |
|                       |       | $                                                        | 180,607    |                                                    | 100        | % | $ | 646,494 |   | 100 | % | $ | 1,399,352 |   | 100 | % | $ | 1,660,640 |   | 100 | % |

 
| ** **                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                                 | ** ** | **Gross  profit %**                                | ** ** | **2007** | ** ** | **Gross  profit %** | ** ** | **2008** | ** ** | **Gross  profit %** | ** ** | **2007** | ** ** | **Gross  profit %** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                  | ** ** |
| ***Gross profit by Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure      |       | $                                                        | 3,032      |                                                    | 10         | % | $ | (4,770 | ) | (12 | )% | $ | 6,922 |   | 7 | % | $ | 9,544 |   | 9 | % |
| Multimedia Communication      |       | 30,846                                                   |       | 53                                                      | %          | 16,643 |   | 29 | % | 92,820 |   | 47 | % | 67,052 |   | 35 | % |
| PCD                           |       | —                                                   |       | —                                                  |       | 26,983 |   | 6 | % | 69,005 |   | 8 | % | 59,750 |   | 5 | % |
| Handsets                      |       | 14,965                                                   |       | 21                                                      | %          | 16,966 |   | 29 | % | 37,961 |   | 23 | % | 64,409 |   | 34 | % |
| Services                      |       | 4,720                                                    |       | 33                                                      | %          | 3,517 |   | 24 | % | 11,832 |   | 29 | % | 4,248 |   | 11 | % |
| Other                         |       | 3,764                                                    |       | 67                                                      | %          | 5,094 |   | 34 | % | 12,814 |   | 60 | % | 14,444 |   | 54 | % |
|                          |       | $                                                        | 57,327     |                                                    | 32         | % | $ | 64,433 |   | 10 | % | $ | 231,354 |   | 17 | % | $ | 219,447 |   | 13 | % |

 
| ** **                              | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                  | ** ** |
| ***Segment Margin and Operating Loss*** |       |                                                     |       |                                                    |       |   |   |   |   |
| Broadband Infrastructure                |       | $                                                        | (3,222     | )                                                       | $          | (12,162 | ) | $ | (12,162 | ) | $ | (13,569 | ) |
| Multimedia Communication                |       | 16,585                                                   |       | (1,744                                                  | )          | 49,042 |   | 13,139 |   |
| PCD                                     |       | —                                                   |       | 19,578                                                  |       | 53,576 |   | 35,657 |   |
| Handsets                                |       | 1,978                                                    |       | 4,017                                                   |       | (3,444 | ) | 26,920 |   |
| Services                                |       | 3,623                                                    |       | 2,504                                                   |       | 8,417 |   | 1,247 |   |
| Other                                   |       | (1,627                                                   | )          | (3,646                                                  | )          | (11,970 | ) | (12,645 | ) |
| Total segment margin                    |       | 17,337                                                   |       | 8,547                                                   |       | 83,459 |   | 50,749 |   |
| General and Corporate                   |       | (52,250                                                  | )          | (60,067                                                 | )          | (180,339 | ) | (209,867 | ) |
| Operating Loss                          |       | $                                                        | (34,913    | )                                                       | $          | (51,520 | ) | $ | (96,880 | ) | $ | (159,118 | ) |

 

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Assets bysegment are as follows:

 
| ** **                               | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                               | ** ** | **(in thousands)** | ** ** |
| ***Property, Plant and Equipment, net*** |       |                    |       |                  |       |
| Broadband Infrastructure                 |       | $                       | 41,649     |                  | $          | 42,756 |   |
| Multimedia Communication                 |       | 76,814                  |       | 77,478                |       |
| PCD                                      |       | —                  |       | 1,513                 |       |
| Handsets                                 |       | 42,072                  |       | 43,191                |       |
| Services                                 |       | 42,784                  |       | 43,922                |       |
| Other                                    |       | 92                      |       | 234                   |       |
|                                     |       | $                       | 203,411    |                  | $          | 209,094 |   |

 
| ** **               | ** ** | **September 30,**   | ** ** | **December 31,** | ** ** |
|--------------------------|------------|---------------------|------------|------------------|------------|
| ** **               | ** ** | **2008**            | ** ** | **2007**         | ** ** |
| ** **               | ** ** | **(in  thousands)** | ** ** |
| ***Total assets***       |       |                |       |             |       |
| Broadband Infrastructure |       | $                   | 459,683    |             | $          | 518,742 |   |
| Multimedia Communication |       | 562,239             |       | 605,930          |       |
| PCD                      |       | —              |       | 357,004          |       |
| Handsets                 |       | 297,979             |       | 360,075          |       |
| Services                 |       | 100,331             |       | 85,269           |       |
| Other                    |       | 20,907              |       | 57,568           |       |
|                     |       | $                   | 1,441,139  |             | $          | 1,984,588 |   |

 

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

 
| ** **                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                | ** ** | **2008**                                                 | ** ** | **% of net  sales**                           | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of net  sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                | ** ** | **(in thousands)**                                  | ** ** |
| ***Net Sales by region*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| United States             |       | $                                                        | 43,127     |                                                    | 24         | % | $ | 457,945 |   | 71 | % | $ | 907,770 |   | 65 | % | $ | 1,112,448 |   | 67 | % |
| China                     |       | 97,605                                                   |       | 54                                                      | %          | 124,228 |   | 19 | % | 325,479 |   | 23 | % | 390,184 |   | 24 | % |
| Japan                     |       | 10,303                                                   |       | 6                                                       | %          | 19,863 |   | 3 | % | 32,696 |   | 2 | % | 54,701 |   | 3 | % |
| Other                     |       | 29,572                                                   |       | 16                                                      | %          | 44,458 |   | 7 | % | 133,407 |   | 10 | % | 103,307 |   | 6 | % |
| Total net sales           |       | $                                                        | 180,607    |                                                    | 100        | % | $ | 646,494 |   | 100 | % | $ | 1,399,352 |   | 100 | % | $ | 1,660,640 |   | 100 | % |

 

Approximately 54% and 19% of the Company’s net salesduring the three months ended September 30, 2008 and 2007, respectively,and approximately 23% and 24% of the Company’s net sales during the nine monthsended September 30, 2008 and 2007, respectively, were in China.  The fluctuations in the percent of net salesin the United States, China, Japan and Other during the three months endedSeptember 30, 2008 compared to the same period in 2007 was primarily due to thesale of PCD on July 1, 2008.

 

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Long-lived assets, consisting of property, plant andequipment, by geographical area are as follows:

 
| ** **              | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **              | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| U.S.                    |       | $                       | 16,996     |                  | $          | 18,470 |   |
| China                   |       | 182,190                 |       | 185,070               |       |
| Other                   |       | 4,225                   |       | 5,554                 |       |
| Total long-lived assets |       | $                       | 203,411    |                  | $          | 209,094 |   |

 

**NOTE 16 – CREDIT RISK ANDCONCENTRATION**

** **

The following customers accounted for 10% or more ofthe Company’s net sales:

 
| ** **        | ** ** | **For the three** | ** ** | **For the nine** | ** ** |
|-------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **        | ** ** | **months ended**       | ** ** | **months ended**      | ** ** |
| ** **        | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** |
| ** **        | ** ** | **% of net**      | ** ** | **% of net**     | ** ** |
| **2008**          | ** ** | **sales**                   | ** ** | **sales**                  | ** ** |
| Verizon Wireless  |       | —                      |       | 24                         | %          |
| Sprint Spectrum   |       | —                      |       | 13                         | %          |
| New PCD           |       | 19                          | %          | 2                          | %          |
| Zhejiang Province |       | 12                          | %          | 5                          | %          |

 
| **2007**           | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------|------------|------------|------------|------------|------------|
| Verizon Wireless   |       | 27         | %          | 22         | %          |
| T-Mobile USA, Inc. |       | 12         | %          | 14         | %          |
| Sprint Spectrum    |       | 14         | %          | 12         | %          |

 

At September 30, 2008, New PCD accounted forapproximately 15% of the total accounts receivable of the Company. AtDecember 31, 2007, Sprint Spectrum L.P. and T-Mobile USA, Inc.accounted for approximately 16% and 15%, respectively, of the total accountsreceivable of the Company. Sales to Verizon, Sprint Spectrum and T-Mobile wereprimarily from the PCD segment.  OnJuly 1, 2008 the Company sold the PCD segment (See Note 3).

 

Approximately 30% and 15% of the Company’s net salesduring the three months ended September 30, 2008 and 2007, respectively, andapproximately 14% and 17% of the Company’s net sales during the nine monthsended September 30, 2008 and 2007, respectively, were to entitiesaffiliated with the government of China. Accounts receivable balances fromthese China government affiliated entities or state owned enterprises were $112.2million and $129.5 million, respectively, as of September 30, 2008 andDecember 31, 2007. The Company extends credit to its customers in Chinagenerally without requiring collateral. With respect to global sales outside ofChina, the Company may require letters of credit from its customers. TheCompany monitors its exposure for credit losses and maintains allowances fordoubtful accounts.

 

**NOTE 17 - RELATED PARTY TRANSACTIONS**

 

*Softbank and affiliates*

 

The Company recognizes revenue with respect to salesof telecommunications equipment to affiliates of Softbank, a significantstockholder of the Company. Softbank offers ADSL coverage throughout Japan,which is marketed under the name “YAHOO! BB.” The Company supports Softbank’sfiber-to-the-home service through sales of its carrier class GEPON product aswell as its NetRingÔ product. Inaddition, the Company supports Softbank’s internet protocol television (“IPTV”),through sales of its RollingStreamÔ product. TheCompany recognized revenue for sales of telecommunications equipment andservices to affiliates of Softbank of $9.7 million and $19.6 million,respectively, during the three months ended September 30, 2008 and 2007and $30.9 million and $53.0 million, respectively, during the nine months endedSeptember 30, 2008 and 2007.

 

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Included in accounts receivable at September 30,2008 and December 31, 2007 were $10.5 million and $26.3 million,respectively, related to these transactions. The Company had immaterial amountsof accounts payable to Softbank and its affiliates at September 30, 2008and December 31, 2007.

 

Sales to Softbank include a three year service periodand a penalty clause if product failure rates exceed a certain level over aseven year period. As of September 30, 2008 and December 31, 2007,the Company’s customer advance balance related to Softbank agreements was $0.7 millionand $0.3 million, respectively.  Thecurrent deferred revenue balance related to Softbank was $4.9 million and $5.6million as of September 30, 2008 and December 31, 2007,respectively.  As of September 30,2008, the Company’s non-current deferred revenue balance related to Softbank was$9.6 million compared to $10.1 million as of December 31, 2007.

 

As of September 30, 2008, Softbank beneficiallyowned approximately 12% of the Company’s outstanding stock.

 

*Audiovox*

 

Prior to the sale of PCD on July 1, 2008, one of theCompany’s former officers served as a director for Audiovox Corporation (“Audiovox”).The Company paid approximately $0.4 million during the three months endedSeptember 30, 2007 and $0.8 million and $1.1 million during the ninemonths ended September 30, 2008 and 2007, respectively, for IT servicesprovided by Audiovox.

 

**NOTE 18 - RESTRUCTURING COSTS**

 

In the fourth quarter of 2007, the Company implementeda restructuring plan (the “2007 Plan”) to reduce operating costs. During thefirst quarter of 2008, the Company completed the reduction in force, reducingthe Company’s headcount by approximately 12%, or approximately 800 employees.The workforce reduction was primarily in the United States and China and, to alesser degree, other international locations.

 

At September 30, 2008 and December 31, 2007,the restructuring accrual included within other current liabilities in theconsolidated balance sheet was approximately $0.9 million and $3.2 million,respectively. The decrease of $2.3 million during the nine months ended September 30,2008 relates primarily to cash payments against the accrual related to theworkforce reductions and lease costs. The remaining restructuring liability isprimarily related to a lease obligation and will be settled over the remaininglease term, which expires in fiscal year 2010.

