**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D. C. 20549**

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**FORM 10-K**

**x**                               ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe Fiscal Year Ended December 31, 2006**

**o**                                  TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe transition period from                to                 **

**CommissionFile Number: 000-29661**

**UTSTARCOM, INC.**

(Exact name of registrantas specified in its charter)

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

 

**(510) 864-8800**

(Registrant’s telephonenumber, including area code)

Securities registered pursuant toSection 12(b) of the Act:

**Common Stock, $0.00125 parvalue**

(Title of class)

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

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Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act.  Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act.  Yes o  No x

Indicate by check markwhether the 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 o  No x

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 incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K. o

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of accelerated filer and largeaccelerated filer in Rule 12b-2 of the Exchange Act. (check one):
| Large accelerated filer x | Accelerated  filer o | Non-accelerated  filer o |
|--------------------------------|---------------------------|-------------------------------|

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

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of thelast business day of the registrant’s most recently completed second fiscalquarter (June 30, 2007) was approximately $580,658,573 based upon theclosing price of $5.61 reported for such date on The NASDAQ Stock Market, LLC.As of June 30, 2006, the aggregate market value of the voting stock heldby non-affiliates of the registrant was approximately $769,074,909 basedupon the closing price of $7.79 reported for such date on The NASDAQ StockMarket, LLC. For purposes of this disclosure, shares of Common Stock held bypersons who hold more than 10% of the outstanding shares of Common Stock andshares held by officers and directors of the registrant, have been excluded inthat such persons may be deemed to be affiliates. This determination is notnecessarily conclusive for other purposes.

As of September 30,2007, the registrant had 121,294,645 outstanding shares of Common Stock.

**DOCUMENTSINCORPORATED BY REFERENCE**

None

 

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**UTSTARCOM, INC.**

**TABLEOF CONTENTS**
|                | ** ** | ** **                                                                                                                           | ** ** | PAGE   | ** ** |
|----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------|------------|
| ** **     |       | Explanatory Note                                                                                                                     |       |   | 3          |   |   |
| PART I.   |       |                                                                                                                                 |       |   |       |   |   |
| Item 1.        |       | Business                                                                                                                             |       |   | 14         |   |   |
| Item 1A.       |       | Risk Factors                                                                                                                         |       |   | 28         |   |   |
| Item 1B.       |       | Unresolved Staff Comments                                                                                                            |       |   | 51         |   |   |
| Item 2.        |       | Properties                                                                                                                           |       |   | 52         |   |   |
| Item 3.        |       | Legal Proceedings                                                                                                                    |       |   | 52         |   |   |
| Item 4.        |       | Submission of Matters to a Vote  of Security Holders                                                                                 |       |   | 56         |   |   |
| PART II.  |       |                                                                                                                                 |       |   |       |   |   |
| Item 5.        |       | Market for  UTStarcom, Inc.’s Common Equity, Related Stockholder Matters, and Issuer  Purchases of Equity Securities  |       |   | 57         |   |   |
| Item 6.        |       | Selected Financial Data                                                                                                              |       |   | 60         |   |   |
| Item 7.        |       | Management’s Discussion and  Analysis of Financial Condition and Results of Operation and Quarterly  Financial Data (Unaudited) |       |   | 63         |   |   |
| Item 7A.       |       | Quantitative and Qualitative  Disclosures About Market Risk                                                                          |       |   | 125        |   |   |
| Item 8.        |       | Financial Statements and  Supplementary Data                                                                                         |       |   | 127        |   |   |
| Item 9.        |       | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                                                |       |   | 206        |   |   |
| Item 9A.       |       | Controls and Procedures                                                                                                              |       |   | 206        |   |   |
| Item 9B.       |       | Other Information                                                                                                                    |       |   | 221        |   |   |
| PART III. |       |                                                                                                                                 |       |   |       |   |   |
| Item 10.       |       | Directors, Executive  Officers and Corporate Governance                                                                              |       |   | 221        |   |   |
| Item 11.       |       | Executive Compensation                                                                                                               |       |   | 226        |   |   |
| Item 12.       |       | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                                      |       |   | 258        |   |   |
| Item 13.       |       | Certain Relationships and  Related Transactions and Director Independence                                                            |       |   | 262        |   |   |
| Item 14.       |       | Principal Accounting Fees  and Services                                                                                              |       |   | 264        |   |   |
| PART IV.  |       |                                                                                                                                 |       |   |       |   |   |
| Item 15.       |       | Exhibits and Financial  Statement Schedules                                                                                          |       |   | 265        |   |   |
|           |       | Exhibit Index                                                                                                                   |       |   |       |   |   |
| Signatures     |       |                                                                                                                                 | 270        |   |       |

