**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

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FORM 10-K

**x**                              ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Fiscal Year Ended December 31, 2004**

** ̈**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe transition period from               to               **

**CommissionFile Number:  000-29661**

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UTSTARCOM, INC.

(Exact name of registrantas specified in its charter)

| Delaware                                                        | **52-1782500**                        |
|-----------------------------------------------------------------|---------------------------------------|
| (State or other jurisdiction  of incorporation or organization) | (I.R.S. Employer  Identification No.) |
| **1275  Harbor Bay Parkway  Alameda, California**               | **94502**                             |
| (Address of principal executive offices)                        | (Zip Code)                            |

 

**(510) 864-8800**

(Registrant’s telephonenumber, including area code)

Securities registeredpursuant to Section 12(b) of the Act: **None**

Securities registered pursuant to Section 12(g) ofthe Act:

**Common stock, $0.00125 parvalue**

(Title of class)

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

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Act). Yes x  No o

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of the lastbusiness day of the registrant’s most recently completed second fiscal quarterwas approximately $2,777,913,977 based upon the closing price of $30.25reported for such date on The Nasdaq National Market. For purposes of thisdisclosure, shares of Common Stock held by persons who hold more than 10% ofthe outstanding shares of Common Stock and shares held by officers anddirectors of the registrant, have been excluded in that such persons may bedeemed to be affiliates. This determination is not necessarily conclusive forother purposes.

As of March 31, 2005the registrant had 114,841,976 outstanding shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the Proxy Statement for the Annual Meeting of Shareholders to be held on May 13,2005 are incorporated herein by reference in Part III.

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**UTSTARCOM, INC.**

**TABLEOF CONTENTS**
|                | ** **                                                                                                                     | **PAGE** |
|----------------|--------------------------------------------------------------------------------------------------------------------------------|----------|
| PART I.   |                                                                                                                           |     |
| Item 1.        | Business                                                                                                                       | 4        |
| Item 2.        | Properties                                                                                                                     | 19       |
| Item 3.        | Legal Proceedings                                                                                                              | 20       |
| Item 4.        | Submission of Matters to a  Vote of Security Holders                                                                           | 23       |
| PART II.  |                                                                                                                           |     |
| Item 5.        | Market for  UTStarcom, Inc.’s Common Equity, Related Stockholder Matters, and Issuer  Purchases of Equity Securities | 24       |
| Item 6.        | Selected Financial Data                                                                                                        | 26       |
| Item 7.        | Management’s Discussion  and Analysis of Financial Condition and Results of Operation                                     | 27       |
| Item 7A.       | Quantitative and Qualitative  Disclosures About Market Risk                                                                    | 76       |
| Item 8.        | Financial Statements and  Supplementary Data                                                                                   | 78       |
| Item  9.       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure                                     | 138      |
| Item 9A.       | Controls and Procedures                                                                                                        | 138      |
| Item 9B.       | Other Information                                                                                                              | 150      |
| PART III. |                                                                                                                           |     |
| Item  10.      | Directors  and Executive Officers of UTStarcom, Inc.                                                                      | 151      |
| Item 11.       | Executive Compensation                                                                                                         | 151      |
| Item  12.      | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                               | 151      |
| Item  13.      | Certain  Relationships and Related Transactions                                                                                | 151      |
| Item 14.       | Principal  Accountant Fees and Services                                                                                        | 151      |
| PART IV.  |                                                                                                                           |     |
| Item  15.      | Exhibits  and Financial Statement Schedules                                                                                    | 152      |
|           | Exhibit Index                                                                                                             | 152      |
| Signatures     | 156                                                                                                                            |

 

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**PART I**

**ADDITIONAL INFORMATION**

“UTStarcom” (which may be referred to as the “Company,”“we,” “us,” or “our”) means UTStarcom, Inc. or UTStarcom, Inc. andits subsidiaries, as the context requires. The name “UTStarcom” is a registeredtrademark of UTStarcom, Inc.

In this Annual Report on Form 10-K,references to and statements regarding China refer to mainland China,references to “U.S. dollars” or “$” are to United States Dollars, andreferences to “Renminbi” are to Renminbi, the legal currency of China.

Unless specifically stated, information in this AnnualReport on Form 10-K assumes an exchange rate of 8.2775 Renminbi forone U.S. dollar, the exchange rate in effect as of December 31, 2004.

Throughout this Annual Report on Form 10-Kwe “incorporate by reference” certain information from other documents filedwith the Securities and Exchange Commission (the “SEC”). Please refer to suchinformation at *www.sec.gov*.

UTStarcom’s public filings, including our annualreports on Form 10-K, quarterly reports on Form 10-Q andcurrent reports on Form 8-K, and any amendments to such reports, areavailable free of charge at our website, *www.utstar.com*.The information contained on our website is not being incorporated herein.

This Annual Report on Form 10-K containsforward-looking statements. Beginning on page 60, we discuss some of therisk factors that could cause actual our results to differ materially fromthose provided in the forward-looking statements.

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**ITEM 1—BUSINESS**

**OVERVIEW**

We design, manufacture and sell telecommunicationsequipment and provide services associated with their installation, operation,and maintenance. Our products are deployed and installed primarily bytelecommunications service providers. We sell an extensive range of productsthat are designed to enable voice, data and video services for our customersaround the world. While historically, the vast majority of our sales have beento service providers in China, the Company has expanded its focus to build aglobal presence and currently sells its products to several other emerging andestablished growth markets, which include North America, Japan, India, Centraland Latin America, Europe, the Middle East and Africa and southeastern and northernAsia.

UTStarcom was incorporatedin Delaware in 1991. Our headquarters are based in Alameda, California, withresearch and design operations in the United States, Canada, China, India andKorea. Our primary mailing address is 1275 Harbor Bay Parkway, Alameda,California, 94502. We can be reached by telephone at (510) 864-8800, andour website address is *www.utstar.com*.All of our SEC filings can be found under the Investor Relations section of ourwebsite, and are available free of charge.

**STRATEGY**

Our objective is to be a leading global provider ofend-to-end Internet Protocol (“IP”)-based communications products and services.We seek to differentiate ourselves by developing innovative products that aredesigned to allow for additional revenue-generating services; integratemultiple functionalities; reduce network complexity, and enable a migration toa new generation of network technologies. Our technology and products aredesigned to make carrier deployments, maintenance and upgrades both economicaland efficient, allowing operators to earn a high return on their investment.

Our strategy isbuilt upon the following key concepts:

·       drivingproduct innovation to offer our customers an increased number of features andenhanced functionality;

·       reducingoverall operational and deployment costs of our customers’ networks, enablingthem to meet the demands of a greater number of consumers by expanding theiraddressable markets; and

·       providingcustom tailored products and services to suit customers’ unique needs.

Our keystrengths in the implementation of our strategy include the following factors:

**A History ofTechnology Innovation**

Since our inception, wehave focused on the development of new innovative and disruptive communicationstechnologies and products that are designed to differentiate us from our peersand create new market opportunities for our carrier customers. For example, wehelped create a new market for wireless telephony in China based upon thedevelopment of our Personal Access Service and IP-based Personal Access Service(collectively “PAS”) solutions offering a low power, low cost alternative toprevailing mobile telephony. We believe PAS became successful with traditionalfixed wireline carriers because it enabled them to leverage their fixed-linenetworks to offer their consumers wireless mobile services. This service, whilelimited in range to each specific city or region in which it was offered,afforded a low-cost alternative to more expensive traditional cellular services.The rapid rate of adoption for PAS positioned us as one of the leading wirelessinfrastructure and handset providers in China and to date over 35 millionsubscribers are using services supported by our technology. In addition, webelieve it has provided a springboard for our development of other similarlydisruptive technologies such as IP-based wireless, broadband and switching.

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**A SignificantCustomer Base and Leverage in China**

Over the course of severalyears, we have built an extensive administrative, research and development,manufacturing, and sales and support infrastructure in China. We believe thisinfrastructure allows us to quickly identify our customers’ needs and to focusour engineering, product development and sales and marketing efforts to addressthose needs. In addition, the low-cost research and development andmanufacturing capabilities in China allow us to be competitive on a cost andpricing basis for our products. Finally, by virtue of its large population andlow teledensity, or the number of telephones per person in a region, and oursignificant customer deployments, the China market provides a highly conduciveplatform for us to deploy our most advanced technology in substantial volume. Webelieve that our infrastructure, cost efficiencies and research and developmentadvances in China provide a significant platform and strategic advantage forour global success.

**A Commitment toCarrier Value**

We believe we have beenable to develop strong relationships with our customers by deliveringend-to-end solutions that are designed to enable carriers to capitalize oneconomies of scale and to easily customize and extend their service portfolios.To ensure our products deliver the most value, the UTStarcom productarchitecture is designed to allow carriers to offer a full range of servicesover multiple access networks, whether wireless or wireline. Our wirelessproducts support a broad range of frequencies for cost-effective deploymentworldwide, and our broadband products support both copper- and fiber-basedaccess. To help ensure we offer high value solutions at a low cost, we leverageour extensive design, development, and manufacturing facilities in China.

**A Focused GlobalMarket Diversification Initiative**

In 2004, we continued to focus on the diversificationof our global customer base and market penetration. Our diversificationstrategy involves a combination of internal efforts and strategic acquisitions.In order to better address new markets outside of China we introduced a numberof new products and completed a number of acquisitions, including theacquisition of the selected assets of the Audiovox Communications Corporation (“ACC”),the wireless handset division of Audiovox Corporation in November of 2004.We believe these efforts have significantly enhanced our ability to gain accessto the largest and most stable operators worldwide. We intend to seekadditional acquisitions and use partnerships to solidify our market positionand expand our technology portfolio and sales channels in new markets.

In addition to the large telecommunications serviceproviders in well-established markets, we also target carriers in emergingmarkets, such as Softbank Group, Vonage in the United States and RelianceInfocomm Ltd. in India, which have focused their network deployments onIP-based voice, data and video services.

We believe emergingmarkets beyond China present significant opportunities for growth. We believethat many developing regions see a correlation between increased teledensityand improved economic growth, recognizing the need to invest in atelecommunications infrastructure in order to compete globally and overcomeeconomic disparities. Our strategy is to develop products and design servicesspecifically tailored to the needs and level of affordability of these emerging-marketservice providers and their customers. In addition, we recognize that to besuccessful in these emerging markets, it is often important to commit toestablishing a local presence in areas such as research and development,manufacturing, sales and support. We continue to explore major growth potentialin global markets outside of China and believe that many of these markets areideal candidates for our products and services as well as operations.

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**TECHNOLOGY ANDPRODUCTS**

Our technology focus centers on an IP-based softswitchcore network architecture that creates a single platform for deliveringmultiple services to the end user of the telecommunications network. Softswitchis a technological approach to telephony networking where all the serviceintelligence for the delivery of telephone services resides in easily adaptableIP-based software. A Softswitch is designed to reduce the cost of long distanceand local exchange switching and to create new differentiated voice, data andvideo services. In contrast, legacy networks are based on the delivery of asingle service, such as voice or data. If a service provider operating atraditional network wanted to offer multiple services, it would have to build,run and maintain a separate network for each service, including separatebilling, network management and support functionalities, adding significantcosts to the carrier’s operating model. An IP-based core network is designed sothat all services can be converged onto one platform with one billing, networkmanagement and support function for all services. In addition, because it islargely software-based, an IP network is by design more cost-effective torun and maintain than traditional infrastructure technologies. All of ourproducts are interoperable and can be integrated into a single IP-based network.We intend to continue to support our IP-based wireless and broadband servicesand enhance their functionality for deployment in all global markets. We alsointend to continue our research and development efforts on future IP-basedaccess services.

Our IP-based, multi-servicesoftswitch architecture (“mSwitch”), is a diverse assembly of software andhardware-based networking elements designed to replace traditionalcentral office telephone switches. Our IP-based softswitch platform enables thedelivery of a common set of value-added end-to-end services over a variety ofaccess networks, whether wireless or wireline. Our architecture is designed tosupport a comprehensive set of services, including broadband and narrowbandaccess, call control of telephone and data communications and delivery of nextgeneration features not offered by the traditional fixed line switchinginfrastructure, including IP-based television (“IPTV”).

**mSwitch Platform**

Our mSwitch platform enables a next-generation corenetwork for all of our wireless, wireline and broadband networks with theexception of CDMA2000, which is supported by its own Softswitch that we expectto integrate into our existing platform in the future. The mSwitch has beenextensively deployed in our Personal Access Systems networks in variousnetworks around the globe. In addition, the mSwitch provides the softswitchfunctionality for various other UTStarcom solutions including, but not limitedto, Voice over Broadband (“VoBB”), Time Division-Code Division Multiple Access(“TD-CDMA”), Wideband Code Division Multiple Access (“WCDMA”) and Televisionover IP (“TVoIP”).

Our mSwitch platform is designedto reliably transport and route packets as well as to handle signaling, networkcontrol, and information management. The architecture includes operationssupport systems for associated billing, provisioning, and service management.

**Key Product Families**

Our key productfamilies fall into three major categories:

·       WirelessInfrastructure:   technologies and products that enable end users, orsubscribers, to send and receive voice and data communication in either a fixedor mobile environment by using wireless devices;

·       BroadbandInfrastructure:   technologies and products that enable end users to accesshigh-speed, cost effective fixed data and voice and media communication; and

·       Handsetsand Customer Premise Equipment:   consumer devices that allow customers toaccess wireless and broadband services.

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Our products within eachof these categories include multiple hardware and software subsystems that canbe offered in various combinations to suit individual carrier needs. Our systemtechnologies and products are based on widely adopted global communicationsstandards and are designed to allow service providers to quickly andcost-efficiently integrate our systems into their existing networks and deployour systems in new broadband, IP and wireless network rollouts. Our systemtechnologies are also designed to allow timely and cost efficient transition tofuture next-generation network technologies, enabling our service providercustomers to protect their initial infrastructure investments. See Item 7, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations—NetSales,” for a discussion of our net sales by product lines.

**WIRELESSINFRASTRUCTURE**

Wireless networking is one of our core technologiesthat refers to communications networks that enable end users to send andreceive voice and data while mobile by using wireless devices such as cellulartelephones, personal computers, personal digital assistants and other wirelesscommunications devices. Wireless networks require the use of customizedequipment that enables an end user or subscriber to be connected and identifiedwhen not in a fixed location within a network. We offer a broad range ofwireless infrastructure products and services, from service platforms to coreinfrastructure systems for large carriers that can support millions ofsubscribers.

We provide wireless networkinginfrastructure products based on a variety of leading global mobile interfacestandards, including: Personal Handyphone System (“PHS”), Code DivisionMultiple Access (“CDMA”), WCDMA, and TD-CDMA. All of our wireless products aredesigned to offer a full suite of integrated, customizable, voice and value-addedservices, including short-message services, web browsing, e-mail, voicemail, and Internet access.

**PHS Wireless MobilePhone Systems**

*Personal AccessSystem (“PAS”)/ IP-based Personal Access System (“iPAS”)*

Our globally deployed PAS, a family of wireless coreinfrastructure equipment, based on the Personal Handyphone System (“PHS”)standards developed by The Association of Radio Industries andTelecommunication Technology Committee in Japan, is designed to help ourcustomers create new revenue opportunities with high quality wireless voice anddata services.

Our PAS wireless access system employs micro-cellularradio technology that is designed to enable service providers to offersubscribers both mobile and fixed access to telephone services. In China, thePAS architecture is designed to allow service providers to transition theirnetwork capabilities from wireline to wireless, allowing them to offer bothmobile wireless voice and data services within a city or community. Using ourproducts, service providers can offer new wireless services, including citywidemobility, e-mail, mobile Internet access, and short message services.

We designed our PAS equipment to meet the needs ofsubscribers that do not require all of the features offered by traditionalcellular technology, but want more than the features offered by standardfixed-line technology, including regional mobility, a more cost-effectivetariff plan, and access to value-added data services. When compared toother traditional macro-cellular wireless systems, PAS offers lower deploymentcosts, easier radio frequency planning, higher traffic capacity, better voicequality, faster data transmission speeds, lighter handsets with lower powerrequirements, and better support of advanced information services.

In comparison totraditional macro-cellular systems, PAS base stations are small and arenormally installed on existing utility poles or buildings rather than on largetowers. Mounting small transmitters this way greatly reduces the cost andcomplexity of installation as there is neither need for a major tower 

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constructionproject nor any significant tower lease fees. Additionally, mounting a smallPAS base station close to its antenna and connecting it to the network usingstandard telephone wire is far simpler and more cost effective than thetraditional cellular approach of installing a large transmitter on the groundand running heavy coaxial cables up a tower to the antennas. PAS base stationinstallation takes a few hours, compared to the several days required toinstall, power, and commission a traditional wireless cell station. Because PASuses “dynamic frequency allocation,” a process where each cell “listens to” allavailable radio channels before selecting one for each call, the overall radioplanning and engineering for PAS is very simple. While adding cells to handlemore calls in a traditional cellular network requires considerable frequencyplanning and balancing, adding cells to a PAS network is less difficult becausePAS cells can automatically determine what channels to use. This capability,combined with the low cost per cell, allows a carrier to start with a verysmall system serving only hundreds of subscribers and grow that system to servemillions, simply by adding small cells.

*CDMA, TD-CDMA,WCDMA and TD-SCDMA Wireless Mobile Systems*

We have developed a suiteof products and services for third-generation (“3G”) wireless networks thatsupport the open 3G wireless standards CDMA, WCDMA, TD-CDMA and TD-SCDMAdefined under 3GPP, the international standardization body, and the standardsof TIA/EIA, the United States Standardization body.

**MovingMedia 2000 WirelessVoice and Data Product (CDMA/CDMA 2000)**

In the fall of 2004, we introduced our MovingMedia2000 All-IP CDMA/CDMA 2000 infrastructure solution. The MovingMedia 2000product line is the first IP-based infrastructure solution in the world forCDMA 2000. It provides for the communication of data and voice over IP andoffers mobile operators savings on infrastructure and transmission costs. Italso allows incumbent CDMA operators to transition smoothly and efficiently toan all-IP network and to offer new value-add services not provided by legacyCDMA networks. We believe these attributes make MovingMedia 2000 an idealsolution for both incumbent and greenfield CDMA operators.

Our CDMA/CDMA 2000 wireless infrastructure productfamily includes IP base stations, intelligent media gateways, signalinggateways, and packet data server nodes (PDSN).

Our MovingMedia 2000 solution employs an advancednext-generation network voice and data over IP architecture that distributesall of the components of a CDMA system throughout the network, rather than inone centralized location. With a distributed architecture, a wireless serviceprovider can deploy various elements of the solution in different cities—NewYork, Dallas, and San Francisco, for example—and they would operate as onesystem transparently to the operator, reducing the size and cost of itsinfrastructure.

MovingMedia 2000 isdesigned to be compatible with all wireless equipment designed tointernationally defined standards, giving service providers enormousflexibility when designing and developing their networks. In addition, ouropen, standards-based architecture is designed to provide the scalabilityand flexibility required by service providers for easy deployment of servicesand applications.

**MovingMedia 6000Wireless Data Product (TDCDMA)**

In the fall of 2004, we introduced our MovingMedia6000 wireless broadband data solution. The MovingMedia6000 wireless broadband solution is based on the Universal MobileTelecommunications System Time Division Duplexing (“UMTS TDD”) standard for 3Gmobile networks, which utilizes TD-CDMA technology. We have an establishedrelationship with IPWireless, Inc., which provides the core technology forour TD-CDMA portfolio. Our MovingMedia 6000 turns a range of low-cost licensedfrequency bands—1900-1920MHz, 2010-2025MHz,2500-2700MHz, and 3400-3600MHz—into valuable 

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assets that we believewill provide a rapid return on operator investment. Mobile and wirelessbroadband service providers worldwide can deploy the solution today to offerhigh-value data services of up to 3Mbps per subscriber, enabling subscribers toaccess the network from home, work, or any other location. We anticipate that,in the near future, operators will be able to use our MovingMedia 6000 solutionto offer wireless Voice over IP (“VoIP”) in addition to the high-mobility dataservices available today.

Our TD-CDMA wirelessinfrastructure product family includes base stations, radio networkcontrollers, Gateway GPRS Support Nodes, which ensure a secure connectionbetween the packet core network and the IP network, and Serving GPRS SupportNodes that provide session management, traffic processing and mobilitymanagement.

**MovingMedia 8000Wireless Voice and Data Product (WCDMA)**

We expect to launch ourMovingMedia 8000 WCDMA solution to the market in the second half of 2005. In November 2004,we successfully completed the Phase II field trials of our MovingMedia 8000with China Netcom Corporation in China. These trials were conducted inconjunction with the Ministry of Information Industry in China.

*TD-SCDMA WirelessVoice and Data Product*

We are developing andtesting a suite of products and services for 3G wireless networks that supportthe time division-synchronous code division multiple access standard, (“TD-SCDMA”)the emerging China-developed 3G standard. As a TD-SCDMA Forum council member,we have been working closely with Datang Telecom Technology on the developmentof certain elements for a TD-SCDMA product that would use the same core networkas the MovingMedia 6000 and 8000 series.

**BROADBANDINFRASTRUCTURE**

Our broadbandinfrastructure products are designed to satisfy customer demand for high speedand cost effective data, voice and multimedia transport. Our wirelinetechnology enables high-speed voice, video and data transmissions overbroadband IP-based networks.

**Broadband AccessSolutions**

Broadband Access NetworkSolutions reside on the network edge enabling the deployment of IP-based,high-speed Internet, voice, data and multimedia services over wireline networks.Digital subscriber line (“DSL”) technology allows high-speed data and contenttransfer while providing simultaneous telephone communications over the samefixed copper line. Our IP-based DSL Access Multiplexers (“IP-DSLAMs”)incorporate the latest DSL technologies combined with a range of form factorsto enable high-speed access and deliver services to residential and commercialsubscribers using broadband networks.

**IP-Based DigitalSubscriber Line Access Multiplexer (“IP-DSLAM”) (“AN-2000”)**

Our AN-2000 platform represents a new generationof DSLAM products that are based on IP technology. We believe the AN-2000platform is economical to deploy as it has been designed to eliminate the needfor more expensive legacy infrastructure, which we believe will result in anaccelerated return on investment. We have designed our AN-2000 platformto serve a variety of commercial and residential customer applications.

Our AN-2000 IPDSLAMs convert customer traffic from legacy infrastructure into IP at the edgeof the network, simplifying the delivery of multiple, high-speed services suchas VoIP and TVoIP, in addition to traditional broadband data services. Anall-IP network also simplifies the process of video streaming, 

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incorporatingtechnologies such as IP multicast and IP Quality of Service (“QoS”). To date,we have deployed more than five million IP DSLAM lines globally.

**Multi-ServiceAccess Node (“iAN-8000”)**

Our iAN-8000 Multi-Service Access Node (“iAN-8000”)platform is an integrated broadband access platform that delivers a mix ofbroadband, traditional voice and data services, and media gateway functionalityvia copper, fiber, or wireless transmission. The iAN-8000 platformintegrates the functionality of our AN-2000 IP DSLAM with a VoIP MediaGateway platform and a traditional digital loop carrier (“DLC”). Byconsolidating traditionally standalone access devices into one standards-basedplatform, the iAN-8000 provides operators the maximum amount of serviceflexibility and allows them to add services and applications efficiently,without incurring additional infrastructure expenses.

Service providers candeploy the iAN-8000 throughout their networks, which allows them to bringnew VoIP and broadband applications to the widest possible service area. TheiAN-8000 is designed to enable providers to offer multiple services fromone platform, including traditional voice, VoIP, and high-speed data accessusing the latest DSL technologies. Because the platform incorporates a DLC,service providers can also deploy it in remote locations to extend their voiceservice reach beyond the area served by the central office. The media gatewayfunction allows providers to aggregate VoIP calls from enterprise networks andtransport them over one line to the central office.

*OpticalMulti-Service Transport and Access*

Our optical productsinclude scalable, cost-effective transport solutions based upon internationallydefined optical transmission standards and access solutions based upon GigabitEthernet Passive Optical Networking (“GEPON”). They support transmission speedsranging from 155 Megabits per second to 10 Gigabits per second that enablemulti-speed integrated transport for both traditional voice and high-speed dataand video services. The product platform supports various complex networktopologies and includes a sophisticated multi-service management system. Ouroptical solutions are also designed to enable providers to easily transitionfrom legacy products to next-generation networks.

**Gigabit EthernetPassive Optical Network (“GEPON”)—Optical Access System**

In June 2004, we introduced our BBS 1000 GEPONsolution, which is designed to enable service providers to offer Fiber To ThePremises (“FTTP”) broadband access to their subscribers at high speeds. Our GEPONplatform is designed to provide high subscriber density and low cost of entry,making it a compelling alternative to legacy, last-mile access solutions.

Our BBS 1000 familyincludes both central office and customer premises equipment, providing the end-to-endoptical last mile, with up to one Gigabit per second of bandwidth toresidential and business customers. By integrating more functionality into theproduct, we have eliminated the need for carriers to deploy additionalswitching and routing equipment, making the BBS 1000 an optimal transportplatform for support of bandwidth-intensive voice, data and video services.

**NetRingTM—OpticalTransport System**

We introduced our NetRingTMMulti-Service Transport Product (“MSTP”) optical product line in December 2003.Our NetRingTM products are designed to provide a broad range of functions forcarriers to manage voice, data and video traffic. NetRingTM provides networkmanagement functions previously available only on multiple independentplatforms. The NetRingTM family is designed to satisfy high-end, mid-range, andentry-level application needs in global carrier networks. Our NetRingTM 600 productsprovide voice and data services for multi-tenant unit buildings (“MTUs”),office buildings, and enterprise campus applications. Our mid-range NetRingTM2500 products offer voice and data transport when more 

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bandwidthand greater capacity is required. Our high-end NetRingTM 10000 products provideservice for regional transport applications, when maximum bandwidth andcapacity is required. NetRingTM provides the availability and reliability ofoptical transport platforms that support full redundancy, multiple protectionoptions, and in-service upgrades.

*Television over IPSystem (“TvoIP”)*

Our TVoIP system, mVision,is a complete end-to-end solution for delivering television and multimedia overcarrier networks based on IP Protocol technology.

**mVision**

Our mVision family is a suite of carrier-classproducts and services that enable a service provider to deliver broadcasttelevision and on-demand video services to residential and commercial premisesover a switched network architecture. It is a carrier-class product that isdesigned to scale to support millions of users and hundreds of thousands ofcontent hours. We believe mVision is the first solution designed to enablecarriers to deploy very-large-scale streaming video content over a switchednetwork architecture.

The mVision product family includes a streaming andstorage server system (MediaSwitch); a device (Content Engine) for assimilatingdisparate video signals onto a unified distribution system; a media consoleset-top-box that resides in the end-user premise and provides Internet access,broadcast TV, video on demand and video conferencing services to thesubscribers; and a network management system that enables non-stop, system-wideoperation.

mVision is designed toallow carriers to offer new, revenue-generating television and multi-mediaservices. The system is also designed to help providers capture customers ofcable and satellite operators by offering a more comprehensive and interactivesuite of services.

**Handsets andCustomer Premise Equipment (“CPE”)**

We also design and sell avariety of handsets and CPE targeted at multiple customer segments for ourwireless and broadband products. These handsets range from basic, low-cost unitsto high-functionality, higher-cost models that offer rich functionality andexcellent value. Today we feature single, dual and multimode handsets withcameras, video recorders and players, high resolution color displays, multiplering tones, bilingual short message service (“SMS”) and High Speed Internetaccess and email capability. We believe our strategy of designing handsetsin-house, licensing, manufacturing, and direct-sourcing components givesus the flexibility to meet demand while offering the broadest line of handsetsto our customers.

*PAS Handsets*

We currently offer morethan 20 different PAS handset models from high-end, data-capable andfeature-rich models to low-cost value models. According to a November 2004report by the industry research firm GfK Ltd., we are the market leader for PAShandsets in China, which is the largest handset market in the world accordingto its Ministry of Information Industry. We shipped more than 14.6 million PAShandsets in 2004.

*CDMA/GSM/WiFi andMulti-Mode Handsets*

In 2004, we announced our entry into the CDMA, GlobalSystem for Mobile Communications (“GSM”) and Wireless Fidelity (“WiFi”) handsetmarkets. We offer carriers a wide selection of price ranges and handsetfeatures by providing a broad range of models supporting each of thesetechnologies. 

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Our product portfolio alsoincludes dual-mode and multi-mode models and includes a comprehensive roadmapto include third generation WCDMA and TD-CDMA handsets in the future.

Our acquisition ofselected assets of the Audiovox Communications Corporation (“ACC”) in November 2004marked our entry into the North and South American handset markets. Withexisting carrier relationships of more than 20 years, ACC has been a leadingwireless handset provider to the regions’ largest operators in the U.S.,Canada, and South America, including Verizon Wireless, Verizon International,Sprint PCS, ALLTEL, US Cellular, Bell Mobility, Telus, BellSouth International,Telefonica, Virgin Mobile, MetroPCS, T-Mobile and others. By combining ACC’schannel assets with our existing handset design and high-volume manufacturingcapabilities, we believe we will be able to realize significant economies ofscale from manufacturing, component sourcing, and development.

*Customer PremiseEquipment*

Our CPE product line iscomprised of various single and multi-port DSL modems, set-top boxes and VoIPAnalog Telephone Adapters (“ATAs”) that allow residential and businesscustomers to access voice, data and video services. Our products are designedto be rich in functionality, simple to set-up, easy to install and easy tomanage. The diversity and flexibility in the product offering enables them towork with both our own infrastructure equipment as well as with other vendor’sinfrastructure equipment. The comprehensive line of CPE products enables carriersto deliver end-to-end services across an array of access technologiesincluding, ADSL2/2+, WiFi/802.11 and GEPON.

**SEGMENT DISCLOSURE**

For the year ended December 31, 2003 and for thefirst three quarters of 2004, we managed our business as a single operatingsegment. For the fourth quarter 2004, we determined that our chief operatingdecision makers were evaluating performance, making operating decisions andallocating resources based on two operating segments: (i) China and (ii) International,consisting of all regions outside of China. In addition, a third operatingsegment, the Personal Communications Division was formed as a result of ouracquisition of the selected assets of Audiovox Communication Corporation in November 2004.

The China segment was comprised of discreteadministrative, research and development, manufacturing and sales and supportinfrastructure for China. International was comprised of operations for allother geographic areas including non-China Asia, Europe, the Middle East, Africaand North and South America. The Personal Communications Division focused onthe North and South American handset markets.

For additional information on our reportable segmentsas of December 31, 2004 see “Item 7—Management’s Discussion and Analysisof Financial Condition and Results of Operations—Segment Disclosures” and Note2 to the Company’s consolidated financial statements for the year ended December 31,2004.

Effective in the firstquarter of 2005, we realigned our business into four units, namely BroadbandInfrastructure, Wireless Infrastructure, Terminal Products (which will bereported as Handsets and our Personal Communication Division), and GlobalService Solutions. Each unit will represent its own reporting segment, with theexception of Terminal Products, which will consist of two reporting segments.

**MARKETS ANDCUSTOMERS**

Our products and servicesare being deployed and implemented in regions throughout the world in markets including China, Japan, India,Central and Latin America, Europe, Middle East and Africa, North America, andsoutheastern and northern Asia. China continues to be our largest market, representing 

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approximately79% of our overall revenue for the year ended December 31, 2004, 86% forthe year ended December 31, 2003 and 84% for the year ended December 31,2002. However our focus ongeographic diversification and extensive work in new technology innovation isbeginning to change the percentage of revenue attributed to various regions globally.Worldwide adoption of our technology and key customer wins in Europe and Africa,North America, Japan, India and the Central and LatinAmerican regions have resulted in a shiftin revenue with international (i.e., non-China regions) contributing 53% oftotal revenues for the fourth quarter and 21% of total revenues for the yearended December 31, 2004. Total revenue attributed to the UnitedStates totaled approximately 13%, 2%, and less than 1% of total revenues forthe years ended December 31, 2004, 2003, and 2002, respectively.

**Global Customers**

Our customers,telecommunications service providers, enable delivery of wireless and broadbandaccess services including data, voice, and/or video communication services totheir subscribers. They include but are not limited to, local, regional,national and international telecommunications carriers, including broadband,cable, Internet, and wireline and wireless providers. Telecommunicationsservice providers typically require extensive proposal review, productcertification, test and evaluation as well as network design, and, in mostcases, are associated with long sales cycles. Our service provider customers’networking requirements are influenced by numerous variables, including theirsize, the number and types of subscribers that they serve, the relativeteledensity of the served geography and their subscriber demand for wirelessand wireline communications and access services in the served geography. In2004, the Guangdong and Jiangsu provinces accounted for 12% and 10% of our netsales, respectively. In 2003, the Hei Long Jiang province accounted for 11% ofnet sales; and in 2002, sales to the Zhejiang province accounted for 18% andsales to Softbank BB Corporation, an affiliate of SOFTBANK America Inc., arelated party, accounted for 13% of net sales.

**Global Sales andService**

Our worldwide sales organization consists of managers,sales representatives, network consultants and technical support personnel. Wehave field sales offices in several locations including China, Japan, India,the Central and Latin American region, the North American, European, MiddleEastern and African regions, and Southeast and North Asia regions. The majorityof our products and services are sold and serviced by our direct sales andsupport staff.

In addition to our productofferings, we provide a broad range of service offerings, including technicalsupport services. Our service offerings complement our products with a range ofconsulting, technical, project, quality and maintenance support-levelservices including 24-hour support through technical assistance centers. Technicalsupport services are designed to help ensure that our products operateefficiently, remain highly available, and benefit from the most up-to-datesystem software. These services enable customers to protect their networkinvestments and minimize downtime for systems running mission-criticalapplications.

**China’s Market**

China is currently our largest market and we believethat it will continue to be an important market for our current and futuretechnologies and product development for the foreseeable future. To supportthis large and growing market, we have sales offices, manufacturing facilitiesand research and development centers throughout China that enable us to reactand respond to our customers’ needs in an expeditious manner.

Webelieve that China continues to be one of the fastest-growing, largestcommunications markets in the world, and the Chinese government has committedto developing a powerful communications 

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infrastructure in order to support demand forcommunications services in support of economic growth in the region. Accordingto China’s State Statistics Bureau, China’s gross domestic product (“GDP”) grew9.5% in 2004, and the GDP per capita surpassed $1,265 in 2004. The bureau alsoestimates that China’s GDP will grow by approximately 8.1% through 2006. Webelieve that China will continue to focus on its telecommunicationsinfrastructure for the foreseeable future. Please refer to the table below forinformation, provided by China’s Ministry of Information Industry (the “MII”),regarding the increasing telecommunications spending in China:
| ** **                              | ** ** | **2004**               | ** ** | **%  increase  over 2003** | ** ** |
|-----------------------------------------|------------|------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **(in millions)** | ** ** | ** **                      | ** ** |
| Telecommunications  revenue             |       |                   | $          | 62,500                          |       |   |   | 12 | % |   |
| Telecommunications  capital expenditure |       |                   | $          | 25,700                          |       |   |   | -3 | % |   |
| Fixed line  subscribers                 |       |                   | 312.4      |                            |       |   | 19 | % |   |
| Cellular subscribers                    |       |                   | 334.8      |                            |       |   | 25 | % |   |

 

Despite the increased teledensity rate of China’sfixed-line and cellular telephony to 25% and 26%, respectively, in 2004, theteledensity remains relatively low in comparison to that of developed countries.In contrast, fixed-line teledensity rates for the United Kingdom, France, Japanand the United States were 59%, 57%, 56%, and 62% respectively, according to areport published by the International Telecommunication Union in May 2004.We believe that China’s low teledensity will continue to drive the growth inits telecommunications market.

Although voice services predominantly drive China’scommunications market growth, the increasing demand for broadband data and multi-mediaservices also presents a growing opportunity in China. According to dataprovided by the MII, Internet users in China reached 94.0 million by theend of 2004, an increase of 18% from 2003. In order to support this growth indata traffic, service providers in China must continue to expand their networks.In 2004, China’s broadband users increased from 11.9 million at thebeginning of the year to approximately 23.9 million at the close of 2004.

Thefollowing chart presents relevant historical and estimated data related to thedevelopment of China’s telecommunications, based on information provided by theMII:
| ** **                         | ** ** | **2000** | ** ** | **2001** | ** ** | **2002** | ** ** | **2003** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| China’s population (Millions) |       | 1,267    |       | 1,276    |       | 1,286    |       | 1,293    |       | 1,300    |       |
| China’s GDP per  capita (RMB) |       | 7,081    |       | 7,543    |       | 7,930    |       | 9,047    |       | 10,501   |       |
| Fixed-line Telephone               |       |     |       |     |       |     |       |     |       |     |       |
| Subscribers (Millions)             |       | 144.8    |       | 180.4    |       | 214.4    |       | 263.3    |       | 312.4    |       |
| Teledensity                        |       | 11       | %          | 14       | %          | 17       | %          | 20       | %          | 25       | %          |
| Mobile Telephone                   |       |     |       |     |       |     |       |     |       |     |       |
| Subscribers (Millions)             |       | 84.5     |       | 144.8    |       | 206.6    |       | 268.7    |       | 334.8    |       |
| Teledensity                        |       | 7        | %          | 11       | %          | 16       | %          | 21       | %          | 26       | %          |
| Internet                           |       |     |       |     |       |     |       |     |       |     |       |
| Users (Millions)                   |       | 22.5     |       | 33.7     |       | 59.1     |       | 79.5     |       | 94.0     |       |
| Teledensity                        |       | 2        | %          | 3        | %          | 5        | %          | 6        | %          | 7        | %          |

 

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**Global Markets Outside of China**

We have continuedto offer our products in growing communications markets outside of mainlandChina (our “International Sales”), leveraging global sales operations in the Southeastand North Asia region, the Central and Latin American region, the European,Middle Eastern and African region, and the North American region. We continueto increase our penetration of these markets in several ways:

·       throughdirect sales offices located in key market regions;

·       bylicensing our technology to local manufacturers where import taxation isfavorable;

·       bydeveloping local sales agency and distributor relationships within specificmarket regions; and

·       byestablishing sales relationships with original equipment manufacturers.

Our International Sales division has continued to aggressively build regional in-countrysales offices and local directsales staff in order to provide support for ourexpanding global operations.

*North America*

With the completion of the acquisition of ACC in November 2004,North America became our second largest market in sales for 2004. Sales inNorth America are derived primarily from the CDMA handset product portfolio butalso include both our broadband and wireless infrastructure products. We expectthe North American market will continue to be our second largest market goingforward.

Wesupply handsets and infrastructure solutions to some of the leading wirelesscarriers in North America including Verizon, Sprint, Cingular, T-Mobile, BellMobility and Metro PCS amongst others. In 2004, we also gained new customersamongst the emerging North American providers such as Vonage whose service isdesigned to enable anyone to make and receive phone calls—worldwide—with atouch-tone telephone using a high-speed Internet connection.

*Japan*

Japan was our third largest market in 2004 and alsorepresents our largest market for broadband products. One of our key customersin Japan is Softbank Group (“SBB”), which is a related party to UTStarcom. SBBis a parent company to several of our key service provider customers in Japan,including Yahoo! BB and Japan Telecom. According to the Japan Ministry ofPublic Management, Yahoo! BB is the leading provider of broadband service inJapan with over 4.5 millionIP-based ADSL lines as of December 31, 2004, representing over 35% of the total market in Japan. Yahoo!BB continues to expand and deploy our AN-2000 IP-DSLAM and iAN-8000 MSAN and mSwitchequipment in support of their Voice over Broadband and 8, 12, 26, 45 and 50 Mbps ADSL services.

In the fall of 2004, Yahoo! BB also launched its PON, or Passive Optical Network, fiber-based HikariService, which will enable the delivery of high-speed broadband voice,data and multi-media services over asingle optical connection to the customer. We are providing both thenetwork infrastructure and customer premise elements to support this GEPON service.

SBB Acquired JapanTelecom, LTD in July 2004, and has deployed our iAN-8000Multi-service access node which is designed to enable Japan Telecom to offerthe combination of the capabilities of a DLC, a next-generation VoIP MediaGateway and an IP DSLAM in a single multi-service access platform.

***India***

We continue to see growth opportunities in India forboth our broadband and wireless products given its large population and lowteledensity. According to the Telecom Regulatory Authority of India 

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(“TRAI”) as of December 31,2004, India had a population of 1.07 billion and a low fixed line teledensityof approximately 4.4%.

We currently offer our AN-2000 Multi-ServiceBroadband Access, NetRingTM Optical Solutions and CDMA Wireless Access productsand services in India. With over one million access lines deployed today, weanticipate that we will continue to implement and deploy our products andconduct trials with several operators, including Reliance Infocomm Ltd.and Bharat Sanchar Nigam Ltd.

We continue to focus onboth customer development as well as the development of our research anddevelopment initiatives in India. We have research and development at ourfacilities in the New Delhi area, Guargan and Bangalore. We have alsoestablished local manufacturing of our AN-2000 technology in associationwith Himachal Futuristic Communications Limited.

*Central and LatinAmerica Region*

We have established sales and service operations insupport of the Central and Latin American region, and anticipate growth in thismarket in fiscal year 2005.

Our target markets inCentral and Latin America include, but are not limited to, countries likeBrazil, Mexico, Panama, Haiti, Honduras and Guatemala. We have shipped our AN-2000Multi-Service Broadband Access and PAS wireless equipment to serviceproviders and continue to perform extensive testing and certification fortelecommunications carriers within these regions. In 2004, key customers inCentral and Latin America included Telefonos de Mexico, S.A. in Mexico,Telefonica del Sur in Chile and Multifon in Honduras.

*European, MiddleEastern and African Region*

We continued to expand our presence in the European,Middle Eastern and African (“EMEA”) region in 2004, with both new customer winsand additional sales and service operations.

We offer our AN-2000, PAS, MovingMedia 2000 andMovingMedia 6000 products and services in each of these markets. We expect to continueto supply our products and conduct trials within this region in 2005.

Specifically, we have seen increased demand for ourwireless data products as a result of increased consumer demand for faster andmore comprehensive data services and proliferation of camera phones, advancedwireless handheld devices and other high data content products.

In 2004, new customers inEMEA included Versatel Nederland BV in the Netherlands, Tiscali S.P.A. in Italyand UK Broadband, a subsidiary of PCCW.

*Southeast and NorthAsia Region*

Southeast and North Asia is another region with alarge population base and relatively low teledensity rate. We have establishedbusiness operations as well as a sales and service presence to support variouscountries in this region including, but not limited to, Vietnam, Thailand andTaiwan. At the close of fiscal year 2004, our customers had approximately onemillion PAS subscribers in Vietnam and Taiwan utilizing our networkinfrastructure.

Key customers in theregion include FITEL and Chunghwa Telecom Co. Ltd. in Taiwan, and Vietnam Postand Telecommunications Corporation in Vietnam.

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**Competition**

We compete in the telecommunications equipment market,providing products and services for transporting data, voice and video trafficacross traditional and IP based networks.

As we expand into new markets, we will facecompetition from both existing and new competitors, including existingcompanies with strong technological, marketing and sales positions in thosemarkets.

We believe our competitive strengths are derived fromthree main tenets: our early entry and commitment to the development of allIP-based communications technologies; our experience in high-volume, low-costmanufacturing and large-scale technology deployments in China; and ourcommitment to developing comprehensive, end-to-end solutions for our carriercustomers that allow them to capitalize on economies of scale and differentiatetheir service offerings.

By contrast, our competitive disadvantages include ourrelatively smaller size in terms of revenues and number of employees ascompared to many of our competitors, our lack of history and experience inselling to many of the largest carriers in well-established markets and ourlack of consumer visibility and brand recognition in markets outside of Asia.

Our principal competitorswithin our current product categories include the following:

***WIRELESS INFRASTRUCTURE***

PAS systems:   Lucent Technologies, Inc. andZhongxing Telecommunications Equipment Corporation.

CDMA and WCDMA Systems:   Alcatel; LM EricssonTelephone Company; Huawei Technology Co., Ltd.; Lucent Technologies, Inc.;Motorola, Inc.; Nokia Corporation; Nortel Networks Corporation; SamsungElectronics Co. Ltd.; Siemens AG and Zhongxing Telecommunications EquipmentCorporation.

TD-CDMA Systems:   InterDigital CommunicationsCorp.

mSwitch:   Alcatel;Cisco Systems, Inc.; Clarent Corporation; LM Ericsson Telephone Co.;Huawei Technology Co., Ltd.; Lucent Technologies, Inc.; Motorola, Inc.;Nokia Corporation; Nortel Networks Corporation; Nuera Communications, Inc.;Siemens AG; Sonus Networks, Inc. and Zhongxing TelecommunicationsEquipment Corporation.

***BROADBAND INFRASTRUCTURE***

iAN-8000/MSANand AN-2000/IP DSLAM:   Alcatel; Datang Telecom TechnologyCo. Ltd.; Huawei Technology Co., Ltd.; Lucent Technologies, Inc.;Tellabs, Inc. and Zhongxing Telecommunications Equipment Corporation.

***HANDSETS AND CUSTOMER PREMISE EQUIPMENT***

PAS handsets:   China PTIC Information IndustryCorporation; Zhongxing Telecommunications Equipment Corporation; LucentTechnologies, Inc.; Amoi Electronics Company, Ltd.; HuaweiTechnologies Co, Ltd; Kyocera Corporation; Nippon Electric Corporation andSanyo Electric Company, Ltd.

CDMA handsets:   LG Electronics, Inc.;Motorola, Inc.; Nokia Corporation; Samsung Electronics Co. Ltd. and SanyoElectric Company, Ltd.

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**OPERATIONS**

**Employees**

As of December 31,2004, we employed a total of approximately 8,200 full-time employees. We alsofrom time to time employ part-time employees and hire contractors. Of the totalnumber of full-time employees at December 31, 2004, approximately 3,600were in research and development, approximately 700 were in manufacturing,approximately 3,400 were in marketing, sales and support, and approximately 500were in administration. We had approximately 6,500 employees located in China,approximately 1,100 employees located in the United States, and approximately600 employees in other countries. Our employees are not represented by anycollective bargaining agreement, and we have never experienced a work stoppage.We believe that we have good employee relations.

**Sales,Marketing and Customer Support**

We pursue a direct sales and marketing strategy inChina, targeting sales to telecommunication operators and equipmentdistributors with closely associated customers. We maintain sales and customersupport sites in all major cities in China. Our customer service operation inHangzhou, China, serves as both a technical resource and liaison to our productdevelopment organization. In China, customer service technicians aredistributed in the regional sales and customer support sites to provide a localpresence.

Our sales efforts in markets outside of China combinedirect sales, original equipment manufacturers, distributors, resellers, agentsand licensees. We maintain 48 sales and customer support offices in 29countries covering the U.S., Canada, Latin America, the Caribbean, Europe, theMiddle East, Africa, India, and the Asia-Pacific region.

To capture businessopportunities in the growing telecommunication service market and furtherimprove our customer service on a global basis, we plan to combine our Chinaand International service operation teams to leverage the strengths from bothteams. The new service organization is structured to provide traditionalservices such as Build, Operate, Turnover and System Maintenance, as well as towork closely with customers and research and development to develop and delivervalue-added customized service solutions.

**Manufacturing, Assembly and Testing**

We manufacture or engage in the final assembly andtesting of our mSwitch, PAS systems, handsets and AN-2000 products at ourmanufacturing facility in the Chinese province of Zhejiang. The manufacturingoperations consist of circuit board assembly, final system assembly, softwareinstallation and testing. We assemble circuit boards primarily using surfacemount technology. Assembled boards are individually tested prior to finalassembly and tested again at the system level prior to system shipment. We useinternally developed functional and parametric tests for quality management andprocess control and have developed an internal system to track qualitystatistics at a serial number level.

Our manufacturing facility is ISO 9001-2000certified. ISO 9001-2000 certification requires that the certified entityestablish, maintain and follow an auditable quality process includingdocumentation requirements, development, training, testing and continuousimprovement which is periodically audited by an independent outside auditor.

We contract with third parties in China to undertakehigh volume assembly and manufacturing of our handsets and some high volumesingle boards for AN-2000, PAS and mSwitch system and we conduct finalassembly, testing and packaging at our own facilities. In addition, wegenerally use third parties for high volume assembly of circuit boards.

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We have also contractedwith various suppliers to provide PAS wireless base station components fordistribution under the UTStarcom label. In China, we undertake final assemblyand test our wireless infrastructure products at our own facilities and havebegun to manufacture some of these products ourselves.

**Research and Development**

We believe that continued and timely development andintroduction of new and enhanced products are essential if we are to maintainour competitive position. While we use competitive analyses and technologytrends as factors in our product development plans, the primary input for newproducts and product enhancements comes from soliciting and analyzinginformation about service providers’ needs. Our relationships with China’s MIIand Telecommunications Administration and individual telecommunications bureausand our full-service post-sale customer support in China provide our researchand development organization with insight into trends and developments in themarketplace. The insight provided from these relationships allows us to developmarket-driven products such as PAS, mSwitch and IP-DSLAM. We maintain astrong relationship between our research centers in the U.S. and China. Werotate engineers between the U.S. and China to further integrate our researchand development operations. We have been able to cost-effectively hire highlyskilled technical employees from a large pool of qualified candidates in China.We also have a development center in India to take advantage of the talent poolavailable there, and to support our operations in India. Our research anddevelopment centers are ISO 9001-2000 certified.

In the past we have made,and expect to continue to make, significant investments in research anddevelopment. Our research and development expenditures totaled $219.0 millionin 2004, $155.3 million in 2003, and $86.2 million in 2002.

**Intellectual Property**

Our ability to compete isdependent in part on our proprietary technology. We rely on a combination ofpatent, copyright, trademark and trade secret laws, as well as confidentialityagreements and licensing arrangements, to establish and protect our proprietaryrights. We hold U.S. and foreign patents for our existing products expiringbetween 2014 and 2023, and have patents pending in both the U.S. and in foreigncountries. In addition, we have, from time to time, chosen to abandonpreviously filed applications. Patents may not be issued and any patents issuedmay not cover the scope of the claims sought in the applications. Additionally,issued patents may be found to be invalid or unenforceable in the courts ofthose countries where we hold or have filed for patents. Our U.S. patents donot afford any intellectual property protection in China or other internationaljurisdictions. Additionally, patents that we hold in countries other than theUnited States do not afford any intellectual property protection in the UnitedStates. Please refer to the discussion of risks associated with ourintellectual property in the section entitled “Management’s Discussion andAnalysis of Financial Statement Results of Operations—Factors Affecting FutureOperating Results.”

**Seasonality**

See “Item 7. Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Resultsof Operations” for a discussion of the impact of seasonality on our business.

**ITEM 2—PROPERTIES**

We lease properties in the United States, China andglobally totaling approximately 1,372,000 square feet. These properties areused for corporate headquarters, sales and support offices, research anddevelopment and manufacturing purposes.

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InNorth America, we have approximately 492,000 square feet of leased propertyused for the following purposes: approximately 63,000 square feet for ourcorporate headquarters in Alameda, 210,000 square feet for research anddevelopment, 88,000 square feet for sales and services, and 131,000 square feetfor our new Personal Communications Division including 5,000 square feet ofretail space.

Welease approximately 730,000 square feet of property in China. Approximately85,000 square feet are for corporate offices in Beijing, approximately 200,000square feet are for sales and support offices, approximately 230,000 squarefeet are used for manufacturing, and approximately 215,000 square feet are usedfor research and development.

In 2001, we purchased the rights to use 49 acres of landlocated in Zhejiang Science and Technology Industry Garden of Hangzhou Hi-techIndustry Development Zone. As of December 31, 2004, we have substantiallycompleted the construction of a 1,150,000 square foot manufacturing facility atthis location which was put in use in October 2004. The facility houses ourmanufacturing operations and administrative offices. We anticipate thecompletion of the remaining construction by the second quarter 2005.

We believe our existing facilities and equipment arewell maintained and in good operating condition, and we believe our facilitiesare sufficient to meet our needs for the foreseeable future.

**ITEM 3—LEGAL PROCEEDINGS**

*Securities Class ActionLitigation*

On October 26, 2004, an alleged formershareholder of the Company filed a class action complaint in the United StatesDistrict Court for the District of Idaho against us and two of our directorsand/or officers, purporting to assert claims under the federal securities lawson behalf of a class of purchasers of the Company’s publicly traded securitiesin the period from April 16, 2003 through September 20, 2004. Amongother things, the complaint refers to our disclosures as to “significantcontrol deficiencies” related to revenue recognition and as to the deferral ofrevenue recognition on a particular transaction and the related lowering of ourfinancial guidance. The complaint further alleges that the defendantspreviously made positive statements regarding our business and financialperformance that were false and misleading because such statements, among otherthings, failed to disclose problems with our internal controls and revenuerecognition policies and procedures and failed to disclose that the revenue onthe transaction at issue would need to be deferred, which allegedly caused theprice of our publicly traded securities to be artificially inflated. Thecomplaint claims that the plaintiff and other class members were damaged as aresult thereof, and seeks monetary recovery in their favor in an unspecifiedamount.

Foursimilar class action complaints were later filed in the United States DistrictCourt for the Northern District of California against us and several of ourdirectors and officers. In both the Idaho court and the California court,competing motions were filed for appointment of lead plaintiff and approval oflead plaintiffs’ counsel, and in the California court various motions forconsolidation of actions were filed as well. On March 15 and 16, 2005, theCalifornia court entered orders consolidating the cases pending in that court,appointing the lead plaintiff and approving the lead plaintiff’s counsel. Pursuantto those orders, a consolidated complaint is to be filed in that court within60 days thereafter. On April 6, 2005, the Idaho court entered an orderappointing the lead plaintiff and approving the lead plaintiff’s counsel.

Thisclass action litigation is in its preliminary stages, and we cannot predict itsoutcome, as the litigation process is inherently uncertain. However, we believethat the allegations and claims in this litigation are without merit and thatwe have valid defenses, and we intend to contest such allegations and claimsand defend ourself vigorously. If the outcome of the litigation is adverse tous and if, in addition, we are required to pay significant monetary damages,our business would be significantly harmed. At a minimum, this litigation couldresult in substantial costs and divert our management’s attention andresources, which could seriously harm our business. As of December 31,2004, no loss amount has been accrued because a loss is not considered probableor estimable.

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***Shareholder Derivative Litigation***

On August 31 and September 2, 2004,respectively, two shareholder derivative actions were filed in the SuperiorCourt of California, Alameda County, by alleged shareholders of the Companypurporting to assert, on our behalf, claims of breach of fiduciary duty againstcertain of our current and former directors and officers, and also naming us asa nominal defendant. The complaints in these actions refer to our disclosuresas to an Audit Committee investigation into revenue recognition issues and asto “significant control deficiencies” related to revenue recognition. Thecomplaints further allege that the individual defendants ignored problems withour accounting and internal control practices and procedures and breached theirfiduciary duties by failing to maintain adequate internal accounting controlsor to make good faith efforts to do so. Plaintiffs claim that such allegedbreaches damaged the Company, and they seek monetary recovery against theindividual defendants and in favor of the Company, as well as equitable relief.In addition, plaintiffs claim that they should be excused from pre-suit demandrequirements based on allegations that our Board of Directors could not havefairly evaluated such pre-suit demand, and thus that such demand would havebeen futile. On November 22, 2004, the Court entered an orderconsolidating the two actions and appointing lead plaintiffs’ counsel.

On November 23 and December 2, 2004, tworelated shareholder derivative actions were filed in the same court. On January 13,2005, the Court consolidated these two newer cases with the previouslyconsolidated actions, and directed plaintiffs to prepare and file an amendedconsolidated complaint, which plaintiffs filed on January 31, 2005. On March 17,2005, we filed a motion, joined by other defendants, seeking dismissal of theconsolidated complaint for failure to adequately plead futility of the pre-suitdemand.

This derivative litigationis in its preliminary stages, and we cannot predict its outcome, as thelitigation process is inherently uncertain. However, we believe that plaintiffs’allegations of “demand futility” are without merit, and we intend to contestthose allegations vigorously. At a minimum, this derivative litigation couldresult in substantial costs and divert our management’s attention andresources, which could seriously harm our business. As of December 31,2004, no loss amount has been accrued because a loss is not considered probableor estimable.

***IPO Allocation***

On October 31, 2001,a complaint was filed in United States District Court for the Southern Districtof New York against us, some of our directors and officers and variousunderwriters for our initial public offering. Substantially similar actionswere filed concerning the initial public offerings for more than 300 differentissuers, and the cases were coordinated as In re Initial Public OfferingSecurities Litigation, 21 MC 92. In April 2002, a consolidatedamended complaint was filed in the matter against us, captioned In reUTStarcom, Initial Public Offering Securities Litigation, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarketand misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of our common stock between March 2,2000 and December 6, 2000. Our directors and officers have been dismissedwithout prejudice pursuant to a stipulation. On February 19, 2003, theCourt granted in part and denied in part a motion to dismiss brought bydefendants including us. The order dismisses all claims against us except for aclaim brought under Section 11 of the Securities Act of 1933, whichalleges that the registration statement filed in accordance with the IPO wasmisleading. In June 2004, a stipulation of settlement and release ofclaims against the issuer defendants, including us, was submitted to the courtfor approval. The terms of the settlement, if approved, would dismiss andrelease all claims against the participating defendants (including us). Inexchange for this dismissal, D&O insurance carriers would agree toguarantee a recovery by the plaintiffs from the underwriter defendants of atleast $1 billion, and 

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theissuer defendants would agree to an assignment or surrender to the plaintiffsof certain claims the issuer defendants may have against the underwriters. Thesettlement is subject to a number of conditions, including court approval. Ifthe settlement does not occur, and litigation against us continues, we believewe have valid defenses and we intend to defend the case vigorously. The totalamount of the loss associated with the above litigation is not determinable atthis time. Therefore we are unable to currently estimate the loss, if any,associated with the litigation.

***Starent Patent InfringementLitigation***

We have sued StarentNetworks Corporation (“Starent”) for patent infringement in the U.S. DistrictCourt for the Northern District of California. On March 22, 2004, we filedour Complaint. On June 3, 2004, we served our Complaint on Starent. On July 30,2004, Starent filed and served its answer and counterclaims. On August 30,2004, we served and filed our Amended Complaint. In our Amended Complaint, weassert that Starent infringes a UTStarcom patent through the manufacture, use,offer for sale, and sale of Starent’s ST-16 Intelligent Mobile Gateway. Weseek, inter alia, compensatory damages and injunctive relief. Starent filed itsanswer to the Amended Complaint and counterclaims on September 17, 2004.In its answer and counterclaims, Starent denies our allegations and seeks adeclaration that the patent-in-suit is not infringed, is invalid and isunenforceable. The Court held an initial case management conference on November 2,2004 and scheduled a hearing to construe the claims of the patent-in-suit for June 30,2005. At that time the Court will hold an additional case management conferenceto schedule a date for trial. On February 17, 2005, we filed a motion fora preliminary injunction against Starent’s use, sale, and offer for sale ofproducts having the infringing feature. A hearing on our motion is set for May 11,2005. Although we cannot reliably predict the outcome of this litigation, webelieve that any adverse judgment on Starent’s counterclaims will not have amaterial adverse effect on the business, financial condition, or results of ouroperations.

***Fenner Investments Patent InfringementLitigation***

On January 6, 2005,Fenner Investments, Ltd. filed suit against us and co-defendants JuniperNetworks, Inc., Nokia, Inc., Nortel Networks Corp., LucentTechnologies, Inc., and Cisco Systems, Inc. in the U.S. DistrictCourt for the Eastern District of Texas. The suit alleges that unspecifiedproducts and services infringe two Fenner patents and seeks compensatory andinjunctive relief. On March 1, 2005, we filed a motion to dismiss thecomplaint due to improper venue; no hearing is yet scheduled for this motion. Thislawsuit is in its initial stage and it is not possible to reliably predict theoutcome or any relief that could be awarded, as the litigation process isinherently uncertain. We intend to contest the allegations and claims and defendourselves vigorously. If the outcome of the litigation is adverse to us and if,in addition, we are enjoined or required to pay significant monetary damages,our business may be harmed. At a minimum, this litigation could result insubstantial costs and divert our management’s attention and resources, whichcould harm our business.