 

**NOTE 19 - OTHER INCOME (EXPENSE), NET**

 

Other income (expense), net for the three and ninemonths ended September 30, 2008 and 2007, respectively are comprised ofthe following:

 
| ** **                                                                     | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                     | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                                     | ** ** | **(in thousands)**                                  | ** ** |
| Gain on sale of investments                                                    |       | $                                                        | —     |                                                    | $          | 2,948 |   | $ | 39,679 |   | $ | 5,761 |   |
| Gain on liquidation of investment in a  variable interest entity (see Note 21) |       | —                                                   |       | —                                                  |       | 8,169 |   | — |   |
| Impairment of long-term investments                                            |       | (4,308                                                   | )          |                                                    |       | (4,308 | ) |   |   |
| Foreign exchange (losses) gains                                                |       | (10,577                                                  | )          | 1,266                                                   |       | (6,427 | ) | 2,080 |   |
| Other                                                                          |       | (58                                                      | )          | 133                                                     |       | 994 |   | 635 |   |
| Total                                                                          |       | $                                                        | (14,943    | )                                                       | $          | 4,347 |   | $ | 38,107 |   | $ | 8,476 |   |
|                                                                                |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |

 

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

 

The Company adopted the provisions of FASBInterpretation No. 48, “Accounting for Uncertainty in Income Taxes-aninterpretation of FASB Statement No. 109” (FIN 48) on January 1,2007. As of December 31, 2007, the Company’s gross unrecognized taxbenefits totaled $79.7 million and are included in other long-term liabilities,net of certain deferred tax assets and the 

 

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federal tax benefit ofstate income tax items totaling $71.3 million. If recognized, the portion ofgross unrecognized tax benefits that would decrease the provision for incometaxes and increase the Company’s net income is approximately $8.4 million.

 

As of September 30, 2008, the Company’s grossunrecognized tax benefits totaled $84.3 million and are included in otherlong-term liabilities, net of certain deferred tax assets and the federal taxbenefit of state income tax items totaling $75.0 million. If recognized, theportion of gross unrecognized tax benefits that would decrease the provisionfor income taxes and increase the Company’s net income is approximately $9.3million. The total unrecognized tax benefits and increase for the currentperiod of these unrecognized tax benefits relate primarily to the allocationsof revenue and costs among the Company’s global operations.

 

The Company recognizes interest expense and penaltiesrelated to the above unrecognized tax benefits within income tax expense.  The Company had accrued interest andpenalties of approximately $3.2 million as of December 31, 2007 andapproximately $3.8 million as of September 30, 2008.

 

The Company is subject to taxation in the U.S. federaljurisdiction and various U.S. state and foreign jurisdictions. The Company’sincome tax returns for the 2003, 2004, and 2005 tax years are currently underaudit by the United States Internal Revenue Service.  TheCompany paid $0.2 million during the quarter in connection with the audit.  The Company is also under audit by thetaxing authorities in China on a recurring basis. The material jurisdictionsthat the Company is subject to examination are in the United States and China.The Company believes that it is reasonably possible that the amount of grossunrecognized tax benefits related to the resolution of income tax matters couldbe reduced by approximately $26 million during the next twelve months as incometax audits are settled and statute of limitations expire.  The portion of the $26 million of grossunrecognized tax benefits that would decrease the provision for income taxesand increase the Company’s net income is approximately $1 million, while theremainder would have no net impact on the Company’s financial statements.

 

FIN 48 established criteria for recognizing orcontinuing to recognize only more-likely-than-not tax positions, which mayresult in income tax expense volatility in future periods. While the Companybelieves that it has adequately provided for all tax positions, amountsasserted by taxing authorities could be greater than the Company’s accruedposition. Accordingly, additional provisions on income tax related matterscould be recorded in the future as revised estimates are made or the underlyingmatters are settled or otherwise resolved.

 

In establishing its deferred income tax assets and liabilities, theCompany makes judgments and interpretations based on the enacted tax laws andpublished tax guidance applicable to its operations as well as the amount andjurisdiction of future taxable income. The Company records deferred tax assetsand liabilities and evaluates the need for valuation allowances to reduce thedeferred tax assets to realizable amounts. The Company will maintain a fullvaluation allowance on its net deferred tax assets in China, the United States,and other countries until an appropriate level of profitability that generatestaxable income is sustained or until the Company is able to develop taxstrategies that would enable it to conclude that it is more likely than notthat a portion of its deferred tax assets will be realizable. Any reversal ofvaluation allowances will favorably impact the Company’s results of operationsin the period of the reversal.

 

Income tax expense was $7.8 million and $3.1million for the three months ended September 30, 2008 and 2007,respectively.  Income tax expense was $7.4 million and $10.7 million for the ninemonths ended September 30, 2008 and 2007, respectively. Due to thesale of PCD, the Company believes that it will not generate sufficient incomein Canada to realize its deferred tax assets in Canada.  Therefore, it is establishing a valuationallowance on its remaining net deferred tax assets in Canada.  The income tax expense recorded during thethree months ended September 30, 2008 associated with establishing thevaluation allowance is $1.9 million.

 

The China Corporate Income Tax Law (“CIT Law”) becameeffective on January 1, 2008.  As aresult of the enactment of new regulations during the first quarter of 2008which address CIT Law, the Company had recorded an income tax benefit of $11.7million in the first quarter of 2008 related to reversing a deferred taxliability on foreign withholding taxes related to the unremitted earnings ofthe Company’s subsidiaries which the Company determined to not be permanentlyreinvested outside the United States. The Company also had accrued $3.2 million of foreign withholding taxesin the first quarter of 2008 related to the realized gain on the sale of itsinvestment in Gemdale.  The Company hasnot provided any tax benefit on any forecasted current year losses incurred andtax credits generated in the United States and other countries, becausemanagement believes that it is more likely than not that the tax benefitassociated with these losses will not be realized. Also, the Company continuesto accrue tax expense in jurisdictions where the Company has been historicallyprofitable. Estimates of the annual effective tax rate at the end of theinterim periods are based on evaluations of possible future events andtransactions and may be subject to subsequent refinement or revision.

 

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**NOTE 21—VARIABLE INTEREST ENTITIES**

 

During the fourth quarter of 2005, the Companyprovided an interest free, $12.4 million loan to a party in China as seedcapital for a venture organized to participate in providing technical service,networking technology and equipment to the emerging market for IPTV products inChina. The loan, partially secured by an indirect ownership interest in theventure, was payable in 10 years and could be called early withoutpenalty. As a result of the foregoing, and the fact that the venture’scontinuing viability was heavily dependent on the further provision of networkand terminal equipment by the Company, the Company determined that the venturewas a variable interest entity (“VIE”) and that the Company was the primarybeneficiary of the venture. Therefore, the Company was required to consolidatethe VIE’s financial statements. The consolidation of this VIE in prior yearsdid not have a significant impact on the Company’s consolidated financialstatements. In March 2008, the Company received a repayment in full of theloan’s principal balance, eliminating its interest in the VIE, and resulting inreconsideration of the Company’s position as the primary beneficiary. Based onthis reconsideration event, management has concluded the Company is no longerthe primary beneficiary under FIN 46R, “Consolidation of Variable InterestEntities” and is no longer required to consolidate the VIE’s financialstatements. The Company’s Consolidated Statement of Operations for the ninemonth period ended September 30, 2008 includes the operating results ofthe VIE through February 2008, at which point the VIE was deconsolidatedfrom the Company’s financial statements. In the first quarter of 2008, theCompany recorded an $8.2 million gain upon the repayment of the loan anddeconsolidation that was included in other income, expense, net.  As management expects continuinginvolvement with the ongoing entity’s business as a supplier of IPTV equipment,the Company has determined the conditions for presentation as a discontinuedoperation were not met.

 

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

 

**FORWARD-LOOKING STATEMENTS**

 

This Quarterly Report on Form 10-Qcontains forward-looking statements regarding future events and our futureresults that are subject to the safe harbors created under the Securities Actof 1933 and the Securities Exchange Act of 1934. Forward-looking statements arebased on current expectations, estimates, forecasts and projections about us,our future performance and the industries in which we operate as well as on ourmanagement’s assumptions and beliefs. Statements that contain words like “expects,”“anticipates,” “may,” “will,” “targets,” “projects,” “intends,” “plans,” “believes,”“seeks,” “estimates,” or variations of such words and similar expressions areforward-looking statements. In addition, any statements that refer to trends inour businesses, future financial results, and our liquidity and business plansare forward-looking statements. Readers are cautioned that theseforward-looking statements are only predictions and are subject to risks anduncertainties, including those discussed in “Part II, Item 1A-Risk Factors”of this Form 10-Q.  Therefore,actual results may differ materially and adversely from those expressed in anyforward-looking statements. We do not guarantee future results, and actualresults, developments and business decisions may differ from those contemplatedby the forward-looking statements.  Weundertake no obligation to update these forward-looking statements to reflectevents or circumstances occurring after the date of this Form 10-Q.

 

**EXECUTIVE SUMMARY**

 

We design, manufactureand sell telecommunications infrastructure, handsets and customer premiseequipment, and provide services associated with their installation, operation,and maintenance. Our products are sold primarily to telecommunications serviceproviders or operators. We sell an extensive range of products that aredesigned to enable voice, data and video services for our operator customersand consumers around the world. Over the past few years, we have expanded ourfocus to build a global presence and currently sell our products in severalestablished and emerging growth markets, including North America, China, Japan,India, Central and Latin America, Europe, the Middle East, Africa and Southeastand North Asia.

 

We differentiateourselves with products designed to reduce network complexity, integrate highperformance capabilities and allow a simple transition to next generationnetworks. We design our products to facilitate cost-effective and efficientdeployment, maintenance and upgrades.

 

Because our products areIP-based, our customers can more easily integrate our products with otherindustry standard hardware and software. Additionally, we believe we canintroduce new features and enhancements that can be cost-effectively added 

 

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to our customers’existing networks. IP-based devices can be changed or upgraded in modules,saving our customers the expense of replacing their entire system installation.Our strategy is built upon the following key concepts:

 

·                  identify key technology shifts and trendsbefore our competitors;

 

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

 

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

 

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

 

Our current strategy isto focus on the key segments of the IP technology market which we haveidentified as having the greatest potential for profitable growth.Specifically, our strategy is to:

 

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

 

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

 

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

 

*ManagementChanges*

 

Effective July 1,2008, Peter Blackmore, President of the Company, was appointed Chief ExecutiveOfficer and a member of the Board of Directors.  Hong Liang Lu, who wasserving as Chief Executive Officer and as a member of the Board, was appointedExecutive Chairman of the Board. Thomas Toy, who was serving as Chairman of theBoard, was appointed as Lead Director of the Board. On August 28, 2008,Francis Barton, our previous Chief Financial Officer and Executive VicePresident, announced his retirement. Viraj Patel, our Corporate Controller,Vice President and Chief Accounting Officer, was also named interim ChiefFinancial Officer.

 

*Sale ofInvestments*

 

Duringthe first quarter of 2008, we sold our remaining investment in Gemdale for approximately$32.9 million and recognized a gain of $32.4 million in other income (expense),net.  We also sold our investment inInfinera for approximately $9.2 million and recognized a gain of $7.3 millionin other income (expense), net.

 

*Sale of Non-core Assets and Restructuring Programs*

 

On July 1, 2008, wesold UTStarcom Personal Communications LLC, a wholly-owned subsidiary of theCompany (“PCD”) to an entity controlled by AIG Global Investment Group andcertain other investors for a total sale consideration of approximately $233.4million. Pursuant to the terms of the divestiture agreement, we may be entitledto receive up to an additional $50 million earnout payment in 2011 based on theachievement of certain earnings levels of the divested business (“New PCD”)through December 31, 2010.  We recorded a net loss of $0.5 millionfrom the divestiture included as a component of continuing operations in thethird quarter of 2008.  As a result ofthe divestiture of PCD, we will lose a substantial part of our revenue;however, management expects improvement in gross margin as a percent of totalsales as the gross margins from our remaining core segments were generallyhigher than that of the PCD segment. Additionally, on July 31, 2008, wecompleted the divestiture of our Mobile Solutions Business Unit (“MSBU”) to aglobal private equity firm.  During thethird quarter of 2008, we recorded a net gain on divestiture of MSBU of $3.9million.

 

In September 2007,we announced the results of an in-depth strategic analysis of the Companyundertaken by the management team with the aim of defining a new corporatestrategy and making UTStarcom an even stronger global competitor. We completedthe workforce reduction during the first quarter of 2008, having reduced our worldwidework force by approximately 800 employees, or approximately 12% of the Company’sheadcount.  We expect cost savings fromplanned restructuring activities to 

 

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provide liquidityfor operations, to be used to offset market forces or to be reinvested in ourbusinesses to strengthen our competitiveness.

