**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D. C. 20549**

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FORM 10-K/A(Amendment No. 1)
| x                                                      | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|--------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| **For the Fiscal Year Ended December 31,  2003.** |
| **o**                                                  | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                    to                    **

**Commission File Number: 000-29661**

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**UTSTARCOM, INC.**

(Exact name of 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**(Zip Code)                   |
| (Address of  principal executive offices)                        |       |                                  |

 

**(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 isnot contained 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 $2,893,028,280 based upon the closing price of $35.64reported 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 February 29,2004 the registrant had 117,110,056 outstanding shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof the Proxy Statement for the Annual Meeting of Shareholders to be held on May 7,2004 are incorporated herein by reference in Part III.

 

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**EXPLANATORY NOTE**

UTStarcom, Inc. (“UTStarcom” or the “Company”) isfiling this Amendment No. 1 to its Annual Report on Form 10-Kfor the year ended December 31, 2003 (this “Amendment”) to reflect therestatement of its consolidated financial statements for the year ended December 31,2003 and the quarters ended March 31, 2003, June 30, 2003 and September 30,2003 and certain corresponding changes described below.

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 avariable interest entity and for whom the Company is considered the primarybeneficiary in accordance with FASB Interpretation No. 46 (“FIN 46”). TheCompany has corrected its 2003 financial statements to reflect theconsolidation of this variable interest entity, MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliated entitiesare referred to, collectively, as “MDC”). At December 31, 2003, thisconsolidation resulted in a $5.5 million increase in total assets and a $0.7million increase in total liabilities. There was no effect on net income as aresult 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 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)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all years presented;

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

(3)         Changes in restrictedcash had been incorrectly categorized as a part of operating cash flows insteadof investing cash flows in accordance with Statement of Financial AccountingStandards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly, theCompany 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

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(4)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirectors and associated transactions have been identified. See Note 22 to theConsolidated Financial Statements.

A discussion of therestatement is set forth in Note 24 to the Consolidated Financial Statementsincluded in this Amendment. Changes also have been made to the following itemsin this Amendment as a result of the restatement:

**Part II**

·        Item6       Selected Consolidated FinancialData (page 3)

·        Item7      Management’s Discussion andAnalysis of Financial Condition and Results of Operations (pages 4-41)

·        Item7A  Quantitative and QualitativeDisclosures About Market Risk (pages 41-43)

·        Item8       Financial Statements andSupplementary Data (pages 44-92)

·        Item9A   Controls and Procedures (pages 93-102)

Items filed in theoriginal Form 10-K that are not impacted by the restatement are notincluded in this amended filing.

**Part IV**

·        Item15    Exhibits, Financial StatementSchedules and Reports on Form 8-K (pages 103-107)

This Amendment does not reflect events that haveoccurred after the March 9, 2004 filing date of the Annual Report on Form 10-Kthat the Company originally filed with the Securities and Exchange Commission,or modify or update the disclosures presented in the original Form 10-K,except to reflect the corrections described above. Accordingly, this Form 10-K/Ashould be read in conjunction with our filings with the Securities and ExchangeCommission subsequent to the filing of the original Form 10-K.

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**ITEM6—SELECTED CONSOLIDATED FINANCIAL 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.
| ** **                                                                                                                               | ** ** | **Year Ended December 31,**                         | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                                                                               | ** ** | **2003**                                                           | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
| ** **                                                                                                                               | ** ** | **Restated(1)**                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| **Consolidated Statement of  Operations Data:**                                                                                          |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Net sales                                                                                                                                |       |                                                               | $          | 1,965,187 |   |   | $ | 981,806 |   | $ | 626,840 |   | $ | 368,646 |   | $ | 187,516 |   |
| Gross profit                                                                                                                             |       |                                                               | 624,385    |   |   | 345,472 |   | 224,548 |   | 128,181 |   | 74,813 |   |
| Operating income                                                                                                                         |       |                                                               | 261,738    |   |   | 145,962 |   | 76,728 |   | 33,780 |   | 16,719 |   |
| Income from continuing operations                                                                                                        |       |                                                               | 215,532    |   |   | 107,862 |   | 56,954 |   | 27,993 |   | 13,119 |   |
| Net income (loss) available to common stockholders                                                                                       |       |                                                               | 215,532    |   |   | 107,862 |   | 56,954 |   | 27,013 |   | (18,514 | ) |
| Basic earnings  (loss) per share:                                                                                                        |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                                                                                 |       |                                                               | $          | 2.08 |   |   | $ | 0.98 |   | $ | 0.56 |   | $ | 0.35 |   | $ | (1.94 | ) |
| Income (loss) from discontinued operations                                                                                               |       |                                                               | —     |   |   | — |   | — |   | — |   | (0.19 | ) |
| Cumulative effect on prior years of the application  of SAB 101 “Revenue Recognition in Financial Statements”             |       |                                                               | —     |   |   | — |   | — |   | (0.01 | ) | — |   |
| Net income (loss)(2)                                                                                                                     |       |                                                               | $          | 2.08 |   |   | $ | 0.98 |   | $ | 0.56 |   | $ | 0.34 |   | $ | (2.13 | ) |
| Diluted earnings  (loss) per share:                                                                                                      |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Income (loss) from continuing operations                                                                                                 |       |                                                               | $          | 1.75 |   |   | $ | 0.94 |   | $ | 0.52 |   | $ | 0.28 |   | $ | (1.94 | ) |
| Income (loss) from discontinued operations                                                                                               |       |                                                               | —     |   |   | — |   | — |   | — |   | (0.19 | ) |
| Cumulative effect on prior years of the application  of SAB 101 “Revenue Recognition in Financial Statements”             |       |                                                               | —     |   |   | — |   | — |   | (0.01 | ) | — |   |
| Net income (loss)                                                                                                                        |       |                                                               | $          | 1.75 |   |   | $ | 0.94 |   | $ | 0.52 |   | $ | 0.27 |   | $ | (2.13 | ) |
| Proforma amounts  assuming application of SAB101 “Revenue Recognition in Financial Statements”  is applied retroactively: |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Net income (loss) available to common stockholders                                                                                       |       |                                                               | $          | 215,532 |   |   | $ | 107,862 |   | $ | 56,954 |   | $ | 27,993 |   | $ | (19,494 | ) |
| Earnings (loss) per  share:                                                                                                              |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                                    |       |                                                               | $          | 2.08 |   |   | $ | 0.98 |   | $ | 0.56 |   | $ | 0.35 |   | $ | (2.25 | ) |
| Diluted                                                                                                                                  |       |                                                               | $          | 1.75 |   |   | $ | 0.94 |   | $ | 0.52 |   | $ | 0.27 |   | $ | (2.25 | ) |
| Weighted average  shares used in per share calculations:                                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                                    |       |                                                               | 103,659    |   |   | 109,566 |   | 101,433 |   | 79,696 |   | 8,678 |   |
| Diluted                                                                                                                                  |       |                                                               | 124,909    |   |   | 114,407 |   | 108,612 |   | 101,867 |   | 8,678 |   |

 
| ** **                            | ** ** | **As of December 31,**  | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2003**                | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** | **1999** | ** ** |
| ** **                            | ** ** | **Restated(1)**         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| **Consolidated Balance Sheet  Data:** |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents             |       |                    | $          | 377,747 |   |   | $ | 231,944 |   | $ | 321,136 |   | $ | 149,112 |   | $ | 87,364 |   |
| Working capital                       |       |                    | 883,334    |   |   | 568,215 |   | 591,103 |   | 369,861 |   | 128,973 |   |
| Total assets                          |       |                    | 2,244,050  |   |   | 1,305,552 |   | 1,005,880 |   | 591,837 |   | 271,788 |   |
| Total short-term debt                 |       |                    | 1          |   |   | — |   | 58,434 |   | 43,381 |   | 43,338 |   |
| Long-term debt                        |       |                    | 410,655    |   |   | — |   | 12,048 |   | 12,048 |   | — |   |
| Total  stockholders’ equity      |       |                    | 893,331    |   |   | 766,395 |   | 681,887 |   | 412,319 |   | 165,720 |   |
|                                       |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)             See Note 24 to the Consolidated FinancialStatements.

(2)             Net loss available to common stockholders for 1999includes a one-time charge for approximately $30.0 million relatedto the issuance of Series F preferred stock in 1999 that included abeneficial conversion feature pursuant to which the preferred shares convertedinto common shares on a one-for-one basis at a price below theexpected offering price upon the completion of our initial public offering.This reduced diluted earnings per share available to common stockholders by$3.45.

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

As discussed in Note 24 to theConsolidated Financial Statements, the Company has restated itsConsolidated Financial Statements for the year ended December 31, 2003 andthe quarters ended March 31, 2003, June 30, 2003 and September 30,2003 to correct errors and reflect certain corresponding changes describedbelow.

As part of the financial closing process for the yearended December 31, 2004, the Company identified certain errors in thecalculation of the Company’s 2003 income tax provision 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 $0.9million, 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 the incometax provision, the Company 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 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 avariable interest entity and for whom the Company is considered the primarybeneficiary in accordance with FASB Interpretation No. 46 (“FIN 46”). TheCompany has corrected its 2003 financial statements to reflect theconsolidation of this variable interest entity, MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliated entitiesare referred to, collectively, as “MDC”). At December 31, 2003, thisconsolidation resulted in a $5.5 million increase in total assets and a $0.7million increase in total liabilities. There was no effect on net income as aresult 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 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)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all years presented;

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

(3)         Changes in restrictedcash had been incorrectly categorized as a part of operating cash flows insteadof investing cash flows in accordance with Statement of Financial AccountingStandards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly, theCompany 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

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(4)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirectors and associated transactions have been identified. See Note 22 to theConsolidated Financial Statements.

The accompanying Management’s Discussion and Analysisgives effect to this restatement.

**FORWARD-LOOKING STATEMENTS**

This Annual Report on Form 10-Kcontains forward-looking statements within the meaning of the federalsecurities laws. These statements are based on information that is currentlyavailable to management. We intend such forward-looking statements to becovered by the safe harbor provisions of the Private Securities LitigationReform Act of 1995, and we are including this statement for purposes ofcomplying with those provisions. The forward-looking statements include,without limitation, those concerning the following: our expectations as to thenature of possible trends; our expectations regarding continued growth in ourbusiness and operations; our expectation that there will be fluctuations in ouroverall gross profit, gross margin, product mix, quarter to quarter results,customer base and selling prices; our plans for expanding the direct salesorganization and our selling and marketing campaigns and activities; ourexpectation that we may use our cash, debt or securities to acquire or investin complementary businesses, technologies or product offerings; our expectationthat there will be increases in selling, marketing, research and development,and general and administrative expenses; our expectations regarding futuregrowth of our business and operations; our expectation that we will continue toinvest significantly in research and development; our expectations regardingthe status of products under development; our expectations regarding our futureinvestments; our expectations regarding our future levels of cash and cashequivalents, as well as our expectation that existing cash and cash equivalentswill be sufficient to finance our operations for the foreseeable future; ourexpectations regarding licensing requirements and our ability to receivelicenses in China for our PAS system and other products; our expectationsregarding the development of a 3G network in China; our expectations regardingthe impact of a reorganization of China Netcom; 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; our expectationsregarding the future allocation of net sales by product group; our expectationsregarding efficiencies we hope to achieve in supply chain and inventorypurchasing, as well as trends in inventory growth; and our expectationsregarding our expansion into new markets around the world. Additional forward-lookingstatements may be identified by the words, “anticipate,” “expect,” “believe,” “intend,”“will” and similar expressions, as they relate to us or our management.Investors are cautioned that these forward-looking statements areinherently uncertain. These statements are subject to risks and uncertaintiesthat may cause actual results and events to differ materially. For a detaileddiscussion of these risks and uncertainties, see the “Factors Affecting FutureOperating Results” section of this Form 10-K. We do not guarantee futureresults and undertake no obligation to update the forward-lookingstatements to reflect events or circumstances occurring after the date of this Form 10-K.

**EXECUTIVE SUMMARY**

We design,manufacture and sell telecommunications equipment and products and provideservices associated with their operation. Our products are deployed andinstalled exclusively by telecommunications wireless and wireline serviceproviders. We provide an extensive range of products for transportation ofvoice, data and video traffic for service providers around the world. Ourbusiness is conducted globally in China, Japan, India, the Central and Latin Americanregion, North America, the European, Middle Eastern and African region andsoutheastern and northern Asia. Our objective is to be a leading globalprovider of Internet Protocol (“IP”) networking products and services. Wedifferentiate ourselves with products designed, developed and commercialized toreduce network complexity, integrate high performance capabilities and thatallow a simple transition to next generation networks. This results 

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in deployment, maintenanceand upgrades that are both economical and efficient, allowing operators to earna high return on their investment.

Our technologiesand products fall into three major categories:

·        wireless,a technology that enables end users, or subscribers, to send and receive voiceand data while mobile and using wireless devices;

·        wireline,a technology that satisfies customer demand for high-speed, cost effectivedata, voice and media transport and carriage; and

·        switching,a diverse assembly of software and hardware based networking elements designedto replace central office telephone switches.

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 and productsare based on widely adopted global communications standards and are designed toallow service providers to quickly and cost-efficiently integrate our systemsinto their existing networks and deploy our systems in new broadband, InternetProtocol (“IP”) and wireless network rollouts. Our system technologies are alsodesigned to allow timely and cost efficient transition to futurenext-generation network technologies, enabling our service provider customersto protect their initial infrastructure investments.

Historically, substantially all of our sales have beento service providers in China. 86% of our sales for the year ended December 31,2003 were derived from China and 10% of our sales were from Japan. However, weare currently expanding our sales efforts to include other communicationsmarkets such as in the Central and Latin American region, the European, MiddleEastern and African region, North America and southeastern and northern Asia.We intend to penetrate these markets through direct sales offices located inkey market regions, by licensing our technology to local manufacturers whereimport taxation is favorable, by developing local sales agency and distributorrelationships within specific market regions, and by establishing sales relationshipswith original equipment manufacturers. Our sales division began establishingregional offices and local direct sales representative offices to providesupport for our expanding global sales operations.

In a telecommunications industry that has experienceda period of contraction over the last few years, we experienced significantgrowth in revenue and profit during this period. In 2003, we had approximately$2.0 billion of revenue, a 100% increase over 2002. This growth in revenuewas driven by China’s growing telecommunications market. China, which webelieve to be one of the fastest growing telecommunications markets in theworld, continued to experience increasing fixed-line and mobile telephone andInternet subscriber growth, from 480.1 million subscribers in 2002 to611.5 million subscribers in 2003, according to China’s Ministry ofInformation Industry. We believe this subscriber growth led to increased demandfor our PAS services and handsets. We use subscriber growth statistics to gaugefuture inventory purchasing requirements as well as to forecast our anticipatedrevenue growth. We expect this subscriber growth trend to continue in 2004 asChina’s teledensity rates remain low in comparison to that of developedcountries.

The number ofcompetitors for communications access and switching systems and handsets inChina grew in 2003 in line with China’s growing telecommunications market. Thisgrowth led to competitive pricing pressure, causing our average selling pricesto decrease in 2003 relative to 2002 levels. At the same time, a largerpercentage of our revenue was derived from handsets sales, which generally havea lower margin than communications access and switching systems, contributingto decreased margins overall from 2001 to 2003. We continued to developproducts with more advanced features and to enhance the features of ourexisting products in 2003, which we believe will enable us to offer ourcustomers a more advanced product at a higher average selling price thanotherwise would be possible. In addition, we worked in 2003, 

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and intend to continue tostrive to, reduce the cost of manufacturing our products by streamlining ourdesign and engineering functions.

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 2003. While these costs increased significantly from 2001to 2003 in line with increased business levels, we reduced these costs as apercentage of our revenues during this period. Operating costs as a percentageof revenue were 18% in 2003 compared to 20% in 2002.

We continued to operate ona positive cash flow basis in 2003, despite increased accounts receivable and inventorybalances. Our increased inventory levels were, in part, attributable to ourincreased backlog. We typically funded our inventory requirements with customeradvances, which we received upon signing new contracts. Our accounts receivablebalance continued to increase in 2003, but at the same time our cashcollections from customers increased as our days sales outstanding continued toimprove, enabling us to continue to obtain net cash provided by our operations.

***ACQUISITIONS AND OTHER KEY TRANSACTIONS***

*Acquisitions andin-process research and development (“IPR&D”)*

Since our incorporation, we have focused our resourceson developing products for the global communications market, with an emphasison the China communications market. We have made several key strategicacquisitions to acquire additional resources to further this development. Theseacquisitions were accounted for as purchases and the results of operations havebeen included in our consolidated financial statements from the closing datesof the acquisitions. Acquisitions prior to 2003 including HUTS, GUTS, Issanniand Advanced Communications Devices Corporation have not had a significantongoing impact on our consolidated results of operations.

Our acquisitions often result in a one-time charge tooperating expenses related to products under development but have not yetreached technological feasibility, or in-process research and development (“IPR&D”).A project is classified as IPR&D if there are significant risks associatedwith completing the development of the acquired technology including bothtechnological and commercial risks. When assessing IPR&D projects, weconsider the key project characteristics as well as its future prospects, therate at which technology changes in the telecommunications equipment 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, of meeting revenue targets or on the duration of employment.

*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 related transaction and other relatedcosts of $9.3 million.

Selected assets acquired included CommWorks’sportfolio of carrier-focused voice and data networking products andcustomer support and professional services. In addition, we 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.

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The amount of the purchase price allocated toIPR&D of $1.3 million, based on an independent valuation was chargedto the Company’s results of operations, as no alternative future uses existedat the acquisition date.

As of the date of the acquisition, CommWorks had twoprojects under development that qualified for IPR&D, SLAP and High DensityVoice (“HDV”) 2.0. SLAP is an IPR&D project in the Wireless division ofCommWorks. It is an interface that connects our products with radio switchmanufacturers’ products in China in order to connect a cellular network to theInternet. HDV 2.0 is an IPR&D project in the Wireline product line ofCommWorks. HDV 2.0 utilizes software technology to increase data capacity forVoice over Internet Protocol (“VoIP”) solutions.

There are significant risks associated with thosetechnologies. The technological risks stem from the fact that the newtechnologies are in an early stage of development. As of the closing date,CommWorks’ SLAP IPR&D project was approximately 60% complete and HDV 2.0was approximately 40% complete. Therefore, there are significant risksassociated with reaching the technological milestones on time and on budget.Commercial risks are associated with the competitive nature of thetelecommunications equipment market.

Additional costs will berequired to complete the IPR&D projects. The SLAP product is now expectedto be commercialized in the first quarter of fiscal 2004. Remaining costsrequired to complete the project, are estimated to be $0.1 million. TheHDV 2.0 product is now expected to be commercialized in the first quarter offiscal 2004. Remaining costs required to complete the project are estimated tobe $0.2 million.

*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 TV-over-Internet-Protocol (“TVoIP”) products andservices for telecommunications operators and broadband service providers. Ourinvestment in RollingStreams was $0.4 million prior to the acquisition.The purchase consideration for all the outstanding shares of RollingStreams,other than those already held by us prior to the acquisition, was 301,074shares of our common stock. In addition, we assumed all outstandingRollingStreams options, which became options to purchase an aggregate of 12,742shares of our common stock, valued at $0.5 million. Of the 301,074 shares,164,115 shares valued at $5.8 million, were issued at the closing, 28,696of which are 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.

The amount of the purchase price allocated toin-process research and development was $6.2 million, based on anindependent valuation. This amount was charged to our results of operations, asno alternative future uses existed at the acquisition date.

As of the date of the acquisition, RollingStreams hadone project under development that qualified for in-process research anddevelopment, MediaSwitch. MediaSwitch is an end-to-end solution designed fortelecom operators and broadband service providers to deliver broadcast qualityTV and on-demand entertainment services over Internet Protocol networks.

MediaSwitch is considered an IPR&D project becausethere are significant risks associated with the development of this technology.These risks include technological and commercial risks. The technological risksstem from the fact that the technology is 70% complete. Therefore, there aresignificant risks 

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associated with reachingthe technological milestones on time and on budget. Commercial risks areassociated with the lack of market acceptance for the TVoIP concept.

In addition to thetechnological and commercial risks stated above, significant additional costswill be required to complete the IPR&D project. MediaSwitch is now expectedto be commercialized in the second quarter of 2004. Remaining costs required tocomplete the project are estimated to be $4.5 million. Remainingengineering tasks include adding new features and functionalities andstabilizing the software code.

*Xebeo*

On May 7, 2003, we completed the purchase of allof the assets of Xebeo Communications, Inc. (“Xebeo”) for$2.4 million in cash. Xebeo develops and manufactures optical packetswitches that 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 amount of the purchase price allocated toin-process research and development of $1.9 million, based on anindependent valuation, was charged to our results of operations, as noalternative future uses existed at the acquisition date.

As of the date of theacquisition, Xebeo was focusing its resources on the development of its firstproduct, MetroBridge, an optical packet switching solution, and was consideredin the development stage. The development of MetroBridge was 60% complete as ofthe closing date. The technological feasibility of the technology was notestablished and the technology had no future alternative uses, therefore thedevelopment of MetroBridge is considered IPR&D. The product achieved itstechnical milestones as of November 2003, and is now available forcustomer trials and evaluations. It is expected to be marketed and sold in thethird quarter of 2004. Commercial risks are associated with the lack of market acceptancewith a product with these features and for its use in TVoIP implementations.

*Shanghai Yi 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 the 342,854shares of restricted stock executed an indemnity escrow agreement in our favorand such shares of restricted stock were placed in escrow. In addition, weissued 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.

*Debt Issuance*

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 annumand are convertible into our common stock at a conversion price of $23.79 pershare and are subordinated to all of our present and future senior debt.Holders of the notes may convert their notes only if: (i) the price of ourcommon stock issuable upon conversion of a note reaches a specified threshold, (ii) 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.

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Concurrent with theissuance of the convertible notes, we entered into convertible bond hedge andcall option transactions 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 fromconversion 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.”

*Transactions withSoftbank*

We recognized revenue of $184.4 million,$123.0 million, and $13.9 million during the years ended December 31,2003, 2002 and 2001, 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 ours. SBBC offersasynchronous digital subscriber line (“ADSL”) coverage throughout Japan, whichis marketed under the name “YAHOO BB!”. The majority of the products we provideto SBBC is associated with ADSL technology. The contract was competitively bidand the terms of this contract were on terms no more favorable than those withunrelated parties. Included in accounts receivable at December 31, 2003and 2002 were $43.9 million and $0.8 million, respectively, relatedto this agreement. There were no amounts included in deferred revenue inrespect to this agreement at December 31, 2003 and 2002.

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 recordedlosses of $0.2 million, $2.8 million and $1.7 million due to another-than-temporary decline in the carrying value of this investment in 2003,2002 and 2001, respectively. The balance in this investment was$5.3 million at December 31, 2003.

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. During the year ended December 31, 2003 werecorded equity losses of $0.1 million, and recorded no losses for the yearended December 31, 2002. The balance in this investment is$1.9 million at December 31, 2003.

On August 29, 2002, we completed the repurchaseof 6.0 million shares of our common stock for $72.9 million from ourlargest shareholder, SOFTBANK America Inc. As part of this transaction,SOFTBANK signed a voluntary “lock up” agreement stipulating that it would notsell any of our common stock within the next six months.

This lock up agreement, which ended on March 1,2003, coincided with the start of our “blackout period” in which insiders arenot permitted to sell shares. The blackout period began March 1, 2003 andended commencing at the close of business on the second trading day followingthe public release of our first quarter fiscal 2003 results on April 16,2003.

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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 31,2003, SOFTBANK America Inc. beneficially owned approximately 14.1% of ouroutstanding stock.

On July 17, 2003, weentered into a Mezzanine Loan Agreement with BB Modem Rental PLC (“BB Modem”),an affiliate of SOFTBANK CORP. Under the terms of the agreement we loaned BBModem $10.1 million, for the purposes of investing in a portfolio of ADSLmodems and associated modem rental agreements, from SOFTBANK BB CORP., formerlyBB Technologies, an affiliate of SOFTBANK CORP. SOFTBANK BB CORP. will continueto service such modems and modem rental agreements. Our loan is subordinated tocertain senior lenders of BB Modem, and repayments are payable to us over aforty-two month period through January 31, 2007, with a substantialportion of the principal amount of the loan schedule to be repaid during thelast 16 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. During2003, we recorded $0.5 million in interest income in respect of this loan.The loan receivable at December 31, 2003 was approximately$11.2 million based on a foreign exchange rate of approximately $1.07 for100 Japanese Yen.

*Subsequent Event*

On January 14, 2004,we sold 12.1 million shares of common stock at $39.25 per share to Banc ofAmerica Securities LLC, for net proceeds of approximately $474.2 million.We intend to use the net proceeds for strategic and general corporate purposes,including, but not limited to, acquisitions, investments, working capital orcapital expenditures.

**RESULTS OF OPERATIONS**

Approximately 86%, 84% and 90% of our net sales forthe years ended December 31, 2003, 2002 and 2001, 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.Our results may be adversely affected by, among other things, changes in thepolitical, economic, competitive and social conditions in China, includingchanges in governmental policies with respect to laws and regulations, changesin the telecommunications industry and regulatory rules and policies, anti-inflationarymeasures, currency conversion and remittance abroad, and rates and methods oftaxation. We extend credit to our customers in China without requiringcollateral. We monitor our exposure for credit losses and maintain allowancesfor doubtful accounts. Business activity in China and many other countries inAsia declines considerably during the first quarter of each year in observanceof the Lunar New Year. As a result, sales during the first quarter of ourfiscal year have typically been lower than sales during the fourth quarter ofthe preceding year, and we expect this trend to continue.

Cost of sales consists primarily of material costs,payments to agents, costs associated with manufacturing, assembly and testingof products, costs associated with installation and customer training andoverhead and warranty costs. Cost of sales also includes import taxes andtariffs on components and assemblies. Some components and materials used in ourproducts are purchased from a single supplier or a 

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limited group of suppliersand, in some cases, are subject to our obtaining Chinese import permits andapprovals. We also rely on third party manufacturers in China to manufactureand assemble most of our handsets.

Our gross profit has been affected by product mix,average 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 large percentageof our costs are fixed and are difficult to quickly reduce in periods ofreduced sales. We intend to pursue aggressive selling and marketing campaignsand to expand our direct sales organization, and, as a result, our sales andmarketing expenses will increase in future periods. We also expect that insupport of our continued growth, general and administrative expenses willcontinue to increase for the foreseeable future.

Research and developmentexpenses consist primarily of salaries and related costs of employees engagedin research, design and development activities, the cost of parts forprototypes, equipment depreciation and third party development expenses. Alarge percentage of our costs are fixed and are difficult to quickly reduce inperiods of reduced sales. We believe that continued investment in research anddevelopment is critical to our long-term success. Accordingly, we expectthat our research and development expenses will increase in future periods.

**NETSALES**

Thefollowing table summarizes our net sales by geographic region and by productline:
| ** **               | ** ** | **Years ended December 31,** | ** **    |
|--------------------------|------------|---------------------------------------------|---------------|
| ** **               | ** ** | **2003**                                    | ** **    | ** ** | ** ** | **2002** | ** ** | ** ** | ** ** | **2001** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Restated(1)**                             | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **(in thousands)**                     | ** **    |
| *Sales by region*        |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| China                    |       | $                                           | 1,680,821     |   | 86 | % | $ | 822,299 |   | 84 | % | $ | 565,880 |   | 90 | % |
| Japan                    |       | 194,894                                     |          | 10 | % | 130,104 |   | 13 | % | 16,303 |   | 3 | % |
| Other                    |       | 89,472                                      |          | 4 | % | 29,403 |   | 3 | % | 44,657 |   | 7 | % |
| **TOTAL NET SALES**      | ** ** | **$**                                       | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** | **$** | **626,840** | ** ** | **100** | **%** |
| *Sales  by product line* |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure |       | $                                           | 720,555       |   | 37 | % | $ | 447,096 |   | 46 | % | $ | 376,538 |   | 60 | % |
| Subscriber  handsets     |       | 968,192                                     |          | 49 | % | 376,805 |   | 38 | % | 187,902 |   | 30 | % |
| Wireline products        |       | 276,440                                     |          | 14 | % | 157,905 |   | 16 | % | 62,400 |   | 10 | % |
| **TOTAL  NET SALES**     | ** ** | **$**                                       | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** | **$** | **626,840** | ** ** | **100** | **%** |

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(1)          SeeNote 24 to the Consolidated Financial Statements.

*Fiscal 2003 vs.2002*

This increase in sales was primarily attributable toincreased demand for our products and services, the continued strength of oursales in China, as well as an increase in our global sales. Net sales growthwas due to an increase in subscribers, which required telecommunicationproviders to expand their telecommunication infrastructures. As a result, wehad more sales to customers that were expanding their existing networks in 2003.Approximately 30% of our sales in 2003 were attributable to new customers 

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comparedto 54% of sales to new customers in 2002. In addition to increasing the amountof infrastructure sales, this increase in subscribers also led to an increasein customer demand for handsets.

During 2003, the Chinaprovincial-level telecommunications service entities continued toconsolidate telecommunications purchasing decisions by province. As a result ofthis consolidation trend, we grouped all of our China customers together byprovince, and treated each province as one customer. At December 31, 2003and 2002, we had approximately 31 such customers. Giving effect to thisconsolidation, in 2003, the Hei Long Jiang province accounted for 11% of ournet sales. In 2002, sales to the Zhejiang province accounted for 18% and salesto SBBC accounted for 13% of our net sales. We expect our sales to grow at amoderate rate through 2004, with our global sales growing at a higher rate thanour China sales. Our handset sales increased as a result of increasedsubscribers, from approximately 12 million subscribers in 2002 toapproximately 35 million subscribers in 2003, and we expect this growthrate to continue into 2004.

We expect that 2004 netsales will be comprised of approximately 35% to 40% wireless infrastructuresales, approximately 40% to 50% subscriber handset sales and approximately 10%to 20% wireline products.

*Fiscal 2002 vs. 2001*

International sales oftelecommunications equipment increased primarily due to sales of equipment toSBBC in Japan to support its ADSL rollout. In 2002, sales to the Zhejiangprovince accounted for 18% and sales to SBBC accounted for 13% of our netsales. In 2001, sales to the Zhejiang and Guangdong provinces accounted for 28%and 10% of our net sales, respectively. 

Our handset salesincreased as a result of subscriber growth and the increased popularity of ourPAS system. 

**GROSS PROFIT**

Thefollowing table summarizes our gross profit:
| ** **              | ** ** | **Years ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **              | ** ** | ** Restated(1) **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | **(in thousands)**                     | ** ** |
| Gross profit            |       |                                        | $          | 624,385 |   |   | $ | 345,472 |   | $ | 224,548 |   |
| Gross profit percentage |       |                                        | 32         | % |   | 35 | % | 36 | % |
|                         |            |                                             |            |  |  |  |  |  |  |  |  |  |

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(1)   See Note 24 to the Consolidated Financial Statements.

*Fiscal 2003 vs. 2002*

Our gross profit variesacross our different product lines and is affected by product mix, averageselling prices and the cost of materials. The decrease in gross profit as apercent of net sales in 2003 from 2002 is attributable to increased competitivemarket pricing pressures and lower margins on our iPAS and PAS systems as wellas to our having a higher volume of sales of our lower margin handset products.The telecommunications market experienced continued pricing pressures in 2003.We anticipate that this pricing pressure will continue on both our iPAS and PASsystems and on our handset products. Our gross profit also decreased in 2003due to an increased cost of sales from foreign exchange losses resulting fromour purchasing significant amounts of inventory denominated in Japanese Yen. Webelieve that our overall gross profit as a percentage of net sales willcontinue to fluctuate from period to period as a result of shifts in productmix, anticipated decreases in average selling prices and our ability to reducecost of sales. We expect that there will be continued competitive marketpricing pressures on our products in line with current trends in the industry.Additionally, we expect that handsets will continue to represent 40% to 50% ofour net sales.

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*Fiscal 2002 vs.2001*

The decrease in grossprofit, as a percentage of net sales, was primarily due to increased sales oflower margin handsets, which comprised 38% of net sales in 2002 compared to 30%in 2001.

**OPERATING EXPENSES**

The following tablesummarizes our operating expenses:
| ** **                                                   | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | **2003**                                    | ** ** | **% of  2003 net  sales** | ** ** | **2002** | ** ** | **% of  2002 net  sales** | ** ** | **2001** | ** ** | **% of   2001 net  sales** | ** ** |
| ** **                                                   | ** ** | ** Restated(1) **                 | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                     | ** ** |
| Selling, general and administrative (“SG&A”)   |       |                                        | $          | 188,339 |   |   |   | 9 | % |   | $ | 110,263 |   |   | 11 | % |   | $ | 75,764 |   |   | 12 | % |   |
| Research and development (“R&D”)               |       |                                        | 155,252    |   |   |   | 8 | % |   | 86,182 |   |   | 9 | % |   | 59,809 |   |   | 10 | % |   |
| In-process research and development  (“IPR&D”) |       |                                        | 10,686     |   |   |   | 1 | % |   | 670 |   |   | 0 | % |   | 4,720 |   |   | 1 | % |   |
| Amortization of intangible assets                            |       |                                        | 8,370      |   |   |   | 0 | % |   | 2,395 |   |   | 0 | % |   | 7,527 |   |   | 1 | % |   |
| **TOTAL OPERATING EXPENSES**                                 |       |                                        | $          | 362,647 |   |   |   | 18 | % |   | $ | 199,510 |   |   | 20 | % |   | $ | 147,820 |   |   | 24 | % |   |

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(1)          SeeNote 24 to the Consolidated Financial Statements.

*Selling, generaland administrative*

*Fiscal 2003 vs.2002*

Selling, general andadministrative expenses include compensation and benefits, professional fees,sales commissions, provision for doubtful accounts receivable and travel andentertainment costs. The increase in absolute dollars of selling, general andadministrative expenses is due to expanding our overall business activitiesboth in China and globally. To support our expanding global business, we hiredapproximately 1,150 additional selling, general and administrative employees in2003, which also contributed to the increased selling, general andadministrative expenses. The decrease in selling, general and administrativeexpenses as a percentage of net sales was primarily due to economies of scaleassociated with the significant increase in net sales.

*Fiscal 2002 vs.2001*

The increase in selling,general and administrative expenses in 2002 was primarily due to the growth innet sales and the expansion of our overall level of business activitiesglobally. The decrease in selling, general and administrative expenses as apercentage of net sales was primarily due to economies of scale associated withthe significant increase in net sales.

*Research anddevelopment*

*Fiscal 2003 vs.2002*

The increase in absolutedollars of research and development expenses was primarily due to the hiring in2003 of approximately 950 additional technical personnel 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.

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*Fiscal 2002 vs.2001*

The increase in researchand development expenses was primarily due to the hiring in 2002 of anadditional 303 technical personnel, and increased prototype expenses andlicensing fees to support our research and development efforts. As a percentageof net sales, research and development expenses decreased to 9% in 2002 from10% in 2001. The reduction in research and development expenses as a percent ofnet sales was attributable to increased economies of scale associated withincreased business levels.