***Other***

On August 19, 2004, we received a letter from thenew management team of Hyundai Syscomm, Inc. (“HSI”) stating that theyconsider the Asset Purchase Agreement, dated as of February 26, 2004,among HSI, UTSI, Dr. Seong-Ik Jang and 3R Inc. (the “APA”), and thevarious ancillary agreements entered into in connection with the closingrelated to the APA on April 27, 2004, to be null and void due tounfulfillment of condition precedents and material breach of terms of suchagreements. Such condition precedents and material breach of terms were notspecified in such letter from HSI. In addition, HSI has made allegations andarguments before Korean governmental agencies and to the Korean press allegingthat the technology that was purchased by us pursuant to the APA has beenexported outside of Korea. We believe none of such technology has been exportedby us from Korea to any foreign country. In addition, 

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we believe that we havematerially complied with all provisions of the APA and the ancillary agreementsand HSI cannot void or nullify such agreements. We have taken, and will continueto take, appropriate legal actions to fully enforce our rights under the APAand the ancillary agreements. We believe that this dispute with HSI would nothave a material adverse effect on our financial condition, results ofoperations or cash flow.

We are a party to other litigation matters and claimsthat are normal in the course of operations, and while the results of suchlitigation matters and claims cannot be predicted with certainty, we believethat the final outcome of such matters will not have a material adverse impacton our financial position or results of operations.

In the future we maysubject to other lawsuits. Any litigation, even if not successful against us,could result in substantial costs and divert management’s attention and otherresources away from our business operations.

**ITEM4—SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

None.

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**PART II**

**ITEM5—MARKET FOR UTSTARCOM, INC.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS,AND ISSUER PURCHASES OF EQUITY SECURITIES**
| ** **         | ** ** | **High** | ** ** | **Low** | ** ** |
|--------------------|------------|----------|------------|---------|------------|
| ***Fiscal  2003*** |       |     |       |    |       |
| First Quarter      |       | $        | 23.90      |    | $          | 16.56 |   |
| Second Quarter     |       | 35.86    |       | 19.70   |       |
| Third Quarter      |       | 46.45    |       | 31.18   |       |
| Fourth Quarter     |       | 39.07    |       | 30.85   |       |
| ***Fiscal 2004***  |       |     |       |    |       |
| First Quarter      |       | $        | 41.34      |    | $          | 28.75 |   |
| Second Quarter     |       | 31.52    |       | 25.75   |       |
| Third Quarter      |       | 29.22    |       | 13.71   |       |
| Fourth Quarter     |       | 22.35    |       | 16.74   |       |

 

Our common stock has been traded on The NasdaqNational Market (“NASDAQ”) under the symbol UTSI since our initial publicoffering on March 3, 2000. The preceding table sets forth the high and lowclosing sales prices per share of our common stock as reported on NASDAQ forthe periods indicated. As of March 31, 2005, we had approximately 194stockholders of record.

To date, we have not paidany cash dividends on our common stock. We currently anticipate that we willretain any available funds to finance the growth and operation of our businessand we do not anticipate paying any cash dividends in the foreseeable future. Certainpresent or future agreements may limit or prevent the payment of dividends onour common stock. For example, our convertible debt requires that we have toprovide notice of our intent to pay certain dividends. Additionally, our cashheld in foreign countries may be subject to certain control limitations orrepatriation requirements, limiting our ability to use this cash to paydividends.

**EquityCompensation Plan Information**

Thefollowing table sets forth information, as of December 31, 2004, aboutequity awards under our equity compensation plans:
| **Plan category(1)**                                   | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise  of outstanding  options, warrants  and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available  for future issuance  under equity  compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                      | ** ** | **(c)**                                                                                                     | ** ** |
| Equity  compensation plans approved by security holders(2)  |       |       | 17,194,626 | (3)                                                                                                                                          |       |                                                                                                        | 21.12      |                                                                                                                                                                                                         |       |   | 6,186,487 | (4) |   |
| Equity  compensation plans not approved by security holders |       |       | 1,341,259  | (5)                                                                                                                                          |       |                                                                                                        | 28.55      | (6)                                                                                                                                                                                                          |       |   | 217,763 | (7) |   |
| Total                                                       |       |       | 18,535,885 |                                                                                                                                         |       |                                                                                                        | 21.64      |                                                                                                                                                                                                         |       |   | 6,404,250 |   |   |

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(1)          See Note 15 of our “Notesto Consolidated Financial Statements” for a description of our equitycompensation plans.

(2)          Includes the 1997 StockPlan which provides for an annual increase in the number of shares availablefor issuance under the plan equal to (i) 4% of the outstanding Shares onsuch date, (ii) 6,000,000 

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shares or (iii) alesser amount determined by the Board, and the 2000 Employee Stock PurchasePlan, which provides for an annual increase in the number of shares availablefor issuance under the plan equal to (i) 2% of the outstanding shares onsuch date, (ii) 2,000,000 shares or (iii) a lesser amount determinedby the Board.

(3)          Includes shares ofcommon stock to be issued upon exercise of options granted under our 1995 StockPlan, 1997 Stock Plan and 2001 Director Option Plan.

(4)          Includes 2,826,910shares of common stock available for issuance under our 2000 Employee StockPurchase Plan, 2,479,577 shares of common stock available for issuance underour 1997 Stock Plan and 880,000 shares of common stock available for issuanceunder our 2001 Director Option Plan. There are no shares available for issuanceunder the 1995 Stock Plan.

(5)          Includes 1,274,287options outstanding under the 2003 Non-Statutory Stock Option Plan, a maximumof 49,030 performance shares outstanding under the Advanced CommunicationDevices Corporation Incentive Program and a maximum of 17,942 performanceshares outstanding under the Issanni Communications, Inc. IncentiveProgram. Does not include 11,453 shares and 8,580 shares of common stocksubject to outstanding options with a weighted-average exercise price of$2.69 that were assumed in our acquisitions of Advanced Communication DevicesCorporation, and RollingStreams Systems, Ltd., respectively.

(6)          Represents the averageweighted exercise price of 1,274,287 options outstanding under the 2003Non-Statutory Stock Option Plan. Excludes performance shares outstanding underthe Advanced Communication Devices Corporation Incentive Program and theIssanni Communications, Inc. Incentive Program because performance sharesdo not have an exercise price.

(7)          Includes 217,763 sharesof common stock available for issuance under our 2003 Non-Statutory StockOption Plan.

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**ITEM 6—SELECTEDFINANCIAL DATA**

Youshould read the selected consolidated financial data set forth below inconjunction with “Management’s Discussion and Analysis of Financial Conditionand Results of Operations” and our Consolidated Financial Statements and theNotes thereto included elsewhere in this report. Historical results are notnecessarily indicative of results that may be expected for any future period.The Company filed an Amendment to its Annual Report on Form 10-K for theyear ended December 31, 2003 to reflect the restatement of itsconsolidated financial statements for the year ended December 31, 2003.See Note 2 to the Consolidated Financial Statements.
| ** **                                                                                                                     | ** ** | **Year Ended December 31,**                         | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2004**                                                           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                                                                                                                     | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated Statement of Operations Data:**                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net sales(1)                                                                                                                   |       | $                                                                  | 2,703,581  |   | $ | 1,965,187 |   | $ | 981,806 |   | $ | 626,840 |   | $ | 368,646 |   |
| Gross profit                                                                                                                   |       | 601,601                                                            |       | 624,385 |   | 345,472 |   | 224,548 |   | 128,181 |   |
| Operating income(2)                                                                                                            |       | 49,902                                                             |       | 261,738 |   | 145,962 |   | 76,728 |   | 33,780 |   |
| Net income                                                                                                                     |       | 73,415                                                             |       | 215,532 |   | 107,862 |   | 56,954 |   | 27,993 |   |
| Net income available to  common  stockholders                                                                                  |       | 73,415                                                             |       | 215,532 |   | 107,862 |   | 56,954 |   | 27,013 |   |
| Basic earnings per share:                                                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income from continuing  operations                                                                                             |       | $                                                                  | 0.64       |   | $ | 2.08 |   | $ | 0.98 |   | $ | 0.56 |   | $ | 0.35 |   |
| Cumulative effect on  prior years of the application of SAB 101, “Revenue Recognition in  Financial Statements” |       | —                                                             |       | — |   | — |   | — |   | (0.01 | ) |
| Net income                                                                                                                     |       | $                                                                  | 0.64       |   | $ | 2.08 |   | $ | 0.98 |   | $ | 0.56 |   | $ | 0.34 |   |
| Diluted earnings per share:                                                                                                    |       |                                                               |       |   |   |   |   |   |   |   |   |
| Income from continuing  operations                                                                                             |       | $                                                                  | 0.56       |   | $ | 1.75 |   | $ | 0.94 |   | $ | 0.52 |   | $ | 0.28 |   |
| Cumulative effect on  prior years of the application of SAB 101, “Revenue Recognition in  Financial Statements” |       | —                                                             |       | — |   | — |   | — |   | (0.01 | ) |
| Net income                                                                                                                     |       | $                                                                  | 0.56       |   | $ | 1.75 |   | $ | 0.94 |   | $ | 0.52 |   | $ | 0.27 |   |

 
| ** **                           | ** ** | **As of December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------|------------|
| ** **                           | ** ** | **2004**                              | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| ** **                           | ** ** | **(in thousands)**               | ** ** |
| **Consolidated Balance Sheet Data:** | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash and cash  equivalents           |       | $                                     | 562,532    |   | $ | 377,747 |   | $ | 231,944 |   | $ | 321,136 |   | $ | 149,112 |   |
| Working capital(3)                   |       | 1,117,497                             |       | 883,334 |   | 568,215 |   | 591,103 |   | 369,861 |   |
| Total assets                         |       | 3,316,005                             |       | 2,244,050 |   | 1,305,552 |   | 1,005,880 |   | 591,837 |   |
| Total short-term  debt               |       | 351,183                               |       | 1 |   | — |   | 58,434 |   | 43,381 |   |
| Long-term debt                       |       | 410,655                               |       | 410,655 |   | — |   | 12,048 |   | 12,048 |   |
| Total stockholders’ equity      |       | $                                     | 1,365,372  |   | $ | 893,331 |   | $ | 766,395 |   | $ | 681,887 |   | $ | 412,319 |   |

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(1)          On November 1,2004, the Company completed its acquisition of Audiovox CommunicationCorporation. Revenue for the two months ended December 31, 2004 from thisacquisition was $277.4 million.

(2)          Operating income for theyear ended December 31, 2004 included an $11.5 million charge associatedwith the impairment of various assets, including $7.0 million of goodwill,related to the substantially abandoned operations of Hyundai Syscomm, Inc.See Note 10 to the Consolidated Financial Statements. Operating income for theyear ended December 31, 2003 included a charge of $10.7 million forin-process research and development associated with various acquisitions.

(3)          Working capital is equalto current assets less current liabilities.

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**ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS**

**FORWARD-LOOKING STATEMENTS**

This Annual Report onForm 10-K contains forward-looking statements within the meaning of thefederal securities laws. These statements are based on information that iscurrently available to management. We intend such forward-looking statements tobe covered by the safe harbor provisions of the Private Securities LitigationReform Act of 1995, and we are including this statement for purposes ofcomplying with those provisions. The forward-looking statements include,without limitation, those concerning the following:  our expectations as to the nature of possibletrends; our expectations regarding continued growth in our business and operations;our expectation that there will be fluctuations in our overall gross profit,gross margin, product mix, quarter to quarter results, customer base andselling prices; our plans for expanding the direct sales organization and ourselling and marketing campaigns and activities; our expectation that we may useour cash, debt or securities to acquire or invest in complementary businesses,technologies or product offerings; our expectation that there will be increasesin selling, marketing, research and development, and general and administrativeexpenses; our expectations regarding future growth of our business andoperations; our expectation that we will continue to invest significantly inresearch and development; our expectations regarding the status of productsunder development; our expectations regarding our future investments; ourexpectations regarding our future levels of cash and cash equivalents, as wellas our expectation that existing cash and cash equivalents will be sufficientto finance our operations for the foreseeable future; our expectationsregarding licensing requirements and our ability to receive licenses in Chinafor our PAS system and other products; our expectations regarding thedevelopment of a 3G network in China; our expectations regarding the impact ofa reorganization of China telecommunication companies; our expectationsregarding the growth of China’s telecom markets; our expectation that ourbusiness will continue to be significantly influenced by the political,economic and legal environment in China, as well as expectations about thenature of political, economic and legal reform in China and other internationalmarkets; our expectations regarding market share percentages for our products;our expectations regarding the future allocation of net sales by product group;our expectations regarding efficiencies we hope to achieve in supply chain capability;and our expectations regarding our expansion into new markets around the world.Additional forward-looking statements may be identified by the words,“anticipate,” “expect,” “believe,” “intend,” “will” and similar expressions, asthey relate to us or our management. Investors are cautioned that theseforward-looking statements are inherently uncertain. These statements aresubject to risks and uncertainties that may cause actual results and events todiffer materially. For a detailed discussion of these risks and uncertainties,see the “Factors Affecting Future Operating Results” section of thisForm 10-K. We do not guarantee future results and undertake no obligationto update the forward-looking statements to reflect events or circumstancesoccurring after the date of this Form 10-K.

**RESTATEMENTOF CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 31, 2003**

We filed the Amendment No. 1 to our Annual Reporton Form 10-K for the year ended December 31, 2003 to reflect therestatement of our consolidated financial statements for the year endedDecember 31, 2003 and the quarters ended March 31, 2003,June 30, 2003 and September 30, 2003 and certain correspondingchanges described below.

As part of the financial closing process for the yearended December 31, 2004, we identified certain errors resulting in arestatement which decreased the provision for income taxes and increased netincome by $20.7 million for the year ended December 31, 2003. In addition,as a result of the correction of the tax provision, retained earnings wasincreased by $20.7 million, additional paid-in capital was increased $0.9 million,income taxes payable was decreased by $2.5 million, other long-term assets wereincreased by 

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$21.6 million, prepaidswere increased by $2.8 million and other current assets were reduced by $5.3million. There was no net effect on cash provided from operating activities asa result of this error.

During the evaluation of the errors related to theincome tax provision, we determined that an additional reclassification ofreported 2003 results was required. Specifically, cost of sales and otherincome both increased by $3.5 million for the year ended December 31, 2003to properly classify certain incentive payments received for exports and value-addedtaxes in China.

In addition to the errors in the 2003 tax provision, wedid not correctly identify a related party that is deemed a variable interestentity and for whom we are considered the primary beneficiary in accordancewith FASB Interpretation No. 46 (“FIN 46”). We have corrected our 2003financial statements to reflect the consolidation of this variable interestentity, MDC Holding Limited (“MDC Holding”) and its affiliated entities (MDCHolding and such affiliated entities are referred to, collectively, as “MDC”).At December 31, 2003, this consolidation resulted in a $5.5 millionincrease in total assets and a $0.7 million increase in total liabilities.There was no effect on net income as a result of this consolidation.

Furthermore, an impairment charge of $7.4 million, netof taxes of $1.3 million, was recorded to reflect an impairment of MDCequipment subject to a revenue sharing arrangement. Due to the uncertaintiessurrounding the customer’s subscriber income and ability to pay under thisarrangement, we determined that an impairment charge should have been recordedin 2003 when these conditions should have been identified. Accordingly, animpairment charge of $7.4 million, net of tax, was recorded, which decreasedboth total assets and equity by $7.4 million at December 31, 2003.

In addition, weidentified the following revisions in classification during the preparation ofthe restated consolidated financial statements:

(1)   Cost ofsales for related party revenue transactions is presented separately from costof sales for non-related party revenue transactions for all years presented;

(2)   Certainother long-term assets increased and intangible assets decreased by $1.7million at December 31, 2003;

(3)   Changes inrestricted cash had been incorrectly categorized as a part of operating cashflows instead of investing cash flows in accordance with Statement of FinancialAccounting Standards No. 95, “Statement of Cash Flows,” (“SFAS 95”).Accordingly, we have reflected this change in categorization in theConsolidated Statement of Cash Flows for each of the three years in the periodended December 31, 2003. The change for 2003 and 2002 is an increase incash flows from operating activities and a decrease in cash flows frominvesting activities of $3.2 million and $21.3 million, respectively, and therewas no change for 2001; and

(4)   A related party which is 31% owned by an individual related to amember of our Board of Directors and associated transactions have beenidentified. See Note 22 to the Consolidated Financial Statements.

**EXECUTIVE SUMMARY**

We design,manufacture and sell telecommunications equipment and products and provideservices associated with their installation, operation and maintenance. Ourproducts are deployed and installed primarily by telecommunications wirelessand wireline service providers. We provide an extensive range of products fortransportation of voice, data and video traffic for service providers aroundthe world. Our business is conducted globally in China, Japan, India, theCentral and Latin American region, North America, the European, Middle Easternand African region, and southeastern and northern Asia. Our objective is to bea leading global provider of Internet Protocol (“IP”) networking products andservices. We differentiate ourselves with products designed, developed andcommercialized to reduce network 

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complexity,integrate high performance capabilities and that allow a simple transition tonext generation networks. This results in deployments, maintenance and upgradesthat are both economical and efficient, and that we believe allow operators toearn a high return on their investment. Our technologies and products fall intothree major categories:

·  Wireless Infrastructure:  technologies and products that enable endusers, or subscribers, to send and receive voice and data communication ineither a fixed or mobile environment using wireless devices;

·  Broadband Infrastructure:  technologies and products that enable endusers to access high-speed, cost effective fixed data, voice and mediacommunication; and

·  Handsets and Customer Premise Equipment:  consumer devices that allow customers toaccess wireless and broadband networks.

Our products within each of these categories includemultiple hardware and software subsystems that can be offered in variouscombinations to suit individual subscriber needs. Our system technologies andproducts are based on widely adopted global communications standards and aredesigned to allow service providers to quickly and cost-efficiently integrateour systems into their existing networks and deploy our systems in new broadband,IP and wireless network rollouts. Our system technologies are also designed toallow timely and cost-efficient transition to future next-generation networktechnologies, enabling our service provider customers to protect their initialinfrastructure investments.

In 2004, we had approximately $2.7 billion of revenue,a 38% increase over 2003, with cost of sales of $2.1 billion, which increasedby 57% compared to 2003. The growth in revenue was driven by our globalizationefforts in gaining sales revenue outside of China as well as $277.4 million ofincremental revenue from our acquisition of ACC in November 2004. Webelieve China remains one of the fastest growing telecommunications markets inthe world. China continued its growth in fixed-line, mobile telephone andinternet subscribership, with approximately 647.2 million subscribers in2004, a 6% increase from 2003, according to a report published inJanuary 2005 by China’s MII. We believe this subscriber growth continuedto support the demand for our PAS services and handsets. We use subscribergrowth statistics to gauge future inventory purchasing requirements, as well asto forecast our anticipated revenue growth.

Historically, substantially all of our sales have beento service providers in China. We derived 79% of our sales for the year endedDecember 31, 2004 from China in comparison to 86% in 2003. In 2004, weearned 13% of our sales from North America. North America replaced Japan as oursecond largest market in 2004 as a result of our global expansion efforts andthe ACC acquisition. We continued expanding our sales efforts to include othercommunications markets, such as markets in the Central and Latin Americanregion, the European, Middle Eastern and African region, the North Americanregion, and the Southeast and North Asia region. We intend to penetrate thesemarkets through direct sales offices located in key market regions, bylicensing our technology to local manufacturers where import taxation isfavorable, by developing local sales agency and distributor relationshipswithin specific market regions, and by establishing sales relationships withoriginal equipment manufacturers. Our sales division has continued to establishregional offices and local direct sales representative offices to providesupport for our expanding global sales operations.

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Thefollowing table summarizes our net sales by geographic region:
| ** **           | ** ** | **Years ended December 31,** | ** **    |
|----------------------|------------|---------------------------------------------|---------------|
| ** **           | ** ** | **2004**                                    | ** **    | **2003** | ** ** | **2002** | ** ** |
| ** **           | ** ** | **(in thousands)**                     | ** **    |
| *Sales by region*    |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| China                |       | $                                           | 2,133,292     |   | 79 | % | $ | 1,680,821 |   | 86 | % | $ | 822,299 |   | 84 | % |
| North America        |       | 341,751                                     |          | 13 | % | 31,908 |   | 2 | % | 2,436 |   | 0 | % |
| Japan                |       | 156,416                                     |          | 6 | % | 194,894 |   | 10 | % | 130,104 |   | 13 | % |
| Other                |       | 72,122                                      |          | 2 | % | 57,564 |   | 2 | % | 26,967 |   | 3 | % |
| **TOTAL  NET SALES** | ** ** | **$**                                       | **2,703,581** | ** ** | **100** | **%** | **$** | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** |

 

The number of competitors for communications accessand switching systems and handsets in China grew in 2004 in line with China’sgrowing telecommunications market. This growth led to competitive pricingpressure, causing our average selling prices to decrease by 10% to 20%  in 2004 relative to 2003 levels. We continuedto develop products with more advanced features and to enhance the features ofour existing products in 2004, which we believe will enable us to offer ourcustomers a more advanced product at a higher average selling price in futureperiods. In addition, we intend to continue to work to reduce the cost ofmanufacturing our products by streamlining our design and engineeringfunctions.

In an effort to penetrate new markets around theworld, support our growing business and expand our product offerings, wecontinued to invest resources in our selling, administrative and research anddevelopment groups in 2004. These costs are expected to increase in the nearfuture as we proceed with our expansion into other markets. Operating costs asa percentage of revenue were 20% in 2004 compared to 18% in 2003.

In 2004, we had negativenet cash flow from operating activities, mainly due to increases in accountsreceivable and inventory balances. Our accounts receivable and inventorybalances increased at December 31, 2004, as compared to 2003, and can beattributed to our global expansion efforts including the sales generated by ourPersonal Communications Division (“PCD”), our new division formed in connectionwith the ACC acquisition.

***KEY ACQUISITIONS AND OTHER TRANSACTIONS***

Since our incorporation, we have focused our resourceson developing products for the global communications market. In particular, wehave made several key strategic acquisitions to acquire additional resources tofurther this development in recent years. These acquisitions were accounted foras purchases, and the results of operations of the acquired companies have beenincluded in our consolidated financial statements from the closing dates of theacquisitions.

Our acquisitions often result in a one-time charge tooperating expenses related to products under development that have not yetreached technological feasibility, or in-process research and development(“IPR&D”). A project is classified as IPR&D if there are significantrisks associated with completing the development of the acquired technologyincluding both technological and commercial risks. When assessing IPR&Dprojects, we consider the key project characteristics as well as its futureprospects, the rate at which technology changes in the telecommunicationsequipment industry, product life cycles and the product’s development stage.

In connection withacquisitions, we often issue stock-based incentives that vest accordingto terms established in the acquisition agreement. Historically, our stock-basedincentives have vested based upon the achievement of product developmentmilestones, the meeting of revenue targets or the duration of employment.

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**GigaTelecom, Inc.**

On October 29, 2004,UTStarcom CDMA Technologies Korea Limited, a limited liability companyorganized under the laws of Korea and our wholly owned subsidiary (“UTStarcomKorea”), entered into an Asset Purchase Agreement with Giga Telecom, Inc.(“Giga”), a Korean corporation that develops and manufactures wirelesshandsets. Pursuant to the Asset Purchase Agreement and related ancillaryagreements, UTStarcom Korea will pay $18.6 million for certain assets relatingto the research and development of CDMA wireless products, of which(i) $13.0 million will be paid in cash at the closing, (ii) $1.6million pursuant to a separate arrangement in respect of certain services renderedby Giga relating to the design of wireless handsets for UTStarcom Korea, is tobe applied against the purchase price, and (iii) $4.0 million is to bepaid in three separate installments tied to certain product design andproduction milestones. We completed the acquisition on January 4, 2005,and at the closing, $13.0 million in cash was paid and an additional $2.0million was paid into an escrow account that will be held by us for a period ofsix months.

**Audiovox Communications Corporation**

On November 1, 2004, we completed our acquisitionof ACC, the wireless handset division of Audiovox Corporation, and acquiredselect assets and liabilities, including inventories, prepaids, payables,accrued expenses and the right to hire approximately 250 employees for $165.1million in cash. We acquired ACC’s sales, service and support infrastructure,its CDMA handset brand, access to supply-chain channels, product marketingexpertise and key relationships with CDMA operators in North and South America.

In consummating this acquisition, we obtain access toACC’s distribution channel into the CDMA handset market particularly in NorthAmerica. We believe this distribution channel strengthens our position in thehandset market by providing additional volume to benefit economies of scale inmanufacturing, sourcing and development. We also plan to improve gross marginson the sale of ACC’s CDMA handsets by supplying products we manufacture to ACC.

Based in part on anindependent valuation, the allocation of the purchase price to intangibleassets is comprised of  customer/dealerrelationships of $24.4 million, supplier relationships of $5.3 million,non-compete agreement of $10.8 million, backlog of $3.2 million, trade name of$4.0 million, and goodwill of $74.1 million. No amount was allocated toIPR&D.

**TELOSTechnology, Inc.**

On May 19, 2004, we completed our acquisition ofsubstantially all of the assets and certain liabilities of TELOSTechnology, Inc. and its subsidiaries (“TELOS”). TELOS is a provider ofmobile switching products and services for voice and data communicationnetworks to developing rural, enterprise and emerging wireless markets. Thetotal consideration for the acquisition, funded from cash on hand, wasapproximately $30.0 million. We paid $29.0 million in cash, in addition to $1.0million of acquisition-related transaction costs. Within one year of theacquisition date, additional payments totaling a maximum of $19.0 million maybecome payable based upon revenue recognized from the sale of TELOS products.In the event these revenue milestones are met, the original purchase price willbe adjusted for the amount of the contingent payment in accordance withStatement of Financial Accounting Standards No. 141 (“SFAS 141”),“Business Combinations.”  As ofDecember 31, 2004, no additional payments or accruals were required.

The existing technology acquired included the entireTELOS product family of CDMA softswitch technology products, supporting serversand operations maintenance centers. CDMA technology is the common platform onwhich second and third-generation wireless data services and applications arebuilt. By assigning unique codes to each communication to differentiate it fromothers in the same spectrum, 

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CDMA technology allowsmany users to occupy the same time and frequency allocations in a given band orspace. The amount of the purchase price allocated to existing technology was$15.9 million. The TELOS product line will be integrated with our suite of CDMAproducts, strengthening our existing CDMA product portfolio.

In addition to developed product technology, weacquired fixed assets, IPR&D, an assembled workforce of approximately 60employees, customer relationships and recorded goodwill. The amount of thepurchase price allocated to IPR&D of $1.4 million was charged to ourresults of operations, as no alternative future uses existed at the acquisitiondate. In assessing TELOS IPR&D projects, we considered key productcharacteristics including the product’s development stage at the acquisitiondate, the product’s life cycle and the product’s future prospects. We alsoconsidered the rate at which technology changes in the telecommunicationsequipment industry, the industry’s competitive environment and the economicoutlook for both local and global markets. We recorded $6.4 million of goodwillrelated to this acquisition.

As of the acquisition date, TELOS had two projectsunder development that qualified for IPR&D: the Sonata SE product family and the iCell product. The objective ofboth projects is to enhance the functionality of products designed to complywith the CDMA2000 technology standard. Specifically, the objective of theSonata SE product family is to provide additional features to operationmaintenance center products. The objective of the iCell product is to enhanceiCell base station features. The projects under development are enhancements toexisting products that do not affect the functionality of those existingproducts.

As of December 31,2004, one project was completed and for the other project, the estimatedcompletion date is June 2005, with estimated remaining costs to completeof $0.6 million.

**HyundaiSyscomm, Inc.**

On April 27, 2004, we completed our acquisitionof the assets, substantially all of the intellectual property, certainemployees and certain contracts related to HSI’s CDMA infrastructure businessfor markets outside of Korea. Subject to the attainment of certain milestonesand the transfer of certain know-how, the total consideration for this transactionwas approximately $12.3 million excluding transaction costs of $1.8 million.Approximately $7.3 million in cash was paid at the closing date and anadditional $3.0 million in cash is payable one year from the closing date. Theremaining purchase price was comprised of $2.0 million to be paid by us uponthe completion of HSI’s training of our manufacturing employees in China underthe terms of a Training Services Agreement. Not included in the purchase pricewas $2.0 million payable upon the completion of certain revenue milestones. Inthe event these revenue milestones are met, the original purchase price will beadjusted for the amount of the contingent payment in accordance with SFAS 141.In conjunction with this transaction, we loaned HSI $3.2 million at aneffective interest rate of 12% per annum, which was used by HSI to satisfyoutstanding debt obligations. The principal amount of the loan is due inApril 2005. We may offset HSI’s payment obligations against theoutstanding $3.0 million of the purchase price and any other liabilities.

Under the terms of the transaction with HSI, weacquired existing technologies and entered into non-compete and licensingagreements. The existing technologies acquired were the base transceiverstation (“BTS”) and base station controller (“BSC”) product lines. BTS is theantenna and radio equipment that enables wireless devices to communicate with aland-based transmission network in a given range. BSC performs radio signalmanagement functions for BTS, managing functions such as frequency assignmentand handoff. As part of the asset purchase agreement, we entered into atraining services agreement with HSI, whereby HSI employees were to providetechnical training to our manufacturing staff in China for the ninth-monthperiod subsequent to the acquisition. This technology and technologicalknow-how will strengthen our existing CDMA product portfolio and thedevelopment of future CDMA technology.

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In addition to acquiring existing technology, weentered non-compete and licensing agreements with HSI. The non-competeagreement prohibits HSI from competing against us in all countries except Koreafor four years from the valuation date. The licensing agreement requires thatHSI pay us 1% of revenue as a royalty for the usage of the intellectualproperty that we acquired under the terms of the acquisition for fifteen yearssubsequent to the valuation date. There were no IPR&D projects acquired.

We initially recordedgoodwill of $6.8 million in connection with the acquisition and subsequentlyincreased the amount of goodwill by $0.2 million upon the completion of thepurchase price allocation. We encountered difficulties integrating the HSIoperations into our operations after the acquisition. In the fourth quarter of2004, we decided to wind-down the legacy operations and transfer employees andtangible assets to support our handset engineering operations in Korea duringthe first quarter of 2005. The decision to abandon the operations occurredwithin nine months of the acquisition and before the HSI operations wereintegrated into our Company. Therefore, in accordance with SFAS 142, we havewritten off the entire goodwill of $7.0 million associated with this acquisition.We have also written off all of the remaining values of the intangible assetsassociated with this acquisition including $3.1 million of purchasedtechnologies, $0.6 million related to non-compete agreements, and $0.8 millionrelated to a license agreement with HSI. At December 31, 2004, we believedwe would utilize most of HSI’s tangible assets to support our new handsetdesign center. If any assets will not be utilized in support of the handsetdesign center, the net book value of those assets will be written off. Weexpect to complete the evaluation and decision during the second quarter of2005.

**CommWorks**

On May 23, 2003, we completed our acquisitionfrom 3Com Corporation, a Delaware corporation, (“3Com”) of selected assets andliabilities from 3Com’s CommWorks division (“CommWorks”). We funded theconsideration for the acquisition from cash on hand, and paid$100.0 million in cash and incurred transaction and other related costs of$9.3 million.

Selected assets acquired included CommWork’s portfolioof carrier-focused voice and data networking products and customersupport and professional services. In addition, we acquired or licensed all ofthe 3Com intellectual property used by CommWorks. CommWorks develops anddeploys carrier-class, IP-based multi-service access and service-creationplatforms for telecommunications service providers.

Based on an independent valuation, $1.3 million of thepurchase price was allocated to IPR&D and was charged to our results ofoperations, as no alternative future uses existed at the acquisition date.

As of the date of theacquisition, CommWorks had two projects under development that qualified forIPR&D, SLAP and High Density Voice (“HDV”) 2.0. SLAP is an IPR&Dproject in the Wireless division of CommWorks. It is an interface that connectsour products with radio switch manufacturers’ products in China in order toconnect a cellular network to the Internet. HDV 2.0 is an IPR&D project inthe Broadband infrastructure product line of CommWorks. HDV 2.0 utilizessoftware technology to increase data capacity for VoIP solutions. Both the SLAPand HDV 2.0 projects were completed and commercialized in 2004.

**RollingStreams**

On June 30, 2003, we completed the acquisition ofRollingStreams Systems, Ltd. (“RollingStreams”), a development-stagecompany, pursuant to a share exchange agreement. RollingStreams designsstreaming, end-to-end TVoIP products and services for telecommunicationsoperators and broadband service providers. Our investment in RollingStreams was$0.4 million prior to the acquisition. The purchase consideration for allof the outstanding shares of RollingStreams, other than those already held byus prior to the acquisition, was 301,074 shares of our common stock. Inaddition, we assumed all 

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outstanding RollingStreamsoptions, which became options to purchase an aggregate of 12,742 shares of ourcommon stock, valued at $0.5 million. Of the 301,074 shares, 164,115shares valued at $5.8 million, were issued at the closing, 28,696 of whichare held in escrow for any undisclosed liabilities or contingencies incurred byRollingStreams prior to the closing or for any breach of the share exchangeagreement. The 28,696 shares held in escrow were released and issued in 2004.Up to 136,959 of the 301,074 shares will be payable in the form of an earnoutafter an earnout period expiring 18 months after the closing, subject to theachievement of certain revenue milestones during such earnout period. No shareshave been issued pursuant to the earnout as of March 31, 2005.

The amount of the purchase price allocated toIPR&D was $6.2 million, based on an independent valuation. This amountwas charged to our results of operations, as no alternative future uses existedat the acquisition date.

As of the date of the acquisition, RollingStreams hadone project under development that qualified for IPR&D, MediaSwitch.MediaSwitch is an end-to-end solution designed for telecom operators andbroadband service providers to deliver broadcast quality TV and on-demandentertainment services over Internet Protocol networks.

MediaSwitch is consideredan IPR&D project because there are significant risks associated with thedevelopment of this technology. These risks include technological andcommercial risks. The technological risks stem from the fact that thetechnology was 70% complete at December 31, 2003. As of December 31,2004, the project was completed and no further cost is anticipated.

**ShanghaiYi Yun**

On October 16, 2002,we acquired the assets and intellectual property of Shanghai Yi Yun TelecomTechnology Co. Ltd. (“Shanghai Yi Yun”), a provider of synchronous digitalhierarchy equipment. Consideration was $0.2 million of cash and 342,854shares of restricted stock valued at $6.0 million. In connection with theacquisition, Shanghai Yi Yun and each of the stockholders that received the342,854 shares of restricted stock executed an indemnity escrow agreement inour favor and such shares of restricted stock were placed in escrow. Inaddition, we issued 514,290 shares of restricted stock valued at that time at$9.0 million to the Shanghai Yi Yun employees that were hired by one ofour subsidiaries. Such shares of restricted stock vest over five years, withaccelerated vesting upon the achievement of specified milestones. We havetreated these 514,290 shares of restricted stock as deferred compensation.

**EquityTransactions**

On January 14, 2004, we sold 12.1 million sharesof common stock at $39.25 per share in a privately negotiated transaction to aninstitution, for net proceeds of approximately $474.6 million. The net proceedsare intended to fund strategic and general corporate activities, including, butnot limited to, acquisitions, investments, working capital or capitalexpenditures. During the first and second quarters of  2004, we used a portion of the capital raisedto repurchase a total of 3.6 million shares of our common stock, at an averageprice of $30.25 per share and a total cost of $107.6 million, includingtransaction  fees.

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OnApril 5, 2003, we repurchased 8.0 million shares of common stockbeneficially owned by SOFTBANK America Inc., at a purchase price of$17.385 per share. The total cost of the repurchase was $139.6 millionincluding transaction fees. In connection with this repurchase transaction,SOFTBANK America Inc. entered into an agreement with us not to offer, sellor otherwise dispose of our common stock for a period of one year, subject to anumber of exceptions.

**DebtIssuance**

On March 12, 2003, we completed an offering of$402.5 million of convertible subordinated notes due March 1, 2008 toqualified institutional buyers pursuant to Rule 144A under the SecuritiesAct of 1933. The notes bear interest at a rate of 7/8%per annum and are convertible into our common stock at a conversion price of$23.79 per share and are subordinated to all of our present and future seniordebt. Holders of the notes may convert their notes only if:  (i) the price of our common stockissuable upon conversion of a note reaches a specified threshold, (ii) specifiedcorporate transactions occur, or (iii) the trading price for the notesfalls below certain thresholds. At the initial conversion price, each $1,000principal amount of notes will be convertible into approximately 42.0345 sharesof common stock.

Concurrent with theissuance of the convertible notes, we entered into a convertible bond hedge anda call option transaction with respect to our common stock. Both the bond hedgeand call option transactions may be settled at our option either in cash or netshares and expire on March 1, 2008. The convertible bond hedge and calloption transactions are expected to reduce the potential dilution from theconversion of the notes. The options have been included in stockholders’ equityin accordance with the guidance in Emerging Issues Task Force Issue No. 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.”

**RESULTS OF OPERATIONS**

Our net sales consist of product and service saleswithin three broad telecommunications product lines; wireless infrastructure,broadband infrastructure and handsets and customer premise equipment. Wirelessinfrastructure is primarily comprised of the PAS and CDMA products. Broadbandinfrastructure is primarily comprised of the AN-2000, iAN-8000,IP-DSLAM, GEPON, NetRingTM and other wireline products. The handsets andcustomer premise equipment products include PAS handsets, CPE and CDMA handsetsthat were introduced in the fourth quarter of 2004. With many of our productsales, we provide installation services. Additionally, we provide maintenanceservices for some of our products. For each of the years endedDecember 31, 2004, 2003 and 2002, total services sales accounted for lessthan 10% of net sales.

Approximately 79%, 86% and 84% of our net sales forthe years ended December 31, 2004, 2003 and 2002, respectively, were inChina. Accordingly, our business, financial condition and results of operationsare likely to be influenced by the political, economic and legal environment inChina, and by the general state of China’s economy for the foreseeable future.For example, we experienced lower demand for our products in China in thefourth quarter of 2004 resulting from the slowdown in China’s economy as wellas from the maturation of the PAS market. Our results may be adversely affectedby, among other things, changes in the political, economic, competitive andsocial conditions in China, including changes in governmental policies withrespect to laws and regulations, changes in the telecommunications industry andregulatory rules and policies, anti-inflationary measures, currencyconversion and remittance abroad, and rates and methods of taxation. We extendcredit to our customers in China without requiring collateral. We monitor ourexposure for credit losses and maintain allowances for doubtful accounts.Business activity in China and many other countries in Asia declineconsiderably during the first quarter of each year in observance of the LunarNew Year. As a result, sales during the first quarter of our fiscal year havetypically been lower than sales during the fourth quarter of the precedingyear, and we expect this trend to continue.

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Cost of sales consists primarily of materials costs,fees to agents, costs associated with manufacturing, assembly and testing ofproducts, costs associated with installation and customer training and overheadand warranty costs. Cost of sales also includes import taxes and tariffs oncomponents and assemblies. Some components and materials used in our productsare purchased from a single supplier or a limited group of suppliers and, insome cases, are subject to our obtaining Chinese import permits and approvals.We also rely on third party manufacturers to manufacture and assemble most ofour handsets.

Our gross profit has been affected by product mix,average selling prices and material costs. Our gross profit, as a percentage ofnet sales, varies among our product families. We expect that our overall grossprofit, as a percentage of net sales, will fluctuate from period to period as aresult of shifts in product mix, anticipated decreases in average sellingprices and our ability to reduce cost of sales.

Selling, general and administrative expenses includecompensation and benefits, professional fees, sales commissions, provision fordoubtful accounts receivable and travel and entertainment costs. A largepercentage of our costs are fixed and are difficult to quickly reduce inperiods of reduced sales. We intend to pursue aggressive selling and marketingcampaigns and to expand our direct sales organization, and, as a result, oursales and marketing expenses will increase in future periods. We also expectthat in support of our continued growth, general and administrative expenseswill continue to increase in the foreseeable future.

Research and development expenses consist primarily ofsalaries and related costs of employees engaged in research, design anddevelopment activities, the cost of parts for prototypes, equipmentdepreciation and third party development expenses. A large percentage of ourcosts are fixed and are difficult to quickly reduce in periods of lower sales. Webelieve that continued investment in research and development is critical toour long-term success. Accordingly, we expect that our research anddevelopment expenses will increase in future periods.

Incometax expense is based upon a blended effective tax rate based upon ourexpectation of the amount of income to be earned in each tax jurisdiction. Theprimary drivers for income tax expense include both the total amount and geographicsource of the income earned. We use credits and other tax incentives tominimize our income tax expense. Income tax expense as a percentage of incomebefore taxes will increase if relatively more income is earned in higher taxjurisdictions.

**NETSALES**

Thefollowing table summarizes our net sales by product line:
| ** **                               | ** ** | **Years ended December 31,** | ** **    |
|------------------------------------------|------------|---------------------------------------------|---------------|
| ** **                               | ** ** | **2004**                                    | ** **    | **2003** | ** ** | **2002** | ** ** |
| ** **                               | ** ** | **(in thousands)**                     | ** **    |
| *Sales by product line*                  |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure                 |       | $                                           | 1,395,521     |   | 52 | % | $ | 720,555 |   | 37 | % | $ | 447,096 |   | 46 | % |
| Handsets and  customer premise equipment |       | 1,026,483                                   |          | 38 | % | 983,392 |   | 50 | % | 376,805 |   | 38 | % |
| Broadband  infrastructure                |       | 281,577                                     |          | 10 | % | 261,240 |   | 13 | % | 157,905 |   | 16 | % |
| **TOTAL  NET SALES**                     | ** ** | **$**                                       | **2,703,581** | ** ** | **100** | **%** | **$** | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** |

 

*Fiscal 2004 vs. 2003*

The 38% increase insales from $2.0 billion in 2003 to $2.7 billion in 2004 was primarilyattributable to increased demand for our products and services and results ofour geographic expansion into other markets. Our new customer wins in prioryears continued to contribute to the increased demand for our products andservices. In addition, our recent acquisitions also attributed to our growth insales. For example, our PCD division contributed $277.4 million in sales sincethe acquisition on November 1, 2004. 

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Net sales growth, excluding PCD, was primarily due toan increase in subscribers, requiring telecommunication providers to expandtheir telecommunication infrastructures. Wireless infrastructure revenues aregenerally affected by the timing of customer acceptance. In 2004, thepercentage of total sales for our wireless product line increased from 37% to52% generally as a result of our international customers who undertook a numberof wireless infrastructure expansion projects including the broadbandfiber-to-the-home projects in Japan. While we experienced an increase in ourwireless infrastructure revenue between 2004 and 2003, our handset revenueremained relatively flat as a result of a combination of factors. For one, ourhandset revenue in China decreased by approximately $225.9 million dueprimarily to lower average selling prices resulting from increased competitionby 10% to 20%, depending on products, while units of shipment remained at thesame level as last year. Secondly, the decline in China handset revenue wasoffset by $277.4 million in handset revenue recognized in the fourth quarter of2004 by PCD. We believe that in 2005 we will maintain approximately 55% to 60%percent market share in China for PAS wireless infrastructure and 50% to 55%percent market share for PAS handsets as smaller competitive handset vendorsexit the market. Additionally, we expect that with the addition of PCD, totalhandset revenue will represent 50% to 60% of our net sales in 2005. Sales torelated parties decreased from 9.4% in 2003 to 5.4% in 2004 of total net sales.See “—RelatedParties” for further discussion.

Most Chinesecarriers have three levels of operations; the central headquarters level, theprovincial level and the local city/county level. Both central and provinciallevels are independent legal entities and have their own corporate mandate. Thepurchasing decision making process maytake various forms for different projects and may also differ significantly from carrier to carrier. Wegroup all of our China customers together by province and treat each provinceas one customer since that is the level at which purchasing decisions are made.At December 31, 2004, and 2003, we had 31 customers in China. In 2004, theGuangdong and Jiangsu provinces accounted for 12% and 10% of our net sales,respectively. In 2003, the Hei Long Jiang province accounted for 11% of our netsales.

In the case of PAS systems, all China Netcom contractsare negotiated and entered into between the provincial operators and the Company.However, thecentralheadquartersof China Telecom recently began exerting more influence in thepurchasing decision-making process by negotiating contractual terms, such as purchase price, paymentterms, and acceptance clauses at the central level. The provincial operator thenfurther negotiates the contract based on the guidelines provided by theheadquarters. Final contracts are entered into between the provincial operatorand the Company.However, if this trend of centralized decision-making expands to unifiedpurchasing, resultingin the negotiation and execution of contracts at the central headquarterlevel,there may bea concentration of customers which could have a significant impact onour business. 

*Three months ended December 31, 2004 and 2003*

In the fourthquarter 2004, net sales increased by $103 million or 16% over the fourth quarterof 2003. This increase was driven by the PCD division, which contributed $277.4million in sales in the fourth quarter 2004. Excluding the impact of the PCDacquisition, our sales declined in the fourth quarter 2004 by 27 % compared tothe prior year. The revenue from our Wireless products experienced a decline inthe fourth quarter of 2004 primarily due to the delay of revenue recognitionfor our PAS infrastructure products due to extended period for productacceptance due to certain new contract terms. In addition, our revenue growth continuedto be impacted negatively by the maturity of PAS market infrastructure.

The percentage of revenue generated outside of Chinaexceeded 53% of total sales in the fourth quarter 2004  versus 13% of total sales in the fourthquarter 2003. Excluding PCD, there was a 37% increase in sales from $83 millionin the fourth quarter 2003 to $114 million in the fourth quarter 2004. This wasprimarily due to telecommunication providers expanding their infrastructurerequirements. In addition, there was an increase in our Broadband product salesdue to the introduction of our GEPON and NetRingTM products.

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*Fiscal 2003 vs. 2002*

The 100% increasein sales from $981.8 million in 2002 to $1,965.2 million in 2003 was primarilyattributable to increased demand for our products and services, the continuedstrength of our sales in China, as well as an increase in our global sales. Netsales growth was due to an increase in subscribers, which requiredtelecommunication providers to expand their telecommunication infrastructures. Asa result, we had more sales to customers that were expanding their existingnetworks in 2003. Approximately 30% of our sales in 2003 were attributable tonew customers compared to 54% of sales to new customers in 2002. In addition toincreasing the amount of infrastructure sales, this increase in subscribersalso led to an increase in customer demand for handsets. Sales to relatedparties decreased from 13% in 2002 to 9% in 2003 of total net sales. See “—RelatedParties” for further discussion.

During 2003, the China provincial-leveltelecommunications service entities continued to consolidate telecommunicationspurchasing decisions by province. As a result of this consolidation trend, wegrouped all of our China customers together by province, and treat eachprovince as one customer. At December 31, 2003 and 2002, we hadapproximately 31 such customers. Giving effect to this consolidation, in 2003,the Hei Long Jiang province accounted for 11% of our net sales. In 2002, salesto the Zhejiang province accounted for 18% and sales to SBBC accounted for 13%of our net sales.

**GROSS PROFIT**

Thefollowing table summarizes our gross profit:
| ** **              | ** ** | **Years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **              | ** ** | **(in thousands)**                     | ** ** |
| Gross profit            |       | $                                           | 601,601    |   | $ | 624,385 |   | $ | 345,472 |   |
| Gross profit percentage |       | 22%                                         |       | 32% |   | 35% |   |
|                         |            |                                             |            |  |  |  |  |  |  |  |

 

*Fiscal 2004 vs.2003*

Our gross profit varies across our different productlines and is affected by product mix, average selling prices and the cost ofmaterials. Gross profit percentage declined by approximately 10% due to severalfactors. The International segment experienced the largest drop in gross profit,declining from 58% for 2003 to 34% for 2004. Most of this decrease was drivenby the decline in our broadband product, which experienced a shift in productmix from our more traditional DSLAM product to newer optical broadband products.These broadband products have experienced lower initial margins upon productintroduction. In addition, the gross profit percentage recognized on handsetsales made through the PCD business is approximately 4% which is significantlylower than those realized on handset sales related to our PAS systems. PCD wasacquired in November 2004 and contributed $11.9 million in gross profit. Thelower PCD gross margin resulted in a decrease in consolidated gross margin of2.1%. The China segment also experienced a decline in gross margin percentage,declining from 27% to 23%, primarily attributable to our handset products,which have experienced increased competitive market pricing pressure. We expectthat there will be continued competitive market pricing pressures on ourproducts in line with current trends in the industry.

In addition, our grossprofit was negatively impacted by a $39 million increase in our provisionfor inventory reserves.

*Three months ended December 31,2004 and 2003*

Gross profit for the three months ended December 31,2004 was $112.2 million or 15% of sales compared to $188.1 million or 29%. Themost significant factor related to this decline is the inclusion of 

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two months of PCD sales atapproximately 4% gross profit. The lower PCD gross profit percentage decreasedthe consolidated gross profit by 6% in the three months ended December 31,2004.

The majority of theremaining decline in gross profit is related to the International segment. Duringthe fourth quarter of 2004, the International segment sold more of its neweroptical broadband products, which has a lower margin than the DSLAM product. Inaddition, the fourth quarter gross profit was negatively impacted by provisionfor inventory and warranty reserves of $34.4 million compared to $12.6 millionin the fourth quarter of 2003.

*Fiscal 2003 vs.2002*

The decrease in grossprofit as a percentage of net sales in 2003 from 2002 was attributable toincreased competitive market pricing pressures and lower margins on our PASsystems as well as to our having a higher volume of sales of our lower marginhandset products. The telecommunications market experienced continued pricingpressures in 2003. Our gross profit decreased in 2003 also due to an increasedcost of sales from foreign exchange losses resulting from our purchasing significantamounts of inventory denominated in Japanese Yen.

**OPERATING EXPENSES**

Thefollowing table summarizes our operating expenses:
| ** **                           | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|
| ** **                           | ** ** | **2004**                                    | ** ** | **% of  2004 net  sales** | ** ** | **2003** | ** ** | **% of  2003 net  sales** | ** ** | **2002** | ** ** | **% of  2002 net  sales** | ** ** |
| ** **                           | ** ** | **(in thousands)**                     | ** ** |
| Selling, general  and administrative |       | $                                           | 315,703    |   |   | 11 | % |   | $ | 188,339 |   |   | 9 | % |   | $ | 110,263 |   |   | 11 | % |   |
| Research and  development            |       | 219,045                                     |       |   | 8 | % |   | 155,252 |   |   | 8 | % |   | 86,182 |   |   | 9 | % |   |
| In-process  research and development |       | 1,400                                       |       |   | 0 | % |   | 10,686 |   |   | 1 | % |   | 670 |   |   | 0 | % |   |
| Amortization of  intangible assets   |       | 15,551                                      |       |   | 1 | % |   | 8,370 |   |   | 0 | % |   | 2,395 |   |   | 0 | % |   |
| **TOTAL OPERATING EXPENSES**         |       | $                                           | 551,699    |   |   | 20 | % |   | $ | 362,647 |   |   | 18 | % |   | $ | 199,510 |   |   | 20 | % |   |

 

*Selling, generaland administrative*

*Fiscal 2004 vs.2003*

Selling, general andadministrative expenses increased by $127.4 million, or 2% as a percentage ofnet sales, compared to 2003. The increase from 2003 to 2004 was primarily dueto the hiring of additional personnel to support our increased businessactivities both in China and globally. Selling, general and administrativeheadcount increased approximately 49% from an average of 2,033 employees for2003 to an average of 3,038 employees for 2004. Additionally, our professionalservices fees increased by approximately $31.7 million in 2004 from 2003 due toexpansion of our overall global activities and also driven in part by expensesof approximately $13.3 million related to systems implementations,Sarbanes-Oxley compliance and supply chain management consulting fees in 2004. Theallowance for doubtful accounts increased from $31.2 million at December 31,2003, to $51.2 million at December 31, 2004, due primarily to theincreased size of our receivable balances in China. The net increase inallowance for doubtful accounts was partially offset by a refinement in ourestimation methodology and assumptions in the fourth quarter of 2004. Therevision  to our allowance for doubtfulaccounts assumptions reflect the changing 2004 collection experience andfurther analysis of collectibility trends within the China accounts receivablebalances. Throughout 2004, we experienced slower collections cycles. Thisslowdown has been attributed to a variety of reasons but principally to changesin customer’s business practices surrounding payment and, to a lesser degree, tomaturation of the telecommunications sector. However, we do not believe thatthe lengthening of the collections cycle will coincide with a reduction in theoverall 

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recoverabilityof the associated receivables. This lengthening of the collection cycle causedus to reevaluate our provisioning methodology. The change in estimationresulted in a $10.1 million lower provision for doubtful accounts than wouldhave been provided under the previous assumptions. Finally, we incurred anasset impairment charge of approximately $11.5 million relating to goodwill andintangible assets impairment of our HSI acquisition.

*Fiscal 2003 vs.2002*

The increase in selling,general and administrative expenses was due to the expansion of our overallbusiness activities both in China and globally. To support our expanding globalbusiness, we hired approximately 1,150 additional selling, general andadministrative employees in 2003, which also contributed to the increasedselling, general and administrative expenses. The decrease in selling, generaland administrative expenses as a percentage of net sales was primarily due toeconomies of scale associated with the significant increase in net sales.

*Research anddevelopment*

*Fiscal 2004 vs.2003*

Research and developmentexpense remained at 8% of total net sales for 2004 as compared to 2003. Theresearch and development expenses increased by $63.8 million primarily due tohiring additional technical personnel to support both product enhancements andnew product development. Research and development headcount increasedapproximately 52% from an average of 1,809 employees for 2003 to an average of 2,757employees for 2004. The significant majority of the increase in research anddevelopment expenses from 2003 to 2004 was attributable to higher payroll andpayroll-related costs resulting from the continued expansion of our researchand development teams in China, from a full year of salaries for CommWorkspersonnel as compared to seven month’s salaries in the same period in the prioryear and from approximately 100 employees hired in conjunction with theacquisitions of TELOS and HSI in 2004.

*Fiscal 2003 vs.2002*

The increase in absolutedollars of research and development expenses was primarily due to the hiring ofapproximately 950 additional technical personnel in 2003 to support ourincreased business levels. The decrease of research and development expenses asa percentage of net sales was due to the majority of the new personnel beinghired in China, where labor costs are less expensive than in the United States,as well as to increased economies of scale associated with increased businesslevels.

*In-process researchand development expenses*

*Fiscal 2004 vs.2003*

The IPR&D charge of $1.4 million for 2004 resultedfrom our acquisition of TELOS and was based, in part, on an independentvaluation.

Pleasesee  “Acquisitions and Other KeyTransactions” for details on our IPR&D expenses incurred in 2004.

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*Fiscal 2003 vs.2002*

The IPR&D charge for2003 resulted from our acquisition of CommWorks and three smalleracquisitions:  RollingStreams, Xebeo andShanghai Yi Yun Telecom Technology Co. Ltd., which accounted for$1.3 million, $6.2 million, $1.9 million and $1.3 million,respectively, and were based on independent valuations. The charge for 2002arose from our acquisition of Issanni Communications, Inc. on April 19,2002 and was based on an independent valuation.

*Amortization ofintangible assets*

*Fiscal 2004 vs.2003*

Amortization of intangibleassets increased by $7.2 million in 2004 primarily due to the addition of $68.6million of intangible assets recorded upon our acquisitions of selected assetsof ACC and TELOS in 2004. Estimated amortization expenses for the next fiveyears, beginning with the year ended December 31, 2005, are $23.1 million,$18.9 million, $16.0 million, $12.7 million, and $6.9 million, respectively.

*Fiscal 2003 vs.2002*

The increase inamortization of intangible assets was primarily due to an additional $44.9million of intangibles recorded upon our acquisition of CommWorks in May 2003.The estimated useful lives of these purchased intangibles range from one to tenyears.

**OTHER INCOME (EXPENSE)**

*Interest income(expense), net*

*Fiscal 2004 vs.2003*

Interest income was $6.2 million in 2004 compared tointerest income of $3.2 million in 2003. Interest income increased due tohigher average cash balances in 2004 compared to 2003 primarily due to cashgenerated from financing activities.

Interest expense was $6.9million in 2004 compared to $4.7 million in 2003. The increase of $2.2 millionin interest expense was in part attributable to the interest associated withour convertible debt issued in March 2003, which accrues at a rate ofapproximately $1.4 million per quarter. In addition, in 2004 we incurredinterest expense relating to short-term borrowings in China. These increases ininterest expense were offset by an increase in capitalized interest ofapproximately $0.8 million relating to the construction of our newmanufacturing facility in Hangzhou, China.

*Fiscal 2003 vs.2002*

Interest income was $3.2 million in 2003 comparedto interest income of $5.5 million in 2002. Interest income decreased dueto lower average cash and short-term investment balances of$319.2 million in 2003 compared to $372.5 million in 2002, as well asdue to a reduction in interest rates on deposits.

Interest expense was$4.7 million in 2003 compared to $1.3 million in 2002. The increaseof $3.4 million in interest expense was primarily attributable to theinterest associated with our convertible debt issued in March 2003. Wecapitalized $0.6 million of interest in 2003.

*Other income(expense), net*

*Fiscal 2004 vs.2003*

Net other income was $15.4million in 2004, compared to $4.9 million in 2003. Net other income in 2004primarily consisted of $10.3 million in financial subsidies received from thelocal Chinese government 

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duringthe first two quarters of 2004. We do not expect to receive any additionalfinancial subsidies or payments in the near future. These subsidies were toencourage our investment in local research and development and manufacturingactivities. Net other income also included Japanese consumption tax refunds ofapproximately $5.3 million and net investment gains and dividends ofapproximately $0.9 million offset by foreign exchange losses of approximately $0.7million.

*Fiscal 2003 vs.2002*

Net other income was$4.9 million in 2003, compared to net other expense of $9.9 millionin 2002. Net other income in 2003 primarily consisted of a reinvestmentincentive payment received in China of $3.9 million, an incentives paymentfor exports and value added taxes in China of $6.1 million, governmentincentives related to our operations in Japan of $6.2 million, offset byforeign exchange losses of approximately $8.7 million and expensesattributable to selling or transferring of notes receivable of$2.3 million.

*Equity in net lossof affiliated companies*

*Fiscal 2004 vs.2003*

Consolidated equity in netloss of affiliated companies was $1.3 million in 2004 compared to$5.3 million in 2003. The equity loss for 2004 primarily consisted of ourshare of losses relating to our joint venture with Matsushita CommunicationsIndustrial Co., Ltd. and Matsushita Electric Industrial Co., Ltd. to jointlydevelop, manufacture and sell telecommunications products. We have a 49%ownership interest in the joint venture. The equity losses for fiscal 2003 wererelated to losses from the same joint venture.

*Fiscal 2003 vs. 2002*

Consolidated equity in netloss of affiliated companies was $5.3 million in 2003 and$4.1 million in 2002. The equity loss for 2003 primarily consisted of ourshare of losses relating to our joint venturewith Matsushita Communications Industrial Co., Ltd. and Matsushita ElectricIndustrial Co., Ltd. The equity loss for 2002 was related to lossesrelating to our interests in investment funds and to our share of lossesgenerated by GUTS prior to our acquisition of the remaining 49% ownershipinterest in this entity.

*Income tax benefit (expense)*

*Fiscal 2004 vs.2003*

We recorded an income tax benefit of $9.8 million in2004 and an expense of $45.4 million in 2003. We have a negative 15% effective incometax rate for 2004. There are three principal reasons for the negative incometax rate for 2004.

The first reason relates to the mix in income or lossbetween income tax jurisdictions. In the United States (a 35% taxjurisdiction), we incurred a loss of $19.7 million before taxes. Therefore, werecorded a tax benefit of approximately $6.9 million related to our 2004domestic losses. In international jurisdictions, we recognized approximately $83.0million of income in 2004. However, our net statutory tax rate for ourinternational locations, principally China, was substantially lower than the35% U.S. statutory rate.

Secondly, the Company experienced a significant taxbenefit resulting from the increase in the tax rate applied to the temporarydifferences within our China companies. In 2003, the Company recorded mostdeferred tax assets for the China jurisdiction at a 15% rate based upon ourlocation within a “high tech zone.”  Whenwe moved into our new facility in China in the fourth quarter of 2004, we nolonger qualified for the lower rate and consequently, the rate applied to ourdeferred tax assets and liabilities increased to 24%. The resulting benefitfrom the higher rate applied to our deferred tax assets is $19.6 million. We arecurrently re-applying for the “high tech zone” certification. However, therecan be no assurance that we 

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will receive thecertification. If we were to receive the approval and our 15% tax rate were tobe re-instated, the tax benefit would be reversed.

The third reason for theincome tax benefit was the utilization of tax credits, primarily within theUnited States. This resulted in a reduction in the effective income tax rate byapproximately 9%.