 

Primarily as a result ofthe success in executing on management’s strategy of divesting our non-corebusinesses, at September 30, 2008, we had cash and cash equivalents of $329.0million as compared to $253.9 million at June 30, 2008.  Although management believes we now havesufficient liquidity to finance our anticipated working capital and capitalexpenditure requirements for the next twelve months, in an effort to furtherimprove our profitability and cash flows, management has intensified its focuson our fixed cost base to better align with operations, market demand andprojected sales levels.  If projectedsales do not materialize, management may need to further reduce expenses. Inaddition, we may require additional equity or debt financing. If future fundsare raised through issuance of stock or debt, these securities could haverights, privileges or preference senior to those of our common stock and debtcovenants could impose restrictions on our operations. The sale of additionalequity securities or debt financing could result in additional dilution to ourcurrent shareholders. There can be no assurance that additional financing, ifrequired, will be available on terms satisfactory to us or at all.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Management’s Discussionand Analysis of Financial Condition and Results of Operations is based upon ourCondensed Consolidated Financial Statements, which we have prepared inaccordance with U.S. generally accepted accounting principles. The preparationof these financial statements requires management to make estimates andassumptions that affect the reported amounts of assets, liabilities, revenueand expenses, and related disclosure of contingent assets and liabilities.Estimates are based on historical experience, knowledge of economic and marketfactors and various other assumptions that management believes to be reasonableunder the circumstances. Actual results may differ from those estimates.

 

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

 

**RECENT ACCOUNTING PRONOUNCEMENTS**

 

For a description of thenew accounting pronouncements that affect us, see Note 2 to our CondensedConsolidated Financial Statements included under Part I, Item 1 ofthis Quarterly Report on Form 10-Q.

 

**RESULTS OF OPERATIONS**

 

During the fourth quarterof 2007, the Company announced a new organization structure to align thebusiness units with its corporate strategy. This new organization structurechanged the reporting segments on which the Company measures performance andallocates resources. Effective October 1, 2007, the new reporting segmentswere as follows:

 

·      Broadband Infrastructure;

 

·      Multimedia Communications;

 

·      Personal Communications Division;

 

·      Handsets;

 

·      Services; and

 

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

 

Our BroadbandInfrastructure segment is responsible for software and hardware products thatenable end users to access high-speed, cost effective wireline data, voice andmedia communication. Our products within each of these categories includemultiple hardware and software subsystems that can be offered in variouscombinations to suit individual carrier needs. Our system products are based onwidely-adopted global communications standards and are designed to allowservice providers to quickly and cost-efficiently integrate our systems intotheir existing networks and deploy our systems in new broadband, IP andwireless network rollouts. Our products are also designed for quick andcost-effective transition to future network technologies, enabling ourcustomers to make the best use of their existing infrastructure.

 

Our MultimediaCommunications segment is responsible for the development and management ofinternet protocol television (“IPTV”) and related technologies plus our coreNext Generation Network (“NGN”) software. The Personal Handyphone System (“PHS”)infrastructure and wireless systems teams are also a part of this segment.

 

On July 1, 2008, wesold our Personal Communications Division, which sold and supported handsetsother than Personal Access System (“PAS”) handsets, mainly in the UnitedStates. See Note 3 to our Condensed Consolidated Financial Statementsincluded under Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Our Handsets segmentdesigns, builds and sells consumer handset devices, including PAS handsets,that allow customers to access wireless services. All handset revenues withinChina are included in this segment.  Afterthe disposition of the Personal Communications Division, all revenue related tohandset sales to the newly formed entity, Personal Communications Devices, LLC,(“New PCD”) are also included in this segment.

 

We support the growth andoperation of the installed base of our system solutions through ourprofessional services business, UTStarcom Services. Our globally-deployedexperts assist the Company’s customers with activities ranging from networkplanning, circuit-to-packet network migration planning, systems integration,program management, operations management and support, and knowledge transfer.

 

Included in our Othersegment are our Mobile Solutions Business Unit and our Custom SolutionsBusiness Unit.  On July 31, 2008, wesold our Mobile Solutions Business Unit (“MSBU”) which was responsible for thedevelopment, sales and service of our wireless IPCDMA/IPGSM product line. OurCustom Solutions Business Unit is responsible for the development, sales andservice of other non-core products such as IP messaging, transaction gateways,and Remote Access Server (“RAS”) which enables users to access network data andservices from remote locations and our Packet Data Services Node (“PDSN”)product line which connects CDMA cellular network infrastructure equipment toIP networks.

 

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**NETSALES**

 
| ** **                 | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|----------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                 | ** ** | **2008**                                                 | ** ** | **% of net  sales**                           | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of net  sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                  | ** ** |
| ***Net Sales by Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure   |       | $                                                        | 31,112     |                                                    | 17         | % | $ | 40,892 |   | 6 | % | $ | 92,591 |   | 7 | % | $ | 105,673 |   | 6 | % |
| Multimedia Communication   |       | 57,787                                                   |       | 32                                                      | %          | 58,289 |   | 9 | % | 199,251 |   | 14 | % | 194,283 |   | 12 | % |
| PCD                        |       | —                                                   |       | —                                                  |       | 458,301 |   | 71 | % | 879,588 |   | 63 | % | 1,104,428 |   | 67 | % |
| Handsets                   |       | 71,906                                                   |       | 40                                                      | %          | 59,254 |   | 9 | % | 165,390 |   | 12 | % | 191,150 |   | 11 | % |
| Services                   |       | 14,197                                                   |       | 8                                                       | %          | 14,655 |   | 2 | % | 41,172 |   | 3 | % | 38,320 |   | 2 | % |
| Other                      |       | 5,605                                                    |       | 3                                                       | %          | 15,103 |   | 3 | % | 21,360 |   | 1 | % | 26,786 |   | 2 | % |
|                       |       | $                                                        | 180,607    |                                                    | 100        | % | $ | 646,494 |   | 100 | % | $ | 1,399,352 |   | 100 | % | $ | 1,660,640 |   | 100 | % |

 
| ** **                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                | ** ** | **2008**                                                 | ** ** | **% of net  sales**                           | ** ** | **2007** | ** ** | **% of net  sales** | ** ** | **2008** | ** ** | **% of net  sales** | ** ** | **2007** | ** ** | **% of net  sales** | ** ** |
| ** **                | ** ** | **(in thousands)**                                  | ** ** |
| ***Net Sales by region*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| United States             |       | $                                                        | 43,127     |                                                    | 24         | % | $ | 457,945 |   | 71 | % | $ | 907,770 |   | 65 | % | $ | 1,112,448 |   | 67 | % |
| China                     |       | 97,605                                                   |       | 54                                                      | %          | 124,228 |   | 19 | % | 325,479 |   | 23 | % | 390,184 |   | 24 | % |
| Japan                     |       | 10,303                                                   |       | 6                                                       | %          | 19,863 |   | 3 | % | 32,696 |   | 2 | % | 54,701 |   | 3 | % |
| Other                     |       | 29,572                                                   |       | 16                                                      | %          | 44,458 |   | 7 | % | 133,407 |   | 10 | % | 103,307 |   | 6 | % |
| Total net sales           |       | $                                                        | 180,607    |                                                    | 100        | % | $ | 646,494 |   | 100 | % | $ | 1,399,352 |   | 100 | % | $ | 1,660,640 |   | 100 | % |

 

*Three months ended September 30, 2008and 2007*

 

Net sales decreased by$465.9 million, or 72%, to $180.6 million during the three months ended September 30,2008 compared to the same period in 2007. The decrease was primarily due to PCDand MSBU being sold in July 2008. For the three months ended September 30,2007, the disposed PCD segment and MSBU represented $458.3 million and $9.4million of net sales, respectively.

 

Net sales excluding PCDand MSBU increased by $1.5 million during the three months ended September 30,2008 compared to the same period in 2007. Net sales of our Handset segment increased by $12.7 million, or 21%,mainly due to sales to New PCD in the third quarter of 2008.   The increased sales to New PCD more thanoffset the decline in sales of PAS handsets in China.  Multimedia Communication segment net salesdecreased by $0.5 million, or 1%, for the three months ended September 30,2008 compared to the same period in 2007, mainly due to higher RollingStream,Set Top Box (“STB”) and NGN sales offset by the decline in PAS infrastructuresales which continue to experience weakening demand. Broadband Infrastructuresegment net sales decreased by $9.8 million due to lower CPE sales.

 

*Nine months ended September 30, 2008 and2007*

 

Net sales decreased by16%, or $261.3 million, for the nine months ended September 30, 2008compared to the same period in 2007.  Thedecrease was primarily due to PCD and MSBU being sold in July 2008. Thenet sales of the disposed PCD segment and MSBU decreased by $224.8 million and$8.2 million, respectively, for the nine months ended September 30, 2008compared to the same period in 2007.

 

Multimedia Communicationsegment net sales increased by $5.0 million, or 3%, during the nine monthsended September 30, 2008 compared to the same period in 2007, mainly dueto an increase of our NGN and STB sales, partially offset by the continuedweakening demand for our PAS infrastructure products.  Broadband Infrastructure segment net salesdecreased by $13.1 million or 12% during the nine months ended September 30,2008 compared to the same period in 2007. This decrease was mainly due to lowerCPE sales.  Due to the customerconcentration in this segment, revenues fluctuate based upon the magnitude andtiming of revenue recognition on certain contracts.  Handset sales declined by $25.8 million, or13%, during the nine months ended September 30, 2008 

 

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due to both priceand volume declines of our PAS handsets sold when compared to the same periodin 2007.  As we have been experiencing inrecent quarters, increased competition and a decline in PAS subscribers haveresulted in lower demand and decrease in average selling price for our handsets.

 

For additional discussionsee “Segment Reporting” section of this Item 2.

 

In 2008 and beyond, weexpect that new orders for PAS handsets and infrastructure equipment willcontinue to decline due to the China telecommunications industry restructuringas well as increased pricing pressure. We expect our CDMA and TDSCDMA handsetswill contribute more to our revenue and partially offset the decline of our PASbusiness.  We also plan to introduceHSDPA (“High Speed Downlink Packet Access”) data cards supported by TDSCDMAnetworks and EVDO (“Evolution Data Only”) data cards supported by CDMA 3Gnetworks, which we expect to have relatively higher gross margins and averageselling prices in mid-2009 to capitalize on the data business in China.  However, we do not anticipate that thesesales will fully offset the decline in PAS handsets and infrastructure sales.We currently offer and have initial market acceptance of our IPTV products inChina, Japan, India, Taiwan and other geographic regions. We believe that theIPTV market presents a meaningful growth opportunity in these regions as wellas other regions where we have targeted to expand our IPTV offerings.

 

**GROSS PROFIT**

** **
| ** **                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                    | ** ** | **2008**                                                 | ** ** | **Gross  profit %**                                | ** ** | **2007** | ** ** | **Gross  profit %** | ** ** | **2008** | ** ** | **Gross  profit %** | ** ** | **2007** | ** ** | **Gross  profit %** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                  | ** ** |
| ***Gross profit by Segment*** |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure      |       | $                                                        | 3,032      |                                                    | 10         | % | $ | (4,770 | ) | (12 | )% | $ | 6,922 |   | 7 | % | $ | 9,544 |   | 9 | % |
| Multimedia Communication      |       | 30,846                                                   |       | 53                                                      | %          | 16,643 |   | 29 | % | 92,820 |   | 47 | % | 67,052 |   | 35 | % |
| PCD                           |       | —                                                   |       | —                                                  |       | 26,983 |   | 6 | % | 69,005 |   | 8 | % | 59,750 |   | 5 | % |
| Handsets                      |       | 14,965                                                   |       | 21                                                      | %          | 16,966 |   | 29 | % | 37,961 |   | 23 | % | 64,409 |   | 34 | % |
| Services                      |       | 4,720                                                    |       | 33                                                      | %          | 3,517 |   | 24 | % | 11,832 |   | 29 | % | 4,248 |   | 11 | % |
| Other                         |       | 3,764                                                    |       | 67                                                      | %          | 5,094 |   | 34 | % | 12,814 |   | 60 | % | 14,444 |   | 54 | % |
|                          |       | $                                                        | 57,327     |                                                    | 32         | % | $ | 64,433 |   | 10 | % | $ | 231,354 |   | 17 | % | $ | 219,447 |   | 13 | % |

 

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

 

Our gross profit has beenaffected by average selling prices, material costs, product mix, the impact ofwarranty charges and contract loss provisions as well as inventory reserves andrelease of deferred revenues and related costs pertaining to prior years. Ourgross profit, as a percentage of net sales, varies among our product families.We expect that our overall gross profit, as a percentage of net sales, willfluctuate in the future as a result of shifts in product mix, stage of productlife cycle, anticipated decreases in average selling prices and our ability toreduce cost of sales.