*In-process researchand development costs*

*Fiscal 2003 vs.2002*

The IPR&D charge for 2003 resulted from ouracquisition of CommWorks, a former division of 3Com, and three smalleracquisitions: RollingStreams, Xebeo and Shanghai Yi Yun Telecom TechnologyCo. Ltd., which accounted for $1.3 million, $6.2 million,$1.9 million and $1.3 million, respectively, and were based onindependent valuations. The charge for 2002 arose from our acquisition ofIssanni Communications, Inc. on April 19, 2002 and was based onindependent valuation.

Refer to the acquisitionsand other key transactions section of the MD&A for additional detail on ourIPR&D costs incurred in 2003.

*Fiscal 2002 vs.2001*

2002 IPR&D costsresulted from our acquisition of Issanni on April 19, 2002. 2001in-process research and development costs resulted from our acquisition of ACDin November 2001. These charges were based upon independent valuations.

*Amortization ofintangible assets*

*Fiscal 2003 vs.2002*

The increase inamortization of intangible assets was primarily due to an additional$44.9 million of intangibles recorded upon our acquisition of CommWorks inMay 2003. The estimated useful lives of these purchased intangibles arefrom one to ten years. Estimated amortization expense for the next five years,beginning with the year ended December 31, 2004, is $10.7 million,$7.6 million, $5.8 million, $5.6 million and $4.0 million,respectively.

*Fiscal 2002 vs.2001*

The decrease inamortization of intangible assets was primarily due to the elimination ofgoodwill amortization upon the adoption of SFAS No. 142 on January 1,2002 of $7.4 million, offset by an increase in amortization of intangiblesof $2.0 million. Had SFAS No. 142 been in effect during the yearended December 31, 2001, amortization expense would have been$0.2 million.

**OTHER INCOME (EXPENSES)**

*Interest income(expense), net*

*Fiscal 2003 vs.2002*

Interest income was $3.2 million in 2003 comparedto interest income of $5.5 million in 2002. Interest income has decreaseddue to 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.

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Interest expense was $4.7million in 2003 compared to $1.3 million in 2002. The increase of$3.4 million in interest expense was primarily attributable to the interestassociated with our convertible debt issued in March 2003, which accruesat a rate of approximately $1.4 million per quarter. $0.6 million ofinterest was capitalized in 2003.

*Fiscal 2002 vs.2001*

Interest income was$5.5 million in 2002 compared to interest income of $8.6 million in2001. Interest expense was $1.3 million in 2002 compared to$3.9 million in 2001. The decrease in interest income was primarily due toa reduction in cash and cash equivalents and short-term investments of$58.3 million and a reduction in interest rates on deposits. The decreaseof $2.7 million in interest expense was related to debt balances that werepaid off in September 2002. At December 31, 2002, we did not have anydebt.

*Other income(expense), net*

*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 was primarily comprised of a reinvestmentincentive payment received in China of $3.9 million, incentive payments forexports and value added taxes in China of $6.1 million, government incentiverelated to our operations in Japan of $6.2 million, offset by foreignexchange losses of approximately $8.7 million and expenses attributable toselling or transferring of notes receivable of $2.3 million.

*Fiscal 2002 vs.2001*

Net other expense was$9.9 million in 2002, compared to net other expense of $0.3 millionin 2001. Net other expense in 2002 was primarily comprised of impairment write-downsof $4.4 million relating to our investment portfolio and foreign exchangelosses of $5.4 million.

*Equity in netincome (loss) of affiliated companies*

*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 was primarily comprised ofour share of losses relating to our joint venture with one of our stockholders,Matsushita Communication Industrial Co., Ltd., to jointly design and develop,manufacture and sell telecommunications products. We have a 49% ownershipinterest in the joint venture company, which has a registered share capital of$10.0 million. The equity loss for 2002 was related to losses relating toour interests in investment funds and to our share of losses generated by GUTSprior to our acquisition of the remaining 49% ownership interest in thisentity.

*Fiscal 2002 vs.2001*

Consolidated equity in netloss of affiliated companies was $4.1 million in 2002 and$3.0 million in 2001. This included equity losses of $2.9 million and$1.7 million in 2002 and 2001, respectively, related to our interest ininvestment funds. In May 2002, we acquired the remaining 49% ownershipinterest in GUTS, which is now a wholly-owned subsidiary. Its results ofoperations are included in our consolidated financial statements beginning June 1,2002. Prior to May 2002, GUTS was accounted for using the equity method ofaccounting. On July 5, 2002, we entered into a joint venture agreementwith Matsushita Communication Industrial Co., Ltd., and MatsushitaElectric Industrial Co., Ltd., to jointly design, develop, manufacture andsell telecommunication products. We have a 49% ownership interest in this joint

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venturecompany. The investment in and results of operations of the joint venturecompany were accounted for using the equity method of accounting, commencing October 2002.

*Income tax expense*

*Fiscal 2003 vs.2002*

Income tax expense was$45.4 million in 2003 and $27.3 million in 2002. The primary reasonfor the increase in income tax expense was that our income increased 91% in2003 from 2002. Our effective tax rate was 17% in 2003 compared to 20% in 2002.The decrease in the effective tax rate is primarily the result of permanentdifferences and tax credits, offset partially by the fact that more of ourrevenue has become subject to higher tax rate jurisdictions as we expand ourbusiness globally.

*Fiscal 2002 vs.2001*

Income tax expense was$27.3 million in 2002 and $19.8 million in 2001. The increase inincome tax expense was due to our increased income. Our effective tax rate was20% in 2002 compared to 25% in 2001. The reduction in our effective tax ratecan be attributed to the increased portion of our net income derived from ouroperations in Chinese jurisdictions, which have granted us temporary taxholidays.

*Minority interestin losses (earnings) of consolidated subsidiaries*

*Fiscal 2003 vs.2002*

Minority interest in losses(earnings) of consolidated subsidiaries was $1.0 million in 2003 and ($1.2) millionin 2002. The change was due primarily to the minority interest in losses in2003 related to MDC, a variable interest entity included in our consolidatedfinancials in the third quarter of 2003, and to the acquisition of theremaining 12% ownership interest in our Zhejiang manufacturing joint venture,UTStarcom Telecom Co., Ltd. (“HUTS”) during 2002. Minority interest in lossesof consolidated subsidiaries for 2003 represented the minority interest inlosses of MDC, as well as the 10% share of earnings of CUTS, our Chongqingmanufacturing joint venture, attributable to our joint venture partner. Minorityinterest in earnings of consolidated subsidiaries for 2002 represented theshare of earnings in HUTS, our Zhejiang manufacturing joint venture,attributable to our joint venture partner, prior to our acquisition of theremaining 12% ownership interest in HUTS in May 2002. HUTS is now a wholly-ownedsubsidiary.

*Fiscal 2002 vs.2001*

Minority interest in losses(earnings) of consolidated subsidiaries was ($1.2) million in 2002 and ($1.3) millionin 2001. The decrease is due to the acquisition of the remaining 12% ownershipinterest in HUTS in May 2002. HUTS is now a wholly-owned subsidiary.The expected decrease was offset by an increase in HUTS net income for the fourmonths ended April 30, 2002 as compared to the corresponding period in2001.

**Liquidity and Capital Resources**

*OperatingActivities*

*2003*

Net cash provided byoperating activities for the year ended December 31, 2003 was$45.2 million. Operating cash was affected by changes in accountsreceivable, inventory, accounts payable, other assets and offset by changes indeferred revenue. The $151.9 million increase in our accounts receivablebalance, attributable to a 100% increase in sales in 2003, reduced our net cashprovided by operations. In 2003, we 

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sold$298.8 million of our notes receivable with associated expenses of$2.3 million. Cash provided by operating activities was also reduced by a$81.6 million and $301.1 million increase in inventory and deferredcosts, respectively. Inventory and deferred costs increased in absolute dollarsin 2003 over 2002 to support our increased backlog. Operating cash alsodecreased due to a $5.9 million decrease in accounts payable. Historically,the majority of our accounts payables have been comprised of inventory relatedpayables. In mid-2003, we implemented a “just in time” inventory process toincrease efficiencies in inventory purchasing. Going forward, we expect tocontinue to improve the efficiencies surrounding our supply chain and inventoryprocess. As such, inventory will grow at a slower rate than we havehistorically experienced. The decrease in operating cash in 2003 was offset byan 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. Customer advances arecomprised of cash we have collected from our customers for which we have notyet recognized revenue; the increase was attributable to an increase incustomer contracts.

*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.

*2001*

Net cash provided byoperating activities in fiscal 2001 was $40.2 million. Net cash providedby operations was mainly due to a $39.1 million, $42.8 million and$41.4 million increase in accounts payable, customer advances and otherliabilities, respectively, offset by increases in inventories, deferred costs,accounts receivable and other assets of $60.4 million, $60.8 million,$39.2 million and $43.0 million, respectively.

*InvestingActivities*

*2003*

Net cash used in investingactivities was $176.5 million for the year ended December 31, 2003.Net cash used in investing activities was affected by increased businessacquisitions and property, plant and equipment purchases. We spent$106.7 million for business acquisitions in 2003. This was primarilyattributable to our May 2003 CommWorks acquisition, which was$109.3 million including transaction and transition fees, offset partiallyby $3.8 million in cash added from the consolidation of MDC. In addition tobusiness acquisitions, net cash used in investing activities increased due to$123.2 million of property, plant and equipment purchases. $45.5 millionof these property, plant and equipment purchases were construction costsincurred on our Hangzhou manufacturing facility. Net cash used in investingactivities also increased due to $147.5 million of purchases of short-terminvestments. Offsetting net cash used in investing activities was$217.2 million of proceeds from the sale of our 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; $28.9 million of investmentsin affiliates which primarily comprised investments in public and privatetechnology companies offset by $22.4 million of net purchases ofshort-term investments.

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*2001*

Net cash used in investingactivities in fiscal 2001 of $43.7 million was primarily due to$30.2 million of property, plant and equipment purchases,$9.8 million of investments in affiliates, which primarily comprisedinvestments in public and private technology companies offset by$2.1 million of net purchases of short-term investments.

*FinancingActivities*

*2003*

Net cash provided by financingactivities was $275.3 million for the year ended December 31, 2003due to proceeds raised from a convertible subordinated notes issuance and stockoption exercises offset by a repurchase of our common stock and the purchase ofa bond hedge and call option. Net cash provided by financing activities wasprimarily attributable to $391.4 million in net proceeds received fromissuing convertible subordinated notes in March 2003. In addition to theproceeds received from our notes issuance, we received $58.9 million forthe issuance of common stock through stock option and ESPP exercises.Offsetting cash provided by financing activities, we used a portion of thecapital raised to repurchase 8.0 million shares of our common stock thatwas beneficially owned by SOFTBANK America, Inc. at a purchase price of$17.385 per share. The total cost of the repurchase was $139.6 million,including transaction fees. We used the remainder of the funds raised to fund2003 business acquisitions. Net cash provided by financing activities was alsooffset by our purchase of a call spread for $43.8 million, which waspurchased to minimize shareholder dilution upon conversion of the convertiblesubordinated notes.

*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 in conjunction with 10.0 million sharesof our common stock sold by SOFTBANK America, Inc. through an underwriterand the issuance of common stock through stock option exercises.

*2001*

Net cash provided byfinancing activities of $175.5 million was primarily due to$160.6 million of proceeds from our follow-on public offering of commonstock in August 2001, stock option exercises, and net proceeds fromborrowings under our line of credit arrangements of $15.1 million.

*Liquidity*

Our working capital was$883.3 million and $568.2 million at December 31, 2003 and 2002,respectively. This increase in working capital is due to increased cash onhand, from $231.9 million in cash and cash equivalents and $107.3 ofshort-term investments in 2002, to $377.7 million of cash and cashequivalents and $48.6 million of short-term investments. Our workingcapital also increased due to larger accounts receivable and inventorybalances, which was offset by larger customer advances and deferred revenuebalances. We anticipate having more working capital and cash on hand in 2004 asa result of our $474.2 million equity offering in January 2004. Goingforward, this cash will position us to take advantage of strategic investmentopportunities. We had lines of credit totaling $583.7 million availablefor future borrowings expiring between 2004 and 2010 with interest ratesranging from approximately 4.5% to 6.0%, and we had not guaranteed any debt notincluded in the consolidated balance sheet.

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*Income taxes*

Our subsidiaries and jointventures located in China enjoy tax benefits in China which are generallyavailable to foreign investment enterprises, including full exemption fromnational enterprise income tax for two years starting from the first profit-makingyear and/or a 50% reduction in national income tax rate for the following threeyears. In addition, local enterprise income tax is often waived or reducedduring this tax holiday/incentive period. Under current regulations in China,foreign investment enterprises that have been accredited as technologicallyadvanced enterprises are entitled to additional tax incentives. These taxincentives vary in different locales and could include preferential nationalenterprise income tax treatment at 50% of the usual rates for different periodsof time. The tax holidays discussed above are applicable to UTStarcom(Chongqing) Co., Ltd. (“CUTS”), HUTS, Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”)and UTStarcom China Co., Ltd. (“UTSC”), our active subsidiaries in China, as thoseentities qualify as accredited technologically advanced enterprises.Specifically, HUTS currently enjoys a 15% tax rate that will continueindefinitely provided they remain as a technologically advanced enterprise andthe Government does not change the tax laws. UTSC currently enjoys a 10%holiday tax rate that expires on December 31, 2005. HSTC and CUTS arecurrently exempt from income tax until December 31, 2004, at which pointthey will be subject to a 7.5% tax rate, which will expire on December 31,2007.

*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, 2003**           | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| ** **                      | ** ** | **Payments Due by Period** | ** ** |
| ** **                      | ** ** | **Total**                                 | ** ** | ** Less than   1 year** | ** ** | **1-3 years** | ** ** | **3-5 years** | ** ** |
| ** **                      | ** ** | **  Restated(1)  **   | ** ** | ** ** | ** ** | **  Restated(1)  ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | **(in thousands)**                   | ** ** |
| *Contractual  Obligations*      |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Notes Payable                   |       |                                      | $          | 1 |   |   |   | $ | 1 |   |   |   | $ | — |   |   | $ | — |   |
| Convertible  Subordinated Notes |       |                                      | $          | 402,500 |   |   |   | $ | — |   |   |   | $ | — |   |   | $ | 402,500 |   |
| Bank Loan                       |       |                                      | $          | 8,155 |   |   |   | $ | — |   |   |   | $ | 8,155 |   |   | $ | — |   |
| Operating leases                |       |                                      | $          | 25,724 |   |   |   | $ | 10,154 |   |   |   | $ | 15,131 |   |   | $ | 439 |   |
| *Other  Commercial Commitments* |       |                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Standby letters  of credit      |       |                                      | $          | 20,461 |   |   |   | $ | 15,353 |   |   |   | $ | 5,108 |   |   | $ | — |   |
| Purchase  Commitments           |       |                                      | $          | 2,261 |   |   |   | $ | 2,261 |   |   |   | $ | — |   |   | $ | — |   |

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(1)          See Note 24 to theConsolidated Financial Statements.

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.

Our $402.5 million of convertible subordinatednotes, due March 1, 2008, bear interest at a rate of 7¤8%per annum, payable semiannually on May 1 and September 1, areconvertible into the Company’s common stock at a conversion price of $23.79 pershare and are subordinated to all present and future senior debt of theCompany. The principal is due only at maturity of the notes.

We recorded a bank loan in connection with a purchaseof inventory resulting from the consolidation of MDC. On January 10, 2003,a third party established a bank loan with Shanghai Pudong Development 

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Bank for the purchase ofthe inventory. We assumed the obligations of the bank loan and relatedinventory on January 23, 2003, which were subsequently transferred to MDCon December 31, 2003. The bank loan of $8.2 million bears interest at arate of 4.94% per annum, and expires on January 10, 2006. For the yearended December 31, 2003, we recorded total interest expense related tothis bank loan amounted to $0.4 million. We do not serve as legal obligor forthe bank loan.

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.

*Accounts receivabletransferred to notes receivable*

We accept bank notesreceivable and commercial notes receivable, with maturity dates between threeand six months, from our customers in China in the normal course of business.We may discount these notes with banking institutions in China. A sale of thesenotes is reflected as a reduction of other current assets and the proceeds ofthe settlement of these notes are included in cash flows from operatingactivities in the consolidated statement of cash flows. Notes receivable soldduring the years ended December 31, 2003 and 2002 were $298.8 millionand $2.5 million, respectively. These notes are not included in ourconsolidated 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. Under SFAS 140, upon a transfer, thetransferor or entity must derecognize financial assets when control has beensurrendered and the transferee obtains control over the assets. In addition,the transferred assets have been isolated from the transferor, beyond the reachof its creditors, and the transferee has the right, without conditions orconstraints, to pledge or exchange the assets it has received. The costs ofsettling or transferring these notes receivable were $2.3 million andimmaterial for the years ended December 31, 2003 and 2002, respectively,and were included in other income (expense), net in the Consolidated Statementsof Operations. Notes receivable available for sale were $11.4 million and$12.0 million at December 31, 2003 and December 31, 2002,respectively.

*Investmentcommitments*

As of December 31, 2003,we had invested a total of $2.0 million in Global Asia Partners L.P. thatis recorded as a long-term investment. The fund size is anticipated to be$100 million and the fund was formed to make private equity investments inprivate or pre-IPO technology and telecommunications companies in Asia. We havea commitment to invest up to a maximum of $5.0 million. The remainingamount is due at such times and in such amounts as shall be specified in one ormore future capital calls to be issued by the general partner.

*Purchasecommitments*

We are obligated topurchase raw materials and work-in-process inventory under variousorders from one supplier, all of which are expected to be fulfilled with noadverse consequences material to our operations or financial condition. As of December 31,2003 total open commitments under these purchase orders were approximately$2.3 million.

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**DISCUSSIONAND ANALYSIS OF QUARTERLY RESULTS OF OPERATIONS, AS RESTATED**

*Three months ended March 31,2003 and 2002*

Income tax expense for the three months ended March 31,2003 was previously reported as $12.4 million and has been restated to $8.6million, a decrease of $3.8 million. The decrease in income tax expense is dueto the correction of the 2003 effective tax rate from 25% to 17%. See Note 24to the consolidated financial statements.

Income tax expense was$4.5 million for the corresponding period in 2002. The increase in incometax expense from the three months ended March 31, 2002 to the three monthsended March 31, 2003 was due to our increasing income. The effective taxrate was 17% and 20% for the three months ended March 31, 2003 and 2002,respectively. The decrease in our effective tax rate was primarily due topermanent differences consisting of deductible expenses related to originalissuance discount on convertible notes and the China “Super R&D deductions”as well as foreign and R&D tax credits, offset partially by the fact thatmore of our revenue has become subject to higher tax rate jurisdictions as weexpand globally.

*Three months andsix months ended June 30, 2003 and 2002*

Income tax expense for the three months ended June 30,2003 was previously reported as $13.1 million and has been restated to $9.1million, a decrease of $4.0 million. Income tax expense for the six monthsended June 30, 2003 was $25.6 and has been restated to $17.7 million, adecrease of $7.9 million. The decrease in income tax expense for the threemonths and six months ended June 30, 2003 is due to the correction of the2003 effective tax rate from 25% to 17%. See Note 24 to the consolidatedfinancial statements.

Income tax expense was$6.6 million and $11.1 million for the three and six months ended June 30,2002, respectively. The increase in income tax expense from the three monthsand six months ended June 30, 2002 to the three months and six monthsended June 30, 2003 was due to our increasing income. The effective taxrate was 17% for three months and six months ended June 30, 2003 and 20%for the three and six months ended June 30, 2002, respectively. Thedecrease in our effective tax rate was due primarily to permanent differencesconsisting of deductible expenses related to original issuance discount onconvertible notes and the China “Super R&D deductions” as well as foreignand R&D tax credits, offset partially by the fact that more of our revenuehas become subject to higher tax rate jurisdictions as we expand globally.

*Three months andnine months ended September 30, 2003 and 2002*

Income tax expense for the three months ended September 30,2003 was previously reported as $19.7 million and has been restated to $13.7million, a decrease of $6.0 million. Income tax expense for the nine monthsended September 30, 2003 was $45.3 million and has been restated to $31.4million, a decrease of $13.9 million. The decrease in income tax expense forthe three months and nine months ended September 30, 2003 is due to thecorrection of the 2003 effective tax rate from 25% to 17%. See Note 24 to theconsolidated financial statements.

Incometax expense was $7.7 million and $18.8 million for the three and ninemonths ended September 30, 2002, respectively. The increase in income taxexpense from the three months and nine months ended September 30, 2002 tothe three months and nine months ended September 30, 2003 was due to ourincreasing income. The effective tax rate was 17% for three months and ninemonths ended June 30, 2003 and 20% for the three and six months ended June 30,2002, respectively. The decrease in our effective tax rate was due primarily topermanent differences consisting of deductible expenses related to originalissuance discount on convertible notes and the China “Super R&D deductions”as well as foreign 

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and R&D tax credits, offset partially by the factthat more of our revenue has become subject to higher tax rate jurisdictions aswe expand globally.
| **Income Tax Expense** | ** ** | ** **              | ** ** | **As Previously  Reported** | ** ** | **As Restated(1)** | ** ** |
|----------------------------------|------------|-------------------------|------------|----------------------------------|------------|-------------------------|------------|
| ** **                       | ** ** | **(in thousands)** | ** ** |
| Three months  ended:             |       |                    |       |                             |       |                    |       |   |   |
| March 31, 2003              |       |                    | $          | 12,447                           |       |                    |       | $ | 8,622 |   |   |
| March 31, 2002              |       |                    | 4,514      |                             |       |                    | 4,514      |   |   |
| Three months  ended:             |       |                    |       |                             |       |                    |       |   |   |
| June 30, 2003               |       |                    | 13,138     |                             |       |                    | 9,100      |   |   |
| June 30, 2002               |       |                    | 6,590      |                             |       |                    | 6,590      |   |   |
| Six months ended:                |       |                    |       |                             |       |                    |       |   |   |
| June 30, 2003               |       |                    | 25,585     |                             |       |                    | 17,722     |   |   |
| June 30, 2002               |       |                    | 11,104     |                             |       |                    | 11,104     |   |   |
| Three months  ended:             |       |                    |       |                             |       |                    |       |   |   |
| September 30, 2003          |       |                    | 19,725     |                             |       |                    | 13,661     |   |   |
| September 30, 2002          |       |                    | 7,686      |                             |       |                    | 7,686      |   |   |
| Nine months  ended:              |       |                    |       |                             |       |                    |       |   |   |
| September 30, 2003          |       |                    | 45,310     |                             |       |                    | 31,383     |   |   |
| September 30,  2002         |       |                    | 18,790     |                             |       |                    | 18,790     |   |   |
|                                  |            |                         |            |                                  |            |                         |            |  |  |  |  |  |  |

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(1)          Restated—SeeNote 24 to Consolidated Financial Statements

**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.

**RevenueRecognition and Product Warranty**

We recognize revenues from sales of telecommunicationsequipment when persuasive evidence of an arrangement exists, delivery of theproduct has occurred, customer acceptance has been obtained, the fee is fixedor determinable and collectibility is reasonably assured. If the payment duefrom the customer is not fixed or determinable due to extended payment terms,revenue is recognized as payments become due from the customer, assuming allother criteria for revenue recognition are met. Normal payment terms differ forvarious reasons amongst different customer regions depending upon the commonbusiness practices for customers within a region. Shipping and handling costsare recorded as revenues and costs of revenues. Any expected losses oncontracts are recognized immediately.

Final acceptance is required in our complex multipleelement contractual arrangements since installation stretches over a time frameof six to twelve months, terms and deliverables are not finalized until projectcompletion, and customers extensively test the systems after installation.Final acceptance indicates that the customer has fully accepted delivery ofequipment and that we are entitled to the full payment. We will not recognizerevenue before final acceptance is granted by the customer if acceptance is consideredsubstantive to the transaction. Additionally, we do not recognize revenue whencash payments 

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are received fromcustomers for transactions that do not have the customer’s final acceptance. Werecord these cash receipts as customer advances, and defer revenue recognitionuntil final acceptance is received.

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 EITF 00-21 and SEC Staff AccountingBulletin No. 104 (“SAB 104”). Multiple element arrangements primarilyinvolve the sale of PAS or iPAS equipment with handsets, installation andtraining and the provision of such equipment to different locations for thesame customer. Revenue is recognized as each element is earned, namely uponinstallation and acceptance of equipment or delivery of handsets; provided thatthe fair value of the undelivered element(s) has been determined, thedelivered element has stand-alone value, there is no right of return ondelivered element(s), and we are in control of delivery of the undeliveredelement(s).

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 Emerging Issues Task Force Issue No. 03-05. TheCompany allocates revenues to each element of software arrangements based onvendor-specific objective evidence (“VSOE”). VSOE of each element isbased on the price charged when the same element is sold separately. We use theresidual method to recognize revenue when an arrangement includes one or moreelements to be delivered at a future date and VSOE of the fair value of all theundelivered elements exists. Under the residual method, the fair value of theundelivered elements is deferred and the remaining portion of the arrangementfee is recognized as revenue. If evidence of fair value of one or moreundelivered elements does not exist, revenue is deferred and recognized whendelivery of those elements occurs or when fair value can be established.

We also sell products, primarily handsets, throughresellers. Revenue is generally recognized when the standard price protectionperiod has lapsed, which ranges from 30 to 90 days. If collectibilitycannot be reasonably assured in a reseller arrangement, revenue is recognizedupon sell-through to the end customer and receipt of cash. In China, there maybe additional obligations in reseller arrangements such as inventory rotation,or stock exchange rights on the product. As such, revenue is recognized inaccordance with Statement of Financial Accounting Standards No. 48 “RevenueRecognition When Right of Return Exists”. We have developed reasonableestimates for stock exchanges. Estimates are derived from historical experiencewith similar types of sales of similar products.

We recognize revenue for system integration,installation and training upon completion of performance if all other revenuerecognition criteria are met. Other service revenue, such as that related tomaintenance and support contracts, is recognized ratably over the contractterm.

The assessment of collectibility is also a factor indetermining whether revenue should be recognized. We assess collectibilitybased on a number of factors, including payment history and thecreditworthiness of the customer. We do not request collateral from ourcustomers in China. In global sales outside of China, we often require lettersof credit that can be drawn on demand if a customer defaults on its payment. Ifwe determine that collection of a fee is not reasonably assured, we recognizerevenue upon receipt of cash.

Because of the nature of doing business in China andother emerging markets, our billings and/or customer payments may not correlatewith the contractual payment terms and we generally do not enforce contractualpayment terms on complex, multiple-element arrangements prior to finalacceptance. Accordingly, these accounts receivable are not booked until werecognize the related customer revenue. Advances from customers are recognizedwhen we have collected cash from the customer prior to recognizing revenue.

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

**Variable Interest Entities**

In January 2003, theFinancial Accounting Standards Board issued Interpretation No. 46, “Consolidationof Variable Interest Entities,” (“FIN 46”). FIN 46 provides accounting guidancefor consolidation of variable interest entities, (“VIE”). FIN 46 applies topublic and private business enterprises that have a controlling interest orbusiness or contractual relationship with a VIE. FIN 46 requires consolidationof existing non-controlled affiliates if the VIE is unable to finance itsoperations without investor support, or where other investors do not haveexposure to the significant risks and rewards of ownership. The Company adoptedFIN 46 for the quarter ended, December 31, 2003. Upon adoption of FIN 46,the Company consolidated a related party that is deemed a VIE and for whom theCompany is a primary beneficiary. (See Note 24 to the Consolidated FinancialStatements.)

**Receivables**

We are required toestimate the collectibility of our trade receivables and notes receivable. Wemaintain an allowance for doubtful accounts for the estimated losses on thetrade receivables and notes receivable. We assess collectibility of thereceivable by determining whether the creditworthiness of the customer hasdeteriorated and could result in an inability to collect payment; ifcollectibility is doubtful, we record an allowance against the receivable. Ifthe financial condition of our customers was to deteriorate and their abilityto make payments suffers as a result, we may need to increase our allowancesfor our receivables.

**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.

**Deferredcosts/Inventories at customer sites under contracts**

Inventories at customersites under contracts awaiting final acceptance are classified as deferredcosts, separate from what we have historically considered inventory. These arestated at the lower of cost or net realizable value, net of reserves based uponassessment of potential losses and obsolescence during the lengthy acceptanceprocess. The title and risk of loss of this inventory is transferred to thecustomer upon delivery. Revenue and cost of sales are recorded when we receivefinal acceptance from the customer.

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**Researchand Development and Capitalized Software Development 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 release. Management judgment is required inassessing 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 in that period.If necessary, we record a valuation allowance to reduce deferred tax assets toan amount management believes is more likely than not to be realized.

**Goodwill and Intangibles**

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 the recoverabilityof these assets. We perform our annual goodwill impairment review in the fourthquarter of each year or when changes in circumstances indicate a potentialimpairment. We currently operate as a single reportable segment withoutreporting units, as our management evaluates performance, makes operatingdecisions and allocates resources based on consolidated financial data. Assuch, we determine whether impairment to goodwill is necessary on aconsolidated basis. When assessing potential impairment to goodwill, we compareour book value to our fair market value. Fair market value is our marketcapitalization at the date impairment is assessed. Historically, our fairmarket value has exceeded our book value and no impairment has been necessary.

**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 NYSE. While quoted market prices are readilyavailable to determine the fair value of our investments in these publiclytraded companies, management judgment is required to determine when losses areother than temporary. Furthermore, management judgment is required inevaluating the carrying value of our private company investments for possibleimpairment. For our private technology company investments, we assessimpairment based on an evaluation of the achievement of business objectives andmilestones, the financial condition and prospects of these companies and otherrelevant factors. We continually monitor these investments for impairment, andcharge to income any impairment amounts in the period such a determination ismade.

**RECENT ACCOUNTING PRONOUNCEMENTS**

In April 2003, theFinancial Accounting Standards Board issued Statement of Financial AccountingStandards No. 149 “Amendment of Statement 133 on Derivative Instrumentsand Hedging Activities” 

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(“SFAS 149”).This statement amends SFAS 133 to provide clarification on the financialaccounting and reporting of derivative instruments and hedging activities. Theadoption of SFAS 149, which was effective for contracts entered into ormodified after June 30, 2003, did not have a material effect on theCompany’s consolidated financial condition or results of operations.

In May 2003, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards No. 150, “Accountingfor Certain Financial Instruments with Characteristics of Both Liabilities andEquity” (“SFAS 150”). SFAS 150 establishes standards for how anissuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of these instruments were previouslyclassified as equity. As the Company does not have any of these financialinstruments, the adoption of SFAS 150 is not expected to have any impacton the Company’s consolidated financial statements.

On December 17, 2003, the Staff of the SEC issuedStaff Accounting Bulletin No. 104 (“SAB 104”), Revenue Recognition, whichsupercedes SAB 101, Revenue Recognition in Financial Statements. SAB 104’sprimary purpose is to rescind accounting guidance contained in SAB 101 relatedto multiple element revenue arrangements, superceded as a result of theissuance of EITF 00-21, “Accounting for Revenue Arrangements withMultiple Deliverables.” Additionally, SAB 104 rescinds the SEC’s RevenueRecognition in Financial Statements Frequently Asked Questions and Answers (“theFAQ”) issued with SAB 101 that had been codified in SAB 101 Topic 13.Selected portions of the FAQ have been incorporated into SAB 104. While thewording of SAB 104 has changed to reflect the issuance of EITF 00-21,the revenue recognition principles of SAB 101 remain largely unchanged bythe issuance of SAB 104. The adoption of SAB 104 did not materiallyaffect our revenue recognition policies, nor our results of operations,financial position or cash flows.

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**FACTORS AFFECTING FUTURE OPERATING RESULTS**

**RISKS RELATED TO OUR COMPANY**

***Our future productsales are unpredictable and, as a result, our operating results are likely tofluctuate 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;

·        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; and

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

As a result of these andother factors, period-to-period comparisons of our operating results are notnecessarily meaningful or indicative of future performance. Furthermore, it ispossible that 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 believe that we willcontinue to face intense competition from both domestic and internationalcompanies in our target markets, many of which may operate under lower coststructures or may be given preferential treatment by applicable governmentalregulators and policies and have much larger sales forces than we do.Additionally, other companies not presently offering competing products mayalso enter our target markets. Many of our competitors have significantlygreater financial, technical, product development, sales, marketing and otherresources than we do. As a result, our competitors may be able to respond morequickly to new or emerging technologies and changes in service providerrequirements. Our competitors may also be able to devote greater resources thanwe can to the development, promotion and sale of new products. Thesecompetitors may be able to offer significant financing arrangements to serviceproviders, which may give them a competitive advantage in selling systems toservice providers with limited financial and currency resources. In many of thedeveloping markets in which we operate or intend to operate, relationships withlocal governmental telecommunications agencies are important to establish andmaintain. In many such markets, our competitors may have or be able toestablish better relationships with local governmental telecommunicationsagencies than we have, which could result in their ability to influencegovernmental policy formation and interpretation to their advantage.Additionally, our competitors might have better relationships with their third-partysuppliers and obtain component parts at a reduced rate, allowing them to offertheir end products at reduced prices. Increased competition is likely to resultin price reductions, reduced gross profit as a percentage of net sales and lossof market share, any one of which could materially harm our business, financialcondition, cash flows, and results of operations.

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***The average sellingprices of our products may decrease, which may reduce our revenues and ourgross profit. As a result, we must introduce new products and reduce our costsin order to maintain profitability.***

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; and

·        rapidtechnological change.

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.Therefore, we must continue to develop and introduce new products andenhancements to existing products that incorporate features that can be sold athigher average selling prices. Failure to do so could cause our revenues andgross 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 haveaccounted for most of our total sales, and our business, financial conditionand results of operations are to a significant degree subject to economic,political and social events in China.***

Approximately$1.7 billion, or 86%, and $822.3 million, or 84%, of our net sales inthe year ended December 31, 2003 and 2002, respectively, occurred inChina. While we anticipate expansion into other foreign markets, a significantmajority of our net sales will be derived from China for the foreseeablefuture. In addition, we plan to continue to make further investments in Chinain the future. Therefore, our business, financial condition and results ofoperations are to a significant degree subject to economic, political, legaland social developments and other events in China. Please read the risksdetailed below under the heading “Risks Related to Conducting Business in China”for additional information about the risks we face in connection with our Chinaoperations.

***Our market issubject to rapid technological change, and to compete effectively, we mustcontinually introduce new products and product enhancements that achieve marketacceptance.***

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.Moreover, from time to time, our competitors or we may announce new products orproduct enhancements, technologies or services that have the potential to replaceor shorten the life cycles of our products and that may cause customers todefer purchasing our existing products, resulting in inventory obsolescence.Future technological advances in the 

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communications industrymay diminish 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.Market acceptance 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;

·        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; and

·        thelevel of customer service available to support new products.