*Fiscal 2003 vs. 2002*

Income tax expense was$45.4 million in 2003 and $27.3 million in 2002. The primary reason for theincrease in income tax expense was that our income increased 91% in 2003 from2002. Our effective tax rate was 17% in 2003 compared to 20% in 2002.

*Minority interestin (losses) earnings of consolidated subsidiaries*

*Fiscal 2004 vs.2003*

Minority interest inlosses of consolidated subsidiaries was ($0.3) million in 2004 and($1.0) million in 2003. Minority interest in the losses of ourconsolidated subsidiaries represents the minority interest in losses of MDCHolding Limited (“MDC Holding”) and its affiliated entities (MDC Holding andsuch affiliated entities are referred to, collectively, as “MDC”), a variableinterest entity consolidated in accordance with Financial Accounting StandardsBoard (“FASB”) Interpretation 46, net of the 10% share of earnings of ourChongqing manufacturing joint venture UTStarcom Co., Ltd. (“CUTS”) attributableto our joint venture partner.

*Fiscal 2003 vs.2002*

Minority interest in(losses) earnings of consolidated subsidiaries was ($1.0) million in 2003and $1.2 million in 2002. The change was due primarily to the minorityinterest in losses in 2003 of MDC, a variable interest entity included in ourconsolidated financials in the fourth quarter of 2003, and to the acquisitionof the remaining 12% ownership interest in our Zhejiang manufacturing jointventure, UTStarcom Telecom Co., Ltd. (“HUTS”) during 2002. Minority interest inlosses of consolidated subsidiaries for 2003 represented the minority interestin losses of MDC, net of the 10% share of earnings of CUTS attributable to ourjoint venture partner. Minority interest in earnings of consolidatedsubsidiaries for 2002 represented the share of earnings in HUTS attributable toour joint venture partner, prior to our acquisition of the remaining 12%ownership interest in HUTS in May 2002. HUTS is now a wholly-ownedsubsidiary.

**Related Parties**

*Softbank*

We recognized revenue of $143.7 million,$184.4 million, and $123.0 million during the years ended December 31,2004, 2003, and 2002, respectively, with respect to sales of telecommunicationsequipment to Softbank BB Corporation (“SBBC”), an affiliate of SOFTBANK CORP.and SOFTBANK America Inc., a significant stockholder of the Company. SBBCoffers asynchronous digital subscriber line (“ADSL”) coverage throughout Japan,which is marketed under the name “YAHOO! BB.” In addition, we support SBBC’s new fiber-to-the-home service throughsales of its carrier class Gigabit Ethernet Passive Optical Network (“GEPON”)product as well as its multi-service optical transport product (“NetRingTM”). Revenuerecognized for the GEPON and NetRingTM products for the twelve months ended December 31,2004 was $93.4 million. Both the GEPON and NetRing contracts were obtainedthrough a form of auction. Included in accounts receivable at December 31,2004 and 2003, were $86.8 million and $43.9 million, respectively, relatedto these contracts.

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During 2000, we invested $10.0 million inSoftbank China, an investment fund established by SOFTBANK CORP. focused oninvestments in Internet companies in China. This investment permits us toparticipate in the anticipated growth of Internet-related businesses inChina. Our investment constitutes 10% of the funding for Softbank China, withSOFTBANK CORP. contributing the remaining 90%. The fund has a separatemanagement team, and none of our employees are employed by the fund. Many ofthe fund’s investments are and will be in privately held companies, many ofwhich are still in the start-up or development stages. These investments areinherently risky as the market for the technologies or products the companieshave under development are typically in the early stages and may nevermaterialize. We account for this investment under the cost method and recordedinsignificant losses in 2004 and losses of $0.2 million, and$2.8 million due to an other-than-temporary decline in the carrying valueof this investment in 2003, and 2002, respectively. The balance in thisinvestment was $5.3 million at December 31, 2004.

During the first quarter of fiscal 2002, we invested$2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. The fund focuses on leveraged buyout investments incompanies in Asia undergoing restructuring or bankruptcy proceedings. The totalfund offering is expected to be between approximately $150.0 million and$226.0 million, with each investor contributing a minimum of$0.8 million. The fund has a separate management team, and none of ouremployees are employed by the fund. We account for this investment under theequity method of accounting. We recorded immaterial equity losses during theyears ended December 31, 2004 and 2003. The balance in this investment was$1.8 million at December 31, 2004.

On August 29, 2002, we completed the repurchaseof 6.0 million shares of our common stock for $72.9 million fromSOFTBANK America Inc.

On April 5, 2003, we repurchased 8.0 millionshares of our common stock beneficially owned by SOFTBANK America Inc., ata purchase price of $17.385 per share. The total cost of the repurchase was$139.6 million, including transaction fees. In connection with thisrepurchase transaction, SOFTBANK America Inc. entered into an agreementwith us not to offer, sell or otherwise dispose of our common stock for aperiod of one year, subject to a number of exceptions. As of December 31,2004 and 2003, SOFTBANK America Inc. beneficially owned approximately12.8% and 14.1% respectively, of our outstanding stock.

On July 17, 2003, we entered into a MezzanineLoan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate of SOFTBANKCORP. Under the terms of the agreement, we loaned BB Modem $10.1 million,for the purpose of investing in a portfolio of ADSL modems and associated modemrental agreements, from SOFTBANK BB CORP., formerly BB Technologies, anaffiliate of SOFTBANK CORP. SOFTBANK BB CORP. will continue to service suchmodems and modem rental agreements. Our loan is subordinated to certain seniorlenders of BB Modem, and repayments are payable to us over a 42-monthperiod through January 31, 2007, with a substantial portion of theprincipal amount of the loan schedule to be repaid during the last16 months of this period. Our recourse for nonpayment of the loan islimited to the assets of BB Modem, the account into which subscriber paymentsare made and its rights under the securitization transaction documents. Thevalue of BB Modem’s modems that serve as collateral for the loan may decreaseover time and may not be sufficient upon sale to pay the outstanding amounts onthe loans. We assess the loan for impairment whenever events or changes incircumstances indicate that the carrying amount may not be recoverable. Weperiodically review the underlying quality of the asset pool securing the loanto assess whether impairment has incurred and needs to be recorded. We recorded$1.3 million and $0.5 million in interest income in respect to this loan in2004, and 2003, respectively. The loan receivable at December 31, 2004 and2003, were approximately $11.8 million and $11.2 million respectively.

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During August 2004, we entered into severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiary ofSOFTBANK Corp., related to the sale of telecommunication equipment andpromotional services. The nature of these agreements contemplate the sale ofiAN-8000 equipment with specified value and delivery dates, as well as anoral agreement, which subsequently converted into specific service contracts tomanage a sales promotional program for JT. We have determined that the serviceactivities revenue should be recorded net of expected promotional spending. Becausewe have not provided these activities in the past and cannot estimate the fairvalue of these services, we have determined under guidance of SAB 104, that allrevenue related to these agreements will be deferred and included in customeradvance until the above-mentioned promotional activities are complete. Wedelivered the majority of the equipment during the third and fourth quarters of2004.

The promotional services discussed above involvecontracting with third party promotional vendors, who in turn, facilitate themarketing and subscriber recruitment for the JT fiber-to-the-home program. Duringthe fourth quarter of 2004, we determined that we would end our involvementwith the JT promotional program after completion of the contract discussedabove. Accordingly, late in the fourth quarter of 2004 and the end of the firstquarter of 2005, we have either cancelled or assigned to another party, all thirdparty contracts with promotional vendors related to the JT contract. We nowexpect to satisfy all equipment and promotional obligations by the end of thefirst quarter of 2005.

The terms of these agreements specify that JT was toremit 50 percent of the contract value in cash to us within one month of theexecution of the contract, which was August 20, 2004. The remaining 50percent is due shortly after delivery of the equipment. As of December 31,2004, approximately 73% of the total expected cash had been received. All cashreceived from JT in advance of revenue recognition has been accounted for as acustomer advance. As we spend cash for promotional activities, such spending isaccounted for as a reduction of customer advance. As of December 31, 2004,there was $217.5 million included in customer advance related to theseagreements.

We also entered into anagreement during the third quarter in 2004 with JT to supply chassis equipmentwith an approximate value of $75 million. Although some of the equipment wasshipped to the customer during the third quarter, it is considered linked tothe iAN-8000 sale noted above and as such, the revenue from this contract willbe deferred until the completion of the above-mentioned promotional activities.

*Cellon*

In September 2001, weinvested $2.0 million in Cellon International Holdings Corporation (“Cellon”).Cellon designs wireless terminals and related technology for handsetmanufacturers and private distributors. We invested an additional $3.0 millioneach in April and December 2002. As of December 31, 2004, we hada 9% ownership interest in Cellon. In October 2002, we entered into alicense and a royalty agreement with Cellon International Holding Corporation(“Cellon”). We paid $0.8 million to license certain technology for thedevelopment of certain handset products in China. Per the terms of the royaltyagreement, we are required to pay Cellon $3 per unit shipped for a minimum of0.1 million units. This agreement is not material to the overall financialresults of Cellon.

*Fiberxon*

In September 2002, weinvested $2.0 million in Fiberxon Inc. (“Fiberxon”), a company that developsand sells optical modules and related systems. In March 2004, we investedan additional $1.0 million in Fiberxon. We have an outstanding purchasecommitment with Fiberxon, in which we have an 11% ownership interest, topurchase component parts for optical networking products. In addition, weprovided a letter of credit for $5.0 million to purchase raw materials for themanufacture of these component parts. This commitment should be fulfilledwithout adverse consequences material to our operations or financial 

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condition.Purchases from Fiberxon totaled $15.1 million in 2004 and we had $13.3 millionin accounts payable to Fiberxon at December 31, 2004.

*Mitsubishi*

We recognized revenue of$1.0 million for the year ending December 31, 2004 with MELCO, anaffiliated member of Mitsubishi, which is an insignificant shareholder of theCompany. We have purchased from Mitsubishi components associated with basestation units used to produce our PAS products totaling approximately $97.4million in 2004, $363.1 million in 2003, and $157.2 million in 2002. Inaddition we had $6.4 million in accounts payable to Mitsubishi atDecember 31, 2004 and $12.7 million at December 31, 2003.

*Starcom Products, Inc.*

We obtain engineeringconsulting and employee placement services from Starcom Products, Inc.(“Starcom”), which is 31% owned by an individual related to a member of ourBoard of Directors. We paid to Starcom $1.1 million in 2004, $1.4 million in2003, and $0.7 million in 2002 for engineering consulting and employeeplacement services provided by Starcom.

**Segment Disclosures**

During 2004, we continued to expand our focus onmarkets and operations outside of China. Effective with the fourth quarter of2004, it was determined that our chief operating decision makers, in accordancewith SFAS No. 131, “Disclosures about Segments of an Enterprise andRelated Information,” were evaluating performance, making operating decisionsand allocating resources based on two operating segments, i) China and ii) allother regions referred to as International (“International”).

On November 1, 2004, we acquired selected assetsof ACC, the wireless handset division of Audiovox Corporation. The acquiredbusiness has been integrated into the Company as a separate and distinctoperating division referred to as the Personal Communications Division. As we determinedto evaluate performance and allocate resources to this division, it wasconsidered a third operating segment.

As a result, as of December 31, 2004, we wereorganized in three operating segments, China, International and PCD, and eachsegment consisted of one reporting unit. For the year ended December 31, 2003and for the first three quarters of 2004, we managed our business as a singlereportable segment.

We evaluate operating performance of and allocateresources to the operating segments based on segment gross profit. Certaincorporate headquarters expenses are not allocated but rather are included inthe International segment. In addition, none of the non-operating items areallocated to a segment.

Thefollowing table sets forth certain financial information for each of ouroperating segments described above:
| ** **                       | ** ** | **Year Ended December 31, 2004** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 2,133,292  |   |   | $ | 292,879 |   |   | $ | 277,410 |   |   | $ | — |   |   | $ | 2,703,581 |   |
| Inter-segment revenues           |       | 233,345                                              |       |   | 573,014 |   |   | — |   |   | (806,359 | ) |   | — |   |
| Gross profit                     |       | 490,868                                              |       |   | 98,847 |   |   | 11,886 |   |   | — |   |   | 601,601 |   |
| Depreciation and amortization    |       | 34,962                                               |       |   | 38,955 |   |   | 2,286 |   |   | — |   |   | 76,203 |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                       | ** ** | **Year Ended December 31, 2003** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 1,680,821  |   |   | $ | 284,366 |   |   | $ | — |   |   | $ | — |   |   | $ | 1,965,187 |   |
| Inter-segment revenues           |       | 47,271                                               |       |   | 724,708 |   |   | — |   |   | (771,979 | ) |   | — |   |
| Gross profit                     |       | 460,408                                              |       |   | 163,977 |   |   | — |   |   | — |   |   | 624,385 |   |
| Depreciation and amortization    |       | 16,972                                               |       |   | 27,736 |   |   | — |   |   | — |   |   | 44,708 |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Year Ended December 31, 2002** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 822,299    |   |   | $ | 159,507 |   |   | $ | — |   |   | $ | — |   |   |   | $ | 981,806 |   |   |
| Inter-segment  revenues          |       | 42,223                                               |       |   | 307,862 |   |   | — |   |   | (350,085 | ) |   |   | — |   |   |
| Gross profit                     |       | 301,813                                              |       |   | 43,659 |   |   | — |   |   | — |   |   |   | 345,472 |   |   |
| Depreciation and  amortization   |       | 9,173                                                |       |   | 13,262 |   |   | — |   |   | — |   |   |   | 22,435 |   |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **Year Ended December 31, 2004** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Capital  expenditures   |       | $                                                    | 111,442    |   | $ | 23,505 |   | $ | 628 |   |   | $ | — |   |   | $ | 135,575 |   |
| Total long-lived assets |       | 229,469                                              |       | 37,960 |   | 1,330 |   |   | — |   |   | 268,759 |   |
| Total assets            |       | 1,857,281                                            |       | 1,271,909 |   | 363,301 |   |   | (176,486 | ) |   | 3,316,005 |   |
|                         |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **Year Ended December 31, 2003** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Capital expenditures    |       | $                                                    | 91,947     |   |   | $ | 31,267 |   |   | $ | — |   |   | $ | — |   |   | $ | 123,214 |   |
| Total long-lived assets |       | 153,653                                              |       |   | 33,386 |   |   | — |   |   | — |   |   | 187,039 |   |
| Total assets            |       | 1,495,782                                            |       |   | 906,759 |   |   | — |   |   | (158,491 | ) |   | 2,244,050 |   |
|                         |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)   Adjustmentsreflect elimination of inter-segment transactions and investments insubsidiaries.

Effective in the firstquarter of 2005, we realigned our business into four units, namely BroadbandInfrastructure, Wireless Infrastructure, Terminal Products (which will bereported as Handsets and PCD), and Global Service Solutions. Each unit will representits own reporting segment, with the exception of Terminal Products, which willconsist of two reporting segments.

*Fiscal 2004 vs.2003*

Revenues from external customers in the China segmentincreased from $1.7 billion in 2003 to $2.1 billion in 2004. For most of 2004,we continued to benefit from the increased demand due to the expansion ofwireless infrastructure in China. Revenues from external customers in theInternational segment increased slightly from 2003 to 2004. Revenues fromexternal customers in the PCD segment increased by $277.4 million in 2004, dueto the acquisition of ACC and the creation of the PCD segment in 2004.

Gross profit percentage declined by 10% due to severalfactors. The International segment experienced the largest drop in gross profitdeclining from 58% for 2003 to 34% for 2004. Most of this decrease was drivenby the decline in our broadband product, which experienced a shift in productmix from our more traditional DSLAM product to newer optical broadbandproducts. We typically experience lower margins in the early stages of aproduct life cycle. In addition, the gross profit percentage recognized onhandset sales made through the PCD business is approximately 4% which issignificantly lower than that realized on handset sales related to our PASsystems. PCD was acquired in November 2004 and contributed $11.9 millionin gross profit. The China segment also experienced a 4% decline in grossmargin percentage primarily attributable to our handset products, which haveexperienced increased competitive market pricing pressure. In addition, ourgross profit was negatively impacted by a $39.0 million increase in ourprovision for inventory reserves.

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*Fiscal 2003 vs.2002*

Revenues from external customers in the China segmentincreased from $822.3 million in 2002 to $1,680.8 million in 2003 isattributable to the increased demand of our products resulting from the stronggrowth in the China telecommunication market. Revenues from external customersin the International segment increased from $159.5 million in 2002 to $284.4million in 2003 and can primarily be attributed to sales growth in Japan.

Gross profit from theChina segment increased from $301.8 million in 2002 to $460.4 million in 2003.The increased sales contributed to the increase in gross profit. Gross profitfrom the International segment increased from $43.7 million in 2002 to $164.0million in 2003.

**Liquidity and Capital Resources**

*OperatingActivities*

*2004*

Net cash used in operating activities for the yearended December 31, 2004 was $95.0 million. Operating cash was affected bychanges in accounts receivable, inventory and customer advances offset bychanges in accounts payable and deferred costs/inventories at customer sitesunder contract.

The $455.9 million increase in accounts receivable wasattributable to increased sales, and longer collection periods experiencedduring 2004. The increase in accounts receivable was, in part, due to theaddition of ACC sales revenue. Approximately 14.4% of the accounts receivablebalance outstanding at December 31, 2004 was attributable to PCD.Inventory increased by $197.6 million in 2004 and includes $156.0 million ofinventory for PCD. Customer advances decreased by $134.2 million for the yearended December 31, 2004. Customer advances represent cash deposits we havereceived from our customers for orders that have not yet received finalacceptance. Upon receipt of final acceptances, customer advance is reduced andrevenue and cost of sales is recorded. The reduction of customer advances anddeferred costs for inventory at customer sites in 2004 is largely a result ofour customers in China transitioning from new system installations to systemexpansions, which generally requires a shorter period between customer advanceand acceptance. Our working capital of $1.1 billion increased inproportion to the growth of our business in addition to the $175.0 millionincrease associated with our acquisition of ACC.

Offsetting the activitythat decreased operating cash for the period were net income and non-cashcharges including a $12.7 million provision for asset impairment andwrite-downs, $76.2 million in depreciation and amortization, a $39.0 millioninventory provision, and a $21.3 million provision for doubtful accounts.Accounts payable increased by $98.3 million, consistent with increasedinventory purchasing. Inventories at customer sites under contracts awaitingfinal acceptance are classified as deferred costs, separate from what washistorically considered inventory. The title and risk of loss of this inventoryis transferred to the customer. Revenue and costs of sales are recorded whenfinal acceptance is received from the customer. Deferred costs/Inventories atcustomer sites under contracts decreased by $299.9 million from December 31,2003 to December 31, 2004. The decrease in deferred costs resulted from agreater number of customer acceptances, corresponding to the decrease incustomer advances.

*2003*

Net cash provided byoperating activities for the year ended December 31, 2003 was $45.2 million.Operating cash was affected by changes in accounts receivable, inventory,accounts payable, other assets and offset by changes in deferred revenue. The$151.9 million increase in our accounts receivable balance, attributableto a 100% increase in sales in 2003, reduced our net cash provided byoperations. In 2003, we sold $298.8 million of our notes receivable withassociated expenses of $2.3 million. Cash provided by operating activitieswas also reduced by an $81.6 million and $301.1 million increase ininventory and 

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deferredcosts, respectively. Operating cash also decreased due to a $5.9 milliondecrease in accounts payable. The decrease in operating cash in 2003 was offsetby an increase in customer advances and deferred revenue of $294.2 millionand $27.4 million, respectively. We collected approximately$2.5 billion in cash from our customers in 2003.

*2002*

Net cash provided byoperating activities in fiscal 2002 was $178.6 million. Net cash providedby operations was mainly due to a $170.5 million and $87.8 millionincrease in accounts payable and customer advances, respectively, offset byincreases in inventories, deferred costs, accounts receivable and other assetsof $76.1 million, $137.8 million, $34.2 million and$24.6 million, respectively.

*InvestingActivities*

*2004*

Net cash used in investingactivities was $468.0 million for the year ended December 31, 2004. Themost significant components of our investing activities are businessacquisitions, additions to property, plant and equipment and the net investmentin short-term securities. Cash used for business acquisitions totaled $217.8million during 2004, including approximately $178.3 million for selected assetsof ACC; $30.0 million for substantially all assets and liabilities of TELOS,and $9.1 million for HSI. Cash used for the purchase of property, plant andequipment, including $57.1 million for the construction of our Hangzhoufacility, totaled $135.6 million. Net cash used for the purchase of short-terminvestments was $82.8 million.

*2003*

Net cash used in investingactivities was $176.5 million for the year ended December 31, 2003.This change was mainly due to $123.2 million of property, plant andequipment purchases, $106.7 million of business acquisitions and offset by$69.6 million of net proceeds from the sale of short-term investments.

*2002*

Net cash used in investingactivities in fiscal 2002 was $165.4 million. This was mainly due to$75.3 million of property, plant and equipment purchases,$17.7 million of business acquisitions, primarily attributable to ourpurchase of the remaining interest in HUTS and $28.9 million ofinvestments in affiliates, which primarily comprised investments in public andprivate technology companies, offset by $22.4 million of net purchases ofshort-term investments.

*FinancingActivities*

*2004*

Net cash provided byfinancing activities was $742.7 million for the year ended December 31,2004. This was primarily due to proceeds raised from the sale of 12.1 millionshares of common stock at $39.25 per share to Banc of America Securities, LLC,in January 2004 for net proceeds of approximately $474.6 million. Inaddition, we incurred net borrowing of $350.0 million during the year fromexisting lines of credit in China to fund our operations needs in China. Wealso received $25.7 million for the issuance of common stock through stockoption and warrant exercises. Offsetting cash provided by financing activities,during the first and second quarter of 2004, we used a portion of the capitalraised to repurchase a total of 3.6 million shares of our common stock at anaverage price of $30.25 per share for a total cost of $107.6 million, includingtransaction fees.

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*2003*

Net cash provided byfinancing activities was $275.3 million for the year endedDecember 31, 2003. This was primarily due to the $58.9 million inproceeds from the issuance of common stock through ESPP and stock optionexercises, and $399.6 million proceeds from net borrowing, and offset by therepurchase of our shares and related transaction costs of $139.6 millionand the purchase of a convertible bond hedge and a call option totaling$43.8 million.

*2002*

Net cash used in financingactivities in fiscal 2002 was $102.4 million. This was primarily due tothe repurchase of our shares and related transaction costs of$72.9 million and net payments of $70.5 million on borrowings underour lines of credit. This was offset by $40.9 million in proceeds from theunderwritten sale of common stock at the same time SOFTBANK America, Inc.sold 10.0 million shares of our common stock through an underwriter andthe issuance of common stock through stock option exercises.

*Liquidity*

Our working capital was $1,117.5 million and$883.3 million at December 31, 2004 and 2003, respectively. Thisincrease in working capital is due to increased cash on hand. Cash on handincreased from $377.7 million in cash and cash equivalents and $48.6 million ofshort-term investments, in 2003 to $562.5 million in cash and cashequivalents and $136.3 million of short-term investments in 2004. Ourworking capital also increased due to larger accounts receivable and inventorybalances, which were offset by increases in accounts payable and notes payablebalances.

We believe that our existing credit facilities andcash and cash equivalents, short-term investments and cash from operations willbe sufficient to finance our operations through at least the next 12 months. Asof December 31, 2004, we had cash, short-term restricted cash andinvestments of $732.2 million. We also had credit facilities, excluding the$8.2 million bank loan resulting from the consolidation of MDC, totaling $780.4million of which $388.0 million remained available for future borrowings. Ofthe $388.0 million available credit facilities, $380.8 million expires in 2005and $7.2 million expires in 2010. We are proceeding with the extension orrenewal of these credit facilities, however, such renewal is not certain.Interest rates for borrowings under these credit facilities range fromapproximately 2.58% to 6.21%. We have not guaranteed any debt that is notincluded in the consolidated balance sheet.

Of our total cash and short-term investment balance,$342.6 million is held in China where currency exchange controls exist. As aresult, our ability to make payments in other jurisdictions could be limited byour ability to transfer money from China to other jurisdictions.

In the event that ourcurrent cash balances, future cash flows from operations and current creditfacilities are not sufficient to meet our obligations or strategic needs or inthe event that market conditions are favorable, we would consider raisingadditional funds in the capital or equity markets. Due to the delinquent filingof our Annual Report on Form 10-K for the year ended December 31,2004, we are not eligible to register equity securities using Form S-3,which could have an impact on our ability to raise additional funds. Ifadditional financing is needed, there can be no assurance that such financingwill be available to us on commercially reasonable terms, or at all. Inaddition, the delayed filing has resulted in a technical default of the Company’s7¤8%Convertible Subordinated Notes due in 2008. Upon filing of this Form 10-K, thetechnical default will be cured.

*Income taxes*

Certain subsidiaries and joint ventures located inChina enjoy tax benefits in China which are generally available to foreigninvestment enterprises, including full exemption from national enterprise 

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income tax for two yearsstarting from the first profit-making year and/or a 50% reduction innational income tax rate for the following three years. In addition, localenterprise income tax is often waived or reduced during this taxholiday/incentive period. Under current regulations in China, foreign investmententerprises that have been accredited as technologically advanced enterprisesare entitled to additional tax incentives. These tax incentives vary indifferent locales and could include preferential national enterprise income taxtreatment at 50% of the usual rates for different periods of time. The taxholidays discussed above are applicable or potentially applicable to CUTS,HUTS, Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”) and UTStarcom China Co.,Ltd. (“UTSC”), our active subsidiaries in China, as those entities may qualifyas accredited technologically advanced enterprises. HSTC and CUTS were exemptfrom income tax for the year ended December 31, 2004.

We are currently in the process of applying for aKnowledge Intensive, Technology Intensive Certificate (“Certificate”) for ournew Hangzhou manufacturing facility. If we are not granted the Certificate,HUTS will continue to be subject to a 24% tax rate and, HSTC and CUTS will thenbe subject to a 12% tax rate for the year ending December 31, 2005. If weare granted the Certificate, HUTS will then be subject to a 15% tax rate. Inaddition, HSTC and CUTS will be subject to a 7.5% tax rate, which will expireon December 31, 2007.

UTSC currently enjoys a 10% holiday tax rate thatexpires on December 31, 2005, at which point it will be subject to a 15%tax rate provided they remain as an advanced and high-tech enterprise and theGovernment does not change the tax laws.

We are working toimplement a research and development cost sharing arrangement among our keyworldwide entities. The purpose of cost sharing is to enable its participantsto jointly develop and own intangibles. Under research and development costsharing, the total research and development expense is paid by cost-sharingparticipants in proportion to each participant’s future sales. The benefit isthat there is greater certainty with respect to transfer pricing and definedownership of IP. Cost sharing in China is a new concept and we are workingclosely with the China Tax and Regulatory Authorities to gain approval for costsharing.

*Off balance sheet arrangements*

Under the definitioncontained in Item 303(a)(4)(iii) of Regulation S-K, we do not have any offbalance sheet arrangements.

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*Contractualobligations and other commercial commitments*

Ourobligations under contractual obligations and commercial commitments areprimarily with regard to leasing arrangements and standby letters of credit andare as follows:
| ** **                            | ** ** | **December 31, 2004  Payments Due by Period** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **Total**                                                              | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than  5 years** | ** ** |
| ** **                            | ** ** | **(in thousands)**                                                | ** ** |
| *Contractual Obligations*             |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Notes payable                         |       | $                                                                      | 1,183      |   | $ | 1,183 |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Bank loans                            |       | $                                                                      | 358,155    |   | $ | 350,000 |   | $ | 8,155 |   | $ | — |   |   | $ | — |   |   |
| Convertible subordinated notes        |       | $                                                                      | 402,500    |   | $ | — |   | $ | — |   | $ | 402,500 |   |   | $ | — |   |   |
| Interest payable on convertible notes |       | $                                                                      | 12,327     |   | $ | 3,522 |   | $ | 8,805 |   | $ | — |   |   | $ | — |   |   |
| Operating leases                      |       | $                                                                      | 48,914     |   | $ | 19,750 |   | $ | 23,912 |   | $ | 3,412 |   |   | $ | 1,840 |   |   |
| *Other Commercial Commitments*        |       |                                                                   |       |   |   |   |   |   |   |   |   |   |   |
| Standby letters of credit             |       | $                                                                      | 35,160     |   | $ | 32,920 |   | $ | 2,240 |   | $ | — |   |   | $ | — |   |   |
| Purchase commitments                  |       | $                                                                      | 578,291    |   | $ | 578,291 |   | $ | — |   | $ | — |   |   | $ | — |   |   |

 

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

*Notes payable*

Occasionally, we issue short-term notes payable to ourvendors in lieu of trade accounts payable. The payment terms are normally threeto nine months and are typically non-interest bearing.

*Bank loans*

AtDecember 31, 2004, we had loans with various banks totaling $350.0 millionwith interest rates ranging from 2.58% to 6.21% per annum. These bank loansmature during 2005 and are included in short-term debt.

The Company has a bank loan in connection with anequipment purchase resulting from the consolidation of MDC. On January 10,2003, a third party established a bank loan with Shanghai Pudong DevelopmentBank for the purchase of the equipment. The obligations of the bank loan andrelated equipment were assumed by the Company on January 23, 2003, andwere subsequently transferred to MDC on January 31, 2003. The bank loan of$8.2 million bears interest at a rate of 4.94% per annum, and expires onJanuary 10, 2006.  The Company doesnot serve as legal obligor for the loan.

*Convertiblesubordinated notes*

Our$402.5 million of convertible subordinated notes, due March 1, 2008,bear interest at a rate of 7¤8% per annum, payable semiannuallyon May 1 and September 1, are convertible into our common stock at aconversion price of $23.79 per share and are subordinated to all present andfuture senior debt of the Company. The principal is due only at maturity of thenotes.

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*Operating leases*

We lease certain facilities under non-cancelableoperating leases that expire at various dates through 2023.

*Standby letters*

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 performance guarantees. The standby letters of credit usually expiresix to nine months from date of issuance without being drawn by the beneficiarythereof.

*Purchasecommitments*

We are obligated to purchase raw materials and work-in-processinventory under various orders from our suppliers, all of which are expected tobe fulfilled, with no adverse consequences material to our operations orfinancial condition. As of December 31, 2004, total open commitments underthese purchase orders were approximately $578.3 million.

We have entered intovarious earnout agreements related to certain acquisitions, which are subjectto the completion of performance milestones. See “Note 5 to the ConsolidatedFinancial Statements.”

*Accounts receivabletransferred to notes receivable*

We accept commercial notesreceivable from our customers in China in the normal course of business. Thenotes are typically non-interest bearing, with maturity dates between three andsix months. Notes receivable available for sale were $27.0 million and$11.4 million at December 31, 2004 and December 31, 2003,respectively. We may discount these notes with banking institutions in China. Asale of these notes is reflected as a reduction of notes receivable and theproceeds of the settlement of these notes are included in cash flows fromoperating activities in the consolidated statement of cash flows. There were nonotes receivable sold during the year ended December 31, 2004 and therewere $298.8 million of notes receivable sold during the year ended December 31,2003. Any notes that have been sold are not included in our consolidatedbalance sheets as the criteria for sale treatment established by Statement ofFinancial Accounting Standards No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishment of Liabilities,” (“SFAS 140”)has been met. The costs of settling or transferring these notes receivable were$2.3 million for the years ended December 31, 2003, and were includedin other income (expense), net in the consolidated statements of operations.

*Investmentcommitments*

Asof December 31, 2004, we had invested a total of $2.0 million inGlobal Asia Partners L.P. that is recorded as a long-term investment. The fundsize is anticipated to be $100 million and the fund was formed to makeprivate equity investments in private or pre-IPO technology andtelecommunications companies in Asia. We have a commitment to invest up to amaximum of $5.0 million. The remaining amount is due at such times and insuch amounts as shall be specified in one or more future capital calls to beissued by the general partner.

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*Joint venture funding*

Pursuant to the jointventure agreement with Matsushita Communications Industrial Co., Ltd. andMatsushita Electric Industrial Co., Ltd., we are jointly liable for the lossesincurred in the operations of the joint venture up to the maximum of ourinvestment in the entity. At December 31, 2004, and 2003, we recordedlosses of $1.3 million and $4.8 million, respectively. In the fourth quarter of2004, we made an additional capital contribution of $9.3 million.

*Intellectualproperty*

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.

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

Our financial conditionand results of operations are based on certain critical accounting policies andestimates, which include judgments, estimates, and assumptions on the part ofmanagement. Estimates are based on historical experience, knowledge of economicand market factors and various other assumptions that management believes to bereasonable under the circumstances. Actual results may differ from thoseestimates. The following summary of critical accounting policies and estimateshighlights those areas of significant judgment in the application of ouraccounting policies that affect our financial condition and results ofoperations.

***Revenue Recognition***

Revenues from sales of telecommunications equipmentand handsets are recognized when persuasive evidence of an arrangement exists,delivery of the product has occurred, customer acceptance has been obtained,the fee is fixed or determinable and collectability is reasonably assured. Ifthe payment due from the customer is not fixed or determinable due to extendedpayment terms, revenue is recognized as payments become due from the customer,assuming all other criteria for revenue recognition are met. Any paymentsreceived prior to revenue recognition are recorded as customer advances. Normalpayment terms differ for various reasons amongst different customer regions,depending upon common business practices for customers within a region. Shippingand handling costs are recorded as revenues and costs of revenues. Any expectedlosses on contracts are recognized when identified.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the areas of multiple element arrangements. Where multipleelements exist in an arrangement, the arrangement fee is allocated to thedifferent elements based upon verifiable objective evidence of the fair valueof the elements, as governed under Emerging Issues Task Force Issue (“EITF”) No. 00-21,and SAB 104. Multiple element arrangements primarily involve the sale of PAS, afamily of wireless access handsets, wireless consumer products and coreinfrastructure equipment or Internet Protocol-based PAS (“iPAS”), wirelessaccess systems that employ micro cell radio technology and specializedhandsets, allowing service providers to offer subscribers both mobile and fixedaccess to telephone services. These multiple element arrangements include thesale of PAS or iPAS equipment with handsets, installation and training and theprovision of such equipment to different locations for the same customer. Revenueis recognized as each element is earned, namely upon installation andacceptance of equipment or delivery of handsets, provided that the fair valueof the undelivered element(s) has been determined, the delivered element(s) hasstand-alone value, there is no 

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right of return ondelivered element, and we are in control of the undelivered element(s). Forarrangements that include service elements, including promotional support andinstallation, for which verifiable objective evidence of fair value does notexist, revenue is deferred until such services are deemed complete.

Final acceptance is required for revenue recognitionwhen installation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and we areentitled to the full payment. We will not recognize revenue before finalacceptance is granted by the customer if acceptance is considered substantiveto the transaction. Additionally, we do not recognize revenue when cashpayments are received from customers for transactions that do not have thecustomer’s final acceptance. We record these cash receipts as customeradvances, and defer revenue recognition until final acceptance is received.

Where multiple elements exist in an arrangement thatincludes software, and the software is considered more than incidental to theequipment or services in the arrangement, software and software relatedelements are recognized under the provisions of Statement of Position 97-2,as amended, and EITF No. 03-05. We allocate revenues to each elementof software arrangements based on vendor specific objective evidence (“VSOE”). VSOEof each element is based on the price charged when the same element is soldseparately. We use the residual method to recognize revenue when an arrangementincludes one or more elements to be delivered at a future date and VSOE of thefair value of all the undelivered elements exists. Under the residual method,the fair value of the undelivered elements is deferred and the remainingportion of the arrangement fee is recognized as revenue. If evidence of fairvalue of one or more undelivered elements does not exist, revenue is deferredand recognized when delivery of those elements occurs or when fair value can beestablished.

We recognize revenue for system integration,installation and training upon completion of performance and if all otherrevenue recognition criteria are met. Other service revenue, such as thatrelated to maintenance and support contracts, is recognized ratably over thecontract term. Revenues from services were less than 10% of revenues for allyears.

We also sell products through resellers. Revenue isgenerally recognized when the standard price protection period, which rangesfrom 30 to 90 days, has lapsed. If collectability cannot be reasonably assuredin a reseller arrangement, revenue is recognized upon sell-through to the endcustomer and receipt of cash. There may be additional obligations in resellerarrangements such as inventory rotation, or stock exchange rights on theproduct. As such, revenue is recognized in accordance with Statement ofFinancial Accounting Standards No. 48, “Revenue Recognition When Right ofReturn Exists,” (“SFAS 48”). We have developed reasonable estimates for stockexchanges. Estimates are derived based on historical experience with similartypes of sales of similar products.

We have sales agreements with certain wirelesscustomers that provide for a rebate of the selling price to such customers ifthe particular product is subsequently sold at a lower price to such customersor to a different customer. The rebate period extends for a relatively shortperiod of time. Historically, the amounts of such rebates paid to customershave not been material. We estimate the amount of the rebate based upon theterms of each individual arrangement, historical experience and futureexpectations of price reductions, and we record our estimate of the rebateamount at the time of the sale. We also enter into sales incentive programs,such as co-marketing arrangements, with certain wireless and handset customers.We record the incurred costs related to the incentive as a reduction of revenuewhen the sales revenue is recognized.

The assessment of collectability is also a factor indetermining whether revenue should be recognized. We assess collectabilitybased on a number of factors, including payment history and the creditworthiness of the customer. We do not request collateral from our customers. Ininternational sales, we often require letters of credit from our customers thatcan be drawn on demand if the customer defaults on its payment. 

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If we determine that collection of a payment is notreasonably assured, we recognize revenue at the time collection becomesreasonably assured, which is generally upon receipt of cash. Occasionally, weenter into revenue sharing arrangements. Under these arrangements, we collectrevenues only after our customer, the telecommunications service provider,collects service revenues. When we enter a revenue sharing arrangement, we donot recognize revenue until collection is reasonably assured.

Because of the nature ofdoing business in China and other emerging markets, our billings and/orcustomer payments may not correlate with the contractual payment terms and wegenerally do not enforce contractual payment terms prior to final acceptance. Accordingly,accounts receivable are not booked until we recognize the related customerrevenue. Advances from customers are recognized when we have collected cashfrom the customer, prior to recognizing revenue. Deferred revenue is recordedif there are undelivered elements after final acceptance has been obtained.

***Product Warranty***

We provide a warranty onour equipment and handset sales for a period generally ranging from one tothree years from the time of final acceptance. Very rarely, we have enteredinto arrangements to provide limited warranty services for periods longer thanthree years. The longest such warranty period is ten years. We provide for theexpected cost of product warranties at the time that revenue is recognizedbased on an assessment of past warranty experience.

***Variable Interest Entities***

The Financial AccountingStandards Board, (“FASB”) issued FASB Interpretation No. 46, (“FIN 46”).FIN 46 requires that if an entity is the primary beneficiary of a variableinterest entity, (“VIE”), the assets, liabilities, and results of operations ofthe VIE should be included in the consolidated financial statements of theentity. We have adopted FIN 46 in the quarter ended December 31,2003, and consolidated a related party deemed a VIE and for whom we are the primarybeneficiary.

***Receivables***

We accept bank notes and commercial notes from ourcustomers in China in the normal course of business and estimate thecollectability of our trade receivables and notes receivable. The notes aretypically non-interest bearing, with maturity dates between three and sixmonths. We provide an allowance for doubtful accounts for the estimated losseson the trade receivables and notes receivable when collection may no longer bereasonably assured. We assess collectability of the receivable by determiningwhether the creditworthiness of the customer has deteriorated and could resultin an inability to collect payment; if collectability is doubtful, we record anallowance against the receivable. If the financial condition of our customerswas to deteriorate and their ability to make payments suffers as a result, wemay need to increase our allowances for our receivables. With the greaterconcentration of accounts receivable with certain customers, the financialcondition of any specific or individual customer may result in increasedconcentration risk exposure. Although we evaluate customer creditworthinessprior to a sale, we generally assess the collectibility of an individualreceivable balance based upon the length of time a receivable has remainedoutstanding.

We periodically reassessour evaluation methodologies based upon changes in facts and circumstances. Forexample, our experience in China throughout 2004 caused us to review ourestimates. Throughout 2004, we experienced a lengthening of the collectioncycle for our China based receivables; however, this lengthening did not necessarilycoincide with a change in the overall estimate of recoverability of anindividual receivable balance. As a result, we revised our estimates to reflectthe changed environment. The incremental amount provided under the new estimatewas $10.1 million lower than would have been provided using historicalestimates in the fourth quarter of 2004. The lengthened 

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collectioncycle has been attributed to a number of factors, but principally to changes incustomers’ business practices surrounding payment and to a lesser degree to thematuration of the telecommunications sector. Although these factors did notresult in a reduction of the overall collectibility of individual receivablesin 2004, the lengthening payment cycle could result in a reduction of theoverall collectibility of our receivable balances in the future. If we were toobserve a deterioration of the actual collectibility of our receivables, ourallowance for doubtful accounts would increase resulting in additional bad debtexpense.

***Inventories***

Inventories consist ofinventories held at our manufacturing facility, warehouses or at customer sitesprior to signing of contracts. We may ship inventory to existing customers thatrequire additional equipment to expand their existing networks prior to thesigning of an expansion contract. Our inventories are stated at the lower ofcost or net realizable value, net of write-downs for excess, slow movingand obsolete inventory. Inventory is written down for estimated obsolescence orunmarketable inventory equal to the difference between inventory cost and theestimated market value. Write-downs are based on our assumptions aboutfuture market conditions and customer demand, including projected changes inaverage selling prices resulting from competitive pricing pressures. Wecontinually monitor inventory valuation for potential losses and obsoleteinventory at our manufacturing facilities as well as at customer sites.

***Deferred costs/Inventories at customer sites undercontracts***

Inventories at customersites under contracts awaiting final acceptance are classified as deferredcosts. Title associated with this inventory has transferred to the customer whohas assumed the risk of physical loss. Deferred costs also include laborrelated to third party integrators and freight. All deferred costs are statedat cost. We periodically assesses the recoverability of deferred costs andprovide reserves against deferred cost balances when recovery of deferred costsis not probable. Recoverability is evaluated based on various factors includinglength of time inventory has been held at the customer site, the viability ofpayment, including assessment of product demand if a revenue sharingarrangement exists. Revenue and cost of sales are recorded when finalacceptance is received from the customer. With greater concentration ofinventory at customer sites under contract with specific or individualcustomer, the financial conditions of any specific or individual customer mayresult in increased concentration risk exposure for our inventory.

***Research and Development and Capitalized SoftwareDevelopment Costs***

Our research anddevelopment costs are charged to expense as incurred. We capitalize softwaredevelopment costs, incurred in the development of software that will ultimatelybe sold, between the time technological feasibility has been attained and therelated product is ready for general release. Management judgment is requiredin assessing technological feasibility, expected future revenues, estimatedproduct lives and changes in product technologies, and the ultimaterecoverability of our capitalized software development costs.

***Deferred Income Taxes***

We recognize deferredincome taxes as the difference between the tax bases of assets and liabilitiesand their financial statement amounts based on enacted tax rates. Managementjudgment is required in the assessment of the recoverability of our deferredtax assets based on our assessment of projected taxable income. Numerousfactors could affect our results of operations in the future. If there was asignificant decline in our future operating results, our assessment of therecoverability of our deferred tax assets would need to be revised, and anysuch adjustment to our deferred tax assets would be charged to income 

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in thatperiod. If necessary, we record a valuation allowance to reduce deferred taxassets to an amount management believes is more likely than not to be realized.

***Goodwill and Intangible Assets***

We have recorded goodwilland intangible assets in connection with our business acquisitions. Managementjudgment is required in the assessment of the related useful lives, assumptionsregarding our ability to successfully develop and ultimately commercializeacquired technology, and assumptions regarding the fair value and therecoverability of these assets. We perform our annual goodwill impairmentreview in the fourth quarter of each year or when changes in circumstancesindicate a potential impairment exists. During the fourth quarter of 2004, withthe consummation of the acquisition of ACC, we evaluated our managementoperation and reporting and determined that we operated as three operatingsegments for the fourth quarter of 2004. Those segments were the PersonalCommunications Division (“PCD”), China and International. PCD includes thelegacy activities of the ACC selected assets acquisition. The China segmentrepresents our activities within our China companies and the Internationalsegment includes all other non-China and non-PCD operations. Management hasdetermined that each segment is its own reporting unit as there are nomanagement or reporting structures below this segment reporting level. We havereallocated our goodwill between our segments and each have a single reportingunit. We have performed goodwill impairment analysis at the reporting unitlevel. When assessing potential impairment to goodwill, we compare our bookvalue to our fair market value. Fair market value is determined based on thepresent value of estimated future cash flows.

***Long-Term Investments***

We have invested in a fundfocused on investments in Internet companies in China and a fund focused oninvestments in companies in Asia undergoing restructuring or bankruptcyprocedures. We have also invested directly in a number of private technology-basedcompanies in the early stages of development and in publicly listed technologycompanies traded on NASDAQ and the New York Stock Exchange. While quoted marketprices are readily available to determine the fair value of our investments inthese publicly traded companies, management judgment is required to determinewhen losses are other than temporary. Furthermore, management judgment isrequired in evaluating the carrying value of our private company investmentsfor possible impairment. For our private technology company investments, weassess impairment based on an evaluation of the achievement of businessobjectives and milestones, the financial condition and prospects of thesecompanies and other relevant factors. We continually monitor these investmentsfor impairment, and charge to income any impairment amounts in the period sucha determination is made.

**RECENT ACCOUNTING PRONOUNCEMENTS**

In December 2004, the Financial AccountingStandards Board, “FASB”, issued SFAS No. 123 (revised 2004), “Share-BasedPayment,” (“SFAS 123(R)”). SFAS 123(R) will require us to measure allemployee stock-based compensation awards using a fair value method and recordsuch expense in its consolidated financial statements. In addition, theadoption of SFAS 123(R) will require additional accounting related to theincome tax effects and additional disclosure regarding the cash flow effectsresulting from share-based payment arrangements. We do not currently have anyplans to modify our existing compensation programs.

In March 2005, the SEC issued Staff AccountingBulletin No. 107 (“SAB 107”) which provides guidance regarding the applicationof SFAS 123(R). SAB 107 expresses views of the staff regarding the interactionbetween SFAS No. 123(R), Share-Based Payment, and certain SEC rules andregulations and provides the staff’s views regarding the valuation ofshare-based payment arrangements for public companies. In particular, SAB 107provides guidance related to share-based payment transactions with 

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nonemployees, thetransition from nonpublic to public entity status, valuation methods (includingassumptions such as expected volatility and expected term), the accounting forcertain redeemable financial instruments issued under share-based paymentarrangements, the classification of compensation expense, non-GAAP financialmeasures, first-time adoption of SFAS 123(R) in an interim period,capitalization of compensation cost related to share-based paymentarrangements, the accounting for income tax effects of share-based paymentarrangements upon adoption of SFAS 123(R), the modification of employee shareoptions prior to adoption of SFAS 123(R) and disclosures in Management’sDiscussion and Analysis (“MD&A”) subsequent to adoption of SFAS 123(R).

On April 14, 2005, the SECapproved a new rule that delays the effective date for SFAS 123(R) toannual periods beginning after June 15, 2005. The adoption of SFAS123(R) on January 1, 2006 is expected to have a material impact onthe Company’s consolidated results of operations, financial position andstatement of cash flows. The Company is evaluating the transition method andpricing model alternatives upon adoption.

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29,” (“SFAS153”). SFAS 153 addresses the measurement of exchanges of non-monetary assetsand redefines the scope of transactions that should be measured based on thefair value of the assets exchanged. SFAS 153 is effective for non-monetaryasset exchanges occurring in fiscal periods beginning after June 15, 2005.The adoption of SFAS 153 is not expected to have a material effect on ourconsolidated financial position or results of operations.

In November 2004, the FASB issued SFAS 151, “InventoryCosts, an amendment of ARB No. 43, Chapter 4,” (“SFAS 151”). SFAS 151clarifies that abnormal inventory costs such as costs of idle facilities,excess freight and handling costs, and wasted materials (spoilage) are requiredto be recognized as current period charges. The provisions of SFAS 151 areeffective for the fiscal year beginning after June 15, 2005. The adoptionof SFAS 151 is not expected to have a material impact on our consolidatedfinancial position, results of operations and cash flows.

In December 2004, theFASB issued FASB Staff Position No. FAS 109-2, “Accounting andDisclosure Guidance for the Foreign Earnings Repatriation Provision within theAmerican Jobs Creation Act of 2004,” (“FSP FAS 109-2”). The American JobsCreation Act of 2004 provides a one-time 85% dividends received deduction forcertain foreign earnings that are repatriated under a plan for reinvestment inthe United States, provided certain criteria are met. FSP FAS 109-2 iseffective immediately and provides accounting and disclosure guidance for therepatriation provision. FSP FAS 109-2 allows companies additional time toevaluate the effects of the law on its unremitted earnings for the purpose ofapplying the “indefinite reversal criteria” under APB Opinion No. 23, “Accountingfor Income Taxes—Special Areas,” and requires explanatory disclosures fromcompanies that have not yet completed the evaluation. We are currentlyevaluating the effects of the repatriation provision and their impact on ourconsolidated financial statements. We do not expect to complete this evaluationbefore the end of 2006. The range of possible amounts of unremitted earningsthat is being considered for repatriation under this provision is between zeroand $541 million and the related potential range of income tax is between zeroand $28 million.

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**FACTORS AFFECTING FUTURE OPERATING RESULTS**

**RISKS RELATED TO OUR COMPANY**

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

Our quarterly andannual operating results have fluctuated in the past and are likely tofluctuate in the future due to a variety of factors, some of which are outsideof our control. Factors that may affect our future operating results, inaddition to those described below, include:

·       thetiming and size of the orders for our products;

·       changesin our customers’ subscriber growth rate;

·       thelengthy and unpredictable sales cycles associated with sales of our products;

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

·       issuesthat might arise from the integration of acquired entities or the inability toachieve expected results from such acquisitions;

·       revenuerecognition, which is based on acceptance, is unpredictable;

·       aseasonal reoccurrence of an outbreak of severe acute respiratory syndrome (“SARS”)or other illnesses;

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

·       changesin accounting rules, such as recording expenses related to employee stockoption compensation plans;

·       shiftin our product mix or market focus; and

·       qualityissues resulting from the design or manufacture of the products, or from thesoftware used in the product.

As a result of these andother factors, period-to-period comparisons of our operating results are notnecessarily meaningful or indicative of future performance. In addition, thefactors noted above may make it difficult for us to forecast and provide in atimely manner public guidance (including updates to prior guidance) related toour projected financial performance of the Company. Furthermore, it is possiblethat in some future quarters our operating results will fall below theexpectations of securities analysts or investors. If this occurs, the tradingprice of our common stock could decline.

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

We have experiencedintense competition in the past years, and we believe that we will continue toface intense competition from both domestic and international companies in ourtarget markets, many of which may operate under lower cost structures or may begiven preferential treatment by applicable governmental regulators and policiesand have much larger sales forces than we do. Additionally, other companies notpresently offering competing products may also enter our target markets. Manyof our competitors have significantly greater financial, technical, productdevelopment, sales, marketing and other resources than we do. As a result, ourcompetitors may be able to respond more quickly to new or emerging technologiesand changes in service provider requirements. Our competitors may also be ableto devote greater resources than we can to the development, promotion and saleof new products. These competitors may be able to offer significant financingarrangements to service providers, which may give them a competitive advantagein selling systems to service providers with limited financial and currency 

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resources.In many of the developing markets in which we operate or intend to operate,relationships with local governmental telecommunications agencies are importantto establish and maintain. In many such markets, our competitors may have or beable to establish better relationships with local governmentaltelecommunications agencies than we have, which could result in their abilityto influence governmental policy formation and interpretation to theiradvantage. Additionally, our competitors might have better relationships withtheir third party suppliers and obtain component parts at a reduced rate,allowing them to offer their end products at reduced prices. Moreover, the telecommunications and cableindustries have experienced significant consolidation*,* and**we expectthis trend to continue. If we have fewer significant customers, we may be more relianton such**large customers and our bargaining positionand profit margins**may suffer.Increased competition is likely to result in price reductions, reduced grossprofit as a percentage of net sales and loss of market share, any one of whichcould materially harm our business, financial condition, cash flows, andresults of operations.

***If we seek to secure additional financing and are notable to do so, our ability to expand strategically may be limited. If we areable to secure additional financing, our stockholders may experience dilutionof their ownership interest, or we may be subject to limitations on ouroperations and increased leverage.***

We currently anticipatethat our available cash resources, which include existing cash and cashequivalents, short-term investments and cash from operations, will besufficient to meet our anticipated needs for working capital and capitalexpenditures for the foreseeable future. If we are unable to generatesufficient cash flows from operations, we may need to raise additional funds todevelop new or enhanced products, respond to competitive pressures, takeadvantage of acquisition opportunities or raise capital for strategic purposes.If we raise additional funds through the issuance of equity securities, ourstockholders will experience dilution of their ownership interest, and thenewly issued securities may have rights superior to those of common stock. Ifwe raise additional funds by issuing debt, we may be subject to limitations onour operations and increase our leverage. For example, in connection with thesale of convertible debt securities in March 2003, we incurred $402.5million of indebtedness. As a result of this indebtedness, our principal andinterest payment obligations have increased substantially. The degree to whichwe are leveraged could materially and adversely affect our ability to obtainfinancing for working capital, acquisitions or other purposes and could make usmore vulnerable to industry downturns and competitive pressures. Our ability tomeet our debt service obligations will be dependent upon our futureperformance, which will be subject to financial, business and other factorsaffecting our operations, many of which are beyond our control. Finally, we arenot certain that we can maintain our existing unsecured credit line availableto our China operations or additional sources of financing may not be availableon reasonable terms or at all if and when we require it, which could harm ourbusiness.

***The average selling prices of our products maydecrease, which may reduce our revenues and our gross profit. As a result, wemust introduce new products and reduce our costs in order to maintainprofitability.***

The average sellingprices for communications access and switching systems and handsets havehistorically declined as a result of a number of factors, including:

·       increasedcompetition;

·       aggressiveprice reductions by competitors;

·       rapidtechnological change; and

·       constantchange in customer buying behavior and market trends.

The average selling prices of our products maycontinue to decrease in the future in response to product introductions by usor our competitors or other factors, including price pressures from customers. Certainof our products, including wireless handsets, have historically had low grossprofit margins*,* and any 

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further deterioration of our profit****margins on such products****couldresult in losses with respect to such products. Therefore, we must continue to developand introduce new products and enhancements to existing products thatincorporate features that can be sold at higher average selling prices. Failureto do so could cause our revenues and gross profit to decline.

Our cost reduction effortsmay not allow us to keep pace with competitive pricing pressures or lead toimproved gross profit, as a percentage of net sales. In order to becompetitive, we must continually reduce the cost of manufacturing our productsthrough design and engineering changes. We may not be successful in theseefforts or in delivering our products to market in a timely manner. Inaddition, any redesign may not result in sufficient cost reductions to allow usto reduce the prices of our products to remain competitive or to improve ormaintain our gross profit, as a percentage of net sales, which would cause ourfinancial results to suffer.

***Sales in China have accounted for most of our totalsales, and our business, financial condition and results of operations are to asignificant degree subject to economic, political and social events in China.***

Approximately $2.1billion, or 79%, and $1.7 billion, or 86%, of our net sales in the years ended December 31,2004 and 2003, respectively, occurred in China. While we anticipate expansioninto other markets, a significant portion of our net sales will be derived fromChina for the foreseeable future. In addition, we plan to continue to makefurther investments in China in the future. Therefore, our business, financialcondition and results of operations are to a significant degree subject toeconomic, political, legal and social developments and other events in China. Pleaseread the risks detailed below under the heading “Risks Related to ConductingBusiness in China” for additional information about the risks we face inconnection with our China operations.

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

The market for communications equipment ischaracterized by rapid technological developments, frequent new productintroductions and evolving industry and regulatory standards. Our success willdepend in large part on our ability to enhance our network and broadband accessand switching technologies and develop and introduce new products and productenhancements that anticipate changing service provider requirements andtechnological developments. We may need to make substantial capitalexpenditures and incur significant research and development costs to developand introduce new products and enhancements. If we fail to develop andintroduce new products or enhancements to existing products that effectivelyrespond to technological change on a timely basis, our business, financialcondition and results of operations could be materially adversely affected. Certainof our products, including wireless handsets, have a short product life. Moreover,from time to time, our competitors or we may announce new products or productenhancements, technologies or services that have the potential to replace orshorten the life cycles of our products and that may cause customers to deferpurchasing our existing products, resulting in inventory reserve due toobsolescence. Future technological advances in the communications industry maydiminish or inhibit market acceptance of our existing or future products orrender our products obsolete.

Even if we are ableto develop and introduce new products, they may not gain market acceptance. Marketacceptance of our products will depend on various factors, including:

·       ourability to obtain necessary approvals from regulatory organizations within thecountries in which we operate and for any new technologies that we introduce;

·       thelength of time it takes service providers to evaluate our products, causing thetiming of purchases to be unpredictable;

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·       ourproducts being compatible with legacy technologies and standards existing inpreviously deployed network equipment;

·       ourability to attract customers who may have preexisting relationships with ourcompetitors;

·       productcost relative to performance;

·       thelevel of customer service available to support new products; and

·       thetiming of new product introductions meeting demand patterns.

If our products fail toobtain market acceptance in a timely manner, our business and results of operations could suffer.

***We depend on some sole source and other key suppliers,as well as international sources, for handsets, base stations, components andmaterials used in our products. If we cannot obtain adequate supplies of highquality products at competitive prices or in a timely manner from thesesuppliers or sources, or if the suppliers successfully market their productsdirectly to our customers, our competitive position, reputation and businesscould be harmed.***

We have contracts with a single supplier or with alimited group of suppliers to purchase some components and materials used inour products. If any supplier is unwilling or unable to provide us withhigh-quality components and materials in the quantities required and at thecosts specified by us, we may not be able to find alternative sources onfavorable terms, in a timely manner, or at all. Further, a supplier couldmarket itsproducts directly to our customers. In particular, our PCD division is highlydependent on a single supplier for our handset devices. The possibility of asupplier marketing its own products would create direct competition and mayaffect our ability to obtain adequate supplies. Our inability to obtain or todevelop alternative sources if and as required could result in delays orreductions in manufacturing or product shipments. From time to time, therecould be shortages of different products or components. Moreover, our suppliersmay supply us with inferior quality products. If an inferior product suppliedby a third party is embedded in our end product and causes a problem, it mightbe difficult to identify the source of the problem as being due to thecomponent parts. If any of these events occur, our competitive position,reputation and business could suffer.

Our ability to source a sufficientquantity of high-quality, cost-effective components used in our products mayalso be limited by import restrictions and duties in the foreign countries inwhich we manufacture our products. We require a significant number of importedcomponents to manufacture our products, and imported electronic components andother imported goods used in the operation of our business may be limited by avariety of permit requirements, approval procedures, import duties andregistration requirements. Moreover, import duties on such components increasethe cost of our products and may make them less competitive.

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

Many of our products arehighly complex and may have quality issues resulting from the design ormanufacture of suchproduct, or from the software used in the product. Often these issues areidentified prior to the shipment of the products and may cause delays in marketacceptance of our products, delays in shipping products to customers, or thecancellation of orders. In other cases, we may identify******the quality issues after the******shipment of products. Insuch cases, we may incur unexpected expenses and diversion of resourcesto replace defective products or correct problems. Such pre-shipment andpost-shipment quality issues could result in delays in the recognition ofrevenue, loss of revenue or future orders, and damage to our reputation andcustomer relationships. In addition, we may be required to pay damages forfailed performance under certaincustomer contracts.

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***Our recent growth has strained our resources, and ifwe are unable to manage and sustain our growth, our operating results will benegatively affected.***

We have recentlyexperienced a period of rapid growth and anticipate that we must continue toexpand our operations to address potential market opportunities. Our expansionhas placed and will continue to place a significant strain on our management,operational, financial and other resources. To manage our growth effectively,we will need to take various actions, including:

·       enhancingmanagement information systems, including forecasting procedures;

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

·       managingour working capital and sources of financing to fund our expansion;

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

·       expanding,training and managing our employee base;

·       enhancinghuman resource operations and improving employee hiring and training programs;

·       reorganizingour business structure to more effectively allocate and utilize our internalresources;

·       improvingand sustaining our supply chain capability;

·       managingthe expansion of both our direct and indirect sales channels in acost-efficient and competitive manner; and

·       fullyreviewing our new customers’credit histories to ensure theirfinancial stability before finalizing contracts.