 

*Three months ended September 30, 2008 and 2007*

 

Gross profit was$57.3 million, or 32% of net sales for the three months ended September 30,2008, compared to $64.4 million, or 10% of net sales for the correspondingquarter of 2007. The overall gross profit decrease in absolute dollars wasprimarily due to the disposition of PCD and MSBU during July 2008 whichaccounted for $28.1 million decrease in gross profit 

 

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resulting from therelated decrease in sales. Gross profit as a percentage of sales increased mainlydue to the disposition of PCD which had relatively lower gross profitpercentages compared to our other segments.

 

Excluding PCD and MSBU,gross profit increased by $21.0 million for the three months ended September 30,2008 compared to the corresponding quarter of 2007. Gross profit in theBroadband Infrastructure segment increased primarily due to higher inventoryand loss contract provision recorded in the third quarter of 2007.  Gross profit in the Multimedia Communicationsegment improved mainly due to increased sales of higher margin NGN products aswell as the impact of the reduction of $4.5 million of accrued third partycommissions in 2008.  In addition, thethree months ended September 30, 2007 included reserves related to theexit of certain product lines.

 

*Nine months ended September 30, 2008 and2007*

 

Gross profit was $231.4million, or 17% of net sales for the nine months ended September 30, 2008,compared to $219.4 million, or 13% of net sales in the corresponding period of2007. The overall gross profit increase in absolute dollars was primarily dueto the increase in sales and improved profit margins in the PCD segment in thefirst six months of the year and increased sales of higher margin products ofthe Multimedia Communication segment, partially offset by decrease in sales andgross profit of the Handsets segment as well as the disposition of PCD in thethird quarter of 2008. However, the overall gross profit as a percentage ofsales increased slightly due primarily to the disposition of the PCD segment inJuly 2008 which had a lower gross profit percentage as compared to ourother segments.

 

Excluding PCD and MSBU,our gross profit was $158.2 million, or 31% of net sales for the nine monthsended September 30, 2008, compared to $153.9 million, or 28% of net sales inthe corresponding period of 2007.

 

For additional discussionsee “Segment Reporting” section of this Item 2.

 

**OPERATING EXPENSES**

 

The following tablesummarizes our operating expenses:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                 | ** ** | **% of  net  sales**                               | ** ** | **2007** | ** ** | **% of  net  sales** | ** ** | **2008** | ** ** | **% of  net  sales** | ** ** | **2007** | ** ** | **% of  net  sales** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| Selling, general and administrative |       | $                                                        | 59,445     |                                                    | 33         | % | $ | 74,297 |   | 11 | % | $ | 211,199 |   | 15 | % | $ | 242,999 |   | 15 | % |
| Research and development            |       | 35,971                                                   |       | 20                                                      | %          | 41,881 |   | 7 | % | 116,657 |   | 8 | % | 127,700 |   | 8 | % |
| Amortization of intangible assets   |       | 279                                                      |       | 0                                                       | %          | 4,046 |   | 1 | % | 3,833 |   | 0 | % | 12,137 |   | 1 | % |
| Net gain on divestitures            |       | (3,455                                                   | )          | (2                                                      | )%         | (4,271 | ) | (1 | )% | (3,455 | ) | 0 | % | (4,271 | ) | (1 | )% |
| Total operating expenses            |       | $                                                        | 92,240     |                                                    | 51         | % | $ | 115,953 |   | 18 | % | $ | 328,234 |   | 23 | % | $ | 378,565 |   | 23 | % |

 

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

 

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*SELLING, GENERAL AND ADMINISTRATIVE*

 

*Three months ended September 30, 2008and 2007*

 

SG&A expenses were$59.4 million for the three months ended September 30, 2008 and $74.3million for the same period in 2007.  Thedecrease of $14.9 million was due in large part to the disposal of the PCDsegment in July 2008, which accounted for $6.5 million of thedecrease.  In addition, the decrease wasalso due to a $3.0 million reduction in legal and accounting fees as we had areduction in investigation and litigation activities, a $3.1 million savingsfrom a reduction in the use of outside services primarily due to theimplementation of the new ERP system which began in 2007 and was completedduring 2008, and a $1.1 million decrease in expenses related to sales promotionand advertising due to reduced sales activities.

 

*Nine months ended September 30, 2008 and2007*

 

SG&A expenses were$211.2 million for the nine months ended September 30, 2008 and $243.0million for the same period in 2007.  Ofthe decrease of $31.8 million, $6.6 million was related to the disposal of thePCD segment in July 2008.  Inaddition, the decrease was also due to a $9.6 million decrease in legal and accountingfees mainly due to reduced activity in investigations and litigation, a $5.6million savings from reduction in the use of outside services primarily due toour accounting restatement in 2007 and the implementation of the new ERPsystem, a $2.6 million decrease in depreciation expense due to thedeconsolidation of a variable interest entity and certain fixed assets beingfully amortized in early 2008, a $1.6 million decrease in advertising &marketing expense due to reduced sales activities, a $1.2 million reduction infacility related expense due to continued streamlining of our operations, a$1.2 million decrease in tax and licenses due to reduced business taxes inChina and a $1.2 million decrease in travel related expenses due to reducedtravel activity.

 

*RESEARCH AND DEVELOPMENT*

 

*Three months ended September 30, 2008and 2007*

 

R&D expensesdecreased by $5.9 million during the three months ended September 30,2008 compared to the same period in 2007. The decrease in R&D expenses was mainly due to the disposal of MSBUwhich accounted for $3.0 million, as well as a $2.0 million decrease inpersonnel related expenses as we continued to streamline our operations.

 

*Nine months ended September 30, 2008 and2007*

 

R&D expenses decreased by $11.0 million during the nine monthsended September 30, 2008 compared to the same period in 2007.  This was primarily due to a $2.2 milliondecrease related to the disposal of MSBU, a $5.4 million decrease in personnelrelated expenses, a $2.0 million decrease in depreciation and $1.1 milliondecrease in software license expense as we continued to streamline ouroperations, as well as a $1.7 million decrease related to the recognition of asale of patent offset by an increase of $2.3 million in consulting and testingexpense related to new handset introductions during 2008.

 

*STOCK-BASED COMPENSATION EXPENSE*

 

The following tablesummarizes the stock-based compensation expense recognized in the Company’scondensed consolidated statements of operations:

 
| ** **                          | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                          | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| Cost of net sales                   |       | $                                                        | 182        |                                                    | $          | 119 |   | $ | 776 |   | $ | 362 |   |
| Selling, general and administrative |       | 3,154                                                    |       | 1,007                                                   |       | 11,180 |   | 3,871 |   |
| Research and development            |       | 750                                                      |       | 905                                                     |       | 1,974 |   | 2,737 |   |
| Total                               |       | $                                                        | 4,086      |                                                    | $          | 2,031 |   | $ | 13,930 |   | $ | 6,970 |   |

 

*Three and nine months ended September 30, 2008 and 2007*

 

The increase in the levelof stock-based compensation during the three and nine months ended September 30,2008 was primarily due to the recognition of expense in 2008 for awards grantedin the fourth quarter of 2007 and during 2008, including annual merit equityawards granted in November 2007 and February 2008, compared withthe same period in 2007 when no awards were granted as we were delinquent inthe filing of our reports with the SEC. The three and nine months ended September 30, 2008 stock-

 

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based compensationexpense attributable to selling, general and administrative includesapproximately $1.5 million resulting from award modifications related to anexecutive retirement.

 

*AMORTIZATION OF INTANGIBLE ASSETS*

 

*Three and nine months ended September 30, 2008 and 2007*

 

Amortization ofintangible assets decreased by $3.8 million in the three months ended September 30,2008 compared to the same quarter last year, and by $8.3 million in the ninemonths ended September 30, 2008 compared to the same period last year.Amortization of intangible assets declined primarily due to the impairment ofintangible assets with a carrying value of $15.7 million in the fourth quarterof 2007, the disposition of intangible assets with a carrying value of $15.8million in the third quarter of 2008 in connection with the sale of PCD, anddue to the fact that several intangible assets became fully amortized duringthe preceding twelve months.

 

*NET GAIN ON DIVESTITURES*

 

*Three months ended September 30, 2008 and2007*

 

The $3.5 million net gainon divestitures for the three and nine months ended September 30, 2008included a $0.5 million loss on the sale of PCD and a $3.9 million gain on thesale of MSBU. The gain on sale of net assets for the three and nine monthsended September 30, 2007 of approximately $4.3 million relates to the saleof substantially all of the assets and selected liabilities of oursemiconductor design operations, including the assets related to the prioracquisition of Advanced Communications Devices Corporation to MarvellTechnology Group Ltd.  See Note 3 toour Condensed Consolidated Financial Statements included under Part I,Item 1 of this Quarterly Report on Form 10-Q for additionalinformation.

 

*INTEREST INCOME*

 

*Three and nine months ended September 30, 2008 and 2007*

 

Interest income was $2.1million and $3.0 million for the three months ended September 30, 2008 and2007, respectively. Interest income was $6.3 million and $11.3 million for thenine months ended September 30, 2008 and 2007, respectively.  The decrease in interest income for the threeand nine months ended September 30, 2008 compared to the same periods in2007 was primarily due to the decrease in cash balances available forinvestment and due to lower interest rates earned in the three and nine monthsended September 30, 2008 as compared to the same periods in 2007.

 

*INTEREST EXPENSE*

 

*Three and nine months ended September 30, 2008 and 2007*

 

Interest expense was $0.4million and $8.9 million for the three months ended September 30,2008 and 2007, respectively. Interest expense was $10.0 million and$22.9 million for the nine months ended September 30, 2008 and 2007,respectively. The decrease in interest expense for the three and nine monthsended September 30, 2008 compared to the same period in 2007 was primarilyattributable to the repayment of $274.6 million of convertible subordinatednotes on March 1, 2008 and $48.0 million of other bank loan repaymentsduring 2008. Interest expense for the nine months ended September 30, 2008included approximately $2.5 million of debt issuance costs related to the $75million secured revolving credit facility. For the period from January 1,2008 through maturity on March 1, 2008, the convertible subordinated noteshad a stated interest rate of 10.875% in accordance with the SecondSupplemental Indenture.  As a result ofthe First Supplemental Indenture, our convertible subordinated notes’ statedinterest rate was 7.625% per annum after January 9, 2007.  Prior to January 9, 2007, our convertiblesubordinated notes accrued interest at 7/8% per annum.

 

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*OTHER INCOME (EXPENSE), NET*

 

*Three months ended September 30, 2008 and 2007*

 

Other expense, net was $14.9 million for thethree months ended September 30, 2008 as compared to other income, net of$4.3 million for the three months ended September 30, 2007. Otherexpense for the three months ended September 30, 2008 consisted primarilyof $10.6 million foreign currency losses and $4.3 million in writedowns oflong-term investments.  The foreigncurrency losses primarily consisted of losses attributed to the appreciation ofthe US dollar on the Indian Rupee denominated intercompany receivables,partially offset by gains for the Company’s China subsidiaries attributed tothe appreciation of the Chinese Renminbi on US dollar denominated intercompanypayables. Net other income for the three months ended September 30, 2007primarily consists of a $2.9 million gain on the sale of our Fiberxoninvestment and a $1.3 million foreign currency gain.

 

*Nine months ended September 30, 2008 and 2007*

 

Other income was $38.1 millionand $8.5 million for the nine months ended September 30, 2008 and2007, respectively. Other income for the nine months ended September 30,2008 consisted primarily of a $32.4 million gain on the sale of the Gemdaleinvestment, a $7.3 million gain on the sale of the Infinera investment, an $8.2million gain on the liquidation of an investment in a variable interest entity,offset partially by a $6.4 million foreign currency loss and $4.3 million inwritedowns of long-term investments. Other income (expense), net for the nine months ended September 30,2007 included a $5.7 million gain on the sale of our ImmenStar and Fiberxoninvestments and a $2.1 million foreign currency gain.

 

*INCOME TAX EXPENSE*

 

Income tax expense isbased upon a blended effective tax rate based upon our expectation of the amountof income to be earned in each tax jurisdiction and is accounted under theliability method. Deferred income taxes are recognized for the differencesbetween the tax bases of assets and liabilities and their financial statementamounts based on enacted tax rates. Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.We expect to maintain a full valuation allowance on our remaining net deferredtax assets until an appropriate level of profitability that generates taxableincome is sustained or until we are able to develop tax strategies that wouldenable us to conclude that it is more likely than not that a portion of ourdeferred tax assets will be realizable. Any reversal of valuation allowanceswill favorably impact our results of operations in the period of the reversal.