·        If our products fail toobtain market acceptance in a timely manner, our business could suffer.

***We depend on somesole source and other key suppliers, as well as international sources, forhandsets, base stations, components and materials used in our products. If wecannot obtain adequate supplies of high quality products at competitive pricesor in a timely manner from these suppliers or sources, our competitiveposition, reputation and business could 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. 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. For example, in 2001and 2002 there was a worldwide shortage of handset components resulting fromour third-party manufacturers’ inability to assemble and manufacture asufficient quantity of handsets to keep pace with consumer demand. Moreover,our suppliers may supply us with inferior quality products. If an inferiorproduct supplied by a third party is embedded in our end product and causes aproblem, it might be difficult to identify the source of the problem as beingdue to the component parts. If any of these events occur, our competitiveposition, reputation and business could suffer.

Our ability to source asufficient quantity of high-quality, cost-effective components used in ourproducts may also be limited by import restrictions and duties in the foreigncountries in which we manufacture our products. We require a significant numberof imported components to manufacture our products, and imported electroniccomponents and other imported goods used in the operation of our business maybe limited by a variety of permit requirements, approval procedures, importduties and registration requirements. Moreover, import duties on suchcomponents increase the cost of our products and may make them lesscompetitive.

***If we seek tosecure additional financing and are not able to do so, our ability to expandstrategically may be limited. If we are able to secure additional financing,our stockholders may experience dilution of their ownership interest, or we maybe subject to limitations on our operations 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 

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needsfor working capital and capital expenditures for the foreseeable future. If weare unable to generate sufficient cash flows from operations, we may need toraise additional funds to develop new or enhanced products, respond tocompetitive pressures, take advantage of acquisition opportunities or raisecapital for strategic purposes. If we raise additional funds through theissuance of equity securities, our stockholders will experience dilution oftheir ownership interest, and the newly issued securities may have rightssuperior to those of common stock. If we raise additional funds by issuingdebt, we may be subject to limitations on our operations and increase ourleverage. For example, in connection with the sale of convertible debtsecurities in March 2003, we incurred $402.5 million of indebtedness.As a result of this indebtedness, our principal and interest paymentobligations have increased substantially. The degree to which we are leveragedcould materially and adversely affect our ability to obtain financing forworking capital, acquisitions or other purposes and could make us morevulnerable to industry downturns and competitive pressures. Our ability to meetour debt service obligations will be dependent upon our future performance,which will be subject to financial, business and other factors affecting ouroperations, many of which are beyond our control. Finally, additional sourcesof financing may not be available on reasonable terms or at all if and when werequire it, which could harm our business.

***Our recent growthhas strained our resources, and if we are unable to manage and sustain ourgrowth, our operating results will be negatively 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 and 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;

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

·        fullyreview our new customers’ credit histories and ensure their financial stabilitybefore 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 isdependent on continuing to hire and retain qualified personnel, and if we arenot successful in attracting and retaining these personnel, our business willsuffer.***

The success of our business depends in significantpart upon the continued contributions of key technical and senior management personnel,many of whom would be difficult to replace. In particular, our success dependsin large part on the knowledge, expertise and services of Hong Liang Lu, ourChairman of the Board, President and Chief Executive Officer, and Ying Wu, ourChairman and Chief Executive Officer of China Operations. The loss of any keyemployee, the failure of any key employee to perform satisfactorily in his orher current position or our failure to attract and retain other key technicaland senior management employees could have a significant negative impact on ouroperations.

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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 with thecombination of skills and attributes required to execute our business strategycan be difficult, time-consuming and expensive. As we grow globally, we mustimplement hiring and training processes that are capable of quickly deployingqualified local residents to knowledgeably support our products and services.Alternatively, if there is an insufficient number of qualified local residentsavailable, we might incur substantial costs importing expatriates to servicenew global markets. For example, we have historically experienced difficultyfinding qualified accounting personnel knowledgeable in both U.S. and Chineseaccounting standards who are Chinese residents. If we fail to attract, hire,assimilate or retain 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 acquisitionsthat we undertake could be difficult to integrate, disrupt our business, diluteour stockholders and harm our operating results.***

We may acquire otherbusinesses, products and technologies. For example, on May 23, 2003, wepurchased certain assets and liabilities of the CommWorks division of 3ComCorporation for $100.0 million in cash and incurred related transactionand other related costs of $9.3 million. Any anticipated benefits of anacquisition may not be realized. We have in the past and will continue toevaluate acquisition prospects that would complement our existing product offerings,augment our market coverage, enhance our technological capabilities, or thatmay otherwise offer growth opportunities. Acquisitions may result in dilutiveissuances of equity securities, use of our cash resources, the incurrence ofdebt and the amortization of expenses related to intangible assets. Inaddition, acquisitions involve numerous risks, including difficulties in theassimilation of operations, technologies, products and personnel of theacquired company, diversion of management’s attention from other businessconcerns, risks of entering markets in which we have no direct or limited priorexperience, and the potential loss of key employees of the acquired company.

***We may be unable toadequately protect the loss or misappropriation of our intellectual property,which could substantially harm our 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 subjectto claims that we infringe the intellectual property rights of others, whichcould substantially harm our business.***

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 indemnificationfrom the supplier with respect to losses or expenses incurred in connectionwith any infringement claim, some of our contracts do not provide for suchprotection. 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 multinationaloperations subject us to various economic, political, regulatory and legalrisks.***

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.Multinational operations 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-partydistributors and 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 control and compliance.

***We do business inmarkets that are not fully developed, which subjects us to various economic,political, regulatory and legal 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 torisks relating to currency rate fluctuations 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 receivablebalances. We do not currently hedge our foreign currency-denominatedtransactions. Historically, the majority of our sales have been made in Chinaand denominated in Renminbi; as such, the impact of currency fluctuations of Renminbithus far has been insignificant as it is fixed to the U.S. dollar. However, inthe future, China could choose to devalue the Renminbi versus the U.S. dollar,or the Renminbi-U.S. dollar exchange rate could float, and the Renminbi coulddepreciate relative to the U.S. dollar. Fluctuations in currency exchange ratesin the future may have a material adverse effect on our results of 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.

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 currency 

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controlsrestricting Renminbi conversion, limiting our ability to engage in currencyhedging activities in China. Various foreign exchange controls may also make itdifficult for us to repatriate earnings, which could have a material adverseeffect 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, and the power required to source ourmanufacturing operations is inconsistent. The Hangzhou facility has in the pastbeen subject to power shortages, which has affected our ability to produce andship sufficient products. We do not have a detailed disaster recovery plan, andthe occurrence of any events like these that disrupt our business could harmour 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 operatingresults could be harmed.

***We have been named as a defendant in securitieslitigation.***

We and variousunderwriters for our initial public offering are defendants in a purportedshareholder class action. The complaint alleges undisclosed improperunderwriting practices concerning the allocation of IPO shares, in violation ofthe federal securities laws. Similar complaints have been filed concerning theIPOs of more than 300 companies, and the litigation has been coordinated inUnited States District Court for the Southern District of New York as In reInitial Public Offering Securities Litigation, 21 MC 92. Although we believe wehave valid defenses to the claims against us and intend to defend thelitigation vigorously, until the matter is resolved, it will be necessary forus to continue to expend time and financial resources on the matter. Moreover,an adverse judgment in the litigation could materially harm our operations.

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

The Sarbanes-Oxley Act of 2002 has required andwill continue to require changes in some of our corporate governance andsecurities disclosure or compliance practices. That Act also requires the SECto promulgate new rules on a variety of subjects, in addition to rule proposalsalready made, and The Nasdaq National Market has revised its requirements forcompanies that are Nasdaq-listed. We expect these developments willrequire us to devote additional resources to our operational, financial andmanagement information systems procedures and controls to ensure our continuedcompliance with current and future 

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laws andregulations. We expect these developments to 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. These developmentscould make it more difficult for us to attract and retain qualified members ofour board of directors, or qualified executive officers. We are presentlyevaluating and monitoring regulatory developments and cannot estimate thetiming or magnitude of additional costs we may incur as a result.

**RISKS RELATED TO CONDUCTING BUSINESS IN CHINA**

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

The Chinesegovernment, through the Ministry of Information Industry, the Chinesetelecommunication industry’s regulating body, has broad discretion andauthority over all aspects of the telecommunications and information technologyindustry in China, with the power to permit or prohibit the sales of any of ourproducts. Since 1978, the Chinese government has been in a state of evolutionand reform. The reforms have resulted in and are expected to continue to resultin significant economic and social development in China. Many of the reformsare unprecedented or experimental and may be subject to change or readjustmentdue to a variety of political, economic and social factors. 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;

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

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

For example, in the year 2000, the Ministry ofInformation Industry temporarily halted deployment of our PAS systems andhandsets, pending its review of personal handyphone system (“PHS”)-basedtelecommunications equipment, a microcellular wireless communicationstechnology. The Ministry of Information Industry later allowed the continueddeployment of PHS-based systems, such as our PAS systems and handsets, in China’scounty-level cities, towns and villages but limited deployments withinlarge and medium-sized cities to very limited areas of dense population,such as campuses, commercial buildings and special development zones. If in thefuture the Ministry of Information Industry determines to prohibit the sale ordeployment of our PAS systems and handsets or our other products, or if itimposes additional limitations on their sale, our business and financialcondition could suffer.

In addition to modifyingthe existing telecommunications regulatory framework, the Chinese government iscurrently preparing a draft of a standard, national telecommunications law (the“Telecommunications Law”) to provide a uniform regulatory framework for thetelecommunications industry. We do not yet know the final nature or scope ofthe regulation that would be created if the Telecommunications Law is passed.Accordingly, we cannot predict whether it will have a positive or negativeeffect on us or on some or all aspects of our business.

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

Since 1978, the Chinese governmenthas been reforming the economic system in China to increase emphasis placed ondecentralization and the utilization of market forces in the development ofChina’s economy. These reforms have resulted in significant economic growth.However, any economic reform policies or measures in China may from time totime be modified or revised by the Chinese government. While we may be able tobenefit from the effects of some of these policies, these policies and othermeasures taken by the Chinese government to regulate the economy could alsohave a significant negative impact on economic conditions in China, which wouldresult in a negative impact on our business. More recently, China’s economicenvironment has been changing as a result of China’s entry into the World TradeOrganization (WTO), which was effective in December of 2001. Entry intothe WTO requires that China reduce tariffs and eliminate non-tariff barriers,including quotas, licenses and other restrictions, by 2005 at the latest, andwe cannot 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,administrative rules and regulations governing foreign companies andforeign investment enterprises in China may still place foreign companies at adisadvantage in relation to Chinese domestic companies and may adversely affectour competitive position.

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

We conduct our business inChina primarily through our wholly-owned subsidiaries incorporated inChina. Our subsidiaries are generally subject to laws and regulationsapplicable to foreign investment in China. Accordingly, our business might beaffected by China’s developing legal system. Since 1978, many new laws andregulations covering general economic matters have been promulgated in China,and government policies and internal rules promulgated by governmentalagencies may not be published in time, or at all. As a result, we may operateour business in violation of new rules and policies without having anyknowledge of their existence. In addition, there are uncertainties regardingthe interpretation and enforcement of laws, rules and policies in China.The Chinese legal system is based on written statutes, and prior courtdecisions have limited precedential value. Because many laws and regulationsare relatively new and the Chinese legal system is still evolving, theinterpretations of many laws, regulations and rules are not alwaysuniform. Moreover, the relative inexperience of China’s judiciary in many casescreates additional uncertainty as to the outcome of any litigation, and theinterpretation of statutes and regulations may be subject to governmentpolicies reflecting domestic political changes. Finally, enforcement ofexisting laws or contracts based on existing law may be uncertain and sporadic,and it may be difficult to obtain swift and equitable enforcement, or to obtainenforcement of a judgment by a court of another jurisdiction. Any litigation inChina may be protracted and result in substantial costs and diversion ofresources and management attention.

***We only have trial licenses to sell certain of ournetwork access products in China.***

Under China’s current regulatory structure, thecommunications products that we offer in China must meet government andindustry standards, and a network access license for the equipment must beobtained. Without a license, telecommunications equipment is not allowed to beconnected to public telecommunications networks or sold in China. Moreover, wemust ensure that the quality of the telecommunications equipment for which wehave obtained a network access license is stable and reliable, and will notlower the quality or performance of other installed licensed products. China’sState Council’s 

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product qualitysupervision department, in concert with China’s Ministry of InformationIndustry, performs spot checks to track and supervise the quality of licensedtelecommunications equipment and publishes the results of such spot checks.

We have obtained aprobationary network access license for our mSwitch product, and after thetrial period, we anticipate that an official network access license will beissued if the trial demonstrates that mSwitch satisfies all the applicablegovernment and industry standards. However, we cannot be certain that we willreceive this license. Moreover, we only have trial licenses for our PAS systemsand handsets. We have applied for, but have not yet received, a final officialnetwork access license for our PAS systems and handsets. Based uponconversations with China’s Ministry of Information Industry, we understand thatour PAS systems and handsets are considered to still be in the trial period andthat sales of our PAS systems and handsets may continue to be made by us duringthis trial period, but that a license will ultimately be required. If we failto obtain the required licenses, we could be prohibited from making furthersales of the unlicensed products, including our PAS systems and handsets, inChina, which would substantially harm our business, financial condition andresults of operations. The regulations implementing these requirements are notvery detailed, have not been applied by a court and may be interpreted andenforced by regulatory authorities in a number of different ways. Our counselin China has advised us that China’s governmental authorities may interpret orapply the regulations with respect to which licenses are required and the abilityto sell a product while a product is in the trial period in a manner that isinconsistent with the information received by our counsel in China, and eitherof these conditions could have a material adverse effect on our business,financial condition and results of operations.

***If China Telecom orChina Netcom obtain licenses allowing them to deliver mobile services, ourability to sell our PAS mobile systems and handsets could be impaired.***

China Telecom and China Netcom hold and operate thefixed line telephone and data communications assets in China, and currently donot have the licenses necessary to offer mobile services. However, China’smedia sources have widely reported that China’s Ministry of InformationIndustry may grant mobile licenses to the new China Telecom or China Netcom, orto both toward the end of 2004. Furthermore, it is anticipated that the mobilelicense granted by the government will be used for 3G mobile networkdeployments.

If China Telecom or ChinaNetcom obtain 3G mobile licenses, they may direct capital expenditures tobuild-out 3G networks, and capital expenditures to build-out PAS networks thatutilize our existing products may decline. Moreover, they may elect not todeploy our PAS systems and handsets or other mobile services that we may offerin the future. In addition, it is possible that current PAS frequency bandsutilized by PAS networks may be reallocated for use by 3G networks, which wouldhave the effect of restricting or shutting down PAS networks. If this were tooccur, we could lose current and potential future customers for our products,and our financial condition and results of operations could be significantlyharmed.

***Promotional orincentive programs offered by mobile operators such as China Mobile and ChinaUnicom may adversely impact the competitiveness and pricing of our PAS systemsand related products.***

The official tariffs andper-minute usage rates charged to mobile users in China are generally set bythe Ministry of Information Industry and the National Development and ReformCommission, and are usually adhered to by mobile operators. However, from timeto time, certain mobile operators such as China Mobile and China Unicom haveoffered special promotional pricing or incentives to customers, such as free incomingcalls or free mobile-to-mobile calls. The continued use of such incentiveprograms by mobile operators may adversely impact the competitiveness andpricing of our PAS systems and related products and their rollout by the newChina Telecom and China Netcom. Such incentive programs may continue or beexpanded in the future. We cannot be certain as to what impact such incentiveprograms 

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may haveon our financial condition. However, it is possible that the continuation orexpansion of such programs may have a material adverse effect on our businessor results of operations.

***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 notcertain whether the government will implement such a unified tax structure orwhether our company will be grandfathered into any new tax structure, if a newtax structure is implemented, a new tax structure may adversely affect ourfinancial condition. Moreover, certain of our subsidiaries and joint ventureslocated in China enjoy tax benefits in China that are generally available toforeign investment enterprises. If these tax benefits are reduced or repealeddue to changes in tax laws, our business could suffer.

**RISKS RELATED TOOUR STOCK PERFORMANCE ANDCONVERTIBLE DEBT 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, such as the temporarysuspension of sales of our PAS systems that occurred in May and June of2000, which caused our stock price to drop;

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

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

·        newsand commentary emanating from the media, securities analysts 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, followingperiods of volatility in a company’s securities, securities class actionlitigation against a company is sometimes instituted. This type of litigationcould result in substantial costs and the diversion of management time andresources.

In addition, publicannouncements by China Telecom and China Netcom, each of which exertsignificant influence over many of our major customers in China, may contributeto volatility in the price of our stock. In 2002, China Telecom completed itsinitial public offering, which has caused that entity to issue press releasesmore frequently than in prior years. The price of our stock may react to suchannouncements. More recently, it has been reported that China Netcom has beenrestructuring its operations for its own initial public offering. More frequentpublic announcements from China Netcom relating to or resulting from theirinitial public offering could cause the price of our stock to become even morevolatile.

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***SOFTBANK CORP. andits related entities, including SOFTBANK America Inc., have significantinfluence over our management and affairs, which it could exercise against yourbest interests.***

SOFTBANK CORP. andits related entities, including SOFTBANK America Inc. (collectively, “SOFTBANK”),beneficially owned approximately 14.1% of our outstanding stock as of December 31,2003. As a result, SOFTBANK has the ability to influence all matters submittedto our stockholders for approval, as well as our management and affairs.Matters that could 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 potentialacquirer from making a tender offer or otherwise attempting to obtain controlof our company, which could decrease the market price of our common stock.

***Delaware law andour charter documents contain provisions that could discourage or prevent apotential takeover, even if the transaction 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.

***The holders of our convertible subordinated notes duein 2008 and we face a variety of risks related to the notes.***

Holders of ourconvertible subordinated notes due 2008 (the “notes”) and we face a variety ofrisks 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;

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·        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.

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

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

*Interest Rate Risk.  *Ourexposure to market risk for changes in interest rates relates primarily to ourinvestment portfolio. The fair value of our investment portfolio would not besignificantly affected by either a 10% increase or decrease in interest ratesdue mainly to the short-term nature of most of our investment portfolio.However, our interest income can be sensitive to changes in the general levelof U.S. interest rates since the majority of our funds are invested ininstruments with maturities less than one year. Our policy is to limit the riskof principal loss and ensure the safety of invested funds by generallyattempting to limit market risk. Funds in excess of current operatingrequirements are mostly invested in government-backed notes, commercialpaper, floating rate corporate bonds, fixed income corporate bonds and taxexempt instruments. In accordance with our investment policy, all short-terminvestments are invested in “investment grade” rated securities with minimum Aor better ratings. Currently, most of our short-term investments have AA orbetter ratings.

Thetable below represents carrying amounts and related weighted-averageinterest rates of our investment portfolio at December 31, 2003:
| **(in thousands except interest rates)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
| Restated(1)                                                  |       |       |       |
| Cash and cash  equivalents                                   |       | $          | 377,747    |       |
| Average interest  rate                                       |       | 1.19       | %          |
| Restricted cash                                              |       | 3,943      |       |
| Average interest  rate                                       |       | 0.50       | %          |
| Restricted short-term  investments                           |       | 20,461     |       |
| Average interest  rate                                       |       | 1.19       | %          |
| Short-term  investments                                      |       | 48,617     |       |
| Average interest  rate                                       |       | 1.36       | %          |
| Total investment  securities                                 |       | 450,768    |       |
| Average interest rate                                        |       | 1.20       | %          |
|                                                              |            |            |            |            |            |  |

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(1)          SeeNote 24 to the Consolidated Financial Statements.

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*Concentration ofCredit Risk and Major Customers:*

Thetable below outlines our sales to, and the accounts receivable balances withrespect to our largest customers:
| **For the year ended December 31,** | ** ** | ** ** | ** ** | **% of Net  Sales** | ** ** | **% of  Accounts  Receivable** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|-------------------------------------|------------|
| **2003**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer A                                                   |       |       | 11         | %                             |       |                                | 3          | % |   |
| **2002**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer B                                                   |       |       | 18         | %                             |       |                                | 6          | % |   |
| Customer C                                                   |       |       | 13         | %                             |       |                                | 0          | % |   |
| **2001**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer B                                                   |       |       | 28         | %                             |       |                                | 29         | % |   |
| Customer D                                                   |       |       | 10         | %                             |       |                                | 8          | % |   |

 

Approximately 76%, 84% and90% of the Company’s net sales during 2003, 2002 and 2001, respectively, wereto entities affiliated with the government of China. Accounts receivablebalances from these China government affiliated entities or state ownedenterprises were $304.0 million and $238.0 million, respectively, asof December 31, 2003 and 2002. The Company extends credit to its customersin China generally without requiring collateral. In global sales outside ofChina, the Company often requires letters of credit from its customers. TheCompany monitors its exposure for credit losses and maintains allowances fordoubtful accounts.

*Country Risks:*

Approximately 86%, 84% and 90% of the Company’s salesfor the year ended December 31, 2003, 2002 and 2001, 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 withrespect to laws and regulations, changes in China’s telecommunications industryand regulatory rules and policies, anti-inflationary measures, currencyconversion and remittance abroad, and rates and methods of taxation.

Approximately 10%, 13% and 3% of the Company’s salesfor the year ended December 31, 2003, 2002 and 2001, respectively, weremade in Japan. Accordingly, the political, economic and legal environment andthe general state of Japan’s economy may influence the Company’s business,financial condition and results of operations.

*Equity Investment Risk.  *Ourinvestment portfolio includes equity investments in publicly traded companies,the values of which are subject to market price volatility. Economic eventscould adversely affect the public equities market and general economicconditions may continue to worsen. Should the fair value of our publicly tradedequity investments decline below their cost basis in a manner deemed to beother-than-temporary, our earnings may be adversely affected. We have alsoinvested in several privately held companies as well as investment funds whichinvest primarily in privately held companies, many of which can still beconsidered in the start-up or development stages. These investments areinherently risky, as the market for the technologies or products they haveunder development are typically in the early stages and may never materialize.

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*Debt Investment Risk.  *Ourdebt investment portfolio consists of a $11.2 million note receivable from BBModem Rental PLC (“BB Modem”), an affiliate of SOFTBANK CORP., pursuant to aMezzanine Loan Agreement we entered into with BB Modem on July 17, 2003.Our loan is subordinated to certain senior lenders of BB Modem, and repaymentsare payable to us over a forty-two month period, with a substantialportion of the principal amount of the loan schedule to be repaid during thelast 16 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 loan.

*Foreign Exchange Rate Risk.  *Weare exposed to foreign exchange rate risk because most of our sales in Chinaare denominated in Renminbi and portions of our accounts payable aredenominated in Japanese Yen. Due to the limitations on converting Renminbi, weare limited in our ability to engage in currency hedging activities in China. Althoughthe impact of currency fluctuations of Renminbi to date has been insignificant,fluctuations in currency exchange rates in the future may have a materialadverse effect on our results of operations. Although we are expanding ourglobal operations outside of China, as of December 31, 2003, we have notexperienced a material foreign exchange rate risk due to the fact that thesignificant majority of our business has remained in China. We have a multi-currencybank account in Japanese Yen for purchasing portions of our inventories andsupplies. The balance of this Japanese Yen account at December 31, 2003was approximately $28.6 million.

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**ITEM8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

**Indexto Consolidated Financial Statements and Financial Statement Schedules**
|                                                                                                                      | **Page** |
|----------------------------------------------------------------------------------------------------------------------|----------|
| Financial Statements  (Restated):                                                                                    |     |   |   |
| Report of Independent  Registered Public Accounting Firm                                                             |     | 45 |   |
| Consolidated Balance Sheets at  December 31, 2003 and 2002                                                      |     | 46 |   |
| Consolidated Statements of  Operations for the years ended December 31, 2003, 2002 and 2001                     |     | 47 |   |
| Consolidated Statements of Stockholders’ Equity  for the years ended December 31, 2003, 2002 and 2001 |     | 48 |   |
| Condensed Consolidated  Statements of Cash Flows for the years ended December 31, 2003, 2002 and  2001          |     | 49 |   |
| Notes  to Consolidated Financial Statements                                                                          |     | 50 |   |
| Financial Statement Schedules  (Restated):                                                                           |     |   |   |
| For each of the three years in the period ended  December 31, 2003                                              |     |   |   |
| Report of Independent  Registered Public Accounting Firm                                                             |     | 110 |   |
| I—Condensed Financial Information of Registrant                                                                 |     | 111 |   |
| II—Valuation  and Qualifying Accounts                                                                           |     | 117 |   |

 

All other schedules areomitted because they are not applicable or the required information is shown inthe consolidated financial statements or notes thereto.

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directorsand Stockholders of UTStarcom, Inc.:

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 (the “Company”)at December 31, 2003 and 2002, and the results of their operations andtheir cash flows for each of the three years in the period ended December 31,2003, in conformity with accounting principles generally accepted in the UnitedStates of America. These financial statements are the responsibility of theCompany’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits. We conducted our audits of thesestatements in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation. We believe that our audits provide a reasonable basis for ouropinion.

As discussed in Note 24 to the Consolidated FinancialStatements, the Company has restated its Consolidated Financial Statements forthe year ended December 31, 2003.

Asdiscussed in Note 2 to the Consolidated Financial Statements, the Companyadopted FASB Interpretation No. 46 in 2003.
| /s/ PricewaterhouseCoopers LLP                                                           |
|------------------------------------------------------------------------------------------|
| San Francisco,  California                                                               |
| February 27, 2004, except for Note 24, as to  which the date is April 12, 2005 |

 

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**UTSTARCOM, INC.CONSOLIDATED BALANCE SHEETS(In thousands)**
| ** **                                                                                                                                                                    | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **Restated(1)**             | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                    |       |                        |       |                        |       |   |   |   |   |
| Current assets:                                                                                                                                                               |       |                        |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                     |       |                        | $          | 377,747                     |       |   |   | $ | 231,944 |   |   |
| Short-term investments                                                                                                                                                        |       |                        | 48,617     |                        |       |   | 107,305 |   |   |
| Accounts receivable, net of allowances for doubtful  accounts                                                                                                                 |       |                        | 325,288    |                        |       |   | 221,215 |   |   |
| Accounts receivable, related parties                                                                                                                                          |       |                        | 43,944     |                        |       |   | 835 |   |   |
| Notes receivable                                                                                                                                                              |       |                        | 11,362     |                        |       |   | 12,048 |   |   |
| Inventories                                                                                                                                                                   |       |                        | 257,065    |                        |       |   | 183,687 |   |   |
| Deferred costs/Inventories at customer sites under  contracts                                                                                                                 |       |                        | 542,060    |                        |       |   | 240,979 |   |   |
| Prepaids                                                                                                                                                                      |       |                        | 139,103    |                        |       |   | 52,272 |   |   |
| Restricted cash and short-term investments                                                                                                                                    |       |                        | 24,404     |                        |       |   | 21,251 |   |   |
| Other current assets                                                                                                                                                          |       |                        | 48,499     |                        |       |   | 35,836 |   |   |
| Total current  assets                                                                                                                                                         |       |                        | 1,818,089  |                        |       |   | 1,107,372 |   |   |
| Property, plant  and equipment, net                                                                                                                                           |       |                        | 187,039    |                        |       |   | 93,980 |   |   |
| Long-term  investments                                                                                                                                                        |       |                        | 24,066     |                        |       |   | 35,360 |   |   |
| Goodwill                                                                                                                                                                      |       |                        | 100,180    |                        |       |   | 44,806 |   |   |
| Intangible assets,  net                                                                                                                                                       |       |                        | 44,051     |                        |       |   | 5,014 |   |   |
| Other long-term  assets                                                                                                                                                       |       |                        | 70,625     |                        |       |   | 19,020 |   |   |
| Total assets                                                                                                                                                                  |       |                        | $          | 2,244,050                   |       |   |   | $ | 1,305,552 |   |   |
| **LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’  EQUITY**                                                                                                             |       |                        |       |                        |       |   |   |   |   |
| Current  liabilities:                                                                                                                                                         |       |                        |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                                                                              |       |                        | $          | 251,122                     |       |   |   | $ | 256,980 |   |   |
| Income taxes payable                                                                                                                                                          |       |                        | 14,265     |                        |       |   | 13,003 |   |   |
| Customer advances                                                                                                                                                             |       |                        | 450,499    |                        |       |   | 156,336 |   |   |
| Deferred revenue                                                                                                                                                              |       |                        | 44,958     |                        |       |   | 7,911 |   |   |
| Other current liabilities                                                                                                                                                     |       |                        | 173,911    |                        |       |   | 104,927 |   |   |
| Total current  liabilities                                                                                                                                                    |       |                        | 934,755    |                        |       |   | 539,157 |   |   |
| Long-term  debt                                                                                                                                                               |       |                        | 410,655    |                        |       |   | — |   |   |
| Total liabilities                                                                                                                                                             |       |                        | 1,345,410  |                        |       |   | 539,157 |   |   |
| Commitments and  contingencies (Note 14)                                                                                                                                      |       |                        |       |                        |       |   |   |   |   |
| Minority interest in consolidated subsidiaries                                                                                                                                |       |                        | 5,309      |                        |       |   | — |   |   |
| Stockholders’  equity:                                                                                                                                                   |       |                        |       |                        |       |   |   |   |   |
| Common stock: $0.00125 par value; authorized:  750,000,000 shares; issued and outstanding: 104,272,477 and 106,787,908 at  December 31, 2003 and 2002, respectively |       |                        | 131        |                        |       |   | 135 |   |   |
| Additional paid-in capital                                                                                                                                                    |       |                        | 654,483    |                        |       |   | 658,546 |   |   |
| Deferred stock compensation                                                                                                                                                   |       |                        | (7,761     | )                           |       |   | (11,766 | ) |   |
| Retained earnings                                                                                                                                                             |       |                        | 243,058    |                        |       |   | 120,520 |   |   |
| Receivable from stockholders                                                                                                                                                  |       |                        | —     |                        |       |   | (282 | ) |   |
| Accumulated other comprehensive income (loss)                                                                                                                                 |       |                        | 3,420      |                        |       |   | (758 | ) |   |
| Total  stockholders’ equity                                                                                                                                              |       |                        | 893,331    |                        |       |   | 766,395 |   |   |
| Total liabilities,  minority interest and stockholders’ equity                                                                                                           |       |                        | $          | 2,244,050                   |       |   |   | $ | 1,305,552 |   |   |

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(1)           See Note 24

 

See accompanying notes to consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OFOPERATIONS(In thousands, except per share amounts)**
| ** **                                                           | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                           | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                           | ** ** | **Restated(1)**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                                            |       |                                       |       |   |   |   |   |
| Unrelated parties                                                    |       | $                                          | 1,780,751  |   | $ | 858,768 |   | $ | 612,907 |   |
| Related parties                                                      |       | 184,436                                    |       | 123,038 |   | 13,933 |   |
|                                                                 |       | 1,965,187                                  |       | 981,806 |   | 626,840 |   |
| Cost of sales                                                        |       |                                       |       |   |   |   |   |
| Unrelated party                                                      |       | 1,261,284                                  |       | 587,799 |   | 394,956 |   |
| Related party                                                        |       | 79,518                                     |       | 48,535 |   | 7,336 |   |
| Gross profit                                                         |       | 624,385                                    |       | 345,472 |   | 224,548 |   |
| Operating  expenses:                                                 |       |                                       |       |   |   |   |   |
| Selling, general and administrative                                  |       | 188,339                                    |       | 110,263 |   | 75,764 |   |
| Research and development                                             |       | 155,252                                    |       | 86,182 |   | 59,809 |   |
| In-process research and development costs                            |       | 10,686                                     |       | 670 |   | 4,720 |   |
| Amortization of intangible assets                                    |       | 8,370                                      |       | 2,395 |   | 7,527 |   |
| Total operating  expenses                                            |       | 362,647                                    |       | 199,510 |   | 147,820 |   |
| Operating income                                                     |       | 261,738                                    |       | 145,962 |   | 76,728 |   |
| Interest income                                                      |       | 3,194                                      |       | 5,522 |   | 8,572 |   |
| Interest expense                                                     |       | (4,671                                     | )          | (1,251 | ) | (3,909 | ) |
| Other income  (expenses), net                                        |       | 4,921                                      |       | (9,908 | ) | (330 | ) |
| Equity in loss of  affiliated companies                              |       | (5,260                                     | )          | (4,053 | ) | (2,962 | ) |
| Income before income taxes and minority interest                     |       | 259,922                                    |       | 136,272 |   | 78,099 |   |
| Income tax  expense                                                  |       | (45,399                                    | )          | (27,254 | ) | (19,823 | ) |
| Minority interest  in losses (earnings) of consolidated subsidiaries |       | 1,009                                      |       | (1,156 | ) | (1,322 | ) |
| Net income                                                           |       | $                                          | 215,532    |   | $ | 107,862 |   | $ | 56,954 |   |
| Basic earnings  per share                                            |       | $                                          | 2.08       |   | $ | 0.98 |   | $ | 0.56 |   |
| Diluted earnings  per share                                          |       | $                                          | 1.75       |   | $ | 0.94 |   | $ | 0.52 |   |
| Weighted average shares  used in per-share calculation:              |       |                                       |       |   |   |   |   |
| —Basic                                                          |       | 103,659                                    |       | 109,566 |   | 101,433 |   |
| —Diluted                                                        |       | 124,909                                    |       | 114,407 |   | 108,612 |   |

----

(1)          See Note 24

 

See accompanying notes to consolidated financial statements.