If we fail to implement orimprove systems or controls or to manage any future growth and expansioneffectively, our business could suffer.

***Our success is dependent on continuing to hire andretain qualified personnel, and if we are not successful in attracting andretaining these personnel, our business will suffer.***

The success of our business depends in significantpart upon the continued contributions of key technical and senior managementpersonnel, many of whom would be difficult to replace. In particular, oursuccess depends in large part on the knowledge, expertise and services of HongLiang Lu, our Chairman of the Board, President and Chief Executive Officer,Ying Wu, our Chairman and Chief Executive Officer of China Operations, andPhilip Christopher, President and Chief Executive Officer of our PCD. Theloss of any key employee, the failure of any key employee to performsatisfactorily in his or her current position or our failure to attract andretain other key technical and senior management employees could have asignificant negative impact on our operations.

To effectively manage our recent growth as well as anyfuture growth, we will need to recruit, train, assimilate, motivate and retainqualified employees both locally and internationally. Competition for qualifiedemployees is intense, and the process of recruiting personnel in all fields,including technology, research and development, sales and marketing,administration and managerial personnel with the combination of skills andattributes required to execute our business strategy can be difficult, time-consumingand expensive. As we grow globally, we must implement hiring and trainingprocesses that are capable of quickly deploying qualified local residents toknowledgeably support our products and services. Alternatively, if there is aninsufficient number of qualified local residents available, we might incursubstantial costs importing expatriates to service new global markets. Forexample, we have historically experienced difficulty finding qualifiedaccounting personnel knowledgeable in both U.S. and 

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Chinese accountingstandards who are Chinese residents. If we fail to attract, hire, assimilate orretain qualified personnel, our business would be harmed.

Competitors and othershave in the past, and may in the future, attempt to recruit our employees. Inaddition, companies in the telecommunications industry whose employees acceptpositions with competitors frequently claim that the competitors have engagedin unfair hiring practices. We may be the subject of these types of claims inthe future as we seek to hire qualified personnel. Some of these claims mayresult in material litigation and disruption to our operations. We could incursubstantial costs in defending ourselves against these claims, regardless oftheir merit.

***Any acquisitions that we undertake could be difficultto integrate, disrupt our business, dilute our stockholders and harm ouroperating results.***

We have acquired otherbusinesses, products and technologies. For example, during the second quarterof 2004, we completed our acquisitions of TELOS and HSI for $30.0 million and$14.1 million, respectively. On November 1, 2004, we completed ourselected asset acquisition of ACC for $165.1 million. Additionally, in October 2004,we entered into an asset purchase agreement with Giga Telecom, Inc. toacquire certain assets related to the research and development of variousproducts. Any anticipated benefits of these acquisitions may not be realized. Wehave in the past and will continue to evaluate acquisition prospects that wouldcomplement our existing product offerings, augment our market coverage, enhanceour technological capabilities, or that may otherwise offer growthopportunities. Acquisitions may result in dilutive issuances of equitysecurities, use of our cash resources, the incurrence of debt and theamortization of expenses related to intangible assets. In addition,acquisitions involve numerous risks, including difficulties in the assimilationof operations, technologies, products and personnel of the acquired company,diversion of management’s attention from other business concerns, risks ofentering markets in which we have no direct or limited prior experience, thepotential loss of key employees of the acquired company, unanticipated costsand, in the case of the acquisition of financially troubled businesses,challenges as to the validity of such acquisitions from third party creditorsof such businesses. For example, in the fourth quarter 2004, we encountereddifficulties in integrating HSI’s legacy operations into our operations anddetermined to abandon HSI’s legacy operations. As a result, in the fourthquarter 2004, we wrote off the entire goodwill and intangibles associated withHSI. In addition, the acquisitions of businesses involved in the manufacturingor sales of handset products could introduce specific litigation risk from thepotential harmful effects of electric and magnetic fields (“EMF”).

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

We rely on a combinationof patents, copyrights, trademarks, trade secret laws and contractualobligations to protect our technology. We have applied for patents in theUnited States and internationally. Additional patents may not be issued fromour pending patent applications, and our issued patents may not be upheld. Inaddition, we have, from time to time, chosen to abandon previously filedapplications. Moreover, we may face difficulties in registering our existingtrademarks in new jurisdictions in which we operate. We cannot guarantee thatthe intellectual property protection measures that we have taken will besufficient to prevent misappropriation of our technology or trademarks or thatour competitors will not independently develop technologies that aresubstantially equivalent or superior to ours. In addition, the legal systems ofmany foreign countries do not protect or honor intellectual property rights tothe same extent as the legal system of the United States. For example, inChina, the legal system in general, and the intellectual property regime inparticular, are still in the development stage. It may be very difficult,time-consuming and costly for us to attempt to enforce our intellectualproperty rights in these jurisdictions.

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

The industry in which we compete is moving towardsaggressive assertion, licensing, and litigation of patents and otherintellectual property rights. From time to time, we have become aware of thepossibility or have been notified that we may be infringing certain patents orother intellectual property rights of others. Regardless of their merit,responding to such claims could be time consuming, divert management’sattention and resources and cause us to incur significant expenses. Inaddition, although some of our supplier contracts provide for indemnification fromthe supplier with respect to losses or expenses incurred in connection with anyinfringement claim, certain contracts with our key suppliers do not provide forsuch protection. Moreover, certain of our sales contracts provide that we mustindemnify our customers against claims by third parties for intellectualproperty rights infringement related to our products. There are no limitationson the maximum potential future payments under these guarantees. Therefore, wemay incur substantial costs related to any infringement claim, which maysubstantially harm our results of operations and financial condition.

We may, in the future, become subject to litigation todefend against claimed infringements of the rights of others or to determinethe scope and validity of the proprietary rights of others. Future litigationmay also be necessary to enforce and protect our trade secrets and otherintellectual property rights. Any intellectual property litigation orthreatened intellectual property litigation could be costly, and adversedeterminations or settlements could result in the loss of our proprietaryrights, subject us to significant liabilities, require us to seek licenses fromor pay royalties to third parties which may not be available on commerciallyreasonable terms, if at all, and/or prevent us from manufacturing or sellingour products, which could cause disruptions to our operations.

In the event that there isa successful claim of infringement against us and we fail to developnon-infringing technology or license the propriety rights on commerciallyreasonable terms and conditions, our business, results of operations orfinancial condition could be materially and adversely impacted.

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

We market and sellour products globally, with the majority of our sales made in China. Theexpansion of our existing multinational operations and entry into new marketswill require significant management attention and financial resources. Multinationaloperations are subject to a variety of risks, such as:

·       theburden of complying with a variety of foreign laws and regulations;

·       theburden of complying with United States laws and regulations for foreignoperations, including the Foreign Corrupt Practices Act;

·       difficultycomplying with continually evolving and changing global product andcommunications standards and regulations for both our end products and theircomponent technology;

·       marketacceptance of our new products, including longer product acceptance periods innew markets into which we enter;

·       relianceon local original equipment manufacturers (“OEMs”), third party distributorsand agents to effectively market and sell our products;

·       unusualcontract terms required by customers in developing markets;

·       changesin local governmental control or influence over our customers;

·       changesto import and export regulations, including quotas, tariffs, licensingrestrictions and other trade barriers;

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·       evolvingand unpredictable nature of the economic, regulatory, competitive and politicalenvironments;

·       reducedprotection for intellectual property rights in some countries;

·       longeraccounts receivable collection periods; and

·       difficultiesand costs of staffing and managing multinational operations, including but notlimited to internal controls and compliance.

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

Less developedmarkets present additional risks, such as the following:

·       customersthat may be unable to pay for our products in a timely manner or at all;

·       newand unproven markets for our products and the telecommunications services thatour products enable;

·       inconsistentinfrastructure support;

·       lackof a large, highly trained workforce;

·       difficultyin controlling local operations from our headquarters;

·       variableethical standards and an increased potential for fraud;

·       unstablepolitical and economic environments; and

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

In particular, thesefactors create the potential for physical loss of inventory and operatingassets. We have in the past experienced cases of vandalism and armed theft ofour equipment that had been or was being installed in the field. If disruptionsfor any of these reasons become too severe in any particular market, it maybecome necessary for us to terminate contracts and withdraw from that marketand suffer the associated costs and lost revenue.

***We are subject to claims of possible health risks fromwireless handsets.***

There have been claims made alleging a link betweenthe use of wireless handsets and the development or aggravation of certaincancers, including brain cancer. The scientific community is divided on whetherthere is a risk from wireless handset use, and if so, the magnitude of the risk.Even if there is no link established between wireless handset use and cancer,the negative publicity and possible litigation could have a material adverseeffect on our business.

In the past, severalplaintiffs’ groups have brought class actions against wireless handsetmanufacturers and distributors, alleging that wireless handsets have causedcancer. To date, we have not been named in any of these actions and none ofthese actions has been successful. In the future we could incur substantialcosts in defending ourselves against similar claims, regardless of their merit.Also, claims may be successful in the future and have a material adverse effecton our business.

***We are subject to risks relating to currency ratefluctuations and exchange controls.***

Because most of our sales are made in foreigncountries, we are exposed to market risk for changes in foreign exchange rateson our foreign currency denominated accounts and notes receivable balances. Historically,the majority of our sales have been made in China and denominated in Renminbi;as such, the impact of currency fluctuations of Renminbi thus far has been insignificantas it is fixed to the U.S. dollar. 

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However, in the future,China could choose to revalue the Renminbi versus the U.S. dollar, or theRenminbi-U.S. dollar exchange rate could float, and the Renminbi coulddepreciate relative to the U.S. dollar. Additionally, during 2004, we madesignificant sales in both Japanese Yen and in Euros. Fluctuations in currencyexchange rates in the future may have a material adverse effect on our resultsof operations.

We enter into transactions that may expose us toforeign currency rate fluctuation risk. Historically, the largest component ofour foreign currency exchange loss has resulted from our purchasing inventorydenominated in foreign currencies. If we continue to purchase inventory inforeign currencies, we may incur additional foreign currency exchange losses,causing our operating results to suffer.

We may, from time to time, enter into foreign exchangeforward contracts to hedge certain translation exposures, due to fluctuationof the U.S. dollar to the Japanese Yen, resulting from JapaneseYen-dominated balance sheet accounts***.***However, our management has had limitedprior experience in engaging in these types of transactions, and the hedgingmay not be effective in limiting our exposure to a decline in operatingresults.

Moreover, some of theforeign countries in which we do business might impose currency restrictionthat may limit the ability of our subsidiaries and joint ventures in suchcountries to obtain and remit foreign currency necessary for the purchase ofimported components and may limit our ability to obtain and remit foreigncurrency in exchange for foreign earnings. For example, China employs currencycontrols restricting Renminbi conversion, limiting our ability to engage incurrency hedging activities in China. Various foreign exchange controls mayalso make it difficult for us to repatriate earnings, which could have amaterial adverse effect on our ability to conduct business globally.

***Business interruptions could adversely affect ourbusiness.***

Our operations arevulnerable to interruption by fire, earthquake, power loss, telecommunicationsfailure, external interference with our information technology systems,incidents of terrorism and other events beyond our control. For example, ourHangzhou manufacturing facility’s ability to produce sufficient products isdependent upon a continuous power supply. However, the Hangzhou facility has in thepast been subject to power shortages, which has affected our ability to produceand ship sufficient products. We do not have a detailed disaster recovery plan,and the occurrence of any events like these that disrupt our business couldharm our operating results.

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

We face the risk of lossrelating to our equipment held at customer sites. In some cases, our equipmentheld at customer sites is under contract, pending final acceptance by thecustomer. We generally do not hold title or risk of loss on such equipment, astitle and risk of loss are typically transferred to the customer upon deliveryof our equipment. However, we do not recognize revenue and accounts receivablewith respect to the sale of such equipment until we obtain acceptance from thecustomer. If we do not obtain final acceptance, we may not be able to collectthe contract price and recover this equipment or its associated costs. In othercases, particularly in China, where governmental approval is required tofinalize certain contracts, inventory not under contract may be held atcustomer sites. We hold title and risk of loss on this inventory until thecontracts are finalized and, as such, are subject to any losses incurredresulting from any damage to or loss of this inventory. If our contractnegotiations fail or if the government of China otherwise delays approvingcontracts, we may not recover or receive payment for this inventory. Moreover,our insurance may not cover all losses incurred if our inventory at customersites not under contracts is damaged prior to contract finalization. If weincur a loss relating to inventory for any of the above reasons, our financialcondition, cash flows, and operating results could be harmed.

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

We are currently adefendant in several securities litigation class actions and other lawsuits, aswell as lawsuits in the ordinary course of our business. In the future, we maybe subject to similar litigation. The defense of these lawsuits may divert ourmanagement’s attention, and we may incur significant expenses in defendingthese lawsuits (including substantial fees of lawyers and other professionaladvisors and potential obligations to indemnify officers and directors who maybe parties to such actions). In addition, we may be required to pay judgmentsor settlements that could have a material adverse effect on our results ofoperations, financial condition and liquidity.

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

Severalforeign governments and U.S. state and local governments have adopted or areconsidering legislation that would restrict or prohibit the use of wirelesshandsets while driving. Widespread legislation that restricts or prohibits theuse of wireless handsets while driving could negatively affect our futuregrowth.

***Failure to achieve and maintain effective internalcontrols in accordance with Section 404 of the Sarbanes-Oxley Act of 2002could have a material adverse effect on our business and stock price.***

Section 404 of the Sarbanes-Oxley Act of 2002 (“theSarbanes-Oxley Act”) requires that we establish and maintain an adequateinternal control structure and procedures for financial reporting and include areport of management on our internal control over financial reporting in ourannual report on Form 10-K. That report must contain an assessmentby management of the effectiveness of our internal control over financialreporting and must include disclosure of any material weaknesses in internalcontrol over financial reporting that we have identified. In addition, ourindependent registered public accounting firm must attest to and report onmanagement’s assessment of the effectiveness of our internal control overfinancial reporting. These requirements first apply to this Annual Report.

We have identifiedmaterial weaknesses in our internal controls over financial reporting. See “Item 9A—Controlsand Procedures—Management’s Report on Internal Control Over Financial Reporting”for a discussion of these material weaknesses. As of the date of this AnnualReport on Form 10-K, we are still in the process of implementingremedial measures related to the material weaknesses identified as discussed atItem 9A—“Controls and Procedures—Management’s Report on Internal Control OverFinancial Reporting.” If our efforts to remedy the weaknesses we identified arenot successful, our business and operating results could be harmed and thereliability of our financial statements could be impaired, which couldadversely affect our stock price. The requirements of Section 404 of theSarbanes-Oxley Act are ongoing and also apply to future years. In addition,during 2005, we will apply the requirements of the Sarbanes-Oxley Act to our November 2004acquisition of ACC, which was exempted from our 2004 assessment as permittedunder the Sarbanes-Oxley Act. We expect that our internal controls overfinancial reporting will continue to evolve as we continue in our efforts togrow and expand our business in the future. Although we are committed tocontinue to improve our internal control processes and we will continue todiligently and vigorously review our internal controls over financial reportingin order to ensure compliance with the Section 404 requirements, anycontrol system, regardless of how well designed, operated and evaluated, canprovide only reasonable, not absolute, assurance that its objectives will bemet. Therefore, we cannot assure you that in the future additional materialweaknesses or significant deficiencies will not exist or otherwise bediscovered.

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***Recently enacted and proposed changes in securitieslaws and regulations are likely to increase our costs.***

The Sarbanes-Oxley Act ,has required and will continue to require changes in some of our corporategovernance and securities disclosure or compliance practices. TheSarbanes-Oxley Act also requires the SEC to promulgate new rules on avariety of subjects, in addition to rule proposals already made, andNASDAQ has revised its requirements for companies that are quoted on it. These developments (i) have required and may continue to require us to devote additionalresources to our operational, financial and management information systemsprocedures and controls to ensure our continued compliance with current andfuture laws and regulations, (ii) will make it more difficult and moreexpensive for us to obtain director and officer liability insurance, and we maybe required to accept reduced coverage, increase our level of self-insurance,or incur substantially higher costs to obtain coverage, and (iii) couldmake it more difficult for us to attract and retain qualified members on ourboard of directors, or qualified executive officers. To ensure our compliancewith Section 404 of the Sarbanes-Oxley Act and other related securityrules, we incurred costs of approximately $4.6 million in 2004 relating to theimplementation of plans designed to ensure our compliance. We continue to evaluateand monitor regulatory developments and cannot estimate the timing or magnitudeof additional costs that we may incur as a result of such developments.

***Changes in accounting rules.***

We prepare our financialstatements in conformity with accounting principles generally accepted in theUnited States of America. These principles are subject to interpretation by theSEC and various bodies formed to interpret and create appropriate accountingpolicies. A change in these policies can have a significant effect on ourreported results and may even retroactively affect previously reportedtransactions. For example, there have been recent changes to FASBguidelines relating to accounting for stock-based compensation that will increase our compensationexpense, could make our net income less predictable in any given reportingperiod and could change the way we compensate our employees or cause otherchanges in the way we conduct our business.

**RISKS RELATED TO CONDUCTING BUSINESS IN CHINA**

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

Since 1978, the Chinese government has been in a stateof evolution and reform. The reforms have resulted in and are expected tocontinue to result in significant economic and social development in China.Many of the reforms are unprecedented or experimental and may be subject tochange or readjustment due to a variety of political, economic and socialfactors. Multiple government bodies are involved in regulating andadministrating affairs in the telecommunications industry, among which the MII,the National Development and Reform Commission (“NDRC”) and the State Asset SupervisoryAdministrative Commission (“SASAC”) play the leading roles. Thesegovernment agencies have broad discretion and authority over all aspects of thetelecommunications and information technology industry in China, including butnot limited to, setting the telecommunications tariff structure, grantingcarrier licenses and frequencies, approving equipment and products, grantingproduct licenses, specifying technological standards as well as appointingcarrier executives, all of which may impact our ability to do business in China.

While we anticipatethat the basic principles underlying the reforms will remain unchanged, any ofthe following changes in China’s political and economic conditions andgovernmental policies could have a substantial impact on our business: 

·       thepromulgation of new laws and regulations and the interpretation of those lawsand regulations; 

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·       inconsistentenforcement and application of the telecommunications industry’s rules andregulations by the Chinese government between foreign and domestic companies; 

·       therestructuring of telecommunications carriers in China;

·       theintroduction of measures to control inflation or stimulate growth; 

·       theintroduction of new guidelines for tariffs and service rates, which affect ourability to competitively price our products and services; 

·       changesin the rate or method of taxation; 

·       theimposition of additional restrictions on currency conversion and remittancesabroad; or 

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

For example, on November 1, 2004, as acontinuation of the restructuring of telecom carriers relating to the initial public offering of China Netcom in 2004, SASACdecided to swap the senior executives of China Mobile, China Unicom, ChinaTelecom and China Netcom in an effort to ease competition among carriers. Thisled to business interruption between China Telecom and China Netcom, which hadan adverse impact of delaying revenue recognition in the fourth quarter of 2004. Moreover,we are not certain whether there may be additional government interference, including government imposed mergers orspin-offs of the existing carriers. 

In addition to modifying the existingtelecommunications regulatory framework, the Chinese government is currentlypreparing a draft of a standard, national telecommunications law (the “TelecommunicationsLaw”) to provide a uniform regulatory framework for the telecommunicationsindustry. We do not yet know the final nature or scope of the regulations thatwould be created if the Telecommunications Law is passed. Accordingly, wecannot predict whether it will have a positive or negative effect on us or onsome or all aspects of our business. 

Under China’s current regulatory structure, thecommunications products that we offer in China must meet government andindustry standards. In addition, a network access license for the equipment mustbe obtained. Without a license, telecommunications equipment is not allowed tobe connected to public telecommunications networks or sold in China. Moreover,we must ensure that the quality of the telecommunications equipment for whichwe have obtained a network access license is stable and reliable, and will not negatively affectthe quality or performance of other installed licensed products. 

The product quality supervision department of the ChinaState Council, in concert with the MII, performs spot checks to track andsupervise the quality of licensed telecommunications equipment and publishesthe results of such spot checks. 

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

Since 1978, the Chinesegovernment has been reforming the economic system in China to increase the emphasis placed on decentralizationand the utilization of market forces in the development of China’s economy. Thesereforms have resulted in significant economic growth. However, any economicreform policies or measures in China may from time to time be modified orrevised by the Chinese government. While we may be able to benefit from theeffects of some of these policies, these policies and other measures taken bythe Chinese government to regulate the economy could also have a significantnegative impact on economic conditions in China, which would result in a negativeimpact on our business. China’s economic environment has been changing as aresult of China’s entry, in December of 2001, intothe World Trade Organization (the “WTO”). Entry into the WTO requires thatChina reduce tariffs and eliminate non-tariff barriers, including quotas,licenses and other restrictions by early 2005 at the latest, 

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and wecannot predict the impact of these changes on China’s economy. Moreover,although China’s entry into the WTO and the related relaxation of traderestrictions may lead to increased foreign investment, it may also lead toincreased competition in China’s markets from other foreign companies. If China’sentry into the WTO results in increased competition or has a negative impact onChina’s economy, our business could suffer. In addition, although China isincreasingly according foreign companies and foreign investment enterprisesestablished in China the same rights and privileges as Chinese domesticcompanies as a result of its admission into the WTO, special laws, administrativerules and regulations governing foreign companies and foreign investmententerprises in China may still place foreign companies at a disadvantage inrelation to Chinese domestic companies and may adversely affect our competitiveposition. 

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

We conduct our business inChina primarily through our wholly owned subsidiaries incorporated in China. Oursubsidiaries are generally subject to laws and regulations applicable to foreigninvestment in China. Accordingly, our business might be affected by China’sdeveloping legal system. Since 1978, many new laws and regulations coveringgeneral economic matters have been promulgated in China, and governmentpolicies and internal rules promulgated by governmental agencies may notbe published in time, or at all. As a result, we may operate our business inviolation of new rules and policies without having any knowledge of theirexistence. In addition, there are uncertainties regarding the interpretationand enforcement of laws, rules and policies in China. The Chinese legalsystem is based on written statutes, and prior court decisions have limitedprecedential value. Because many laws and regulations are relatively new andthe Chinese legal system is still evolving, the interpretations of many laws,regulations and rules are not always uniform. Moreover, the relativeinexperience of China’s judiciary in many cases creates additional uncertaintyas to the outcome of any litigation, and the interpretation of statutes andregulations may be subject to government policies reflecting domestic politicalchanges. Finally, enforcement of existing laws or contracts based on existinglaw may be uncertain and sporadic, and it may be difficult to obtain swift andequitable enforcement, or to obtain enforcement of a judgment by a court ofanother jurisdiction. Any litigation in China may be protracted and result insubstantial costs and diversion of resources and management’s attention. 

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

The Chinese government isconsidering the imposition of a “unified” corporate income tax that would phaseout, over time, the preferential tax treatment to which foreign investmententerprises, such as our Company, are currently entitled. While it is not certain whetherthe government will implement such a unified tax structure or whether our Companywill be grandfathered under into any new tax structure, if a new tax structure isimplemented, a new tax structure may adversely affect our financial condition. Moreover,certain of our subsidiaries and joint ventures located in China enjoy taxbenefits in China that are generally available to foreign investmententerprises. If these tax benefits are reduced or repealed due to changes intax laws, our business could suffer. 

***Our ability to continue successful deployment of PASsystem and sales of PAS handsets are limited***by certain factors, including the following:

***Maturing PAS market and increased competition inhandsets and tariffs.***

The market for PAS exceeded 66 million users as of theend of fiscal year 2004 and is present throughout China. As the PAS market hasmatured, we believe that it may level off in the near future. In addition, theincrease in handset competitors entering the market during 2004 has resulted indecreased average selling prices and margins. If additional handset competitorsenter the market or if competitors decide to further reduce pricing, our salesof PAS handsets may be adversely impacted.

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Furthermore, competitionfrom mobile operators, such as China Mobile and China Unicom, has increased in cities where PAS isdeployed. Mobile operators offering special promotional pricing or incentives to customers,such as free incoming calls or free mobile-to-mobile calls, haveharmed the ability of our customers, China Telecom and China Netcom, to competeeffectively. The continued use of such incentive programs by mobile operatorsmay adversely impact China Telecom and China Netcom’s ability to increase PASsubscriptions. Dueto our relationships with China Telecom and China Netcom, reduced subscriptiongrowth at these carriers may have a material adverse effect on ourpricing and harm our business or results of operations. 

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

China’s media sources havewidely reported that the MII may grant 3G mobile licenses to China Telecom or ChinaNetcom, or to both during 2005. If China Telecom or China Netcom obtain 3G mobilelicenses, they may re-allocate capital expenditures to construct 3G networks, and as a consequence,may significantly reduce capital expenditures relating to PAS networks that utilizeour existing products. In addition, it is possible that current PAS frequencybands utilized by PAS networks may be reallocated for use by 3G networks, resulting inthe restrictionof or shutting down of PAS networks. If this were to occur, we could lose currentand potential future customers of our products, and our financial conditionand results of operations could be significantly harmed. 

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

We only have trial licenses for our PASsystems and handsets. We have applied for, but have not yet received, a finalofficial network access license for our PAS systems and handsets. Based uponconversations with the MII, we understand that our PAS systems and handsets areconsidered to still be in the trial period and that sales of our PAS systemsand handsets may continue to be made by us during this trial period, but that licenseswill ultimately be required. If we fail to obtain the required licenses, wecould be prohibited from making further sales of the unlicensed products,including our PAS systems and handsets, in China, which would substantiallyharm our business, financial condition and results of operations. Theregulations implementing these requirements are not very detailed, have notbeen applied by a court and may be interpreted and enforced by regulatoryauthorities in a number of different ways. Our legal counsel in China has advised usthat China’s governmental authorities may interpret or apply the regulationswith respect to which licenses are required and the ability to sell a productwhile a product is in the trial period in a manner that is inconsistent withthe information received by our legal counsel in China, and either of theseconditions could have a material adverse effect on our business, financialcondition and results of operations. 

***Increasing centralization of purchasing***decision-making by carriers maylead to customer concentration and affect the results of our business.

Most Chinese carriers have three levels of operations;the central headquarters level, the provincial level and the local city/countylevel. Both central and provincial levels are independent legal persons andhave their own corporate mandate. The purchasing decision making process may takevarious forms for different projects and may also differ significantly fromcarrier to carrier. 

In the case of PASsystems, all China Netcom contracts are negotiated and entered into between the provincialoperators and theCompany. However, the central headquarters of China Telecom recently began exertingmore influence in the purchasing decision-making process by negotiating contractualterms,such as purchase price, payment terms, and acceptance clauses at the central level. Theprovincial operator then further negotiates the contract based on theguidelines provided by the headquarters. Final contracts are entered intobetween the provincial operator and the Company. However, if this trend ofcentralized 

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decision-makingexpands to unified purchasing, resulting in the negotiation and execution ofcontracts at the central headquarter level, there may be a concentration ofcustomers which could have a significant impact on our business. 

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

***Our stock price is highly volatile.***

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

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

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

·       changesin governmental regulations or policies in China; 

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

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

·       newsand commentary emanating from the media, securities analysts or governmentbodies in China relating to us and to the industry in general. 

General market conditions and domestic orinternational macroeconomic factors unrelated to our performance may alsoaffect our stock price. For these reasons, investors should not rely on recenttrends to predict future stock prices or financial results. In addition,following periods of volatility in a company’s securities, securities classaction litigation against a company is sometimes instituted. This type oflitigation could result in substantial costs and the diversion of management’stime and resources. 

In addition, publicannouncements by China Telecom, China Netcom, China Mobile, and China Unicomeach of which exert significant influence over many of our major customers inChina, may contribute to volatility in the price of our stock. The price of ourstock may react to such announcements. 

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

SOFTBANK CORP. and its related entities, includingSOFTBANK America Inc. (collectively, “SOFTBANK”), beneficially ownedapproximately 12.8% of our outstanding stock as of December 31, 2004. As aresult, SOFTBANK has the ability to influence all matters submitted to ourstockholders for approval, as well as our management and affairs. Matters thatcould require stockholder approval include: 

·       electionand removal of directors; 

·       mergeror consolidation of our Company; and 

·       saleof all or substantially all of our assets. 

This concentration ofownership may delay or prevent a change of control or discourage a potential acquirerfrom making a tender offer or otherwise attempting to obtain control of ourCompany, which could decrease the market price of our common stock. 

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***Delaware law and our charter documents containprovisions that could discourage or prevent a potential takeover, even if thetransaction would benefit our stockholders.***

Other companies mayseek to acquire or merge with us. An acquisition or merger of our Company couldresult in benefits to our stockholders, including an increase in the value ofour common stock. Some provisions of our Certificate of Incorporation andBylaws, as well as provisions of Delaware law, may discourage, delay or preventa merger or acquisition that a stockholder may consider favorable. Theseprovisions include: 

·       authorizingthe board of directors to issue additional preferred stock; 

·       prohibitingcumulative voting in the election of directors; 

·       limitingthe persons who may call special meetings of stockholders; 

·       prohibitingstockholder action by written consent; 

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

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

***Together with the holders of our convertiblesubordinated notes due in 2008, we face a variety of risks related to thenotes.***

Holders of ourconvertible subordinated notes due in 2008 (the “Notes”) and we face a varietyof risks with respect to the Notes, including the following:

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

·       anevent of default under our senior debt, including one of our subsidiaries,could restrict our ability to purchase or pay any or all amounts due on Notes,and after paying our senior debt in full, we may not have sufficient assetsremaining to pay any or all amounts due on the Notes; 

·       thereis no listed trading market for the Notes, which could have a negative impacton the market price of the Notes; 

·       wehave significantly increased our leverage as a result of the sale of the Noteswhich could have an adverse impact on our ability to obtain additionalfinancing for working capital; 

·       hedgingtransactions related to the Notes and our common stock and other transactions,as well as changes in interest rates and our creditworthiness, may affect thevalue of the Notes and of our common stock; and 

·       theNotes might not be rated or may receive a lower rating than anticipated byinvestors, ultimately having a negative affect on the price of the Notes and ofour common stock.

·       Inaddition, we are subject to various covenants and obligations pursuant to theterms of the indenture governing the Notes (the “Indenture”). Should we defaulton certain of these obligations, then all unpaid principal and accrued intereston the Notes then outstanding could become immediately due and payable. Forexample, as of April 1, 2005, we were in technical noncompliance under theIndenture due to the untimely filing of our Annual Report on Form 10-K for theyear ended December 31, 2004. If we had failed to file this Annual Reportwithin 60 days of written notice being provided to us be either the trusteeunder the Indenture or the holders of at least 25% 

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in aggregateprincipal amount of the Notes then outstanding, an event of default under theIndenture would have occured. If an event of default under the Indenture occursand if payment of principal and accrued interest on the Notes is accelerated,our business could be seriously harmed.

***Nasdaq has informed us that our common stock may bedelisted, which could materially impair the ability of investors to trade inour common stock and could have a material adverse effect on our stock price.***

On April 5, 2005, wereceived a notice from the staff of Nasdaq, indicating that we failed to complywith Marketplace Rule 4310(c)(14), due to the fact that we did not filethis Annual Report on Form 10-K with the SEC by March 31, 2005. Beginningat the opening of business on April 7, 2005, Nasdaq appended the fifthcharacter “E” to the trading symbol for our common stock. We have requested ahearing before a Nasdaq Listing Qualifications Panel, (the “Panel”), to reviewthe Nasdaq staff’s determination. The hearing request has stayed the delistingof our common stock pending the Panel’s decision. There can be no assurancethat the Panel will grant our request for continued listing. In the event thatthe Panel denies our request for continued listing and our common stock isdelisted from Nasdaq, the ability of our investors to buy and sell shares ofour common stock could be materially impaired. In addition, the delisting ofour common stock from Nasdaq could have a material adverse effect on our stockprice.

**ITEM7A—QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

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

Thetable below represents carrying amounts and related weighted-averageinterest rates of our investment portfolio at December 31, 2004 and 2003:
| ** **                         | ** ** | **December 31,**                                     | ** ** |
|------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                         | ** ** | **2004**                                                  | ** ** | **2003** | ** ** |
| ** **                         | ** ** | **(in thousands, except  interest rates)** | ** ** |
| Cash and cash  equivalents         |       | $                                                         | 562,532    |   | $ | 377,747 |   |
| Average interest rate              |       | 0.84                                                      | %          | 1.19 | % |
| Restricted cash                    |       | $                                                         | 24,712     |   | $ | 3,943 |   |
| Average interest rate              |       | 1.93                                                      | %          | 0.50 | % |
| Restricted short-term  investments |       | $                                                         | 8,635      |   | $ | 20,461 |   |
| Average interest rate.             |       | 2.48                                                      | %          | 1.19 | % |
| Short-term  investments            |       | $                                                         | 136,283    |   | $ | 48,617 |   |
| Average interest rate              |       | 1.50                                                      | %          | 1.36 | % |
| Total investment  securities       |       | $                                                         | 732,162    |   | $ | 450,768 |   |
| Average interest rate              |       | 1.02                                                      | %          | 1.20 | % |

 

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*Equity InvestmentRisk:*

Our investment portfolioincludes equity investments in publicly traded companies, the values of whichare subject to market price volatility. Economic events could adversely affectthe public equities market and general economic conditions may continue toworsen. 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. We have also invested in several privatelyheld companies as well as investment funds which invest primarily in privatelyheld companies, many of which can still be considered in the start-up ordevelopment stages. These investments are inherently risky, as the market forthe technologies or products they have under development are typically in theearly stages and may never materialize.

*Debt InvestmentRisk:*

Our debt investmentportfolio consists of an $11.8 million note receivable from BB Modem, anaffiliate of SOFTBANK CORP., pursuant to a Mezzanine Loan Agreement we enteredinto with BB Modem on July 17, 2003. Our loan is subordinated to certain seniorlenders of BB Modem, and repayments are payable to us over a 42- month period,with a substantial portion of the principal amount of the loan schedule to berepaid during the last 16 months of this period. Our recourse fornonpayment of the loan is limited to the assets of BB Modem, the account intowhich subscriber payments are made and its rights under the securitizationtransaction documents. The value of BB Modem’s modems that serve as collateralfor the loan may decrease over time and may not be sufficient upon sale to paythe outstanding amounts on the loan.

*Foreign ExchangeRate Risk:*

We are exposed to foreign exchange rate risk becausemost of our sales in China are denominated in Renminbi and portions of ouraccounts receivable and payable are denominated in Japanese Yen. Due to thelimitations on converting Renminbi, we are limited in our ability to engage incurrency hedging activities in China. Although the impact of currencyfluctuations of Renminbi to date has been insignificant, fluctuations incurrency exchange rates in the future may have a material adverse effect on ourresults of operations. Additionally, during 2004 we made significant sales inboth Japanese Yen and in Euros. Although we are expanding our global operationsoutside of China, as of December 31, 2004, we have not experienced amaterial foreign exchange rate risk due to the fact that the significantmajority of our business has remained in China as well as our increasedpresence in the United States. We maintain Japanese yen bank accounts forpurchasing portions of our inventories and supplies. The balance of theseJapanese Yen accounts at December 31, 2004 was approximately $223.4 million.

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**ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

**Indexto Consolidated Financial Statements and Financial Statement Schedules**
|                                                                                                                                                                 | ** ** | **Page** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Financial Statements:                                                                                                                                           |       |     |       |
| Report of Independent  Registered Public Accounting Firm                                                                                                        |       | 79       |       |
| Consolidated Balance Sheets at  December 31, 2004 and 2003                                                                                                 |       | 84       |       |
| Consolidated Statements of  Operations for the years ended December 31, 2004, 2003, and 2002                                                               |       | 85       |       |
| Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2004, 2003, and 2002        |       | 86       |       |
| Condensed Consolidated  Statements of Cash Flows for the years ended December 31, 2004, 2003,  and 2002                           |       | 87       |       |
| Notes to Consolidated  Financial Statements                                                                                                                     |       | 88       |       |
| Financial Statement  Schedules:                                                                                                                                 |       |     |       |
| For each of the three years in the period ended  December 31, 2004, 2003, and 2002                                                                         |       |     |       |
| I—Condensed Financial Information of Registrant                                                                                                            |       | 158      |       |
| II—Valuation and Qualifying Accounts                                                                                                                       |       | 162      |       |

 

All other schedules are omitted because they are notapplicable or the required information is shown in the consolidated financialstatements or notes thereto.

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

To the Board of Directors and Stockholders ofUTStarcom, Inc.:

We have completed anintegrated audit of UTStarcom, Inc.’s (the “Company”) 2004 consolidatedfinancial statements and of its internal control over financial reporting as ofDecember 31, 2004 and audits of its 2003 and 2002 consolidated financialstatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidated financial statementsand financial statement schedules*

In our opinion, the consolidated financial statementslisted in the accompanying index present fairly, in all material respects, thefinancial position of UTStarcom, Inc. and its subsidiaries at December 31,2004 and 2003, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2004 inconformity with accounting principles generally accepted in the United Statesof America. In addition, in our opinion, the financial statement scheduleslisted in the accompanying index presents fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedconsolidated financial statements. These financial statements and financialstatement schedules are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements andfinancial statement schedules based on our audits. We conducted our audits ofthese statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit of financialstatements includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

As discussed inNote 2 to the consolidated financial statements, the Company adopted FinancialAccounting Standards Board Interpretation No. 46 in 2003.

*Internal control over financialreporting*

Also, we have audited management’s assessment,included in Management’s Report on Internal Control Over Financial Reportingappearing under Item 9A—Controls and Procedures, that UTStarcom, Inc. didnot maintain effective internal control over financial reporting as of December 31,2004, because (1) the Company did not maintain effective controls over thefinancial reporting process due to an insufficient complement of personnel witha level of accounting knowledge, experience and training in the application ofgenerally accepted accounting principles commensurate with the Company’sfinancial reporting requirements,  (2) theCompany did not maintain effective controls over the identification of andaccounting for  related partyrelationships and related party transactions, (3) the Company did notmaintain effective controls over the monitoring of its accounting functionslocated outside of the U.S. and (4) the Company did not maintain aneffective control environment based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”). The Company’s management is responsible for maintainingeffective internal control over financial reporting and for its assessment ofthe effectiveness of internal control over financial reporting. Ourresponsibility is to express opinions on management’s assessment and on theeffectiveness of the Company’s internal control over financial reporting basedon our audit.

We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over 

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financial reporting wasmaintained in all material respects. An audit of internal control overfinancial reporting includes obtaining an understanding of internal controlover financial reporting, evaluating management’s assessment, testing andevaluating the design and operating effectiveness of internal control, andperforming such other procedures as we consider necessary in the circumstances.We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, in reasonabledetail, accurately and fairly reflect the transactions and dispositions of theassets of the company; (ii) provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (iii) providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use, or disposition of the company’s assets that could have amaterial effect on the financial statements.

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures may deteriorate.

A material weaknessis a control deficiency, or combination of control deficiencies, that resultsin more than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. The followingmaterial weaknesses have been identified and included in management’sassessment.

1.      *As of December 31, 2004, the Company did not maintain effectivecontrols over the financial reporting process due to an insufficient complementof personnel with a level of accounting knowledge, experience and training inthe application of generally accepted accounting principles commensurate withthe Company’s financial reporting requirements.* This materialweakness contributed to the following control deficiencies relating to thepreparation of the Company’s financial statements which are individuallyconsidered to be material weaknesses:

a)               The Company did notmaintain effective controls over its revenue and deferred revenue accounts andassociated cost of sales. Specifically, the Company’s controls over itsprocesses and procedures related to the recording and review of its revenue anddeferred revenue accounts were not adequate to ensure that such accounts werecompletely and accurately recorded. In particular, the following exceptionswere identified in which revenue recognition criteria were not properlyassessed: treatment of upgrade protection in a multiple element arrangement,non-standard contractual terms and conditions, exceptions to finalacceptance confirmations received from customers, tracking of proof of deliveryand timing of execution of final acceptance confirmations, and theidentification of the appropriate costs associated with selected salestransactions. This control deficiency resulted in adjustments to the secondquarter 2004 financial statements and audit adjustments to the fourth quarter2004 financial statements to properly recognize revenue and cost of sales.

b)              The Company did notmaintain effective controls over its inventory, deferred costs, inventoryreserve accounts and cost of sales. Specifically, the Company’s controls failedto adequately identify, document and analyze the conditions that should havebeen considered relative to the existence and expected recoverability ofinventory and deferred costs. Principally in Japan, controls were not adequateto properly track and confirm inventory movements or ensure the 

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timely recognition of costof goods sold. In addition, certain inventory purchases were approved locallybut were not in accordance with the Company’s usual procurement polices andprocedures. This control deficiency resulted in certain audit adjustments tothe fourth quarter 2004 financial statements to correct cost of goods sold andthe related inventory and deferred costs accounts.

c)               The Company did notmaintain effective controls over its processes for accounting for goodwill.Specifically, the Company’s controls over its processes and procedures relatedto its assessment of the impairment of its goodwill account were notsufficiently detailed to identify instances of impairment as required undergenerally accepted accounting principles. This control deficiency resulted inan audit adjustment to the fourth quarter 2004 financial statements torecognize the impairment of the Company’s goodwill associated with theoperations of an entity acquired and substantially abandoned in 2004.

d)              The Company did notmaintain effective controls over the process for the translation of itsaccounts and transactions denominated in a currency other than U.S. dollars.Specifically, the Company’s controls over its processes and procedures relatedto the translation of transactions and account balances denominated in acurrency other than U.S. dollars failed to identify and utilize the appropriateforeign exchange rates, primarily related to the cash, accounts receivable,accounts payable, and other comprehensive income accounts. This controldeficiency resulted in certain audit adjustments to the fourth quarter 2004financial statements to properly record unrealized foreign exchange gains.

e)               The Company did notmaintain effective controls over the recording of accrued expenses, primarilyin China and Japan. Specifically, the Company’s controls over its processes andprocedures related to accrued expenses failed to completely and accuratelyrecord expenses in the proper period. The review of open purchase orders andinvoices received as part of the close process was insufficient to ensure thatthe 2004 year-end accrued expense balances were completely and accuratelyrecorded in the proper period. This control deficiency resulted in certainaudit adjustments to the fourth quarter 2004 financial statements to properlyrecord certain accrued expense and related income statement accounts.

f)                 The Company didnot maintain effective controls over the financial reporting process to ensurethe accurate preparation and review of its financial statements. Specifically,the Company’s controls over the completeness, accuracy and review of itsdocumentation of close processes relating to reconciliations, journal entries,spreadsheets, international reporting packages and review and preparation ofmonthly expenditure reports were ineffective in their design and execution. Inaddition, the Company did not have effective controls over the process foridentifying and accumulating all required supporting information to ensure thecompleteness of its footnote disclosures, including the support for theaccounting positions taken on non-routine transactions, goodwill impairment,purchase accounting, segment reporting, accounting for potential variableinterest entities, intercompany profit eliminations and income tax accountingand proper classification of inventory and deferred costs, deferred revenue andaccounts receivable, and revenue and cost of goods sold. These controldeficiencies resulted in certain audit adjustments to and additionaldisclosures made in the 2003 and 2004 financial statements.

g)               The Company did notmaintain effective controls over the completeness and accuracy of its incometax provision and related balance sheet accounts. Specifically, as part of its2004 year-end close process, certain errors related to income taxes payable,deferred income tax assets and liabilities, other long-term assets, prepaidsand other current assets were identified in the calculation of the Company’s2003 income tax provision. This control deficiency resulted in the restatementof the Company’s financial statements for the quarters and full year of 2003 aswell 

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as audit adjustments tothe fourth quarter 2004 financial statements to adjust the provision for incometaxes, stockholders’ equity, income taxes payable, other long-term assets,prepaids and other current assets.

h)              TheCompany did not maintain effective controls in relation to segregation ofduties and user access to certain Oracle business process applications nor werethere effective controls in place to monitor user access. There were instancesin which either information technology or finance personnel maintained accessto specific applications within the Oracle environment beyond that needed toperform their individual job responsibilities. This deficiency related tofinancial reporting, inventory and purchasing applications in China andfinancial reporting applications in the United States.

As discussed above, certain of these controldeficiencies resulted in either the restatement of the Company’s financialstatements for each of the quarters in 2003 and the year ended December 31,2003, and/or audit adjustments to the second or fourth quarter 2004 financialstatements. Additionally, these control deficiencies could individually or inthe aggregate result in a material misstatement to the annual or interimfinancial statements that would not be prevented or detected. Accordingly,management has determined that these control deficiencies constitute materialweaknesses.

2.      *As of December 31, 2004, the Company did not maintain effectivecontrols over the identification of and accounting for related party relationshipsand related party transactions.  *Specifically, the Company’scontrols over its policies and procedures were ineffective in identifying allsignificant related party relationships and transactions on a timely basis inorder for such relationships and transactions to be appropriately reflected inthe Company’s financial statements in accordance with generally acceptedaccounting principles. Specifically, a previously undisclosed significantrelated party relationship was identified during the 2004 financial closeprocess. This related party was also determined to be a variable interestentity in which the Company was determined to be the primary beneficiary. Thiscontrol deficiency resulted in a restatement of the Company’s financial statements for the year endedDecember 31, 2003, as well as an audit adjustment to the 2004 financial statements. Additionally, thiscontrol deficiency could result in a material misstatement to annual or interimfinancial statements that would not be prevented or detected. Accordingly,management has determined that this control deficiency constitutes a materialweakness.

3.      *As of December 31, 2004, the Company did not maintain effectivecontrols over the monitoring of its accounting functions located outside of theU.S.*   The Company’s policies and procedures with respect to thereview and supervision of its accounting operations in foreign locations,principally Japan and China, were inadequate. Specifically, corporate seniorfinancial management did not provide adequate oversight of the accountingfunctions based principally in Japan and China, nor was there sufficient andaccurate information for monitoring the financial results of non-U.S.operations. Reviews of local financial results were inadequate in either their designor operation to detect errors to the Company’s financial statements asdescribed in items 1 and 2 above. Additionally, this control deficiency couldresult in a material misstatement to annual or interim financial statementsthat would not be prevented or detected. Accordingly, management has determinedthat this control deficiency constitutes a material weakness.

4.      As *of December 31, 2004 the Company did notmaintain an effective control environment.  *The financialreporting organizational structure was not adequate to support the size,complexity, operating activities or locations of the Company. Deficiencies inlocal accounting operations, such as the lack of a senior finance director inChina with sufficient depth and skill in the application of U.S. generallyaccepted accounting principles and inadequate understanding of U.S. generallyaccepted accounting principles by local accounting staff resulted in theadjustments to the financial statements 

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as discussed in items 1—3above. In addition, in some cases, certain key finance positions were staffedwith individuals who did not have the appropriate skills, training andexperience to meet the objectives as outlined in their job descriptions or thatshould be expected of these roles. Further, the following specific areas areexamples of some of the corporate departments in the Company where additionalskilled resources are required: tax, external financial reporting, revenuerecognition, treasury, financial planning and analysis and corporate accounting.This control deficiency, together with the material weaknesses described initems 1—3 above, indicate that the Company did not maintain an effectivecontrol environment. These control deficiencies could result in a materialmisstatement to annual or interim financial statements that would not beprevented or detected. Accordingly, management has determined that this controldeficiency constitutes a material weakness.

These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the 2004 consolidated financial statements, and our opinion regarding theeffectiveness of the Company’s internal control over financial reporting doesnot affect our opinion on those consolidated financial statements.

As described in Management’s Report on InternalControl Over Financial Reporting, management has excluded AudiovoxCommunications Corporation from its assessment of internal control overfinancial reporting as of December 31, 2004 because it was acquired by theCompany through a purchase business combination in November 2004. We have alsoexcluded Audiovox Communications Corporation from our audit of internal controlover financial reporting. Audiovox Communications Corporation is a wholly-ownedsubsidiary whose total assets and total revenues represent approximately 11.0%and approximately 10.3%, respectively, of the related consolidated financialstatement amounts as of and for the year ended December 31, 2004.

In ouropinion, management’s assessment that UTStarcom, Inc. did not maintaineffective internal control over financial reporting as of December 31,2004, is fairly stated, in all material respects, based on criteria establishedin Internal Control—Integrated Framework issued by the COSO. Also, in ouropinion, because of the effects of the material weaknesses described above onthe achievement of the objectives of the control criteria, UTStarcom, Inc.has not maintained effective internal control over financial reporting as of December 31,2004, based on criteria established in Internal Control—Integrated Frameworkissued by the COSO.
| PricewaterhouseCoopers LLP |
|----------------------------|
| San Jose, California       |
| April 14, 2005        |

 

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**UTSTARCOM, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except share data)**
| ** **                                                                                                                                                               | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                               |       |                        |       |                        |       |
| Current assets:                                                                                                                                                          |       |                        |       |                        |       |
| Cash and cash  equivalents                                                                                                                                               |       | $                           | 562,532    |                        | $          | 377,747 |   |
| Short-term  investments                                                                                                                                                  |       | 136,283                     |       | 48,617                      |       |
| Accounts receivable, net  of allowances for doubtful accounts                                                                                                            |       | 719,625                     |       | 325,288                     |       |
| Accounts receivable-related  parties, net of allowances for doubtful accounts                                                                                            |       | 86,988                      |       | 43,944                      |       |
| Notes receivable                                                                                                                                                         |       | 26,982                      |       | 11,362                      |       |
| Inventories                                                                                                                                                              |       | 590,832                     |       | 257,065                     |       |
| Deferred costs/Inventories  at customer sites under contracts                                                                                                            |       | 198,155                     |       | 542,060                     |       |
| Prepaids                                                                                                                                                                 |       | 112,525                     |       | 139,103                     |       |
| Current deferred taxes                                                                                                                                                   |       | 143,123                     |       | 18,179                      |       |
| Short-term restricted  cash and investments                                                                                                                              |       | 33,347                      |       | 24,404                      |       |
| Other current assets                                                                                                                                                     |       | 42,058                      |       | 30,320                      |       |
| Total current assets                                                                                                                                                     |       | 2,652,450                   |       | 1,818,089                   |       |
| Property, plant and  equipment, net                                                                                                                                      |       | 268,759                     |       | 187,039                     |       |
| Long-term  investments                                                                                                                                                   |       | 35,590                      |       | 24,066                      |       |
| Goodwill                                                                                                                                                                 |       | 180,627                     |       | 100,180                     |       |
| Intangible assets, net                                                                                                                                                   |       | 98,211                      |       | 44,051                      |       |
| Other long-term  assets                                                                                                                                                  |       | 80,368                      |       | 70,625                      |       |
| Total assets                                                                                                                                                             |       | $                           | 3,316,005  |                        | $          | 2,244,050 |   |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY**                                                                                                        |       |                        |       |                        |       |
| Current liabilities:                                                                                                                                                     |       |                        |       |                        |       |
| Accounts payable                                                                                                                                                         |       | $                           | 407,536    |                        | $          | 251,121 |   |
| Short-term debt                                                                                                                                                          |       | 351,183                     |       | 1                           |       |
| Income taxes payable                                                                                                                                                     |       | 143,778                     |       | 14,265                      |       |
| Customer advances                                                                                                                                                        |       | 323,938                     |       | 450,499                     |       |
| Deferred revenue                                                                                                                                                         |       | 66,941                      |       | 44,958                      |       |
| Other current  liabilities                                                                                                                                               |       | 241,577                     |       | 173,911                     |       |
| Total current  liabilities                                                                                                                                               |       | 1,534,953                   |       | 934,755                     |       |
| Long-term debt                                                                                                                                                           |       | 410,655                     |       | 410,655                     |       |
| Total liabilities                                                                                                                                                        |       | 1,945,608                   |       | 1,345,410                   |       |
| Commitments and contingencies (Note 18)                                                                                                                                  |       |                        |       |                        |       |
| Minority interest in  consolidated subsidiaries                                                                                                                          |       | 5,025                       |       | 5,309                       |       |
| Stockholders’ equity:                                                                                                                                               |       |                        |       |                        |       |
| Common stock: $0.00125  par value; authorized: 750,000,000 shares; issued and outstanding:  114,486,632 and 104,272,477 at December 31, 2004 and 2003, respectively |       | 144                         |       | 131                         |       |
| Additional paid-in  capital                                                                                                                                              |       | 1,123,065                   |       | 654,483                     |       |
| Deferred stock  compensation                                                                                                                                             |       | (6,102                      | )          | (7,761                      | )          |
| Retained earnings                                                                                                                                                        |       | 243,452                     |       | 243,058                     |       |
| Accumulated other  comprehensive income                                                                                                                                  |       | 4,813                       |       | 3,420                       |       |
| Total stockholders’  equity                                                                                                                                         |       | 1,365,372                   |       | 893,331                     |       |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                      |       | $                           | 3,316,005  |                        | $          | 2,244,050 |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share amounts)**
| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales:                                                           |       |                                       |       |   |   |   |   |
| Unrelated party                                                      |       | $                                          | 2,558,908  |   | $ | 1,780,751 |   | $ | 858,768 |   |
| Related party                                                        |       | 144,673                                    |       | 184,436 |   | 123,038 |   |
|                                                                 |       | 2,703,581                                  |       | 1,965,187 |   | 981,806 |   |
| Cost of net sales:                                                   |       |                                       |       |   |   |   |   |
| Unrelated parties                                                    |       | 2,010,571                                  |       | 1,261,284 |   | 587,799 |   |
| Related party                                                        |       | 91,409                                     |       | 79,518 |   | 48,535 |   |
| Gross profit                                                         |       | 601,601                                    |       | 624,385 |   | 345,472 |   |
| Operating expenses:                                                  |       |                                       |       |   |   |   |   |
| Selling, general and administrative                                  |       | 315,703                                    |       | 188,339 |   | 110,263 |   |
| Research and development                                             |       | 219,045                                    |       | 155,252 |   | 86,182 |   |
| In-process research and development costs                            |       | 1,400                                      |       | 10,686 |   | 670 |   |
| Amortization of intangible assets                                    |       | 15,551                                     |       | 8,370 |   | 2,395 |   |
| Total operating  expenses                                            |       | 551,699                                    |       | 362,647 |   | 199,510 |   |
| Operating income                                                     |       | 49,902                                     |       | 261,738 |   | 145,962 |   |
| Interest income                                                      |       | 6,172                                      |       | 3,194 |   | 5,522 |   |
| Interest expense                                                     |       | (6,916                                     | )          | (4,671 | ) | (1,251 | ) |
| Other income  (expense), net                                         |       | 15,431                                     |       | 4,921 |   | (9,908 | ) |
| Equity in loss of  affiliated companies                              |       | (1,300                                     | )          | (5,260 | ) | (4,053 | ) |
| Income before  income taxes and minority interest                    |       | 63,289                                     |       | 259,922 |   | 136,272 |   |
| Income tax  benefit (expense)                                        |       | 9,841                                      |       | (45,399 | ) | (27,254 | ) |
| Minority interest  in (losses) earnings of consolidated subsidiaries |       | (285                                       | )          | (1,009 | ) | 1,156 |   |
| Net income                                                           |       | $                                          | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |
| Basic earnings per share                                             |       | $                                          | 0.64       |   | $ | 2.08 |   | $ | 0.98 |   |
| Diluted earnings  per share                                          |       | $                                          | 0.56       |   | $ | 1.75 |   | $ | 0.94 |   |
| Weighted average shares  used in per-share calculation:              |       |                                       |       |   |   |   |   |
| —Basic                                                          |       | 114,135                                    |       | 103,659 |   | 109,566 |   |
| —Diluted                                                        |       | 135,541                                    |       | 124,909 |   | 114,407 |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OFSTOCKHOLDERS’ EQUITY(In thousands, except share data)**
| ** **                                                                  | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | **Deferred  Stock ** | ** ** | **Retained**     | ** ** | **Notes  Receivable  from** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Total  Stockholders’ ** | ** ** | **Comprehensive** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|---------------------------|------------|------------------|------------|-----------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|-------------------|------------|
| ** **                                                                  | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Paid-in-Capital**       | ** ** | **Compensation** | ** ** | **Earnings**                | ** ** | **Stockholders**                      | ** ** | **Income/(Loss)**                   | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| Balances,  December 31, 2001                                           |       | 109,302,816           |       |           | $          | 138                       |       |             |       | $                           | 638,697    |                                  |       |                                | $          | (6,045            | )          |   | $ | 49,146 |   |   | $ | (381 | ) |   |   | $ | 332 |   |   |   | $ | 681,887 |   |   |   |   |   |   |
| Common stock  issued upon exercise of options                               |       | 1,717,899             |       |           | 3          |                      |       |             | 9,162      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 9,165 |   |   |   |   |   |   |
| Common stock  issued upon Softbank offering, net of expenses                |       | 1,500,000             |       |           | 2          |                      |       |             | 28,933     |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 28,935 |   |   |   |   |   |   |
| Common stock  issued upon ESPP purchases                                    |       | 182,437               |       |           |       |                      |       |             | 2,828      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 2,828 |   |   |   |   |   |   |
| ACD acquisition-related  stock issuances                                    |       | 84,756                |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Repurchase of  Softbank shares, including fees                              |       | (6,000,000            | )          |           | (8         | )                         |       |             | (36,433    | )                           |       |                                  |       |                                |       | (36,488           | )          |   |   |   |   |   |   |   |   |   | (72,929 | ) |   |   |   |   |   |
| Cancellation of  deferred compensation charges due to employee terminations |       |                  |       |           |       |                      |       |             | (1,282     | )                           |       |                                  | 1,282      |                                |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Amortization of  deferred stock compensation                                |       |                  |       |           |       |                      |       |             | 103        |                        |       |                                  | 2,997      |                                |       |              |       |   |   |   |   |   |   |   |   |   | 3,100 |   |   |   |   |   |   |
| Acquisition-related  deferred compensation                                  |       |                  |       |           |       |                      |       |             | 10,000     |                        |       |                                  | (10,000    | )                                   |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Tax benefits for  non-qualified stock option exercises                      |       |                  |       |           |       |                      |       |             | 6,538      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 6,538 |   |   |   |   |   |   |
| Collections on  notes receivable from stockholders                          |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   | 99 |   |   |   |   |   |   |   | 99 |   |   |   |   |   |   |
| Net income                                                                  |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       | 107,862           |       |   |   |   |   |   |   |   |   |   | 107,862 |   |   |   | $ | 107,862 |   |   |
| Other comprehensive income:                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding  loss (net of tax of $298)                               |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | (952 | ) |   |   | (952 | ) |   |   | (952 | ) |   |
| Translation  adjustment                                                     |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | (138 | ) |   |   | (138 | ) |   |   | (138 | ) |   |
| Total  comprehensive income                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 106,772 |   |   |
| Balances,  December 31, 2002                                           |       | 106,787,908           |       |           | 135        |                      |       |             | 658,546    |                        |       |                                  | (11,766    | )                                   |       | 120,520           |       |   | (282 | ) |   |   | (758 | ) |   |   | 766,395 |   |   |   |   |   |   |
| Common stock  issued upon exercise of options                               |       | 4,490,195             |       |           | 6          |                      |       |             | 55,053     |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 55,059 |   |   |   |   |   |   |
| Common stock  issued upon ESPP purchases                                    |       | 261,103               |       |           |       |                      |       |             | 3,839      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 3,839 |   |   |   |   |   |   |
| Repurchase of  Softbank shares, including fees                              |       | (8,000,000            | )          |           | (10        | )                         |       |             | (46,605    | )                           |       |                                  |       |                                |       | (92,994           | )          |   |   |   |   |   |   |   |   |   | (139,609 | ) |   |   |   |   |   |
| Purchase of  convertible bond hedge and call option                         |       |                  |       |           |       |                      |       |             | (43,792    | )                           |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | (43,792 | ) |   |   |   |   |   |
| Common stock  issued for RollingStreams acquisition                         |       | 164,115               |       |           |       |                      |       |             | 6,233      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 6,233 |   |   |   |   |   |   |
| Shanghai Yi Yun  acquisition-related stock issuance                         |       | 226,302               |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Deferred compensation  related to RollingStreams acquisition                |       |                  |       |           |       |                      |       |             |       |                        |       |                                  | (434       | )                                   |       |              |       |   |   |   |   |   |   |   |   |   | (434 | ) |   |   |   |   |   |
| Cancellation of  deferred compensation charges due to employee terminations |       |                  |       |           |       |                      |       |             | (156       | )                           |       |                                  | 156        |                                |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Amortization of  deferred stock compensation                                |       |                  |       |           |       |                      |       |             |       |                        |       |                                  | 4,283      |                                |       |              |       |   |   |   |   |   |   |   |   |   | 4,283 |   |   |   |   |   |   |
| Common stock  issued for Shanghai Yi Yun acquisition                        |       | 342,854               |       |           |       |                      |       |             | 6,001      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 6,001 |   |   |   |   |   |   |
| Tax benefits for non-qualified  stock option exercises                      |       |                  |       |           |       |                      |       |             | 15,364     |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 15,364 |   |   |   |   |   |   |
| Collections of  notes receivable from stockholders                          |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   | 282 |   |   |   |   |   |   |   | 282 |   |   |   |   |   |   |
| Net income                                                                  |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       | 215,532           |       |   |   |   |   |   |   |   |   |   | 215,532 |   |   |   | $ | 215,532 |   |   |
| Other comprehensive income:                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding  gain (net of tax of $506)                               |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | 2,166 |   |   |   | 2,166 |   |   |   | 2,166 |   |   |
| Translation  adjustment                                                     |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | 2,012 |   |   |   | 2,012 |   |   |   | 2,012 |   |   |
| Total  comprehensive income                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 219,710 |   |   |
| Balances,  December 31, 2003                                           |       | 104,272,477           |       |           | 131        |                      |       |             | 654,483    |                        |       |                                  | (7,761     | )                                   |       | 243,058           |       |   | — |   |   |   | 3,420 |   |   |   | 893,331 |   |   |   |   |   |   |
| Common stock  issued upon exercise of options                               |       | 1,191,877             |       |           | 2          |                      |       |             | 18,525     |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 18,527 |   |   |   |   |   |   |
| Common stock  issued upon ESPP purchases                                    |       | 445,844               |       |           |       |                      |       |             | 7,130      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 7,130 |   |   |   |   |   |   |
| Common stock  issued upon secondary offering, net of expenses               |       | 12,100,000            |       |           | 15         |                      |       |             | 474,539    |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 474,554 |   |   |   |   |   |   |
| Common stock  issued upon exercise of warrants                              |       | 32,000                |       |           |       |                      |       |             | 80         |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 80 |   |   |   |   |   |   |
| Common stock  repurchased per Repurchase Plan, including fees               |       | (3,555,566            | )          |           | (4         | )                         |       |             | (34,544    | )                           |       |                                  |       |                                |       | (73,021           | )          |   |   |   |   |   |   |   |   |   | (107,569 | ) |   |   |   |   |   |
| Amortization of  deferred stock compensation                                |       |                  |       |           |       |                      |       |             |       |                        |       |                                  | 519        |                                |       |              |       |   |   |   |   |   |   |   |   |   | 519 |   |   |   |   |   |   |
| Cancellation of  deferred compensation charges due to employee terminations |       |                  |       |           |       |                      |       |             | (1,140     | )                           |       |                                  | 1,140      |                                |       |              |       |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Tax benefits for  non-qualified stock option exercises                      |       |                  |       |           |       |                      |       |             | 3,992      |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   | 3,992 |   |   |   |   |   |   |
| Net income                                                                  |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       | 73,415            |       |   |   |   |   |   |   |   |   |   | 73,415 |   |   |   | $ | 73,415 |   |   |
| Other comprehensive income:                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding  loss (net of tax of $516)                               |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | (1,351 | ) |   |   | (1,351 | ) |   |   | (1,351 | ) |   |
| Translation  adjustment                                                     |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   | 2,744 |   |   |   | 2,744 |   |   |   | 2,744 |   |   |
| Total  comprehensive income                                                 |       |                  |       |           |       |                      |       |             |       |                        |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 74,808 |   |   |
| Balances,  December 31, 2004                                           |       | 114,486,632           |       |           | $          | 144                       |       |             |       | $                           | 1,123,065  |                                  |       |                                | $          | (6,102            | )          |   | $ | 243,452 |   |   | $ | — |   |   |   | $ | 4,813 |   |   |   | $ | 1,365,372 |   |   |   |   |   |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OFCASH FLOWS(In thousands)**
| ** **                                                                        | ** ** | **Year ended December 31** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                        | ** ** | **2004**                                  | ** ** | **2003** | ** ** | **2002** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                             |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                        |       |                                      | $          | 73,415 |   |   |   | $ | 215,532 |   |   |   | $ | 107,862 |   |   |
| Adjustment to reconcile  net income to net cash provided by operating activities: |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                    |       |                                      | 76,203     |   |   |   | 44,708 |   |   |   | 22,435 |   |   |
| Loss on sale of  assets                                                           |       |                                      | 2,201      |   |   |   | 1,920 |   |   |   | 1,098 |   |   |
| Loss on impairment  of long-term assets                                           |       |                                      | —     |   |   |   | 8,762 |   |   |   | — |   |   |
| Loss on impairment  of goodwill and intangible assets                             |       |                                      | 12,706     |   |   |   | — |   |   |   | — |   |   |
| Loss on sale of  notes receivable                                                 |       |                                      | —     |   |   |   | 2,286 |   |   |   | — |   |   |
| In-process  research and development costs                                        |       |                                      | 1,400      |   |   |   | 10,686 |   |   |   | 670 |   |   |
| Amortization of  debt issuance costs                                              |       |                                      | 2,332      |   |   |   | 1,953 |   |   |   | — |   |   |
| Warrants  adjustment to fair value                                                |       |                                      | (46        | ) |   |   | (424 | ) |   |   | — |   |   |
| Loss (gain) on  sale of investment                                                |       |                                      | (1,912     | ) |   |   | 73 |   |   |   | — |   |   |
| Impairment of long-term  investment                                               |       |                                      | 1,608      |   |   |   | 75 |   |   |   | 4,442 |   |   |
| Stock compensation  expense                                                       |       |                                      | 519        |   |   |   | 4,302 |   |   |   | 3,100 |   |   |
| Provision for  doubtful accounts                                                  |       |                                      | 21,284     |   |   |   | 4,922 |   |   |   | 7,197 |   |   |
| Provision for  inventory reserve                                                  |       |                                      | 39,000     |   |   |   | 14,626 |   |   |   | 18,937 |   |   |
| Equity in loss of  affiliated companies                                           |       |                                      | 1,300      |   |   |   | 5,261 |   |   |   | 4,053 |   |   |
| Deferred income  taxes                                                            |       |                                      | (119,220   | ) |   |   | (10,675 | ) |   |   | (14,704 | ) |   |
| Minority interest  in losses (earnings) of consolidated subsidiary                |       |                                      | (285       | ) |   |   | (1,009 | ) |   |   | 1,156 |   |   |
| Changes in operating assets and liabilities, net of  acquisitions:                |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Accounts  receivable                                                              |       |                                      | (455,865   | ) |   |   | (151,863 | ) |   |   | (34,207 | ) |   |
| Inventories                                                                       |       |                                      | (197,604   | ) |   |   | (81,618 | ) |   |   | (76,056 | ) |   |
| Deferred  costs/Inventories at customer sites under contracts                     |       |                                      | 299,918    |   |   |   | (301,081 | ) |   |   | (137,806 | ) |   |
| Other current and  non-current assets                                             |       |                                      | (14,074    | ) |   |   | (120,206 | ) |   |   | (24,551 | ) |   |
| Accounts payable                                                                  |       |                                      | 98,281     |   |   |   | (5,906 | ) |   |   | 170,452 |   |   |
| Income taxes  payable                                                             |       |                                      | 133,509    |   |   |   | 16,626 |   |   |   | 9,007 |   |   |
| Customer advances                                                                 |       |                                      | (134,157   | ) |   |   | 294,163 |   |   |   | 87,776 |   |   |
| Deferred revenue                                                                  |       |                                      | 21,918     |   |   |   | 27,379 |   |   |   | 47 |   |   |
| Other current  liabilities                                                        |       |                                      | 42,564     |   |   |   | 64,681 |   |   |   | 27,683 |   |   |
| Net cash (used in)  provided by operating activities                              |       |                                      | (95,005    | ) |   |   | 45,173 |   |   |   | 178,591 |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                             |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Additions to  property, plant and equipment                                       |       |                                      | (135,575   | ) |   |   | (123,214 | ) |   |   | (75,271 | ) |   |
| Investment in  affiliates, net of cash acquired                                   |       |                                      | (19,292    | ) |   |   | (661 | ) |   |   | (28,933 | ) |   |
| Issuance of note  receivable to related party                                     |       |                                      | —     |   |   |   | (10,071 | ) |   |   | — |   |   |
| Purchase of  businesses, net of cash acquired                                     |       |                                      | (217,751   | ) |   |   | (106,713 | ) |   |   | (17,706 | ) |   |
| Proceeds from  disposal of property, plant and equipment                          |       |                                      | 428        |   |   |   | 21 |   |   |   | 175 |   |   |
| Purchase of  intangible assets                                                    |       |                                      | (4,158     | ) |   |   | (2,340 | ) |   |   | — |   |   |
| Change in  restricted cash                                                        |       |                                      | (8,943     | ) |   |   | (3,153 | ) |   |   | (21,251 | ) |   |
| Purchase of short-term  investments                                               |       |                                      | (319,253   | ) |   |   | (147,544 | ) |   |   | (140,583 | ) |   |
| Proceeds from sale  of short-term investments                                     |       |                                      | 236,497    |   |   |   | 217,180 |   |   |   | 118,168 |   |   |
| Net cash used in  investing activities                                            |       |                                      | (468,047   | ) |   |   | (176,495 | ) |   |   | (165,401 | ) |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                             |       |                                      |       |   |   |   |   |   |   |   |   | *** *** |   |
| Issuance of stock,  net of expenses                                               |       |                                      | 25,737     |   |   |   | 58,878 |   |   |   | 40,928 |   |   |
| Purchase of  convertible bond hedge and call option                               |       |                                      | —     |   |   |   | (43,792 | ) |   |   | — |   |   |
| Proceeds from  borrowing                                                          |       |                                      | 390,000    |   |   |   | 422,976 |   |   |   | 39,621 |   |   |
| Payments for  borrowing                                                           |       |                                      | (40,000    | ) |   |   | (23,389 | ) |   |   | (110,101 | ) |   |
| Repurchase of  stock                                                              |       |                                      | (107,569   | ) |   |   | (139,609 | ) |   |   | (72,929 | ) |   |
| Proceeds from  equity offering                                                    |       |                                      | 474,554    |   |   |   | — |   |   |   | — |   |   |
| Proceeds from  stockholder notes                                                  |       |                                      | —     |   |   |   | 282 |   |   |   | 99 |   |   |
| Net cash provided  by (used in) financing activities                              |       |                                      | 742,722    |   |   |   | 275,346 |   |   |   | (102,382 | ) |   |
| Effect of exchange  rate changes on cash                                          |       |                                      | 5,115      |   |   |   | 1,779 |   |   |   | — |   |   |
| Net increase  (decrease) in cash and cash equivalents                             |       |                                      | 184,785    |   |   |   | 145,803 |   |   |   | (89,192 | ) |   |
| Cash and cash  equivalents at beginning of period                                 |       |                                      | 377,747    |   |   |   | 231,944 |   |   |   | 321,136 |   |   |
| Cash and cash equivalents  at end of period                                       |       |                                      | $          | 562,532 |   |   |   | $ | 377,747 |   |   |   | $ | 231,944 |   |   |