 

We adopted the provisionsof FASB Interpretation No. 48, “Accounting for Uncertainty in IncomeTaxes-an interpretation of FASB Statement No. 109” (“FIN 48”) on January 1,2007. FIN 48 established criteria for recognizing or continuing to recognizeonly more-likely-than-not tax positions, which may result in income tax expensevolatility in future periods. While we believe that we have adequately providedfor all tax positions, amounts asserted by taxing authorities could be greaterthan our accrued position. Accordingly, additional provisions on income taxrelated matters could be recorded in the future as revised estimates are madeor the underlying matters are settled or otherwise resolved.

 

*Three months ended September 30, 2008 and 2007*

 

Income tax expense was$7.8 million and $3.1 million for the three months ended September 30,2008 and 2007, respectively. Due to the sale of PCD, we believe that we willnot generate sufficient income in Canada to realize our deferred tax assets inCanada.  Therefore, we established avaluation allowance on our remaining net deferred tax assets in Canada.  The income tax expense associated withestablishing the valuation allowance is $1.9 million.

 

*Ninemonths ended September 30, 2008 and 2007*

 

Income tax expense was $7.4 million and $10.7 million forthe nine months ended September 30, 2008 and 2007, respectively.  The China Corporate Income Tax Law (“CIT Law”)became effective on January 1, 2008. As a result of the enactment of new regulations during the first quarterof 2008 which address CIT Law, we recorded an income tax benefit of $11.7million in the first quarter of 2008 related to reversing a deferred taxliability on foreign withholding taxes related to the unremitted earnings ofour subsidiaries which we determined to not be permanently reinvested outsidethe United States.  We also have accrued$3.2 million of foreign withholding taxes in the first quarter of 2008 relatedto the realized gain on the sale of our investment in Gemdale.

 

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We have notprovided any tax benefit on any forecasted current year losses incurred and taxcredits generated in the United States and other countries, because we believethat it is more likely than not that the tax benefit associated with theselosses will not be realized.  Also, wecontinue to accrue tax expense in jurisdictions where we have been historicallyprofitable.

 

**SEGMENT REPORTING**

 

As noted previously,during the fourth quarter of 2007, the Company announced a new corporateorganization to align the business units with its corporate strategy.

 

Summarized below are oursegment net sales revenue and gross profit figures for the three and ninemonths ended September 30, 2008 and 2007, respectively.

 

***Broadband Infrastructure***

*** ***
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                  | ** ** |
| Net sales                                 |       | $                                                        | 31,112     |                                                    | $          | 40,892 |   | $ | 92,591 |   | $ | 105,673 |   |
| Gross profit                              |       | $                                                        | 3,032      |                                                    | $          | (4,770 | ) | $ | 6,922 |   | $ | 9,544 |   |
| Gross profit as a percentage of net sales |       | 10                                                       | %          | -12                                                     | %          | 7 | % | 9 | % |
|                                           |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Sales decreased due to adecline in our CPE product line as Softbank in Japan completed its currentphase of ADSL expansion. Softbank in Japan represented approximately21% and 38% of total Broadband Infrastructure sales during the three monthsended September 30, 2008 and 2007, respectively, and 24% and 37% duringthe nine months ended September 30, 2008 and 2007, respectively. Thisdecline was partially offset by higher sales in Optical products.

 

Gross profit increasedfor the three months ended September 30, 2008 when compared to correspondingperiods in 2007, primarily due to a higher inventory and loss contract reserve,as well as more lower gross margin CPE sales in 2007. Gross profit decreasedfor the nine months ended September 30, 2008 compared to correspondingperiods in 2007 mainly due to a provision for additional anticipated lossesduring the second quarter of 2008 on an infrastructure deployment contract thatoriginated in 2006 and increased inventory cost related to our optical productsin China in 2008.

 

We may incur additionalwarranty expense as we introduce new products and may be required to accrueadditional contract losses for certain fixed price contracts as these contractsprogress. Both events may have negative impacts on our future gross profits,results of operations and financial position.

 

***Multimedia Communications***

*** ***
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                  | ** ** |
| Net sales                                 |       | $                                                        | 57,787     |                                                    | $          | 58,289 |   | $ | 199,251 |   | $ | 194,283 |   |
| Gross profit                              |       | $                                                        | 30,846     |                                                    | $          | 16,643 |   | $ | 92,820 |   | $ | 67,052 |   |
| Gross profit as a percentage of net sales |       | 53                                                       | %          | 29                                                      | %          | 47 | % | 35 | % |
|                                           |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

During the three monthsended September 30, 2008, Multimedia Communications sales decreased by 1%, or $0.5 million. Theincrease of our NGN products, RollingStream and STB sales mostly offset thecontinued decline of PAS system sales. Thesales 

 

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of our main product line, PAS system, comprised approximately 68%and 88% of our Multimedia Communications segment sales for the third quarter of2008 and 2007, respectively.

 

Sales for the nine monthsended September 30, 2008 increased 3%, or $5.0 million.  The increase was mainly due to higher STBsales to a customer in China and NGN Sales during the period, partially offsetby lower PAS system sales and 3G related product sales in 2008 as we exited 3Grelated product lines in 2007.

 

The gross profitpercentage increased to 53% for the three months ended September 30, 2008from 29% for the corresponding period in 2007. The increase was primarily due to increased sales of the higher grossmargin NGN product line as well as the impact of the reduction of $4.5 millionof accrued third party commissions during the third quarter of 2008. The grossprofit percentage increased to 47% for the nine months ended September 30,2008 from 35% for the corresponding period in 2007 primarily due to lowerwarranty and inventory costs as well as the impact of the reduction of $4.5million of accrued third party commissions in the nine months ended September 30,2008 and $9.1 million of 3G product sales with very low margin in 2007, offsetin part by sales of lower margin STB products in 2008. The reduction in accruedthird party commissions in the third quarter of 2008 resulted from thedetermination that such aged accruals were no longer needed as the statute oflimitations with respect to such unclaimed commissions had expired and theCompany had exhausted all efforts to extinguish these liabilities in accordancewith established Company procedures.

 

We expect future PASinfrastructure spending to decline in 2008 and beyond as China launched its 3Gnetwork. We expect the decline in new PAS infrastructure orders will continueand we plan to aggressively pursue opportunities for our dual mode enterprisePAS products and NGN products in multiple markets.  However, we do not anticipate that thesesales will fully offset the anticipated decline in PAS sales in 2008 andbeyond.

 

We believe that the IPTVmarket presents a meaningful growth opportunity. We currently offer and haveinitial market acceptance of our IPTV products in China, Japan, India, Taiwanand other geographic regions.

 

***Personal Communications Division (PCD)***

 

On July 1, 2008, wesold our PCD operations (See Note 3 to our Condensed ConsolidatedFinancial Statements included under Part I, Item 1 of this QuarterlyReport on Form 10-Q).

 

***Handsets***

*** ***
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                  | ** ** |
| Net sales                                 |       | $                                                        | 71,906     |                                                    | $          | 59,254 |   | $ | 165,390 |   | $ | 191,150 |   |
| Gross profit                              |       | $                                                        | 14,965     |                                                    | $          | 16,966 |   | $ | 37,961 |   | $ | 64,409 |   |
| Gross profit as a percentage of net sales |       | 21                                                       | %          | 29                                                      | %          | 23 | % | 34 | % |
|                                           |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net sales increased 21% and declined 13% for the three and ninemonth ended September 30, 2008, respectively, as compared to the sameperiods in 2007.  The majority of ourhandset sales were historically in China, where we have experienced a declinein volume and price for our PAS handsets. After the disposition of our PCD operations on July 1, 2008, ourhandset sales to New PCD totaled $34.5 million and contributed significantly tothe overall handset sales in the third quarter of 2008.

 

ThePAS handset units sold in China declined to 0.8 million and 2.9 millionunits for the three and nine months ended September 30, 2008,respectively, compared to 1.3 million and 3.8 million units in the comparableperiods of 2007.  The 35% and 25% volumedecline for three and nine months periods, respectively, was primarilyattributed to lower demand for our PAS handsets resulting from a decline in PASsubscribers as service providers reduced marketing efforts for PAS handsets inanticipation for next generation technology networks and the restructuring ofChina telecommunication industry. The average selling price per unit in the 

 

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PAS products declined 5% and 10% during the three and nine months ended September 30,2008, respectively, compared with the same periods in 2007 due tocompetitive pricing pressures and increased sales through distributorchannels.  We have experienced such continuingpricing pressure in the China telecommunications market since the latter partof 2003, which has driven average unit selling prices lower. We expect acontinued decline in PAS subscribers in future periods.

 

Gross profit as apercentage of net sales for our Handsets segment decreased for both the threeand nine months ended September 30, 2008 compared to the correspondingperiods in 2007.  For the three monthperiod, the decrease was primarily due to continued price erosion of our PAShandsets as well as increased sales of lower gross margin CDMA handsets to NewPCD. The decrease in gross margin was partially offset by a $4.2 millionsupplier rebate in the third quarter of 2008. The decrease for the nine months period was primarily due to losses fromour GSM products as we reduced inventory of older models, costs related tocancelation of a CDMA model in the second quarter of 2008 and higher inventorycost of our PAS data card business, as well as continued price erosion and adecrease in demand of our PAS product lines.

 

In 2008 and beyond, weexpect a decline in PAS subscribers as the China telecommunication industryreorganizes and prepares for 3G launch. Furthermore, we expect more priceerosion and gross margin deterioration in PAS handsets because of increasingcompetition.  However, we expect our CDMA and TDSCDMA handsets willcontribute more to our revenue and partially offset the decline of PASbusiness. We also plan to introduceHSDPA data card supported by TDSCDMA network and EVDO data card supported byCDMA 3G network, which we expect to have relatively higher gross margin andaverage selling prices in mid 2009 to capitalize the data business in China.  In addition, we expect to continue tofocus on product cost reduction efforts through supply chain improvements andR&D improvements, including outsourcing part of our product development.

 

***Services***

*** ***
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                  | ** ** |
| Net sales                                 |       | $                                                        | 14,197     |                                                    | $          | 14,655 |   | $ | 41,172 |   | $ | 38,320 |   |
| Gross profit                              |       | $                                                        | 4,720      |                                                    | $          | 3,517 |   | $ | 11,832 |   | $ | 4,248 |   |
| Gross profit as a percentage of net sales |       | 33                                                       | %          | 24                                                      | %          | 29 | % | 11 | % |

 

Our Services segment’srevenue from external customers was relatively stable for the three monthsended September 30, 2008 as compared to the corresponding period of lastyear.  For the nine months ended September 30,2008, net sales increased by 7%, as compared to the corresponding period oflast year.  The increase during the ninemonths period was mainly due to the continued growth of our China service salesresulting from increased service contracts for value added services.

 

Gross profit increasedfrom 24% for the three months ended September 30, 2007 to 33% for thecorresponding period in 2008.  Grossprofit was 29% and 11% for the nine months ended September 30, 2008 and2007, respectively.  The increase wasprimarily due to China service sales increase without a corresponding increasein associated cost by utilizing excess capacity.

 

***Other***

*** ***
| ** **                                | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                | ** ** | **(in thousands)**                                  | ** ** |
| Net sales                                 |       | $                                                        | 5,605      |                                                    | $          | 15,103 |   | $ | 21,360 |   | $ | 26,786 |   |
| Gross profit                              |       | $                                                        | 3,764      |                                                    | $          | 5,094 |   | $ | 12,814 |   | $ | 14,444 |   |
| Gross profit as a percentage of net sales |       | 67                                                       | %          | 34                                                      | %          | 60 | % | 54 | % |
|                                           |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Our Other segmentconsists of Mobile Solutions and Custom Solutions business units. On July 31,2008, we sold MSBU. The revenue decreased by $9.5 million, or 63% for thethree months ended September 30, 2008 as compared to the same period in2007.  The revenue decreased by$5.4 million, or 20% for the nine months ended September 30, 2008 ascompared to the same period in 2007.  Thedecrease was primarily due to the disposition of MSBU in July 2008.

 

Gross profit percentage increased to 67% and 60% for the three and ninemonths ended September 30, 2008, respectively, from 34% and 54% for thesame periods in 2007.  The increase wasdue to the disposition of MSBU which had lower gross margin as well as therecognition of revenue of a low margin contract during the third quarter of2007.

 

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**RELATED PARTY TRANSACTIONS**

 

For a description ofrelated party transactions, see Note 17 to our Condensed Consolidated FinancialStatements included under Part 1, Item 1 of this Quarterly Report on Form 10-Q.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The following sectionsdiscuss the effects of changes in our balance sheet and cash flows, contractualobligations and other commitments on our liquidity and capital resources.