47

----

**UTStarcom, Inc.and SubsidiariesConsolidated Statements of Stockholders’ Equity(In thousands, except share data)**
| ** **                                                                                   | ** ** | **Common Stock** | ** ** | **Additional  Paid-in-Capital** | ** ** | **Deferred  Stock  Compensation** | ** ** | **Retained  Earnings  (Accumulated  Deficit** | ** **     | **Notes  Receivable  from  stockholders** | ** ** | **Accumulated  Other  Comprehensive  Income/(Loss)** | ** **    | **Total  Stockholders’  Equity** | ** ** | **Comprehensive  Income** | ** **          |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|---------------------------------|------------|-----------------------------------|------------|-----------------------------------------------|----------------|-------------------------------------------|------------|------------------------------------------------------|---------------|---------------------------------------|------------|---------------------------|---------------------|
| ** **                                                                                   | ** ** | **Shares**            | ** ** | **Amount**                      | ** ** | ** **                        |
| ** **                                                                                   | ** ** | ** **            | ** ** | ** **                      | ** ** | **Restated(1)**                   | ** ** | ** **                                    | ** **     | **Restated(1)**                           | ** ** | ** **                                           | ** **    | ** **                            | ** ** | **Restated(1)**           | ** **          | **Restated(1)** | ** ** |
| Balances,  December 31, 2000                                                            |       | 95,032,657            |       |                            | $ 120 |                              |       |                                          | $ 426,665 |                                      |       |                                                 | $ (6,491 | )                                     |       |                      | $  (7,808 | ) |   |   | $ (314 | ) |   |   | $  147 |   |   |   | $ 412,319 |   |   |   |   |   |   |
| Common stock  issued upon exercise of options                                                |       | 5,363,601             |       |                            | 8          |                              |       |                                          | 18,756         |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 18,764 |   |   |   |   |   |   |
| Common stock  issued upon ESPP purchases                                                     |       | 118,223               |       |                            |       |                              |       |                                          | 1,866          |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 1,866 |   |   |   |   |   |   |
| Common stock  issued related to acquisition of Stable Gain                                   |       | 439,810               |       |                            |       |                              |       |                                          | 10,700         |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 10,700 |   |   |   |   |   |   |
| Common stock  issued upon secondary offering, net of expenses                                |       | 7,400,000             |       |                            | 9          |                              |       |                                          | 139,911        |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 139,920 |   |   |   |   |   |   |
| Common stock  issued for ACD acquisition, net of expenses                                    |       | 948,525               |       |                            | 1          |                              |       |                                          | 20,733         |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 20,734 |   |   |   |   |   |   |
| ACD deferred  compensation                                                                   |       |                  |       |                            |       |                              |       |                                          | 5,000          |                                      |       |                                                 | (5,000        | )                                     |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Amortization of  deferred compensation related to ACD acquisition                            |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 | 1,250         |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 1,250 |   |   |   |   |   |   |
| Amortization of  deferred stock compensation related to grants of stock options to employees |       |                  |       |                            |       |                              |       |                                          | 23             |                                      |       |                                                 | 3,928         |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 3,951 |   |   |   |   |   |   |
| Cancellation of  deferred compensation charges due to employee terminations                  |       |                  |       |                            |       |                              |       |                                          | (268           | )                                         |       |                                                 | 268           |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Tax benefits for  non-qualified stock option exercises                                       |       |                  |       |                            |       |                              |       |                                          | 15,311         |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   | 15,311 |   |   |   |   |   |   |
| Issuance of notes  receivable from stockholders                                              |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   | (67 | ) |   |   |   |   |   |   | (67 | ) |   |   |   |   |   |
| Net income                                                                                   |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      | 56,954              |   |   |   |   |   |   |   |   |   |   |   | 56,954 |   |   |   | $ 56,954 |   |   |
| Other comprehensive income:                                                                  |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrealized holding  gain (net of tax of $95)                                                 |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   | 211 |   |   |   | 211 |   |   |   | 211 |   |   |
| Translation  adjustment                                                                      |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   | (26 | ) |   |   | (26 | ) |   |   | (26 | ) |   |
| Total  comprehensive income                                                                  |       |                  |       |                            |       |                              |       |                                          |           |                                      |       |                                                 |          |                                  |       |                      |                |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ 57,139 |   |   |
| 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 RollingStream 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 |   |   |   |   |   |   |

----

(1)          See Note 24

See accompanyingnotes to the consolidated financial statements.

----

**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OFCASH FLOWS(In thousands)**
| ** **                                                                        | ** ** | **Twelve months ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                        | ** ** | **December 31,  2003**       | ** ** | **December 31,  2002** | ** ** | **December 31,  2001** | ** ** |
| ** **                                                                        | ** ** | **Restated(1)**                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                            |       |                              | * *   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                        |       |                              | $          | 215,532 |   |   |   | $ | 107,862 |   |   |   | $ | 56,954 |   |   |
| Adjustment to reconcile  net income to net cash provided by operating activities: |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Gain on change in  ownership interest in subsidiary                               |       |                              | —     |   |   |   | — |   |   |   | (277 | ) |   |
| Depreciation and  amortization                                                    |       |                              | 44,708     |   |   |   | 22,435 |   |   |   | 18,533 |   |   |
| Non-qualified  stock option exercise tax benefits                                 |       |                              | 15,364     |   |   |   | 6,537 |   |   |   | 15,311 |   |   |
| Loss on sale of  assets                                                           |       |                              | 1,920      |   |   |   | 1,098 |   |   |   | 802 |   |   |
| Impairment of  long-term assets                                                   |       |                              | 8,762      |   |   |   | — |   |   |   | — |   |   |
| Loss on sale of  notes receivable                                                 |       |                              | 2,286      |   |   |   | — |   |   |   | — |   |   |
| In-process  research and development costs                                        |       |                              | 10,686     |   |   |   | 670 |   |   |   | 4,720 |   |   |
| Amortization of  debt issuance costs                                              |       |                              | 1,953      |   |   |   | — |   |   |   | — |   |   |
| Warrants  adjustment to fair value                                                |       |                              | (424       | ) |   |   | — |   |   |   | — |   |   |
| Loss on sale of  investment                                                       |       |                              | 73         |   |   |   | — |   |   |   | — |   |   |
| Impairment of long-term  investment                                               |       |                              | 75         |   |   |   | 4,442 |   |   |   | 1,690 |   |   |
| Stock compensation  expense                                                       |       |                              | 4,302      |   |   |   | 3,100 |   |   |   | 5,200 |   |   |
| Allowance for  doubtful accounts                                                  |       |                              | 4,922      |   |   |   | 7,197 |   |   |   | 6,218 |   |   |
| Inventory reserve                                                                 |       |                              | 14,626     |   |   |   | 18,937 |   |   |   | 11,143 |   |   |
| Equity in loss of  affiliated companies                                           |       |                              | 5,261      |   |   |   | 4,053 |   |   |   | 2,962 |   |   |
| Deferred income  taxes                                                            |       |                              | (10,675    | ) |   |   | (14,704 | ) |   |   | (9,629 | ) |   |
| Minority interest  in earnings of consolidated subsidiary                         |       |                              | (1,009     | ) |   |   | 1,156 |   |   |   | 1,322 |   |   |
| Changes in  operating assets and liabilities, net of acquisitions:                |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Accounts  receivable                                                              |       |                              | (151,863   | ) |   |   | (34,207 | ) |   |   | (39,196 | ) |   |
| Inventories                                                                       |       |                              | (81,618    | ) |   |   | (76,056 | ) |   |   | (60,419 | ) |   |
| Deferred  costs/Inventories at customer sites under contracts                     |       |                              | (301,081   | ) |   |   | (137,806 | ) |   |   | (60,779 | ) |   |
| Other current and  non-current assets                                             |       |                              | (120,206   | ) |   |   | (24,551 | ) |   |   | (42,990 | ) |   |
| Accounts payable                                                                  |       |                              | (5,906     | ) |   |   | 170,452 |   |   |   | 39,085 |   |   |
| Income taxes  payable                                                             |       |                              | 1,262      |   |   |   | 2,470 |   |   |   | 3,366 |   |   |
| Customer advances                                                                 |       |                              | 294,163    |   |   |   | 87,776 |   |   |   | 42,833 |   |   |
| Deferred revenue                                                                  |       |                              | 27,379     |   |   |   | 47 |   |   |   | 1,913 |   |   |
| Other current  liabilities                                                        |       |                              | 64,681     |   |   |   | 27,683 |   |   |   | 41,407 |   |   |
| Net cash provided  by operating activities                                        |       |                              | 45,173     |   |   |   | 178,591 |   |   |   | 40,169 |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                            |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Additions to  property, plant and equipment                                       |       |                              | (123,214   | ) |   |   | (75,271 | ) |   |   | (30,199 | ) |   |
| Investment in  affiliates, net of cash acquired                                   |       |                              | (661       | ) |   |   | (28,933 | ) |   |   | (9,779 | ) |   |
| Issuance of note  receivable to related party                                     |       |                              | (10,071    | ) |   |   | — |   |   |   | — |   |   |
| Purchase of  minority interest                                                    |       |                              | —     |   |   |   | — |   |   |   | (705 | ) |   |
| Purchase of  businesses, net of cash acquired                                     |       |                              | (106,713   | ) |   |   | (17,706 | ) |   |   | — |   |   |
| Proceeds from  disposal of property, plant and equipment                          |       |                              | 21         |   |   |   | 175 |   |   |   | 214 |   |   |
| Purchase of  intangible assets                                                    |       |                              | (2,340     | ) |   |   | — |   |   |   | (1,078 | ) |   |
| Change in  restricted cash                                                        |       |                              | (3,153     | ) |   |   | (21,251 | ) |   |   | — |   |   |
| Purchase of short-term  investments                                               |       |                              | (147,544   | ) |   |   | (140,583 | ) |   |   | (89,625 | ) |   |
| Proceeds from sale  of short-term investments                                     |       |                              | 217,180    |   |   |   | 118,168 |   |   |   | 87,516 |   |   |
| Net cash used in  investing activities                                            |       |                              | (176,495   | ) |   |   | (165,401 | ) |   |   | (43,656 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                            |       |                              |       |   |   |   |   |   |   |   |   |   |   |
| Issuance of stock,  net of expenses                                               |       |                              | 58,878     |   |   |   | 40,928 |   |   |   | 160,550 |   |   |
| Purchase of  convertible bond hedge and call option                               |       |                              | (43,792    | ) |   |   | — |   |   |   | — |   |   |
| Proceeds from  borrowing                                                          |       |                              | 422,976    |   |   |   | 39,621 |   |   |   | 137,108 |   |   |
| Payments for  borrowing                                                           |       |                              | (23,389    | ) |   |   | (110,101 | ) |   |   | (122,055 | ) |   |
| Repurchase of  stock                                                              |       |                              | (139,609   | ) |   |   | (72,929 | ) |   |   | — |   |   |
| Proceeds from  stockholder notes                                                  |       |                              | 282        |   |   |   | 99 |   |   |   | (67 | ) |   |
| Net cash provided  by (used in) financing activities                              |       |                              | 275,346    |   |   |   | (102,382 | ) |   |   | 175,536 |   |   |
| Effect of exchange  rate changes on cash                                          |       |                              | 1,779      |   |   |   | — |   |   |   | (25 | ) |   |
| Net increase (decrease)  in cash and cash equivalents                             |       |                              | 145,803    |   |   |   | (89,192 | ) |   |   | 172,024 |   |   |
| Cash and cash  equivalents at beginning of period                                 |       |                              | 231,944    |   |   |   | 321,136 |   |   |   | 149,112 |   |   |
| Cash and cash  equivalents at end of period                                       |       |                              | $          | 377,747 |   |   |   | $ | 231,944 |   |   |   | $ | 321,136 |   |   |

----

(1)              See Note 24

See accompanying notes to the consolidated financial statements.

49

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**NOTES** TO CONSOLIDATED FINANCIAL STATEMENTS

**NOTE 1—DESCRIPTION OFBUSINESS**

UTStarcom Inc. (the “Company”),a Delaware corporation, provides Internet Protocol (“IP”) networking productand service platforms and global service and support. The Company sellswireless, wireline and switching platforms to operators in both fast growth andestablished telecommunications markets around the world. The Company enablesits customers to rapidly deploy revenue-generating access services usingtheir existing infrastructure, while providing a migration path to cost-efficientend-to-end IP networks. Incorporated in 1991 and headquartered in Alameda,California, the Company has research and design operations in New Jersey,China, and India.

**NOTE 2—SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

The Company restated itsConsolidated Financial Statements for the year ended December 31, 2003 tocorrect certain errors in the previously reported Annual Report on Form 10-K.The accompanying notes to the consolidated financial statements related to therestatement have been revised. See note 24 for a discussion of the restatement.

*Basis ofPresentation:*

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly and majority (over 50 percent) owned subsidiaries. All significantintercompany 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.”

*Reclassifications:*

Certain reclassificationshave been made in the prior years’ financial statements to conform to the 2003presentation. Such reclassifications had no impact on previously reported netincome or stockholders’ equity.

*Use of Estimates:*

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe consolidated financial statements and the reported amounts of revenues andexpenses during the reporting period. Actual results could differ from thoseestimates.

*Cash and CashEquivalents:*

Cash and cash equivalentsconsist of instruments with maturities of three months or less at the date ofpurchase.

*Short-termInvestments:*

Short-term investmentsconsist of investments with original maturities of less than twelve months. Inaccordance with the Company’s investment policy, all short-term investments areinvested in “investment 

50

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

grade” rated securities with a minimum of A or betterratings. Currently, most of the Company’s short-term investments have AA orbetter ratings. Marketable securities are classified as available-for-sale andare carried at fair value. Unrealized holding gains and losses on securitiesclassified as available-for-sale are recorded as a separate component ofstockholders’ equity. Unrealized losses on securities classified asavailable-for-sale that are determined to be other-than temporary losses arereported in earnings. Realized gains and losses are reported in earnings. Thefair value of investments is based on quoted market prices. At December 31,2003 and 2002, short-term investments in available-for-sale securitiesconsisted of (in thousands):
| ** **                                   | ** ** | **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 |   |   |

 
| ** **                                   | ** ** | **December 31, 2002** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **Amortized  Cost**             | ** ** | **Gross  Unrealized  Gains** | ** ** | **Estimated  Fair  Value** | ** ** |
| Government and  agency obligations           |       |                            | $          | 11,006 |   |   |   | $ | 12 |   |   |   | $ | 11,018 |   |   |
| Debt securities                              |       |                            | 96,233     |   |   |   | 54 |   |   |   | 96,287 |   |   |
| Total current available  for-sale securities |       |                            | $          | 107,239 |   |   |   | $ | 66 |   |   |   | $ | 107,305 |   |   |

 

*RevenueRecognition:*

Revenues from sales of telecommunications equipmentare recognized when persuasive evidence of an arrangement exists, delivery of theproduct has occurred, customer acceptance has been obtained, the fee is fixedor determinable and collectability is reasonably assured. If the payment duefrom the customer is not fixed or determinable due to extended payment terms,revenue is recognized as payments become due from the customer, assuming allother criteria for revenue recognition are met. Any payments received prior torevenue recognition are recorded as customer advances. Normal payment termsdiffer for various reasons amongst different customer regions, depending uponcommon business practices for customers within a region. Shipping and handlingcosts are recorded as revenues and costs of revenues. Any expected losses oncontracts are recognized immediately.

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 EITF 00-21, and SEC Staff AccountingBulletin No. 104 (“SAB 104”). Multiple element arrangements primarilyinvolve the sale of PAS or iPAS equipment with handsets, installation andtraining and the provision of such equipment to different locations for thesame customer. Revenue is recognized as each element is earned, namely uponinstallation and acceptance of equipment or delivery of handsets, provided thatthe fair value of the undelivered element(s) has been determined, thedelivered element has stand-alone value, there is no right of return ondelivered element(s), and the vendor is in control of the undeliveredelement(s).

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 the 

51

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

Company is entitled to thefull payment. The Company will not recognize revenue before final acceptance isgranted by the customer if acceptance is considered substantive to thetransaction. Additionally, the Company does not recognize revenue when cashpayments are received from customers for transactions that do not have thecustomer’s final acceptance. The Company records these cash receipts ascustomer advances, and defers revenue recognition until final acceptance isreceived.

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 Emerging Issues Task Force Issue No. 03-05. The Companyallocates revenues to each element of software arrangements based on vendor-specificobjective evidence (“VSOE”). VSOE of each element is based on the price chargedwhen the same element is sold separately. The Company uses the residual methodto recognize revenue when an arrangement includes one or more elements to bedelivered at a future date and VSOE of the fair value of all the undeliveredelements exists. Under the residual method, the fair value of the undeliveredelements is deferred and the remaining portion of the arrangement fee isrecognized as revenue. If evidence of fair value of one or more undeliveredelements does not exist, revenue is deferred and recognized when delivery ofthose elements occurs or when fair value can be established.

The Company recognizes revenue for system integration,installation and training upon completion of performance if all other revenuerecognition criteria are met. Other service revenue, such as that related tomaintenance and support contracts, is recognized ratably over the contractterm. Revenues from services were less than 10% of revenues for all years.

The Company also sells products through resellers.Revenue is generally recognized when the standard price protection period whichranges from 30 to 90 days, has lapsed. If collectability cannot bereasonably assured in a reseller arrangement, revenue is recognized uponsell-through to the end customer and receipt of cash. In China, there may beadditional obligations in reseller arrangements such as inventory rotation, orstock exchange rights on the product. As such, revenue is recognized inaccordance with Statement of Financial Accounting Standards No. 48 “RevenueRecognition When Right of Return Exists” (“SFAS 48”). The Company has developedreasonable estimates for stock exchanges. Estimates are derived from historicalexperience with similar types of sales of similar products.

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 requestcollateral from its customers. In international sales, the Company oftenrequires letters of credit from its customers that can be drawn on demand ifthe customer defaults on its payment. If the Company determines that collectionof a payment is not reasonably assured, the Company recognizes revenue at thetime collection becomes reasonably assured, which is generally upon receipt ofcash.

Because of the nature of doing business in China andother emerging markets, the Company’s billings and/or customer payments may notcorrelate with the contractual payment terms and the Company generally does notenforce contractual payment terms prior to final acceptance. Accordingly,accounts receivable are not booked until the Company recognizes the relatedcustomer revenue. Advances from customers are recognized when the Company hascollected cash from the customer, prior to recognizing 

52

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

revenue. Deferred revenueis recorded if there are undelivered elements after final acceptance has beenobtained.

The Company provides awarranty on its equipment and handset sales for a period generally ranging fromtwelve to eighteen months from the time of final acceptance. The Companyprovides for the expected cost of product warranties at the time that revenueis recognized, based on an assessment of past warranty experience.

*Accounts and notesreceivable:*

The Company accepts banknotes and commercial notes, with maturity dates between three and six months,from its customers in China in the normal course of business and estimates thecollectability of its trade receivables and notes receivable. An allowance fordoubtful accounts is maintained for the estimated losses on the tradereceivables and notes receivable. The Company assesses collectability of thereceivable by determining whether the creditworthiness of the customer hasdeteriorated and could result in an inability to collect payment; ifcollectability is doubtful, the Company records an allowance against thereceivable. If a customer’s financial condition were to deteriorate, causingtheir ability to make payments to suffer as a result, the allowances forreceivables would be increased. Allowances for doubtful accounts were$31.2 million and $26.3 million at December 31, 2003 and 2002,respectively.

*Inventories:*

Inventories consist ofinventories held at the Company’s manufacturing facility, at 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. Cost is computed using standardcost, which approximates actual cost on a first-in, first-out basis. Inventoryis written down for estimated obsolescence or unmarketable inventory equal tothe difference between inventory cost and the estimated market value.

*Deferredcosts/Inventories at customer sites under contracts:*

Inventories at customersites under contracts awaiting final acceptance are classified as deferredcosts, separate from what was historically considered inventory. These arestated at the lower of cost or net realizable value, net of reserves based uponassessment of potential losses and obsolescence during the lengthy acceptanceprocess. The title and risk of loss of this inventory is transferred to thecustomer upon delivery. Revenue and cost of sales are recorded when finalacceptance is received from the customer.

*Research andDevelopment and Capitalized Software Development Costs:*

Research and developmentcosts are charged to expense as incurred. Costs incurred in the development ofsoftware that will ultimately be sold are capitalized between the time whentechnological feasibility has been attained and the related product is readyfor release. During 2003 and 2002, the Company capitalized $4.2 millionand $3.4 million of software development costs, respectively. Amortizationof capitalized development costs was $1.8 million, $1.1 million and$0.3 million in 2003, 2002 and 2001, respectively. Unamortized capitalizedsoftware development costs for 2003 and 2002 were $7.5 million and$4.5 million, respectively. Direct costs of software developed forinternal use are expensed during the preliminary project stage and capitalizedduring the application development stage.

53

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

*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 the followingperiods:
| ** **                                  | ** ** | **Years**                            | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| Furniture, test  or manufacturing equipment |       | 5                                    |       |
| Computers and  software                     |       | 2-3                                  |       |
| Buildings                                   |       | 39                                   |       |
| 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. As of December 31, 2003, the Company had recorded$0.6 million of interest to construction in progress applicable to theconstruction of its Hangzhou manufacturing facility and had incurred interestexpenses associated with the building’s construction of $2.8 million forthe year ended December 31, 2003. The Company will continue to capitalizeinterest until the building is placed into service, upon which timeamortization will begin. Capitalized interest will be amortized on a straight-linebasis over the life of the building.

*Goodwill andIntangible Assets:*

The Company has recordedgoodwill and intangible assets in connection with business acquisitions.Management judgment is required in the assessment of the related useful lives,assumptions regarding the ability to successfully develop and ultimatelycommercialize acquired technology, and assumptions regarding the fair value andthe recoverability of these assets. An annual goodwill impairment review isperformed in the fourth quarter of each year or when changes in circumstancesindicate a potential impairment. The Company currently operates as a singlereportable segment without reporting units, as its management evaluatesperformance, makes operating decisions and allocates resources based onconsolidated financial data. As such, the Company determines whether impairmentto goodwill is necessary on a consolidated basis. When assessing potentialimpairment to goodwill, book value is compared to fair value. Fair value is theCompany’s market capitalization at the date impairment is assessed.Historically, fair value has exceeded book value and no impairments have beennecessary.

*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.

54

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

*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 theoption.

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.

The following tableillustrates the effect on net income and earnings per share if the Company hadapplied the fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation (in thousands, except per share data):
| ** **                                                                                                                   | ** ** | **Year ended December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                                                                   | ** ** | **Restated(1)**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                                                                        |       |                                       |       |   |   |   |   |   |   |
| Net income:                                                                                                                  |       |                                       |       |   |   |   |   |   |   |
| As reported                                                                                                                  |       |                                       | $          | 215,532 |   |   | $ | 107,862 |   | $ | 56,954 |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                  |       |                                       | 3,071      |   |   | 2,209 |   | 3,706 |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       |                                       | (30,290    | ) |   | (20,060 | ) | (15,827 | ) |
| Pro forma net income                                                                                                         |       |                                       | $          | 188,313 |   |   | $ | 90,011 |   | $ | 44,833 |   |
| Basic income per  share:                                                                                                     |       |                                       |       |   |   |   |   |   |   |
| As reported                                                                                                                  |       |                                       | $          | 2.08 |   |   | $ | 0.98 |   | $ | 0.56 |   |
| Pro forma                                                                                                                    |       |                                       | $          | 1.82 |   |   | $ | 0.82 |   | $ | 0.44 |   |
| Diluted                                                                                                                      |       |                                       |       |   |   |   |   |   |   |
| Net income:                                                                                                                  |       |                                       |       |   |   |   |   |   |   |
| As reported                                                                                                                  |       |                                       | $          | 215,532 |   |   | $ | 107,862 |   | $ | 56,954 |   |
| 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                  |       |                                       | 3,071      |   |   | 2,209 |   | 3,706 |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       |                                       | (30,290    | ) |   | (20,060 | ) | (15,827 | ) |
| Pro forma net income                                                                                                         |       |                                       | $          | 191,403 |   |   | $ | 90,011 |   | $ | 44,833 |   |
| Diluted income  per share:                                                                                                   |       |                                       |       |   |   |   |   |   |   |
| As reported                                                                                                                  |       |                                       | $          | 1.75 |   |   | $ | 0.94 |   | $ | 0.52 |   |
| Pro forma                                                                                                                    |       |                                       | $          | 1.57 |   |   | $ | 0.81 |   | $ | 0.42 |   |

----

(1)          See Note 24

55

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

The following assumptionswere used to calculate the fair value of the options granted:
| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| Expected  remaining term in years         |       | 3.00                                       |       | 3.00 |   | 3.00 |   |
| Weighted average  risk-free interest rate |       | 1.91                                       | %          | 3.43 | % | 4.04 | % |
| Expected dividend  rate                   |       | 0.00                                       | %          | 0.00 | % | 0.00 | % |
| Volatility                                |       | 64.00                                      | %          | 67.50 | % | 86.07 | % |

 

The weighted average fairvalue per share of options granted in 2003, 2002 and 2001 was $11.41, $9.16 and$11.30, respectively.

***ComprehensiveIncome:***

Comprehensive incomeincludes all changes in equity (net assets) during a period from non-ownersources. Accumulated other comprehensive income or loss is shown in theconsolidated statement of stockholders’ equity

***IncomeTaxes:***

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

***SegmentReporting:***

The Company operates in asingle segment, selling wireless, wireline and switching platforms to operatorsin both fast growth and established telecommunications markets around theworld.

***DisclosuresAbout Fair Value of Financial Instruments:***

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.

56

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

The following tablesummarizes the Company’s carrying values and fair values of its other financialinstruments:
| ** **              | ** ** | **December 31,**     | ** ** |
|-------------------------|------------|---------------------------|------------|
| ** **              | ** ** | **2003 Restated(1)** | ** ** | **2002** | ** ** |
| ** **              | ** ** | **Carrying value**   | ** ** | **Fair value** | ** ** | **Carrying value** | ** ** | **Fair value** | ** ** |
| ** **              | ** ** | **(In thousands)**   | ** ** |
| Convertible debt        |       |                      | $          | (402,500 | ) |   | $ | (686,263 | ) |   | $ | — |   |   |   | $ | — |   |   |
| Bank note               |       |                      | (8,155     | ) |   | (8,155 | ) |   | — |   |   |   | — |   |   |
| Convertible bond  hedge |       |                      | 125,040    |   |   | 356,314 |   |   | — |   |   |   | — |   |   |
| Written call  option    |       |                      | (81,248    | ) |   | (283,730 | ) |   | — |   |   |   | — |   |   |
| Long-term  investments  |       |                      | 24,066     |   |   | 35,545 |   |   | 35,360 |   |   |   | 57,894 |   |   |
|                         |            |                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          SeeNote 24

***ForeignCurrency Translation:***

Operationsof the Company’s subsidiaries are conducted primarily in China and thefinancial statements of those subsidiaries are translated from China’sRenminbi, the functional currency, into U.S. Dollars in accordance with SFAS No. 52,“Foreign Currency Translation.” Accordingly, all foreign currency assets andliabilities are translated at the period-end exchange rate and all revenues andexpenses are translated at the average exchange rate for the period. Theeffects of translating the financial statements of foreign subsidiaries intoU.S. Dollars are reported as a cumulative translation adjustment, a separatecomponent of comprehensive income in stockholders’ equity. Some inventorypurchases are made in Japan and consequentially, portions of accounts payableare denominated in Japanese Yen. Foreign currency transaction gains and lossesare reported in earnings and were $8.7 million and $5.4 million oflosses in 2003 and 2002, respectively. They were not material for 2001.

***EarningsPer Share:***

Basic earnings per share is computed by dividing netincome available to common stockholders by the weighted average number ofshares of the Company’s common stock outstanding during the period. Dilutedearnings per share is determined by adjusting net income as reported by theeffect of dilutive securities and increasing the number of shares bypotentially dilutive common shares outstanding during the period. Potentiallydilutive common shares consist of employee stock options, a written calloption, warrants and convertible subordinated notes.

57

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 2—SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES (Continued)**

The following is a summaryof the calculation of basic and diluted earnings per share (in thousands,except per share data):
| ** **                                    | ** ** | **Year ended December 31.** | ** ** |
|-----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                    | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                    | ** ** | **Restated(1)**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Numerator:                                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Net income (for  basic EPS computation)       |       |                                       | $          | 215,532 |   |   | $ | 107,862 |   |   | $ | 56,954 |   |   |
| Effect of  Dilutive Securities                |       |                                       |       |   |   |   |   |   |   |   |   |
| 7¤8%  Convertible Subordinated Notes     |       |                                       | 3,090      |   |   | — |   |   | — |   |   |
| Net income adjusted for dilutive securities   |       |                                       | $          | 218,622 |   |   | $ | 107,862 |   |   | $ | 56,954 |   |   |
| Denominator:                                  |       |                                       |       |   |   |   |   |   |   |   |   |
| Shares used to  compute basic EPS             |       |                                       | 103,659    |   |   | 109,566 |   |   | 101,433 |   |   |
| Dilutive common  stock equivalent shares:     |       |                                       |       |   |   |   |   |   |   |   |   |
| Stock options                                 |       |                                       | 5,770      |   |   | 4,510 |   |   | 7,151 |   |   |
| Written call  option                          |       |                                       | 1,235      |   |   | — |   |   | — |   |   |
| Conversion of  convertible subordinated notes |       |                                       | 13,674     |   |   | — |   |   | — |   |   |
| Warrants                                      |       |                                       | 29         |   |   | 28 |   |   | 28 |   |   |
| Other                                         |       |                                       | 542        |   |   | 303 |   |   | — |   |   |
| Shares used to compute diluted EPS            |       |                                       | 124,909    |   |   | 114,407 |   |   | 108,612 |   |   |
| Basic earnings per share                      |       |                                       | $          | 2.08 |   |   | $ | 0.98 |   |   | $ | 0.56 |   |   |
| Diluted earnings  per share                   |       |                                       | $          | 1.75 |   |   | $ | 0.94 |   |   | $ | 0.52 |   |   |

----

(1)          See Note 24

Certain potential shares related to employee stockoptions and warrants outstanding during the years ended December 31, 2003,2002 and 2001 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, 2003, 2002 and 2001, these shares totaled17.6 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 and 1.8 million shares with a weighted average exercise price of$24.18 per share, respectively. The Company has outstanding warrants forissuance of 32,000 shares at the exercise price of $2.50 per share.

On December 31, 2003, each of the Company’s 7¤8%convertible subordinated notes outstanding was eligible 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 commonstock, if the Company’s stock price exceeds a specified threshold. AtDecember 31, 2003 the closing price of the Company’s common stock exceededthe specified threshold, which had the effect of increasing the denominator fordiluted earnings per share by 13.7 million. Additionally, during the yearended December 31, 2003, the average price of the Company’s stock exceededthe specified strike prices of the convertible bond hedge and call optiontransactions that the Company entered into to reduce the potential dilutionfrom conversion of the notes. Both the bond hedge and call option transactionsmay be settled at the Company’s option either in cash or net shares and expireon March 1, 2008. Using the treasury stock method, under FAS 128,this would have the effect of decreasing the denominator for diluted earningsper 

58

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE2—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)**

share by 3.1 millionshares for the bond hedge transaction, and increasing the denominator fordiluted earnings per share by 1.2 million shares for the call optiontransaction. However, only the dilutive effect of the 1.2 million shareswith respect to the call option transaction is included in the Company’sdiluted earnings per share calculation above. The convertible bond hedge, underFAS 128, is always anti-dilutive.

The net income for the diluted EPS computationreflects the reduction in interest expense of $3.1 million for the yearended December 31, 2003, that would result from an assumed conversion ofthe 7¤8%convertible subordinated notes.

The Company sold12.1 million shares of common stock in January 2004, which would havea dilutive effect on the earnings per share calculation. Refer to Note 23for additional detail on this stock issuance.

***RecentAccounting Pronouncements:***

In April 2003, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards No. 149“Amendment of Statement 133 on Derivative Instruments and Hedging Activities”(“SFAS 149”). This statement amends SFAS 133 to provide clarificationon the financial accounting and reporting of derivative instruments and hedgingactivities. The adoption of SFAS 149, which was effective for contractsentered into or modified after June 30, 2003, did not have a materialeffect on the Company’s consolidated financial condition or results ofoperations.

In May 2003, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standards No. 150,“Accounting for Certain Financial Instruments with Characteristics of bothLiabilities and Equity” (“SFAS 150”). SFAS 150 establishes standards forhow an issuer classifies and measures certain financial instruments withcharacteristics of both liabilities and equity. It requires that an issuerclassify a financial instrument that is within its scope as a liability (or anasset in some circumstances). Many of these instruments were previouslyclassified as equity. As the Company does not have any of these financialinstruments, the adoption of FAS 150 is not expected to have any impact onthe Company’s consolidated financial statements.

On December 17, 2003,the Staff of the SEC issued Staff Accounting Bulletin No. 104(“SAB 104”), Revenue Recognition, which supercedes SAB 101, RevenueRecognition in Financial Statements. SAB 104’s primary purpose is to rescindaccounting guidance contained in SAB 101 related to multiple element revenuearrangements, superceded as a result of the issuance of EITF 00-21,“Accounting for Revenue Arrangements with Multiple Deliverables.” Additionally,SAB 104 rescinds the SEC’s Revenue Recognition in Financial StatementsFrequently Asked Questions and Answers (“the FAQ”) issued with SAB 101 that hadbeen codified in SAB 101 Topic 13. Selected portions of the FAQ have beenincorporated into SAB 104. While the wording of SAB 104 has changed to reflectthe issuance of EITF 00-21, the revenue recognition principles of SAB 101remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104did not materially affect the Company’s revenue recognition policies, nor theCompany’s results of operations, financial position or cash flows.

**NOTE 3—FOLLOW-ON PUBLICOFFERING AND RESALE PUBLIC OFFERING**

On August 3, 2001,the Company completed a follow-on public offering and sold an aggregate of7,400,000 shares of common stock at $20.00 per share. Selling stockholders soldan additional 2,950,000 shares of common stock in the offering. The aggregatenet proceeds to the Company were $139.9 million. On February 28,2002, the Company sold 1,500,000 shares of common stock in connection with theresale 

59

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE3—FOLLOW-ON PUBLIC OFFERING AND RESALE PUBLIC OFFERING (Continued)**

publicoffering of 10,000,000 shares of our common stock by SOFTBANKAmerica Inc., one of the Company’s stockholders. The aggregate netproceeds to the Company were $28.9 million.

**NOTE4—SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION**
| ** **                        | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------|------------|
| ** **                        | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                        | ** ** | **(In thousands)**                    | ** ** |
| Cash paid during the  period for: |       |                                       |       |   |   |   |   |
| Interest                          |       | $                                          | 2,795      |   | $ | 1,492 |   | $ | 3,798 |   |
| Income taxes                      |       | $                                          | 47,192     |   | $ | 18,442 |   | $ | 10,832 |   |

 

Non-cashactivities were as follows: 
| ** **                                                   | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                   | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**                    | ** ** |
| Noncash operating  activities were as follows:               |       |                                       |       |   |   |   |   |
| Accounts receivable transferred to notes receivable          |       | $                                          | 92,181     |   | $ | 14,545 |   | $ | — |   |
| Noncash investing and financing  activities were as follows: |       |                                       |       |   |   |   |   |
| Common stock  issued in conjunction with  acquisitions       |       | $                                          | 12,234     |   | $ | — |   | $ | 31,434 |   |

 

**NOTE 5—RESTRICTED CASH ANDSHORT-TERM INVESTMENTS**

At December 31, 2003, the Company had restrictedcash and short-term investments of $24.4 million primarily comprised of$20.5 million of restricted short-term investments for standby letters ofcredit and a $3.7 million time deposit required for Japanese tax purposes.At December 31, 2002, the Company had restricted cash of $21.3 millioncomprised of $9.8 million of standby letters of credit, and an$11.5 million deposit required by China regulatory authorities. 

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 process. In addition, theCompany may be required to issue standby letters of credit as guarantees foradvance customer payments upon contract signing or performance guarantees. Thestandby letters of credit usually expire six to nine months from date ofissuance without being drawn by the beneficiary thereof.

**NOTE 6—ACQUISITIONS ANDDIVESTITURES OF COMPANIES**

***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. 

60

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

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 CommWorks’ 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, SLAP and High DensityVoice (“HDV”) 2.0. SLAP is an IPR&D project in the Wireless division ofCommWorks. The objective of SLAP is to develop an interface that connectsUTStarcom’s products with radio switch manufacturers’ products in China inorder to connect a cellular network to the Internet. HDV 2.0 is an IPR&Dproject in the Wireline product line of CommWorks. HDV 2.0 utilizes softwaretechnology to increase data capacity for Voice over Internet Protocol (“VoIP”) solutions.