 

See accompanying notes to the consolidated financial statements.

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**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1—DESCRIPTION OF BUSINESS**

UTStarcom Inc. (the “Company”),a Delaware corporation, provides Internet Protocol (“IP”) networking productand service platforms and global service and support. The Company sells wirelessinfrastructure, broadband infrastructure and handsets and customer premiseequipment to operators in both fast growth and established telecommunicationsmarkets around the world. The Company enables its customers to rapidly deployrevenue-generating access services using their existing infrastructure,while providing a migration path to cost-efficient end-to-end IP networks. TheCompany was incorporated in 1991 and is headquartered in Alameda, California.

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

*Basis ofPresentation:*

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly and majority (over 50 percent) owned subsidiaries. All significantinter-company accounts and transactions have been eliminated in the preparationof the consolidated financial statements. Minority interest in consolidatedsubsidiaries and equity in affiliated companies are shown separately in theconsolidated financial statements. The Company also consolidates variableinterest entities (“VIE”) as defined by Financial Accounting Standards BoardInterpretation No. 46 (“FIN 46”), “Consolidation of Variable InterestEntities.”

*Restatement ofConsolidated Financial Statements:*

The Company filed the Amendment No. 1 to itsAnnual Report on Form 10-K for the year ended December 31, 2003 toreflect the restatement of its consolidated financial statements for the yearended December 31, 2003 and the quarters ended March 31, 2003, June 30,2003 and September 30, 2003 and certain corresponding changes describedbelow.

As part of the financial closing process for the yearended December 31, 2004, the Company identified certain errors resultingin a restatement which decreased the provision for income taxes and increasednet income by $20.7 million for the year ended December 31, 2003. Inaddition, as a result of the correction of the tax provision, retained earningswas increased by $20.7 million, additional paid-in capital was increased $0.9million, income taxes payable was decreased by $2.5 million, other long-termassets were increased by $21.6 million, prepaids were increased by $2.8 millionand other current assets were reduced by $5.3 million. There was no net effecton cash provided from operating activities as a result of this error.

During the evaluation of the errors related to theincome tax provision, the Company determined that an additionalreclassification of reported 2003 results was required. Specifically, cost ofsales and other income both increased by $3.5 million for the year ended December 31,2003 to properly classify certain incentive payments received for exports andvalue-added taxes in China.

In addition to the errors in the 2003 tax provision,the Company had not correctly identified a related party that is deemed a variableinterest entity and for whom the Company is considered the primary beneficiaryin accordance with FASB Interpretation No. 46 (“FIN 46”). The Company hascorrected its 2003 financial statements to reflect the consolidation of thisvariable interest entity, MDC Holding Limited (“MDC Holding”) and itsaffiliated entities (MDC Holding and such affiliated entities are referred to,collectively, as “MDC”). At December 31, 2003, this consolidation resultedin a $5.5 million increase in total assets and a $0.7 million increase in totalliabilities. There was no effect on net income as a result of thisconsolidation.

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Furthermore, an impairment charge of $7.4 million, netof taxes of $1.3 million, was recorded to reflect an impairment of MDCequipment subject to a revenue share arrangement. Due to the uncertaintiessurrounding the customer’s subscriber income and ability to pay under thisarrangement, the Company determined that an impairment charge should have beenrecorded in 2003 when these conditions should have been identified. Accordingly,an impairment charge of $7.4 million, net of tax, was recorded, which decreasedboth total assets and equity by $7.4 million at December 31, 2003.

In addition, theCompany identified the following revisions in classification during thepreparation of the restated consolidated financial statements:

(1)          Costof sales for related party revenue transactions is presented separately fromcost of sales for non-related party revenue transactions for all years presented;

(2)          Certainother long-term assets increased and intangible assets decreased by $1.7million at December 31, 2003;

(3)          Changesin restricted cash had been incorrectly categorized as a part of operating cashflows instead of investing cash flows in accordance with Statement of FinancialAccounting Standards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly,the Company has reflected this change in categorization in the ConsolidatedStatement of Cash Flows for each of the three years in the period ended December 31,2003. The change for 2003 and 2002 is an increase in cash flows from operatingactivities and a decrease in cash flows from investing activities of $3.2million and $21.3 million, respectively, and there was no change for 2001 and

(4)          Arelated party which is 31% owned by an individual related to a member of theCompany’s Board of Directors and associated transactions have been identified. SeeNote 22 to the Consolidated Financial Statements.

*Use of Estimates:*

The preparation of consolidated financial statementsin conformity with generally accepted accounting principles in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Estimates are used for revenue recognition, allowance fordoubtful accounts and sales returns, reserves for inventory, deferred costs andaccrued product warranty costs, tax valuation allowances, goodwill impairmentsand loss contingencies, among others. Actual results could differ from thoseestimates.

During 2004, the Companychanged its estimate related to allowance for doubtful accounts to reflect newtrends in the collection cycles, primarily in China. At December 31, 2004,this change in estimate resulted in a $10.1 million lower allowance fordoubtful accounts than would have been recorded using the prior rates.

*Cash and CashEquivalents:*

Cash and cash equivalentsconsist of highly liquid instruments with maturities of three months or less atthe date of purchase.

*Short-termInvestments:*

Short-terminvestments consist of investments with original or remaining maturities ofmore than three months but less than twelve months. In accordance with theCompany’s investment policy, all short-term investments are invested in “investmentgrade” rated securities with a minimum of A or better 

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ratings. Currently, most of the Company’s short-terminvestments have AA or better ratings. Marketable securities are classified asavailable-for-sale and are carried at fair value. Unrealized holding gains andlosses on securities classified as available-for-sale are recorded as aseparate component of stockholders’ equity. Unrealized losses on securitiesclassified as available-for-sale that are determined to be other-than-temporaryare reported in earnings. Realized gains and losses are reported in earnings. Thefair value of investments is based on quoted market prices. At December 31,2004 and 2003, short-term investments in available-for-sale securitiesconsisted of (in thousands):
| ** **                                   | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Estimated  Fair  Value** | ** ** |
| Debt securities                              |       | $                               | 136,283    |   |   | $ | — |   |   | $ | 136,283 |   |
| Total current available  for-sale securities |       | $                               | 136,283    |   |   | $ | — |   |   | $ | 136,283 |   |

 
| ** **                                   | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Estimated  Fair  Value** | ** ** |
| Debt securities                              |       | $                               | 48,617     |   |   | $ | — |   |   | $ | 48,617 |   |
| Total current available  for-sale securities |       | $                               | 48,617     |   |   | $ | — |   |   | $ | 48,617 |   |

 

*Long-termInvestments:*

The Company hasinvestments in various privately held companies and investments funds. Investmentsin less than majority-owned affiliates over which we exercise significantinfluence are accounted for under the equity method pursuant to AccountingPrinciples Board Opinion No. 18. All other investments in affiliates arecarried at cost. The Company monitors for impairment and makes appropriatereductions in the carrying value if the Company determines that an impairmentcharge is required based on the financial condition and near-term prospects ofthese companies.

*Revenue Recognition:*

Revenues from sales of telecommunications equipmentand handsets are recognized when persuasive evidence of an arrangement exists,delivery of the product has occurred, customer acceptance has been obtained,the fee is fixed or determinable and collectability is reasonably assured. Ifthe payment due from the customer is not fixed or determinable due to extendedpayment terms, revenue is recognized as payments become due from the customer,assuming all other criteria for revenue recognition are met. Any paymentsreceived prior to revenue recognition are recorded as customer advances. Normalpayment terms differ for various reasons amongst different customer regions,depending upon common business practices for customers within a region. Shippingand handling costs are recorded as revenues and costs of revenues. Any expectedlosses on contracts are recognized when identified.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the areas of multiple element arrangements. Where multipleelements exist in an arrangement, the arrangement fee is allocated to thedifferent elements based upon verifiable objective evidence of the fair valueof the elements, as governed under Emerging Issues Task Force Issue (“EITF”) No. 00-21,and SEC Staff Accounting Bulletin No. 104 (“SAB 104”). Multiple elementarrangements primarily involve the sale of Personal Access Systems (“PAS”), afamily of wireless access handsets, wireless consumer products and coreinfrastructure equipment or Internet Protocol-based PAS, (“iPAS”), wirelessaccess systems that employ micro cell radio technology and specializedhandsets, allowing service providers to offer subscribers both mobile and fixedaccess to telephone services. These multiple element arrangements include thesale of PAS or iPAS equipment with handsets, installation and 

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training and the provisionof such equipment to different locations for the same customer. Revenue isrecognized as each element is earned, namely upon installation and acceptanceof equipment or delivery of handsets, provided that the fair value of theundelivered element(s) has been determined, the delivered element(s) hasstand-alone value, there is no right of return on delivered element(s), and theCompany is in control of the undelivered element(s). For arrangements thatinclude service elements, including promotional support and installation, forwhich verifiable objective evidence of fair value does not exist, revenue isdeferred until such services are deemed complete.

Final acceptance is required for revenue recognitionwhen installation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and theCompany is entitled to the full payment. The Company will not recognize revenuebefore final acceptance is granted by the customer if acceptance is consideredsubstantive to the transaction. Additionally, the Company does not recognizerevenue when cash payments are received from customers for transactions that donot have the customer’s final acceptance. The Company records these cashreceipts as customer advances, and defers revenue recognition until finalacceptance is received.

Where multiple elements exist in an arrangement thatincludes software, and the software is considered more than incidental to theequipment or services in the arrangement, software and software relatedelements are recognized under the provisions of Statement of Position 97-2, asamended, and EITF No. 03-05. The Company allocates revenues to eachelement of software arrangements based on vendor specific objective evidence (“VSOE”).VSOE of each element is based on the price charged when the same element issold separately. The Company uses the residual method to recognize revenue whenan arrangement includes one or more elements to be delivered at a future dateand VSOE of the fair value of all the undelivered elements exists. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the arrangement fee is recognized as revenue. If evidenceof fair value of one or more undelivered elements does not exist, revenue isdeferred and recognized when delivery of those elements occurs or when fairvalue can be established.

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

The Company also sells products through resellers. Revenueis generally recognized when the standard price protection period, which rangesfrom 30 to 90 days, has lapsed. If collectability cannot be reasonably assuredin a reseller arrangement, revenue is recognized upon sell-through to the endcustomer and receipt of cash. There may be additional obligations in resellerarrangements such as inventory rotation, or stock exchange rights on theproduct. As such, revenue is recognized in accordance with Statement ofFinancial Accounting Standards No. 48, “Revenue Recognition When Right ofReturn Exists,” (“SFAS 48”). The Company has developed reasonable estimates forstock exchanges. Estimates are derived based on historical experience withsimilar types of sales of similar products.

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

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The assessment of collectability is also a factor indetermining whether revenue should be recognized. The Company assessescollectability based on a number of factors, including payment history and thecredit worthiness of the customer. The Company does not request collateral fromits customers. In international sales, the Company often requires letters ofcredit from its customers that can be drawn on demand if the customer defaultson its payment. If the Company determines that collection of a payment is notreasonably assured, the Company recognizes revenue at the time collectionbecomes reasonably assured, which is generally upon receipt of cash.Occasionally, the Company enters into revenue sharing arrangements. Under thesearrangements, the Company collects revenues only after its customer, thetelecommunications service provider, collects service revenues. When theCompany enters a revenue sharing arrangement, the Company does not recognizerevenue until collection is reasonably assured.

Because of the nature ofdoing business in China and other emerging markets, the Company’s billingsand/or customer payments may not correlate with the contractual payment termsand the Company generally does not enforce contractual payment terms prior tofinal acceptance. Accordingly, accounts receivable are not booked until theCompany recognizes the related customer revenue. Advances from customers arerecognized when the Company has collected cash from the customer, prior torecognizing revenue. Deferred revenue is recorded if there are undeliveredelements after final acceptance has been obtained.

*Product Warranty:*

The Company provides awarranty on its equipment and handset sales for a period generally ranging fromone to three years from the time of final acceptance. Very rarely, the Companyhas entered into arrangements to provide limited warranty services for periodslonger than three years. The longest such warranty period is ten years. TheCompany provides for the expected cost of product warranties at the time thatrevenue is recognized based on an assessment of past warranty experience.

*Accounts and NotesReceivable:*

The Company accepts banknotes and commercial notes from its customers in China in the normal course ofbusiness and estimates the collectability of its trade receivables and notesreceivable. The notes are typically non-interest bearing, with maturity datesbetween three and six months. An allowance for doubtful accounts is maintainedfor the estimated losses on the trade receivables and notes receivable whencollection may no longer be reasonably assured. The Company assessescollectability of the receivable by determining whether the creditworthiness ofthe customer has deteriorated and could result in an inability to collectpayment; if collectability is doubtful, the Company records an allowanceagainst the receivable. If a customer’s financial condition were todeteriorate, causing their ability to make payments to suffer as a result, theallowances for receivables may need to be increased. With greater concentrationof accounts receivable with certain customers, the financial conditions of anyspecific or individual customer may result in increased concentration riskexposure. Allowances for doubtful accounts were $51.2 million and$31.2 million at December 31, 2004 and 2003, respectively, for totalreceivables, including accounts receivable from related parties.

*Inventories:*

Inventories consist ofinventories held at the Company’s manufacturing facility, warehouses or atcustomer sites prior to signing of contracts. The Company may ship inventory toexisting customers that require additional equipment to expand their existingnetworks prior to the signing of an expansion contract. Inventories are statedat the lower of cost or net realizable value, net of write-downs forexcess, slow moving and obsolete inventory. With the exception of the handsetinventory for our Personal Communications Division (“PCD”), which is based onweighted average cost, inventory cost is computed using standard cost, whichapproximates actual cost on a first-in, first-out basis. Inventory is writtendown 

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forestimated obsolescence or unmarketable inventory equal to the differencebetween inventory cost and the estimated market value.

*Deferredcosts/Inventories at customer sites under contracts:*

Inventories at customersites under contracts awaiting final acceptance are classified as deferredcosts. Title associated with this inventory has transferred to the customer whohas assumed the risk of physical loss. Deferred costs also includes laborrelated to third party integrators and freight. All deferred costs arestated at cost. Management periodically assesses the recoverability of deferredcosts and provides reserves against deferred cost balances when recoveryof deferred costs is not probable. Recoverabilityis evaluated based on various factors including length of time inventory hasbeen held at the customer site, the viability of payment, including assessmentof product demand if a revenue sharing arrangement exists. Revenue andcost of sales are recorded when final acceptance is received from the customer.With greater concentration of inventory at customer sites under contract withspecific or individual customer, the financial conditions of any specific orindividual customer may result in increased concentration risk exposure for ourinventory.

*Research andDevelopment and Capitalized Software Development Costs:*

Research and development costs are charged to expenseas incurred. Research and development costs include payroll related costs,contractor fees, facility expenses, third party license fees and allocations ofoverhead costs.

Costs incurred in thedevelopment of software that will ultimately be sold are capitalized during thetime between when technological feasibility has been attained and the relatedproduct is ready for general release. During 2004 and 2003, the Companycapitalized $5.3 million and $4.2 million of software development costs,respectively. Amortization of capitalized development costs were $3.0 million,$1.8 million and $1.1 million in 2004, 2003 and 2002, respectively. Unamortizedcapitalized software development costs for 2004 and 2003 were $15.9 million and$7.5 million, respectively. Direct costs of software developed forinternal use are expensed during the preliminary project stage and capitalizedduring the application development stage.

*Property, Plant andEquipment:*

Property,plant and equipment are recorded at cost and are stated net of accumulateddepreciation. Depreciation is provided for on a straight-line basis over theestimated useful lives of the related assets. Land use rights related toproperty leased by the Company in China are amortized over the life of thelease. Leasehold improvements are amortized on a straight-line basis over theshorter of the useful life of the improvements or the term of the lease. Whenassets are disposed of, the cost and related accumulated depreciation areremoved from the accounts and the resulting gains or losses are included inresults of operations. The Company generally depreciates its assets over thefollowing periods:
| ** **                                  | ** ** | **Years**                            | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| Furniture, test  or manufacturing equipment |       | 5                                    |       |
| Computers and  software                     |       | 2-3                                  |       |
| Buildings                                   |       | land  use rights                     |       |
| Automobiles                                 |       | 5                                    |       |
| Land use rights                             |       | life  of use rights                  |       |
| Leasehold  improvements                     |       | lesser  of 5 or remaining lease life |       |

 

The Company capitalizesinterest incurred related to construction of property, plant or equipment untilit is ready for use. During 2004, and 2003, the Company recorded $1.4 millionand $0.6 million, respectively, of capitalized interest applicable to theconstruction of its Hangzhou manufacturing facility. 

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TheHangzhou manufacturing facility was placed in service in October 2004. Capitalizedinterest is being amortized on a straight-line basis over the life of thebuilding.

*Consolidation ofVariable Interest Entities:*

The Financial AccountingStandards Board, (“FASB”) issued FASB Interpretation No. 46, (“FIN 46”).FIN 46 requires that if an entity is the primary beneficiary of a variableinterest entity, (“VIE”), the assets, liabilities, and results of operations ofthe VIE should be included in the consolidated financial statements of theentity. The Company has consolidated a related party deemed a VIE and with whomthe Company is the primary beneficiary.

*Goodwill andIntangible Assets:*

The Company has recordedgoodwill and intangible assets in connection with business acquisitions. Managementjudgment is required in the assessment of the related useful lives, assumptionsregarding the ability to successfully develop and ultimately commercializeacquired technology, and assumptions regarding the fair value and therecoverability of these assets. An annual goodwill impairment review isperformed in the fourth quarter of each year or when changes in circumstancesindicate a potential impairment exists. In the fourth quarter of 2004, theCompany reorganized its operations into three reportable segments and each havea single operating segment/reporting unit. The Company performed a goodwillimpairment analysis at the reporting unit level. At this time, no impairmentwas identified. When assessing potential impairment to goodwill, book value ofa reporting unit is compared to its fair value. Fair value is determined basedon the present value of estimated future cash flows.

*Impairment of Long-LivedAssets:*

Long-lived assetsand certain intangible assets are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount may not berecoverable. If undiscounted expected future cash flows are less than thecarrying value of the assets, an impairment loss will be recognized based onthe excess of the carrying amount over the fair value of the assets. Long-livedassets that are to be disposed of by sale are measured at the lower of bookvalue or fair value less cost to sell.

*Advertising Costs:*

The Company expenses alladvertising costs as incurred. Payment to customers for marketing developmentcosts are accounted for as a reduction of the revenue associated with customersas incurred. For the years ended December 31, 2004, 2003 and 2002,advertising costs totaled $8.0 million, $4.2 million and $1.7 million,respectively.

*Stock-BasedCompensation:*

The Company accounts for employee stock option grantsin accordance with Accounting Principles Board Opinion No. 25, “Accountingfor Stock Issued to Employees,” (“APB 25”) and has adopted the disclosure-onlyalternative of SFAS No. 123, as amended by SFAS No. 148, “Accountingfor Stock- Based Compensation,” (“SFAS 123”). Under APB 25,compensation expense is based on the difference, if any, on the date of grantbetween the fair value of the common stock and the exercise price of the option.

The fair value of warrants, options or stock exchangedfor services from non-employees is expensed over the period benefited. Thewarrants and options are valued using the Black-Scholes option-pricingmodel.

On December 31, 2004, a sub-committee of the Company’sBoard of Directors (the “Board”) approved an immediate and full acceleration ofvesting of all stock options outstanding under the 

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Company’s 1997 StockOption Plan with a per share exercise price greater than $22.15 (the “Acceleration”).The Company amended all relevant option agreements to reflect the Acceleration.The Company adopted the Acceleration in anticipation of the impact of FASBStatement No. 123(R), which requires expensing unvested options startingon January 1, 2006. As a result of the Acceleration, options to purchaseapproximately 6.4 million shares of the Company’s common stock becameimmediately exercisable as of December 31, 2004. The Acceleration had theeffect of decreasing 2004 pro forma net income by approximately $33.0 million. TheAcceleration had no impact on the financial statements as of and for the yearended December 31, 2004 and is not expected to have an impact on theCompany’s results of operations upon adoption of FASB Statement No. 123(R).

Thefollowing table illustrates the effect on net income and earnings per share ifthe Company had applied the fair value recognition provisions of SFAS 123 tostock-based employee compensation (in thousands, except per share data):
| ** **                                                                                                                   | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Basic                                                                                                                        |       |                                       |       |   |   |   |   |
| Net income:                                                                                                                  |       |                                       |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                          | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                  |       | 370                                        |       | 3,071 |   | 2,209 |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       | (68,083                                    | )          | (30,290 | ) | (20,060 | ) |
| Pro forma net  income                                                                                                        |       | $                                          | 5,702      |   | $ | 188,313 |   | $ | 90,011 |   |
| Basic income per share:                                                                                                      |       |                                       |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                          | 0.64       |   | $ | 2.08 |   | $ | 0.98 |   |
| Pro forma                                                                                                                    |       | $                                          | 0.05       |   | $ | 1.82 |   | $ | 0.82 |   |
| Diluted                                                                                                                      |       |                                       |       |   |   |   |   |
| Net income:                                                                                                                  |       |                                       |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                          | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |
| Effect of dilutive securities 7¤8%  convertible subordinated notes                                                      |       | —                                     |       | 3,090 |   | — |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                  |       | 370                                        |       | 3,071 |   | 2,209 |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       | (68,083                                    | )          | (30,290 | ) | (20,060 | ) |
| Pro forma net  income                                                                                                        |       | $                                          | 5,702      |   | $ | 191,403 |   | $ | 90,011 |   |
| Diluted income per share:                                                                                                    |       |                                       |       |   |   |   |   |
| As reported                                                                                                                  |       | $                                          | 0.56       |   | $ | 1.75 |   | $ | 0.94 |   |
| Pro forma                                                                                                                    |       | $                                          | 0.05       |   | $ | 1.57 |   | $ | 0.81 |   |

 

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Thefollowing assumptions were used to calculate the fair values:
| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| **Stock  Options:**                       | ** ** | ** **                                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Expected  remaining term in years         |       | 3.00                                       |       | 3.00 |   | 3.00 |   |
| Weighted average  risk-free interest rate |       | 2.78                                       | %          | 1.91 | % | 3.43 | % |
| Expected dividend  rate                   |       | 0.00                                       | %          | 0.00 | % | 0.00 | % |
| Volatility                                |       | 55.90                                      | %          | 64.00 | % | 67.50 | % |
|                                           |            |                                            |            |  |  |  |  |  |  |

 
|                                      |       | **Year ended December 31,** |       |
|-------------------------------------------|------------|--------------------------------------------|------------|
| **ESPP Shares:**                          | ** ** | ** **                                 | ** ** | **2004** | ** ** | **2003** | ** ** | ** ** | **2002** | ** ** |
| Expected  remaining term in years         |       | 0.53                                       |       | 0.74 |   |   | 0.50 |   |
| Weighted average  risk-free interest rate |       | 1.15                                       | %          | 1.48 | % |   | 1.96 | % |
| Expected dividend  rate                   |       | 0.00                                       | %          | 0.00 | % |   | 0.00 | % |
| Volatility                                |       | 47.0                                       | %          | 57.5 | % |   | 57.5 | % |
|                                           |            |                                            |            |  |  |  |  |  |  |  |

 

The weighted average fairvalue per share of options granted in 2004, 2003, and 2002 was $11.38, $11.41,and $9.16, respectively.

The weighted average fairvalue per share of ESPP shares granted in 2004, 2003, and 2002 was $7.41,$5.57, and $7.07, respectively.

*Comprehensive Income:*

Comprehensiveincome includes all changes in equity (net assets) during a period fromnon-owner sources. Accumulated other comprehensive income or loss is shown inthe consolidated statement of stockholders’ equity. As of December 31, thecomponents of Accumulated othercomprehensive income were as follows (in thousands): 
| ** **                                                                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|---------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized gains  and losses on available-for-sale securities, net of tax |       | $        | (11        | )        | $          | 1,340    |       | $ | (826 | ) |
| Foreign currency  translation                                             |       | 4,824    |       | 2,080    |       | 68       |       |
| Accumulated other  comprehensive income                                   |       | $        | 4,813      |     | $          | 3,420    |       | $ | (758 | ) |

 

*Income Taxes:*

The Company accounts for income taxes under the liabilitymethod, and deferred income taxes are recognized for thedifferences between the tax bases of assets and liabilities and their financialstatement amounts based on enacted tax rates. Valuation allowances areestablished when necessary to reduce deferred tax assets to the amount expectedto be realized. The Company is required to adjust its deferred tax asset and liabilitiesin the period when tax rates or the provisions of the income tax laws change.

The Company does notprovide for U.S. Federal taxes on undistributed earnings of its foreignsubsidiaries or affiliates as they are considered reinvested for an indefiniteperiod.

*Segment Reporting:*

As of December 31,2004, the Company was organized in three reportable segments:  China, International and PCD. The Chinareportable segment was comprised of discrete administrative, research anddevelopment, manufacturing, and sales and support infrastructure. TheInternational segment was comprised of operations of all other geographic areasincluding non-China Asia, Europe, the Middle East, Africa, and North and SouthAmerica. Resulting from the Company’s acquisition of selected assets ofAudiovox Communication Corporation, the handset division of AudiovoxCorporation, the acquired business was integrated into the Company as aseparate and distinct operating division referred to as the Personal CommunicationsDivision (“PCD”) and became the third reportable segment of the Company.

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*FinancialInstruments and Derivatives:*

Financial instruments consist of cash and cashequivalents, short and long-term investments, notes receivable, accountsreceivable and payable, convertible subordinated debt, purchased and writtencall options and accrued liabilities. The carrying amounts of cash and cashequivalents, short-term investments, accounts receivable and payable andaccrued liabilities approximate their fair values because of the short-termnature of those instruments. The carrying amounts of the loan receivableapproximates its fair value based on the discounted value of future cash flowexpected to be received from this loan.

The Company uses derivative financial instruments tomanage its exposures to foreign currency exchange rate changes. The objectivesfor holding derivatives include reducing, eliminating, and efficiently managingthe economic impact of these exposures as effectively as possible. Derivativeinstruments are recognized as either assets or liabilities on the balance sheet.The Company measures those instruments at fair value and recognizes changes inthe fair value of derivatives in earnings in the period of change unless thederivative qualifies as an effective hedge that offsets certain exposures. Suchcontracts are designated at inception to the related foreign currency exposuresbeing hedged.

Thefollowing table summarizes the Company’s carrying values and fair values of itsother financial instruments:
| ** **              | ** ** | **December 31,**   | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **2004**                | ** ** | **2003** | ** ** |
| ** **              | ** ** | **Carrying value** | ** ** | **Fair value** | ** ** | **Carrying value** | ** ** | **Fair value** | ** ** |
| ** **              | ** ** | **(In thousands)** | ** ** |
| Convertible debt        |       |                    | $          | (402,500 | ) |   | $ | (475,200 | ) |   | $ | (402,500 | ) |   | $ | (686,263 | ) |
| Bank loans              |       |                    | (358,155   | ) |   | (358,155 | ) |   | (8,155 | ) |   | (8,155 | ) |
| Convertible bond  hedge |       |                    | 125,040    |   |   | 151,610 |   |   | 125,040 |   |   | 356,314 |   |
| Written call  option    |       |                    | (81,248    | ) |   | (107,582 | ) |   | (81,248 | ) |   | (283,730 | ) |
| Long-term  investments  |       |                    | $          | 35,590 |   |   | $ | 47,398 |   |   | $ | 24,066 |   |   | $ | 35,545 |   |

 

*Foreign CurrencyTranslation:*

Company operations areconducted through international subsidiaries and the financial statements ofthose subsidiaries are translated from their respective, functional currenciesinto U.S. dollars in accordance with SFAS No. 52, “Foreign CurrencyTranslation.” All foreign currency assets and liabilities are translated at theperiod-end exchange rate and all revenues and expenses are translated at theaverage exchange rate for the period. The effects of translating the financialstatements of foreign subsidiaries into U.S. dollars are reported as acumulative translation adjustment, a separate component of comprehensive incomein stockholders’ equity. Some inventory purchases are made in Japan andconsequentially, portions of accounts payable are denominated in Japanese Yen. Foreigncurrency transaction gains and losses are reported in earnings and were $0.8million, $8.7 million and $5.4 million of losses in 2004, 2003, and 2002,respectively.

*Earnings Per Share(“EPS”):*

Basic EPS is computed by dividing net income availableto common stockholders by the weighted average number of shares of the Company’scommon stock outstanding during the period. Diluted EPS is determined byadjusting net income as reported by the effect of dilutive securities andincreasing the number of shares by potentially dilutive common sharesoutstanding during the period. Potentially dilutive common shares consist ofemployee stock options, a written call option, warrants, convertiblesubordinated notes and vested acquisition-related stock options.

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Thefollowing is a summary of the calculation of basic and diluted EPS (inthousands, except per share data):
| ** **                                    | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Numerator:                                    |       |                                       |       |   |   |   |   |
| Net income (for  basic EPS computation)       |       | $                                          | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |
| Effect of  Dilutive Securities                |       |                                       |       |   |   |   |   |
| 7¤8%  Convertible subordinated notes     |       | 2,785                                      |       | 3,090 |   | — |   |
| Net income  adjusted for dilutive securities  |       | $                                          | 76,200     |   | $ | 218,622 |   | $ | 107,862 |   |
| Denominator:                                  |       |                                       |       |   |   |   |   |
| Shares used to  compute basic EPS             |       | 114,135                                    |       | 103,659 |   | 109,566 |   |
| Dilutive common stock  equivalent shares:     |       |                                       |       |   |   |   |   |
| Stock options                                 |       | 3,839                                      |       | 5,770 |   | 4,510 |   |
| Written call  option                          |       | 262                                        |       | 1,235 |   | — |   |
| Conversion of  convertible subordinated notes |       | 16,919                                     |       | 13,674 |   | — |   |
| Warrants                                      |       | 9                                          |       | 29 |   | 28 |   |
| Other                                         |       | 377                                        |       | 542 |   | 303 |   |
| Shares used to  compute diluted EPS           |       | 135,541                                    |       | 124,909 |   | 114,407 |   |
| Basic earnings per share                      |       | $                                          | 0.64       |   | $ | 2.08 |   | $ | 0.98 |   |
| Diluted earnings  per share                   |       | $                                          | 0.56       |   | $ | 1.75 |   | $ | 0.94 |   |

 

Certain potential shares related to employee stockoptions and warrants outstanding during the years ended December 31, 2004,2003 and 2002 were excluded in the diluted per share computations, since theirexercise prices were greater than the average market price of the common sharesduring the period and, accordingly, their effect is anti-dilutive. For theyears ended December 31, 2004, 2003 and 2002, these shares totaled 24.0million with a weighted average exercise price of $31.32 per share,17.6 million with a weighted average exercise price of $32.22 per share,2.8 million shares with a weighted average exercise price of $23.35 pershare, respectively.

On December 31, 2004, the Company’s 7¤8%convertible subordinated notes outstanding were ineligible for conversion intoshares of common stock. For each $1,000 of aggregate principal amount of notesconverted, the Company will deliver approximately 42.0345 shares of common stock,if the Company’s closing stock price exceeds a specified threshold as of thelast trading day of the immediately preceding fiscal quarter. At December 31,2004, the closing price of the Company’s common stock was below the specifiedthreshold. In September 2004, the EITF reached a consensus related to EITFNo. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earningsper Share.” The consensus requires contingently convertible debt instrumentswith a market price trigger to be treated the same as traditional convertibledebt instruments for purposes of computed earnings per share using the “ifconverted” method. The EITF pronouncement is effective and conversion isassumed in this diluted EPS computation.

The Company entered into convertible bond hedge andcall option transactions to reduce the potential dilution from conversion ofthe notes. Both the bond hedge and call option transactions may be settled atthe Company’s option either in cash or net shares and expire on March 1,2008. During the year ended December 31, 2004, the average price of theCompany’s stock was below the specified strike prices of both the convertiblebond hedge and call option transactions that the Company entered into to reducethe potential dilution from conversion of the notes.

For the twelve months ended December 31, 2004,the dilutive and anti-dilutive effects of the call option and the bond hedgewere derived by taking the weighted average of the first, second, third and 

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fourth quarters, inaccordance with SFAS 128. For the twelve months ended December 31, 2004,this would have the effect of decreasing the denominator for diluted earningsper share by 2.0 million shares for the bond hedge transaction, and increasingthe denominator for diluted earnings per share by 0.3 million shares for thecall option transaction. For the twelve months ended December 31, 2003,this would have the effect of decreasing the denominator for diluted earningsper share by 2.9 million shares for the bond hedge transaction, and increasingthe denominator for diluted earnings per share by 1.0 million shares for thecall option transaction. However, only the dilutive effect of the 0.3 millionshares for the twelve months ended December 31, 2004, and the 1.0 millionshares for the twelve months ended December 31, 2003, with respect to thecall option transaction, were included in the Company’s diluted earnings pershare calculation above. The convertible bond hedge, under SFAS 128, is alwaysanti-dilutive.

The net income for thediluted EPS computation reflects the reduction in interest expense of $2.8million and $3.1 million for the years ended December 31, 2004 and2003, respectively, that would result from an assumed conversion of the 7¤8%convertible subordinated notes.

*Recent AccountingPronouncements:*

In December 2004, the Financial AccountingStandards Board, “FASB”, issued SFAS No. 123 (revised 2004), “Share-BasedPayment,” (“SFAS 123(R)”). SFAS 123(R) will require the Company to measureall employee stock-based compensation awards using a fair value method andrecord such expense in its consolidated financial statements. In addition, theadoption of SFAS 123(R) will require additional accounting related to theincome tax effects and additional disclosure regarding the cash flow effectsresulting from share-based payment arrangements.

In March 2005, the Securities and ExchangeCommission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”)which provides guidance regarding the application of SFAS 123(R). SAB 107 expressesviews of the staff regarding the interaction between SFAS No. 123(R),Share-Based Payment, and certain SEC rules and regulations and providesthe staff’s views regarding the valuation of share-based payment arrangementsfor public companies. In particular, SAB 107 provides guidance related toshare-based payment transactions with nonemployees, the transition fromnonpublic to public entity status, valuation methods (including assumptionssuch as expected volatility and expected term), the accounting for certainredeemable financial instruments issued under share-based payment arrangements,the classification of compensation expense, non-GAAP financial measures,first-time adoption of SFAS 123(R) in an interim period,capitalization of compensation cost related to share-based paymentarrangements, the accounting for income tax effects of share-based paymentarrangements upon adoption of SFAS 123(R), the modification of employee shareoptions prior to adoption of SFAS 123(R) and disclosures in Management’sDiscussion and Analysis (“MD&A”) subsequent to adoption of SFAS 123(R).

On April 14, 2005, the SEC approved a new rulethat delays the effective date for SFAS 123(R) to annual periods beginningafter June 15, 2005. The adoption of SFAS 123(R) on January 1, 2006 isexpected to have a material impact on the Company’s consolidated results ofoperations, financial position and statement of cash flows. The Company isevaluating the transition method and pricing model alternatives upon adoption.

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Non-monetary Assets, an amendment of APB Opinion No. 29,” (“SFAS153”). SFAS 153 addresses the measurement of exchanges of non-monetary assetsand redefines the scope of transactions that should be measured based on thefair value of the assets exchanged. SFAS 153 is effective for non-monetaryasset exchanges occurring in fiscal periods beginning after June 15, 2005.The adoption of SFAS 153 is not expected to have a material effect on theCompany’s consolidated financial position or results of operations.

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In November 2004, the FASB issued SFAS No. 151,“Inventory Costs, an amendment of ARB No. 43, Chapter 4,” (“SFAS 151”). SFAS151 clarifies that abnormal inventory costs such as costs of idle facilities,excess freight and handling costs, and wasted materials (spoilage) are requiredto be recognized as current period charges. The provisions of SFAS 151 areeffective for the fiscal year beginning after June 15, 2005. The adoptionof SFAS 151 is not expected to have a material impact on the Company’sconsolidated financial position, results of operations and cash flows.

In December 2004, theFASB issued FSP No. FAS 109-2, “Accounting and Disclosure Guidance for theForeign Earnings Repatriation Provision within the American Jobs Creation Actof 2004.” The American Jobs Creation Act of 2004 provides a one-time 85%dividends received deduction for certain foreign earnings that are repatriatedunder a plan for reinvestment in the United States, provided certain criteriaare met. FSP No. FAS 109-2 is effective immediately and providesaccounting and disclosure guidance for the repatriation provision. FSP No. FAS109-2 allows companies additional time to evaluate the effects of the law onits unremitted earnings for the purpose of applying the “indefinite reversalcriteria” under APB Opinion No. 23, “Accounting for Income Taxes—SpecialAreas,” and requires explanatory disclosures from companies that have not yetcompleted the evaluation. The Company is currently evaluating the effects ofthe repatriation provision and their impact on our consolidated financialstatements. The Company does not expect to complete this evaluation before theend of 2006. The range of possible amounts of unremitted earnings that is beingconsidered for repatriation under this provision is between zero and $541million and the related potential range of income tax is between zero and $28million.

**NOTE3—SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION**
| ** **                        | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                        | ** ** | **(in thousands)**                    | ** ** |
| Cash paid during  the period for: |       |                                       |       |   |   |   |   |
| Interest                          |       | $                                          | 5,074      |   | $ | 2,795 |   | $ | 1,492 |   |
| Income taxes                      |       | $                                          | 11,177     |   | $ | 47,192 |   | $ | 18,442 |   |

 

Non-cashactivities were as follows:
| ** **                                                    | ** ** | **Year ended December 31,** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                    | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                    | ** ** | **(in thousands)**                    | ** ** |
| Non-cash  operating activities were as follows:               |       |                                       |       |   |   |   |   |
| Accounts receivable transferred to notes receivable           |       | $                                          | 118,021    |   | $ | 92,181 |   | $ | 14,545 |   |
| Non-cash  investing and financing activities were as follows: |       |                                       |       |   |   |   |   |
| Common stock  issued in conjunction with acquisitions         |       | $                                          | —     |   | $ | 12,234 |   | $ | — |   |

 

**NOTE4—SHORT-TERM RESTRICTED CASH AND INVESTMENTS**

At December 31, 2004, the Company had short-term restrictedcash and investments of $33.3 million, primarily comprised of $24.3 million ofrestricted cash and $8.6 million of restricted short-term investments held forstandby letters of credit. At December 31, 2003, the Company hadrestricted cash and short-term investments of $24.4 million primarilycomprised of $20.5 million of restricted short-term investments forstandby letters of credit and restricted cash of a $3.7 million timedeposit required for Japanese tax purposes.

The Company issues standbyletters of credit primarily to support international sales activities outsideof China. When the Company submits a bid for a sale, often the potentialcustomer will require that the Company issue a bid bond or a standby letter ofcredit to demonstrate its commitment through the bid 

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process.In addition, the Company may be required to issue standby letters of credit asguarantees for advance customer payments upon contract signing or performanceguarantees. The standby letters of credit usually expire six to nine monthsfrom date of issuance without being drawn by the beneficiary thereof. Finally,the Company may issue letters of credit in support of purchase commitments.

**NOTE5—ACQUISITIONS AND DIVESTITURES OF COMPANIES**

*AudiovoxCommunications Corporation*

On November 1, 2004, the Company completed itsacquisition of Audiovox Communications Corporation (“ACC”) of select assets andliabilities, including inventories, prepaids, payables, accrued expenses andthe right to hire approximately 250 employees for $165.1 million in cash. TheCompany acquired ACC’s sales, service and support infrastructure, its CDMAhandset brand, access to supply-chain channels, product marketing expertise,and key relationships with CDMA operators in North and South America. Thegoodwill created in this acquisition results from this decreased time to marketand volume related synergies. This goodwill is tax deductible.

Thepurchase agreement allows for purchase price adjustments based on the actualworking capital balances at the date of acquisition. As a result of the workingcapital calculation, the purchase price will increase by $8.5 million. TheCompany made an additional payment of $5.7 million in cash in 2004 and paid theremaining balance of $2.8 million related to the working capital adjustment subsequentto year-end. Additionally, the Company incurred professional fees of $4.6million in connection with the acquisition. The following table summarizes theallocation of the purchase price for ACC based in part upon an independentvaluation:
| ** **                                                                                     | ** ** | **(in thousands)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets:                                                            |       |                    |       |   |   |
| Property, plant and equipment                                                                  |       |                    | $          | 873 |   |   |
| Inventory                                                                                      |       |                    | 116,254    |   |   |
| Deferred income taxes                                                                          |       |                    | 7,739      |   |   |
| Other tangible assets                                                                          |       |                    | 5,719      |   |   |
| Fair value of  identified intangible assets:                                                   |       |                    |       |   |   |
| Customer/dealer relationships                                                                  |       |                    | 24,400     |   |   |
| Supplier relationships                                                                         |       |                    | 5,300      |   |   |
| Non-compete agreement                                                                          |       |                    | 10,800     |   |   |
| Trade names                                                                                    |       |                    | 4,000      |   |   |
| Backlog                                                                                        |       |                    | 3,200      |   |   |
| Liabilities  assumed                                                                           |       |                    | (74,159    | ) |   |
| Excess of costs  of acquiring ACC over fair value of identified net assets acquired (goodwill) |       |                    | 74,125     |   |   |
|                                                                                           |       |                    | $          | 178,251 |   |   |

 

The Company acquired $47.7 million of intangibleassets, principally consisting of carrier and dealer relationships andnon-compete agreement. No amount was allocated to in-process research anddevelopment. The fair value of these identifiable intangible assets wereestimated based, in part, on an independent valuation.

The intangible assets have estimated useful livesranging from one to ten years as follows: customer relationships, ten years;dealer relationships, two years; supplier relationships, two years; non-competeagreement, four years; trade name, three years; and backlog, one year.

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The results of operations of ACC have been included inthe Company’s consolidated results of operations beginning on the acquisitiondate of November 1, 2004.

Refer to the consolidatedtable below for pro forma results of operations reflecting the combined resultsof the Company and ACC for the years ended December 31, 2004 and 2003 asif the business combination occurred at the beginning of the period. Theseresults do not purport to be indicative of what would have occurred had theacquisition been made as of that date or the results of operations which mayoccur in future periods.

*TELOS Technology, Inc.*

On May 19, 2004, the Company completed itsacquisition of substantially all of the assets and certain liabilities of TELOSTechnology, Inc. and its subsidiaries (“TELOS”). TELOS is a provider ofmobile switching products and services for voice and data communicationnetworks to developing rural, enterprise and emerging wireless markets. Thetotal consideration for the acquisition, funded from cash on hand, wasapproximately $30.0 million. The Company paid $29.0 million in cash, inaddition to $1.0 million of acquisition-related transaction costs. Within oneyear of the acquisition date, additional payments totaling a maximum of $19.0million may become payable based upon revenue recognized from the sale of TELOSproducts. In the event these revenue milestones are met, the original purchaseprice will be adjusted for the amount of the contingent payment in accordancewith Statement of Financial Accounting Standards No. 141, “BusinessCombinations,” (“SFAS 141”).

The existing technology acquired included the entireTELOS product family of code division multiple access (“CDMA”) softswitchtechnology products, supporting servers and operations maintenance centers. TheTELOS product line will be integrated with the Company’s suite of CDMAproducts, strengthening the Company’s existing CDMA product portfolio. Inaddition to developed product technology, the Company acquired fixed assets,in-process research and development (“IPR&D”), an assembled workforce ofapproximately 60 employees, customer relationships and recorded goodwill. Thegoodwill created in this acquisition results from decreased time to market inCDMA technologies. This goodwill is tax deductible.

Subsequent to the May 19, 2004 acquisition ofTELOS, the Company completed the allocation of the purchase price based in partupon an independent valuation. The amount of the purchase price allocated toIPR&D of $1.4 million was charged to the Company’s results of operations,as no alternative future uses existed at the acquisition date. The Companyinitially recorded goodwill of $6.6 million in connection with the acquisition.During the third quarter of 2004, the Company reduced both the purchase priceand goodwill associated with this acquisition by $0.2 million to reflect thedifference between the estimated and actual professional services fees incurredrelated to this acquisition. In total, the Company recorded $6.4 million ofgoodwill related to this acquisition. The results of operations of TELOS havebeen included in the Company’s consolidated results of operations beginning onthe acquisition date of May 19, 2004.

As of the acquisition date, TELOS had two projectsunder development that qualified for IPR&D. The objective of both projectsis to enhance the functionality of products designed to comply with theCDMA2000 technology standard. In assessing TELOS IPR&D projects, theCompany considered key product characteristics including the product’sdevelopment stage at the acquisition date, the product’s life cycle and theproduct’s future prospects. The Company also considered the rate at whichtechnology changes in the telecommunications equipment industry, the industry’scompetitive environment and the economic outlook for both local and globalmarkets.

The projects under development are enhancements toexisting products that do not affect the functionality of those existingproducts. As such, the significant risk the Company faces is to complete theseprojects within the scope of the budget. As of the closing date, these projectswere approximately 20% and 30% complete, respectively. As of December 31,2004, one project was completed, and for the 

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other project, theestimated completion date is June 2005, with estimated remaining costs tocomplete of $0.6 million.

Thefollowing table summarizes the allocation of the purchase price for TELOS basedupon the independent valuation (in thousands):
| Fair value of  tangible net assets:                                                               |   |   |   |
|---------------------------------------------------------------------------------------------------|--------|--------|--------|
| Property, plant and equipment                                                                     |   | $      | 2,010  |   |
| Inventory                                                                                         |   | 1,382  |   |
| Other tangible assets                                                                             |   | 1,242  |   |
| Fair value of  identified intangible assets:                                                      |   |   |   |
| Customer relationships                                                                            |   | 5,000  |   |
| Existing technology                                                                               |   | 15,900 |   |
| In-process research and development                                                               |   | 1,400  |   |
| Liabilities assumed                                                                               |   | (3,380 | )      |
| Excess of costs of acquiring TELOS over fair value  of identified net assets  acquired (goodwill) |   | 6,449  |   |
|                                                                                              |   | $      | 30,003 |   |

 

The estimated useful lives of the customerrelationships and existing technology intangible assets are five years.

Refer to the consolidatedtable below for the pro forma results of operations reflecting the combinedresults of the Company and TELOS for the year ended December 31, 2004 and2003 as if the business combination occurred at the beginning of the period. Theseresults do not purport to be indicative of what would have occurred had theacquisition been made as of that date or the results of operations which mayoccur in future periods.

*Hyundai Syscomm, Inc.*

On April 27, 2004, the Company completed itsacquisition of the assets, substantially all of the intellectual property,certain employees and certain contracts related to Hyundai Syscomm, Inc.’s(“HSI”) CDMA infrastructure business for markets outside of Korea. Subject tothe attainment of certain milestones and the transfer of certain know-how, thetotal consideration for this transaction was approximately $12.3 millionexcluding transaction costs of $1.8 million. Approximately $7.3 million in cashwas paid at the closing date and an additional $3.0 million in cash is payableone year from the closing date. The remaining purchase price was comprised of$2.0 million to be paid by the Company upon the completion of HSI training ofthe Company’s manufacturing employees in China under the terms of a TrainingServices Agreement. Not included in the purchase price was $2.0 million payableupon the completion of certain revenue milestones. In the event these revenuemilestones are met, the original purchase price will be adjusted for the amountof the contingent payment in accordance with SFAS 141.

In conjunction with this transaction, the Companyloaned HSI $3.2 million at an effective interest rate of 12% per annum, whichwas used by HSI to satisfy outstanding debt obligations. The principal amountof the loan is due in April 2005. The Company may offset HSI’s paymentobligations against the outstanding $3.0 million of the purchase price and anyother liabilities.

Under the terms of the transaction with HSI, theCompany acquired existing technologies and entered into non-compete andlicensing agreements. The existing technologies acquired were the basetransceiver station (“BTS”) and base station controller (“BSC”) product lines. Aspart of the asset purchase agreement, the Company and HSI entered into atraining services agreement, whereby HSI employees were to provide technicaltraining to Company manufacturing staff in China for the ninth-month period 

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subsequent to theacquisition. This technology and technological know-how will strengthen theCompany’s existing CDMA product portfolio and the development of future CDMAtechnology.

In addition to acquiring existing technology, theCompany entered non-compete and licensing agreements with HSI. The non-competeagreement prohibits HSI from competing against the Company in all countriesexcept Korea for four years from the consummation date. The licensing agreementrequires that HSI pay the Company 1% of revenue as royalty for the usage of theintellectual property that the Company acquired under the terms of theacquisition for fifteen years subsequent to the consummation date.

Subsequent to the April 27, 2004 acquisition ofHSI, the Company completed the allocation of the purchase price based in partupon an independent valuation. The Company recorded goodwill of $7.0 million inconnection with the acquisition. The results of operations of HSI have beenincluded in the Company’s consolidated results of operations beginning on theacquisition date of April 27, 2004.