 

***Balance Sheet and Cash Flows***

 

Cash and Cash Equivalents and Short-termInvestments

 
| ** **                        | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** | ** ** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------|------------|------------|------------|
| ** **                        | ** ** | **2008**                | ** ** | **2007**              | ** ** | **Change** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
|                              |       |                    |       |                  |       |       |       |
| Cash and cash equivalents         |       | $                       | 328,969    |                  | $          | 437,449    |       | $ | (108,480 | ) |
| Bank notes                        |       | 1,593                   |       | 23,275                |       | (21,682    | )          |
| Publicly traded equity securities |       | —                  |       | 42,354                |       | (42,354    | )          |
| Total                             |       | $                       | 330,562    |                  | $          | 503,078    |       | $ | (172,516 | ) |

 
| ** **                                                    | ** ** | **Nine months ended September 30,** | ** ** |
|---------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                    | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **Change** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                                 | ** ** |
| Cash used in operating activities                             |       | $                                                       | (31,872    | ) | $ | (193,355 | ) | $ | 161,483 |   |
| Cash provided by (used in) investing  activities              |       | 245,684                                                 |       | (16,729 | ) | 262,413 |   |
| Cash (used in) provided by financing  activities              |       | (333,224                                                | )          | 39,073 |   | (372,297 | ) |
| Effect of exchange rate changes on cash and  cash equivalents |       | 10,932                                                  |       | 18,938 |   | (8,006 | ) |
| Net decrease in cash and cash equivalents                     |       | $                                                       | (108,480   | ) | $ | (152,073 | ) | $ | 43,593 |   |

 

Cashand cash equivalents, consisting primarily of bank deposits and money marketfunds, are recorded at cost which approximates fair value because of theshort-term nature of these instruments.At September 30, 2008, cash and cash equivalents approximating$155.4 million was held by our subsidiaries in China. The $108.5 million decrease in cash and cash equivalents was primarilya result of $333.2 million cash used in financing activities and $31.9million cash used in operating activities,partially offset by cash provided by investing activities of approximately$245.7 million.

 

During the nine monthsended September 30, 2008, our operating activities were significantlyimpacted by the following:

 

·                  Net loss of$69.4 million adjusted for gains on sale of investments of $40.2 million, the$8.2 million gain on liquidation of ownership interest in a variable interestentity, the $3.5 million gain on divestitures and non-cash charges of $53.4million, which resulted in a net use of cash of $67.8 million. The non-cashcharges of $53.4 million included $30.6 million in depreciation andamortization, $13.9 million in stock-based compensation expense, $4.3 millionimpairment of long-term investments, and a $12.8 million provision for deferredcosts, partially offset by a deferred tax benefit of $7.9 million.  The deferred tax benefit is primarily due toan $11.7 million benefit resulting from a change in the China Corporate IncomeTax Law, offset partially by $1.9 million of expense related to placing avaluation allowance on the Company’s Canadian deferred tax assets.

 

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·                  Changes in net operating assets andliabilities providing net cash of $35.9 million, which was primarily the resultof management of working capital, in part necessitated by the repayment of theconvertible subordinated notes due March 1, 2008.

 

Cash provided byinvesting activities during the nine months ended September 30, 2008 of$245.7 million included approximately$207.1 million in net proceeds from the sale of PCD and MSBU, $53.7 million netproceeds from the sale of investments, net of purchases, and $7.7 million fromthe repayment of a loan by a variable interest entity, partially offset by$12.7 million used to purchase property, plant and equipment and a $10.4million change in restricted cash.

 

Cash used in financingactivities during the nine months ended September 30, 2008 of $333.2million related primarily to the repayment of the convertible subordinatednotes of $274.6 million on March 1, 2008 and the net repayment of $48.0million of other bank loans during 2008.

 

Accounts Receivable, Net

 

The followingtable summarizes our accounts receivable, net:

 
| ** **                                                       | ** ** | **September 30,**                    | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                                       | ** ** | **2008**                                  | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** |
| ** **                                                       | ** ** | **(in thousands,  except DSO)** | ** ** |
|                                                             |       |                                      |       |                  |       |           |       |
| Accounts receivable, net                                         |       | $                                         | 141,429    |                  | $          | 304,654        |       | $ | (163,225 | ) |
| Accounts receivable, related parties                             |       | 10,543                                    |       | 26,256                |       | (15,713        | )          |
| Total accounts receivable                                        |       | $                                         | 151,972    |                  | $          | 330,910        |       | $ | (178,938 | ) |
|                                                             |       |                                      |       |                  |       |           |       |
| Days sales outstanding in accounts  receivable (“DSO”) |       | 76                                        |       | 48                    |       | 28             |       |

 

Accounts receivabledecreased $178.9 million primarily as a result of the sale of PCD.  Accounts receivable at December 31, 2007related to our PCD business approximated $155.8 million.  DSO increased to 76 at September 30,2008 from 48 at December 31, 2007 primarily as a result of the divestitureof PCD, which historically had lower DSO than the Company’s other segments.

 

Inventories andDeferred Costs

 

The followingtable summarizes our inventories and deferred costs:

 
| ** **                | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                | ** ** | **2008**                | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** |
| ** **                | ** ** | **(in thousands)** | ** ** |
| Inventories:              |       |                    |       |                  |       |           |       |
| Raw materials             |       | $                       | 28,915     |                  | $          | 34,413         |       | $ | (5,498 | ) |
| Work in-process           |       | 34,353                  |       | 35,853                |       | (1,500         | )          |
| Finished goods            |       | 132,139                 |       | 264,201               |       | (132,062       | )          |
| Total inventories         |       | $                       | 195,407    |                  | $          | 334,467        |       | $ | (139,060 | ) |
|                      |       |                    |       |                  |       |           |       |
| Short-term deferred costs |       | $                       | 142,307    |                  | $          | 190,260        |       | $ | (47,953 | ) |
| Long-term deferred costs  |       | $                       | 156,789    |                  | $          | 164,766        |       | $ | (7,977 | ) |

 

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Inventories consist ofproduct held at our manufacturing facility and warehouses, as well as finishedgoods at customer sites for which the customer has taken possession, but basedon specific contractual terms, title has not yet passed to the customer.Deferred costs consist of product shipped to the customer where the rights andobligations of ownership have passed to the customer, but revenue has not yetbeen recognized. Inventories decreased approximately $139.1 million primarilyas a result of the sale of PCD. Finished goods inventory at December 31,2007 held by our PCD business approximated $156.6 million. Short-term deferredcosts decreased approximately $48.0 million primarily due to timing of revenuerecognition, as well as the reduction of deferred costs of approximately $13.8million resulting from the sale of MSBU.

 

Debt

 

The followingtable summarizes our debt:

 
| ** **                                              | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** | **Increase**   | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|----------------|------------|
| ** **                                              | ** ** | **2008**                | ** ** | **2007**              | ** ** | **(Decrease)** | ** ** |
| ** **                                              | ** ** | **(in thousands)** | ** ** |
|                                                    |       |                    |       |                  |       |           |       |
| Bank loans                                              |       | $                       | —     |                  | $          | 47,981         |       | $ | (47,981 | ) |
| Capital lease obligations                               |       | —                  |       | 581                   |       | (581           | )          |
| Convertible subordinated notes, due  March 1, 2008 |       | —                  |       | 274,600               |       | (274,600       | )          |
| Total debt                                              |       | —                  |       | 323,162               |       | (323,162       | )          |
| Long-term debt                                          |       | —                  |       | 333                   |       | (333           | )          |
| Short-term debt                                         |       | $                       | —     |                  | $          | 322,829        |       | $ | (322,829 | ) |

 

Wehave no bank loans outstanding at September 30, 2008.  In March 2008, we repaid our convertiblesubordinated debt of $274.6 million.  Wealso repaid $48.0 million of bank loans during 2008. Currently, ourprimary sources of available credit are a series of credit facilities inChina.  During the third quarter of 2008,we entered into a new credit facility in China providing $265.1 million inadditional borrowing availability. However, this facility imposes sub-limits of $147.3 million for workingcapital draws, and $117.8 million for the issuance of letters of credit andcorporate guarantees (“non-working capital draws”), and additionally requirescollateralization for working capital draws in excess of $29.5 million and/ornon-working capital draws in excess of $44.2 million. At September 30,2008, we had credit facilities in China with a total of approximately $389.8million available for future borrowings, of which an aggregate of $191.5million remained available for general working capital purposes and $198.3million remained available in support of letters of credit and corporateguarantees.  Approximately $163.5 millionof the China facilities expire during the fourth quarter of 2008 andapproximately $265.1 million of the China facilities expire in the third quarterof 2009.

 

Our available lines ofcredit in China are now significantly less than what has been available to ushistorically. During the fourth quarter of 2007, credit facilities in China inthe aggregate amount of approximately $481.7 million matured or wereextinguished. While we were able to renew approximately $265.1 million of theselines of credit during the third quarter of 2008, borrowings above a certainthreshold now require collateralization of our real property in China and eachborrowing under the credit facilities is subject to the bank’s then currentfavorable opinion of the credit worthiness of the Company’s China subsidiaries,as well as the bank having funds available for lending and other Chinesebanking regulations. We cannot be certain that additional lines of credit willbe available to us on commercially reasonable terms or at all.

 

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

 

***Liquidity***

 

We reported net losses of$195.6 million, $117.3 million and $532.6 million for the yearsended December 31, 2007, 2006 and 2005, respectively. At December 31,2007 we had an accumulated deficit of $691.2 million.  We used $218.2 million of cash inoperations during the year ended December 31, 2007, and at December 31,2007 we had cash and cash equivalents of $437.4 million, of which $289.5 millionwas used to repay our convertible subordinated notes and the accrued interestthereon, that matured in

 

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March 2008.These factors, as well as others discussed below, raised substantial doubt asto our ability to continue as a going concern and our independent registeredpublic accounting firm included an explanatory paragraph highlighting thisuncertainty in their “Report of Independent Registered Public Accounting Firm”dated February 29, 2008 included in “Part II, Item 8-FinancialStatements and Supplementary Data” in our Annual Report on Form 10-K forthe year ended December 31, 2007.

 

We had an operating lossof $96.9 million and a net loss of $69.4 million for the nine months ended September 30,2008. Cash used in operations was $31.9 million for the nine months ended September 30,2008.  During the nine months ended September 30,2008, we also sold certain short-term investments, net of purchases, for $57.5 million.In the third quarter of 2008, we completed the sale of PCD for a total saleconsideration of approximately $233.4 million. See Note 3 to our CondensedConsolidated Financial Statements included under Part I, Item 1 ofthis Quarterly Report on Form 10-Q for a description of the sale ofPCD.  At September 30, 2008, we hadcash and cash equivalents of $329.0 million in the aggregate to meet ourliquidity requirements of which $155.4 million was held by our subsidiaries inChina and continues to be subject to currency exchange controls on transfers offunds from China. In 2007 and through the first quarter of 2008, our Chinasubsidiaries were a significant source of working cash for the Company. OurChina subsidiaries transferred in aggregate $150 million of dividendsduring the year ended December 31, 2007 and another $100 million in February 2008.  Going forward, the amount of cash availablefor transfer from the China subsidiaries is limited both by the liquidity needsof the subsidiaries in China and by Chinese-government mandated requirementsincluding currency exchange controls on transfers of funds outside of China.

 

Currently, our primarysources of available credit are a series of credit facilities in China and eachborrowing under the credit facilities is subject to the bank’s then currentfavorable opinion of the credit worthiness of the Company’s China subsidiaries,as well as the bank having funds available for lending and other Chinesebanking regulations. We cannot be certain that additional lines of credit willbe available to us on commercially reasonable terms or at all.

 

Primarily as a result ofthe success in executing on management’s strategy of divesting our non-corebusinesses, at September 30, 2008, we had cash and cash equivalents of$329.0 million as compared to $253.9 million at June 30, 2008.  Although management believes we now havesufficient liquidity to finance our anticipated working capital and capitalexpenditure requirements for the next twelve months, in an effort to furtherimprove our profitability and cash flows, management has intensified its focuson our fixed cost base to better align with operations, market demand andprojected sales levels.  If projectedsales do not materialize, management may need to further reduce expenses. Inaddition, we may require additional equity or debt financing. If future fundsare raised through issuance of stock or debt, these securities could haverights, privileges or preference senior to those of our common stock and debtcovenants could impose restrictions on our operations. The sale of additionalequity securities or debt financing could result in additional dilution to ourcurrent shareholders. There can be no assurance that additional financing, ifrequired, will be available on terms satisfactory to us or at all.