There are significant risks associated with thosetechnologies. The technological risks stem from the fact that the newtechnologies are in an early stage of development. As of the closing date,CommWorks’ SLAP IPR&D project was approximately 60% complete and HDV 2.0was approximately 40% complete. Therefore, there are significant risksassociated with reaching the technological milestones on time and on budget.Commercial risks are associated with the competitive nature of thetelecommunications equipment market.

Significant additional costs will be required tocomplete the IPR&D projects. The SLAP product is approximately 80% completeas of December 31, 2003 and commercialization is expected in the firstquarter of fiscal 2004. Remaining costs required to complete the project areestimated to be $0.1 million. The HDV 2.0 product is approximately 50%complete as of December 31, 2003. Commercialization is expected in thefirst quarter of fiscal 2004. Remaining costs required to complete the projectare estimated to be $0.2 million.

61

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

The following tablesummarizes the final allocation of the purchase price for CommWorks based uponthe final independent valuation. The final valuation resulted in changes inestimated fair value, changes in the estimated useful lives of the intangibleassets acquired and a change in the amount attributable to goodwill, mainly dueto revised assumptions of future revenues from existing customers. The Companyalso recorded additional employee-related liabilities. The estimateduseful life of purchased technology is from one to five years, the estimateduseful life of customer relationships is ten years, and the estimated usefullives of backlog 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 |   |   |

 

The following pro formaresults of operations reflect the combined results of the Company and CommWorksfor the years ended December 31, 2003 and 2002 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 future periods.
| ** **                                      | ** ** | **Year ended December 31,**                     | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                                       | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | **Restated(1)**                                                | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **(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 |   |

----

(1)          See Note 24

62

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

The pro forma results ofoperations include historical operations of the Company and CommWorks. Certainnon-recurring charges were recorded by CommWorks and are included aboveincluding a $15.0 million restructuring charge in both the first andsecond quarter of 2002 and a $15.0 million and $6.1 million chargerelating to goodwill impairment, which was recorded in the second quarter of2002 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.RollingStreams designs 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 the Company’s common stock, valued at$0.5 million. Of the 301,074 shares, 164,115 shares valued at$5.8 million, were issued at the closing, including 28,696 of which wereheld in escrow for any undisclosed liabilities or contingencies incurred byRollingStreams prior to the closing or for any breach of the share exchange agreement.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 tothe achievement of certain revenue milestones during such earnout period. 

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. 

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 considered an IPR&D project becausethere are significant risks associated with the development of this technology.These risks include technological and commercial risks. The technological risksstem from the fact that the technology was 70% complete as of December 31,2003. Therefore, there are significant risks associated with reaching thetechnological milestones on time and on budget. Commercial risks are associatedwith the lack of market acceptance for the TVoIP concept. 

In addition to the technological and commercial risksstated above, significant additional costs will be required to complete theIPR&D project. Commercialization of MediaSwitch is expected in the secondquarter of 2004. Remaining costs required to complete the project are estimatedto be $4.5 million. This involves adding new features and functionalitiesand stabilizing the software code. 

63

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

The following tablerepresents the final allocation of the purchase price for RollingStreams. Theallocation of the purchase price is based upon an independent valuation. 
| ** **                                  | ** ** | **(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 packetswitches that 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 amount of the purchase price allocated toIPR&D of $1.9 million was charged to the Company’s results of operations,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, and is now available for customer trialsand evaluations. It is expected to be marketed and sold in the third quarter of2004. Commercial risks are associated with the lack of market acceptance with aproduct with these features and for its use in TVoIP implementations. 

The following tablerepresents the final allocation of the purchase price for Xebeo based upon theindependent 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 TechnologyCo. Ltd. (“Shanghai Yi Yun”), a provider of synchronous digital hierarchyequipment. Shortly thereafter, there was a claim surrounding potentialinfringement of the intellectual property acquired which led to a possiblerecission of the transaction, creating a contingency whose outcome was notdeterminable beyond a reasonable doubt. This transaction was recorded in March 2003,when the Company determined that none of the intellectual property acquired wassubject to the claim. 

64

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

Consideration was$0.2 million of cash and 342,854 shares of restricted stock valued at$6.0 million. In connection with the acquisition, Shanghai Yi Yun and eachof the stockholders that received part of the 342,854 shares of restrictedstock executed an indemnity escrow agreement in favor of the Company and suchshares of restricted stock were placed in escrow. In addition, the Companyissued 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 ofthe Company’s subsidiaries. Such shares of restricted stock vest over fiveyears through 2007, with accelerated vesting upon the achievement of specifiedmilestones. The Company has treated these 514,290 shares of restricted stock asdeferred compensation. During 2003, 226,302 of these shares vested uponachievement of specified milestones. 

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% ownershipinterest in HUTS, one of the Company’s two primary manufacturing facilities inChina, for a total consideration of $14.5 million in cash. As a result ofthe GUTS and HUTS transactions, which closed in May 2003, the Company wasable to 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 

65

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE6—ACQUISITIONS AND DIVESTITURES OF COMPANIES (Continued)**

employeeswho will continue to perform services for the Company. These shares vest at theearlier of five years or upon the achievement of certain performancemilestones. The Company records this amount as compensation expense ratablyover the vesting period and will accelerate the amortization if the milestonesare met. The amount of the purchase price allocated to in-processresearch and development of $0.7 million was charged to the Company’s resultsof operations, as no alternative future uses existed at the acquisition date.Goodwill of $0.2 million was recorded in connection with the acquisition and isexpected to be deductible for tax purposes. The results of operations ofIssanni were included in the Company’s consolidated results of operationsbeginning on April 19, 2002. 

*2001*

*AdvancedCommunication Devices Corporation*

In November 2001, the Company completed thepurchase of Advanced Communication Devices Corporation (“ACD”) for$21.3 million, comprised of approximately one million shares of theCompany’s common stock valued at $19.9 million, $0.9 million ofvested common stock options valued using the Black-Scholes pricing model,and $0.5 million of acquisition-related expenses. ACD was a Systemon Chip (“SoC”) semiconductor company focusing on LAN and IP switchingtechnology whose then current markets included Taiwan, China and Korea. Inaddition, the Company adopted an incentive plan providing for the issuance ofshares of common stock valued at $5 million to ACD employees who willcontinue to perform services for the Company. The acquisition has beenaccounted for as a purchase and the results of operations have been included inthe Company’s consolidated financial statements since the acquisition. 

In association with itsacquisition of ACD, the Company allocated $0.1 million to tangible net assetsacquired, $4.3 million to identified intangible assets, $4.7 million of in-processresearch and development costs were charged to the Company’s results ofoperations, as no alternative future use existed at the balance sheet date and$12.2 million was charged to goodwill, as this was the excess of costs ofacquiring ACD over the fair value of identified net assets acquired. 

**NOTE 7—INVENTORIES AND DEFERRED COSTS/INVENTORIES ATCUSTOMER SITES UNDER CONTRACTS**

As of December 31,2003 and 2002, total inventories consist of the following (in thousands):
| ** **                                                      | ** ** | **December 31,  2003 ** | ** ** | **December 31,  2002** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------|------------|-----------------------------|------------|
| ** **                                                      | ** ** | **Restated(1)**                   | ** ** | ** **                  | ** ** |
| *Inventories*                                                   |       |                              |       |                        |       |   |   |   |   |
| Raw materials                                                   |       |                              | $          | 66,753                      |       |   |   | $ | 97,086 |   |   |
| Work-in-process                                                 |       |                              | 51,116     |                        |       |   | 37,467 |   |   |
| Finished goods                                                  |       |                              | 48,206     |                        |       |   | 9,131 |   |   |
| Inventories at  customer sites without contracts                |       |                              | 90,990     |                        |       |   | 40,003 |   |   |
|                                                            |       |                              | $          | 257,065                     |       |   |   | $ | 183,687 |   |   |
| *Deferred costs/Inventories at  customer sites under contracts* |       |                              |       |                        |       |   |   |   |   |
| Finished goods                                                  |       |                              | 542,060    |                        |       |   | 240,979 |   |   |
|                                                            |       |                              | $          | 542,060                     |       |   |   | $ | 240,979 |   |   |

----

(1)          SeeNote 24

66

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 8—ACCOUNTS AND NOTESRECEIVABLE**

The Company accepts banknotes receivable and commercial notes receivable, with maturity dates betweenthree and six months, from its customers in China in the normal course ofbusiness. The Company may discount these notes with banking institutions inChina. A sale of these notes is reflected as a reduction of other currentassets and the proceeds of the settlement of these notes are included in cashflows from operating activities in the consolidated statement of cash flows.Notes receivable sold during the years ended December 31, 2003 and 2002were $298.8 million and $2.5 million, respectively. These notes arenot included in the Company’s consolidated balance sheets as the criteria forsale treatment established by Statement of Financial Accounting Standards No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentof Liabilities” (“SFAS 140”), has been met. Under SFAS 140, upon atransfer, the transferor or entity must derecognize financial assets whencontrol has been surrendered and the transferee obtains control over theassets. In addition, the transferred assets have been isolated from thetransferor, beyond the reach of its creditors, and the transferee has theright, without conditions or constraints, to pledge or exchange the assets ithas received. The costs of settling or transferring these notes receivable were$2.3 million and immaterial for the years ended December 31, 2003 and2002, respectively, and were included in other income (expense), net in theConsolidated Statements of Operations. Notes receivable available for sale were$11.4 million and $12.0 million at December 31, 2003 and December 31,2002, respectively. 

**NOTE9—PROPERTY, PLANT AND EQUIPMENT**

As of December 31,2003 and 2002, property, plant and equipment consists of the following: 
| **(In thousands)**        | ** ** | ** **      | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|--------------------------------|------------|-----------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                     | ** ** | **Restated(1)** | ** ** | ** **                      | ** ** |
| Buildings                      |       |            | $          | 406                             |       |                            |       | $ | 406 |   |   |
| Leasehold  improvements        |       |            | 10,446     |                            |       |                            | 7,052      |   |   |
| Automobiles                    |       |            | 5,587      |                            |       |                            | 4,846      |   |   |
| Software                       |       |            | 14,616     |                            |       |                            | 10,119     |   |   |
| Equipment and  furniture       |       |            | 119,796    |                            |       |                            | 61,614     |   |   |
| Construction in  progress      |       |            | 104,548    |                            |       |                            | 46,527     |   |   |
|                           |       |            | $          | 255,399                         |       |                            |       | $ | 130,564 |   |   |
| Less accumulated  depreciation |       |            | (68,360    | )                               |       |                            | (36,584    | ) |   |
|                           |       |            | $187,039   |                            |       |                            | $          | 93,980 |   |   |

----

(1)          See Note 24

Depreciation expense was$34.3 million, $18.9 million and $10.7 million for the yearsended December 31, 2003, 2002 and 2001, respectively. 

67

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 10—LONG-TERMINVESTMENTS**

TheCompany’s investments are as follows: 
| ** **                                   | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| Softbank China                               |       |                            | $          | 5,308                           |       |   |   | $ | 5,526 |   |   |
| Cellon  International                        |       |                            | 8,000      |                            |       |   | 8,000 |   |   |
| Restructuring  Fund No. 1               |       |                            | 1,861      |                            |       |   | 1,981 |   |   |
| Global Asia  Partners L.P.                   |       |                            | 1,653      |                            |       |   | 882 |   |   |
| Fiberxon Inc.                                |       |                            | 2,000      |                            |       |   | 2,000 |   |   |
| InterWave  Communications International Ltd. |       |                            | 3,319      |                            |       |   | 1,546 |   |   |
| China Telecom                                |       |                            | —     |                            |       |   | 9,106 |   |   |
| Joint Venture  with Matsushita               |       |                            | 517        |                            |       |   | 4,683 |   |   |
| Others                                       |       |                            | 1,408      |                            |       |   | 1,636 |   |   |
| Total                                        |       |                            | $          | 24,066                          |       |   |   | $ | 35,360 |   |   |

 

*Softbank China*

The Company has a$5.3 million investment in Softbank China, an investment fund establishedby SOFTBANK 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 and recorded lossesof $0.2 million, $2.8 million and $1.7 million due to an otherthan temporary decline in the carrying value of this investment during theyears ended December 31, 2003, 2002 and 2001, respectively. 

*Restructuring Fund*

During the first quarter of fiscal 2002, the Companyinvested $2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliatedwith SOFTBANK CORP., is a significant stockholder of the Company. The fundfocuses on leveraged buyout investments in companies in Asia undergoingrestructuring or bankruptcy procedures. The total fund offering is expected tobe between approximately $150.0 million and $226.0 million, with eachinvestor contributing a minimum of $0.8 million. 

The fund has a separate management team, and none ofthe Company’s employees are employed by the fund. The Company accounts for thisinvestment under the equity method of accounting. During the year ended December 31,2003 the Company recorded equity losses of $0.1 million, and recorded nolosses for the year ended December 31, 2002. The balance in thisinvestment is $1.9 million at December 31, 2003.

68

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE10—LONG-TERM INVESTMENTS (Continued)**

*Global AsiaPartners, L.P.*

In June 2002, theCompany invested $1.0 million in Global Asia Partners L.P., and anadditional $1.0 million in June 2003, with a commitment to invest upto a maximum of $5.0 million. The remaining amount is due at such timesand in such amounts as shall be specified in one or more future capital callsto be issued by the general partner. The fund size is anticipated to be$100 million and the fund was formed to make private equity investments inprivate or pre-IPO technology and telecommunications companies. The fund’sgeographic focus is on technology investments in Asia, in particular India andChina. The Company accounts for this investment under the equity method ofaccounting. The Company recorded equity losses of $0.2 million and$0.1 million for the years ended December 31, 2003 and 2002,respectively. The balance in this investment is $1.7 million at December 31,2003. 

*Interwave*

During 2002, the Companypurchased approximately 5.8 million shares of common stock of InterWaveCommunications, Inc., a technology company listed on NASDAQ, forapproximately $3.0 million. In addition, the Company received warrants topurchase 2.0 million shares of InterWave’s common stock at $0.21 pershare. The Company’s holdings were adjusted for a 1:10 reverse stock split on April 30,2003, and were 0.6 million shares of common stock and warrants to purchase0.2 million shares of InterWave’s common stock at $2.10 per share. Thewarrants were valued at $0.7 million at December 31, 2003, using theBlack-Scholes option-pricing model. The Company recorded theincrease in the carrying value of these common stock securities of$1.3 million for the year ended December 31, 2003, in comprehensiveincome in equity. The Company recorded a gain of $0.4 million in otherincome (expense) in 2003 to reflect the change in the fair value of thewarrants and a loss of $1.4 million in 2002 in other income (expenses) toreflect an other than temporary decline in the carrying value of thesemarketable securities. 

*Matsushita*

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 has a registered sharecapital of $10.0 million. The cash consideration of $4.9 millionpayable by the Company was paid in October 2002. As the Company does nothave voting control over significant matters of the joint venture company, theinvestment in and results of operations of the joint venture company areaccounted for using the equity method of accounting. The Company recordedequity losses of $4.8 million and $0.2 million for the years ended December 31,2003 and 2002, respectively. 

*China Telecom*

In November 2002, theCompany purchased approximately 0.5 million shares of common stock ofChina Telecom in its initial public offering for approximately$10.0 million. China Telecom is listed on the New York Stock Exchange.During the first and second quarters of 2003, the Company sold these sharesrealizing a loss of $0.1 million. China Telecom is the leading provider ofwireline telephone, data and Internet and leased line services in four of themost economically developed regions of China, and its affiliates are customersof the Company. 

69

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE10—LONG-TERM INVESTMENTS (Continued)**

*Other investments*

The Company has alsoinvested directly in a number of private technology-based companies inthe early stages of development. These investments are accounted for on thecost basis. The Company continually evaluates the carrying value of theseinvestments for possible impairment based on the achievement of businessobjectives and milestones, the financial condition and prospects of thesecompanies and other relevant factors. During the year ended December 31,2003, there were no impairment charges in respect of these private technologyinvestments. During the years ended December 31, 2002 and 2001, impairmentcharges in respect of these private technology investments were$3.0 million and $1.7 million, respectively. 

**NOTE 11—GOODWILL ANDINTANGIBLE ASSETS**

As of December 31,2003 and 2002, goodwill and other acquired intangible assets consisted of thefollowing (in thousands): 
| ** **                     | ** ** | **December 31,**                               | ** ** |
|--------------------------------|------------|-----------------------------------------------------|------------|
| ** **                     | ** ** | **2003**                                            | ** ** | **2002** | ** ** |
| ** **                     | ** ** | **   Restated(1)   ** | ** ** | ** ** | ** ** |
| Goodwill                       |       |                                                | $          | 113,003 |   |   | $ | 57,629 |   |
| Less accumulated  amortization |       |                                                | (12,823    | ) |   | (12,823 | ) |
|                           |       |                                                | $          | 100,180 |   |   | $ | 44,806 |   |
| Identified  intangible assets  |       |                                                |       |   |   |   |   |
| Existing  technology           |       |                                                | $          | 23,630 |   |   | $ | 7,570 |   |
| Less accumulated  amortization |       |                                                | (7,255     | ) |   | (2,556 | ) |
|                           |       |                                                | $          | 16,375 |   |   | $ | 5,014 |   |
| Customer  relationships        |       |                                                | $          | 27,820 |   |   | $ | — |   |
| Less accumulated  amortization |       |                                                | (1,623     | ) |   | — |   |
|                           |       |                                                | $          | 26,197 |   |   | $ | — |   |
| Trade names                    |       |                                                | $          | 940 |   |   | $ | — |   |
| Less accumulated  amortization |       |                                                | (274       | ) |   | — |   |
|                           |       |                                                | $          | 666 |   |   | $ | — |   |
| Backlog                        |       |                                                | $          | 1,950 |   |   | $ | — |   |
| Less accumulated  amortization |       |                                                | (1,137     | ) |   | — |   |
|                           |       |                                                | $          | 813 |   |   | $ | — |   |
| Total intangible assets        |       |                                                | $          | 44,051 |   |   | $ | 5,014 |   |

----

(1)          See Note 24.

Amortization expense was $8.4 million,$2.4 million and $7.5 million for the years ended December 31,2003, 2002 and 2001, respectively. The estimated aggregate amortization expensefor intangibles for each of the five years beginning 2004 through 2008 is $10.7 million,$7.6 million, $5.8 million, $5.6 million and $4.0 million,respectively. 

Goodwill increased by $55.4 million andintangible assets increased by $49.1 million during the year ended December 31,2003. The increase during the year ended December 31, 2003 was mainlyattributable to goodwill of $52.3 million and intangible assets of$44.9 million which was comprised of purchased 

70

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE11—GOODWILL AND INTANGIBLE ASSETS (Continued)**

technology of$14.2 million, customer relationships of $27.8 million and otherintangibles 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. 

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

SFAS No. 142 was adopted by the Company on January 1,2002. SFAS No. 142 had the effect of eliminating amortization of goodwillcommencing January 1, 2002; however, impairment reviews may result infuture periodic write-downs. The Company completed the requiredtransitional assessment of goodwill during the first quarter of fiscal 2002.Based on this assessment, there was no transition goodwill impairment charge.The Company performed its annual impairment review in the fourth quarter of2003 and 2002. No impairment in goodwill was noted. 

Thereconciliation of net income to adjusted net income as if there had been nogoodwill amortization for the year ended December 31, 2001 is as follows(in thousands): 
| ** **                             | ** ** | **Year ended  December 31, 2001** | ** ** |
|----------------------------------------|------------|--------------------------------------------------|------------|
| Reported net  income                   |       |                                             | $          | 56,954 |   |   |
| Add back:  goodwill amortization       |       |                                             | 7,365      |   |   |
| Adjusted net  income                   |       |                                             | $          | 64,319 |   |   |
| Basic earnings per  share:             |       |                                             |       |   |   |
| Reported net income                    |       |                                             | $          | 0.56 |   |   |
| Goodwill amortization                  |       |                                             | 0.07       |   |   |
| Adjusted net income                    |       |                                             | $          | 0.63 |   |   |
| Diluted earnings per  share:           |       |                                             |       |   |   |
| Reported net income                    |       |                                             | $          | 0.52 |   |   |
| Goodwill amortization                  |       |                                             | 0.07       |   |   |
| Adjusted net income                    |       |                                             | $          | 0.59 |   |   |
| Average number of shares  outstanding: |       |                                             |       |   |   |
| Basic                                  |       |                                             | 101,433    |   |   |
| Diluted                                |       |                                             | 108,612    |   |   |

 

71

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 12—DEBT**

Thefollowing represents the outstanding borrowings at December 31, 2003 and2002 (in thousands): 
| ** **                      | ** ** | ** ** | ** ** | ** **             | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|
| **Note**                        | ** ** | ** ** | ** ** | **Rate**               | ** ** | **Maturity**          | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                      | ** ** | ** ** | ** ** | ** **             | ** ** | **Restated(1)**       | ** ** | ** ** | ** ** |
| Notes Payable                   |       | N/A        |       | January 31,  2004 |       | $                     | 1          |   | $ | — |   |
| Convertible  Subordinated Notes |       | 7/8        | %          | March 1,  2008    |       | 402,500               |       | — |   |
| Bank Loan                       |       | 4.94       | %          | January 10,  2006 |       | 8,155                 |       | — |   |
| Total Debt                      |       |       |       |                   |       | $                     | 410,656    |   | $ | — |   |
| Long-term  debt                 |       |       |       |                   |       | 410,655               |       | — |   |
| Short-term debt                 |       |       |       |                   |       | $                     | 1          |   | $ | — |   |
|                                 |            |            |            |                        |            |                       |            |  |  |  |  |  |  |

----

(1)          See Note 24

The Company has available borrowing facilities of$583.7 million as of December 31, 2003. $529.4 million of thesefacilities expire in 2004 and $54.3 million of these facilities expirebetween 2008 and 2010 with interest rates ranging from approximately 4.5% to6.0%, and the Company has not guaranteed any debt not included in theconsolidated balance sheet. 

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 annum and are convertibleinto the Company’s common stock at a conversion price of $23.79 per share andare subordinated to all present and future senior debt of the Company. Holdersof the notes may convert their notes only if: (i) the price of the Company’scommon stock issuable 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. 

The Company has a bank loan in connection with apurchase of inventory 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 inventory. The Company assumed the obligations ofthe bank loan and related inventory on January 23, 2003, which weresubsequently 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 the year ended December 31, 2003, total interest expenserecorded by the Company related to this bank loan amounted to $0.4 million. At December 31,2003, the Company did not serve as legal obligor for the bank loan. See Note 24for a description of MDC.

Concurrent with theissuance of the convertible notes, the Company entered into convertible bondhedge and call option transaction at a cost of $43.8 million. The convertiblebond hedge allows the company to purchase 16,918,873 shares of its common stockat $23.79 per share from the other party to the agreement. The written calloption allows the holder to purchase 16,918,873 shares of the Company’s commonstock from the Company at $32.025 per share. Both the bond hedge and calloption transactions may be settled at the Company’s option either in cash ornet shares and expire on March 1, 2008. The Company recorded theseinstruments at cost, and their carrying value at December 31, 2003approximates their original cost. The convertible bond hedge and call optiontransactions are expected to reduce the potential dilution from conversion ofthe notes. The options have been included in stockholders’ equity in 

72

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 12—DEBT(Continued)**

accordancewith the guidance in Emerging Issues Task Force Issue No. 00-19, “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock.” 

**NOTE 13—OTHER CURRENTLIABILITIES**

Othercurrent liabilities at December 31, 2003 and 2002 consist of thefollowing: 
| ** **                                            | ** ** | **December 31, 2003** | ** ** | **December 31, 2002** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **Restated(1)**                 | ** ** | ** **                      | ** ** |
| Accrued contract  costs                               |       |                            | $          | 67,950                          |       |   |   | $ | 45,756 |   |   |
| Accrued payroll  and compensation                     |       |                            | 34,200     |                            |       |   | 24,633 |   |   |
| Accrued other  taxes                                  |       |                            | 10,725     |                            |       |   | 2,869 |   |   |
| Warranty costs                                        |       |                            | 26,267     |                            |       |   | 13,297 |   |   |
| Accrued  construction costs                           |       |                            | 20,462     |                            |       |   | 9,889 |   |   |
| Liability related  to purchase of Xebeo and CommWorks |       |                            | 2,690      |                            |       |   | — |   |   |
| Other                                                 |       |                            | 11,617     |                            |       |   | 8,483 |   |   |
|                                                  |       |                            | $          | 173,911                         |       |   |   | $ | 104,927 |   |   |

----

(1)          See Note 24

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 receivedpayment; 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.

**NOTE14—WARRANTY OBLIGATIONS AND OTHER GUARANTEES**

Warrantyobligations are as follows (in thousands):
| Balance at  January 1, 2002                  |   | $       | 6,271  |   |
|---------------------------------------------------|--------|---------|--------|--------|
| Accruals for warranties  issued during the period |   | 15,156  |   |
| Settlements made during  the period               |   | (8,130  | )      |
| Balance at  December 31, 2002                |   | $       | 13,297 |   |
| Accruals for warranties  issued during the period |   | 37,904  |   |
| Settlements made during  the period               |   | (24,934 | )      |
| Balance at December 31, 2003                 |   | $       | 26,267 |   |

 

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’sproducts. There are no limitations on the maximum potential future paymentsunder these guarantees. The Company has accrued no amounts in relation to theseprovisions as no such claims have been made and the Company believes it hasvalid, enforceable rights to the intellectual property embedded in itsproducts.

73

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 14—WARRANTY OBLIGATIONS AND OTHER GUARANTEES**(Continued)

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 process. In addition, theCompany may be required to issue standby letters of credit as guarantees foradvance customer payments upon contract signing or performance guarantees. Thestandby letters of credit usually expire six to nine months from date ofissuance without being drawn by the beneficiary thereof.

**NOTE15—PROVISION FOR INCOME TAXES**

UnitedStates and foreign income (loss) before income taxes, minority interest andcumulative effect of a change in accounting principle were as follows (inthousands):
| ** **    | ** ** | **Year ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **    | ** ** | ** Restated(1) **                | ** ** | ** ** | ** ** | ** ** | ** ** |
| United States |       |                                       | $          | 57,784 |   |   | $ | 13,245 |   | $ | (12,237 | ) |
| Foreign       |       |                                       | 202,138    |   |   | 123,027 |   | 90,336 |   |
|          |       |                                       | $          | 259,922 |   |   | $ | 136,272 |   | $ | 78,099 |   |

 

The components of theprovision (benefit) for income taxes are as follows (in thousands):
| ** **     | ** ** | **Year ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **     | ** ** | **  Restated(1)  **    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Current:       |       |                                       |       |   |   |   |   |   |   |
| Federal        |       |                                       | $          | 8,376 |   |   | $ | 12,222 |   | $ | 7,246 |   |
| State/Other    |       |                                       | (242       | ) |   | 1,515 |   | 621 |   |
| Foreign        |       |                                       | 47,940     |   |   | 28,222 |   | 21,586 |   |
| Total current  |       |                                       | 56,074     |   |   | 41,959 |   | 29,453 |   |
| Deferred:      |       |                                       |       |   |   |   |   |   |   |
| Federal        |       |                                       | 7,214      |   |   | (6,665 | ) | (8,002 | ) |
| State          |       |                                       | (1,351     | ) |   | (315 | ) | (172 | ) |
| Foreign        |       |                                       | (16,538    | ) |   | (7,725 | ) | (1,456 | ) |
| Total deferred |       |                                       | (10,675    | ) |   | (14,705 | ) | (9,630 | ) |
| Total          |       |                                       | $          | 45,399 |   |   | $ | 27,254 |   | $ | 19,823 |   |

----

(1)          SeeNote 24

In establishing itsdeferred income tax assets and liabilities, the Company makes judgments andinterpretations based on the enacted tax laws and published tax guidanceapplicable to its operations. The Company records deferred tax assets andliabilities and evaluates the need for valuation allowances to reduce thedeferred tax assets to realizable amounts. The likelihood of a material changein the Company’s expected realization of these assets is dependent on futuretaxable income, its ability to use foreign tax credit carryforwards andcarrybacks, and the effectiveness of its tax planning strategies in the variousrelevant jurisdictions. Changes to the Company’s income tax provision or in thevaluation of the deferred tax assets and liabilities may affect its annualeffective income tax rate.

74

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 15—PROVISIONFOR INCOME TAXES (Continued)**

Deferred income taxesarise from temporary differences between the tax bases of assets andliabilities and their reported amounts in the consolidated financialstatements. Current deferred tax assets are included in othe current assets,and non-current deferred tax assets are included in other long-term assets inthe consolidated financial statements. A summary of the components of netdeferred tax assets is as follows (in thousands):
| ** **                               | ** ** | **U.S.** | ** ** | **China** | ** ** | **Other** | ** ** | **Total** | ** ** |
|------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|-----------|------------|
| **December 31, 2003: Restated(1)**  |       |     |       |      |       |      |       |      |       |
| Current deferred tax assets:             |       |     |       |      |       |      |       |      |       |
| Allowances and reserves                  |       | $        | 7,632      |      | $          | 12,833    |       | $         | —     |   | $ | 20,465 |   |
| Deferred revenue, 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      | )          |
| Net non-current deferred tax assets      |       | $        | 11,070     |      | $          | 16,490    |       | $         | 853        |   | $ | 28,413 |   |

----

(1)          SeeNote 24
| ** **                             | ** ** | **U.S.** | ** ** | **China** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|-----------|------------|
| **December 31, 2002:**            |       |     |       |      |       |      |       |      |       |
| Current deferred tax assets(2):        |       |     |       |      |       |      |       |      |       |
| Allowances and reserves                |       | $        | 8,586      |      | $          | 8,184     |       | $         | —     |   | $ | 16,770 |   |
| Total current deferred  tax assets     |       | $        | 8,586      |      | $          | 8,184     |       | $         | —     |   | $ | 16,770 |   |
| Non-current deferred tax assets:       |       |     |       |      |       |      |       |      |       |
| Net operating loss  carryforward       |       | $        | 1,988      |      | $          | —    |       | $         | 2,974      |   | $ | 4,962 |   |
| Future period  compensation deductions |       | 1,575    |       | —    |       | —    |       | 1,575     |       |
| Tax credit carryforwards               |       | 6,413    |       | —    |       | —    |       | 6,413     |       |
| Fixed assets                           |       | 356      |       | 461       |       | —    |       | 817       |       |
| Other                                  |       | 3,967    |       | —    |       | —    |       | 3,967     |       |
| Total non-current  deferred tax assets |       | 14,299   |       | 461       |       | 2,974     |       | 17,734    |       |
| Valuation allowances                   |       | (4,964   | )          | —    |       | —    |       | (4,964    | )          |
| Net non-current deferred tax assets    |       | $        | 9,335      |      | $          | 461       |       | $         | 2,974      |   | $ | 12,770 |   |

----

(2)          Certainreclassifications have been made to the 2002 financial statements to conform tothe 2003 presentation, see Note 24.

75

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE15—PROVISION FOR INCOME TAXES (Continued)**

Deferred taxes have not been recognized onundistributed earnings from foreign subsidiaries because the Company does notintend to repatriate such earnings. As of December 31, 2003, undistributedearnings from investments in foreign subsidiaries amounted to$472.0 million.

As of December 31, 2003, state net operating losscarryforwards were $0.9 million (tax effected). The state net operatingloss carryforwards will expire in varying amounts between 2004 and 2006 andcould not be utilized in 2003. As of December 31, 2003, the Company hadforeign net operating loss carryforwards of approximately $0.8 million(tax effected), which do not expire and can be carried forward indefinitely. In2003, the Company reversed all of its valuation allowances that wereattributable to state research and development credits, because the Companybelieves that it will more likely than not have sufficient taxable income toutilize these credits.

The Company’s subsidiaries UTSC, HUTS, CUTS and HSTCwere granted tax holidays, which started to phase out in 1999. The net impactof these tax holidays was to decrease tax expense by approximately$38.0 million, $10.0 million and $6.7 million for the yearsended December 31, 2003, 2002 and 2001, respectively.

The difference between the Company’s effective incometax rate and the federal statutory rate is reconciled below:
| ** **                                      | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                      | ** ** | **2003**                                   | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                      | ** ** | **Restated(1)**                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Federal statutory  rate                         |       |                                       | 35         | % |   | 34 | % | 34 | % |
| State taxes, net  of federal income tax benefit |       |                                       | 1          |   |   | 0 |   | 0 |   |
| Permanent  differences                          |       |                                       | 1          |   |   | 5 |   | 5 |   |
| Amortization of  deferred compensation          |       |                                       | 0          |   |   | 1 |   | 2 |   |
| Effect of  difference in foreign tax rates      |       |                                       | (13        | ) |   | (16 | ) | (14 | ) |
| Tax credits and  other                          |       |                                       | (7         | ) |   | (4 | ) | (2 | ) |
| Effective rate                                  |       |                                       | 17         | % |   | 20 | % | 25 | % |

----

(1)          See Note 24

In 2001, audits of theCompany’s federal income tax returns for the years ended December 31,1999, 1998 and 1997 were completed. No audits of the Company’s income taxreturns were underway as of December 31, 2003.

**NOTE 16—COMMON STOCK AND STOCK INCENTIVE PLANS**

***StockOption Plans***

***The 1995 Stock Plan.  ***OnJuly 31, 1995, the Board of Directors adopted, and in October 1995,the Company’s stockholders approved, the Company’s 1995 Stock Plan. Under the1995 plan, officers, employees and consultants were eligible to acquire sharesof common stock pursuant to options or stock purchase rights. At the time ofadoption, 3,705,232 shares of common stock were reserved for issuance under the1995 plan. 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 31,2003, 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. 

76

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE16—COMMON STOCK AND STOCK INCENTIVE PLANS (Continued)**

On January 31, 1997,the Board of Directors elected not to grant any further options under the 1995plan. Upon the adoption of the 1997 plan, all remaining unissued shares underthe 1995 plan not already subject to options or other awards ceased to bereserved for issuance under the 1995 plan.

***The 1997 Stock Plan.  ***OnJanuary 31, 1997, the Board of Directors adopted, and the Company’sstockholders approved, the Company’s 1997 Stock Plan. Under the 1997 plan,officers, employees and consultants are eligible to receive options to purchaseshares of common stock and stock purchase rights. In December 1999, theBoard of Directors amended the 1997 plan, which the Company’s stockholdersapproved in February 2000. As of December 31, 2003, the Company isauthorized to issue up to 25,464,775 shares subject to options. During the termof the 1997 plan, the number of shares issuable under the plan will beincreased annually on the first day of each fiscal year beginning in 2001 by anamount equal to the lesser of 6,000,000 shares or 4% of the outstanding sharesof common stock on that date, or a lesser amount determined by the Board. Theplan terminates in January 2007, but may be terminated earlier by theBoard of Directors. As of December 31, 2003, there were options topurchase 12,740,174 shares of common stock outstanding under the 1997 plan. TheCompensation Committee administers the 1997 plan.