Thefollowing table summarizes the final allocation of the purchase price for HSIbased upon the final independent valuation (in thousands):
| Fair value of  tangible net assets:                                                            | ** ** | ** ** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------|------------|
| Property, plant and equipment                                                                  |       | $          | 1,440      |   |
| Other tangible assets                                                                          |       | 437        |       |
| Fair value of  identified intangible assets:                                                   |       |       |       |
| Existing technology                                                                            |       | 3,559      |       |
| Non-compete agreement                                                                          |       | 761        |       |
| IP license agreement                                                                           |       | 891        |       |
| Excess of costs  of acquiring HSI over fair value of identified net assets acquired (goodwill) |       | 7,042      |       |
|                                                                                           |       | $          | 14,130     |   |

 

The intangible assets have estimated useful livesranging from three to five years as follows: existing technology, five years;non-compete agreement, three years; and intellectual property licenseagreement, three years. In the fourth quarter 2004, a decision was made tosubstantially abandon the acquired operations due to integration difficulties. Thus,the entire goodwill and all intangibles were written off in the fourth quarter2004. Refer to Note 10, Goodwill and Intangible Assets, for discussion ofwrite-off in relation to the HSI acquisition.

Refer to the consolidated table below for unauditedpro forma results of operations reflecting the combined results of the Companyand HSI for the years ended December 31, 2004 and 2003, as if the businesscombination occurred at the beginning of the period. These results do notpurport to be indicative of what would have occurred had the acquisition beenmade as of that date or the results of operations which may occur in futureperiods.

Theunaudited pro forma results of operations include historical operations of theCompany, TELOS, HSI and ACC (in thousands, except per share data):
| ** **                                     | ** ** | **Year Ended December 31,**                         | ** ** |
|------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2004**                                                           | ** ** | **2003** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share data)** | ** ** |
| Pro forma  adjusted net sales                  |       |                                                               | $          | 3,793,118 |   |   |   | $ | 2,777,440 |   |   |
| Pro forma  adjusted net income                 |       |                                                               | $          | 65,054 |   |   |   | $ | 154,992 |   |   |
| Pro forma adjusted basic earnings per share    |       |                                                               | $          | 0.57 |   |   |   | $ | 1.50 |   |   |
| Pro forma adjusted  diluted earnings per share |       |                                                               | $          | 0.48 |   |   |   | $ | 1.27 |   |   |

 

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*Giga Telecom, Inc.*

On October 29, 2004,UTStarcom CDMA Technologies Korea Limited, a limited liability companyorganized under the laws of Korea and a wholly owned subsidiary of the Company,entered into an Asset Purchase Agreement with Giga Telecom, Inc., (“Giga”)a Korean corporation that develops and manufactures wireless handsets. Pursuantto the Asset Purchase Agreement and related ancillary agreements, the Companywill pay $18.6 million for certain assets relating to the research anddevelopment of CDMA wireless products, of which $13.0 million will be paid incash at the closing, $1.6 million that has been paid by the Company pursuant toa separate arrangement in respect of certain services rendered by Giga relatingto the design of wireless handsets for the Company will be applied against thepurchase price and $4.0 million is to be paid in three separate installmentstied to certain product design and production milestones. The closing of thetransaction is subject to consent by creditors holding not less than 80% ofGiga’s aggregate debt (including all debt held by certain financialinstitutions) and other customary closing conditions, including approvalsand/or clearances from applicable governmental agencies (including thosenecessary to transfer assets acquired in the transaction outside the country)and certain other material consents and approvals. This transaction closed on January 4,2005. See Note 23, Subsequent Events.

***2003***

*CommWorks*

On May 23, 2003, the Company completed itsacquisition of selected assets and liabilities of the CommWorks division (“CommWorks”)from 3Com Corporation, a Delaware corporation, (“3Com”). The Company paid$100.0 million in cash and incurred related transaction and other relatedcosts of $9.3 million. The Company funded the consideration for theacquisition from cash on hand.

Selected assets acquired included CommWork’s portfolioof carrier-focused voice and data networking products and customersupport and professional services. In addition, the Company acquired orlicensed all of the 3Com intellectual property used by CommWorks. CommWorksdevelops and deploys carrier-class, IP-based multi-service accessand service-creation platforms for telecommunications service providers.

The Company made a preliminary allocation of thepurchase price based in part upon a preliminary independent appraisal. Duringthe three months ended September 30, 2003, the Company completed theallocation of the purchase price of CommWorks. The estimated amounts forintangible assets and goodwill changed due to revised assumptions of futurerevenues from existing customers. The amount of the purchase price allocated toin-process research and development (“IPR&D”) of $1.3 million wascharged to the Company’s results of operations, as no alternative future usesexisted at the acquisition date. The Company recorded goodwill of$52.3 million, the excess of costs of acquiring CommWorks and the fairvalue of identified net assets acquired, in connection with the acquisition.Goodwill is expected to be deductible for tax purposes. The results ofoperations of CommWorks have been included in the Company’s consolidatedresults of operations beginning on the acquisition date of May 23, 2003.

In assessing CommWork’s IPR&D projects, the keycharacteristics of the products under development were considered as well asfuture prospects, the rate at which technology changes in thetelecommunications equipment industry, product life cycles, and the projects’stages of development.

As of the date of the acquisition, CommWorks had twoprojects under development that qualified for IPR&D, which wereapproximately 60% and 40% complete. As of the fourth quarter of 2004, bothprojects were completed.

Thefollowing table summarizes the final allocation of the purchase price forCommWorks based upon the final independent valuation. The final valuationresulted in changes in estimated fair value, changes in the estimated usefullives of the intangible assets acquired and a change in the amount 

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attributable to goodwill, mainly due to revisedassumptions of future revenues from existing customers. The Company alsorecorded additional employee-related liabilities. The estimated usefullife of purchased technology is from one to five years, the estimated usefullife of customer relationships is ten years, and the estimated useful lives ofbacklog and trade names are from one to two years.
| ** **                                                                                           | ** ** | **(in thousands)** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets                                                                   |       |                    |       |   |   |
| Property, plant and equipment                                                                        |       |                    | $          | 10,973 |   |   |
| Other tangible assets                                                                                |       |                    | 6,522      |   |   |
| Deferred transition costs                                                                            |       |                    | 6,588      |   |   |
| Fair value of  identified intangible assets                                                          |       |                    |       |   |   |
| Customer relationships                                                                               |       |                    | 27,820     |   |   |
| Backlog                                                                                              |       |                    | 1,950      |   |   |
| Trade names                                                                                          |       |                    | 940        |   |   |
| Existing technology                                                                                  |       |                    | 14,190     |   |   |
| In-process research and development                                                                  |       |                    | 1,290      |   |   |
| Liabilities assumed                                                                                  |       |                    | (13,315    | ) |   |
| Excess of costs of acquiring CommWorks over fair  value of identified net assets acquired (goodwill) |       |                    | 52,349     |   |   |
|                                                                                                 |       |                    | $          | 109,307 |   |   |

 

Thefollowing unaudited pro forma results of operations reflect the combinedresults of the Company and CommWorks for the years ended December 31, 2003and 2002 as if the business combination occurred at the beginning of theperiod. These results do not purport to be indicative of what would haveoccurred had the acquisition been made as of that date or the results ofoperations which may occur in future periods.
| ** **                                     | ** ** | **Year Ended December 31,**                                                                                                   | ** ** |
|------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                     | ** ** | **           2003           ** | ** ** | **           2002           ** | ** ** |
| ** **                                     | ** ** | **(In thousands, except per share data)**                                                                           | ** ** |
| Pro forma  adjusted net sales                  |       |                                                                                                                                         | $          | 2,006,975 |   |   |   | $ | 1,142,146 |   |   |
| Pro forma  adjusted net income                 |       |                                                                                                                                         | $          | 190,585 |   |   |   | $ | 18,132 |   |   |
| Pro forma  adjusted basic earnings per share   |       |                                                                                                                                         | $          | 1.84 |   |   |   | $ | 0.17 |   |   |
| Pro forma adjusted  diluted earnings per share |       |                                                                                                                                         | $          | 1.55 |   |   |   | $ | 0.16 |   |   |

 

The unaudited pro formaresults of operations include historical operations of the Company andCommWorks. Certain non-recurring charges were recorded by CommWorks and areincluded above including a $15.0 million restructuring charge in both thefirst and second quarter of 2002 and a $15.0 million and $6.1 millioncharge relating to goodwill impairment, which was recorded in the secondquarter of 2002 and the first quarter of 2003, respectively.

*RollingStreams*

On June 30, 2003, the Company completed theacquisition of RollingStreams Systems, Ltd. (“RollingStreams”), adevelopment-stage company, pursuant to a share exchange agreement. RollingStreamsdesigns streaming, end-to-end TV-over-Internet-Protocol (“TVoIP”)solutions for telecommunications operators and broadband service providers. TheCompany’s investment in RollingStreams was $0.4 million prior to theacquisition. The purchase consideration for all the outstanding shares ofRollingStreams, other than those already held by the Company prior to theacquisition, was 301,074 shares of the Company’s common stock. In addition, theCompany assumed all outstanding RollingStreams options, which became options topurchase an aggregate of 12,742 shares of 

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the Company’s commonstock, valued at $0.5 million. Of the 301,074 shares, 164,115 sharesvalued at $5.8 million, were issued at the closing, including 28,696 ofwhich were held in escrow for any undisclosed liabilities or contingenciesincurred by RollingStreams prior to the closing or for any breach of the shareexchange agreement. These shares will be distributed to the former shareholdersof RollingStreams within ten days of the six-month anniversary of the closing,after deducting any claims. Up to 136,959 of the 301,074 shares will be payablein the form of an earnout after an earnout period expiring 18 months afterthe closing, subject to the achievement of certain revenue milestones duringsuch earnout period. 28,696 shares held in escrow were released and issued in2004.

The amount of the purchase price allocated toIPR&D was $6.2 million. This amount was charged to the Company’sresults of operations, as no alternative future uses existed at the acquisitiondate. The results of operations of RollingStreams have been included in theCompany’s consolidated results of operations beginning on July 1, 2003. Assuch, operations are considered immaterial and pro forma presentation is notdeemed necessary.

As of the date of the acquisition, RollingStreams hadone project under development that qualified for IPR&D, MediaSwitch. Theproject was 70% complete as of December 31, 2003. As of December 31,2004, the project was completed and no further cost is anticipated.

Thefollowing table represents the final allocation of the purchase price for RollingStreams.The allocation of the purchase price is based in part upon an independentvaluation.
| ** **                                  | ** ** | **(in thousands)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets acquired |       |                    | $          | 34 |   |   |
| In-process  research and development        |       |                    | 6,189      |   |   |
| Investment                                  |       |                    | (363       | ) |   |
| Deferred compensation                       |       |                    | 434        |   |   |
| Liabilities  assumed                        |       |                    | (3         | ) |   |
|                                        |       |                    | $          | 6,291 |   |   |

 

*Xebeo*

On May 7, 2003, the Company completed thepurchase of all of the assets of Xebeo Communications, Inc. (“Xebeo”) for$2.4 million in cash. Xebeo develops and manufactures optical packet switchesthat enable telecommunications carriers to provide single fiber, multi-serviceaccess to customers. In addition, an amount up to $0.7 million may bepayable based on future contingencies related to employment. The results ofoperations of Xebeo are not considered material and as such pro formapresentation is not deemed necessary.

The amount of the purchase price allocated toIPR&D of $1.9 million was charged to the Company’s results ofoperations, as no alternative future uses existed at the acquisition date.

As of the date of the acquisition, Xebeo was focusingits resources on the development of its first product, MetroBridge, an opticalpacket switching solution, and was considered in the development stage. Thedevelopment of MetroBridge was 60% complete as of the closing date. Thetechnological feasibility of the technology was not established and thetechnology had no future alternative uses, therefore the development ofMetroBridge is considered IPR&D. The product achieved its technicalmilestones as of November 2003, however the product was nevercommercialized.

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Thefollowing table represents the final allocation of the purchase price for Xebeobased, in part, upon an independent valuation.
| ** **                                  | ** ** | **(in thousands)** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets acquired |       |                    | $          | 659 |   |   |
| In-process  research and development        |       |                    | 1,888      |   |   |
| Liabilities  assumed                        |       |                    | (129       | ) |   |
|                                        |       |                    | $          | 2,418 |   |   |

 

*Shanghai Yi Yun*

On October 16, 2002, the Company acquired theassets and intellectual property of Shanghai Yi Yun Telecom Technology Co. Ltd.(“Shanghai Yi Yun”), a provider of synchronous digital hierarchy equipment.Shortly thereafter, there was a claim surrounding potential infringement of theintellectual property acquired which led to a possible recision of thetransaction, creating a contingency whose outcome was not determinable beyond areasonable doubt. This transaction was recorded in March 2003, when theCompany determined that none of the intellectual property acquired was subjectto the claim. Consideration was $0.2 million of cash and 342,854 shares ofrestricted stock valued at $6.0 million. In connection with theacquisition, Shanghai Yi Yun and each of the stockholders that received part ofthe 342,854 shares of restricted stock executed an indemnity escrow agreementin favor of the Company and such shares of restricted stock were placed inescrow. In addition, the Company issued 514,290 shares of restricted stockvalued at that time at $9.0 million to the Shanghai Yi Yun employees thatwere hired by one of the Company’s subsidiaries. Such shares of restrictedstock vest over five years through 2007, with accelerated vesting upon theachievement of specified milestones. The Company has treated these 514,290shares of restricted stock as deferred compensation. During 2003, 226,302 ofthese shares vested upon achievement of specified milestones. The results ofoperations of Shanghai Yi Yun is not considered material and as such proformapresentation is not deemed necessary.

This acquisition will enable the Company to enter thesynchronous digital hierarchy transport market with internally developedproducts. Goodwill of $3.0 million was recorded in connection with thisacquisition and is expected to be deductible for tax purposes. The amount ofthe purchase price allocated to in-process research and development of$1.3 million was charged to the Company’s results of operations, as noalternative future uses existed at the acquisition date.

Thefollowing represents the allocation of the purchase price for Shanghai Yi Yun:
| ** **                                                                                            | ** ** | **(in thousands)** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets acquired                                                           |       |                    | $          | 250 |   |   |
| Fair value of  identified intangible assets—technology                                           |       |                    | 1,870      |   |   |
| In-process  research and development                                                                  |       |                    | 1,319      |   |   |
| Excess costs of  acquiring Shanghai Yi Yun Telecom over fair value of net assets acquired  (goodwill) |       |                    | 3,021      |   |   |
|                                                                                                  |       |                    | $          | 6,460 |   |   |

 

***2002***

*HUTS and GUTS*

On December 18, 2001,the Company entered into an agreement to acquire the remaining 49% ownershipinterest in GUTS, one of the Company’s two primary manufacturing facilities inChina, for a total consideration of $3.6 million in cash, in order toachieve 100% ownership in the joint venture. On January 21, 2002, theCompany entered into an agreement to acquire the remaining 12% ownership 

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interestin HUTS, one of the Company’s two primary manufacturing facilities in China,for a total consideration of $14.5 million in cash. As a result of theGUTS and HUTS transactions, which closed in May 2003, the Company was ableto conduct its operations in China through wholly owned subsidiaries.

*Issanni*

On April 19, 2002,the Company completed the purchase of Issanni Communications, Inc. (“Issanni”).The Company’s investment in Issanni was $2.0 million prior to theacquisition. The purchase consideration for all the outstanding shares ofIssanni, other than those already held by the Company prior to the acquisition,was $2.1 million in cash. In addition, $2.0 million will be payable in the formof an earnout to all Issanni shareholders of record at closing, subject to thecompletion of certain performance milestones during 2002, 2003 and 2004. Thisearnout will be recorded as additional purchase price when earned. Nomilestones have been met as of December 31, 2003. Furthermore, the Companyadopted an incentive program providing for the issuance of 39,876 shares ofcommon stock valued at $1.0 million to Issanni employees who will continue toperform services for the Company. These shares vest at the earlier of fiveyears or upon the achievement of certain performance milestones. The Companyrecords this amount as compensation expense ratably over the vesting period andwill accelerate the amortization if the milestones are met. The amount of thepurchase price allocated to in-process research and development of $0.7million was charged to the Company’s results of operations, as no alternativefuture uses existed at the acquisition date. Goodwill of $0.2 million wasrecorded in connection with the acquisition and is deductible for tax purposes.The results of operations of Issanni were included in the Company’sconsolidated results of operations beginning on April 19, 2002.

**NOTE 6—INVENTORIES**

As ofDecember 31, 2004 and 2003, inventories consist of the following (inthousands):
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| ** **                                       | ** ** | **2004**              | ** ** | **2003** | ** ** |
| *Inventories*                                    |       |                  |       |   |   |
| Raw materials                                    |       | $                     | 154,977    |   | $ | 66,753 |   |
| Work-in-process                                  |       | 65,551                |       | 51,116 |   |
| Finished goods                                   |       | 271,357               |       | 48,206 |   |
| Inventories at  customer sites without contracts |       | 98,947                |       | 90,990 |   |
|                                             |       | $                     | 590,832    |   | $ | 257,065 |   |

 

As ofDecember 31, 2004 and 2003, inventory balances by segment (in thousands):
| ** **    | ** ** | **December 31,** | ** ** |
|---------------|------------|-----------------------|------------|
| ** **    | ** ** | **2004**              | ** ** | **2003** | ** ** |
| China         |       | $                     | 372,457    |   | $ | 241,452 |   |
| International |       | 62,352                |       | 15,613 |   |
| PCD           |       | 156,023               |       | — |   |
|          |       | $                     | 590,832    |   | $ | 257,065 |   |

 

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**NOTE 7—ACCOUNTS AND NOTES RECEIVABLE**

The Company acceptscommercial notes receivable from its customers in China in the normal course ofbusiness. The notes are typically non-interest bearing, with maturity datesbetween three and six months. Notes receivable available for sale were $27.0million and $11.4 million at December 31, 2004 and December 31, 2003,respectively. The Company may discount these notes with banking institutions inChina. A sale of these notes is reflected as a reduction of notes receivableand the proceeds of the settlement of these notes are included in cash flowsfrom operating activities in the consolidated statement of cash flows. Therewere no notes receivable sold during the year ended December 31, 2004, andthere were $298.8 million of notes receivable sold during the year ended December 31,2003. Any notes that have been sold are not included in the Company’sconsolidated balance sheets as the criteria for sale treatment established byStatement of Financial Accounting Standards No. 140, “Accounting forTransfers and Servicing of Financial Assets and Extinguishment of Liabilities,”(“SFAS 140”), has been met. The costs of selling these notes receivable were$2.3 million for the year ended December 31, 2003.

**NOTE 8—PROPERTY, PLANT AND EQUIPMENT**

As of December 31,2004 and 2003, property, plant and equipment consists of the following:
| ** **                     | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|--------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **(In thousands)**         | ** ** |
| Buildings                      |       |                            | $          | 138,277                         |       |   |   | $ | 406 |   |   |
| Leasehold  improvements        |       |                            | 16,235     |                            |       |   | 10,446 |   |   |
| Automobiles                    |       |                            | 6,171      |                            |       |   | 5,587 |   |   |
| Software                       |       |                            | 34,537     |                            |       |   | 14,616 |   |   |
| Equipment and  furniture       |       |                            | 181,704    |                            |       |   | 119,796 |   |   |
| Construction in  progress      |       |                            | 3,651      |                            |       |   | 104,548 |   |   |
|                           |       |                            | $          | 380,575                         |       |   |   | $ | 255,399 |   |   |
| Less accumulated  depreciation |       |                            | (111,816   | )                               |       |   | (68,360 | ) |   |
|                           |       |                            | $          | 268,759                         |       |   |   | $ | 187,039 |   |   |

 

Depreciation expense was $55.8million, $34.3 million, and $18.9 million for the years ended December 31,2004, 2003, and 2002, respectively. 

**NOTE 9—LONG-TERM INVESTMENTS**

TheCompany’s investments are as follows:
| ** **                                   | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Softbank China                               |       |                            | $          | 5,294                           |       |   |   | $ | 5,308 |   |   |
| Cellon  International                        |       |                            | 8,000      |                            |       |   | 8,000 |   |   |
| Restructuring  Fund No. 1               |       |                            | 1,836      |                            |       |   | 1,861 |   |   |
| Global Asia  Partners L.P.                   |       |                            | 1,150      |                            |       |   | 1,653 |   |   |
| Fiberxon Inc.                                |       |                            | 3,000      |                            |       |   | 2,000 |   |   |
| InterWave  Communications International Ltd. |       |                            | —     |                            |       |   | 3,319 |   |   |
| ImmenStar                                    |       |                            | 2,000      |                            |       |   | — |   |   |
| Matsushita Joint  Venture                    |       |                            | 7,959      |                            |       |   | 517 |   |   |
| GCT SemiConductor                            |       |                            | 3,000      |                            |       |   | — |   |   |
| Infinera                                     |       |                            | 1,902      |                            |       |   | — |   |   |
| Others                                       |       |                            | 1,449      |                            |       |   | 1,408 |   |   |
| Total                                        |       |                            | $          | 35,590                          |       |   |   | $ | 24,066 |   |   |

 

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*Softbank China*

The Company has a $5.3million investment in Softbank China, an investment fund established bySOFTBANK CORP. focused on investments in Internet companies in China. Thisinvestment permits the Company to participate in the anticipated growth ofInternet related businesses in China. SOFTBANK CORP. and its related companiesare significant stockholders of the Company. The Company’s investmentconstitutes 10% of the funding for Softbank China, with SOFTBANK CORP.contributing the remaining 90%. The fund has a separate management team, andnone of the Company’s employees are employed by the fund. Many of the fund’sinvestments are and will be in privately held companies, many of which arestill in the start-up or development stages. These investments are inherentlyrisky as the markets for the technologies or products the companies have underdevelopment are typically in the early stages and may never materialize. TheCompany accounts for this investment under the cost method. The Companyrecorded losses of $0.2 million and $2.8 million due to an other-than-temporarydecline in the carrying value of this investment during the years ended December 31,2003 and 2002, respectively. Refer to Note 22, Related Party Transactions.

*Cellon International*

In September 2001,the Company invested $2.0 million in Cellon International Holdings Corporation(“Cellon”). Cellon designs wireless terminals and related technology forhandset manufacturers and private distributors. The Company invested anadditional $3.0 million each in April and December 2002. As of December 31,2004, the Company had a 9% ownership interest in Cellon. This investment isaccounted for under the cost method, and its carrying value has been evaluatedfor possible impairment based on the achievement of business objectives andmilestones, the financial condition and prospects of the company and otherrelevant factors. As of December 31, 2004, the Company has not recordedany impairment of this investment. The Company has outstanding purchasecommitments to Cellon. Refer to Note 22, Related Party Transactions.

*Restructuring Fund No. 1*

During the first quarterof fiscal 2002, the Company invested $2.0 million in Restructuring Fund No. 1,a venture capital investment limited partnership established by SOFTBANKINVESTMENT CORP., an affiliate of SOFTBANK CORP. SOFTBANK America Inc., anentity affiliated with SOFTBANK CORP., is a significant stockholder of theCompany. The balance of this investment was $1.8 million and $1.9 million at December 31,2004 and 2003, respectively. The fund focuses on leveraged buyout investmentsin companies in Asia undergoing restructuring or bankruptcy procedures. Thetotal fund offering is expected to be between approximately $150.0 million and$226.0 million, with each investor contributing a minimum of $0.8 million. Thefund has a separate management team, and none of the Company’s employees areemployed by the fund. The Company accounts for this investment under the equitymethod of accounting. The Company recorded immaterial equity losses during theyears ended December 31, 2004 and 2003. The Company recorded no lossduring the year ended December 31, 2002. 

*Global AsiaPartners L.P.*

In June 2002, theCompany invested $1.0 million in Global Asia Partners L.P., and an additional$1.0 million in June 2003, with a commitment to invest up to a maximum of$5.0 million. The remaining amount is due at such times and in such amounts asshall be specified in one or more future capital calls to be issued by thegeneral partner. The fund size is anticipated to be $100 million and the fundwas formed to make private equity investments in private or pre-IPO technologyand telecommunications companies. The fund’s geographic focus is on technologyinvestments in Asia, in particular India and China. The Company accounts forthis investment under the equity method of accounting. The balance in thisinvestment was $1.2 million and $1.7 million at December 31, 2004 and2003, respectively. The Company recorded equity 

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lossesof $0.5 million; $0.2 million and $0.1 million for the years ended December 31,2004, 2003 and 2002, respectively. 

*Fiberxon Inc.*

In September 2002,the Company invested $2.0 million in Fiberxon Inc. (“Fiberxon”), a company thatdevelops and sells optical modules and related systems. In March 2004, theCompany invested an additional $1.0 million in Fiberxon. This investment isaccounted for under the cost method, and its carrying value is evaluated forpossible impairment based on the achievement of business objectives andmilestones, the financial condition and prospects of the company and otherrelevant factors. As of December 31, 2004, the Company has not recordedany impairment in respect of this investment. The Company has outstandingpurchase commitments with Fiberxon. Refer to Note 22, Related PartyTransactions.

*InterWaveCommunications International Ltd.*

During 2002, the Company purchased approximately 5.8million shares of common stock of InterWave Communications International Ltd.,a technology company listed on Nasdaq, for approximately $3.0 million. Inaddition, the Company received warrants to purchase 2.0 million shares ofInterWave’s common stock at $0.21 per share. The Company’s holdings wereadjusted for a 1:10 reverse stock split on April 30, 2003, and were 0.6million shares of common stock and warrants to purchase 0.2 million shares ofInterWave’s common stock at $2.10 per share. 

During the third quarterof 2004, the Company sold its shares of InterWave common stock at an averageprice of $5.65 per share. The Company recorded a $2.1 million gain as a resultof this sale within other income. During the fourth quarter of 2004, theCompany net share exercised its warrants for shares of common stock and thensold the shares for $0.5 million resulting in a $0.3 million realized lossrecorded within other income (expense). At December 31, 2004, the Companyno longer owned any investments in InterWave.

*ImmenStar*

On September 28,2004, the Company invested $2.0 million in the Series A preferred stock ofImmenStar, Inc. (“ImmenStar”). ImmenStar is a development stage companythat is designing a chip that can be used in the Company’s product. Thisinvestment is accounted for under the cost method and there have been no gainsor losses recorded during the year ended December 31, 2004, related tothis investment. 

*Matsushita JointVenture*

On July 5, 2002, theCompany entered into a joint venture agreement with Matsushita CommunicationIndustrial Co., Ltd., a stockholder of the Company, to jointly design anddevelop, manufacture and sell telecommunication products. The Company has a 49%ownership interest in the joint venture company, which had an originalregistered share capital of $10.0 million. The cash consideration of $4.9million payable by the Company was paid in October 2002. As the Companydoes not have voting control over significant matters of the joint venturecompany, the investment in and results of operations of the joint venturecompany are accounted for using the equity method of accounting. During thefourth quarter of 2004, the Company contributed an additional $9.3 million (its49% interest of the $19 million capital call) to the joint venture. The Companyhas recorded equity losses of $1.9 million; $4.8 million and $0.2 million forthe years ended December 31, 2004, 2003 and 2002, respectively. 

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*GCT Semiconductor*

In October 2004, theCompany invested $3.0 million in three million shares of GCT Semiconductor, Inc.(“GCT”) Series D Preferred Stock at $1.00 per share. The investmentrepresents approximately a 2% interest in the company, which designs, developsand markets integrated circuit solutions for the wireless communicationsindustry. The investment is accounted for under the cost method and there havebeen no gains or losses recorded during the year ended December 31, 2004in relation to this investment.

*Infinera*

In July 2004, theCompany invested $3.0 million in 1,339,285 shares of Infinera Corporation (“Infinera”)Series D Preferred Stock at $2.24 per share. The investment represents anapproximately 2% interest in Infinera, which develops opticaltelecommunications systems using photonic integrated circuits. This investmentis accounted for under the cost method. In September 2004, Infinera closeda Series E Preferred Stock round at $0.60 per share. As a result of theclose proximity between the Series D and Series E preferred stockfinancing rounds and the decrease in the share price between rounds, Infineraand the Company entered into an exchange agreement whereby the Companyexchanged 669,643 shares of Series D preferred stock for 2,500,000 sharesof Series E preferred stock. After the exchange, the Company owns a totalof 669,643 shares Series D and 2,500,000 shares of Series E preferredstock. For the year ended December 31, 2004, the Company recorded a lossof $1.1 million to reflect the other-than-temporary decrease in the fair valueof its remaining Series D shares.

**NOTE10—GOODWILL AND INTANGIBLE ASSETS**

*Goodwill:*
| ** ** | ** ** | **December 31,** | ** ** |
|------------|------------|-----------------------|------------|
| ** ** | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Goodwill   |       | $                     | 180,627    |   | $ | 100,180 |   |
|            |            |                       |            |  |  |  |  |

 

*As of December 31, 2004 and2003, goodwill was $180.6 million and $100.2 million, respectively. Goodwillincreased by $80.4 million during the year ended December 31, 2004 and wasattributable to the goodwill acquired through Audiovox CommunicationsCorporation (“ACC”) of $74.1 million, TELOS Technology, Inc. (“TELOS”) of$6.4 million and Hyundai Syscomm, Inc. (“HSI”) of $7.0 million. In thefourth quarter 2004, a decision was made to substantially abandon the acquiredoperations of HSI due to integration difficulties. Thus, the entire goodwilland all intangibles associated with the HSI acquisition were written off in thefourth quarter 2004. In addition, goodwill decreased $0.1 million from thefinalization of the purchase accounting for the CommWorks acquisition.*

Goodwill increased by $55.4 million during theyear ended December 31, 2003. The increase during the year ended December 31,2003 was mainly attributable to goodwill of $52.3 million that wasrecorded on the acquisition of CommWorks.

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Duringthe fourth quarter, with the consummation of the acquisition of ACC, theCompany evaluated its management operation and reporting and determined thatthe Company operated as three operating segments for the fourth quarter of 2004.Those segments were the Personal Communications Division (“PCD”), China andInternational. PCD includes the legacy activities of the ACC selected assetsacquisition. The China segment represents the Company’s activities within itsChina companies and the International segment includes all other non-China andnon-PCD operations. Management has determined that each segment is its ownreporting unit as there are no management or reporting structures below thissegment reporting level. The Company has reallocated its goodwill between itssegments (reporting units) and the reallocation is reflected as follows:
| ** **                        | ** ** | **September 30,  2004** | ** ** | **Re-organization** | ** ** | **ACC  Acquisition** | ** ** | **HSI  Impairment** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------|------------|------------------------------|------------|---------------------|------------|----------------------|------------|---------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(in thousands)**      | ** ** |
| UTStarcom                         |       |                         | $          | 113,544             |       |                 |       | $                   | (113,544   | )                           |       |   | $ | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| China                             |       |                         | —     |                |       |                 | 69,370     |                |       |                        | 49,417     |   |   |   | — |   |   |   | 118,787 |   |   |
| International                     |       |                         | —     |                |       |                 | 44,174     |                |       |                        | —     |   |   |   | (7,042 | ) |   |   | 37,132 |   |   |
| Personal  Communications Division |       |                         | —     |                |       |                 |       |                |       |                        | 24,708     |   |   |   | — |   |   |   | 24,708 |   |   |
| Total                             |       |                         | $          | 113,544             |       |                 |       | $                   | —     |                        |       |   | $ | 74,125 |   |   |   | $ | (7,042 | ) |   |   | $ | 180,627 |   |   |

 

*Intangible Assets:*

As of December 31,2004 and 2003, intangible assets consisted of the following (in thousands):
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Existing  technology           |       | $                     | 39,530     |   | $ | 23,630 |   |
| Less accumulated  amortization |       | (14,933               | )          | (7,255 | ) |
|                           |       | $                     | 24,597     |   | $ | 16,375 |   |
| Customer  relationships        |       | $                     | 57,220     |   | $ | 27,820 |   |
| Less accumulated  amortization |       | (5,455                | )          | (1,623 | ) |
|                           |       | $                     | 51,765     |   | $ | 26,197 |   |
| Supplier  relationships        |       | $                     | 5,300      |   | $ | — |   |
| Less accumulated  amortization |       | (442                  | )          | — |   |
|                           |       | $                     | 4,858      |   | $ | — |   |
| Trade names                    |       | $                     | 4,940      |   | $ | 940 |   |
| Less accumulated  amortization |       | (966                  | )          | (274 | ) |
|                           |       | $                     | 3,974      |   | $ | 666 |   |
| Backlog                        |       | $                     | 5,150      |   | $ | 1,950 |   |
| Less accumulated  amortization |       | (2,483                | )          | (1,137 | ) |
|                           |       | $                     | 2,667      |   | $ | 813 |   |
| Non-compete                    |       | $                     | 10,800     |   | $ | — |   |
| Less accumulated  amortization |       | (450                  | )          | — |   |
|                           |       | $                     | 10,350     |   | $ | — |   |
| Total intangible assets        |       | $                     | 98,211     |   | $ | 44,051 |   |

 

Amortization expense was $15.6 million,$8.4 million, and $2.4 million for the years ended December 31,2004, 2003 and 2002, respectively. The estimated aggregate amortization expensefor intangibles for each of the five years beginning 2005 through 2009 is$23.1 million, $18.9 million, $16.0 million, $12.7 millionand $6.9 million, respectively. There is no significant foreign exchangeimpact related to intangible assets.

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Theweighted average amortization period for each class of unamortized identifiableintangible assets includes:
| **Identified Intangible Asset Class** | ** ** | ** ** | ** ** | **Weighted Average Life** | ** ** |
|------------------------------------------------------|------------|------------|------------|-------------------------------------|------------|
| Technology                                           |       |       | 4.7 years  |                                |       |
| Customer  Relationships                              |       |       | 9.4 years  |                                |       |
| Supplier  Relationships                              |       |       | 2 years    |                                |       |
| Trade Names                                          |       |       | 2.8 years  |                                |       |
| Backlog                                              |       |       | 1 year     |                                |       |
| Non-compete                                          |       |       | 4 years    |                                |       |
| Total                                                |       |       | 6.5 years  |                                |       |

 

Intangible assets increased by $54.2 million duringthe year ended December 31, 2004. The increase during the year ended December 31,2004 was mainly attributable to intangible asset recorded on acquisitions in2004 including customer/supplier relationships of $34.7 million, purchasedtechnology of $15.9 million and other intangibles of $18.0 million and offsetby the amortization expenses for the year. The estimated useful lives ofcustomer relationships are ten to five years, the estimated life of purchasedtechnology is five years, and the estimated useful lives of other intangiblesare from one to four years. 

During the second quarter of 2004, the Companyconsummated the acquisition of HSI in order to gain a foothold in the CDMAinfrastructure market. The Company encountered difficulties integrating the HSIoperations into the Company’s CDMA operations after the acquisition. In thefourth quarter of 2004, the Company decided to wind-down the legacy operationsand transfer employees to support handset engineering in Korea. The decision tosubstantially abandon the operations occurred within nine months of theacquisition and before the HSI operations were integrated into the Company. Therefore,the Company has written off all of the remaining values of the intangibleassets associated with this acquisition including $3.1 million of purchasedtechnology; $0.6 million related to non-compete agreement; and $0.8 millionrelated to a license agreement with HSI. The write-offs are all recorded under “Selling,general and administrative” expense in the statement of operations for the yearended December 31, 2004.

Intangible assetsincreased by $49.1 million during the year ended December 31, 2003. Theincrease during the year ended December 31, 2003 was mainly attributableto intangible assets of $44.9 million which was comprised of purchasedtechnology of $14.2 million, customer relationships of $27.8 million andother intangibles of $2.9 million that was recorded on the acquisition ofCommWorks, based on the final purchase price allocation. The estimated usefullife of purchased technology is from one to five years, the estimated usefullife of customer relationships is ten years, and the estimated useful lives ofbacklog and trade names are from one to two years. 

**NOTE 11—DEBT**

Thefollowing represents the outstanding borrowings at December 31, 2004 and2003 (in thousands):
| ** **                      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|
| **Note**                        | ** ** | ** **            | ** ** | **2004** | ** ** | **2003** | ** ** |
| Notes payable                   |       | $                     | 1,183      |   | $ | 1 |   |
| Bank loans                      |       | 358,155               |       | 8,155 |   |
| Convertible  subordinated notes |       | 402,500               |       | 402,500 |   |
| Total Debt                      |       | $                     | 761,838    |   | $ | 410,656 |   |
| Long-term  debt                 |       | 410,655               |       | 410,655 |   |
| Short-term debt                 |       | $                     | 351,183    |   | $ | 1 |   |
|                                 |            |                       |            |  |  |  |  |  |  |

 

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Occasionally, the Company issues short-term notespayable to its vendors in lieu of trade accounts payable. The payment terms arenormally three to nine months and are typically non-interest bearing. 

At December 31, 2004, the Company has loans withvarious banks totaling $350.0 million with interest rates ranging from 2.58% to6.21% per annum. These bank loans mature during 2005 and are included inshort-term debt.

The Company has a bank loan in connection with anequipment purchase resulting from the consolidation of MDC. On January 10,2003, a third party established a bank loan with Shanghai Pudong DevelopmentBank for the purchase of the equipment. The obligations of the bank loan andrelated equipment were assumed by the Company on January 23, 2003, andsubsequently transferred to MDC on December 31, 2003. The bank loan of$8.2 million bears interest at a rate of 4.94% per annum, and expires on January 10,2006. For each of the years ended December 31, 2004 and 2003, totalinterest expense related to this loan amounted to $0.4 million. The Companydoes not serve as legal obligor for the loan.

On March 12, 2003, the Company completed anoffering of $402.5 million of convertible subordinated notes due March 1,2008 to qualified buyers pursuant to Rule 144A under the Securities Act of1933. The notes bear interest at a rate of 7/8% per annumand are convertible into the Company’s common stock at a conversion price of$23.79 per share and are subordinated to all present and future senior debt ofthe Company. Holders of the notes may convert their notes only if: (i) theprice of the Company’s common stock issuable upon conversion of a note reachesa specified threshold, (ii) specified corporate transactions occur, or (iii) thetrading price for the notes falls below certain thresholds. At the initialconversion price, each $1,000 principal amount of notes will be convertible intoapproximately 42.0345 shares of common stock. Expenses associated with theconvertible subordinated notes issuance were $11.7 million and have beenrecorded with in other long-term assets and are being amortized over the lifeof the notes. The convertible subordinated notes include covenants surroundingthe timely filing of financial reports with the Securities and ExchangeCommission. See Note 24, Subsequent Events.

Concurrent with the issuance of the convertible notes,the Company entered into a convertible bond hedge and call option transactionat a cost of $43.8 million. The convertible bond hedge allows the Company topurchase 16.9 million shares of its common stock at $23.79 per share from theother party to the agreement. The written call option allows the holder topurchase 16.9 million shares of the Company’s common stock from the Company at$32.025 per share. Both the bond hedge and call option transactions may besettled at the Company’s option either in cash or net shares and expire on March 1,2008. The Company recorded these instruments at cost, and their carrying valueat December 31, 2004 equaled their original cost. The convertible bondhedge and call option transactions are expected to reduce the potentialdilution from conversion of the notes. The options have been included instockholders’ equity in accordance with the guidance in EITF No. 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.”

The Company has creditfacilities, excluding the $8.2 million bank loan resulting from theconsolidation of MDC, totaling $780.4 million of which $388.0 million remainedavailable for borrowing as of December 31, 2004. Of the $388.0 millionavailable credit facilities, $380.8 million of these facilities expire in 2005and $7.2 million of these facilities expire in 2010 with interest rates of upto 6.21%. There is no guarantee that these facilities will be renewed. TheCompany has not guaranteed any debt not included in the consolidated balancesheet. The Company had available borrowing facilities of $583.7 million asof December 31, 2003.

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**NOTE 12—OTHER CURRENT LIABILITIES**

Othercurrent liabilities at December 31, 2004 and 2003 consist of the following(in thousands):
| ** **                        | ** ** | **December 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Accrued contract  costs           |       |                            | $          | 86,565                          |       |   |   | $ | 67,950 |   |   |
| Warranty costs                    |       |                            | 46,596     |                            |       |   | 26,267 |   |   |
| Accrued payroll  and compensation |       |                            | 41,187     |                            |       |   | 34,200 |   |   |
| Accrued other  taxes              |       |                            | 20,596     |                            |       |   | 10,725 |   |   |
| Accrued  construction costs       |       |                            | 3,642      |                            |       |   | 20,462 |   |   |
| Other                             |       |                            | 42,991     |                            |       |   | 14,307 |   |   |
|                              |       |                            | $          | 241,577                         |       |   |   | $ | 173,911 |   |   |

 

Other current liabilitiesprimarily consist of accrued contract costs, which relate to purchases ofinventory, installation services and other testing and consulting workperformed by outside vendors for which the Company has not yet receivedinvoices; accrued payroll and compensation costs, which relate to wages,bonuses, and commissions earned but not yet paid; warranty costs, which areestimated costs of equipment replacement and repair and accrued constructioncosts, which represent accruals for work performed and materials purchased inrelation to the facility being built in Hangzhou. The construction is expectedto be fully completed in April 2005.

**NOTE13—WARRANTY OBLIGATIONS AND OTHER GUARANTEES**

Warrantyobligations are as follows (in thousands):
| Balance at  January 1, 2003                  |   | $       | 13,297 |   |
|---------------------------------------------------|--------|---------|--------|--------|
| Accruals for  warranties issued during the period |   | 36,523  |   |
| Warranty  obligations assumed upon acquisition    |   | 1,381   |   |
| Settlements made  during the period               |   | (24,934 | )      |
| Balance at  December 31, 2003                |   | $       | 26,267 |   |
| Accruals for warranties issued during the period  |   | 53,777  |   |
| Warranty  obligations assumed upon acquisition    |   | 6,964   |   |
| Settlements made  during the period               |   | (40,412 | )      |
| Balance at  December 31, 2004                |   | $       | 46,596 |   |

 

Certain of the Company’s sales contracts includeprovisions under which customers would be indemnified by the Company in theevent of, among other things, a third-party claim against the customerfor intellectual property rights infringement related to the Company’s products.There are no limitations on the maximum potential future payments under theseguarantees. The Company has accrued no amounts in relation to these provisionsas no such claims have been made and the Company believes it has valid,enforceable rights to the intellectual property embedded in its products.

The Company issues standbyletters of credit primarily to support international sales activities outsideof China. When the Company submits a bid for a sale, often the potential customerwill require that the Company issue a bid bond or a standby letter of credit todemonstrate its commitment through the bid process. In addition, the Companymay be required to issue standby letters of credit as guarantees for advancecustomer payments upon contract signing or performance guarantees. The standbyletters of credit usually expire six to nine months from date of issuancewithout being drawn by the beneficiary thereof. The Company may issuecommercial letters of credit in support of purchase commitments.

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**NOTE 14—PROVISION FOR INCOME TAXES**

UnitedStates and foreign income (loss) before income taxes and minority interest wereas follows (in thousands):
| ** **    | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| United States |       | $                                          | (19,666    | ) | $ | 57,784 |   | $ | 13,245 |   |
| Foreign       |       | 82,955                                     |       | 202,138 |   | 123,027 |   |
|          |       | $                                          | 63,289     |   | $ | 259,922 |   | $ | 136,272 |   |

 

Thecomponents of the (provision) benefit for income taxes are as follows (inthousands):
| ** **     | ** ** | **Year ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:       |       |                                       |       |   |   |   |   |
| Federal        |       | $                                          | 18,060     |   | $ | (8,376 | ) | $ | (12,222 | ) |
| State/Other    |       | 2,081                                      |       | 242 |   | (1,515 | ) |
| Foreign        |       | (127,321                                   | )          | (47,940 | ) | (28,222 | ) |
| Total current  |       | (107,180                                   | )          | (56,074 | ) | (41,959 | ) |
| Deferred:      |       |                                       |       |   |   |   |   |
| Federal        |       | 2,728                                      |       | (7,214 | ) | 6,665 |   |
| State          |       | 933                                        |       | 1,351 |   | 315 |   |
| Foreign        |       | 113,360                                    |       | 16,538 |   | 7,725 |   |
| Total deferred |       | 117,021                                    |       | 10,675 |   | 14,705 |   |
| Total          |       | $                                          | 9,841      |   | $ | (45,399 | ) | $ | (27,254 | ) |

 

In establishing its deferred income tax assets andliabilities, the Company makes judgments and interpretations based on theenacted tax laws and published tax guidance applicable to its operations. TheCompany records deferred tax assets and liabilities and evaluates the need forvaluation allowances to reduce the deferred tax assets to realizable amounts. Thelikelihood of a material change in the Company’s expected realization of theseassets is dependent on future taxable income, its ability to use foreign taxcredit carryforwards and carrybacks. Changes to the Company’s income taxprovision or in the valuation of the deferred tax assets and liabilities mayaffect its annual effective income tax rate.

Deferred income taxes arise from temporary differencesbetween the tax bases of assets and liabilities and their reported amounts inthe consolidated financial statements. The Company recorded a $91.7 millioncurrent deferred tax asset for the year ended December 31, 2004 inrelation to the $217.5 million deferred revenue recorded under customeradvances pertaining to several agreements entered into with Japan Telecom Co.,Ltd in 2004. Refer to Note 22, Related Party Transactions.

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Asummary of the components of net deferred tax assets is as follows (inthousands):
| ** **                                                                 | ** ** | **U.S.** | ** ** | **China** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|-----------|------------|
| **December 31, 2004:**                                                |       |     |       |      |       |      |       |      |       |
| Current deferred tax  assets:                                              |       |     |       |      |       |      |       |      |       |
| Allowances and reserves                                                    |       | $        | 17,455     |      | $          | 36,209    |       | $         | —     |   | $ | 53,664 |   |
| Deferred revenue, net                                                      |       | —   |       | 8,117     |       | 91,668    |       | 99,785    |       |
| Other                                                                      |       | —   |       | 119       |       | —    |       | 119       |       |
| Total current deferred  tax assets                                         |       | $        | 17,455     |      | $          | 44,445    |       | $         | 91,668     |   | $ | 153,568 |   |
| Current deferred tax  liability:                                           |       |     |       |      |       |      |       |      |       |
| Investments                                                                |       | (1,276   | )          | —    |       | —    |       | (1,276    | )          |
| Accrued royalty                                                            |       | —   |       | (2,312    | )          | —    |       | (2,312    | )          |
| Prepaids                                                                   |       | (399     | )          | (6,458    | )          | —    |       | (6,857    | )          |
| Total current deferred  tax liability                                      |       | (1,675   | )          | (8,770    | )          | —    |       | (10,445   | )          |
| Total current deferred  tax assets, net                                    |       | $        | 15,780     |      | $          | 35,675    |       | $         | 91,668     |   | $ | 143,123 |   |
| Non-current  deferred tax assets:                                          |       |     |       |      |       |      |       |      |       |
| Net operating loss  carryforward                                           |       | $        | 384        |      | $          | —    |       | $         | 4,564      |   | $ | 4,948 |   |
| Tax credit carryforwards                                                   |       | 9,644    |       | —    |       | —    |       | 9,644     |       |
| Fixed assets                                                               |       | 876      |       | 4,717     |       | —    |       | 5,593     |       |
| Demo equipment income                                                      |       | —   |       | 7,435     |       | —    |       | 7,435     |       |
| Accrued warranties                                                         |       | 4,808    |       | —    |       | —    |       | 4,808     |       |
| Investments                                                                |       | 3,223    |       | —    |       | —    |       | 3,223     |       |
| Other                                                                      |       | 1,019    |       | 1,107     |       | —    |       | 2,126     |       |
| Total non-current  deferred tax assets                                     |       | $        | 19,954     |      | $          | 13,259    |       | $         | 4,564      |   | $ | 37,777 |   |
| Valuation allowance                                                        |       | (328     | )          | —    |       | (4,564    | )          | (4,892    | )          |
| Net non-current deferred  tax assets                                       |       | $        | 19,626     |      | $          | 13,259    |       | $         | —     |   | $ | 32,885 |   |
| Non-current deferred tax  liability                                        |       | (2,457   | )          | —    |       | —    |       | (2,457    | )          |
| Non-current deferred tax  assets, net (included in other long-term assets) |       | $        | 17,169     |      | $          | 13,259    |       | —    |       | $ | 30,428 |   |
| **December 31,  2003:**                                               |       |     |       |      |       |      |       |      |       |
| Current deferred tax  assets:                                              |       |     |       |      |       |      |       |      |       |
| Allowances and reserves                                                    |       | $        | 7,632      |      | $          | 12,833    |       | $         | —     |   | $ | 20,465 |   |
| Deferred revenues, net                                                     |       | —   |       | 2,244     |       | —    |       | $         | 2,244      |   |
| Total current deferred  tax assets                                         |       | $        | 7,632      |      | $          | 15,077    |       | $         | —     |   | $ | 22,709 |   |
| Current deferred tax  liability                                            |       | $        | (199       | )         | $          | (4,331    | )          | $         | —     |   | $ | (4,530 | ) |
| Total current deferred  tax assets, net                                    |       | $        | 7,433      |      | $          | 10,746    |       | $         | —     |   | $ | 18,179 |   |
| Non-current  deferred tax assets:                                          |       |     |       |      |       |      |       |      |       |
| Net operating loss  carryforward                                           |       | $        | 1,186      |      | $          | —    |       | $         | 853        |   | $ | 2,039 |   |
| Tax credit carryforwards                                                   |       | 3,830    |       | —    |       | —    |       | 3,830     |       |
| Fixed assets                                                               |       | 1,276    |       | 1,658     |       | —    |       | 2,934     |       |
| Demo equipment income                                                      |       | —   |       | 14,513    |       | —    |       | 14,513    |       |
| Accrued warranties                                                         |       | 1,360    |       | —    |       | —    |       | 1,360     |       |
| Investments                                                                |       | 2,849    |       | 319       |       | —    |       | 3,168     |       |
| Other                                                                      |       | 897      |       | —    |       | —    |       | 897       |       |
| Total non-current  deferred tax assets                                     |       | 11,398   |       | 16,490    |       | $         | 853        |      | 28,741     |   |
| Valuation allowance                                                        |       | (328     | )          | —    |       | —    |       | (328      | )          |
| Non-current deferred tax assets, net (included in  other long-term assets) |       | $        | 11,070     |      | $          | 16,490    |       | $         | 853        |   | $ | 28,413 |   |

 

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Deferred taxes have notbeen recognized on undistributed earnings from foreign subsidiaries because theCompany does not intend to repatriate such earnings. As of December 31,2004, undistributed earnings from investments in foreign subsidiaries amountedto $541 million.

As of December 31,2004, state net operating loss carryforwards were $0.1 million (taxeffected and net of valuation allowance of $0.3 million). The state netoperating loss carryforwards will expire in varying amounts between 2005 and2007 and could not be utilized in 2004. As of December 31, 2004, theCompany had foreign net operating loss carryforwards (“NOLs”) of approximately$4.6 million (tax effected), for which a $4.6 million valuation allowancewas provided. The NOLs do not expire and can be carried forward indefinitely. However,given the lack of earnings, management concluded these losses did not meet themore likely than not standard contained in FAS 109 and has therefore placed avaluation allowance on such losses.

The Company’s subsidiariesUTSC, HUTS, CUTS and HSTC were granted tax holidays, which started to phase outin 1999. Income tax exemption for HSTC and CUTS ended December 31, 2004. Thenet impact of these tax holidays was to decrease tax expense by approximately$16.2 million, $38.0 million and $10.0 million for the years ended December 31,2004, 2003 and 2002, respectively.

Thedifference between the Company’s effective income tax rate and the federalstatutory rate is reconciled below:
| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** |
| Federal statutory  rate                         |       | 35                                         | %          | 35 | % | 34 | % |
| State taxes, net  of federal income tax benefit |       | (1                                         | )          | 1 |   | — |   |
| Permanent  differences                          |       | (2                                         | )          | 1 |   | 5 |   |
| Amortization of  deferred compensation          |       | —                                     |       | — |   | 1 |   |
| Effect of  difference in foreign tax rates      |       | (4                                         | )          | (13 | ) | (16 | ) |
| Deferred tax  asset rate adjustment             |       | (34                                        | )          | — |   | — |   |
| Tax credits and  other                          |       | (9                                         | )          | (7 | ) | (4 | ) |
| Effective rate                                  |       | (15                                        | )%         | 17 | % | 20 | % |

 

The deferred tax rateadjustment of 34% is primarily due to the tax benefit of $19.6 millionresulting from the revaluation of deferred tax assets in China due to statutoryrate increases for certain of the Company’s subsidiaries in China from 15% to24% in the fourth quarter of 2004.

No significant audits ofthe Company’s income tax returns were underway as of December 31, 2004.

**NOTE15—COMMON STOCK AND STOCK INCENTIVE PLANS**

***Stock Option Plans***

*The 1995 Stock Plan:*

On July 31, 1995, theBoard of Directors adopted, and in October 1995, the Company’sstockholders approved, the Company’s 1995 Stock Plan. Under the 1995 plan,officers, employees and consultants were eligible to acquire shares of commonstock pursuant to options or stock purchase rights. At the time of adoption,3,705,232 shares of common stock were reserved for issuance under the 1995plan. In 1995 and 1996, the Company’s Board and stockholders added anadditional 5,400,000 shares to the 1995 plan, raising the total number ofauthorized shares reserved under the 1995 plan to 9,105,232. As of December 31,2004, there were 6,711,744 shares authorized for issuance under the 1995 planand options to purchase 88,885 shares of common stock were outstanding underthe 1995 plan. On January 31, 1997, the Board of Directors elected not togrant any further options under the 1995 plan. Upon the adoption of the 1997plan, all remaining unissued shares under the 1995 plan not already subject tooptions or other awards ceased to be reserved for issuance under the 1995 plan.

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*The 1997 Stock Plan:*

On January 31, 1997,the Board of Directors adopted, and the Company’s stockholders approved, theCompany’s 1997 Stock Plan. Under the 1997 plan, officers, employees andconsultants are eligible to receive options to purchase shares of common stockand stock purchase rights. In December 1999, the Board of Directorsamended the 1997 plan, which the Company’s stockholders approved in February 2000.As of December 31, 2004, the Company is authorized to issue up to29,645,836 shares subject to options under the plan. During the term of the1997 plan, the number of shares issuable under the plan will be increasedannually on the first day of each fiscal year beginning in 2001 by an amountequal to 6,000,000 shares, or 4% of the outstanding shares of common stock onthat date, or a lesser amount determined by the Board. The plan terminates in January 2007,but may be terminated earlier by the Board of Directors. As of December 31,2004, there were options to purchase 16,827,269 shares of common stockoutstanding under the 1997 plan. The Compensation Committee administers the1997 plan.

Options granted under the1997 plan may be incentive stock options (“ISOs”) which are intended to qualifyfor favorable federal income tax treatment under the provisions of Section 422of the Internal Revenue Code of 1986, as amended, or non-qualified stockoptions (“NSOs”), which do not so qualify. The Compensation Committee selectsthe eligible persons to whom options will be granted and determines the grantdate, amounts, exercise prices, vesting periods and other relevant terms of theoptions, including whether the options will be ISOs or NSOs. The exercise priceof ISOs granted under the 1997 plan may not be less than 100% of the fairmarket value of common stock on the grant date, while the exercise price ofNSOs can be determined by the Compensation Committee in its discretion. Optionsare generally not transferable during the life of the optionee.

Options vest and becomeexercisable as determined by the Compensation Committee, generally over fouryears. Options may generally be exercised at any time after they vest andbefore their expiration date as determined by the Compensation Committee. However,no option may be exercised more than ten years after the grant date. Optionswill generally terminate (i) 12 months after the death or permanentdisability of an optionee and (ii) 90 days after termination ofemployment for any other reason. The aggregate fair market value of the sharesof common stock represented by ISOs that become exercisable in any calendaryear by any one option holder may not exceed $100,000. Options in excess ofthis limit are treated as NSOs.

In the event the Companyis merged with or into another corporation, or all or substantially all of theCompany’s assets are sold, each outstanding option will be assumed or anequivalent option or right will be substituted by the successor corporation orits parent or subsidiary. If the successor corporation refuses to assume orsubstitute for the option or right, the option or right will automatically vestand become exercisable in full for a period of at least fifteen days, afterwhich time the option or right will terminate.

Under the 1997 plan, theCompany may grant stock purchase rights to eligible participants. Any sharespurchased pursuant to stock purchase rights will be subject to a restrictedstock purchase agreement. Unless the Compensation Committee determinesotherwise, this agreement will grant the Company a right to repurchase thestock upon the voluntary or involuntary termination of the employee for anyreason, including death or disability. The purchase price for repurchasedshares will be the original price paid and may be paid by cancellation of anyindebtedness owed to the Company. The shares of stock subject to the right ofrepurchase lapse over time. There were no stock purchase rights granted in2004, 2003 or 2002.

*2001 Director Option Plan:*

On March 2, 2001, theBoard of Directors adopted, and in May 2001, the Company’s stockholdersapproved, the Company’s 2001 Director Option Plan. Under the 2001 DirectorOption Plan, those directors who are not employees of the Company (“OutsideDirectors”) are eligible to receive options to 

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purchaseshares of common stock. As of December 31, 2004, Directors Horner, Atkins,and Toy were Outside Directors. All grants of options to Outside Directors areautomatic and nondiscretionary. In July 2001, the Board of Directorsamended the 2001 Director Option Plan. As of December 31, 2004, theCompany is authorized to issue up to 1,200,000 shares pursuant to options underthe 2001 Director Option Plan. The plan terminates in May 2011, but may beterminated earlier by the Board of Directors. As of December 31, 2004, therewere options to purchase 312,000 shares of common stock outstanding under the2001 Director Option Plan. The Compensation Committee administers the 2001Director Plan.

Pursuant to the terms ofthe 2001 Director Option Plan, each Outside Director is automatically grantedan option to purchase eighty thousand shares of common stock (the “First Option”)on the date on which such person first becomes an Outside Director (the “AnniversaryDate”). A director who is an employee of the Company and ceases employment withthe Company to become an Outside Director receives an option to purchase twentythousand shares of common stock (a “Subsequent Option”) at the Company’s firstannual meeting of stockholders following such conversion to an Outside Directorand at each subsequent annual stockholder meeting thereafter, provided he orshe is serving as an Outside Director on each such date. As such time as eachOutside Director’s First Option is fully vested, each Outside Director isautomatically granted a Subsequent Option on the Anniversary Date of each yearprovided he or she is then an Outside Director.

Under the terms of the2001 Director Option Plan, the exercise price of each option granted is equalto the market value of the common stock on the date of grant. Such options haveterms of ten years, but terminate earlier if the individual ceases to serve asa director. The First Option grants vest as to 25% of shares subject to theFirst Option on each of the first four anniversaries of its date of grant. TheSubsequent Option grants vest as to 100% of the shares subject to theSubsequent Option on the first anniversary of its date of grant.

*Issanni Communications, Inc. Incentive Program:*

The Issanni plan wasestablished for the issuance of up to a total of 39,876 shares of UTStarcom’scommon stock to specified former employees of Issanni Communications, Inc.(“Issanni”) who became UTStarcom’s employees in connection with UTStarcom’sacquisition of Issanni. The Issanni plan is administered by the Board ofDirectors or a committee appointed by the Board. A participant in the Issanniplan is eligible to earn and vest in a designated number of shares that aresubject to the award of shares made to a participant under the plan, based uponthe attainment of one of six milestones related to the amount of revenuegenerated from Issanni products in 2002 and 2003 and subject to the participant’scontinued employment with Issanni, the Company or one of their subsidiariesthrough the day of the determination that the applicable milestone has beensatisfied. In addition, each participant is entitled to receive the unearnedshares, if any, on the fifth anniversary of the acquisition of Issanni if theemployee continues to be employed with Issanni, the Company or any of theirsubsidiaries on such date regardless of whether any milestone is attained. Theshares subject to an award will in any event become issuable, whether or notthe milestones were achieved and whether or not the five-year vesting schedulehas elapsed, upon (i) the sale or the discontinuation of the Company orUTStarcom International Products Inc., (ii) the sale of substantiallyall or any of the technology acquired by UTStarcom InternationalProducts Inc. in connection with the acquisition of Issanni, or (iii) theemployment termination of certain Issanni principals.

If, prior to the date onwhich all of a participant’s shares are earned, the participant’s service withIssanni, the Company or one of their subsidiaries is terminated (i) voluntarilyor for cause, the Company may exercise its repurchase option with respect toany of the participant’s unearned shares, (ii) other than voluntarily orfor cause, death or disability, the participant will be entitled to receive theshares that the participant would have otherwise earned with respect tomilestones achieved within 24 months of the 

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participant’stermination, or (iii) as a result of death or disability, the participant(or his estate) will be entitled to receive the unearned portion of his shareswith respect to all milestones.