 

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**ADDITIONALINFORMATION**

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

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

Unless specifically stated, information in this AnnualReport on Form 10-K assumes an exchange rate of $7.80 Renminbi forone U.S. dollar, the exchange rate in effect as of December 31, 2006.

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

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

This Annual Report onForm 10-K contains forward-looking statements. Beginning onpage 28 we discuss some of the risk factors that could cause our actualresults to differ materially from those provided in the forward-lookingstatements.

**EXPLANATORY NOTE**

Our consolidated financialstatements and financial information in this Annual Report on Form 10-Kfor accounting periods prior to the third quarter of 2006 have been restated.

***Summary***

In July 2007, the Company announced the AuditCommittee was conducting an independent investigation of historical sales withcertain customers in China and stated that it could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in previously issuedfinancial statements. In September 2007, the Company announced theinvestigative phase of the Audit Committee’s investigation had been completed.After consultation with and upon the recommendation of management, the AuditCommittee determined revenue in the Company’s Western Region of China wasrecognized earlier than it should have been and that the financial statementsfor the affected periods should be restated. The Company also announced thatits previously issued financial statements for each of the fiscal years endedDecember 31 in the period 2000 through 2005, the financial statements forthe interim periods contained in the Quarterly Reports on Form 10-Qfiled with respect to each of these years, and the quarterly reports onForm 10-Q filed with respect to each of the quarterly periods endedMarch 31 and June 30, 2006 should not be relied upon. In this Annual Report wehave corrected for the effects of net sales and related costs of net sales thatwere recorded earlier than they should have been. The net effect atDecember 31, 2005 was to reduce and defer previously recognized revenueand gross profit of $278.6 million and $97.7 million, respectively.

We alsoconducted a voluntary review of historical stock option practices underthe direction of the Nominating and Corporate Governance Committee of our Boardof Directors (“Governance Committee”). This review considered all option grantawards made in the period from February 29, 2000, shortly before theinitial public offering of our Common Stock, through August 2006 forcompliance with the various stock-based compensation accounting standardsapplicable during this period as well as the 

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rules of our stockoption plans. We found that in a number of instances we did not use the properdate as the measurement date in determining whether stock options had beenissued with exercise prices below the fair value of our common stock.Therefore, we have restated our previously issued financial statements for theyears ended December 31, 1998 through 2005 to account for an additional$25.5 million of stock compensation expense that should have been recognizedover the period together with an equal increase in additional paid-in capitalto recognize the intrinsic value assigned to these issuances of equitysecurities. Related adjustments of payroll and income taxes resulted in anadditional $0.5 million of expense being recognized for the 1998 through 2005period and total stockholders’ equity being reduced by a total of $2.1 millionat December 31, 2005. During the first six months of 2006 an additional$1.2 million of stock compensation expense was recognized, which reduces ourpreviously reported operating results for this period.

In restating ourpreviously issued financial statements for the investigations described above,we also corrected other previously reported amounts. We corrected our reporting for $80.3 million of net sales to certainthird party resellers and $41.2 million of associated cost of net sales in 2005to classify these amounts as related party net sales and related party cost ofnet sales classifications, respectively, because in 2006 we determined thatsales to these entities were, in substance, sales to one of our significantshareholders, SOFTBANK CORP. The accounts receivable from these sales wassimilarly reclassified into accounts receivable from related parties in our2005 balance sheets. We also corrected our reporting of $6.3 million oftime deposits at March 31 and June 30, 2006 because they did notmature within three months. Formerly the time deposits had been reported inerror as cash equivalents, but now these amounts are included in short-terminvestments in these balance sheets and in the statements of cash flows for theMarch and June 2006 reporting periods. The corrections for all 2006and 2005 interim periods have been recorded in the condensed consolidatedfinancial statements included in Exhibit 99.1 of this Annual Report.