 

***Off-balancesheet arrangements***

 

At September 30,2008, we do not have any off-balance sheet arrangements.

 

***Contractual obligations and other commitments***

 

Our obligations undercontractual obligations and commercial commitments at September 30, 2008were as follows:

 
| ** **                       | ** ** | **Payments due by period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| ** **                       | ** ** | ** **                                | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| ** **                       | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** | **5 years** | ** ** |
| ** **                       | ** ** | **(in thousands)**                   | ** ** |
| **Contractual Obligations**      |       |                                      |       |   |   |   |   |   |   |   |   |
| Bank loans                       |       | $                                         | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   |
| Lease obligations                |       | $                                         | 22,593     |   | $ | 12,232 |   | $ | 8,043 |   | $ | 2,244 |   | $ | 74 |   |
| **Other Commercial Commitments** | ** ** | ** **                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Letters of credit                |       | $                                         | 69,747     |   | $ | 51,199 |   | $ | 18,548 |   | $ | — |   | $ | — |   |
| Purchase commitments             |       | $                                         | 10,853     |   | $ | 9,703 |   | $ | 1,150 |   | $ | — |   | $ | — |   |

 

*Bank loans*

 

At September 30,2008, we had no bank loans outstanding.

 

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*Operating leases*

 

We lease certain facilities under non-cancelable operating leases thatexpire at various dates through 2013.

 

*Letters of credit*

 

We issue standby lettersof credit primarily to support international sales activities outside of China.When we submit a bid for a sale, often the potential customer will require thatwe issue a bid bond or a standby letter of credit to demonstrate our commitmentthrough the bid process. In addition, we may be required to issue standbyletters of credit as guarantees for advance customer payments upon contractsigning, or for performance and/or warranty guarantees. The standby letters ofcredit usually expire six to twelve months from date of issuance without beingdrawn by the beneficiary thereof.

 

*Purchase commitments*

 

We are obligated topurchase raw materials and work-in-process inventory under various orders fromvarious suppliers, all of which should be fulfilled without adverseconsequences material to our operations or financial condition. Purchasecommitments exclude agreements that are cancelable without penalty.  As of September 30, 2008, total opencommitments under these purchase orders extending beyond one year wereapproximately $1.1 million. Additionally, we have agreed to purchase fromMarvell Semiconductors, Inc. certain chip-sets that will be included in50% to 100% of our PAS handsets, through 2011.

 

*Intellectual property*

 

Certain sales contractsinclude provisions under which customers would be indemnified by us in theevent of, among other things, a third-party claim against the customer forintellectual property rights infringement related to our products. There are nolimitations on the maximum potential future payments under these guarantees. Wehave not accrued any amounts in relation to these provisions as no such claimshave been made and we believe we have valid enforceable rights to theintellectual property embedded in our products.

 

*Uncertain tax positions*

 

Effective January 1,2007, we adopted the provisions of FIN 48.  As of September 30, 2008,we had $84.3 million of gross unrecognized tax benefits. If recognized, theportion of gross unrecognized tax benefits that would decrease the provisionfor income taxes and increase our net income is $9.3 million. The impact on netincome reflects the gross unrecognized tax benefits net of certain deferred taxassets and the federal tax benefit of state income tax items totaling $75.0million. We have not included these amounts in the table of contractualobligations and commercial commitments because of the difficulty in makingreasonably reliable estimates of the timing of cash settlements with therespective taxing authorities.

 

*Thirdparty commissions*

 

The Company recordsaccruals for commissions payable to third parties in the normal course ofbusiness.  Such commissions are recorded based on the terms of thecontracts between the Company and the third parties and paid pursuant to suchcontracts.  Consistent with our accounting policies, these commissions arerecorded as operating expense in the period in which the liability isincurred. As of September 30, 2008, approximately $6 million of suchaccrued commissions had not been claimed by the third parties for more thanthree years.  Management has performed, and continues to perform,follow-up procedures with respect to these accrued commissions. Upon completionof such follow-up procedures, if the accrued commissions have not been claimedand the statute of limitations, if any, has expired or a reasonable period oftime has elapsed, the Company reduces such accruals. Such reduction is recordedin the Statement of Operations during the period management determinesthat certain accruals are no longer necessary. During the three and nine monthsended September 30, 2008, the Company reduced approximately $4.5 millionof accrued commissions payable and such reduction was recorded in cost of netsales. During the three and nine months ended September 30, 2007, nosignificant accruals related to third party commissions were reversed.

 

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

 

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

 

***Interest Rate Risk***

 

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

 

We maintain an investmentportfolio of various holdings, types and maturities. We do not use derivativefinancial instruments. We place our cash investments in instruments that meethigh credit quality standards, as specified in our investment policyguidelines. Our policy is to limit the risk of principal loss and to ensure thesafety of invested funds by generally attempting to limit market risk. Funds inexcess of current operating requirements are mostly invested in money marketfunds which are rated AAA. Our cash and cash equivalents are not subject tosignificant interest rate risk due to the short maturities of these instruments.As of September 30, 2008 the carrying value of our cash and cashequivalents approximated fair value.

 

The table belowrepresents carrying amounts and related weighted-average interest rates of ourinvestment portfolio at September 30, 2008:

 

| ** **                   | ** ** | **(in thousands, except** | ** ** |
|------------------------------|------------|-------------------------------------|------------|
| ** **                   | ** ** | **interest rates)**            | ** ** |
| Cash and cash equivalents    |       | $                                   | 328,969    |   |
| Average interest rate        |       | 1.85                                | %          |
|                         |       |                                |       |
| Restricted cash - short-term |       | $                                   | 18,535     |   |
| Average interest rate        |       | 1.75                                | %          |
|                         |       |                                |       |
| Short-term investments       |       | $                                   | 1,593      |   |
| Average interest rate        |       | 1.51                                | %          |
|                         |       |                                |       |
| Restricted cash - long-term  |       | $                                   | 18,548     |   |
| Average interest rate        |       | 2.42                                | %          |
|                         |       |                                |       |
| Total investment securities  |       | $                                   | 367,645    |   |
| Average interest rate        |       | 1.87                                | %          |

 

***Equity Investment Risk***

 

Our investment portfolioincludes equity investments in publicly traded companies, the values of whichare subject to market price volatility. Economic events could adversely affect the public equities market andgeneral economic conditions may worsen. Should the fair value of our publicly traded equity investments declinebelow their cost basis in a manner deemed to be other-than-temporary, ourearnings may be adversely affected.  Wehave also invested in several privately held companies as well as investmentfunds which invest primarily in privately held companies, many of which canstill be considered in the start-up or development stages.  These investments are inherently risky, asthe market for the technologies or products they have under development aretypically in the early stages and may never materialize.

 

***Foreign Exchange Rate Risk***

 

As a multinationalcompany, we conduct our business in a wide variety of currencies and aretherefore subject to market risk for changes in foreign exchange rates.  We expect to continue to expand our businessglobally and, as such, expect that an increasing proportion of our business maybe denominated in currencies other than U.S. Dollars.  As a result, fluctuations in foreigncurrencies may have a material impact on our business, results of operationsand financial condition.

 

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Historically, themajority of our foreign-currency denominated sales have been made in China,denominated in Renminbi.  Additionally,during 2006, 2007 and through 2008, we made significant sales in Japanese Yen,Euros, Indian Rupees and Canadian Dollars. Due to China’s currency exchange control regulations, we are limited inour ability to convert and repatriate Renminbi, as well as in our ability toengage in foreign currency hedging activities in China.  The balance of our cash and cash equivalentsand short-term investments held in China was $155.4 million at September 30,2008.  Since China un-pegged the Renminbifrom the U.S. Dollar in July 2005 through September 30, 2008, theRenminbi has strengthened by more than 15% versus the U.S. Dollar.  However, it is uncertain what furtheradjustments may be made in the future.

 

We may manage foreigncurrency exposures using forward and option contracts to hedge and thusminimize exposure to the risk of the eventual net cash inflows and outflowsresulting from foreign currency denominated transactions with customers,suppliers, and non-U.S. subsidiaries; however, we are not currently hedging anysuch transactions.  As our foreigncurrency balances are not currently hedged, any significant revaluation of ourforeign currency exposures may materially and adversely affect our business,results of operation and financial condition. We do not enter into foreign exchange forward or option contracts fortrading purposes.

 

Given our exposure to international markets,we regularly monitor all of our material foreign currency exposures.  We use sensitivity analysis to measure ourforeign currency risk by computing the potential decrease in cash flows thatmay result from adverse or beneficial changes in foreign exchange rates,relative to the functional currency with all other variables heldconstant.  The analysis covers all of ourunderlying exposures for foreign currency denominated financialinstruments.  The foreign currencyexchange rates used were based on market rates in effect at September 30,2008.  The sensitivity analysis indicatedthat a hypothetical 10% adverse or beneficial movement in exchange rates wouldhave resulted in a loss or gain in the fair values of our foreign currencydenominated financial instruments of $14.8 million at September 30, 2008.

 

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**ITEM 4—CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

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

 

In connection with thepreparation of this Quarterly Report on Form 10-Q (“Form 10-Q”), theCompany carried out an evaluation as of September 30, 2008 under the supervisionand with the participation of the Company’s management, including the CEO andCFO, of the effectiveness of the design and operation of the Company’sdisclosure controls and procedures, as such term is defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act. Based upon this evaluation, managementconcluded that as of September 30, 2008 the Company’s disclosure controlsand procedures were not effective because of the material weaknesses describedin “Management’s Annual Report on Internal Control over Financial Reporting,”included in “Part II, Item 9A - Controls and Procedures” (“Item 9A”) inthe Company’s Annual Report on Form 10-K for the fiscal year ended December 31,2007, which have not yet been remediated. Investors are directed to Item 9A inthe 2007 Annual Report for the description of these weaknesses.

 

A “material weakness” isa deficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the Company’s annual or interim financial statementswill not be prevented or detected on a timely basis. To address these materialweaknesses in internal control over financial reporting noted above, theCompany performed additional analyses and other procedures (as furtherdescribed below under “Management’s Planned Remediation Initiatives and InterimMeasures”) to ensure that the Company’s consolidated financial statements areprepared in accordance with generally accepted accounting principles in theUnited States (“GAAP”). Accordingly, the Company’s management believes that theconsolidated financial statements included in this Form 10-Q fairlypresent in all material respects the Company’s financial condition, results ofoperations and cash flows for the periods presented and that this Form 10-Qdoes not contain any untrue statement of a material fact or omit to state amaterial fact necessary to make the statements made, in light of thecircumstances under which such statements were made, not misleading withrespect to the periods covered by this report.

 

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

 

The Company plans to makenecessary changes and improvements to the overall design of its controlenvironment to address the material weaknesses in internal control overfinancial reporting described in Item 9A in the 2007 Annual Report. Inparticular, the Company has implemented during 2007 and the first ,second andthird quarters of 2008, and plans to continue to implement during the remainderof 2008, the specific measures described below. In addition, in connection with the September 30, 2008 quarter-endreporting process, the Company has undertaken additional measures describedunder the subheading “Interim Measures” below to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of theCompany’s consolidated financial statements included in this Form 10-Q andto ensure that material information relating to the Company and its consolidatedsubsidiaries was made known to management in connection with the preparation ofthis Form 10-Q.

 

***Remediation Initiatives***

 

1.             To remediate the material weakness described in Item 9Ain the 2007 Annual Report, in “*The Company failed toprevent or detect non-compliance with established policies and proceduresintended to ensure compliance with laws and regulations,”* theCompany launched a formal investigation at the direction of the Audit Committeeof the Company’s Board of Directors (“Audit Committee”) to review allegedviolations of the FCPA during the second quarter of 2006; refer to “*Governmental Investigations*” under Note14 to our Condensed Consolidated Financial Statements included under Part 1,Item 1 of this Quarterly Report on Form 10-Q for additional information. Throughout the course of thisinvestigation, the Company has taken and plans to continue to take allappropriate actions including changes to its training, processes and proceduresrelated to its code of business conduct and ethics, its payment controlsparticularly in outlying regions, and its due diligence evaluation of businesspartnerships. Upon conclusion of this investigation, the Company will reviewand, as necessary, further enhance its procedures to reduce the risk of ongoingcontrol deficiencies in this area. In the third and fourth quarters of 2007 andthe first, second and third quarters of 2008, the Company provided training topersonnel in offices in various regions including North America, Europe, Chinaand India and, in the remainder of

 

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2008,plans to continue to provide training and expand its coverage to personnelemployed in other regions and countries. In addition, the Company’s internalaudit staff commenced audits and plans to continue to expand and increase thescope of the Company’s efforts to monitor controls at company operationsglobally, through reviews and audits of employee compliance with applicablepolicies and procedures at business units, subsidiaries and other locations.