*Advanced Communication Devices Corporation IncentiveProgram:*

The ACD Plan provides forthe issuance of an additional 49,030 shares of UTStarcom’s common stockpursuant to awards of shares granted to designated former employees of AdvancedCommunication Devices Corporation (“ACD”) who became UTStarcom’s employees inconnection with UTStarcom’s merger with ACD. The ACD plan is administered bythe Board of Directors. The Company did not grant any shares under the plan in2004 and 2003, and 31,275 shares were granted in 2002.

A participant in the ACDplan is entitled to earn and vest in a designated number of shares subject tothe award made to the participant upon the attainment of one of five milestonesand subject to the participant’s continued employment with ACD, the Company orany of their subsidiaries through the day of the determination that theapplicable milestone has been satisfied. In addition, each participant isentitled to receive the unearned shares, if any, subject to the award on thefifth anniversary of the merger if the participant has continued to performservices for ACD, the Company or any of their subsidiaries on such dateregardless of whether any milestone is obtained.

If a participant’s servicewith ACD, the Company or any of their subsidiaries is terminated for cause bythe applicable employer, voluntarily by the participant or as a result of deathor disability, the participant will forfeit all of the shares subject to theaward that were not yet earned and distributed. If the participant’s service isterminated for any other reason, the participant will be entitled to receivethe shares subject to the award with respect to any milestones achieved within12 months following the participant’s termination and will forfeit allother shares that were unearned as of the date of termination.

*The 2003 Non-Statutory Stock Option Plan:*

On April 15, 2003,the Board of Directors adopted the Company’s 2003 Non-Statutory Stock OptionPlan. Under the 2003 plan, directors, officers, employees and consultants ofthe Company are eligible to be granted options to purchase shares of theCompany’s common stock. Only non-statutory stock options, which do not qualifyfor favorable federal income tax treatment under the provisions of Section 422of the Internal Revenue Code of 1986, as amended, may be granted under the 2003plan. As of December 31, 2004, the Company was authorized to issue up to1,500,000 shares pursuant to options granted under the 2003 plan, subject toadjustment in certain instances (including stock splits, stock dividends,business combinations or other changes in capitalization). As of December 31,2004, options to purchase 1,274,287 shares of common stock were outstandingunder the 2003 plan.

The 2003 plan isadministered by the Compensation Committee of the Board of Directors. TheCompensation Committee is charged with selecting the eligible persons to whomoptions will be granted and determines the number of shares subject to theoption, exercise prices, vesting periods and other terms applicable to eachoption.

Options granted under the2003 plan generally vest and become exercisable over four years, and may beexercised at any time after they vest but before their expiration date. Optionswill generally terminate (i) 12 months after the death or employmenttermination due to disability of an option holder and (ii) 90 daysafter termination of an option holder’s service for any other reason other thanfor disability or due to the option holder’s death. However, no option may beexercised more than ten years after the grant date.

In the event the Companyis merged with or into another corporation, or all or substantially all of theCompany’s assets are sold, the 2003 plan provides for each outstanding optionto be assumed or an equivalent option or right to be substituted by thesuccessor corporation or its parent or subsidiary. If the successor corporationrefuses to assume or substitute for the option, the option will automaticallyvest and 

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becomeexercisable in full for a period determined by the compensation committee,after which time the option will terminate.

Asummary of activity under the Plans follows:
| ** **                                   | ** ** | **Shares Available  for Grant** | ** ** | **Number  of shares** | ** ** | **Weighted average  exercise price** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|----------------------------|------------|------------------------------------------------|------------|
| Options  Outstanding, December 31, 2001 |       |                                      | 2,450,501  |                       |       | 12,578,417                                     |       |   | $ | 12.22 |   |   |
| Options  Authorized in 2002                  |       |                                      | 4,372,167  |                       |       | —                                         |       |   |   |   |   |
| Options Granted                              |       |                                      | (4,977,723 | )                          |       | 4,977,723                                      |       |   | $ | 19.46 |   |   |
| Options Exercised                            |       |                                      | —     |                       |       | (1,717,899                                     | )          |   | $ | 5.38 |   |   |
| Options Forfeited  or Expired                |       |                                      | 915,326    |                       |       | (915,326                                       | )          |   | $ | 18.40 |   |   |
| Options  Outstanding, December 31, 2002 |       |                                      | 2,760,271  |                       |       | 14,922,915                                     |       |   | $ | 15.05 |   |   |
| Options  Authorized in 2003                  |       |                                      | 5,887,041  |                       |       | —                                         |       |   |   |   |   |
| Options Granted                              |       |                                      | (4,866,309 | )                          |       | 4,866,309                                      |       |   | $ | 25.03 |   |   |
| Options Exercised                            |       |                                      | —     |                       |       | (4,490,195                                     | )          |   | $ | 12.27 |   |   |
| Options Forfeited  or Expired                |       |                                      | 681,900    |                       |       | (681,900                                       | )          |   | $ | 20.55 |   |   |
| Options  Outstanding, December 31, 2003 |       |                                      | 4,462,903  |                       |       | 14,617,129                                     |       |   | $ | 18.97 |   |   |
| Options  Authorized in 2004                  |       |                                      | 4,178,874  |                       |       | —                                         |       |   |   |   |   |
| Options Granted                              |       |                                      | (5,875,197 | )                          |       | 5,875,197                                      |       |   | $ | 27.48 |   |   |
| Options Exercised                            |       |                                      | —     |                       |       | (1,191,877                                     | )          |   | $ | 15.54 |   |   |
| Options Forfeited  or Expired                |       |                                      | 811,503    |                       |       | (811,503                                       | )          |   | $ | 24.75 |   |   |
| Options Outstanding,  December 31, 2004 |       |                                      | 3,578,083  |                       |       | 18,488,946                                     |       |   | $ | 21.62 |   |   |

 

Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable as of December 31, 2004:
| ** **                             | ** ** | **Options Outstanding** | ** ** | ** **                                   | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------------------------|------------|
| ** **                             | ** ** | ** **              | ** ** | ** **                                   | ** ** | **Weighted** | ** ** | **Options Exercisable** | ** ** |
| **Range of  Exercise Price**      | ** ** | ** **              | ** ** | **Outstanding  at  December 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Average  Remaining  Contractual  Life** | ** ** | **Exercisable  at  December 31,  2004** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| ** **                             | ** ** | ** **              | ** ** | ** **                                   | ** ** | **(in years)** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $  0.06 - $  0.06  |       | 28,821                  |       |                                         | $          | 0.06 |   |   |   | 3.9 |   |   |   | 28,821 |   |   |   | $ | 0.06 |   |   |
| $  0.25  - $  0.25 |       | 25,189                  |       |                                         | $          | 0.25 |   |   |   | 4.1 |   |   |   | 25,189 |   |   |   | $ | 0.25 |   |   |
| $  0.85  - $  0.85 |       | 55,357                  |       |                                         | $          | 0.85 |   |   |   | 0.8 |   |   |   | 55,357 |   |   |   | $ | 0.85 |   |   |
| $  1.57  - $  2.28 |       | 170,545                 |       |                                         | $          | 2.23 |   |   |   | 3.1 |   |   |   | 169,272 |   |   |   | $ | 2.23 |   |   |
| $  2.50  - $  3.64 |       | 151,519                 |       |                                         | $          | 3.45 |   |   |   | 4.5 |   |   |   | 151,519 |   |   |   | $ | 3.45 |   |   |
| $  4.00  - $  5.65 |       | 712,283                 |       |                                         | $          | 4.48 |   |   |   | 4.3 |   |   |   | 712,283 |   |   |   | $ | 4.48 |   |   |
| $  9.38  - $13.61            |       | 1,439,080               |       |                                         | $          | 11.80 |   |   |   | 5.5 |   |   |   | 1,416,997 |   |   |   | $ | 11.78 |   |   |
| $14.23 -  $21.31                       |       | 7,335,552               |       |                                         | $          | 18.24 |   |   |   | 7.5 |   |   |   | 4,155,007 |   |   |   | $ | 18.12 |   |   |
| $21.53 -  $32.05                       |       | 6,901,353               |       |                                         | $          | 26.33 |   |   |   | 8.3 |   |   |   | 6,799,530 |   |   |   | $ | 26.39 |   |   |
| $32.60 -  $45.21                       |       | 1,669,247               |       |                                         | $          | 37.72 |   |   |   | 8.9 |   |   |   | 1,669,247 |   |   |   | $ | 37.72 |   |   |
| $  0.06 -  $45.21            |       | 18,488,946              |       |                                         | $          | 21.61 |   |   |   | 7.6 |   |   |   | 15,183,222 |   |   |   | $ | 22.30 |   |   |
|                                        |            |                         |            |                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*2000 Employee Stock Purchase Plan:*

In February 2000, the Company’s stockholders approved the2000 Employee Stock Purchase Plan. The purchase plan is intended to qualify asan “employee stock purchase plan” under Section 423 of the InternalRevenue Code.

The Company has reserved2.8 million shares of common stock for sale under the stock purchase plan at December 31,2004. The number of shares reserved for sale under the plan will be increasedannually on 

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thefirst day of each fiscal year beginning in 2001 by an amount equal 2.0 millionshares, or 2% of the outstanding shares of the Company’s common stock on thatdate, or a lesser amount determined by the Board of Directors. The stockpurchase plan will be administered by the Board or a committee appointed by theBoard.

The stock purchase plan isimplemented by offering periods, the duration of which may not exceed24 months. Offering periods may contain interim purchase periods. Sharespurchased under the stock purchase plan will be held in separate accounts foreach participant. The first offering period began in March 2000 and endedon the last trading day before April 30, 2002. Subsequent consecutiveoverlapping offering periods begin on May 1 and November 1 annually. Theseoffering periods end twenty-four months thereafter.

Employees will be eligibleto participate in the stock purchase plan if they are employed by the Companyfor more than 20 hours per week and more than five months in a calendaryear. The stock purchase plan permits eligible employees to purchase theCompany’s common stock through payroll deductions, which may not exceed 15% ofthe employee’s total compensation. Stock may be purchased under the plan at aprice equal to 85% of the fair market value of the Company’s stock on eitherthe date of purchase or the first day of the offering period, whichever islower. However, the Board of Directors may in its discretion provide that theprice at which shares of common stock are purchased under the plan shall be 85%of the fair market value of the Company’s shares on the date of purchase. Participantsmay not purchase shares of common stock having a value greater than $25,000during any calendar year.

Participants may increaseor decrease their payroll deductions at any time during an offering period,subject to limits imposed by the Board of Directors. If a participant withdrawsfrom the stock purchase plan, any contributions that have not been used topurchase shares shall be refunded. A participant who has withdrawn may notparticipate in the stock purchase plan again until the next offering period. Inthe event of retirement or cessation of employment for any reason, anycontributions that have not yet been used to purchase shares will be refundedto the participant, or to the participant’s designated beneficiary in the caseof death, and a certificate will be issued for the full shares in theparticipant’s account.

The Board of Directors mayterminate or amend the stock purchase plan, subject to stockholder approval insome circumstances. Unless terminated earlier by the Board, the stock purchaseplan will have a term of ten years.

Total shares purchasedunder the plan were 445,844, 261,103, and 182,437 in 2004, 2003, and 2002,respectively. At December 31, 2004, there were 2,826,910 shares availablefor purchase under the plan.

**NOTE16—DEFERRED STOCK COMPENSATION**

In connection with thegrant of certain stock options and restricted common stock to employees,non-employees and members of the Board of Directors and in connection withcertain acquisitions (see Note 5), the Company recorded net deferred stockcompensation of $0.3 million, and $8.7 million for the years ended2003 and 2002, respectively, representing the fair value of restricted stockand the difference between the fair value of common stock and the optionexercise price of options at the date of grant. The Company did not record anynet deferred stock compensation for the year ended December 31, 2004. Deferredcompensation is presented as a reduction of stockholders’ equity, withamortization recorded over the vesting period of the related restricted stockand options. The Company recorded stock compensation expense of $0.5 million,$4.3 million, and $3.1 million for the year ended December 31,2004, 2003, and 2002, respectively. At December 31, 2004, approximately$6.1 million remained to be amortized over the corresponding vestingperiod of each respective option or restricted share, generally four to five years.

In November 2001, theCompany completed the purchase of Advanced Communication Devices Corporation (“ACD”).The Company adopted an incentive plan providing for the issuance of shares of 

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commonstock valued at $5 million to ACD employees who will continue to performservices for the Company.

Stock granted as part ofincentive programs related to certain acquisitions (see Note 5), as well as theACD acquisition noted above, vest over five years through 2007, withaccelerated vesting upon the achievement of specified milestones.

**NOTE 17—401(K) PLAN**

On January 1, 2000,the Company adopted the UTStarcom, Inc. 401(k) Savings Plan (the “401(k) Plan”),a cash-or-deferred arrangement, which covers the Company’s eligible employeeswho have attained the age of 21. The 401(k) Plan is intended to qualifyunder Sections 401(a), 401(m) and 401(k) of the Internal Revenue Codeof 1986, as amended (the “Code”), and the 401(k) Plan trust is intended toqualify under Section 501(a) of the Code. All contributions to the401(k) Plan by eligible employees or by the Company, and the investmentearnings thereon, are not taxable to such employees until withdrawn, and anycontributions the Company may make are expected to be deductible by the Company.The Company’s eligible employees may elect to reduce their current eligiblecompensation by one percent (1%) up to fifty percent (50%), subject to themaximum statutorily prescribed annual limit of $13,000 for participants underage 50 and $16,000 for participants age 50 and over for the year ended December 31,2004 and $12,000 for participants under age 50 and $14,000 for participants age50 and over for the year ended December 31, 2003, and to have such salaryreductions contributed on their behalf to the 401(k) Plan. The 401(k) Planpermits, but does not require, the Company to make matching contributions onbehalf of all eligible employees who make salary reduction contributions to the401(k) Plan. Commencing with the plan year beginning January 1, 2001,the Company elected to begin making matching contributions on behalf ofqualified employees who participate in the 401(k) Plan. The Company willcontribute $0.50 for each dollar contributed by qualified employees to the 401(k) Plan,to a maximum of $5,500 for the 2004 and 2003 plan years, respectively. TheCompany’s matching contributions are subject to a five-year vesting schedulebased upon longevity of employee service with the Company. Matchingcontributions were $2.7 million, $2.1 million, and $0.7 million for2004, 2003, and 2002, respectively.

**NOTE 18—COMMITMENTS AND CONTINGENCIES**

*Leases:*

TheCompany leases certain facilities under non-cancelable operating leases thatexpire at various dates through 2023. The minimum future lease payments underthe leases at December 31, 2004 are as follows:
| ** **                      | ** ** | **(in thousands)** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| Years ending  December 31: |       |                    |       |   |   |
| 2005                            |       |                    | $19,750    |   |   |
| 2006                            |       |                    | 15,137     |   |   |
| 2007                            |       |                    | 8,775      |   |   |
| 2008                            |       |                    | 2,510      |   |   |
| 2009 and after                  |       |                    | 2,742      |   |   |
| Total minimum lease  payments   |       |                    | $          | 48,914 |   |   |
|                                 |            |                         |            |  |  |  |

 

Rentexpense for the years ended December 31, 2004, 2003 and 2002 was $17.3million, $11.5 million and $6.5 million, respectively.

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*InvestmentCommitments:*

As of December 31,2004, the Company had invested a total of $2.0 million in Global AsiaPartners L.P. The fund size is anticipated to be $100 million and the fundwas formed to make private equity investments in private or pre-IPO technologyand telecommunications companies in Asia. The Company has a commitment toinvest up to a maximum of $5.0 million. The remaining amount is due atsuch times and in such amounts as shall be specified in one or more futurecapital calls to be issued by the general partner.

*PurchaseCommitments:*

The Company is obligated to purchase raw materials andwork-in-process inventory under various orders from one supplier,all of which are expected to be fulfilled with no adverse consequences materialto the operations or financial condition of the Company. As of December 31,2004, total open commitments under these purchase orders due within a year areapproximately $578.3 million.

The Company has alsoentered into various earnout agreements related to certain acquisitions, whichare subject to the completion of performance miletstones (see Note 5).

*Contractualobligations and commercial commitments*

Ourobligations under contractual obligations and commercial commitments are asfollows:
| ** **                             | ** ** | **December 31, 2004  Payments Due by Period** | ** ** |
|----------------------------------------|------------|------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Total**                                                              | ** ** | **Less than  1 year** | ** ** | **1-3  years** | ** ** | **3-5  years** | ** ** | **More than  5 years** | ** ** |
| ** **                             | ** ** | **(in thousands)**                                                | ** ** |
| Notes payable                          |       | $                                                                      | 1,183      |   | $ | 1,183 |   | $ | — |   | $ | — |   |   | $ | — |   |   |
| Bank loans                             |       | $                                                                      | 358,155    |   | $ | 350,000 |   | $ | 8,155 |   | $ | — |   |   | $ | — |   |   |
| Convertible  subordinated notes        |       | $                                                                      | 402,500    |   | $ | — |   | $ | — |   | $ | 402,500 |   |   | $ | — |   |   |
| Interest payable  on convertible notes |       | $                                                                      | 12,327     |   | $ | 3,522 |   | 8,805 |   | $ | — |   |   | $ | — |   |   |
| Standby letters  of credit             |       | $                                                                      | 35,160     |   | $ | 32,920 |   | $ | 2,240 |   | $ | — |   |   | $ | — |   |   |

 

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

*Litigation:*

**Securities Class ActionLitigation**

On October 26, 2004, an alleged formershareholder of the Company filed a class action complaint in the United StatesDistrict Court for the District of Idaho against the Company and two of theCompany’s directors and/or officers, purporting to assert claims under thefederal securities laws on behalf of a class of purchasers of the Company’spublicly traded securities in the period from April 16, 2003 through September 20,2004. Among other things, the complaint refers to the Company’s disclosures asto “significant control deficiencies” related to revenue recognition and as tothe deferral of revenue recognition on a particular transaction and the relatedlowering of the Company’s financial guidance. The complaint further allegesthat the defendants previously made positive statements regarding the Company’sbusiness and financial performance that were false and misleading because suchstatements, among other things, failed to disclose problems with the Company’sinternal controls and revenue 

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recognition policies andprocedures and failed to disclose that the revenue on the transaction at issuewould need to be deferred, which allegedly caused the price of the Company’spublicly traded securities to be artificially inflated. The complaint claimsthat the plaintiff and other class members were damaged as a result thereof,and seeks monetary recovery in their favor in an unspecified amount.

Four similar class action complaints were later filedin the United States District Court for the Northern District of Californiaagainst the Company and several of the Company’s directors and officers. Inboth the Idaho court and the California court, competing motions were filed forappointment of lead plaintiff and approval of lead plaintiffs’ counsel, and inthe California court various motions for consolidation of actions were filed aswell. On March 15 and 16, 2005, the California court entered ordersconsolidating the cases pending in that court, appointing the lead plaintiff,and approving the lead plaintiff’s counsel. Pursuant to those orders, aconsolidated complaint is to be filed in that court within 60 days thereafter. OnApril 6, 2005, the Idaho court entered an order appointing the leadplaintiff and approving the lead plaintiff’s counsel.

This class actionlitigation is in its preliminary stages, and the Company cannot predict itsoutcome, as the litigation process is inherently uncertain. However, theCompany believes that the allegations and claims in this litigation are withoutmerit and that the Company has valid defenses, and intends to contest suchallegations and claims and defend itself vigorously. As of December 31,2004, no loss amount has been accrued because a loss is not considered probableor estimable.

**Shareholder Derivative Litigation**

On August 31 and September 2, 2004,respectively, two shareholder derivative actions were filed in the SuperiorCourt of California, Alameda County, by alleged shareholders of the Companypurporting to assert, on its behalf, claims of breach of fiduciary duty againstcertain of its current and former directors and officers, and also naming theCompany as a nominal defendant. The complaints in these actions refer to theCompany’s disclosures as to an Audit Committee investigation into revenuerecognition issues and as to “significant control deficiencies” related torevenue recognition. The complaints further allege that the individualdefendants ignored problems with the Company’s accounting and internal controlpractices and procedures and breached their fiduciary duties by failing tomaintain adequate internal accounting controls or to make good faith efforts todo so. Plaintiffs claim that such alleged breaches damaged the Company, andthey seek monetary recovery against the individual defendants and in favor ofthe Company, as well as equitable relief. In addition, plaintiffs claim thatthey should be excused from pre-suit demand requirements based on allegationsthat the Company’s Board of Directors could not have fairly evaluated suchpre-suit demand, and thus that such demand would have been futile. On November 22,2004, the Court entered an order consolidating the two actions and appointinglead plaintiffs’ counsel.

On November 23 and December 2, 2004, tworelated shareholder derivative actions were filed in the same court. On January 13,2005, the Court consolidated these two newer cases with the previouslyconsolidated actions, and directed plaintiffs to prepare and file an amendedconsolidated complaint, which plaintiffs filed on January 31, 2005. On March 17,2005, the Company filed a motion, joined by other defendants’, seekingdismissal of the consolidated complaint for failure to adequately pleadfutility of the pre-suit demand.

This derivative litigationis in its preliminary stages, and the Company cannot predict its outcome, asthe litigation process is inherently uncertain. However, the Company believesthat plaintiffs’ allegations of “demand futility” are without merit, and theCompany intends to contest those allegations vigorously. As of December 31,2004, no loss amount has been accrued because a loss is not considered probableor estimable.

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**IPO Allocation**

On October 31, 2001,a complaint was filed in United States District Court for the Southern Districtof New York against the Company, some of its directors and officers and variousunderwriters for the Company’s initial public offering. Substantially similaractions were filed concerning the initial public offerings for more than 300different issuers, and the cases were coordinated as In re Initial Public OfferingSecurities Litigation, 21 MC 92. In April 2002, a consolidated amendedcomplaint was filed in the matter against the Company, captioned In reUTStarcom, Initial Public Offering Securities Litigation, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarketand misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock between March 2,2000 and December 6, 2000. The Company’s directors and officers have beendismissed without prejudice pursuant to a stipulation. On February 19,2003, the Court granted in part and denied in part a motion to dismiss broughtby defendants including the Company. The order dismisses all claims against theCompany except for a claim brought under Section 11 of the Securities Actof 1933, which alleges that the registration statement filed in accordance withthe IPO was misleading. In June 2004, a stipulation of settlement andrelease of claims against the issuer defendants, including the Company, wassubmitted to the court for approval. The terms of the settlement, if approved,would dismiss and release all claims against the participating defendants(including the Company). In exchange for this dismissal, D&O insurancecarriers would agree to guarantee a recovery by the plaintiffs from theunderwriter defendants of at least $1 billion, and the issuer defendants wouldagree to an assignment or surrender to the plaintiffs of certain claims theissuer defendants may have against the underwriters. The settlement is subjectto a number of conditions, including court approval. If the settlement does notoccur, and litigation against the Company continues, the Company believes ithas valid defenses and intends to defend the case vigorously. The total amountof the loss associated with the above litigation is not determinable at thistime. Therefore the Company is unable to currently estimate the loss, if any,associated with the litigation.

*Starent Patent InfringementLitigation*

The Company has suedStarent Networks Corporation (“Starent”) for patent infringement in the U.S.District Court for the Northern District of California. On March 22, 2004,the Company filed its Complaint. On June 3, 2004, the Company served itsComplaint on Starent. On July 30, 2004, Starent filed and served itsanswer and counterclaims. On August 30, 2004, the Company served and filedits Amended Complaint. In the Company’s Amended Complaint, the Company assertsthat Starent infringes a Company’s patent through the manufacture, use, offerfor sale, and sale of Starent’s ST-16 Intelligent Mobile Gateway. The Companyseeks, inter alia, compensatory damages and injunctive relief. Starent filedits answer to the Amended Complaint and counterclaims on September 17,2004. In its answer and counterclaims, Starent denies the Company’s allegationsand seeks a declaration that the patent-in-suit is not infringed, is invalidand is unenforceable. The Court held an initial case management conference on November 2,2004 and scheduled a hearing to construe the claims of the patent-in-suit for June 30,2005. At that time the Court will hold an additional case management conferenceto schedule a date for trial. On February 17, 2005, the Company filed amotion for a preliminary injunction against Starent’s use, sale, and offer forsale of products having the infringing feature. A hearing on the Company’smotion is set for May 11, 2005. The Company cannot reliably predict theoutcome of this litigation.

**Fenner Investments Patent InfringementLitigation**

On January 6, 2005,Fenner Investments, Ltd. filed suit against the Company and co-defendantsJuniper Networks, Inc., Nokia, Inc., Nortel Networks Corp., LucentTechnologies, Inc., and 

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Cisco Systems, Inc.in the U.S. District Court for the Eastern District of Texas. The suit allegesthat unspecified products and services infringe two Fenner patents and seekscompensatory and injunctive relief. On March 1, 2005, the Company filed amotion to dismiss the complaint due to improper venue; no hearing is yetscheduled for this motion. This lawsuit is in its initial stage and it is notpossible to reliably predict the outcome or any relief that could be awarded,as the litigation process is inherently uncertain. Therefore, the Company isunable to currently estimate the loss, if any, associated with the litigation. TheCompany intends to contest the allegations and claims and defend itselfvigorously.

*Other*

On August 19, 2004, the Company received a letterfrom the new management team of Hyundai Syscomm, Inc. (“HSI”) stating thatthey consider the Asset Purchase Agreement, dated as of February 26, 2004,among HSI, UTSI, Dr. Seong-Ik Jang and 3R Inc. (the “APA”), and thevarious ancillary agreements entered into in connection with the closing relatedto the APA on April 27, 2004, to be null and void due to unfulfillment ofcondition precedents and material breach of terms of such agreements. Suchcondition precedents and material breach of terms were not specified in suchletter from HSI. In addition, HSI has made allegations and arguments beforeKorean governmental agencies and to the Korean press alleging that thetechnology that was purchased by the Company pursuant to the APA has beenexported outside of Korea. The Company believes none of such technology hasbeen exported by the Company from Korea to any foreign country. In addition,the Company believes that the Company has materially complied with allprovisions of the APA and the ancillary agreements and HSI cannot void ornullify such agreements. The Company has taken, and will continue to take,appropriate legal actions to fully enforce its rights under the APA and theancillary agreements.

The Company is a party toother litigation matters and claims that are normal in the course of operations,and while the results of such litigation matters and claims cannot be predictedwith certainty, the Company believes that the final outcome of such matterswill not have a material adverse impact on its financial position or results ofoperations.

**NOTE 19—HEDGING**

The Company usesderivative financial instruments to manage its exposures to foreign currencyexchange rate changes. The derivative instruments are accounted for pursuant toSFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,”as amended by SFAS No. 138, “Accounting for Certain Derivative Instrumentsand Certain Hedging Activities,” (“SFAS 133”). As amended, SFAS 133 requiresthat an entity recognize all derivatives as either assets or liabilities on thebalance sheet, measure those instruments at fair value and recognize changes inthe fair value of derivatives in earnings in the period of change unless thederivative qualifies as an effective hedge that offsets certain exposures. Suchcontracts are designated at inception to the related foreign currency exposuresbeing hedged. Beginning in the first quarter of 2004, the Company hedgescertain of its Japanese Yen-denominated balance sheet exposures againstfuture movements in foreign currency exchange rates by using foreign currencyforward contracts. Hedged transactions are denominated in U.S. dollars onbehalf of these transactions denominated in Japanese Yen. Pursuant to itsforeign currency exchange hedging policy, the Company may hedge anticipatedtransactions and the related payables denominated in foreign currencies usingforward foreign currency exchange rate contracts. The Company has not hedgedany such transactions. Gains and losses on these fair value hedges are intendedto offset gains and losses from the revaluation of Japanese Yen-denominatedrecognized liabilities. The net result of these gains and losses on contractsand revaluation included in interest and other income (expense) wasinsignificant for the year ended December 31, 2004. The Company’s foreigncurrency forward contracts generally mature within three months. Thesederivative financial instruments are not held for speculative 

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tradingpurposes. There were no foreign currency forward contracts open as of December 31,2004, 2003 or 2002.

**NOTE 20—OPERATINGRISKS**

*Financial Risks:*

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash, cash equivalents, short-term investments and accounts andnotes receivable. The Company places its temporary cash and short-terminvestments with several financial institutions. Approximately $589.8 millionand $350.0 million of the Company’s cash and short-term investments was ondeposit in foreign accounts at December 31, 2004 and 2003, respectively. TheCompany invests excess cash in highly liquid investments with originalmaturities of twelve months or less, such as certificates of deposit,government sponsored entities notes, commercial paper, floating rate corporatebonds, fixed income corporate bonds, and money market funds, which the Companybelieves have limited exposure to risk.

*Concentration ofCredit Risk and Major Customers:*

Thetable below outlines the Company’s sales to and the accounts receivablebalances with respect to the Company’s customers:
| **For the year ended December 31,** | ** ** | ** ** | ** ** | **% of  Net Sales** | ** ** | **% of  Accounts Receivable** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|-----------------------------------------|------------|
| **2004**                                                     |       |       |       |                          |       |                                    |       |   |   |
| Customer A                                                   |       |       | 12         | %                             |       |                                    | 5          | % |   |
| Customer B                                                   |       |       | 10         | %                             |       |                                    | 9          | % |   |
| Customer C                                                   |       |       | 5          | %                             |       |                                    | 15         | % |   |
| **2003**                                                     |       |       |       |                          |       |                                    |       |   |   |
| Customer D                                                   |       |       | 11         | %                             |       |                                    | 3          | % |   |
| **2002**                                                     |       |       |       |                          |       |                                    |       |   |   |
| Customer E                                                   |       |       | 18         | %                             |       |                                    | 6          | % |   |
| Customer F                                                   |       |       | 13         | %                             |       |                                    | 0          | % |   |

 

Approximately 73%, 76%,and 84% of the Company’s net sales during 2004, 2003, and 2002, respectively,were to entities affiliated with the government of China. Accounts receivablebalances from these China government affiliated entities or state ownedenterprises were $582.3 million and $304.0 million, respectively, as of December 31,2004 and 2003. The Company extends credit to its customers in China generallywithout requiring collateral. In global sales outside of China, the Companyoften requires letters of credit from its customers. The Company monitors itsexposure for credit losses and maintains allowances for doubtful accounts.

*Country Risks:*

Approximately 79%, 86%, and 84% of the Company’s salesfor the year ended December 31, 2004, 2003, and 2002, respectively, weremade in China. Accordingly, the political, economic and legal environment, aswell as the general state of China’s economy may influence the Company’sbusiness, financial condition and results of operations. The Company’soperations in China are subject to special considerations and significant risksnot typically associated with companies in the United States. These includerisks associated with, among others, the political, economic and legalenvironments and foreign currency exchange. The Company’s results may beadversely affected by, among other things, changes in the political, economicand social conditions in China, and by changes in governmental policies with 

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respect to laws andregulations, changes in China’s telecommunications industry and regulatory rules andpolicies, anti-inflationary measures, currency conversion and remittanceabroad, and rates and methods of taxation.

Approximately 6%, 10%, and13% of the Company’s sales for the year ended December 31, 2004, 2003, and2002, respectively, were made in Japan. Accordingly, the political, economicand legal environment and the general state of Japan’s economy may influencethe Company’s business, financial condition and results of operations.

**NOTE 21—SEGMENTREPORTING**

As of December 31, 2004, the Company wasorganized around three operating segments: China, International and PCD. Forthe year ended December 31, 2003 and for the first three quarters of 2004,the Company managed its business as a single operating segment. During 2004,the Company continued to expand its focus on markets and operations outside ofChina. Effective with the fourth quarter of 2004, it was determined that theCompany’s chief operating decision makers in accordance with SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” were evaluatingperformance, making operating decisions and allocating resources based on twooperating segments, namely China and all other regions referred to as International(“International”).

The China operating segment was comprised of discrete administrative,research and development, manufacturing, and sales and support infrastructure. Itremained the largest market for the Company and derived the majority of itsrevenue from voice products such as PAS and iPAS. The segment was managed bythe CEO and COO of UTStarcom China. The International segment was comprised of operationsof all other geographic areas including non-China Asia, Europe, the MiddleEast, Africa, and North and South America. Revenues are attributed to variouscountries based on the location of the respective country’s principal offices.

On November 1, 2004, the Company acquiredselected assets of Audiovox Communication Corporation, the wireless handsetdivision of Audiovox Corporation. The acquired business was integrated into theCompany as a separate and distinct operating division referred to as thePersonal Communications Division (“PCD”) and was managed by the President ofPCD. As the Company determined to also evaluate the performance and allocateresources to this division as a separate unit, it was considered a thirdoperating segment. PCD primarily derived its revenue from the design and salesof a variety of handsets, which primarily support the CDMA markets in North andSouth America.

The Company evaluates the performance of and allocatesresources to the operating segments based on segment gross profit. Theaccounting policies used in measuring segment assets and operating performanceare the same as those described in Note 2. Certain operating expenses of theCompany’s corporate headquarters, are not allocated but are included in theInternational segment. In addition, none of the non-operating items areallocated.

Thefollowing table sets forth certain financial information to each of ouroperating segments described above:
| ** **                       | ** ** | **Year Ended December 31, 2004** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 2,133,292  |   |   | $ | 292,879 |   |   | $ | 277,410 |   |   | $ | — |   |   | $ | 2,703,581 |   |
| Inter-segment revenues           |       | 233,345                                              |       |   | 573,014 |   |   | — |   |   | (806,359 | ) |   | — |   |
| Gross profit                     |       | 490,868                                              |       |   | 98,847 |   |   | 11,886 |   |   | — |   |   | 601,601 |   |
| Depreciation and  amortization   |       | 34,962                                               |       |   | 38,955 |   |   | 2,286 |   |   | — |   |   | 76,203 |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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| ** **                       | ** ** | **Year Ended December 31, 2003** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | ** PCD ** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 1,680,821  |   |   | $ | 284,366 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 1,965,187 |   |
| Inter-segment revenues           |       | 47,271                                               |       |   | 724,708 |   |   |   | — |   |   |   | (771,979 | ) |   | — |   |
| Gross profit                     |       | 460,408                                              |       |   | 163,977 |   |   |   | — |   |   |   | — |   |   | 624,385 |   |
| Depreciation and  amortization   |       | 16,972                                               |       |   | 27,736 |   |   |   | — |   |   |   | — |   |   | 44,708 |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **                       | ** ** | **Year Ended December 31, 2002** | ** ** |
|----------------------------------|------------|------------------------------------------------------|------------|
| ** **                       | ** ** | **China**                                            | ** ** | **International** | ** ** | ** PCD ** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Revenues from external customers |       | $                                                    | 822,299    |   |   | $ | 159,507 |   |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 981,806 |   |   |
| Inter-segment revenues           |       | 42,223                                               |       |   | 307,862 |   |   |   | — |   |   |   | (350,085 | ) |   |   | — |   |   |
| Gross profit                     |       | 301,813                                              |       |   | 43,659 |   |   |   | — |   |   |   | — |   |   |   | 345,472 |   |   |
| Depreciation and  amortization   |       | 9,173                                                |       |   | 13,262 |   |   |   | — |   |   |   | — |   |   |   | 22,435 |   |   |
|                                  |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **Year Ended December 31, 2004** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **China**                                            | ** ** | **International** | ** ** | **PCD** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Capital expenditures    |       | $                                                    | 111,442    |   | $ | 23,505 |   | $ | 628 |   |   | $ | — |   |   | $ | 135,575 |   |
| Total long-lived assets |       | 229,469                                              |       | 37,960 |   | 1,330 |   |   | — |   |   | 268,759 |   |
| Total assets            |       | 1,857,281                                            |       | 1,271,909 |   | 363,301 |   |   | (176,486 | ) |   | 3,316,005 |   |
|                         |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** **              | ** ** | **Year Ended December 31, 2003** | ** ** |
|-------------------------|------------|------------------------------------------------------|------------|
| ** **              | ** ** | **China**                                            | ** ** | **International** | ** ** | ** PCD ** | ** ** | **Adjustments(1)** | ** ** | **Consolidated** | ** ** |
| Capital expenditures    |       | $                                                    | 91,947     |   |   | $ | 31,267 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 123,214 |   |
| Total long-lived assets |       | 153,653                                              |       |   | 33,386 |   |   |   | — |   |   |   | — |   |   | 187,039 |   |
| Total assets            |       | 1,495,782                                            |       |   | 906,759 |   |   |   | — |   |   |   | (158,491 | ) |   | 2,244,050 |   |
|                         |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Adjustments reflectelimination of inter-segment transactions and investments in subsidiaries.

Geographicalarea and product sales data are as follows (in thousands):
| ** **                               | ** ** | **Years ended December 31,** | ** **    |
|------------------------------------------|------------|---------------------------------------------|---------------|
| ** **                               | ** ** | **2004**                                    | ** **    | **2003** | ** ** | **2002** | ** ** |
| ** **                               | ** ** | **(in thousands)**                     | ** **    |
| *Sales by region:*                       |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| China                                    |       | $                                           | 2,133,292     |   | 79 | % | $ | 1,680,821 |   | 86 | % | $ | 822,299 |   | 84 | % |
| North America                            |       | 341,751                                     |          | 13 | % | 31,908 |   | 2 | % | 2,436 |   | 0 | % |
| Japan                                    |       | 156,416                                     |          | 6 | % | 194,894 |   | 10 | % | 130,104 |   | 13 | % |
| Other                                    |       | 72,122                                      |          | 2 | % | 57,564 |   | 2 | % | 26,967 |   | 3 | % |
| **TOTAL NET SALES**                      | ** ** | **$**                                       | **2,703,581** | ** ** | **100** | **%** | **$** | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** |
| *Sales  by product line:*                |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure                 |       | $                                           | 1,395,521     |   | 52 | % | $ | 720,555 |   | 37 | % | $ | 447,096 |   | 46 | % |
| Handsets and  customer premise equipment |       | 1,026,483                                   |          | 38 | % | 983,392 |   | 50 | % | 376,805 |   | 38 | % |
| Broadband  infrastructure                |       | 281,577                                     |          | 10 | % | 261,240 |   | 13 | % | 157,905 |   | 16 | % |
| **TOTAL  NET SALES**                     | ** ** | **$**                                       | **2,703,581** | ** ** | **100** | **%** | **$** | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** |

 

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As of December 31,2004 and 2003, inventory balances by segment are as follows (in thousands):
| ** **    | ** ** | **December 31,** | ** ** |
|---------------|------------|-----------------------|------------|
| ** **    | ** ** | **2004**              | ** ** | **2003** | ** ** |
| China         |       | $                     | 372,457    |   | $ | 241,452 |   |
| International |       | 62,352                |       | 15,613 |   |
| PCD           |       | 156,023               |       | — |   |
|          |       | $                     | 590,832    |   | $ | 257,065 |   |

 

Long-livedassets by geographical area are as follows (in thousands):
| ** **               | ** ** | **December 31,  2004** | ** ** | **December 31,  2003** | ** ** |
|--------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| U.S.                     |       |                        | $          | 24,958                      |       |   |   | $ | 32,807 |   |   |
| China                    |       |                        | 229,469    |                        |       |   | $ | 153,653 |   |   |
| Other                    |       |                        | 14,332     |                        |       |   | 579 |   |   |
| Total long-lived  assets |       |                        | $          | 268,759                     |       |   |   | $ | 187,039 |   |   |

 

**NOTE 22—RELATED PARTY TRANSACTIONS**

*Softbank*

The Company recognizedrevenue of $143.7 million, $184.4 million and $123.0 million during the yearsended December 31, 2004, 2003 and 2002, respectively, with respect tosales of telecommunications equipment to SBBC, an affiliate of SOFTBANK CORP.and SOFTBANK America Inc., which is a significant stockholder of theCompany. SBBC offers asynchronous digital subscriber line (“ADSL”) coveragethroughout Japan, which is marketed under the name “YAHOO! BB.” In addition,the Company supports SBBC’s new fiber-to-the-home service through sales of itscarrier class Gigabit Ethernet Passive Optical Network (“GEPON”) product aswell as its multi-service optical transport product (“NetRingTM”). Revenuerecognized for the GEPON and NetRingTM products for the twelve months ended December 31,2004 was $93.4 million.

Included in accountsreceivable at December 31, 2004 and December 31, 2003 were $86.8million and $43.9 million, respectively, related to these agreements. Therewere insignificant amounts included in deferred revenue with respect of theseagreements at December 31, 2004 and no amounts included in deferredrevenue with respect of these agreements at December 31, 2003.

During August 2004,the Company entered several agreements with Japan Telecom Co., Ltd (“JT”), awholly owned subsidiary of SOFTBANK Corp., related to the sale oftelecommunication equipment and promotional services. The nature of theseagreements contemplate the sale of iAN-8000 equipment with specified value anddelivery dates, as well as an oral agreement which subsequently converted intospecific service contracts to manage a sales promotional program for JT. TheCompany has determined that the service activities revenue should be recordednet of expected promotional spending. Because the Company has not providedthese activities in the past and cannot estimate the fair value of theseservices, the Company has determined under guidance of SAB 104, that allrevenue related to these agreements will be deferred and included in customeradvance until the above-mentioned promotional activities are complete. TheCompany delivered the majority of the equipment during the third and fourthquarters of 2004.

The promotional servicesdiscussed above involve contracting with third party promotional vendors, whoin turn, facilitate the marketing and subscriber recruitment for the JTfiber-to-the-home program. During the fourth quarter of 2004, the Companydetermined that it would end its involvement with the JT promotional programafter completion of the contract discussed above. Accordingly, late in thefourth quarter of 2004 and the first quarter of 2005, the Company has eithercancelled or assigned to another 

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party,all third party contracts with promotional vendors related to the JT contract. TheCompany now expects to satisfy all its equipment and promotional obligations bythe end of the first quarter of 2005.

The terms of theseagreements specify that JT was to remit 50 percent of the contract value incash to the Company within one month of the execution of the contract, whichwas August 20, 2004. The remaining 50 percent is due shortly afterdelivery of the equipment. All cash received from JT in advance of revenuerecognition has been accounted for as a customer advance. As the Company spendscash for promotional activities, such spending is accounted for as a reductionof customer advance. As of December 31, 2004, there was $217.5 millionincluded in customer advance related to these agreements.

The Company also enteredinto an agreement during the third quarter with JT to supply chassis equipmentwith an approximate value of $75 million. Although some of the equipment wasshipped to the customer during the third quarter, it is considered linked tothe iAN-8000 sale noted above and as such, the revenue from this contract willbe deferred until the completion of the above-mentioned promotional activities.

The Company has investedin Softbank China and Restructuring Fund No. 1, which are investmentvehicles established by SOFTBANK CORP. and its affiliates. See Note 9.

On July 17, 2003, theCompany entered into a Mezzanine Loan Agreement with BB Modem Rental PLC (“BBModem”), an affiliate of SOFTBANK CORP. Under the terms of the agreement, theCompany loaned BB Modem $10.1 million at an effective interest rate of 12.01%per annum, for the purpose of investing in a portfolio of ADSL modems andassociated modem rental agreements, from SBBC. SBBC will continue to servicesuch modems and modem rental agreements. The Company’s loan is subordinated tocertain senior lenders of BB Modem, and repayments are payable to the Companyover a 42-month period through January 31, 2007, with a substantialportion of the principal amount of the loan schedule to be repaid duringthe last 16 months of this period. The Company’s recourse for nonpayment of theloan is limited to the assets of BB Modem, the account into which subscriberpayments are made and its rights under the securitization transaction documents.The value of BB Modem’s modems that serve as collateral for the loan may decreaseover time and may not be sufficient upon sale to pay the outstanding amounts onthe loans. The Company assesses the loan for impairment whenever events orchanges in circumstances indicate that the carrying amount may not berecoverable. The Company periodically reviews the underlying quality of theasset pool securing the loan to assess whether impairment has incurred andneeds to be recorded. During 2004 and 2003, the Company recorded $1.3 millionand $0.5 million, respectively, in interest income in respect to this loan. Theloan receivable at December 31, 2004 and 2003 was approximately $11.8 and$11.2 million, respectively and is included in other long-term assets.

On April 5, 2003, theCompany repurchased 8.0 million shares of common stock beneficially ownedby SOFTBANK America Inc., at a purchase price of $17.385 per share. Thetotal cost of the repurchase was $139.6 million including transaction fees.In connection with this repurchase transaction, SOFTBANK America Inc.entered into an agreement with the Company not to offer, sell or otherwisedispose of the Company’s common stock for a period of one year, subject to anumber of exceptions. As of December 31, 2004, SOFTBANK America Inc.beneficially owned approximately 12.8% of the Company’s outstanding stock.

On August 29, 2002, theCompany completed the repurchase of 6.0 million shares of our common stock for$72.9 million from SOFTBANK America, Inc.

*Cellon*

In October 2002, theCompany entered into a license and a royalty agreement with CellonInternational Holding Corporation (“Cellon”), in which the Company has a 9%ownership interest. The Company paid $0.8 million to license certain technologyfor the development of certain handset products in China. Per the terms of theroyalty agreement, the Company is required to pay Cellon $3 per unit 

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shippedfor a minimum of 0.1 million units. This agreement is not material to theoverall financial results of Cellon. The Company has evaluated its relationshipwith Cellon under FIN 46, and determined that consolidation is not necessary.

*Fiberxon*

The Company has anoutstanding purchase commitment with Fiberxon, in which the Company has an 11%ownership interest, to purchase component parts for optical networking products.In addition, the Company provided a letter of credit for $5.0 million topurchase raw materials for the manufacture of these component parts. Thiscommitment should be fulfilled without adverse consequences material to theoperations or financial condition of the Company. Purchases from Fiberxontotaled $15.1 million in 2004 and the Company has $13.3 million in accountspayable to Fiberxon at December 31, 2004.

*Mitsubishi*

The Company recognizedrevenue of $1.0 million for the year ending December 31, 2004 with MELCO,an affiliated member of Mitsubishi, which owns insignificant shares of theCompany. In addition, the Company also made purchases from Mitsubishi ofapproximately $97.4 million of parts and inventory in 2004, $363.1 million in2003, and $157.2 million in 2002. At December 31, 2004 and 2003, theCompany had $6.4 million and $12.7 million, respectively, in accounts payableto Mitsubishi.

*Starcom Products, Inc.*

The Company obtainsengineering consulting and employee placement services from Starcom Products, Inc.(“Starcom”), which is 31% owned by an individual related to a member of theCompany’s Board of Directors. The Company paid to Starcom $1.1 million in 2004,$1.4 million in 2003, and $0.7 million in 2002 for engineering consulting andemployee placement services provided by Starcom.

**NOTE 23—VARIABLE INTEREST ENTITY**

The Financial AccountingStandards Board (“FASB”) issued FASB Interpretation No. 46, (“FIN 46”).FIN 46 requires that if an entity is the primary beneficiary of a variableinterest entity, (“VIE”), the assets, liabilities, and results of operations ofthe VIE should be included in the consolidated financial statements of theentity. The Company has consolidated a related party deemed a VIE and with whomthe Company is the primary beneficiary. Beijing MDC Telecom Co., Ltd. (“MDC BJ”)was formed in 2001. In 2002, a venture capital fund with affiliation to ashareholder of the Company made an additional capital investment andestablished MDC Holding Limited (“MDC Holding”) and its affiliated entities(MDC Holding and such affiliated entities, including MDC BJ, are referred to,collectively, as “MDC”). MDC is in the business of providing value-addedservices, such as short message, voicemail or ring-tone services for PAStelecom networks. The Company has consolidated MDC, a VIE, for whom the Companyis the primary beneficiary. At December 31, 2004, the consolidationresulted in a $4.2 million increase in both total assets and total liabilitiesand equity. There was no effect on net income as a result of this consolidation.No assets were provided as collateral for MDC’s obligations. MDC’s creditorshave no recourse to the general credit of the Company.

**NOTE 24—SUBSEQUENT EVENTS**

Pursuant to the AssetPurchase Agreement entered into on October 29, 2004, between UTStarcomCDMA Technologies Korea Limited, a limited liability company organized underthe laws of Korea and a wholly owned subsidiary of the Company, and GigaTelecom, Inc., (“Giga”), a Korean corporation that develops andmanufactures wireless handsets, the Company completed the acquisition on January 4,2005. At the closing, $13.0 million in cash was paid, and an additional $2.0million was paid into an escrow account held by the Company for six months.

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On January 20, 2005,the Company, formed a joint venture with two other parties to provide mobilecommunication, broadband and IP related value added services in Mongolia. Accordingto the joint venture agreement, the joint venture will be capitalized with $20million in cash and equipment. On February 25, 2005, the Companycontributed $1.8 million of capital. The Company presently expects toconsolidate the operations of the joint venture beginning in the first quarterof 2005.

On March 31, 2005,the Company filed a current report on Form 8-K with the Securities and ExchangeCommission disclosing that the Company would delay the filing of its AnnualReport on Form 10-K for the year ended December 31, 2004. The delayresults in a technical default of the Company’s 7¤8% ConvertibleSubordinated Notes due 2008. The default would not become an event of defaultunless the Company failed to file the 2004 Form 10-K within 60 days ofwritten notice of the default being provided to the Company by either thetrustee under the indenture or the holders of at least 25% in aggregateprincipal amount of the notes then outstanding. If an event of default were tooccur and be continuing, the trustee or the holders of at least 25% inaggregate principal amount of the notes then outstanding could declare allunpaid principal and accrued interest on the Notes then outstanding to beimmediately due and payable. The Company believes that this technical defaultwill be remediated with the filing of this 2004 Form 10-K.

**QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)**

Quarterlyfinancial data for the periods indicated are as follows:
| ** **                       | ** ** | **Quarter ended**                                                | ** ** |
|----------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                       | ** ** | **Dec. 31,  2004(1)(2)**                                         | ** ** | **Sept. 30,  2004** | ** ** | **June 30,  2004** | ** ** | **March 31,  2004** | ** ** | **Dec. 31,  2003(4)** | ** ** | **Sept. 30,  2003(4)** | ** ** | **June 30,  2003(3)(4)** | ** ** | **March 31,  2003(4)** | ** ** |
| ** **                       | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues                         |       | $                                                                     | 746,645    |   | $ | 645,016 |   | $ | 689,628 |   | $ | 622,292 |   | $ | 644,451 |   | $ | 584,382 |   | $ | 405,834 |   | $ | 330,520 |   |
| Gross profit                     |       | $                                                                     | 112,163    |   | $ | 137,134 |   | $ | 176,270 |   | $ | 176,034 |   | $ | 188,094 |   | $ | 186,102 |   | $ | 137,504 |   | $ | 112,685 |   |
| Net income (loss)                |       | $                                                                     | (30,201    | ) | $ | 4,987 |   | $ | 43,863 |   | $ | 54,766 |   | $ | 65,710 |   | $ | 65,204 |   | $ | 43,450 |   | $ | 41,168 |   |
| Net earnings (loss) per  share:* |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                            |       | $                                                                     | (0.26      | ) | $ | 0.04 |   | $ | 0.39 |   | $ | 0.48 |   | $ | 0.63 |   | $ | 0.63 |   | $ | 0.43 |   | $ | 0.38 |   |
| Diluted                          |       | $                                                                     | (0.26      | ) | $ | 0.04 |   | $ | 0.33 |   | $ | 0.40 |   | $ | 0.51 |   | $ | 0.50 |   | $ | 0.36 |   | $ | 0.37 |   |

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(1)          OnNovember 1, 2004, the Company completed its acquisition of AudiovoxCommunication Corporation. Revenue for the two months ended December 31,2004 from this acquisition was $277.4 million.

(2)          Netincome for the quarter ended December 31, 2004 included an $7.5 millioncharge associated with the impairment of various assets, including $7.0 millionof goodwill, related to the substantial abandonment of operations of HyundaiSyscomm, Inc. See Note 10 to the Consolidated Financial Statements. 

(3)          Netincome for the quarter ended June 30, 2003 included a charge of $7.0million for in-process research and development associated with variousacquisitions.

(4)   The Company filed an Amendment to its Annual Report on Form 10-Kfor the year ended December 31, 2003 to reflect the restatement of itsconsolidated financial statements for the year ended December 31, 2003.See Note 2 to the Consolidated Financial Statements.

*                    Netearnings (loss) per share is computed independently for each of the quarterspresented and, therefore, the sum of the quarterly net earnings per share maynot equal the annual earnings per share.

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**ITEM 9—CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

Not applicable.

**ITEM 9A—CONTROLS AND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

UTStarcom, Inc. (the “Company”) maintains disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in the reports the Company files or submits under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to the Company’s management,including its Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”),as appropriate, to allow timely decisions regarding required financialdisclosure.

In connection with the preparation of this AnnualReport on Form 10-K, the Company carried out an evaluation under thesupervision and with the participation of the Company’s management, includingthe CEO and CFO, as of December 31, 2004 of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures, assuch term is defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act. Based upon this evaluation, the CEO and CFO concluded that asof December 31, 2004 the Company’s disclosure controls and procedures werenot effective because of the material weaknesses described below under “Management’sReport on Internal Control Over Financial Reporting.”

To address the materialweaknesses described below, the Company performed additional analyses and otherprocedures (as further described below under the subheadings “Interim Measures”under “Management’s Remediation Initiatives and Interim Measures”) to ensurethat the Company’s consolidated financial statements were prepared inaccordance with generally accepted accounting principles in the United States. Accordingly,the Company’s management believes that the consolidated financial statementsincluded in this Annual Report on Form 10-K fairly present in allmaterial respects the Company’s financial condition, results of operations andcash flows for the periods presented and that this Annual Report on Form 10-Kdoes 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 period covered by this report.

**Management’sReport on Internal Control Over Financial Reporting**

Management is responsible for establishing andmaintaining adequate internal control over financial reporting for the Company,as such term is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act. The Company’s internal control over financial reporting is aprocess designed to provide reasonable assurance regarding the reliability offinancial reporting and the preparation of financial statements for externalreporting purposes in accordance with generally accepted accounting principlesin the United States. Internal control over financial reporting includes thosepolicies and procedures that: pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions and dispositionsof the assets of the Company; provide reasonable assurance that transactionsare recorded as necessary to permit preparation of financial statements inaccordance with generally accepted accounting principles, and that receipts andexpenditures of the Company are being made only in accordance withauthorizations of management and directors of the Company; and providereasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the Company’s assets that could have amaterial effect on the consolidated financial statements.

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Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

Management has conducted an assessment, includingtesting, of the effectiveness of the Company’s internal control over financialreporting as of December 31, 2004. In making its assessment of internalcontrol over financial reporting, management used the criteria in *Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

Management has excluded Audiovox CommunicationCorporation (“Audiovox”) from its assessment of the Company’s internal controlover financial reporting as of December 31, 2004 because Audiovox wasacquired by the Company through a purchase business combination in November 2004.Audiovox’s total assets and total revenue represent approximately 11.0% and approximately 10.3%, respectively, of the Company’srelated consolidated financial statement amounts as of and for the year ended December 31,2004.

A material weaknessis a control deficiency, or combination of control deficiencies, that resultsin more than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected.  As of December 31, 2004, managementidentified the following material weaknesses in its assessment of theeffectiveness of the Company’s internal control over financial reporting:

1.   *As of December 31, 2004, the Companydid not maintain effective controls over the financial reporting process due toan insufficient complement of personnel with a level of accounting knowledge,experience and training in the application of generally accepted accountingprinciples commensurate with the Company’s financial reporting requirements.*   Thismaterial weakness contributed to the following control deficiencies relating tothe preparation of  the Company’sfinancial statements which are individually considered to be materialweaknesses:

(a)    TheCompany did not maintain effective controls over its revenue and deferredrevenue accounts and associated cost of sales. Specifically, the Company’scontrols over its processes and procedures related to the recording and reviewof its revenue and deferred revenue accounts were not adequate to ensure thatsuch accounts were completely and accurately recorded. In particular, thefollowing exceptions were identified in which revenue recognition criteria werenot properly assessed: treatment of upgrade protection in a multiple elementarrangement, non-standard contractual terms and conditions, exceptions to finalacceptance confirmations received from customers, tracking of proof of deliveryand timing of execution of final acceptance confirmations, and theidentification of the appropriate costs associated with selected salestransactions. This control deficiency resulted in adjustments to the secondquarter 2004 financial statements and audit adjustments to the fourth quarter2004 financial statements to properly recognize revenue and cost of sales.

(b)   The Companydid not maintain effective controls over its inventory, deferred costs,inventory reserve accounts and cost of sales. Specifically, the Company’scontrols failed to adequately identify, document and analyze the conditionsthat should have been considered relative to the existence and expectedrecoverability of inventory and deferred costs. Principally in Japan, controlswere not adequate to properly track and confirm inventory movements or ensurethe timely recognition of cost of goods sold. In addition, certain inventorypurchases were approved locally but were not in accordance with the Company’susual procurement polices and procedures. This control deficiency resulted incertain audit adjustments to the fourth quarter 2004 financial statements tocorrect cost of goods sold and the related inventory and deferred costsaccounts.

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(c)    TheCompany did not maintain effective controls over its processes for accountingfor goodwill. Specifically, the Company’s controls over its processes andprocedures related to its assessment of the impairment of its goodwill accountwere not sufficiently detailed to identify instances of impairment as requiredunder generally accepted accounting principles. This control deficiencyresulted in an audit adjustment to the fourth quarter 2004 financial statementsto recognize the impairment of the Company’s goodwill associated with theoperations of an entity acquired and substantially abandoned in 2004.

(d)   The Companydid not maintain effective controls over the process for the translation of itsaccounts and transactions denominated in a currency other than U.S. dollars. Specifically,the Company’s controls over its processes and procedures related to thetranslation of transactions and account balances denominated in a currencyother than U.S. dollars failed to identify and utilize the appropriate foreignexchange rates, primarily related to the cash, accounts receivable, accountspayable, and other comprehensive income accounts. This control deficiencyresulted in certain audit adjustments to the fourth quarter 2004 financialstatements to properly record unrealized foreign exchange gains.

(e)    TheCompany did not maintain effective controls over the recording of accruedexpenses, primarily in China and Japan. Specifically, the Company’s controlsover its processes and procedures related to accrued expenses failed tocompletely and accurately record expenses in the proper period. The review ofopen purchase orders and invoices received as part of the close process wasinsufficient to ensure that the 2004 year-end accrued expense balances werecompletely and accurately recorded in the proper period. This controldeficiency resulted in certain audit adjustments to the fourth quarter 2004financial statements to properly record certain accrued expense and relatedincome statement accounts.

(f)    TheCompany did not maintain effective controls over the financial reportingprocess to ensure the accurate preparation and review of its financialstatements. Specifically, the Company’s controls over the completeness,accuracy and review of its documentation of close processes relating toreconciliations, journal entries, spreadsheets, international reportingpackages and review and preparation of monthly expenditure reports wereineffective in their design and execution. In addition, the Company did nothave effective controls over the process for identifying and accumulating allrequired supporting information to ensure the completeness of its footnotedisclosures, including the support for the accounting positions taken onnon-routine transactions, goodwill impairment, purchase accounting, segmentreporting, accounting for potential variable interest entities, intercompanyprofit eliminations and income tax accounting and proper classification ofinventory and deferred costs, deferred revenue and accounts receivable, andrevenue and cost of goods sold. These control deficiencies resulted in certainaudit adjustments to and additional disclosures made in the 2003 and 2004financial statements.

(g)    TheCompany did not maintain effective controls over the completeness and accuracyof its income tax provision and related balance sheet accounts. Specifically,as part of its 2004 year-end close process, certain errors related to incometaxes payable, deferred income tax assets and liabilities, other long-termassets, prepaids and other current assets were identified in the calculation ofthe Company’s 2003 income tax provision. This control deficiency resulted inthe restatement of the Company’s financial statements for the quarters and fullyear of 2003 as well as audit adjustments to the fourth quarter 2004 financialstatements to adjust the provision for income taxes, stockholders’ equity,income taxes payable, other long-term assets, prepaids and other currentassets.

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(h)   The Companydid not maintain effective controls in relation to segregation of duties anduser access to certain Oracle business process applications nor were thereeffective controls in place to monitor user access. There were instances inwhich either information technology or finance personnel maintained access tospecific applications within the Oracle environment beyond that needed toperform their individual job responsibilities. This deficiency related tofinancial reporting, inventory and purchasing applications in China andfinancial reporting applications in the United States.

As discussed above, certain of these control deficienciesresulted in either the restatement of the Company’s financial statements foreach of the quarters in 2003 and the year ended December 31, 2003, and/oraudit adjustments to the second or fourth quarter 2004 financial statements. Additionally,these control deficiencies could individually or in the aggregate result in amaterial misstatement to the annual or interim financial statements that wouldnot be prevented or detected. Accordingly, management has determined that thesecontrol deficiencies constitute material weaknesses.