Options granted under the 1997 plan may be incentivestock options, or ISOs, which are intended to qualify for favorable federalincome tax treatment under the provisions of Section 422 of the InternalRevenue Code of 1986, as amended, or non-qualified stock options, or NSOs,which do not so qualify. The Compensation Committee selects the eligiblepersons to whom options will be granted and determines the grant date, amounts,exercise prices, vesting periods and other relevant terms of the options,including whether the options will be ISOs or NSOs. The exercise price of ISOsgranted under the 1997 plan may not be less than 100% of the fair market valueof common stock on the grant date, while the exercise price of NSOs can bedetermined by the Compensation Committee in its discretion. Options aregenerally not transferable during the life of the optionee.

Options vest and become exercisable as determined bythe Compensation Committee, generally over four years. Options may generally beexercised at any time after they vest and before their expiration date asdetermined by the Compensation Committee. However, no option may be exercisedmore than ten years after the grant date. Options will generally terminate (i) 12 monthsafter the death or permanent disability of an optionee and (ii) 90 daysafter termination of employment for any other reason. The aggregate fair marketvalue of the shares of common stock represented by ISOs that become exercisablein any calendar year by any one option holder may not exceed $100,000. Optionsin excess of this limit are treated as NSOs.

In the event the Company is merged with or intoanother corporation, or all or substantially all of the Company’s assets aresold, each outstanding option will be assumed or an equivalent option or rightwill be substituted by the successor corporation or its parent or subsidiary.If the successor corporation refuses to assume or substitute for the option orright, the option or right will automatically vest and become exercisable infull for a period of at least fifteen days, after which time the option orright will terminate.

Under the 1997 plan, the Company may grant stockpurchase rights to eligible participants. Any shares purchased pursuant tostock purchase rights will be subject to a restricted stock purchase agreement.Unless the Compensation Committee determines otherwise, this agreement willgrant the Company a right to repurchase the stock upon the voluntary or involuntarytermination of the employee for any reason, including death or disability. Thepurchase price for repurchased shares will be the original price paid and maybe paid by cancellation of any indebtedness owed to the Company. The shares ofstock 

77

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE16—COMMON STOCK AND STOCK INCENTIVE PLANS (Continued)**

subject to the right ofrepurchase lapse over time. There were no stock purchase rights granted in2003, 2002 or 2001.

***2001 DirectorOption Plan.  ***On March 2, 2001, the Board ofDirectors adopted, and in May 2001, the Company’s stockholders approved,the Company’s 2001 Director Option Plan. Under the 2001 Director Option Plan,those directors who are not employees of the Company (“Outside Directors”) areeligible to receive options to purchase shares of common stock. DirectorsHorner, Atkins, Son and Toy are Outside Directors. All grants of options toOutside Directors are automatic and nondiscretionary. In July 2001, theBoard of Directors amended the 2001 Director Option Plan. As of December 31,2003, the Company is authorized to issue up to 1,200,000 shares pursuant tooptions under the 2001 Director Option Plan. The plan terminates in May 2011,but may be terminated earlier by the Board of Directors. As of December 31,2003, there were options to purchase 320,000 shares of common stock outstandingunder the 2001 Director Option Plan. The Compensation Committee administers the2001 Director Plan.

Pursuant to the terms of the 2001 Director OptionPlan, each Outside Director is automatically granted an option to purchaseeighty thousand shares of common stock (the “First Option”) on the date onwhich such person first becomes an Outside Director (the “Anniversary Date”). Adirector who is an employee of the Company and ceases employment with theCompany 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 the 2001 Director Option Plan, theexercise price of each option granted is equal to the market value of thecommon stock on the date of grant. Such options have terms of ten years, butterminate earlier if the individual ceases to serve as a director. The FirstOption grants vest as to 25% of shares subject to the First Option on each ofthe first four anniversaries of its date of grant. The Subsequent Option grantsvest as to 100% of the shares subject to the Subsequent Option on the firstanniversary of its date of grant.

***IssanniCommunications, Inc. Incentive Program.  ***TheIssanni plan was established for the issuance of up to a total of 39,876 sharesof UTStarcom’s common stock to specified former employees of IssanniCommunications, Inc. (“Issanni”) who became UTStarcom’s employees inconnection with UTStarcom’s acquisition of Issanni. The Issanni plan isadministered by the Board of Directors or a committee appointed by the Board. Aparticipant in the Issanni plan is eligible to earn and vest in a designatednumber of shares that are subject to the award of shares made to a participantunder the plan, based upon the attainment of one of six milestones related tothe amount of revenue generated from Issanni products in 2002 and 2003 andsubject to the participant’s continued employment with Issanni, the Company orone 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, on the fifth anniversary ofthe acquisition of Issanni if the employee continues to be employed withIssanni, the Company or any of their subsidiaries on such date regardless ofwhether any milestone is attained. The shares subject to an award will in anyevent become issuable, whether or not the milestones were achieved and whetheror not the five-year vesting schedule has elapsed, upon (i) the sale orthe discontinuation of the Company or UTStarcom InternationalProducts Inc., (ii) the sale of substantially all or any of thetechnology acquired 

78

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE16—COMMON STOCK AND STOCK INCENTIVE PLANS (Continued)**

by UTStarcom InternationalProducts Inc. in connection with the acquisition of Issanni, or (iii) theemployment termination of certain Issanni principals.

If, prior to the date on which all of a participant’sshares are earned, the participant’s service with Issanni, the Company or oneof their subsidiaries is terminated (i) voluntarily or for cause, theCompany may exercise its repurchase option with respect to any of the participant’sunearned shares, (ii) other than voluntarily or for cause, death ordisability, the participant will be entitled to receive the shares that theparticipant would have otherwise earned with respect to milestones achievedwithin 24 months of the participant’s termination, or (iii) as aresult of death or disability, the participant (or his estate) will be entitledto receive the unearned portion of his shares with respect to all milestones.

***AdvancedCommunication Devices Corporation Incentive Program.  ***TheACD Plan provides for the issuance of an additional 73,637 shares of UTStarcom’scommon stock pursuant to awards of shares granted to designated formeremployees of Advanced Communication Devices Corporation (“ACD”) who becameUTStarcom’s employees in connection with UTStarcom’s merger with ACD. The ACDplan is administered by the Board of Directors. The Company did not grant anyshares under the plan in 2003 and granted 31,275 shares and 52,133 shares in2002 and 2001, respectively.

A participant in the ACD plan is entitled to earn andvest in a designated number of shares subject to the award made to theparticipant upon the attainment of one of five milestones and subject to theparticipant’s continued employment with ACD, the Company or any of theirsubsidiaries through the day of the determination that the applicable milestonehas been satisfied. In addition, each participant is entitled to receive theunearned shares, if any, subject to the award on the fifth anniversary of themerger if the participant has continued to perform services for ACD, theCompany or any of their subsidiaries on such date regardless of whether anymilestone is obtained.

If a participant’s service with ACD, the Company orany of their subsidiaries is terminated for cause by the applicable employer,voluntarily by the participant or as a result of death or disability, theparticipant will forfeit all of the shares subject to the award that were notyet earned and distributed. If the participant’s service is terminated for anyother reason, the participant will be entitled to receive the shares subject tothe award with respect to any milestones achieved within 12 monthsfollowing the participant’s termination and will forfeit all other shares thatwere unearned as of the date of termination.

***The 2003Non-Statutory Stock Option Plan.  ***On April 15,2003, the Board of Directors adopted the Company’s 2003 Non-Statutory StockOption Plan. Under the 2003 plan, directors, officers, employees andconsultants of the Company are eligible to be granted options to purchaseshares of the Company’s common stock. Only non-statutory stock options, whichdo not qualify for favorable federal income tax treatment under the provisionsof Section 422 of the Internal Revenue Code of 1986, as amended, may begranted under the 2003 plan. As of December 31, 2003, the Company wasauthorized to issue up to 1,500,000 shares pursuant to options granted underthe 2003 plan, subject to adjustment in certain instances (including stocksplits, stock dividends, business combinations or other changes incapitalization). As of December 31, 2003, options to purchase 1,438,300shares of common stock were outstanding under the 2003 plan.

The 2003 plan is administered by the CompensationCommittee of the Board of Directors. The Compensation Committee is charged withselecting the eligible persons to whom options will be granted and determinesthe number of shares subject to the option, exercise prices, vesting periodsand other terms applicable to each option.

79

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE16—COMMON STOCK AND STOCK INCENTIVE PLANS (Continued)**

Options granted under the 2003 plan generally vest andbecome exercisable over four years, and may be exercised at any time after theyvest but before their expiration date. Options will generally terminate (i) 12 monthsafter the death or employment termination due to disability of an option holderand (ii) 90 days after termination of an option holder’s service forany other reason other than for disability or due to the option holder’s death.However, no option may be exercised more than ten years after the grant date.

In the event the Company is merged with or intoanother corporation, or all or substantially all of the Company’s assets aresold, the 2003 plan provides for each outstanding option to be assumed or anequivalent option or right to be substituted by the successor corporation orits parent or subsidiary. If the successor corporation refuses to assume orsubstitute for the option, the option will automatically vest and 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, 2000 |       |                                      | 155,035    |                       |       | 15,174,724                                     |       |   | $ | 7.54 |   |   |
| Options Authorized in 2001                   |       |                                      | 5,062,760  |                       |       | —                                         |       |   | $ | — |   |   |
| Options Granted                              |       |                                      | (3,326,957 | )                          |       | 3,326,957                                      |       |   | $ | 19.77 |   |   |
| Options Exercised                            |       |                                      | —     |                       |       | (5,363,601                                     | )          |   | $ | 3.48 |   |   |
| Options Forfeited  or Expired                |       |                                      | 559,663    |                       |       | (559,663                                       | )          |   | $ | 13.79 |   |   |
| 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 |   |   |

 

80

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE16—COMMON STOCK AND STOCK INCENTIVE PLANS (Continued)**

The following tablesummarizes information with respect to stock options outstanding andexercisable as of December 31, 2003:
| ** **                             | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of**                      | ** ** | **Outstanding  at**          | ** ** | **Weighted  Average**        | ** ** | **Weighted  Average  Remaining** | ** ** | **Exercisable  at** | ** ** | **Weighted  Average** | ** ** |
| **Exercise**                           | ** ** | **December 31,**        | ** ** | **Exercise**                 | ** ** | **Contractual** | ** ** | **December 31,** | ** ** | **Exercise** | ** ** |
| **Price**                              | ** ** | **2003**                     | ** ** | **Price**                    | ** ** | **Life** | ** ** | **2003** | ** ** | **Price** | ** ** |
| ** **                             | ** ** | **(in thousands)**      | ** ** | ** **                   | ** ** | **(in years)** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| $  0.06 -  $  0.06 |       |                         | 36,519     |                         |       |   | $ | 0.06 |   |   |   | 4.8 |   |   |   | 36,519 |   |   |   | $ | 0.06 |   |   |
| $  0.25 -  $  0.25 |       |                         | 27,764     |                         |       |   | $ | 0.25 |   |   |   | 5.1 |   |   |   | 27,764 |   |   |   | $ | 0.25 |   |   |
| $  0.85 -  $  0.85 |       |                         | 88,885     |                         |       |   | $ | 0.85 |   |   |   | 1.8 |   |   |   | 88,885 |   |   |   | $ | 0.85 |   |   |
| $  1.71 -  $  2.50 |       |                         | 197,303    |                         |       |   | $ | 2.28 |   |   |   | 3.8 |   |   |   | 197,054 |   |   |   | $ | 2.28 |   |   |
| $  3.39 -  $  4.71 |       |                         | 920,116    |                         |       |   | $ | 4.30 |   |   |   | 5.4 |   |   |   | 920,116 |   |   |   | $ | 4.30 |   |   |
| $  5.65 -  $  5.65 |       |                         | 5,785      |                         |       |   | $ | 5.65 |   |   |   | 4.4 |   |   |   | 5,785 |   |   |   | $ | 5.65 |   |   |
| $  9.38 -  $13.61            |       |                         | 1,660,131  |                         |       |   | $ | 11.74 |   |   |   | 6.5 |   |   |   | 1,269,637 |   |   |   | $ | 11.47 |   |   |
| $14.23 - $21.31                        |       |                         | 7,534,310  |                         |       |   | $ | 18.34 |   |   |   | 8.2 |   |   |   | 2,368,827 |   |   |   | $ | 17.79 |   |   |
| $21.85 - $32.67                        |       |                         | 3,657,867  |                         |       |   | $ | 26.23 |   |   |   | 8.6 |   |   |   | 779,747 |   |   |   | $ | 24.44 |   |   |
| $34.40 - $45.21                        |       |                         | 488,449    |                         |       |   | $ | 39.23 |   |   |   | 9.6 |   |   |   | 33,958 |   |   |   | $ | 42.91 |   |   |
| $  0.06 - $45.21             |       |                         | 14,617,129 |                         |       |   | $ | 18.97 |   |   |   | 7.9 |   |   |   | 5,728,292 |   |   |   | $ | 14.27 |   |   |

 

***2000 Employee StockPurchase Plan.  ***In February 2000, the Company’sstockholders approved the 2000 Employee Stock Purchase Plan. The purchase planis intended to qualify as an “employee stock purchase plan” under Section 423of the Internal Revenue Code.

The Company has reserved 2,000,000 shares of commonstock for sale under the stock purchase plan. The number of shares reserved forsale under the plan will be increased annually on the first day of each fiscalyear beginning in 2001 by an amount equal to the lesser of 4,000,000 shares or2% of the outstanding shares of the Company’s common stock on that date, or alesser amount determined by the Board of Directors. The stock purchase planwill be administered by the Board or a committee appointed by the Board.

The stock purchase plan is implemented by offeringperiods, the duration of which may not exceed 24 months. Offering periodsmay contain interim purchase periods. Shares purchased under the stock purchaseplan will be held in separate accounts for each participant. The first offeringperiod began in March 2000 and ended on the last trading day before April 30,2002. Subsequent consecutive overlapping offering periods begin on May 1and November 1 annually. These offering periods end twenty-four monthsthereafter.

Employees will be eligible to participate in the stockpurchase plan if they are employed by the Company for more than 20 hoursper week and more than five months in a calendar year. The stock purchase planpermits eligible employees to purchase the Company’s common stock throughpayroll deductions, which may not exceed 15% of the employee’s totalcompensation. Stock may be purchased under the plan at a price equal to 85% ofthe fair market value of the Company’s stock on either the date of purchase orthe first day of the offering period, whichever is lower. However, the Board ofDirectors may in its discretion provide that the price at which shares ofcommon stock are purchased under the plan shall be 85% of the fair market valueof the Company’s shares on the date of purchase. Participants may not purchaseshares of common stock having a value greater than $25,000 during any calendaryear.

81

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 16—COMMON STOCK AND STOCK INCENTIVE PLANS**(Continued)

Participants may increase or decrease their payrolldeductions at any time during an offering period, subject to limits imposed bythe Board of Directors. If a participant withdraws from the stock purchaseplan, any contributions that have not been used to purchase shares shall berefunded. A participant who has withdrawn may not participate in the stockpurchase plan again until the next offering period. In the event of retirementor cessation of employment for any reason, any contributions that have not yetbeen used to purchase shares will be refunded to the participant, or to theparticipant’s designated beneficiary in the case of death, and a certificatewill be issued for the full shares in the participant’s account.

The Board of Directors may terminate or amend thestock purchase plan, subject to stockholder approval in some circumstances.Unless terminated earlier by the Board, the stock purchase plan will have aterm of ten years.

Total shares purchasedunder the plan were 261,103, 182,437 and 118,223 in 2003, 2002 and 2001,respectively. At December 31, 2003, there were 3,272,754 shares availablefor purchase under the plan.

**NOTE 17—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 6), the Company recorded net deferred stockcompensation of $0.3 million, $8.7 million and $4.7 million forthe years ended December 31, 2003, 2002 and 2001, respectively,representing the fair value of restricted stock and the difference between thefair value of common stock and the option exercise price of options at the dateof grant. Deferred compensation is presented as a reduction of stockholders’equity, with amortization recorded over the vesting period of the relatedrestricted stock and options. The Company recorded stock compensation expenseof $4.3 million, $3.1 million and $5.2 million for the yearended December 31, 2003, 2002 and 2001, respectively. At December 31,2003, approximately $7.8 million remained to be amortized over thecorresponding vesting period of each respective option or restricted share,generally four to five years.

**NOTE18—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 theCompany. The Company’s eligible employees may elect to reduce their currenteligible compensation by one percent (1%) up to fifty percent (50%), subject tothe maximum statutorily prescribed annual limit of $12,000 for participantsunder age 50 and $14,000 for participants age 50 and over for the year ended December 31,2003 and $11,000 for participants under age 50 and $12,000 for participants age50 and over for the year ended December 31, 2002, 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 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE18—401(K) PLAN (Continued)**

willcontribute $0.50 for each dollar contributed by qualified employees to the 401(k) Plan,to a maximum of $5,500 and $3,000 for the 2003 and 2002 plan years,respectively. The Company’s matching contributions are subject to a five-yearvesting schedule based upon longevity of employee service with the Company.Matching contributions were $2.1 million, $0.7 million and$0.4 million for 2003, 2002 and 2001, respectively.

**NOTE 19—COMMITMENTS AND CONTINGENCIES**

*Leases:*

TheCompany leases certain facilities under non-cancelable operating leases whichexpire at various dates through 2008. The minimum future lease payments underthe leases at December 31, 2003 are as follows:
| ** **                      | ** ** | **(in thousands)** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| Years ending  December 31: |       |                    |       |   |   |
| 2004                            |       |                    | $          | 10,154 |   |   |
| 2005                            |       |                    | 8,057      |   |   |
| 2006                            |       |                    | 4,969      |   |   |
| 2007                            |       |                    | 2,105      |   |   |
| 2008 and after                  |       |                    | 439        |   |   |
| Total minimum lease payments    |       |                    | $          | 25,724 |   |   |

 

Rent expense for the yearsended December 31, 2003, 2002 and 2001 was $11.5 million,$6.5 million and $3.8 million, respectively.

*InvestmentCommitments:*

As of December 31,2003, 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 obligatedto purchase raw materials and work-in-process inventory undervarious orders from one supplier, all of which are expected to be fulfilledwith no adverse consequences material to the operations or financial conditionof the Company. As of December 31, 2003 total open commitments under thesepurchase orders are approximately $2.3 million.

*Litigation:*

On October 31, 2001, a complaint was filed inUnited States District Court for the Southern District of New York against theCompany, some of its directors and officers and various underwriters for itsinitial public offering. Substantially similar actions were filed concerningthe initial public offerings for more than 

83

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE19—COMMITMENTS AND CONTINGENCIES (Continued)**

300 different issuers, andthe cases were coordinated as In re Initial Public Offering SecuritiesLitigation, 21 MC 92. In April 2002, a consolidated amended complaint wasfiled in the matter against the Company, captioned In re UTStarcom, InitialPublic Offering Securities Litigation, Civil Action No. 01-CV-9604.Plaintiffs allege violations of the Securities Act of 1933 and the SecuritiesExchange Act of 1934 through undisclosed improper underwriting practicesconcerning the allocation of IPO shares in exchange for excessive brokeragecommissions, agreements to purchase shares at higher prices in the aftermarket,and misleading analyst reports. Plaintiffs seek unspecified damages on behalfof a purported class of purchasers of the Company’s common stock between 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 dismissbrought by defendants including the Company. The order dismisses all claimsagainst the Company except for a claim brought under Section 11 of theSecurities Act of 1933, which alleges that the Company’s initial publicoffering registration statement contained untrue statements of material factand omitted to state material facts required to be stated in the registrationstatement, or necessary to make the statements therein not misleading. Aproposal has been made for the settlement and release of claims against theissuer defendants, including UTStarcom. The settlement is subject to a numberof conditions, including approval of the proposed settling parties and thecourt. If the settlement does not occur, and litigation against UTStarcomcontinues, UTStarcom believes it has valid defenses and intends to defend thecase vigorously. The Company is unable to currently estimate the loss, if any,associated with the above litigation.

The Company is a party toother litigation matters and claims which are normal in the course ofoperations, and while the results of such litigation matters and claims cannotbe predicted with certainty, the Company believes that the final outcome ofsuch matters will not have a material adverse impact on its financial positionor results of operations.

**NOTE 20—OPERATING RISKS**

*Financial Risks:*

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash, cash equivalents, short-term investments and accountsreceivable. The Company places its temporary cash and short-term investmentswith several financial institutions. Approximately $350.0 million and$141.7 million of the Company’s cash and short term investments was ondeposit in foreign accounts at December 31, 2003 and 2002, respectively.The Company 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.

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE20—OPERATING RISKS (Continued)**

*Concentration ofCredit Risk and Major Customers:*

Thetable below outlines the Company’s sales to and the accounts receivablebalances with respect to the Company’s largest customers:
| **For the year ended December 31,** | ** ** | ** ** | ** ** | **% of Net  Sales** | ** ** | **% of  Accounts  Receivable** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|-------------------------------------|------------|
| **2003**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer A                                                   |       |       | 11         | %                             |       |                                | 3          | % |   |
| **2002**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer B                                                   |       |       | 18         | %                             |       |                                | 6          | % |   |
| Customer C                                                   |       |       | 13         | %                             |       |                                | 0          | % |   |
| **2001**                                                     |       |       |       |                          |       |                                |       |   |   |
| Customer B                                                   |       |       | 28         | %                             |       |                                | 29         | % |   |
| Customer D                                                   |       |       | 10         | %                             |       |                                | 8          | % |   |

 

Approximately 76%, 84% and90% of the Company’s net sales during 2003, 2002 and 2001, respectively, wereto entities affiliated with the government of China. Accounts receivablebalances from these China government affiliated entities or state ownedenterprises were $304.0 million and $238.0 million, respectively, asof December 31, 2003 and 2002. The Company extends credit to its customersin China generally without requiring collateral. In global sales outside ofChina, the Company often requires letters of credit from its customers. TheCompany monitors its exposure for credit losses and maintains allowances fordoubtful accounts.

*Country Risks:*

Approximately 86%, 84% and 90% of the Company’s salesfor the year ended December 31, 2003, 2002 and 2001, 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 withrespect to laws and regulations, changes in China’s telecommunications industryand regulatory rules and policies, anti-inflationary measures, currencyconversion and remittance abroad, and rates and methods of taxation.

Approximately 10%, 13% and3% of the Company’s sales for the year ended December 31, 2003, 2002 and2001, 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—SEGMENT REPORTING**

The Company sells wireless, wireline and switchingplatforms to operators in both fast growth and established telecommunicationsmarkets around the world. The Company primarily operates in two 

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE21—SEGMENT REPORTING (Continued)**

geographic areas, Chinaand other regions. The chief operating decision makers evaluate performance,make operating decisions, and allocate resources based on consolidated financialdata. Gross profit, operating income, income from operations, and income taxesare not allocated to specific individual departments within the organization.In accordance with SFAS No. 131 “Disclosures about Segments of anEnterprise and Related Information,” the Company is considered a singlereportable segment. The Company is required to disclose certain informationabout product revenues, information about geographic areas, information aboutmajor customers, and information about long-lived assets.

China sales accounted for 86% and 84% of net sales for2003 and 2002, respectively. During 2003, the provincial-leveltelecommunications service entities continued to consolidate telecommunicationspurchasing decisions by province. As a result of this consolidation trend, allcustomers were grouped together by province, and each province is treated asone customer. At December 31, 2003 and 2002, there were approximately 31such customers. Giving effect to this consolidation, in 2003, the Hei LongJiang province accounted for 11% of net sales. In 2002, sales to the Zhejiangprovince accounted for 18% and sales to Softbank BB Corporation (“SBBC”)accounted for 13% of net sales. In 2001, sales to the Zhejiang and Guangdongprovinces accounted for 28% and 10% of net sales, respectively.

Geographical area andproduct sales data are as follows (in thousands):
| ** **               | ** ** | **Years ended December 31,** | ** **    |
|--------------------------|------------|---------------------------------------------|---------------|
| ** **               | ** ** | **2003**                                    | ** **    | ** ** | ** ** | **2002** | ** ** | ** ** | ** ** | **2001** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **Restated(1)**                             | ** **    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | **(in thousands)**                     | ** **    |
| *Sales  by region*       |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| China                    |       | $                                           | 1,680,821     |   | 86 | % | $ | 822,299 |   | 84 | % | $ | 565,880 |   | 90 | % |
| Japan                    |       | 194,894                                     |          | 10 | % | 130,104 |   | 13 | % | 16,303 |   | 3 | % |
| Other                    |       | 89,472                                      |          | 4 | % | 29,403 |   | 3 | % | 44,657 |   | 7 | % |
| **TOTAL NET SALES**      | ** ** | **$**                                       | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** | **$** | **626,840** | ** ** | **100** | **%** |
| *Sales by product line*  |       |                                        |          |   |   |   |   |   |   |   |   |   |   |
| Wireless  infrastructure |       | $                                           | 720,555       |   | 37 | % | $ | 447,096 |   | 46 | % | $ | 376,538 |   | 60 | % |
| Subscriber  handsets     |       | 968,192                                     |          | 49 | % | 376,805 |   | 38 | % | 187,902 |   | 30 | % |
| Wireline products        |       | 276,440                                     |          | 14 | % | 157,905 |   | 16 | % | 62,400 |   | 10 | % |
| **TOTAL NET SALES**      | ** ** | **$**                                       | **1,965,187** | ** ** | **100** | **%** | **$** | **981,806** | ** ** | **100** | **%** | **$** | **626,840** | ** ** | **100** | **%** |

 

Long-lived assets bygeography are as follows (in thousands):
| ** **               | ** ** | **December 31,  2003** | ** ** | **December 31,  2002** | ** ** |
|--------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **               | ** ** | **Restated(1)**             | ** ** | ** **                  | ** ** |
| U.S.                     |       |                        | $          | 155,240                     |       |   |   | $ | 43,600 |   |   |
| Foreign                  |       |                        | 184,407    |                        |       |   | 104,731 |   |   |
| Total long-lived  assets |       |                        | $          | 339,647                     |       |   |   | $ | 148,331 |   |   |

----

(1)          SeeNote 24

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 22—RELATED PARTY TRANSACTIONS**

*Softbank*

The Company recognized revenue of $184.4 million,$123.0 million and $13.9 million during the years ended December 31,2003, 2002 and 2001, respectively, with respect to sales of telecommunicationsequipment to SBBC, an affiliate of SOFTBANK America Inc., which is asignificant stockholder of the Company. SBBC offers asynchronous digitalsubscriber line (“ADSL”) coverage throughout Japan, which is marketed under thename “YAHOO BB!”. The Company provides ADSL technology to SBBC. Included inaccounts receivable at December 31, 2003 and 2002 were $43.9 millionand $0.8 million, respectively, related to this agreement. There were noamounts included in deferred revenue in respect of this agreement at December 31,2003 and 2002.

The Company has invested in Softbank China andRestructuring Fund No. 1, which are investment vehicles established bySOFTBANK CORP. and its affiliates. See Note 10.

On April 5, 2003, the Company repurchased 8.0 millionshares of common stock beneficially owned by SOFTBANK America Inc., at apurchase price of $17.385 per share. The total cost of the repurchase was$139.6 million including transaction fees. In connection with thisrepurchase transaction, SOFTBANK America Inc. entered into an agreementwith the Company not to offer, sell or otherwise dispose of the Company’scommon stock for a period of one year, subject to a number of exceptions. As ofDecember 31, 2003, SOFTBANK America Inc. beneficially owned approximately14.1% of the Company’s outstanding stock.

On July 17, 2003, theCompany entered into a Mezzanine Loan Agreement with BB Modem Rental PLC (“BBModem”), an affiliate of SOFTBANK America, Inc. Under the terms of theagreement the Company loaned BB Modem $10.1 million at an effectiveinterest rate of 12.01% per annum, for the purposes of investing in a portfolioof ADSL modems and associated modem rental agreements, from SOFTBANK BB CORP.,formerly BB Technologies, an affiliate of SOFTBANK America, Inc. SOFTBANKBB CORP. will continue to service such modems and modem rental agreements. TheCompany’s loan is subordinated to certain senior lenders of BB Modem, andrepayments are payable to the Company over a forty-two month period through January 31,2007, with a substantial portion of the principal amount of the loan scheduleto be repaid during the last 16 months of this period. The Company’srecourse for nonpayment of the loan is limited to the assets of BB Modem, theaccount into which subscriber payments are made and its rights under thesecuritization transaction documents. The value of BB Modem’s modems that serveas collateral for the loan may decrease over time and may not be sufficientupon sale to pay the outstanding amounts on the loans. The Company assesses theloan for impairment whenever events or changes in circumstances indicate thatthe carrying amount may not be recoverable. The Company periodically reviewsthe underlying quality of the asset pool securing the loan to assess whether impairmenthas incurred and needs to be recorded. During 2003, the Company recorded$0.5 million in interest income in respect of this loan. The loanreceivable at December 31, 2003 was approximately $11.2 million andis included in other long-term assets.

*StarcomProducts, 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 $1.4 million in 2003, $0.7million in 2002, and $0.7 million in 2001, for engineering consulting andemployee placement services from Starcom.

87

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 23—SUBSEQUENT EVENT**

On January 14, 2004,the Company sold 12.1 million shares of common stock at $39.25 per shareto Banc of America Securities, LLC, for net proceeds of approximately$474.2 million. The Company intends to use the net proceeds for strategicand general corporate purposes, including, but not limited to, acquisitions,investments, working capital or capital expenditures.

**NOTE 24—RESTATEMENTOF FINANCIAL STATEMENTS**

TheCompany has restated its consolidated financial statements for the yearended December 31, 2003 and the quarters ended March 31, 2003,June 30, 2003 and September 30, 2003 to correct errors and reflectcertain corresponding changes described below.

As part of the financialclosing process for the year ended December 31, 2004, the Companyidentified certain errors in the calculation of the Company’s 2003 income taxprovision resulting in a restatement which decreased the provision for incometaxes and increased net income by $20.7 million ($0.20 per basic share) for theyear ended December 31, 2003. In addition, as a result of the correctionof the tax provision retained earnings was increased by $20.7 million,additional paid-in capital was increased $0.9 million, income taxes payable wasdecreased by $2.5 million, other long-term assets were increased by $21.6million, prepaids were increased by $2.8 million and other current assets werereduced by $5.3 million. There was no net effect on cash provided fromoperating activities as a result of this error. The identified errors were asfollows:

(a)    The Company incorrectly applied intercompanyprofit on sales from UTStarcom, Inc. (a U.S. company) to its Chineseaffiliates as profit on sales between the Chinese affiliates. As a result, whenthe intercompany profit was eliminated, the income tax on these sales waseliminated at the lower Chinese blended income tax rate instead of the higherU.S. Company income tax rate. This error resulted in the taxes on intercompanyprofit not being fully eliminated and the consolidated income tax provisionbeing overstated. In addition, the changes in the deferred tax balances relatedto intercompany profit in the beginning and ending inventory were notaccurately calculated. The impact of the correction of these errors was adecrease in income tax expense of $10.7 million.

(b)   The Company did not correctly record thegeneration and use of research and development credits and foreign tax creditsin the preparation of the 2003 tax provision. The impact of the correction ofthis error was a decrease in income tax expense of $7.2 million.

(c)    TheCompany incorrectly recognized permanent and temporary differences with respectto (1) earnings of a foreign subsidiary currently taxable in the U.S., (2) taxexempt interest income, and (3) amortization of intangible assets. Theimpact of the correction of these errors is a net decrease in income taxexpense of $3.0 million.

(d)   Theoriginal 2003 U.S. tax provision was computed using an incorrect pre-tax incomeamount resulting from the failure to properly account for certain intercompanytransactions in consolidation, resulting in an increase in income tax expenseof $1.6 million.

(e)    TheCompany did not properly identify and account for certain permanent differencesin the preparation of the 2003 income tax provision for the Chinese entities. Theimpact of the correction to these permanent differences is a net decrease inincome tax expense of $1.4 million.

In addition to the tax matters described above, theCompany also determined that a reclassification of reported 2003 results wasrequired. Specifically, cost of sales and other income both increased by $3.5 

88

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE24—RESTATEMENT OF FINANCIAL STATEMENTS (Continued)**

million for the year endedDecember 31, 2003 to properly classify certain incentive payments receivedfor exports and value added taxes in China.

In addition, the Company had not correctly identifieda related party that is deemed a variable interest entity (“VIE”) and for whichthe Company is considered the primary beneficiary as defined by FASBInterpretation No. 46 (“FIN 46”).

In December 2002, UTStarcom was granted a warrantfor ordinary shares in MDC Holding Limited (“MDC Holding”) with an exerciseprice of approximately $0.8 million for a 16% ownership interest. Upon furtheranalysis of the Company’s relationship with MDC Holding, management determinedthat certain of the Company’s employees participated in MDC Holding’s formationand initial capital contribution in 2001, and acquired an ownership interestrepresenting, at that time, approximately 67%. In addition, the same employeesparticipated in the formation and initial capital contribution of Beijing MDCTelecommunications Co, Ltd., an affiliate of MDC Holding (“MDC BJ”), in 2001. Certainof these employees held management positions at MDC and a Company executive,though not a shareholder of MDC, held an alternate Board of Director positionat MDC. In 2002, a venture capital fund affiliated with a principal shareholderof the Company made an additional capital investment in MDC Holding. MDCHolding issued 16.5 million ordinary shares to investors who participated inthe initial funding and 11.3 million preferred convertible shares to theventure capital fund.

As a subsequent event, on December 31, 2004, theCompany exercised $0.8 million of outstanding warrants for common stock of MDC,which represents 16% of ownership interest.

Management has determined that MDC Holding and its affiliatedentities, including MDC BJ (MDC Holding and such affiliated entities arereferred to, collectively, as “MDC”), are related parties of the Company andthat MDC is a VIE as defined by FIN 46. Management has also concluded that theCompany is the primary beneficiary because the Company and its related partieswill absorb a majority of MDC’s expected losses and receive a majority of MDC’sexpected returns and the Company’s activities are most closely aligned with MDC’sactivities. Therefore, the Company has consolidated the results of MDC as ofits adoption of FIN 46 in the fourth quarter of 2003.

The Company has corrected its 2003 financialstatements to reflect this consolidation of the VIE, MDC. At December 31,2003, this consolidation resulted in a $5.5 million increase in total assetsand a $0.7 million increase in total liabilities. There was no effect on netincome 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 MDC equipmentsubject to a revenue share arrangement. Due to the uncertainties surroundingthe customer’s subscriber income and ability to pay under this arrangement, theCompany determined that an impairment charge should have been recorded in 2003when these conditions should have been identified. Accordingly, an impairmentcharge of $7.4 million ($0.07 per basic share), net of tax, was recorded whichdecreased both 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)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all years represented;

(2)         Certain other long-termassets increased and intangible assets decrease by $1.7 million at December 31,2003;

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE 24—RESTATEMENTOF FINANCIAL STATEMENTS (Continued)**

(3)         Changes in restrictedcash had been incorrectly categorized as a part of operating cash flows insteadof investing cash flows in accordance with Statement of Financial AccountingStandards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly, theCompany 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 $3.2 millionand $21.3 million, respectively, and there was no change for 2001; and

(4)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirectors and associated transactions have been identified. See Note 22 to theConsolidated Financial Statements.