 

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

 

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

 

ii.        In the first, second and thirdquarters of 2008, the Company enhanced, and in the remainder of 2008, theCompany plans to continue enhancing, its processes and procedures to ensure thecompleteness and accuracy of the recording of the cost of sales when revenue isrecognized, and the accuracy and adequacy of recording of the reserves forlosses on customer contracts. The revised processes included involving andobtaining detailed and timely input from business units, operations and salesoperations personnel to enhance the information available for finance toanalyze these accounts. Additional analytical processes were put in place toensure the accuracy of the recording of the cost of sales when revenue isrecognized. In addition, finance management has placed increased attention onreviewing in detail the accounting in this area.

 

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

 

i.        During 2007 and the first,second and third quarters of 2008 the Company enhanced, and in the remainder of2008 the Company plans to continue enhancing, the month and quarter-end closingprocedures within its corporate accounting function to standardize itsprocesses for financial review to ensure that reviewers at its U.S.headquarters analyze and monitor financial information in a consistent andthorough manner. The enhanced procedures included timely communication with theCompany’s remote locations to ensure the completeness and accuracy of the closeprocesses.

 

ii.        During 2007 and the first,second and third quarters of 2008 the Company implemented, and in the remainderof 2008 the Company plans to continue enhancing and improving the documentationand review of required information associated with the preparation of itsquarterly and annual filings under the Exchange Act. Additional reviews wereput in place to ensure the accuracy of the financial statements in thequarterly and annual filings, and procedures were added to ensure thecompleteness of the reviews of the quarterly and annual filings.

 

***Interim Measures***

 

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

 

1.    TheCompany retained on an interim basis outside consultants with relevantaccounting experience, skills and knowledge, working under the supervision anddirection of the Company’s management, to assist with its review in a number ofareas including SEC external financial reporting.

 

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2.    TheCompany implemented and performed a number of additional detailed proceduresand a comprehensive review of its accounting in various areas, including:

 

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

 

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

 

***Management’s Conclusion***

 

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

 

The Company is committedto continuing to improve its internal control processes and will continue todiligently and vigorously review its disclosure controls and procedures and itsinternal control over financial reporting in order to ensure compliance withthe requirements of Section 404 of the Sarbanes-Oxley Act of 2002.However, any control system, regardless of how well designed, operated andevaluated, can provide only reasonable, not absolute, assurance that itsobjectives will be met. As management continues to evaluate and work to improvethe Company’s internal control over financial reporting, it may determine totake additional or alternate measures to address control deficiencies, and itmay determine not to complete certain of the measures described under “Management’s Planned Remediation Initiativesand Interim Measures” above.

 

**Changes in Internal Control over Financial Reporting**

 

The Company concluded itsimplementation of an upgrade to its enterprise resource planning (“ERP”)system. The Company will continue to enhance its ERP system through theremainder of 2008 and beyond. The Company has modified and will continuemodifying the design and documentation of internal controls processes andprocedures relating to the upgraded system as appropriate and necessary tosupplement and complement existing internal controls over financial reporting.

 

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

 

**PART II—OTHERINFORMATION**

 

**ITEM 1—LEGAL PROCEEDINGS**

 

For a description oflitigation and governmental investigations, see Note 14 to our CondensedConsolidated Financial Statements included under Part 1, Item 1 of thisQuarterly Report on Form 10-Q.

 

**ITEM 1A—RISK FACTORS**

 

For a description of risk factors that could materially affect ourbusiness, financial condition and future operating results, please consider therisk factors set forth in “Part II, Item 1A – Risk Factors” of ourQuarterly Report on Form 10-Q for the fiscal

 

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quarterended March 31, 2008, which superseded the description of riskfactors previously disclosed in “Part I, Item 1A - Risk Factors” ofour Annual Report on Form 10-K for the fiscal year ended December 31,2007.  The descriptions below includematerial changes to the respective risk factor as previously disclosed in ourQuarterly Report on Form 10-Q for the fiscal quarter ended March 31,2008.  Additional risks and uncertaintiesnot currently known to us or that we currently deem to be immaterial also maymaterially and adversely affect our business, financial condition or futureoperating results.

 

**FACTORS AFFECTING FUTURE OPERATING RESULTS**

 

**RISKS RELATED TO OUR COMPANY**

 

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

 

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

 

As a result of the saleof PCD on July 1, 2008 (see Note 3 to our Condensed Consolidated FinancialStatements included under Part I, Item 1 of this Quarterly Report on Form 10-Q),management believes the Company now has sufficient liquidity to finance itsworking capital and capital expenditure requirements for the next twelvemonths.

 

Management will continueto implement its liquidity plans, which include reducing our operatingexpenses, continuing to divest noncore assets or operations, and obtainingloans from financial institutions. If we cannot successfully implement ourliquidity plans, it may be necessary for us to make significant changes to ourbusiness plan in order to maintain adequate liquidity beyond the nexttwelve months. In addition, various other matters may impact our liquiditysuch as:

 

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

 

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

 

·                     changesin China’s currency exchange control regulations that could limit our abilityto access cash in China to meet liquidity requirements for our operations inChina or elsewhere.

 

Although management hasdeveloped liquidity plans, we may have difficulty maintaining existingrelationships, or developing new relationships, with suppliers or vendors as aresult of our financial condition. Our suppliers or vendors could choose toprovide supplies or services to us on more stringent payment terms than thosecurrently in place, such as by requiring advance payment or payment upondelivery of such supplies or services, which would have an adverse impact onour short-term cash flows. As a result, our ability to retain currentcustomers, attract new customers and maintain contracts that are critical toour operations may be adversely affected.

 

Thus, our ability tocontinue as a going concern beyond the next twelve months and until we generatesustained profits and/or positive cash flows from operations is subject to ourability to successfully reduce operating expenses, divest noncore assets oroperations, and/or obtain loans from financial institutions. Our continuingoperating losses increase the difficulty of our meeting such goals and ourefforts to continue as a going concern may not prove successful.

 

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

 

As discussed in Note 3 toour Condensed Consolidated Financial Statements included under Part 1,Item 1 of this Quarterly Report on Form 10-Q, we divested two of ournoncore operations (and the assets associated with these operations) in July 2008.There

 

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is no assurancethat the anticipated benefits of these divestitures, including withoutlimitation the receipt of any earnout payment provided in the PCD sale based onthe achievement of cumulative earnings levels by New PCD, and any otherdivestitures we may undertake in the future will be realized.

 

*Recent market turmoil may negatively impact our customersand suppliers, which could result in material losses.*

 

Recentturmoil in the markets is likely to make it more difficult for our customersand suppliers to maintain their business operations.  As a result, the ability of our customers andsuppliers to pay or supply us, respectively, could be adversely impacted.  Most of our customer sales are on an opencredit basis.  Although we monitorindividual customer payment capability in granting such open creditarrangements, seek to limit such open credit to amounts we believe the customerscan pay, and maintain reserves we believe are adequate to cover exposure fordoubtful accounts, there can be no assurance that all customers will be capableof making all contractual payments when due. For example, we have had customers declare bankruptcy, causing us toincur financial losses. These losses and future losses, if incurred, could harmour business and have a material adverse effect on our operating results andfinancial condition.  To the extent oursuppliers are unable to supply us with necessary products, our business could beharmed and have a material adverse effect on our operating results andfinancial condition.

 

**RISKS RELATED TO CONDUCTINGBUSINESS IN CHINA**

 

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

 

TheState Administration of Foreign Exchange (“SAFE”) has promulgated regulationsthat require PRC residents and PRC corporate entities to register with localbranches of SAFE in connection with their direct or indirect offshoreinvestment activities.  Under the SAFE regulations, PRC residents whomake, or have previously made, direct or indirect investments in offshorecompanies will be required to register those investments.  In addition,any PRC resident who is a direct or indirect shareholder of an offshore companyis required to file or update the registration with the local branch of SAFEwith respect to that offshore company any material change involving itsround-trip investment, capital variation, such as an increase or decrease incapital, transfer or swap of shares, merger, division, long-term equity or debtinvestment or creation of any security interest.  If any PRC shareholderfails to make the required SAFE registration or file or update theregistration, the PRC subsidiaries of that offshore parent company may beprohibited from distributing their profits and the proceeds from any reductionin capital, share transfer or liquidation to their offshore parent company, andthe offshore parent company may also be prohibited from injecting additionalcapital into its PRC subsidiaries.  Moreover, failure to comply with thevarious SAFE registration requirements described above could result inliability under PRC laws for evasion of applicable foreign exchangerestrictions.

 

Wecannot provide any assurances that all of our shareholders who are PRCresidents will make or obtain any applicable registrations or approvalsrequired by these SAFE regulations.  The failure or inability of our PRCresident shareholders to comply with the registration procedures set forththerein may subject us to fines and legal sanctions, restrict our cross-borderinvestment activities, or limit our PRC subsidiaries’ ability to distributedividends or obtain foreign-exchange-denominated loans to our company.

 

OnMarch 28, 2007, SAFE promulgated a stock option rule under which PRCcitizens who are granted stock options by an overseas publicly-listed companyare required to register with SAFE and complete certain other procedures. We and our PRC employees who have been granted stock options are subject tothis stock option rule.  If we or our PRC employees holding options failto comply with these regulations, we or our employees may be subject to finesand legal sanctions.

 

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

 

None

 

**ITEM 3—DEFAULTS UPON SENIOR SECURITIES**

 

None

 

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

** **

None

 

**ITEM 5—OTHER INFORMATION**

 

None.

 

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**ITEM 6—EXHIBITS**

 
| **Exhibit  Number** | ** ** | **EXHIBIT DESCRIPTION**                                                                                                                                                                                                                                                                                                                                |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                 |       | Thirteenth  Amended and Restated Certificate of Incorporation of UTStarcom, Inc., as  amended (incorporated by reference to Exhibit 3.1 of Current Report on  Form 8-K filed with the SEC on December 12, 2003)                                                                                                                         |
| 3.2                 |       | Second  Amended and Restated Bylaws of UTStarcom, Inc., effective June 28,  2008 (incorporated by reference to Exhibit 3.1 of Current Report on  Form 8-K filed with the SEC on April 14, 2008)                                                                                                                                    |
| 4.1                 |       | See  exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and  Bylaws defining the rights of holders of Common Stock.                                                                                                                                                                                                                    |
| 4.2                 |       | Specimen  Common Stock Certificate (incorporated by reference to Exhibit 4.1 of  Form S-1/A filed with the SEC on February 7, 2000)                                                                                                                                                                                                          |
| 4.3                 |       | Third  Amended and Restated Registration Rights Agreement dated December 14,  1999 (incorporated by reference to Exhibit 4.2 of Form S-1 filed  with the SEC on December 20, 1999)                                                                                                                                                      |
| 10.1                |       | Merger  Agreement, dated as of June 30, 2008, by and among UTStarcom, Inc.,  UTStarcom Personal Communications Devices, LLC, Personal Communications  Devices, LLC and Personal Communications Devices Holdings, LLC (incorporated  by reference to Exhibit 2.1 of Current Report on Form 8-K filed  with the SEC on July 7, 2008) |
| 10.2*               |       | Separation  Agreement and Release, dated August 28, 2008, by and between Francis P.  Barton and UTStarcom, Inc.                                                                                                                                                                                                                                        |
| 10.3*               |       | 2006 Equity Incentive Plan Stock Option Award  Agreement as amended September 3, 2008                                                                                                                                                                                                                                                                  |
| 31.1                |       | Certification  of the Chief Executive Officer pursuant to Rule 13a-14(a) or  Rule 15d-14(a) promulgated under the Securities Exchange Act of  1934, as amended                                                                                                                                                                          |
| 31.2                |       | Certification  of the Chief Financial Officer pursuant to Rule 13a-14(a) or  Rule 15d-14(a) promulgated under the Securities Exchange Act of  1934, as amended                                                                                                                                                                          |
| 32.1                |       | Certifications  of the Chief Executive Officer and Chief Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                  |

 

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*              Management contract, plan or arrangement

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
|                             | UTSTARCOM, INC. |
|-----------------------------|----------------------|
|                        |                 |
| Date: November 7, 2008 | By:                  | /s/ VIRAJ J. PATEL |
|                        |                 | Viraj J. Patel |
| * *                    | * *             | *Interim Chief Financial Officer* |
| * *                    | * *             | *(Principal Financial Officer)* |

 

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