2.   *As of December 31, 2004, the Companydid not maintain effective controls over the identification of and accountingfor related party relationships and related party transactions.*   Specifically,the Company’s controls over its policies and procedures were ineffective inidentifying all significant related party relationships and transactions on atimely basis in order for such relationships and transactions to beappropriately reflected in the Company’s financial statements in accordancewith generally accepted accounting principles. Specifically, a previouslyundisclosed significant related party relationship was identified during the2004 financial close process. This related party was also determined to be avariable interest entity in which the Company was determined to be the primarybeneficiary. This control deficiency resulted in a restatement of the Company’sfinancial statements for the year ended December 31, 2003, as well as anaudit adjustment to the 2004 financial statements. Additionally, this controldeficiency could result in a material misstatement to annual or interimfinancial statements that would not be prevented or detected. Accordingly,management has determined that this control deficiency constitutes a materialweakness.

3.   *As of December 31, 2004, the Companydid not maintain effective controls over the monitoring of its accountingfunctions located outside of the U.S.*   The Company’s policiesand procedures with respect to the review and supervision of its accountingoperations in foreign locations, principally Japan and China, were inadequate. Specifically,corporate senior financial management did not provide adequate oversight of theaccounting functions based principally in Japan and China nor was there sufficientand accurate information for monitoring the financial results of non-U.S.operations. Reviews of local financial results were inadequate in either theirdesign or operation to detect errors to the Company’s financial statements asdescribed in items 1 and 2 above. Additionally, this control deficiency couldresult in a material misstatement to annual or interim financial statementsthat would not be prevented or detected. Accordingly, management has determinedthat this control deficiency constitutes a material weakness.

4.   *As of December 31, 2004, the Companydid not maintain an effective control environment.*   Thefinancial reporting organizational structure was not adequate to support thesize, complexity, operating activities or locations of the Company. Deficienciesin local accounting operations, such as the lack of a senior finance directorin China with sufficient depth and skill in the application of U.S. generallyaccepted accounting principles and inadequate understanding of U.S. generallyaccepted accounting principles by local accounting staff resulted in theadjustments to the financial statements as discussed in items 1 - 3 above.In addition, in some cases, certain key finance positions were staffed withindividuals who did not have the appropriate skills, training and experience tomeet the objectives as outlined in their job descriptions or that should beexpected of these roles. Further, the following specific areas are examples ofsome of the corporate departments in the Company where additional 

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skilled resources arerequired: tax, external financial reporting, revenue recognition, treasury,financial planning and analysis and corporate accounting. This controldeficiency, together with the material weaknesses described in items 1 - 3above, indicate that the Company did not maintain an effective controlenvironment. These control deficiencies could result in a material misstatementto annual or interim financial statements that would not be prevented ordetected. Accordingly, management has determined that this control deficiencyconstitutes a material weakness.

Because of the material weaknesses described above,management has concluded that the Company did not maintain effective internalcontrol over financial reporting as of December 31, 2004, based on criteriaestablished in *Internal Control—IntegratedFramework*issued by the COSO.

Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independentregistered public accounting firm, as stated in their report which appearsunder Item 8 of this Annual Report on Form 10-K.

**Management’sRemediation Initiatives and Interim Measures**

In response to the mattersdiscussed in “Management’s Report on Internal Control Over Financial Reporting”above, the Company plans to continue to review and make necessary changes tothe overall design of its control environment, including the roles andresponsibilities of each functional group within the organization and reportingstructure, as well as policies and procedures to improve the overall internalcontrol over financial reporting. In particular, the Company has implementedand/or plans to implement during 2005 the specific measures described below toremediate the material weaknesses described above in “Management’s Report onInternal Control Over Financial Reporting.” In addition, in the absence of full implementation of these remediationmeasures as of December 31, 2004, subsequent to this date and in connectionwith the 2004 year-end reporting process, the Company has undertaken theadditional measures described under the subheadings “—Interim Measures” belowto provide reasonable assurance regarding the reliability of financialreporting and the preparation of the Company’s financial statements included inthis Annual Report on Form 10-K and to ensure that materialinformation relating to the Company and its consolidated subsidiaries was madeknown to management in connection with the preparation of this Annual Report onForm 10-K.

***Material weaknesses described in item 1 of “Management’sReport on Internal Control Over Financial Reporting”***

*RemediationInitiatives*.   The Company’s failure to have a sufficientcomplement of personnel with a level of accounting knowledge, experience andtraining in the application of generally accepted accounting principlescommensurate with the Company’s financial reporting requirements contributed tothe Company’s failure to maintain effective controls over the financialreporting process. To remediate the material weaknesses described in item 1 of “Management’sReport on Internal Control Over Financial Reporting” above, the Company hasimplemented or plans to implement the measures described below, and willcontinue to evaluate and may in the future implement additional measures.

1.      Generalplan for hiring and training of personnel—The Company’s planned remediationmeasures are intended to generally address this material weakness by ensuringthat the Company will have sufficient personnel with knowledge, experience andtraining in the application of generally accepted accounting principlescommensurate with the Company’s financial reporting requirements. Thesemeasures include the following:

(a)    TheCompany’s chief financial officer, with assistance from senior financial staffand outside consultants, other than the Company’s independent registered publicaccounting firm, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial 

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reporting structure,including the roles and responsibilities of each functional group within theCompany;

(b)   The Companyhired regional controllers with relevant accounting experience, skills andknowledge for each of the Asia-Pacific region, the Central America and LatinAmerica region, the Europe, Middle East and Africa region and Japan in late2004 and early 2005;

(c)    TheCompany hired a consolidation manager in China with relevant accountingexperience, skills and knowledge in February 2005;

(d)   The Companyhired a senior manager for SEC reporting with relevant accounting experience,skills and knowledge in February 2005;

(e)    TheCompany promoted an individual within the Company with relevant accountingexperience, skills and knowledge to become the controller of China operationsin April 2005;

(f)    TheCompany retained and intends to continue to retain the services of outsideconsultants, other than the Company’s independent registered public accountingfirm, with relevant accounting experience, skills and knowledge, working underthe supervision and direction of the Company’s management, to supplement theCompany’s existing accounting personnel;

(g)    TheCompany plans to hire and is actively recruiting a vice president of financefor the Company’s China operations with extensive relevant accountingexperience, skills and knowledge;

(h)   The Companyplans to continue to hire, and has allocated resources to hire, additional accountingpersonnel in the U.S., China and Japan, in the areas of tax, external financialreporting, revenue recognition, treasury, financial planning and analysis andcorporate accounting with relevant accounting experience, skills and knowledge;and

(i)    TheCompany in February 2005 implemented an enhanced formal training processfor the training of financial staff and plans to continue this process toensure that personnel have the necessary competency, training and supervisionfor their assigned level of responsibility and the nature and complexity of theCompany’s business.

2.      Revenue Recognition—The Company’s planned remediation measuresare intended to address material weaknesses related to revenue and deferredrevenue accounts and associated cost of sales. These material weaknesses wereevidenced by the identification of six separate transactions aggregatingapproximately $5 million in which revenue was initially included in the Company’sfourth quarter 2004 financial statements before all criteria for revenuerecognition were met. In addition, there were other transactions for whichthere was insufficient initial documentation for revenue recognition purposes,but which did not result in any adjustments to the Company’s fourth quarter2004 financial statements. If unremediated, these material weaknesses have thepotential of misstating revenue in future financial periods. The Company’splanned remediation measures include the following:

(a)    TheCompany plans to design a contract review process in China requiring financialand legal staff to provide input during the contract negotiation process toensure timely identification and accurate accounting treatment of non-standardcontracts;

(b)   In March 2005,the Company conducted a training seminar regarding revenue recognition,including identification of non-standard contracts, in the U.S., and, in April 2005,the Company conducted a similar seminar in China. Starting in May 2005,the Company plans to conduct additional training seminars in variousinternational locations regarding revenue recognition and the identification ofnon-standard contracts; and

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(c)    At the endof 2004, the Company began requiring centralized retention of documentationevidencing proof of delivery and final acceptance for revenue recognitionpurposes.

3.      Inventory Management—The Company’s planned remediation measuresare intended to address material weaknesses related to inventory, deferredcosts, inventory reserve accounts and cost of sales that have the potential ofmisstating inventory and deferred costs and expected recoverability ofinventory in future financial periods. The Company’s planned remediationmeasures include the following:

(a)    TheCompany is in the process of continuing to upgrade and implement additionalOracle modules to more effectively track inventory and evaluate deferred costs;

(b)   The Companyimplemented in late 2004, and plans to improve during 2005, its process toconfirm the existence of off-site inventory by systematically obtainingcustomer confirmations, investigating discrepancies in the confirmed results,and properly recording and reporting the results of the investigation;

(c)    During thefourth quarter of 2004, the Company initiated a process to accumulateinformation necessary to evaluate inventory and deferred cost contracts forimpairment. The Company plans to continue to enhance this process in 2005 bybetter coordinating the accumulation of such information from non-U.S.locations;

(d)   The Companyplans to implement in 2005 more robust controls over the release of costs tothe income statement by better utilizing the Oracle system;

(e)    TheCompany is in the process of selecting a service provider with expertise andsystems to more effectively manage and track the Company’s inventory in Japan,to whom the Company plans to outsource this function in 2005; and

(f)    TheCompany plans to deploy the Oracle system in Japan by the third quarter of2005.

4.      Accounting for Goodwill—The Company’s planned remediationmeasures are intended to address a material weakness related to the Company’saccounting for goodwill that has the potential of misstating goodwill amountsand the impairment of the Company’s goodwill in future financial periods. TheCompany’s planned remediation measures include the following:

(a)    In thefirst quarter of 2005, the Company implemented a process of reallocatinggoodwill to the Company’s five reporting units in a manner reflective of theCompany’s new organization; and

(b)   As part ofthe process described in (a) above, the Company retained an outsideconsultant, working under the supervision and direction of the Company’smanagement, to assist in a valuation analysis that was used in the allocationprocess. The Company plans to use the consultant on at least an annual basis toassist in a valuation and impairment analysis with respect to goodwill.

5.      ForeignExchange Translations—The Company’s planned remediation measures are intendedto address a material weakness related to the Company’s controls over itsprocesses and procedures related to the translation of its accounts andtransactions denominated in a currency other than U.S. dollars that has thepotential of misstating various accounts in future financial periods. TheCompany’s planned remediation measures include the implementation in the firstquarter of 2005 of an enhanced foreign exchange accounting process utilizingthe actual month-end exchange rates.

6.      Recordingof Accrued Expenses and Open Purchase Orders—The Company’s planned remediationmeasures are intended to address a material weakness related to the Company’s 

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recording of accruedexpenses, primarily in China and Japan, that has the potential of misstatingaccrued expenses and related income statement accounts in future financialperiods. The Company’s planned remediation measures include the implementationin the first quarter of 2005 of a process of enhanced review of open purchaseorders and review of invoices and receipts after the end of each quarter toensure proper recording of accrued expenses and open purchase order commitments.

7.           Accurate Preparation and Review ofFinancial Statements, Reconciliations, Journal Entries and Segment Reporting—TheCompany’s planned remediation measures are intended to address materialweaknesses related to the financial close and reporting process that have thepotential of preventing the accurate preparation and review of the Company’sconsolidated financial statements in future financial periods. The Company’splanned remediation measures include the following:

(a)    During thefirst quarter of 2005, the Company began to implement, and plans to continue toimprove, new and enhanced procedures to ensure that non-routine transactionsare identified and escalated to senior financial management during the closeprocess to help ensure proper accounting treatment. Specific steps includetraining and ongoing monitoring of financial staff, expansion of the officersubcertifications and active review of contracts by knowledgeable financial andlegal staff, from the contract negotiation process through recognition ofrevenue for such contracts;

(b)   During thefourth quarter of 2004, the Company implemented, and plans to continue toenhance, its month-end closing procedures, including reconciliations andcontrols over spreadsheets, and standardized checklists to ensure suchprocedures are consistently and effectively applied throughout theorganization; and

(c)    TheCompany plans to enhance in 2005 the communication and distribution of itsaccounting policies and procedures and development of a process to moreeffectively accumulate and analyze information required for financial statementfootnote disclosures.

8.      Income Tax Analysis—The Company’s planned remediation measuresare intended to address material weaknesses related to the calculation of itsprovision for income taxes that have the potential of misstating the provisionfor income taxes and related balance sheet accounts in future financial periods.The Company’s planned remediation measures include the following:

(a)    TheCompany plans to hire and train additional experienced tax managers andsupporting staff in 2005 to closely monitor reporting from China and Japan, toassist in managing audits and to monitor tax compliance in China and Japan;

(b)   During thefirst quarter of 2005, the Company utilized outside consultants, other than theCompany’s independent registered public accounting firm, to assist the Company’smanagement, working under its supervision and direction, in its analysis andcalculation of its income tax provision, and the Company plans to continue toutilize outside consultants, other than the Company’s independent registeredpublic accounting firm, to assist the Company’s management, working under itssupervision and direction, in its analysis of such matters in future periods;and

(c)    The Company plans to develop a comprehensiveprocess to accumulate and organize financial and tax data used in connectionwith income tax calculation and reporting.

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9.      Utilization of Automated Controls—The Company’s plannedremediation measures are intended to address a material weakness related to thesegregation of duties and user access to certain Oracle business processapplications that have the potential of misstating of various accounts infuture financial periods. The Company’s planned remediation measures includethe following:

(a)    During thefirst quarter of 2005, the Company outsourced to a third-party expert theposition of chief security officer to, among other duties, monitor accessrights with respect to the Oracle system and manage ongoing provisioning andchanges;

(b)   The Companyplans to improve utilization of current functionality and continue to upgradeand expand functionality of the Oracle financial reporting system throughutilization of additional modules to reduce manual procedures and theutilization of spreadsheets;

(c)    TheCompany plans to deploy the Oracle system in Japan by the third quarter of2005;

(d)   The Companyis in the process of continuing to upgrade and implement additional Oraclemodules to more effectively track inventory and evaluate deferred costs; and

(e)    TheCompany plans to implement in 2005 more robust controls over the release ofcosts to the income statement by better utilizing the Oracle system.

*InterimMeasures*.   Management has not yet implemented all of themeasures described in items 1 through 9 above and/or tested them. Nevertheless,management believes those measures identified above as having been implemented,together with the other measures undertaken by the Company described below, allof which were undertaken subsequent to December 31, 2004 and in connectionwith the 2004 year-end reporting process, address the material weaknessesdescribed in item 1 of “Management’s Report on Internal Control Over FinancialReporting.”  These other measures includethe following:

·  The2004 year-end reporting process was extended significantly, allowing theCompany to conduct additional analysis and make additional adjustments asnecessary to ensure the accuracy of financial reporting.

·  Seniorcorporate finance staff traveled to China and Japan subsequent to the closeprocess and prior to the reporting of 2004 year-end financial results toconduct a review of the reporting process in those jurisdictions and to causeadditional measures relating to the reporting process to be undertaken asnecessary to ensure the accuracy of financial reporting.

·  TheCompany retained on an interim basis outside consultants, other than theCompany’s independent registered public accounting firm, with relevantaccounting experience, skills and knowledge, working under the supervision anddirection of the Company’s management, to assist with the 2004 year-endreporting process.

·  TheCompany conducted an additional review of a substantial majority of itsrevenue-generating contracts for compliance with revenue recognition criteria.As part of this review, the Company gathered and analyzed evidence of deliveryand final acceptance.

·  TheCompany performed the following reviews of inventory-related matters: itreviewed consolidated revenue schedules from the fourth quarter of 2004 todetermine the proper recording of cost of goods sold; it conducted areconciliation of inventories at customer sites to outstanding contracts as ofthe year end and analyzed inventory for recovery and potential impairment; itconducted physical inventory counts; it verified inventory at customerlocations with customer confirmations; and it conducted an analysis ofinventory relating to purchase orders to identify under-recorded inventory.

·  TheCompany conducted a review of the processes to record inventory reserves and areview of the manual procedures by which the Company tracks the cost of itsproducts.

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·  TheCompany conducted a variety of manual review procedures, such as an extensivereview of journal entry postings into the Oracle system and an extensive reviewof account reconciliations.

·  TheCompany conducted a detailed and extensive review of the following matters: allnon-routine transactions and internal representations; financial statements, aswell as certifications from decentralized locations, for accuracy;spreadsheets; and journal entries.

·  TheCompany reviewed its reserves and related schedules and reported its findingsto the Audit Committee.

·  TheCompany processed an adjustment relating to foreign exchange accounting usingthe enhanced foreign exchange accounting process implemented in the firstquarter of 2005 described above.

***Material weakness described in item 2 of “Management’sReport on Internal Control Over Financial Reporting”***

*RemediationInitiatives*.   The Company’s failure to ensure that keymanagement fully understood the nature and potential significance of relatedparties and to ensure that a robust process for the identification of related partytransactions contributed to the Company’s failure to maintain effectivecontrols over the identification of and accounting for related partyrelationships and related party transactions with the Company. To remediate thematerial weakness described in item 2 of “Management’s Report on InternalControl Over Financial Reporting,” the Company has implemented or plans toimplement the measures described below, and will continue to evaluate and mayin the future implement additional measures.

1.      TheCompany conducted an educational seminar with the Company’s key management in March 2005in which the Company’s internal and outside legal counsel and members of theAudit Committee reviewed certain key objectives of the Company’s Code ofConduct, including the identification, recognition and disclosure of relatedparty transactions.

2.      In thefirst quarter of 2005, the Company expanded the number of Company personnelrequired to certify to senior management with respect to identification,recognition and disclosure of related party transactions for SEC reportingpurposes, and revised the Company’s internal certification process concerningidentification, recognition and disclosure of related party transactions.

3.      TheCompany plans to continue to evaluate the Company’s procedures to ensure theidentification, recognition and disclosure of related party transactions.

4.      TheCompany plans to conduct periodic training sessions with key managers andsenior executives regarding the Code of Conduct, including the identification,recognition and disclosure of related party transactions.

5.      TheCompany plans to provide key managers and senior executives with access tolegal and accounting personnel to enable such managers and executives to moreaccurately and comprehensively comply with the Company’s internal certificationprocess for SEC reporting purposes.

*InterimMeasures*.   Management has not yet implemented all of themeasures described above and/or tested them. Nevertheless, management believesthose measures identified above as having been implemented, together with theother measures undertaken by the Company described below, all of which wereundertaken subsequent to December 31, 2004 and in connection with the 2004year-end reporting process are sufficient to address the material weaknessdescribed in item 2 of “Management’s Report on Internal Control Over FinancialReporting.” These other measures include the following:

·  Managementdirectly interviewed senior executives regarding related party transactions.

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·  Afterreceiving additional training on related party transactions, all key managersand senior executives provided new certifications regarding related partytransactions.

***Material weakness described in item 3 of “Management’sReport on Internal Control Over Financial Reporting”***

*RemediationInitiatives*.   Lack of clarity in roles andresponsibilities in certain areas affecting the Company’s financial reportingstructure contributed to a material weakness relating to the monitoring ofnon-U.S. operations. To remediate this material weakness, described in item 3of “Management’s Report on Internal Control Over Financial Reporting,” theCompany has implemented or plans to implement the measures described under “—Materialweaknesses described in item 1 of ‘Management’s Report on Internal Control OverFinancial Reporting’—Remediation Measures—1. General plan for hiring and trainingof personnel,” as well as those described below. The Company will continue toevaluate and may in the future implement additional measures.

1.      TheCompany streamlined the reporting structure between all non-U.S. accountingfunctions and the comparable groups in the corporate headquarters, includingtax, treasury and financial planning and analysis groups, in early 2005 toprovide for direct reporting to, and oversight by, the U.S. corporateheadquarters.

2.      TheCompany plans to expand the size of the internal audit group and the scope ofthe internal audit group’s responsibilities to monitor non-U.S. operationsthrough reviews and audits of such locations.

3.      TheCompany’s chief financial officer, with assistance from senior financial staffand outside consultants, other than the Company’s independent registered publicaccounting firm, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company.

4.      TheCompany has implemented, and plans to continue to improve, a closing checklistto standardize its procedures for financial review to ensure that U.S.reviewers monitor financial information from non-U.S. locations in a consistentmanner, through such measures as use of standardized reporting packages andreview procedures.

*InterimMeasures*.   Management has not yet implemented all of themeasures described above and/or tested them. Nevertheless, management believesthose measures identified above as having been implemented, together with theother measures undertaken by the Company described below, all of which were undertakensubsequent to December 31, 2004 and in connection with the 2004 year-endreporting process, address the material weakness described in item 3 of “Management’sReport on Internal Control Over Financial Reporting.”  These other measures include the following:

·  Seniorcorporate finance staff traveled to China and Japan subsequent to the closeprocess and prior to the reporting of 2004 year-end financial results toconduct a review of the reporting process in those jurisdictions, to supervisea physical inventory count and to cause additional measures relating to thereporting process to be undertaken as necessary to ensure the accuracy offinancial reporting.

·  Seniorfinancial staff performed additional review of invoices and cash disbursementsin Japan.

·  Seniorfinancial staff in the Company’s U.S. headquarters did a thorough review oftrial balances issued from non-U.S. locations.

·  TheCompany utilized outside consultants, other than the Company’s independent registeredpublic accounting firm, to assist the Company’s management, working under itssupervision and direction, with the year-end review of China operations.

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·  Allnon-routine transactions in non-U.S. locations were documented by staff in suchnon-U.S. locations and reviewed by senior financial staff in the Company’s U.S.headquarters.

***Material weakness described in item 4 of “Management’sReport on Internal Control Over Financial Reporting”***

*RemediationInitiatives*.   The Company’s failure to have sufficientpersonnel with knowledge, experience and training in the application ofgenerally accepted accounting principles commensurate with the Company’sfinancial reporting requirements contributed to a material weakness relating tothe Company’s control environment. To remediate this material weakness,described in item 4 of “Management’s Report on Internal Control Over FinancialReporting,” the Company has implemented or plans to implement the measuresdescribed under “—Material weaknesses described in item 1 of ‘Management’sReport on Internal Control Over Financial Reporting’—Remediation Measures—1. Generalplan for hiring and training of personnel,” as well as those described below. TheCompany will continue to evaluate and may in the future implement additionalmeasures.

1.      TheCompany streamlined the reporting structure between all non-U.S. accountingfunctions and the comparable groups in the corporate headquarters, includingtax, treasury and financial planning and analysis groups, in early 2005 toprovide for direct reporting to, and oversight by, the U.S. corporateheadquarters.

2.      TheCompany plans to expand the size of the internal audit group and the scope ofthe internal audit group’s responsibilities to monitor non-U.S. operationsthrough reviews and audits of such locations.

3.      TheCompany’s chief financial officer, with assistance from senior financial staffand outside consultants, other than the Company’s independent registered publicaccounting firm, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company.

4.      TheCompany has implemented, and plans to continue to improve, a closing checklistto standardize its procedures for financial review to ensure that U.S.reviewers monitor financial information from non-U.S. locations in a consistentmanner, through such measures as use of standardized reporting packages and reviewprocedures.

*InterimMeasures*.   Management has not yet implemented all of themeasures described above and/or tested them. Nevertheless, management believesthose measures identified above as having been implemented, together with theother measures undertaken by the Company described below, all of which were undertakensubsequent to December 31, 2004 and in connection with the 2004 year-endreporting process, address the material weaknesses described in item 4 of “Management’sReport on Internal Control Over Financial Reporting.”  These other measures include the following:

·  Seniorcorporate finance staff traveled to China and Japan subsequent to the closeprocess and prior to the reporting of 2004 year-end financial results toconduct a review of the reporting process in those jurisdictions, to supervisea physical inventory count and to cause additional measures relating to thereporting process to be undertaken as necessary to ensure the accuracy offinancial reporting.

·  Seniorfinancial staff performed additional review of invoices and cash disbursementsin Japan.

·  Seniorfinancial staff in the Company’s U.S. headquarters did a thorough review oftrial balances issued from non-U.S. locations.

·  TheCompany utilized outside consultants, other than the Company’s independentregistered public accounting firm, to assist the Company’s management, workingunder its supervision and direction, with the year-end review of Chinaoperations.

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·  Allnon-routine transactions in non-U.S. locations were documented by staff in suchnon-U.S. locations and reviewed by senior financial staff in the Company’s U.S.headquarters.

***Control deficiencies not constituting materialweaknesses***

In addition to thematerial weaknesses described in “Management’s Report on Internal Control OverFinancial Reporting,” management has identified other deficiencies in internalcontrol over financial reporting that did not constitute material weaknesses asof December 31, 2004. The Company has implemented and/or plans toimplement during 2005 various measures to remediate these control deficienciesand has undertaken other interim measures to address these controldeficiencies.

***Management’s Conclusions***

Management believes the remediation measures describedunder “Management’s Remediation Initiatives and Interim Measures” above willstrengthen the Company’s internal control over financial reporting andremediate the material weaknesses identified in “Management’s Report onInternal Control Over Financial Reporting.” However, management has not yet implemented all of these measures and/ortested them. Management has concluded that the interim measures described under“Management’s Remediation Initiatives and Interim Measures” above providereasonable assurance regarding the reliability of financial reporting and thepreparation of the Company’s financial statements included in this AnnualReport on Form 10-K and has discussed its conclusions with theCompany’s Audit Committee.

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. However, anycontrol system, regardless of how well designed, operated and evaluated, canprovide only reasonable, not absolute, assurance that its objectives will bemet. As management continues to evaluate and work to improve the Company’sinternal control over financial reporting, it may determine to take additionalmeasures to address control deficiencies, and it may determine not to completecertain of the measures described under “Management’s Remediation Initiativesand Interim Measures” above.

**Changesin Internal Control over Financial Reporting**

The discussion above under“Management’s Remediation Initiatives and Interim Measures” describes thematerial planned and actual changes to the Company’s internal control overfinancial reporting during the fourth quarter of 2004 and subsequent to December 31,2004 that materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.

**ITEM 9B—OTHER INFORMATION**

(a)   On April 12,2005, a committee of the Board consisting solely of disinterested directorsdetermined to extend from three months to twelve months the post-terminationperiod of exercisability of options to purchase 25,000 shares of common stockof the Company which were granted in August 2004 to each of thenon-employee directors at such date pursuant to the Company’s 1997 Stock OptionPlan. Directors Betsy Atkins, Larry Horner and Thomas Toy are the non-employeedirectors affected by such extension.

(b)   On April 11, 2005, Betsy Atkins notifiedus that she will not seek re-election to our Board of Directors at our AnnualStockholder Meeting to be held on May 13, 2005. Ms. Atkins willcontinue to serve as a Director and as a member of our Audit Committee andCompensation Committee until May 13, 2005 and has advised us that herdecision to leave was not due to any disagreement with the Company.

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**PART III**

**ITEM10—DIRECTORS AND EXECUTIVE OFFICERS OF UTSTARCOM, INC.**

The information required by Item 401 ofRegulation S-K concerning our directors is incorporated by reference fromthe information in the section entitled “Proposal One—Election of Directors” inthe Proxy Statement for the Annual Meeting of Stockholders to be held on May 13,2005 (the “Proxy Statement”). The required information concerning our executiveofficers is contained in the section entitled “Management—Executive Officers.”

Item 405 of Regulation S-K calls for disclosureof any known late filing or failure by an insider to file a reportrequired by Section 16 of the Exchange Act. This disclosure is containedin the section entitled “Management—Section 16(a) BeneficialOwnership Reporting Compliance” in the Proxy Statement and is incorporatedherein by reference.

We have adopted a code of ethics that applies to ourprincipal executive officer and all members of our finance department,including the principal financial officer and principal accounting officer. Suchcode of ethics is available, free of charge, to any stockholder who sends arequest for a paper copy to: UTStarcom, Inc., 1275 Harbor Bay Parkway,Alameda, California 94502, Attn: Legal Department.

We intend to satisfy thedisclosure requirement under Item 10 of Form 8-K regarding an amendmentto, or waiver from, a provision of this code of ethics by posting suchinformation on our website, at *www.utstar.com*.

**ITEM 11—EXECUTIVE COMPENSATION**

The information requiredby this section is incorporated by reference from the information in thesections entitled “Board of Directors—Directors’ Compensation,” “Management—ExecutiveCompensation,” “Management—Employment Contracts and Change of ControlArrangements” and “Management—Compensation Committee Interlocks and InsiderParticipation” in the Proxy Statement.

**ITEM12—SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATEDSTOCKHOLDER MATTERS**

The information requiredby this section is incorporated by reference from the information in thesection entitled “Security Ownership of Certain Beneficial Owners andManagement” in the Proxy Statement. The required information concerning ourequity compensation plans is contained in the section entitled “Item 5—Marketfor UTStarcom, Inc.’s Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities” in Part II of this Form 10-K.

**ITEM13—CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

The information requiredby this section is incorporated by reference from the information in thesection entitled “Certain Relationships and Related Transactions” in the ProxyStatement.

**ITEM14—PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The information appearingunder the heading “PricewaterhouseCoopers LLP Fees for the Fiscal Year Ended December 31,2004” in the Proxy Statement is incorporated by reference.

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**PART IV**

**ITEM15—EXHIBITS AND FINANCIAL STATEMENT SCHEDULES**

(a)           (1)   Financial Statements—See Index toConsolidated Financial Statements and Financial Statement Schedules at page 78of this Form 10-K.

(2)         FinancialStatement Schedule—See Index to Consolidated Financial Statements and FinancialStatement Schedules at page 78 of this Form 10-K.
| (3) Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                         |
|------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(14)                      |       | Thirteenth Amended and Restated Certificate of  Incorporation of UTStarcom, Inc., as amended.                                                                                                                                      |
| 3.2(18)                      |       | First Amended and Restated Bylaws of  UTStarcom, Inc., as amended.                                                                                                                                                                 |
| 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(1)                       |       | Specimen Common Stock Certificate.                                                                                                                                                                                                      |
| 4.3(1)                       |       | Third Amended and Restated Registration Rights  Agreement dated December 14, 1999.                                                                                                                                                 |
| 4.4(9)                       |       | Convertible Subordinated Notes Indenture dated as of  March 12, 2003 between UTStarcom, Inc. and U.S. Bank National  Association, including the form of the 7¤8%  Convertible Subordinated Notes due 2008.               |
| 4.6(16)                      |       | Registration Rights Agreement, dated as of  June 30, 2003, by and among UTStarcom, Inc. and the shareholders of  RollingStreams Systems, Ltd.                                                                                 |
| 4.7                          |       | Underwriting Agreement, dated January 8, 2004  between the Company and Bank of America Securities LLC as amended on  January 14, 2004.                                                                                        |
| 10.1(1)                      |       | Form of Indemnification Agreement.                                                                                                                                                                                                 |
| 10.3(1)                      |       | 1995 Stock Plan and forms of related agreements.                                                                                                                                                                                        |
| 10.4(1)                      |       | 1997 Stock Plan, as amended, and forms of related  agreements.                                                                                                                                                                          |
| 10.5(1)                      |       | 2000 Employee Stock Purchase Plan and forms of  related agreements.                                                                                                                                                                     |
| 10.22(1)                     |       | Lease dated December 23, 1997 between  UTStarcom, Inc. and Tech Center Partners.                                                                                                                                              |
| 10.23(1)                     |       | Lease Agreement dated April 1995, as amended,  between UTStarcom, Inc. and Metro Park Associates.                                                                                                                             |
| 10.24(1)                     |       | Lease Agreements dated December 31, 1997 and  May 14, 1998 between Guangdong UTStarcom Telecom Co., Ltd. and Guangdong  Southern Telecom Group Huizhou Company.                                                               |
| 10.25(1)                     |       | Lease Contract dated December 15, 1996 between  UTStarcom (Hangzhou) Telecommunications Co., Ltd. and Yile Village, Gudang  Township.                                                                                              |
| 10.28(1)                     |       | Payment Agent Contract dated June 11, 1998  among UTStarcom, UTStarcom (China) Ltd, Softbank Corporation and Jitong  Communication Co., Ltd.                                                                                       |
| 10.29(1)                     |       | Agreement on Termination of Contract dated  August 30, 1999 among UTStarcom, Inc., UTStarcom (China) Ltd.,  Softbank Corporation and Jitong Communication Co., Ltd.                                                           |
| 10.30(1)                     |       | Exchange Agreement dated October 15, 1997  between UTStarcom, Inc. and certain investors.                                                                                                                                     |
| 10.31(1)                     |       | Exchange Agreement dated October 15, 1997  between UTStarcom, Inc. and certain investors.                                                                                                                                     |
| 10.41(2)*                    |       | Joint Venture Agreement between SOFTBANK Corporation  and UTStarcom, Inc. dated May 29, 2000.                                                                                                                                 |
| 10.42(2)*                    |       | Land Use Right Assignment Agreement between the  Administration Committee of Hangzhou Hi-Tech Industry Development Zone  of Zhejiang Province of the People’s Republic of China and  UTStarcom, Inc. dated May 18, 2000. |

152

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| 10.54(5)*  |   | Software License Agreement between  UTStarcom, Inc. and DDI Corporation, Inc. dated October 4,  2000.                                                                                                 |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.66(3)   |   | Amended 2001 Director Option Plan.                                                                                                                                                                                   |
| 10.67(4)   |   | Purchase Contract between UTStarcom Inc. and  Softbank BB Corporation, dated October 9, 2001.                                                                                                                   |
| 10.71(6)   |   | Lease Agreement between UTStarcom, Inc. and  Legend Tech., dated September 12, 2001.                                                                                                                       |
| 10.75(7)   |   | Change of Control Severance Agreement between  Michael J. Sophie and UTStarcom, Inc. dated April 12, 2002.                                                                                                 |
| 10.80(8)*  |   | Joint Venture Contract between UTStarcom Telecom  Co., Ltd., Matsushita Electric Industrial Co., Ltd. and Matsushita  Communication Industrial Co., Ltd. dated as of July 5, 2002.                              |
| 10.83(11)* |   | Broadband Access Network General Terms and  Conditions between Reliance Infocomm Limited and UTStarcom, Inc. dated  as of October 1, 2002.                                                                 |
| 10.84(11)* |   | Broadband Access Equipment Contract between Reliance  Infocomm Limited and UTStarcom, Inc. dated as of October 1, 2002.                                                                                    |
| 10.85(11)* |   | Broadband Access Services Contract between Reliance  Infocomm Limited and UTStarcom, Inc. dated as of October 1, 2002.                                                                                     |
| 10.86(11)* |   | Broadband Access Software Contract between Reliance  Infocomm Limited and UTStarcom, Inc. dated as of October 1, 2002.                                                                                     |
| 10.87(10)* |   | Equipment Purchase Agreement, dated as of February 4,  2003, by and between Tata Teleservices Limited and UTStarcom, Inc.                                                                                  |
| 10.88(12)  |   | UTStarcom, Inc. 2003 Nonstatutory Stock Option  Plan                                                                                                                                                            |
| 10.89(13)  |   | Change of Control Severance Agreement, dated as of  January 17, 2003, by and between Hong Liang Lu and UTStarcom, Inc.                                                                                     |
| 10.90(13)  |   | Change of Control Severance Agreement, dated as of  January 31, 2003, by and between Ying Wu and UTStarcom, Inc.                                                                                           |
| 10.91(13)  |   | Change of Control Severance Agreement, dated as of  January 31, 2003, by and between Shao-Ning Chou and UTStarcom, Inc.                                                                                    |
| 10.92(13)  |   | Change of Control Severance Agreement, dated as of  January 31, 2003, by and between William X. Huang and  UTStarcom, Inc.                                                                                 |
| 10.93(13)* |   | Distributor Agreement, dated as of October 21,  2003, by and between UTStarcom, Inc. and Multidata.                                                                                                        |
| 10.94(13)* |   | Amendment #1 to Distributor Agreement, dated as of  December 17, 2003, by and between UTStarcom, Inc. and Multidata.                                                                                       |
| 10.95(13)* |   | Revenue Sharing Purchase Agreement, dated as of  October 21, 2003 by and between UTStarcom, Inc. and Multidata.                                                                                            |
| 10.96(13)* |   | Amendment #1 to Revenue Sharing Purchase Agreement,  dated as of December 17, 2003, by and between UTStarcom, Inc. and  Multidata.                                                                         |
| 10.97(15)* |   | Infrastructure Equipment  License Agreement between Qualcomm Inc. and UTStarcom, Inc., dated  January 30, 2004.                                                                                            |
| 10.98(15)* |   | Subscriber Unit License Agreement between Qualcomm  Inc. and UTStarcom, Inc., dated January 30, 2004.                                                                                                      |
| 10.99(15)* |   | Asset Purchase Agreement among Hyundai  Syscomm, Inc., 3R Inc., Dr. Seong IK Jang and UTStarcom, Inc.,  dated February 26, 2004.                                                                 |
| 10.100(16) |   | Asset Purchase Agreement among UTStarcom, Inc.,  Telos Technology, Inc., Telos Technology (Canada), Inc., Telos  Technology (Bermuda) Ltd. and Telos Engineering Limited, dated April 21,  2004. |

153

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| 10.101(16)  |   | Asset Purchase Agreement  by and among Audiovox Communications Corp., Quintex Mobile Communications  Corporation, Audiovox Communications Canada Co., UTStarcom, Inc.,  UTStarcom Canada Company and Audiovox Corporation, dated as of June 11,  2004. |
|-------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.102(17)* |   | Continuous Basic Sale and Purchase Agreement between  Japan Telecom Co., Ltd. and Telecom Sales and Marketing K.K., dated  August 20, 2004.                                                                                                                 |
| 10.103(17)* |   | Sale and Purchase Agreement between Japan Telecom  Co., Ltd. and Telecom Sales and Marketing K.K., dated August 20, 2004.                                                                                                                                   |
| 10.104**    |   | Distributor Agreement, dated as of December 20,  2004, by and between Curitel Communications, Inc. and UTStarcom Personal  Communications LLC.                                                                                                         |
| 10.105**    |   | Asset Purchase Agreement by and between UTStarcom  CDMA Technologies Korea Limited and Giga Telecom, Inc., dated October 29,  2004.                                                                                                                    |
| 21.1        |   | Subsidiaries of UTStarcom.                                                                                                                                                                                                                                       |
| 23.1        |   | Consent of Independent Registered Public Accounting  Firm                                                                                                                                                                                                        |
| 24.1        |   | Power of Attorney (included on signature page).                                                                                                                                                                                                                  |
| 31.1        |   | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                   |
| 31.2        |   | Certification Pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                   |
| 32.1        |   | Certification Pursuant to 18 U.S.C.  Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                              |

----

*                    Portions of theexhibit have been omitted pursuant to an order granted by the Securities andExchange Commission for confidential treatment.

**             Portions of theexhibit have been omitted pursuant to a request for confidential treatmentfiled with the SEC concurrently with the filing of this Annual Report on Form 10-K.

(1)          Incorporated byreference to the registrant’s Registration Statement on Form S-1 (No. 333-93069),which became effective March 2, 2000.

(2)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2000.

(3)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2001.

(4)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2001.

(5)          Incorporated byreference to the registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000.

(6)          Incorporated byreference to the registrant’s Annual Report on Form 10-K for theyear ended December 31, 2001.

(7)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended March 31, 2002.

(8)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2002.

(9)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended March 31, 2003.

(10)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q/A (Amendment No. 1)for the quarter ended March 31, 2003.

154

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(11)   Incorporated by reference tothe registrant’s Annual Report on Form 10-K/A (Amendment No. 1)for the year ended December 31, 2002.

(12)   Incorporated by reference tothe registrant’s Registration Statement on Form S-8, which was filedon September 15, 2003.

(13)   Incorporated by reference tothe registrant’s Annual Report on Form 10-K for the year ended December 31,2003.

(14)   Incorporated by reference tothe registrant’s Current Report on Form 8-K, which was filed on December 12,2003.

(15)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2004.

(16)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedJune 30, 2004.

(17)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2004.

(18)   Incorporated by reference tothe registrant’s Current Report on Form 8-K, which was filed on March 16,2005.

155

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.
|                            | UTSTARCOM, INC. |
|----------------------------|-----------------|
| Date: April 15,  2005 | By:             | /s/  MICHAEL J. SOPHIE |
|                       | Name:           | Michael J. Sophie |
|                       | Title:          | *Senior  Vice President of Finance and  Chief Financial Officer* |

 

156

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**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENT, that each personwhose signature appears below constitutes and appoints Hong Liang Lu andMichael J. Sophie, jointly and severally, his or her attorneys-in-fact, eachwith the power of substitution, for him in any and all capacities, to sign anyamendments to this report on Form 10-K, and to file the same, withexhibits thereto and other documents in connection therewith with theSecurities and Exchange Commission, hereby ratifying and confirming all thateach of said attorneys-in-fact, or his substitute or substitutes may do orcause to be done by virtue hereof.

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated:
|                         | **Signature** | ** **                                              | ** ** | ** **           | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-------------------------|---------------|---------------------------------------------------------|------------|----------------------|-----------|------------|------------|------------|----------|------------|
| /s/ HONG  LIANG LU |          | President and Chief  Executive Officer (principal       |       | April 15,  2005 |
| Hong Liang Lu           |          | executive officer), Chairman of the Board of  Directors |       |                 |
| /s/  MICHAEL J. SOPHIE  |          | Senior Vice President of  Finance and Chief Financial   |       | April 15,  2005 |
| Michael J. Sophie       |          | Officer (principal financial and accounting officer)    |       |                 |
| /s/  BETSY S. ATKINS    |          | Director                                                |       | April 15,  2005 |
| Betsy S. Atkins         |          |                                                    |       |                 |
| /s/  JEFF CLARKE        |          | Director                                                |       | April 15,  2005 |
| Jeff Clarke             |          |                                                    |       |                 |
| /s/  LARRY D. HORNER    |          | Director                                                |       | April 15,  2005 |
| Larry D. Horner         |          |                                                    |       |                 |
| /s/  ALLEN LENZMEIER    |          | Director                                                |       | April 15,  2005 |
| Allen Lenzmeier         |          |                                                    |       |                 |
| /s/  THOMAS J. TOY      |          | Director                                                |       | April 15,  2005 |
| Thomas J. Toy           |          |                                                    |       |                 |
| /s/  YING WU            |          | Director                                                |       | April 15,  2005 |
| Ying Wu                 |          |                                                    |       |                 |

 

157

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**SCHEDULE I**

**UTSTARCOM, INC. (UNCONSOLIDATED—PARENT COMPANYBASIS)REGISTRANT BALANCE SHEETS(in thousands, except share and per share data)**
| ** **                                                                                                                                                                   | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                   | ** ** | **2004**              | ** ** | **2003** | ** ** |
| **ASSETS**                                                                                                                                                                   |       |                  |       |   |   |
| Current assets:                                                                                                                                                              |       |                  |       |   |   |
| Cash and cash equivalents                                                                                                                                                    |       | $                     | 169,924    |   | $ | 71,230 |   |
| Short-term investments                                                                                                                                                       |       | 8,342                 |       | 9,139 |   |
| Accounts receivable—unrelated party, net of  allowances for doubtful accounts                                                                                           |       | 20,537                |       | 35,843 |   |
| Accounts receivable—related party                                                                                                                                       |       | 84,754                |       | 43,944 |   |
| Accounts receivable—intercompany                                                                                                                                        |       | 666,228               |       | 442,480 |   |
| Inventories                                                                                                                                                                  |       | 27,723                |       | 15,427 |   |
| Deferred costs/Inventories at customer sites under  contracts                                                                                                                |       | 66,878                |       | 38,308 |   |
| Income tax receivable                                                                                                                                                        |       | —                |       | 10,677 |   |
| Prepaids                                                                                                                                                                     |       | 55,146                |       | 19,599 |   |
| Short-term restricted cash and investments                                                                                                                                   |       | 32,920                |       | 20,461 |   |
| Deferred tax assets                                                                                                                                                          |       | 13,109                |       | 7,432 |   |
| Other current assets                                                                                                                                                         |       | 4,832                 |       | 962 |   |
| Total current assets                                                                                                                                                         |       | 1,150,393             |       | 715,502 |   |
| Property, plant and equipment, net                                                                                                                                           |       | 27,237                |       | 32,031 |   |
| Note receivable                                                                                                                                                              |       | 9,630                 |       | 11,222 |   |
| Investment in affiliated companies                                                                                                                                           |       | 554,364               |       | 493,163 |   |
| Goodwill                                                                                                                                                                     |       | 105,234               |       | 98,015 |   |
| Intangible assets, net                                                                                                                                                       |       | 52,625                |       | 44,949 |   |
| Deferred tax assets                                                                                                                                                          |       | 12,100                |       | 11,070 |   |
| Other long-term assets                                                                                                                                                       |       | 23,984                |       | 19,226 |   |
| Total assets                                                                                                                                                                 |       | $                     | 1,935,567  |   | $ | 1,425,178 |   |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                               |       |                  |       |   |   |
| Current  liabilities:                                                                                                                                                        |       |                  |       |   |   |
| Accounts payable—unrelated party                                                                                                                                        |       | $                     | 83,398     |   | $ | 56,256 |   |
| Accounts payable—intercompany                                                                                                                                           |       | 1,221                 |       | — |   |
| Income taxes payable                                                                                                                                                         |       | 13,391                |       | — |   |
| Customer advances                                                                                                                                                            |       | 19,890                |       | 13,940 |   |
| Deferred revenue                                                                                                                                                             |       | 14,841                |       | 24,966 |   |
| Other                                                                                                                                                                        |       | 38,389                |       | 36,196 |   |
| Total current liabilities                                                                                                                                                    |       | 171,130               |       | 131,358 |   |
| Long-term debt                                                                                                                                                               |       | 402,500               |       | 402,500 |   |
| Stockholders’  equity:                                                                                                                                                  |       |                  |       |   |   |
| Common stock: $.00125 par value; authorized:  750,000,000 shares; issued and outstanding: 114,486,632 and 104,272,477 at  December 31, 2004 and 2003, respectively |       | 144                   |       | 131 |   |
| Additional paid-in capital                                                                                                                                                   |       | 1,123,065             |       | 654,483 |   |
| Deferred stock compensation                                                                                                                                                  |       | (6,102                | )          | (7,761 | ) |
| Retained earnings                                                                                                                                                            |       | 243,652               |       | 243,058 |   |
| Accumulated other comprehensive income                                                                                                                                       |       | 1,178                 |       | 1,409 |   |
| Total stockholders’ equity                                                                                                                                              |       | 1,361,937             |       | 891,320 |   |
| Total liabilities  and stockholders’ equity                                                                                                                             |       | $                     | 1,935,567  |   | $ | 1,425,178 |   |

 

The accompanying notes are an integral part of these financial statements.

158

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**SCHEDULE I**

**UTSTARCOM, INC.(UNCONSOLIDATED—PARENT COMPANY BASIS)**

**CONDENSED INFORMATION ASTO THERESULTS OF OPERATIONSOF THE REGISTRANT**

**(in thousands)**
| ** **                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Net sales:                                    |       |                                        |       |   |   |   |   |
| Unrelated party                               |       | $                                           | 120,010    |   | $ | 100,115 |   | $ | 35,365 |   |
| Related party                                 |       | 143,164                                     |       | 184,436 |   | 16,038 |   |
| Intercompany                                  |       | 571,001                                     |       | 724,708 |   | 307,862 |   |
|                                          |       | 834,175                                     |       | 1,009,259 |   | 359,265 |   |
| Cost of net sales:                            |       |                                        |       |   |   |   |   |
| Unrelated party                               |       | 81,961                                      |       | 50,157 |   | 24,306 |   |
| Related party                                 |       | 91,409                                      |       | 79,518 |   | 8,635 |   |
| Intercompany                                  |       | 449,199                                     |       | 646,016 |   | 276,603 |   |
| Gross profit                                  |       | 211,606                                     |       | 233,568 |   | 49,721 |   |
| Operating expenses:                           |       |                                        |       |   |   |   |   |
| Selling, general and administrative           |       | 103,706                                     |       | 57,666 |   | 38,793 |   |
| Research and development                      |       | 39,687                                      |       | 46,588 |   | 9,146 |   |
| In-process research and development costs     |       | 1,400                                       |       | 10,686 |   | 670 |   |
| Amortization of intangible assets             |       | 12,668                                      |       | 8,370 |   | 2,395 |   |
| Total operating  expenses                     |       | 157,461                                     |       | 123,310 |   | 51,004 |   |
| Operating income                              |       | 54,145                                      |       | 110,258 |   | (1,283 | ) |
| Interest income                               |       | 12,349                                      |       | 2,709 |   | 4,454 |   |
| Interest expense                              |       | (4,819                                      | )          | (4,142 | ) | (16 | ) |
| Other income  (expense), net                  |       | (29,943                                     | )          | (18,404 | ) | 18,964 |   |
| Equity in net  income of affiliated companies |       | 14,950                                      |       | 144,520 |   | 98,396 |   |
| Income before  income taxes                   |       | 46,682                                      |       | 234,941 |   | 120,515 |   |
| Income tax  expense (benefit)                 |       | (26,733                                     | )          | 19,409 |   | 12,653 |   |
| Net income                                    |       | $                                           | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |

 

The accompanying notes are an integral part of these financial statements.

159

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**SCHEDULE I**

**UTSTARCOM, INC.(UNCONSOLIDATED—PARENT COMPANY BASIS)**

**CONDENSED INFORMATION ASTO THE CASH FLOWS OF THE REGISTRANT**

**(In thousands)**
| ** **                                                                     | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2004**                                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |
| Net income                                                                     |       | $                                           | 73,415     |   | $ | 215,532 |   | $ | 107,862 |   |
| Adjustments to reconcile net income to net cash used  in operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                 |       | 34,219                                      |       | 25,235 |   | 13,202 |   |
| In-process  research and development costs                                     |       | 1,400                                       |       | 10,686 |   | 670 |   |
| Impairment of long-term  investments                                           |       | 1,608                                       |       | 75 |   | 4,442 |   |
| Loss on sale of  assets                                                        |       | 1,672                                       |       | 620 |   | 449 |   |
| Warrants  adjustment to fair value                                             |       | (46                                         | )          | (424 | ) | — |   |
| (Gain)/Loss on  sale of investment                                             |       | (1,912                                      | )          | 73 |   | — |   |
| Amortization of  debt issuance costs                                           |       | 2,332                                       |       | 1,953 |   | — |   |
| Deferred income  taxes                                                         |       | (11,725                                     | )          | 4,471 |   | (6,980 | ) |
| Provision for  doubtful accounts                                               |       | 3,045                                       |       | 813 |   | 124 |   |
| Provision for  inventory                                                       |       | 7,640                                       |       | 3,328 |   | 5,446 |   |
| Stock compensation  expense                                                    |       | 519                                         |       | 4,302 |   | 3,100 |   |
| Equity in net  income of affiliated companies                                  |       | (12,659                                     | )          | (145,375 | ) | (95,608 | ) |
| Changes in operating  assets and liabilities, net of acquisitions:             |       |                                        |       |   |   |   |   |
| Accounts  receivable                                                           |       | (244,983                                    | )          | (288,163 | ) | (120,122 | ) |
| Inventories                                                                    |       | (18,960                                     | )          | (2,742 | ) | (9,626 | ) |
| Deferred  costs/Inventories at customer sites under contracts                  |       | (28,570                                     | )          | (10,012 | ) | (18,815 | ) |
| Other current and  non-current assets                                          |       | (32,427                                     | )          | (15,611 | ) | (680 | ) |
| Accounts payable                                                               |       | 27,738                                      |       | (56,924 | ) | 98,947 |   |
| Income taxes payable                                                           |       | 20,109                                      |       | (9,265 | ) | (5,182 | ) |
| Customer advances                                                              |       | 5,595                                       |       | (3,201 | ) | 14,511 |   |
| Deferred revenue                                                               |       | (10,167                                     | )          | 13,505 |   | (4,451 | ) |
| Other current  liabilities                                                     |       | 3,085                                       |       | 10,637 |   | 4,649 |   |
| Net cash used in  operating activities                                         |       | (179,072                                    | )          | (221,957 | ) | (2,302 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |
| Additions to  property, plant and equipment                                    |       | (13,710                                     | )          | (29,745 | ) | (980 | ) |
| Investment in  affiliates, net of cash acquired                                |       | (57,150                                     | )          | (8,920 | ) | (27,447 | ) |
| Acquisition of  business, net of cash acquired                                 |       | (33,185                                     | )          | (111,720 | ) | (17,705 | ) |
| Purchase of  intangible assets                                                 |       | (4,158                                      | )          | (2,340 | ) | — |   |
| Issuance of note  receivable to related party                                  |       | —                                      |       | (10,071 | ) | — |   |
| Change in  restricted cash                                                     |       | (12,459                                     | )          | (10,682 | ) | (9,779 | ) |
| Purchase of short-term  investments                                            |       | (55,379                                     | )          | (10,775 | ) | (85,688 | ) |
| Sales of short-term  investments                                               |       | 61,086                                      |       | 93,246 |   | 89,916 |   |
| Net cash used in  investing activities                                         |       | (114,955                                    | )          | (91,007 | ) | (51,683 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |
| Issuance of stock,  net of expenses                                            |       | 25,736                                      |       | 58,878 |   | 40,928 |   |
| Repurchase of  stock                                                           |       | (107,569                                    | )          | (139,609 | ) | (72,929 | ) |
| Proceeds  (payments) from borrowing, net                                       |       | —                                      |       | 391,431 |   | — |   |
| Proceeds from  equity offering                                                 |       | 474,554                                     |       | — |   | — |   |
| Purchase of  convertible bond hedge and call option                            |       | —                                      |       | (43,792 | ) | — |   |
| Proceeds from  stockholder notes                                               |       | —                                      |       | 282 |   | 99 |   |
| Net cash provided  by (used in) financing activities                           |       | 392,721                                     |       | 267,190 |   | (31,902 | ) |
| Effects of  exchange rates on cash                                             |       | —                                      |       | 1 |   | 1 |   |
| Net increase  (decrease) in cash and cash equivalents                          |       | 98,694                                      |       | (45,773 | ) | (81,282 | ) |
| Cash and cash equivalents  at beginning of period                              |       | 71,230                                      |       | 117,003 |   | 198,285 |   |
| Cash and cash equivalents  at end of period                                    |       | $                                           | 169,924    |   | $ | 71,230 |   | $ | 117,003 |   |

 

The accompanying notes are an integral part of these financial statements.

160

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**SCHEDULE I**

**UTSTARCOM, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

**NOTE 1—BASIS OF PRESENTATION**

UTStarcom, Inc., a Delaware corporation, is theparent company of all UTStarcom, Inc. subsidiaries. The accompanyingcondensed financial statements reflect the financial position, results ofoperations and cash flows of UTStarcom, Inc. on a separate basis. Allsubsidiaries of UTStarcom, Inc. are reflected as investments accounted forusing the equity method. Accordingly, inter-company transactions have not beeneliminated. Inventory balances at December 31, 2004 and 2003 includeintercompany profit of $9.9 million and $2.3 million, respectively. Nocash dividends were paid to UTStarcom, Inc. by its subsidiaries during thethree years ended December 31, 2004. For accounting policies and otherinformation, see the Notes to Consolidated Financial Statements includedelsewhere herein.

The Company filed anAmendment to its Annual Report on Form 10-K for the year ended December 31,2003 to reflect the restatement of its consolidated financial statements forthe year ended December 31, 2003. See Note 2 to the Consolidated FinancialStatements.

**NOTE 2—LONG TERM OBLIGATIONS**

On March 12, 2003, UTStarcom, Inc. completedan offering of $402.5 million of convertible subordinated notes due March 1,2008 to qualified buyers pursuant to Rule 144A under the Securities Act of1933. The notes bear interest at a rate of 7¤8% per annumand are convertible into common stock of UTStarcom Inc. at a conversion priceof $23.79 per share and are subordinated to all present and future senior debtof UTStarcom Inc. See Note 11 to the Consolidated Financial Statements.

161

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**SCHEDULE II**

**UTSTARCOM, INC.Valuation and Qualifying Accounts and ReservesFor the Years Ended December 31, 2004, 2003, and 2002**
| **Description**                          | ** ** | ** ** | ** ** | **Balance at  beginning of  the period** | ** ** | **  Additions    charged to  costs and  expenses** | ** ** | **Obligations  assumed upon   acquisition** | ** ** | **Deductions** | ** ** | **Balance at  end of    the period  ** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|----------------|------------|---------------------------------------------------------------------------|------------|
| ***Year  ended December 31, 2004*** |       |       |       |                                                    |       |                                                                             |       |                                                  |       |           |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Provision for inventory             |       |       | $          | 29,560                                                  |       |                                                                             |       | $                                                     | 20,723     |           |       |                                                                      | $          | 3,534 |   |   |   | $ | 4,039 |   |   |   | $ | 49,778 |   |   |
| Provision for deferred cost         |       |       | $          | 7,608                                                   |       |                                                                             |       | $                                                     | 18,277     |           |       |                                                                      | $          | — |   |   |   | $ | 2,210 |   |   |   | $ | 23,675 |   |   |
| Provision for  doubtful accounts         |       |       | $          | 31,172                                                  |       |                                                                             |       | $                                                     | 21,284     |           |       |                                                                      | $          | — |   |   |   | $ | 1,249 |   |   |   | $ | 51,207 |   |   |
| Accrued product  warranty costs          |       |       | $          | 26,267                                                  |       |                                                                             |       | $                                                     | 53,777     |           |       |                                                                      | $          | 6,964 |   |   |   | $ | 40,412 |   |   |   | $ | 46,596 |   |   |
| Tax valuation allowance                  |       |       | $          | 328                                                     |       |                                                                             |       | $                                                     | 4,564      |           |       |                                                                      | $          | — |   |   |   | $ | — |   |   |   | $ | 4,892 |   |   |
| ***Year  ended December 31, 2003*** |       |       |       |                                                    |       |                                                                             |       |                                                  |       |           |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Provision for inventory                  |       |       | $          | 18,287                                                  |       |                                                                             |       | $                                                     | 14,626     |           |       |                                                                      | $          | 6,345 |   |   |   | $ | 9,698 |   |   |   | $ | 29,560 |   |   |
| Provision for deferred  cost             |       |       | $          | 14,453                                                  |       |                                                                             |       | $                                                     | —     |           |       |                                                                      | $          | — |   |   |   | $ | 6,845 |   |   |   | $ | 7,608 |   |   |
| Provision for  doubtful accounts         |       |       | $          | 26,250                                                  |       |                                                                             |       | $                                                     | 5,025      |           |       |                                                                      | $          | — |   |   |   | $ | 103 |   |   |   | $ | 31,172 |   |   |
| Accrued product  warranty costs          |       |       | $          | 13,297                                                  |       |                                                                             |       | $                                                     | 36,523     |           |       |                                                                      | $          | 1,381 |   |   |   | $ | 24,934 |   |   |   | $ | 26,267 |   |   |
| Tax valuation  allowance                 |       |       | $          | 4,964                                                   |       |                                                                             |       | $                                                     | —     |           |       |                                                                      | $          | — |   |   |   | $ | 4,636 |   |   |   | $ | 328 |   |   |
| ***Year  ended December 31, 2002*** |       |       |       |                                                    |       |                                                                             |       |                                                  |       |           |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Provision for inventory                  |       |       | $          | 17,744                                                  |       |                                                                             |       | $                                                     | 7,084      |           |       |                                                                      | $          | — |   |   |   | $ | 6,541 |   |   |   | $ | 18,287 |   |   |
| Provision for deferred  cost             |       |       | $          | 2,600                                                   |       |                                                                             |       | $                                                     | 11,853     |           |       |                                                                      | $          | — |   |   |   | $ | — |   |   |   | $ | 14,453 |   |   |
| Provision for  doubtful accounts         |       |       | $          | 19,053                                                  |       |                                                                             |       | $                                                     | 7,434      |           |       |                                                                      | $          | — |   |   |   | $ | 237 |   |   |   | $ | 26,250 |   |   |
| Accrued product  warranty costs          |       |       | $          | 6,271                                                   |       |                                                                             |       | $                                                     | 15,156     |           |       |                                                                      | $          | — |   |   |   | $ | 8,130 |   |   |   | $ | 13,297 |   |   |
| Tax valuation allowance                  |       |       | $          | 4,787                                                   |       |                                                                             |       | $                                                     | 177        |           |       |                                                                      | $          | — |   |   |   | $ | — |   |   |   | $ | 4,964 |   |   |

 

 

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