In connection with the restatement of the 2003Consolidated Financial Statements, certain 2002 financial statements amountswere reclassified to conform to the 2003 presentation. Specifically, prepaidsat December 31, 2002, which were previously reported as $47.2 millionincreased to $52.3 million, and other current assets at December 31, 2002,which were previously reported as $40.9 million decreased to $35.8 million. Thisreclassification presented the tax effect on intercompany profit in endinginventory in 2002 on a basis consistent with 2003 and had no impact onpreviously reported net income or stockholders’ equity.

Thefollowing table shows the effect of the restatement and other revisions inclassification (in thousands, except per share data):
| ** **                                                    | ** ** | **As Previously   Reported** | ** ** | **As Restated** | ** ** |
|---------------------------------------------------------------|------------|-----------------------------------|------------|----------------------|------------|
| As of December 31,  2003:                                     |       |                              |       |                 |       |
| Current assets:                                               |       |                              |       |                 |       |
| Cash and cash equivalents                                     |       | $                                 | 373,974    |                 | $          | 377,747 |   |
| Accounts receivable, net                                      |       | 324,921                           |       | 325,288              |       |
| Inventories, net                                              |       | 257,038                           |       | 257,065              |       |
| Deferred costs/Inventories at customer sites under  contracts |       | 558,977                           |       | 542,060              |       |
| Prepaid expenses                                              |       | 136,262                           |       | 139,103              |       |
| Other current assets                                          |       | 52,408                            |       | 48,499               |       |
| Property, plant and  equipment, net                           |       | 186,076                           |       | 187,039              |       |
| Goodwill and intangible  assets, net                          |       | 145,933                           |       | 144,231              |       |
| Other long-term assets                                        |       | 38,976                            |       | 70,625               |       |
| Current liabilities:                                          |       |                              |       |                 |       |
| Accounts payable                                              |       | 251,176                           |       | 251,122              |       |
| Income taxes  payable                                         |       | 16,780                            |       | 14,265               |       |
| Customer advances                                             |       | 458,654                           |       | 450,499              |       |
| Other current  liabilities                                    |       | 173,139                           |       | 173,911              |       |
| Long-term debt                                                |       | 402,500                           |       | 410,655              |       |
| Minority interest in  consolidated subsidiaries               |       | 560                               |       | 5,309                |       |
| Stockholders’ equity:                                    |       |                              |       |                 |       |
| Additional paid-in  capital                                   |       | 653,624                           |       | 654,483              |       |
| Retained earnings                                             |       | 229,777                           |       | 243,058              |       |
| For the year ended  December 31, 2003:                   |       |                              |       |                 |       |
| Net sales                                                     |       | 1,964,332                         |       | 1,965,187            |       |
|                                                               |            |                                   |            |                      |            |  |  |

** **

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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

**NOTE24—RESTATEMENT OF FINANCIAL STATEMENTS (Continued)**
| Cost of sales                                                                     |   | 1,328,164 |   | 1,340,802 |   |
|-----------------------------------------------------------------------------------|--------|-----------|--------|-----------|--------|
| Gross profit                                                                      |   | 636,168   |   | 624,385   |   |
| Selling, general and  administrative                                              |   | 187,128   |   | 188,339   |   |
| Operating income                                                                  |   | 274,732   |   | 261,738   |   |
| Interest expense                                                                  |   | (4,281    | )      | (4,671    | )      |
| Other income (expenses),  net                                                     |   | 1,384     |   | 4,921     |   |
| Income before income  taxes and minority interest                                 |   | 269,769   |   | 259,922   |   |
| Income tax expense                                                                |   | 67,442    |   | 45,399    |   |
| Minority interest in  (earnings) loss of consolidated subsidiaries                |   | (76       | )      | 1,009     |   |
| Net Income                                                                        |   | 202,251   |   | 215,532   |   |
| Earnings per share                                                                |   |      |   |      |   |
| —Basic                                                                       |   | 1.95      |   | 2.08      |   |
| —Diluted                                                                     |   | 1.64      |   | 1.75      |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                             |   |      |   |      |   |
| Net income                                                                        |   | 202,251   |   | 215,532   |   |
| Adjustment to  reconcile net income to net cash provided by operating activities: |   |      |   |      |   |
| Depreciation and amortization                                                     |   | 44,595    |   | 44,708    |   |
| Non-qualified  stock option exercise tax benefits                                 |   | 14,505    |   | 15,364    |   |
| Impairment of  long-term assets                                                   |   | —    |   | 8,762     |   |
| Deferred income  taxes                                                            |   | 5,567     |   | (10,675   | )      |
| Minority interest  in earnings of consolidated subsidiary                         |   | 76        |   | (1,009    | )      |
| Changes in operating  assets and liabilities:                                     |   |      |   |      |   |
| Accounts  receivable                                                              |   | (151,737  | )      | (151,863  | )      |
| Inventories                                                                       |   | (81,632   | )      | (81,618   | )      |
| Deferred  costs/Inventories at customer sites under contracts                     |   | (317,998  | )      | (301,081  | )      |
| Other current and  non-current assets                                             |   | (102,583  | )      | (120,206  | )      |
| Accounts payable                                                                  |   | (5,804    | )      | (5,906    | )      |
| Income taxes  payable                                                             |   | 3,777     |   | 1,262     |   |
| Customer advances                                                                 |   | 302,318   |   | 294,163   |   |
| Other current  liabilities                                                        |   | 64,140    |   | 64,681    |   |
| Net cash provided  by operating activities                                        |   | 50,534    |   | 45,173    |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                            |   |      |   |      |   |
| Additions to property,  plant and equipment                                       |   | (122,339  | )      | (123,214  | )      |
| Purchase of businesses,  net of cash acquired                                     |   | (111,720  | )      | (106,713  | )      |
| Change in restricted  cash                                                        |   | —    |   | (3,153    | )      |
| Net cash used in  investing activities                                            |   | (177,474  | )      | (176,495  | )      |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                            |   |      |   |      |   |
| Proceeds from borrowing                                                           |   | 414,821   |   | 422,976   |   |
| Net cash provided by  (used in) financing activities                              |   | 267,191   |   | 275,346   |   |
| Net increase  (decrease) in cash and cash equivalents                             |   | 142,030   |   | 145,803   |   |
| Cash and cash  equivalents at end of period                                       |   | 373,974   |   | 377,747   |   |

 

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**QUARTERLY RESULTS OFOPERATIONS (UNAUDITED)**

Amountsdiffer from that previously reported in the applicable quarters as reported inQuarterly Reports on Form 10-Q for each of the quarters ended March 31,June 30, and September 30, 2003 due to the correction of certainerrors in the 2003 income tax provision calculation, the reclassification ofcertain incentive payments received for exports and value added taxes in China,the consolidation of a variable interest entity and an asset impairment chargein the fourth quarter of 2003. Quarterly financial data for the periodsindicated are as follows:
| ** **             | ** ** | **Quarter ended**                                                | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **             | ** ** | **Dec. 31, 2003**                                           | ** ** | **Sept. 30, 2003** | ** ** | **June 30, 2003** | ** ** | **March 31, 2003** | ** ** |
| ** **             | ** ** | **As  Previously  Reported**                                          | ** ** | ** As Restated ** | ** ** | **As  Previously  Reported** | ** ** | ** As Restated ** | ** ** | **As  Previously  Reported** | ** ** | ** As Restated ** | ** ** | **As  Previously  Reported** | ** ** | ** As Restated ** | ** ** |
| ** **             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues(1)            |       | $                                                                     | 643,596    |   |   | $ | 644,451 |   |   | $ | 584,382 |   |   | $ | 584,382 |   |   | $ | 405,834 |   |   | $ | 405,834 |   |   | $ | 330,520 |   |   | $ | 330,520 |   |   |
| Gross  profit(1)(2)    |       | $                                                                     | 199,877    |   |   | $ | 188,094 |   |   | $ | 186,102 |   |   | $ | 186,102 |   |   | $ | 137,504 |   |   | $ | 137,504 |   |   | $ | 112,685 |   |   | $ | 112,685 |   |   |
| Net income(3)          |       | $                                                                     | 66,356     |   |   | $ | 65,710 |   |   | $ | 59,140 |   |   | $ | 65,204 |   |   | $ | 39,412 |   |   | $ | 43,450 |   |   | $ | 37,343 |   |   | $ | 41,168 |   |   |
| Earnings per share:(4) |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                  |       | $                                                                     | 0.64       |   |   | $ | 0.63 |   |   | $ | 0.58 |   |   | $ | 0.63 |   |   | $ | 0.39 |   |   | $ | 0.43 |   |   | $ | 0.35 |   |   | $ | 0.38 |   |   |
| Diluted                |       | $                                                                     | 0.52       |   |   | $ | 0.51 |   |   | $ | 0.46 |   |   | $ | 0.50 |   |   | $ | 0.33 |   |   | $ | 0.36 |   |   | $ | 0.33 |   |   | $ | 0.37 |   |   |

 
| ** **             | ** ** | **Quarter ended**                                                | ** ** |
|------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **             | ** ** | **Dec. 31, 2002**                                           | ** ** | **Sept. 30, 2002** | ** ** | **June 30, 2002** | ** ** | **March 31, 2002** | ** ** |
| ** **             | ** ** | **(In thousands, except per share amounts)** | ** ** |
| Revenues               |       | $                                                                     | 301,095    |   |   |   | $ | 265,513 |   |   |   | $ | 231,508 |   |   |   | $ | 183,690 |   |   |   |
| Gross profit           |       | $                                                                     | 101,101    |   |   |   | $ | 92,817 |   |   |   | $ | 85,912 |   |   |   | $ | 65,642 |   |   |   |
| Net income             |       | $                                                                     | 33,852     |   |   |   | $ | 30,749 |   |   |   | $ | 25,735 |   |   |   | $ | 17,526 |   |   |   |
| Earnings per share:(4) |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                  |       | $                                                                     | 0.32       |   |   |   | $ | 0.28 |   |   |   | $ | 0.23 |   |   |   | $ | 0.16 |   |   |   |
| Diluted                |       | $                                                                     | 0.30       |   |   |   | $ | 0.27 |   |   |   | $ | 0.22 |   |   |   | $ | 0.15 |   |   |   |

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(1)          Revenuesand gross profit in the fourth quarter of 2003 have been restated to reflectthe consolidation of MDC as discussed in this Note 24.

(2)          Amountsdiffer from that previously reported in the fourth quarter of 2003 as a resultof the reclassification of $3.5 million of incentive payments received forexports and value added taxes in China. Originally these payments were includedas an offset of cost of sales. These incentive payments have been reclassifiedas other income in the restated consolidated financial statements. Gross profitin the fourth quarter of 2003 has also been reduced by an asset impairment chargeof $8.8 million.

(3)          Netincome has been restated to reflect the correction of certain errors, asdiscussed in this Note 24. These corrections increased net income by $3.8million, $4.0 million, and $6.1 million for each of the first, second, and thirdquarters, respectively, and decreased net income by $0.6 million in the fourthquarter of 2003. Basic earnings per common shares increased $0.03, $0.04, $0.05for each of the first, second and third quarters of 2003, respectively, anddecreased $0.01 for the fourth quarter of 2003. Diluted earnings per commonshare increased $0.04, $0.03, and $0.04 for each of the first, second and thirdquarters of 2003, respectively, and decreased $0.01 for the fourth quarter of2003.

(4)          Earningsper share is computed independently for each of the quarters presented and,therefore, the sum of the quarterly net earnings per share may not equal theannual earnings per share.

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**ITEM 9A—CONTROLSAND PROCEDURES**

**Evaluationof Disclosure Controls and Procedures**

UTStarcom (the “Company”) maintains disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our reports under the Securities Exchange Act of 1934, asamended (the “Exchange Act”), is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’s rules andforms, and that such information is accumulated and communicated to the Company’smanagement, including our 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’s management carried out anevaluation under the supervision and with the participation of the Company’smanagement, including the CEO and CFO, as of December 31, 2003 of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures, as such term is defined under Rules 13a-15(e) and15d-15(e) under the Exchange Act. Based upon this evaluation, the CEO andCFO concluded that, as of December 31, 2003, the Company’s disclosurecontrols and procedures were not effective because of the material weaknessesdescribed below under “Identification of Material Weaknesses.”

The Company has restated its previously issuedconsolidated financial statements for the year ended December 31, 2003 andthe four quarters of 2003 as described more fully below under “The Restatement.”

After giving effect to theadjustments and other revisions in classification described under “TheRestatement,” the Company’s management believes that the consolidated financialstatements included in this Annual Report on Form 10-K fairlypresent in all material respects the Company’s financial condition, results ofoperations and cash flows for the periods presented and that this Annual Reporton Form 10-K does not contain any untrue statement of a materialfact or omit to state a material fact necessary to make the statements made, inlight of the circumstances under which such statements were made, notmisleading with respect to the period covered by this report.

**Identificationof Material Weaknesses**

In connection with the assessment by the Company’smanagement of the effectiveness of the Company’s internal control overfinancial reporting as of December 31, 2004, the Company’s managementidentified the material weaknesses described below, certain of whichcontributed to the restatement of the Company’s financial statements for eachof the quarters in 2003 and year ended December 31, 2003, as more fullydescribed under “The Restatement.”

1.     *The Company did not maintain effective controls over the financialreporting process due to an insufficient complement of personnel with a levelof accounting knowledge, experience and training in the application ofgenerally accepted accounting principles commensurate with the Company’sfinancial reporting requirements.* This material weakness contributedto the following control deficiencies relating to the preparation of theCompany’s financial statements which are individually considered to be materialweaknesses:

(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.

(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 

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identify, document andanalyze the conditions which should have been considered relative to theexistence and expected recoverability of inventory and deferred costs.

(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.

(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.

(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 thatyear-end accrued expense balances were completely and accurately recorded inthe proper period.

(f)            The Company did notmaintain effective controls over the financial reporting process to ensure the accuratepreparation and review of its consolidated 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 variable interestentities, intercompany profit eliminations and income tax accounting and properclassification of inventory and deferred costs, deferred revenue and accountsreceivable, and revenue and cost of goods sold. These control deficienciesresulted in certain audit adjustments to and additional disclosures made in the2003 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 2003financial statements to adjust the provision for income taxes, stockholders’equity, income taxes payable, other long-term assets, prepaids and othercurrent assets.

(h)         The Company did notmaintain effective controls in relation to segregation of duties and useraccess to certain Oracle business process applications nor were there effectivecontrols in place to monitor user access. There were instances in which eitherinformation technology or finance personnel maintained access to specificapplications within the Oracle environment beyond that needed to perform theirindividual job responsibilities. This deficiency related to financialreporting, inventory and purchasing applications in China and financialreporting applications in the United States.

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As discussed above,certain of these control deficiencies resulted in the restatement of theCompany’s financial statements for each of the quarters in 2003 and the yearended December 31, 2003, as more fully described under “The Restatement.”Additionally, the control deficiencies described above 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.     *The Company did not maintain effective controls over the identificationof and accounting for related party relationships and related partytransactions.* Specifically, the Company’s controls over its policiesand procedures were ineffective in identifying all significant related partyrelationships and transactions on a timely basis in order for suchrelationships and transactions to be appropriately reflected in the Company’s financialstatements in accordance with generally accepted accounting principles.Specifically, a previously undisclosed significant related party relationshipwas identified and determined to be a variable interest entity in which theCompany was determined to be the primary beneficiary. This control deficiencyresulted in a restatement of the Company’s financial statements for the yearended December 31, 2003. 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.

3.     *The Company did not maintain effective controls over the monitoring ofits accounting functions located outside of the U.S.*The Company’spolicies and procedures with respect to the review and supervision of itsaccounting operations in foreign locations, principally Japan and China, wereinadequate. Specifically, corporate senior financial management did not provideadequate oversight of the accounting functions based principally in Japan andChina nor was there sufficient and accurate information for monitoring thefinancial results of non-U.S. operations. Reviews of local financial resultswere inadequate in either their design or operation to detect errors to theCompany’s financial statements as described in items 1 and 2 above.Additionally, this control deficiency 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.

4.     *The Company did not maintain an effectivecontrol environment.*The financial reporting organizationalstructure was not adequate to support the size, complexity, operatingactivities or locations of the Company. Deficiencies in local accountingoperations, such as the lack of a senior finance director in China withsufficient depth and skill in the application of U.S. generally acceptedaccounting principles and inadequate understanding of U.S. generally accepted accountingprinciples by local accounting staff resulted in the adjustments to thefinancial statements as discussed in items 1—3 above. In addition, in somecases, certain key finance positions were staffed with individuals who did nothave the appropriate skills, training and experience to meet the objectives asoutlined in their job descriptions or that should be expected of these roles.Further, the following specific areas are examples of some of the corporatedepartments in the Company where additional skilled resources are required:tax, external financial reporting, revenue recognition, treasury, financialplanning and analysis and corporate accounting. This control deficiency,together with the material weaknesses described in items 1—3 above, indicatethat the Company did not maintain an effective control environment. Thesecontrol deficiencies could result in a material misstatement to annual orinterim financial statements that would not be prevented or detected.Accordingly, management has determined that this control deficiency constitutesa material weakness.

**The Restatement**

The restatement ofthe consolidated financial statements for the year ended December 31, 2003and the four quarters of 2003 related to the identification of certain errorsin the calculation of the Company’s 2003 income tax provision discovered aspart of the 2004 financial close process. The discovered error also affectedstockholders’ equity, income tax payable, other long-term assets, prepaids andother current 

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assets.There was no net effect on cash provided from operating activities as a resultof the restatement. The identified errors were as follows:

(a)    TheCompany incorrectly applied intercompany profit on sales from UTStarcom, Inc.(a U.S. company) to its Chinese affiliates as profit on sales between theChinese affiliates. As a result, when the intercompany profit was eliminated,the income tax on these sales was eliminated at the lower Chinese blendedincome tax rate instead of the higher U.S. Company income tax rate. This errorresulted in the taxes on intercompany profit not being fully eliminated and theconsolidated income tax provision being overstated. In addition, the changes inthe deferred tax balances related to intercompany profit in the beginning and endinginventory were not accurately calculated. The impact of the correction of theseerrors was a decrease in income tax expense.

(b)   The Companydid not correctly record the generation and use of research and developmentcredits and foreign tax credits in the preparation of the 2003 tax provision.The impact of the correction of this error was a decrease in income taxexpense.

(c)    TheCompany incorrectly recognized permanent and temporary differences with respectto (1) earnings of a foreign subsidiary currently taxable in the U.S., (2) taxexempt interest income, and (3) amortization of intangible assets. The impactof the correction of these errors is a net decrease in income tax expense.

(d)   Theoriginal 2003 U.S. tax provision was computed using an incorrect pre-tax incomeamount resulting from the failure to properly account for certain intercompanytransactions in consolidation, resulting in an increase in income tax expense.

(e)    TheCompany did not properly identify and account for certain permanent differencesin the preparation of the 2003 income tax provision for the Chinese entities.The impact of the correction to these permanent differences is a net decrease inincome tax expense.

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 for the year ended December 31, 2003to properly classify certain incentive payments for exports and value-addedtaxes in China.

In addition to the errors in the 2003 tax provision,the Company had not correctly identified a related party that is deemed avariable interest entity and for whom the Company is considered the primarybeneficiary in accordance with FASB Interpretation No. 46 (“FIN 46”). TheCompany has corrected its 2003 financial statements to reflect theconsolidation of this variable interest entity, MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliated entitiesare referred to, collectively, as “MDC”). At December 31, 2003, thisconsolidation resulted in an in increase in both assets and total liabilities. Therewas no effect on net income as a result of this consolidation.

Furthermore, an impairment charge was recorded toreflect an impairment of MDC equipment subject to a revenue share arrangement. Dueto the uncertainties surrounding the customer’s subscriber income and abilityto pay under this arrangement, the Company determined that an impairment chargeshould have been recorded in 2003 when these conditions should have beenidentified. Accordingly, an impairment charge was recorded, which decreasedboth total assets and equity at December 31, 2003.

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

(1)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all years represented;

(2)         Certain other long-termassets increased and intangible assets decreased at December 31, 2003;

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(3)         Changes in restrictedcash had been incorrectly categorized as a part of operating cash flows insteadof investing cash flows in accordance with Statement of Financial AccountingStandards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly, theCompany 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. There was nochange 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.

**Management’sRemediation Initiatives**

In response to the mattersdiscussed under “Identification of Material Weaknesses” above, the Companyplans to continue to review and make necessary changes to the overall design ofits control environment, including the roles and responsibilities of eachfunctional group within the organization and reporting structure, as well aspolicies and procedures to improve the overall internal control over financialreporting. In particular, the Company has implemented and/or plans to implementsubsequent to December 31, 2003 the specific measures described below toremediate the material weaknesses described above.

***Materialweaknesses described in item 1 of “Identification of Material Weaknesses”***

The Company’sfailure to have a sufficient complement of personnel with a level of accountingknowledge, experience and training in the application of generally acceptedaccounting principles commensurate with the Company’s financial reporting requirementscontributed to the Company’s failure to maintain effective controls over thefinancial reporting process. To remediate the material weaknesses described initem 1 of “Identification of Material Weaknesses,” the Company has implemented orplans to implement the measures described below, and will continue to evaluateand 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)          The Company’s chieffinancial officer, with assistance from senior financial staff and outsideconsultants, other than the Company’s independent registered public accountingfirm, has reviewed and will continue to review and adapt the overall design ofthe Company’s financial reporting structure, including the roles andresponsibilities of each functional group within the Company;

(b)         The Company hiredregional controllers with relevant accounting experience, skills and knowledgefor each of the Asia-Pacific region, the Central America and Latin Americaregion, the Europe, Middle East and Africa region and Japan in late 2004 andearly 2005;

(c)          The Company hired aconsolidation manager in China with relevant accounting experience, skills andknowledge in February 2005;

(d)         The Company hired asenior manager for SEC reporting with relevant accounting experience, skillsand knowledge in February 2005;

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(e)          The Company promoted anindividual within the Company with relevant accounting experience, skills andknowledge to become the controller of China operations in April 2005;

(f)            The Company retainedand intends to continue to retain the services of outside consultants, otherthan the Company’s independent registered public accounting firm, with relevantaccounting experience, skills and knowledge, working under the supervision anddirection of the Company’s management, to supplement the Company’s existingaccounting personnel;

(g)          The Company plans tohire and is actively recruiting a vice president of finance for the Company’sChina operations with extensive relevant accounting experience, skills andknowledge;

(h)         The Company plans tocontinue 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)            The Company in February 2005implemented an enhanced formal training process for the training of financialstaff and plans to continue this process to ensure that personnel have thenecessary competency, training and supervision for their assigned level ofresponsibility and the nature and complexity of the Company’s business.

2.     RevenueRecognition—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to revenue and deferred revenue accounts andassociated cost of sales. The Company’s planned remediation measures includethe following:

(a)          The Company plans todesign a contract review process in China requiring financial and legal staffto provide input during the contract negotiation process to ensure timelyidentification and accurate accounting treatment of non-standard contracts;

(b)         In March 2005, theCompany conducted a training seminar regarding revenue recognition, includingidentification 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

(c)          At the end of 2004, theCompany began requiring centralized retention of documentation evidencing proofof delivery and final acceptance for revenue recognition purposes.

3.     InventoryManagement—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to inventory, deferred costs, inventory reserveaccounts and cost of sales that have the potential of misstating inventory anddeferred costs and expected recoverability of inventory in future financialperiods. The Company’s planned remediation measures include the following:

(a)          The Company is in theprocess of continuing to upgrade and implement additional Oracle modules tomore effectively track inventory and evaluate deferred costs;

(b)         The Company implementedin late 2004, and plans to improve during 2005, its process to confirm theexistence of off-site inventory by systematically obtaining customerconfirmations, investigating discrepancies in the confirmed results, andproperly recording and reporting the results of the investigation;

(c)          During the fourthquarter of 2004, the Company initiated a process to accumulate informationnecessary to evaluate inventory and deferred cost contracts for impairment. TheCompany plans to continue to enhance this process in 2005 by bettercoordinating the accumulation of such information from non-U.S. locations;

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(d)         The Company plans toimplement in 2005 more robust controls over the release of costs to the incomestatement by better utilizing the Oracle system;

(e)          The Company is in theprocess of selecting a service provider with expertise and systems to moreeffectively manage and track the Company’s inventory in Japan, to whom theCompany plans to outsource this function in 2005; and

(f)            The Company plans todeploy the Oracle system in Japan by the third quarter of 2005.

4.     Accountingfor Goodwill—The Company’s planned remediation measures are intended to addressa material weakness related to the Company’s accounting for goodwill that hasthe potential of misstating goodwill amounts and the impairment of the Company’sgoodwill in future financial periods. The Company’s planned remediationmeasures include the following:

(a)          In the first quarter of2005, the Company implemented a process of reallocating goodwill to the Company’sfive reporting units in a manner reflective of the Company’s new organization;and

(b)         As part of the processdescribed in (a) above, the Company retained an outside consultant,working under the supervision and direction of the Company’s management, toassist in a valuation analysis that was used in the allocation process. TheCompany plans to use the consultant on at least an annual basis to assist in avaluation 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 its processesand procedures related to the translation of its accounts and transactionsdenominated in a currency other than U.S. dollars that has the potential ofmisstating various accounts in future financial periods. The Company’s plannedremediation measures include the implementation in the first quarter of 2005 ofan enhanced foreign exchange accounting process utilizing the actual month-endexchange 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 recordingof accrued expenses, primarily in China and Japan, that has the potential ofmisstating accrued expenses and related income statement accounts in futurefinancial periods. The Company’s planned remediation measures include theimplementation in the first quarter of 2005 of a process of enhanced review ofopen purchase orders and review of invoices and receipts after the end of eachquarter to ensure proper recording of accrued expenses and open purchase ordercommitments.

7.     AccuratePreparation and Review of Financial Statements, Reconciliations, JournalEntries and Segment Reporting—The Company’s planned remediation measures areintended to address material weaknesses related to the financial close andreporting process that have the potential of preventing the accuratepreparation and review of the Company’s consolidated financial statements infuture financial periods. The Company’s planned remediation measures includethe following:

(a)          During the first quarterof 2005, the Company began to implement, and plans to continue to improve, newand enhanced procedures to ensure that non-routine transactions are identifiedand escalated to senior financial management during the close process to helpensure proper accounting treatment. Specific steps include training and ongoingmonitoring of financial staff, expansion of the officer sub-certifications andactive review of contracts by knowledgeable financial and legal staff, from thecontract negotiation process through recognition of revenue for such contracts;

(b)         During the fourth quarterof 2004, the Company implemented, and plans to continue to enhance, itsmonth-end closing procedures, including reconciliations and controls overspreadsheets, and 

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standardized checklists toensure such procedures are consistently and effectively applied throughout theorganization; and

(c)          The Company plans toenhance in 2005 the communication and distribution of its accounting policiesand procedures and development of a process to more effectively accumulate andanalyze information required for financial statement footnote disclosures.

8.     Income TaxAnalysis—The Company’s planned remediation measures are intended to addressmaterial weaknesses related to the calculation of its provision for incometaxes that have the potential of misstating the provision for income taxes andrelated balance sheet accounts in future financial periods. The Company’splanned remediation measures include the following:

(a)          The Company plans tohire and train additional experienced tax managers and supporting staff in 2005to closely monitor reporting from China and Japan, to assist in managing auditsand to monitor tax compliance in China and Japan;

(b)         During the first quarterof 2005, the Company utilized outside consultants, other than the Company’sindependent 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 todevelop a comprehensive process to accumulate and organize financial and taxdata used in connection with income tax calculation and reporting.

9.     Utilizationof Automated Controls—The Company’s planned remediation measures are intendedto address a material weakness related to the segregation of duties and useraccess to certain Oracle business process applications that have the potentialof misstating of various accounts in future financial periods. The Company’splanned remediation measures include the following:

(a)          During the first quarterof 2005, the Company outsourced to a third-party expert the position of chiefsecurity officer to, among other duties, monitor access rights with respect tothe Oracle system and manage ongoing provisioning and changes;

(b)         The Company plans toimprove utilization of current functionality and continue to upgrade and expandfunctionality of the Oracle financial reporting system through utilization ofadditional modules to reduce manual procedures and the utilization ofspreadsheets;

(c)          The Company plans todeploy the Oracle system in Japan by the third quarter of 2005;

(d)         The Company is in theprocess of continuing to upgrade and implement additional Oracle modules tomore 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.

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***Materialweakness described in item 2 of “Identification of Material Weaknesses”***

The Company’sfailure to ensure that key management fully understood the nature and potentialsignificance of related parties and to ensure that a robust process for theidentification of related party transactions contributed to the Company’sfailure to maintain effective controls over the identification of andaccounting for related party relationships and related party transactions withthe Company. To remediate the material weakness described in item 2 of“Identification of Material Weaknesses,” the Company has implemented or plansto implement the measures described below, and will continue to evaluate andmay in the future implement additional measures.

1.                The Companyconducted 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 the firstquarter of 2005, the Company expanded the number of Company personnel requiredto certify to senior management with respect to identification, recognition anddisclosure of related party transactions for SEC reporting purposes, andrevised the Company’s internal certification process concerning identification,recognition and disclosure of related party transactions.

3.                The Company plansto continue to evaluate the Company’s procedures to ensure the identification,recognition and disclosure of related party transactions.

4.                The Company plansto conduct periodic training sessions with key managers and senior executivesregarding the Code of Conduct, including the identification, recognition anddisclosure 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.

***Materialweakness described in item 3 of “Identification of Material Weaknesses”***

Lack of clarity inroles and responsibilities in certain areas affecting the Company’s financialreporting structure contributed to a material weakness relating to themonitoring of non-U.S. operations. To remediate this material weakness,described in item 3 of “Identification of Material Weaknesses,” the Company hasimplemented or plans to implement the measures described under “—Materialweaknesses described in item 1 of ‘Identification of Material Weaknesses’—RemediationMeasures—1. General plan for hiring and training of personnel,” as well asthose described below. The Company will continue to evaluate and may in thefuture implement additional measures.

1.                The Companystreamlined the reporting structure between all non-U.S. accounting functionsand the comparable groups in the corporate headquarters, including tax,treasury and financial planning and analysis groups, in early 2005 to providefor direct reporting to, and oversight by, the U.S. corporate headquarters.

2.                The Company plansto expand the size of the internal audit group and the scope of the internalaudit group’s responsibilities to monitor non-U.S. operations through reviewsand audits of such locations.

3.                The Company’schief financial officer, with assistance from senior financial staff andoutside 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.

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.

***Materialweakness described in item 4 of “Identification of Material Weaknesses”***

The Company’sfailure to have sufficient personnel with knowledge, experience and training inthe application of generally accepted accounting principles commensurate withthe Company’s financial reporting requirements contributed to a materialweakness relating to the Company’s control environment. To remediate thismaterial weakness, described in item 4 of “Identification of MaterialWeaknesses,” the Company has implemented or plans to implement the measuresdescribed under “—Material weaknesses described in item 1 of ‘Identification ofMaterial Weaknesses’—Remediation Measures—1. General plan for hiring andtraining of personnel,” as well as those described below. The Company willcontinue to evaluate and may in the future implement additional measures.

1.                The Companystreamlined the reporting structure between all non-U.S. accounting functionsand the comparable groups in the corporate headquarters, including tax,treasury and financial planning and analysis groups, in early 2005 to providefor direct reporting to, and oversight by, the U.S. corporate headquarters.

2.                The Company plansto expand the size of the internal audit group and the scope of the internalaudit group’s responsibilities to monitor non-U.S. operations through reviewsand audits of such locations.

3.                The Company’s chieffinancial officer, with assistance from senior financial staff and outsideconsultants, other than the Company’s independent registered public accountingfirm, has reviewed and will continue to review and adapt the overall design ofthe 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.

**Changesin Internal Control over Financial Reporting**

There have not been any significant changes in ourinternal control over financial reporting (as such term is defined in Rules13a-15(f) and 15d-15(f) under the Exchange Act) during the fourth quarter of2003 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting. The discussion aboveunder “Management’s Remediation Initiatives” describes the material planned andactual changes to the Company’s internal control over financial reporting subsequentto December 31, 2003 that have materially affected, or are reasonable likely tomaterially affect, the Company’s internal control over financial reporting.

102

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**PART IV**

**ITEM15—EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K**

(a)          (1)         **FinancialStatements**—See Index to Consolidated Financial Statements andFinancial Statement Schedules at page 44 of this Form 10-K/A.

                          (2)         **FinancialStatement Schedules**—See Index to Consolidated Financial Statementsand Financial Statement Schedules at page 44 of this Form 10-K/A.
| **Exhibit   Number** | ** ** | **Description**                                                                                                                                                                                                           |
|----------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1(16)              |       | Thirteenth Amended and Restated Certificate of  Incorporation of UTStarcom, Inc., as amended.                                                                                                                        |
| 3.2(17)              |       | 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(12)              |       | 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. |
| 4.5(12)              |       | Registration Rights  Agreement between UTStarcom, Inc. and the Initial Purchasers named  therein dated as of March 12, 2003.                                                                                    |
| 4.6(16)*             |       | Registration Rights  Agreement, dated as of June 30, 2003, by and among UTStarcom, Inc.  and the shareholders of RollingStreams Systems, Ltd.                                                                   |
| 10.1(1)              |       | Form of  Indemnification Agreement.                                                                                                                                                                                  |
| 10.2(1)              |       | 1992 Omnibus Equity  Incentive Plan and form of related 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.                                                                                                                                                       |
| 10.6(1)              |       | Common Stock Purchase  Warrant dated February 5, 1998 between UTStarcom, Inc. and Lintech  Limited.                                                                                                             |
| 10.7(1)              |       | Common Stock Purchase  Warrant dated September 20, 1999 between UTStarcom, Inc. and Talent  Group International, Ltd.                                                                                           |
| 10.17(1)*            |       | Loan Agreement dated  June 15, 1998 between UTStarcom, Inc. and SOFTBANK Corp.                                                                                                                                  |
| 10.18(a)(1)*         |       | Loan Agreement dated  March 9, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                       |
| 10.18(b)(1)*         |       | Loan Agreement dated  June 7, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                        |
| 10.18(c)(1)*         |       | Loan Agreement dated  June 29, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                       |
| 10.18(d)(1)*         |       | Loan Agreement dated  July 7, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                        |
| 10.18(e)(1)*         |       | Loan Agreement dated  July 14, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                       |

103

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| 10.18(f)(1)* |   | Loan Agreement dated July 21, 1999 between Bank  of China and UTStarcom Hangzhou Telecommunications Co., Ltd.                                                                                                                      |
|--------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.18(g)(1)* |   | Loan Agreement dated  August 5, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                                    |
| 10.18(h)(1)* |   | Loan Agreement dated  August 17, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                                   |
| 10.18(i)(1)* |   | Loan Agreement dated  September 2, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                                 |
| 10.18(j)(1)* |   | Loan Agreement dated  September 17, 1999 between Bank of China and UTStarcom Hangzhou  Telecommunications Co., Ltd.                                                                                                                |
| 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.                                                                                                                                     |
| 10.39(2)*    |   | Technical Collaboration  Agreement between Sharp Corporation and UTStarcom, Inc., dated  March 31, 2000.                                                                                                                      |
| 10.40(2)*    |   | Parts Supply Agreement  between Sharp Corporation and UTStarcom, Inc. undated.                                                                                                                                                     |
| 10.41(3)*    |   | Joint Venture Agreement  between SOFTBANK Corporation and UTStarcom, Inc. dated May 29,  2000.                                                                                                                                |
| 10.42(3)*    |   | 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. |
| 10.43(3)*    |   | Supply Agreement between  Matsushita Electric Industrial Co., Ltd., Matsushita Communications  Industrial Co., Ltd., and UTStarcom, Inc. dated April 1, 2000.                                                                 |
| 10.54(8)*    |   | Software License  Agreement between UTStarcom, Inc. and DDI Corporation, Inc. dated  October 4, 2000.                                                                                                                    |
| 10.55(8)*    |   | Strategic Alliance,  Purchase and License Agreement between UTStarcom, Inc. and  Telecommunication D’Haiti S.A.M., dated December 5, 2000.                                                                               |

104

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| 10.56(4)*  |   | Assignment Agreement  between UTStarcom, Inc. and Stable Gain International Limited dated  July 24, 2000.                                                                      |
|------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.57(4)*  |   | Amendment No.1 to  July 24, 2000 Assignment Agreement between UTStarcom, Inc. and  Stable Gain International Limited, dated March 2, 2001.                                |
| 10.58(4)*  |   | Loan Agreement between  China Merchant Bank and UTStarcom (China) Co., Ltd., dated March 14,  2001.                                                                                 |
| 10.59(4)*  |   | Technical Service  Agreement between UTStarcom (China) Co., Ltd. and Hainan Xinhuangpu  Investment Co., Ltd., dated August 18, 2000.                                                |
| 10.60(4)*  |   | Assets Transfer  Agreement between Hainan Xinhuangpu Investment Co., Ltd. and UTStarcom  (China) Co., Ltd., dated August 18, 2000.                                                  |
| 10.61(4)*  |   | Equity Transferring  Agreement between Zhe Jiang Nantian Telecommunication Development Group Share  Company and UTStarcom, dated February 5, 2001.                                  |
| 10.65(6)*  |   | Strategic Alliance,  Purchase and License Agreement between UTStarcom, Inc. and  Telecommunications D’Haiti S.A.M. dated as of April 12, 2001.                            |
| 10.66(5)   |   | Amended 2001 Director  Option Plan.                                                                                                                                                      |
| 10.67(7)*  |   | Purchase Contract  between UTStarcom Inc. and Softbank BB Corporation, dated October 9,  2001.                                                                                      |
| 10.68(9)*  |   | Comprehensive Credit-Extension  Agreement between UTStarcom (China) Ltd. and China Everbright Bank, Chaoyang  Branch, Beijing, dated November 30, 2001.                             |
| 10.71(9)   |   | Lease Agreement between  UTStarcom, Inc. and Legend Tech., dated September 12, 2001.                                                                                           |
| 10.73(10)  |   | Change of Control  Severance Agreement between Gerald Soloway and UTStarcom, Inc. dated  April 12, 2002.                                                                       |
| 10.74(10)  |   | Change of Control  Severance Agreement between Howard Kwock and UTStarcom, Inc. dated  April 12, 2002.                                                                         |
| 10.75(10)  |   | Change of Control  Severance Agreement between Michael J. Sophie and UTStarcom, Inc. dated  April 12, 2002.                                                                    |
| 10.78(11)* |   | Professional Services  Agreement between UTStarcom, Inc. and N. Lohr Bangle, Jr. dated as  of September 10, 2002.                                                         |
| 10.80(11)* |   | 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. |
| 10.82(14)* |   | Joint Development  Agreement between Datang Mobile Communications Equipment Co., Ltd and  UTStarcom (China) Co., Ltd. dated November 22, 2002.                                      |
| 10.83(14)* |   | Broadband Access Network  General Terms and Conditions between Reliance Infocomm Limited and  UTStarcom, Inc. dated as of October 1, 2002.                                     |
| 10.84(14)* |   | Broadband Access  Equipment Contract between Reliance Infocomm Limited and UTStarcom, Inc.  dated as of October 1, 2002.                                                       |
| 10.85(14)* |   | Broadband Access  Services Contract between Reliance Infocomm Limited and UTStarcom, Inc.  dated as of October 1, 2002.                                                        |

105

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| 10.86(14)* |   | Broadband Access  Software Contract between Reliance Infocomm Limited and UTStarcom, Inc.  dated as of October 1, 2002.            |
|------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------|
| 10.87(13)* |   | Equipment Purchase  Agreement, dated as of February 4, 2003, by and between Tata  Teleservices Limited and UTStarcom, Inc.         |
| 10.88(15)  |   | UTStarcom, Inc.  2003 Nonstatutory Stock Option Plan                                                                                    |
| 10.89(18)  |   | Change of Control  Severance Agreement, dated as of January 17, 2003, by and between Hong  Liang Lu and UTStarcom, Inc.            |
| 10.90(18)  |   | Change of Control  Severance Agreement, dated as of January 31, 2003, by and between Ying  Wu and UTStarcom, Inc.                  |
| 10.91(18)  |   | Change of Control Severance Agreement, dated as of  January 31, 2003, by and between Shao-Ning Chou and  UTStarcom, Inc.           |
| 10.92(18)  |   | Change of Control  Severance Agreement, dated as of January 31, 2003, by and between  William X. Huang and UTStarcom, Inc.         |
| 10.93(18)* |   | Distributor Agreement,  dated as of October 21, 2003, by and between UTStarcom, Inc. and  Multidata.                               |
| 10.94(18)* |   | Amendment #1 to  Distributor Agreement, dated as of December 17, 2003, by and between  UTStarcom, Inc. and Multidata.              |
| 10.95(18)* |   | Revenue Sharing Purchase  Agreement, dated as of October 21, 2003 by and between  UTStarcom, Inc. and Multidata.                   |
| 10.96(18)* |   | Amendment #1 to Revenue  Sharing Purchase Agreement, dated as of December 17, 2003, by and  between UTStarcom, Inc. and Multidata. |
| 21.1(18)   |   | Subsidiaries of  UTStarcom.                                                                                                                  |
| 23.1       |   | Consent of  PricewaterhouseCoopers LLP.                                                                                                      |
| 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 ofthe exhibit have been omitted pursuant to an order granted by the Securitiesand Exchange Commission for confidential treatment.

(1)          Incorporated byreference to the registrant’s Registration Statement on Form S-1 (No. 333-93069),which became effective March 2, 2000.

(2)          Incorporated by referenceto the registrant’s Quarterly Report on Form 10-Q for the quarterended March 31, 2000.

(3)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2000.

(4)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended March 31, 2001.

(5)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2001.

106

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(6)          Incorporated byreference to the registrant’s Registration Statement on Form S-3,which became effective July 18, 2001.

(7)          Incorporated byreference to the registrant’s Quarterly Report on Form 10-Q for thequarter ended September 30, 2001.

(8)          Incorporated byreference to the registrant’s Annual Report on Form 10-K for theyear ended December 31, 2000.

(9)          Incorporated byreference to the registrant’s Annual Report on Form 10-K for theyear ended December 31, 2001.

(10)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2002.

(11)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2002.

(12)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2003.

(13)   Incorporated by reference tothe registrant’s Quarterly Report on Form 10-Q/A (Amendment No. 1)for the quarter ended March 31, 2003.

(14)   Incorporated by reference tothe registrant’s Annual Report on Form 10-K/A (Amendment No. 1)for the year ended December 31, 2002.

(15)   Incorporated by reference tothe registrant’s Registration Statement on Form S-8, which was filedon September 15, 2003.

(16)   Incorporated by reference tothe registrant’s Current Report on Form 8-K, which was filed on December 12,2003.

(17)   Incorporated by reference tothe registrant’s Current Report on Form 8-K, which was filed on January 13,2004.

(18)   Previously filed on March 9,2004.

(b)          Reports on Form 8-K:

1.                 On December 12,2003, UTStarcom filed with the SEC a Current Report on Form 8-K(dated December 12, 2003) under Items 5 and 7 in connection with itsrevised risk factors.

(c)           Exhibits

                           SeeItem 15(a)(3) above.

107

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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, hereunto duly authorized.
|                            | UTSTARCOM, INC. |
|----------------------------|-----------------|
| Date: April 13,  2005 | By:             | /s/  MICHAEL J. SOPHIE |
|                       | Name:           | Michael J. Sophie |
|                       | Title:          | Senior Vice  President of Finance and |
|                       |            | Chief Financial  Officer |

 

108

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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/A, 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  in the capacities and on the dates indicated:
| Signature                 | ** ** | **Title**                                               | ** ** | **Date**                   |
|---------------------------|------------|---------------------------------------------------------|------------|----------------------------|
| /s/ HONG LIANG LU         |       | President and Chief  Executive Officer (principal       |       |                       |
| Hong Liang Lu             |       | executive officer), Chairman of the Board of  Directors |       | April 13 , 2005  |
| /s/ MICHAEL J. SOPHIE     |       | Senior Vice President of  Finance and Chief Financial   |       |                       |
| Michael J. Sophie         |       | Officer (principal financial and accounting officer)    |       | April 13 , 2005  |
| /s/ BETSY S. ATKINS  |       | Director                                                |       |                       |
| Betsy S. Atkins           |       |                                                    |       | April 13 , 2005  |
| /s/ JEFF CLARKE      |       | Director                                                |       |                       |
| Jeff Clarke               |       |                                                    |       | April 13 , 2005  |
| /s/ LARRY D. HORNER  |       | Director                                                |       |                       |
| Larry D. Horner           |       |                                                    |       | April 13 , 2005  |
| /s/ ALLEN LENZMEIER  |       | Director                                                |       |                       |
| Allen Lenzmeier           |       |                                                    |       | April 13 , 2005  |
| /s/ THOMAS J. TOY    |       | Director                                                |       |                       |
| Thomas J. Toy             |       |                                                    |       | April 13 ,  2005 |
| /s/ YING WU               |       | Director                                                |       |                       |
| Ying Wu                   |       |                                                    |       | April 13 ,  2005 |

 

109

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRMONFINANCIAL STATEMENT SCHEDULES**

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

Our audits of the consolidated financial statements referred to in ourreport dated February 27, 2004, except for Note 24, as to which thedate is April 12, 2005, appearing inthis Annual Report on Form 10-K/A also included an audit of thefinancial statement schedules listed in Item 15(a)(2) of this Form 10-K.In our opinion, these financial statement schedules present fairly, in allmaterial respects, the information set forth therein when read in conjunctionwith the related consolidated financial statements.
| /s/ PricewaterhouseCoopers LLP                                                                                                     |
|------------------------------------------------------------------------------------------------------------------------------------|
| San Francisco,  California                                                                                                         |
| February 27, 2004, except for Note 24 to the  consolidated financial statements, as to which the date is April 12,  2005 |

 

110

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**SCHEDULE I**

**UTSTARCOM, INC. (UNCONSOLIDATED PARENT-COMPANYBASIS)REGISTRANT BALANCE SHEETS(in thousands, except share and per share data)**
| ** **                                                                                                                                                                    | ** ** | **December 31,**                   | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                                                                                                                    | ** ** | **2003**                                | ** ** | **2002** | ** ** |
| ** **                                                                                                                                                                    | ** ** | **  Restated(1)  ** | ** ** | ** ** | ** ** |
| **ASSETS**                                                                                                                                                                    |       |
| Current assets:                                                                                                                                                               |       |                                    |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                    |       |                                    | $          | 71,230 |   |   | $ | 117,003 |   |
| Short-term  investments                                                                                                                                                       |       |                                    | 9,139      |   |   | 80,662 |   |
| Accounts  receivable- unrelated party, net of allowances for doubtful accounts                                                                                                |       |                                    | 35,843     |   |   | 5,403 |   |
| Accounts  receivable- related party                                                                                                                                           |       |                                    | 43,944     |   |   | 835 |   |
| Accounts  receivable- intercompany                                                                                                                                            |       |                                    | 442,480    |   |   | 228,679 |   |
| Inventories                                                                                                                                                                   |       |                                    | 15,427     |   |   | 9,668 |   |
| Deferred  costs/Inventories at customer sites under contracts                                                                                                                 |       |                                    | 38,308     |   |   | 28,296 |   |
| Income tax  receivable                                                                                                                                                        |       |                                    | 10,677     |   |   | — |   |
| Prepaids                                                                                                                                                                      |       |                                    | 19,599     |   |   | 9,959 |   |
| Restricted cash  and short-term investments                                                                                                                                   |       |                                    | 20,461     |   |   | 9,779 |   |
| Deferred tax  assets                                                                                                                                                          |       |                                    | 7,432      |   |   | 8,586 |   |
| Other current  assets                                                                                                                                                         |       |                                    | 962        |   |   | 4,359 |   |
| Total current  assets                                                                                                                                                         |       |                                    | 715,502    |   |   | 503,229 |   |
| Property, plant  and equipment, net                                                                                                                                           |       |                                    | 32,031     |   |   | 12,254 |   |
| Note receivable                                                                                                                                                               |       |                                    | 11,222     |   |   | — |   |
| Investment in  affiliated companies                                                                                                                                           |       |                                    | 493,163    |   |   | 346,645 |   |
| Goodwill                                                                                                                                                                      |       |                                    | 98,015     |   |   | 43,542 |   |
| Intangible assets,  net                                                                                                                                                       |       |                                    | 44,949     |   |   | 5,014 |   |
| Deferred tax  assets                                                                                                                                                          |       |                                    | 11,070     |   |   | 9,335 |   |
| Other long-term  assets                                                                                                                                                       |       |                                    | 19,226     |   |   | 6,076 |   |
| Total assets                                                                                                                                                                  |       |                                    | $          | 1,425,178 |   |   | $ | 926,095 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                |       |
| Current liabilities:                                                                                                                                                          |       |                                    |       |   |   |   |   |
| Accounts payable                                                                                                                                                              |       |                                    | $          | 56,256 |   |   | $ | 113,180 |   |
| Income taxes  payable                                                                                                                                                         |       |                                    | —     |   |   | 6,099 |   |
| Customer advances                                                                                                                                                             |       |                                    | 13,940     |   |   | 17,141 |   |
| Deferred revenue                                                                                                                                                              |       |                                    | 24,966     |   |   | 1,793 |   |
| Other                                                                                                                                                                         |       |                                    | 36,196     |   |   | 21,487 |   |
| Total current  liabilities                                                                                                                                                    |       |                                    | 131,358    |   |   | 159,700 |   |
| Long-term  debt                                                                                                                                                               |       |                                    | 402,500    |   |   | — |   |
| Stockholders’ equity:                                                                                                                                                    |       |                                    |       |   |   |   |   |
| Common stock:  $.00125 par value; authorized: 750,000,000 shares; issued and  outstanding: 104,272,477 and 106,787,908 at December 31, 2003 and 2002,  respectively |       |                                    | 131        |   |   | 135 |   |
| Additional paid-in  capital                                                                                                                                                   |       |                                    | 654,483    |   |   | 658,546 |   |
| Deferred stock  compensation                                                                                                                                                  |       |                                    | (7,761     | ) |   | (11,766 | ) |
| Retained earnings                                                                                                                                                             |       |                                    | 243,058    |   |   | 120,520 |   |
| Receivable from  stockholders                                                                                                                                                 |       |                                    | —     |   |   | (282 | ) |
| Accumulated other  comprehensive income (loss)                                                                                                                                |       |                                    | 1,409      |   |   | (758 | ) |
| Total  stockholders’ equity                                                                                                                                              |       |                                    | 891,320    |   |   | 766,395 |   |
| Total liabilities  and stockholders’ equity                                                                                                                              |       |                                    | $          | 1,425,178 |   |   | $ | 926,095 |   |

----

(1)           See Note 2

The accompanying notes are an integral part of these financial statements.

111

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**SCHEDULE I**

**UTSTARCOM, INC. (UNCONSOLIDATED PARENT-COMPANYBASIS)**

**CONDENSED INFORMATION ASTO THERESULTS OF OPERATIONSOF THE REGISTRANT**

**(in thousands)**
| ** **                                    | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                    | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                    | ** ** | **Restated(1)**                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales                                     |       |                                        |       |   |   |   |   |
| Unrelated party                               |       | $                                           | 100,115    |   | $ | 35,365 |   | $ | 46,999 |   |
| Related party                                 |       | 184,436                                     |       | 16,038 |   | 13,900 |   |
| Inter-company                                 |       | 724,708                                     |       | 307,862 |   | 290,474 |   |
|                                          |       | 1,009,259                                   |       | 359,265 |   | 351,373 |   |
| Cost of sales                                 |       |                                        |       |   |   |   |   |
| Unrelated party                               |       | 50,157                                      |       | 24,306 |   | 26,908 |   |
| Related party                                 |       | 79,518                                      |       | 8,635 |   | 7,336 |   |
| Inter-company                                 |       | 646,016                                     |       | 276,603 |   | 260,751 |   |
| Gross profit                                  |       | 233,568                                     |       | 49,721 |   | 56,378 |   |
| Operating expenses:                           |       |                                        |       |   |   |   |   |
| Selling, general and administrative           |       | 57,666                                      |       | 38,793 |   | 25,199 |   |
| Research and development                      |       | 46,588                                      |       | 9,146 |   | 56,937 |   |
| In-process research and development costs     |       | 10,686                                      |       | 670 |   | 4,720 |   |
| Amortization of intangible assets             |       | 8,370                                       |       | 2,395 |   | 7,440 |   |
| Total operating  expenses                     |       | 123,310                                     |       | 51,004 |   | 94,296 |   |
| Operating income                              |       | 110,258                                     |       | (1,283 | ) | (37,918 | ) |
| Interest income                               |       | 2,709                                       |       | 4,454 |   | 7,832 |   |
| Interest expense                              |       | (4,142                                      | )          | (16 | ) | (644 | ) |
| Other income  (expenses), net                 |       | (18,404                                     | )          | 18,964 |   | (1,737 | ) |
| Equity in net  income of affiliated companies |       | 144,520                                     |       | 98,396 |   | 99,506 |   |
| Income before  income taxes                   |       | 234,941                                     |       | 120,515 |   | 67,039 |   |
| Income tax  expense                           |       | 19,409                                      |       | 12,653 |   | 10,085 |   |
| Net income                                    |       | $                                           | 215,532    |   | $ | 107,862 |   | $ | 56,954 |   |

 

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(1)          See Note 2

The accompanying notes are an integral part of these financial statements.

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**SCHEDULEI**

**UTSTARCOM, INC.(UNCONSOLIDATED PARENT-COMPANY BASIS)CONDENSED INFORMATION AS TO THE CASH FLOWS OF THE REGISTRANT(In thousands)**
| ** **                                                                     | ** ** | **Years ended December 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2003**                                    | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                     | ** ** | **Restated(1)**                             | ** ** | ** ** | ** ** | ** ** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |   |   |
| Net income                                                                     |       |                                        | $          | 215,532 |   |   | $ | 107,862 |   | $ | 56,954 |   |
| Adjustments to reconcile net income to net cash used  in operating activities: |       |                                        |       |   |   |   |   |   |   |
| Gain or change in ownership interest in subsidiary                             |       |                                        | —     |   |   | — |   | (277 | ) |
| Depreciation and amortization                                                  |       |                                        | 25,235     |   |   | 13,202 |   | 15,218 |   |
| Non-qualified stock option exercise tax  benefits                              |       |                                        | 15,364     |   |   | 6,538 |   | 15,311 |   |
| In-process research and development costs                                      |       |                                        | 10,686     |   |   | 670 |   | 4,720 |   |
| Impairment of long-term investments                                            |       |                                        | 75         |   |   | 4,442 |   | 3,376 |   |
| Loss on sale of assets                                                         |       |                                        | 620        |   |   | 449 |   | 527 |   |
| Warrants adjustment to fair value                                              |       |                                        | (424       | ) |   | — |   | — |   |
| Loss on sale of investment                                                     |       |                                        | 73         |   |   | — |   | — |   |
| Amortization of debt issuance costs                                            |       |                                        | 1,953      |   |   | — |   | — |   |
| Deferred income taxes                                                          |       |                                        | 4,471      |   |   | (6,980 | ) | (8,173 | ) |
| Allowance for doubtful accounts                                                |       |                                        | 813        |   |   | 124 |   |   |   |
| Inventory reserve                                                              |       |                                        | 3,328      |   |   | 5,446 |   | 11,143 |   |
| Stock compensation expense                                                     |       |                                        | 4,302      |   |   | 3,100 |   | 5,201 |   |
| Equity in net income of affiliated companies                                   |       |                                        | (145,375   | ) |   | (95,608 | ) | (97,816 | ) |
| Changes in operating assets and liabilities:                                   |       |                                        |       |   |   |   |   |   |   |
| Accounts receivable                                                            |       |                                        | (288,163   | ) |   | (120,122 | ) | (10,288 | ) |
| Inventories                                                                    |       |                                        | (2,742     | ) |   | (9,626 | ) | (11,583 | ) |
| Deferred costs/Inventories at customer sites under  contracts                  |       |                                        | (10,012    | ) |   | (18,815 | ) | 4,385 |   |
| Other current and non-current assets                                           |       |                                        | (15,611    | ) |   | (680 | ) | (10,887 | ) |
| Accounts payable                                                               |       |                                        | (56,924    | ) |   | 98,947 |   | (7,440 | ) |
| Income taxes payable                                                           |       |                                        | (6,099     | ) |   | (1,356 | ) | 3,459 |   |
| Customer advances                                                              |       |                                        | (3,201     | ) |   | 14,511 |   | (4,935 | ) |
| Deferred revenue                                                               |       |                                        | 13,505     |   |   | (4,451 | ) | 2,352 |   |
| Other current liabilities                                                      |       |                                        | 10,637     |   |   | 4,649 |   | 2,956 |   |
| Net cash used in  operating activities                                         |       |                                        | (221,957   | ) |   | 2,302 |   | (25,797 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |   |   |
| Additions to property,  plant and equipment                                    |       |                                        | (29,745    | ) |   | (980 | ) | (19,853 | ) |
| Investment in affiliates,  net of cash acquired                                |       |                                        | (8,920     | ) |   | (27,447 | ) | (18,135 | ) |
| Acquisition of business,  net of cash acquired                                 |       |                                        | (111,720   | ) |   | (17,705 | ) | — |   |
| Purchase of intangible  assets                                                 |       |                                        | (2,340     | ) |   | — |   | (1,078 | ) |
| Issuance of note  receivable to related party                                  |       |                                        | (10,071    | ) |   | — |   | — |   |
| Change in restricted cash                                                      |       |                                        | (10,682    | ) |   | (9,779 | ) | — |   |
| Purchase of short-term  investments                                            |       |                                        | (10,775    | ) |   | (85,688 | ) | (89,625 | ) |
| Sales of short-term  investments                                               |       |                                        | 93,246     |   |   | 89,916 |   | 87,516 |   |
| Net cash used in  investing activities                                         |       |                                        | (91,007    | ) |   | (51,683 | ) | (41,175 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                          |       |                                        |       |   |   |   |   |   |   |
| Issuance of stock, net of  expenses                                            |       |                                        | 58,878     |   |   | 40,928 |   | 160,550 |   |
| Repurchase of stock                                                            |       |                                        | (139,609   | ) |   | (72,929 | ) | — |   |
| Proceeds (payments) from  borrowing, net                                       |       |                                        | 391,431    |   |   | — |   | (5 | ) |
| Purchase of convertible  bond hedge and call option                            |       |                                        | (43,792    | ) |   | — |   | — |   |
| Proceeds from stockholder  notes                                               |       |                                        | 282        |   |   | 99 |   | (67 | ) |
| Net cash provided by  (used in) financing activities                           |       |                                        | 267,190    |   |   | (31,902 | ) | 160,478 |   |
| Effects of exchange rates  on cash                                             |       |                                        | 1          |   |   | 1 |   | (26 | ) |
| Net increase (decrease)  in cash and cash equivalents                          |       |                                        | (45,773    | ) |   | (81,282 | ) | 93,480 |   |
| Cash and cash equivalents  at beginning of period                              |       |                                        | 117,003    |   |   | 198,285 |   | 104,805 |   |
| Cash and cash equivalents  at end of period                                    |       |                                        | $          | 71,230 |   |   | $ | 117,003 |   | $ | 198,285 |   |

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(1)              See Note 2

 

The accompanying notes are an integral part of these financial statements.

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**SCHEDULE I**

**UTSTARCOM, INC.NOTES TO CONDENSED FINANCIAL STATEMENTS**

**NOTE 1—BASIS OF PRESENTATION**

UTStarcom, Inc., aDelaware corporation, is the parent company of all UTStarcom, Inc.subsidiaries. The accompanying condensed financial statements reflect the financialposition, results of operations and cash flows of UTStarcom, Inc. on aseparate basis. All subsidiaries of UTStarcom, Inc. are reflected asinvestments accounted for using the equity method. Accordingly, intercompanytransactions have not been eliminated. Inventory balances at December 31,2003, and 2002 include inter-company profit of $2.3 million and $1.9 million,respectively. No cash dividends were paid to UTStarcom, Inc. by itssubsidiaries during the three years ended December 31, 2003. For accountingpolicies and other information, see the Notes to Consolidated FinancialStatements included elsewhere herein.

**NOTE2—RESTATEMENT OF FINANCIAL STATEMENTS**

As discussed in Note 24 to the Consolidated FinancialStatements, the Company has restated its Consolidated Financial Statements forthe year ended December 31, 2003, and the quarters ended March 31,2003, June 30, 2003 and September 30, 2003 to correct errors andreflect certain corresponding changes described below. See Note 24 to theConsolidated Financial Statements for a discussion of the errors and the effecton the Consolidated Financial Statements. The Condensed Financial Statementshave been restated to reflect the effect of the restatement on the parentcompany.

The restatement corrects certain errors in the 2003income tax provision calculation. The correction of these errors decreased theprovision for income taxes by $20.2 million and increased equity in net incomeof affiliated companies by $0.6 million, resulting in an increase of net incomeof $20.7 million for the year ended December 31, 2003. In addition, as aresult of the correction of the tax provision, in the aggregate, retainedearnings was increased by $20.7 million, additional paid-in capital wasincreased $0.9 million, income tax receivable was increased by $4.7 million,prepaids were increased by $17.0 million, other current assets were reduced by$6.6 million, investment in affiliates was increased $0.6 million and otherlong-term assets were increased by $5.9 million. There was no net effect oncash provided from operating activities as a result of the restatement.

In addition to the errors in the 2003 tax provision,the Company did not correctly identify a related party who is deemed a variableinterest entity and with whom the Company is considered the primary beneficiaryin accordance with FASB Interpretation No. 46 (“FIN 46”). The Companyrestated its 2003 financial statements to reflect the consolidation of MDCHolding Limited (“MDC Holding”) and its affiliated entities (MDC Holding andsuch affiliated entities are referred to, collectively, as “MDC”). Thecorrection to include MDC in the consolidated financial statements had noimpact on parent-company basis financial statements of the parent, UTStarcom, Inc.

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. At December 31, 2003this impairment decreased equity in income of affiliated companies, net income,total assets, and equity by $7.4 million.

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

(1)         Cost of sales for relatedparty revenue transactions is presented separately from cost of sales fornon-related party revenue transactions for all years presented;

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

(3)         Changes in restrictedcash had been incorrectly categorized as a part of operating cash flows insteadof investing cash flows in accordance with Statement of Financial AccountingStandards No. 95, “Statement of Cash Flows,” (“SFAS 95”). Accordingly, theCompany 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 $10.7million and $9.8 million, respectively, and there was no change for 2001; and

(4)         A related party which is31% owned by an individual related to a member of the Company’s Board ofDirector and associated transactions have been identified. See Note 22 to theConsolidated Financial Statements.

In connection with the restatement of the 2003Consolidated Financial Statements, certain reclassifications have been made inthe 2002 financial statements to conform to the 2003 presentation. As a resultof this reclassification, prepaids at December 31, 2002 which werepreviously reported as $4.9 million increased to $10.0 million and deferred taxassets at December 31, 2002, which were previously reported as $13.6million decreased to $8.6 million. This reclassification had no impact onpreviously reported net income or stockholders’ equity.

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Thefollowing table shows the effect of the restatement and other revisions inclassification (in thousands, except per share data):
| ** **                                                                        | ** ** | **As Previously Reported** | ** ** | **As Restated** | ** ** |
|-----------------------------------------------------------------------------------|------------|--------------------------------------|------------|----------------------|------------|
| As of December 31,  2003:                                                    |       |                                 |       |                 |       |   |   |
| Income tax  receivable                                                            |       |                                 | $          | 5,930                |       |   | $ | 10,677 |   |
| Prepaids                                                                          |       |                                 | 2,605      |                 |       | 19,599 |   |
| Deferred tax  assets—current                                                 |       |                                 | 14,038     |                 |       | 7,432 |   |
| Investment in  affiliates                                                         |       |                                 | 500,036    |                 |       | 493,163 |   |
| Intangible  assets, net                                                           |       |                                 | 46,651     |                 |       | 44,949 |   |
| Deferred tax  assets                                                              |       |                                 | 5,192      |                 |       | 11,070 |   |
| Other long-term  assets                                                           |       |                                 | 17,524     |                 |       | 19,226 |   |
| Additional  paid-in capital                                                       |       |                                 | 653,624    |                 |       | 654,483 |   |
| Retained earnings                                                                 |       |                                 | 229,777    |                 |       | 243,058 |   |
| For the year ended  December 31, 2003:                                       |       |                                 |       |                 |       |   |   |
| Equity in income  of affiliated companies                                         |       |                                 | 151,393    |                 |       | 144,520 |   |
| Income before  income taxes                                                       |       |                                 | 241,814    |                 |       | 234,941 |   |
| Income tax  expense                                                               |       |                                 | 39,563     |                 |       | 19,409 |   |
| Net Income                                                                        |       |                                 | 202,251    |                 |       | 215,532 |   |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                            |       |                                 |       |                 |       |   |   |
| Net income                                                                        |       |                                 | 202,251    |                 |       | 215,532 |   |
| Adjustment to reconcile  net income to net cash provided by operating activities: |       |                                 |       |                 |       |   |   |
| Non-qualified  stock option exercise tax benefits                                 |       |                                 | 14,505     |                 |       | 15,364 |   |
| Deferred income  taxes                                                            |       |                                 | 3,743      |                 |       | 4,471 |   |
| Equity in net  income of affiliated companies                                     |       |                                 | (152,248   | )                    |       | (145,375 | ) |
| Changes in operating  assets and liabilities:                                     |       |                                 |       |                 |       |   |   |
| Other current and  non-current assets                                             |       |                                 | (4,552     | )                    |       | (15,611 | ) |
| Net cash provided  by operating activities                                        |       |                                 | (232,639   | )                    |       | (221,957 | ) |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                            |       |                                 |       |                 |       |   |   |
| Change in  restricted cash                                                        |       |                                 | —     |                 |       | (10,682 | ) |
| Net cash used in  investing activities                                            |       |                                 | (80,325    | )                    |       | (91,007 | ) |
|                                                                                   |            |                                      |            |                      |            |  |  |  |  |

 

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**SCHEDULE II**

**UTSTARCOM, INC.Valuation and Qualifying Accounts and ReservesFor the Years Ended December 31, 2003, 2002 and 2001.(In thousands)**
| **Description**                          | ** ** | ** ** | ** ** | **Balance at  beginning of  the period** | ** ** | **Additions  charged to  costs and    expenses  ** | ** ** | **Additions  assumed upon  acquisition** | ** ** | **Deductions**  | ** ** | **Balance at  end of the  period** | ** ** |
|------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|-----------------|------------|---------------------------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                                              | ** ** | ** **                                                                       | ** ** | **Restated(1)**                               | ** ** | **Restated(1)** | ** ** |
| ***Year  ended December 31, 2003*** |       |       |       |                                                    |       |                                                                             |       |                                          |       |            |       |                                              |       |   |   |   |   |   |   |   |   |
| Inventory reserve                        |       |       | $          | 18,287                                                  |       |                                                                             |       | $14,626                                       |       |            |       | $                                                 | 6,345      |   |   |   | $ | 9,698 |   |   |   | $ | 29,560 |   |   |
| Deferred cost  reserve                   |       |       | $          | 14,453                                                  |       |                                                                             |       | $                                             | —     |            |       |                                              | $          | — |   |   |   | $ | 6,845 |   |   |   | $ | 7,608 |   |   |
| Allowance 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*** |       |       |       |                                                    |       |                                                                             |       |                                          |       |            |       |                                              |       |   |   |   |   |   |   |   |   |
| Inventory reserve                        |       |       | $          | 17,744                                                  |       |                                                                             |       | $                                             | 7,084      |            |       |                                              | $          | — |   |   |   | $ | 6,541 |   |   |   | $ | 18,287 |   |   |
| Deferred cost  reserve                   |       |       | $          | 2,600                                                   |       |                                                                             |       | $                                             | 11,853     |            |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | 14,453 |   |   |
| Allowance 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 |   |   |
| ***Year  ended December 31, 2001*** |       |       |       |                                                    |       |                                                                             |       |                                          |       |            |       |                                              |       |   |   |   |   |   |   |   |   |
| Inventory reserve                        |       |       | $          | 8,025                                                   |       |                                                                             |       | $                                             | 9,719      |            |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | 17,744 |   |   |
| Deferred cost  reserve                   |       |       | $          | 1,176                                                   |       |                                                                             |       | $                                             | 1,424      |            |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | 2,600 |   |   |
| Allowance for  doubtful accounts         |       |       | $          | 12,835                                                  |       |                                                                             |       | $                                             | 6,218      |            |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | 19,053 |   |   |
| Accrued product  warranty costs          |       |       | $          | 3,133                                                   |       |                                                                             |       | $                                             | 6,792      |            |       |                                              | $          | — |   |   |   | $ | 3,654 |   |   |   | $ | 6,271 |   |   |
| Tax valuation allowance                  |       |       | $          | 4,153                                                   |       |                                                                             |       | $                                             | 634        |            |       |                                              | $          | — |   |   |   | $ | — |   |   |   | $ | 4,787 |   |   |

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(1)          In connection with thecorrection of the tax provision calculation, the tax valuation allowanceincreased from zero to $0.3 million at December 31, 2003. See Note 24 tothe consolidated financial statements.

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