None of these restatementshas any effect on any of our December 31 cash balances; however, cashequivalents were reduced in the March and June 2006 periods due tothe reclassifications described above.

Additional informationabout these restatements and their effects on our financial statements ispresented below as well as in the Notes to Consolidated Financial Statements.

***China SalesInvestigation***

TheAudit Committee of the Company’s Board of Directors (“Audit Committee”) engagedindependent counsel to conduct an investigation of sales in China following adetermination by the Internal Audit group that allegations of improperactivities in a sales office in the Western Region were credible. Theallegations were made by a Company employee using the Company’s whistle blowerprogram. The independent counsel engaged forensic accountants, and this groupis collectively referred to as the Investigating Team in the rest of thisdiscussion.

Inconducting its procedures, the Investigating Team found instances where thecustomer contracts that evidenced the arrangement contained obligations for theCompany to deliver software upgrades when and if made available for theequipment sold for no additional consideration and for an unspecified periodthat could extend over the term of the contract. This additional contractobligation is an element of “post contract support.” In these cases, theInvestigating Team found that the contract documentation for the sametransaction submitted by the sales office to the Company’s China headquartersfor accounting purposes and utilized by the Company in determining the amountof revenue recognized did not include evidence of such post contract supportobligations.

Accountingstandards governing revenue recognition for system sales require all revenue tobe deferred while there are undelivered elements under the arrangement unlessthe seller has established vendor specific objective evidence (“VSOE”) of fairvalue for such contract elements. Because these arrangements included suchundelivered elements, revenue should be deferred based on the VSOE of the fairvalue of the underlying elements. VSOE of fair value represents the price chargedwhen the same 

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element is sold separately. Since the Company does notsell this element separately, it has not established VSOE for such undeliveredelements, and as such the revenue from such contracts is required to bedeferred and recognized over the period the Company is obligated to provide thepost contract support.

The China salesinvestigation covered each of the seven years in the period endedDecember 31, 2006 and included: investigating approximately 1,200contracts in all of our five regions in China; reviews of the electronic filesof 45 employees; and formal interviews of 96 employees in China. Additionally,the China sales investigation included reviewing contract files, performingvarious financial analyses including comparison of payments received per ouraccounting records to the contract terms, and computer forensic procedureswhere destruction of electronic documents was suspected. In the aggregate, theInvestigating Team expended approximately 25,000 hours in conducting this investigation,which commenced in February 2007 and was completed in September 2007when the independent counsel and forensic accountants presented their finalreport to the Audit Committee. In July 2007, we announced the AuditCommittee was conducting an independent investigation of historical sales withcertain customers in China and we stated that we could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in our previously issuedfinancial statements.

Uponcompletion of the investigative phase of the independent investigation by theAudit Committee, our management:

·       conductedfollow-up procedures to attempt to locate any additional relevant informationto ensure the Company considered all available information and documents;

·       evaluatedthe accounting for identified system sales using the contract template anddocumentation found in the sales contract files from the Western Regionoffices. This included calculating the financial statement effects ofcorrecting the accounting for all system sales where the contract templatefound at our sales offices contained post contract support obligations torecognize revenue and cost of net sales over estimated period of post contractsupport;

·       concludedthat as a result of the existence of this undelivered post contract supportobligation our previously issued financial statements should be restated todefer system sales contract revenue and the related cost of net sales over theestimated period of post contract support when a contract contained unspecifiedsoftware upgrade rights.

The Audit Committeeconcurred with management’s decisions.

Theeffect of correcting improperly recognized revenue and cost of net sales is to(reduce) increase previously reported net sales, gross profit and net income bythe following amounts (in thousands of dollars):

| ** **                                 | ** ** | ** ** | ** ** | ** **         | ** ** | ** **            | ** ** |
|--------------------------------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|
| **Year ended December 31,** | ** ** | ** ** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
| 2000                                       |       | $          | (12,408    | )                  |       | $                     | (5,294     | ) |   |   | $ | (4,781 | ) |   |
| 2001                                       |       | (17,154    | )          |               | (6,330     | )                     |       |   | (5,779 | ) |   |
| 2002                                       |       | (64,732    | )          |               | (22,924    | )                     |       |   | (19,697 | ) |   |
| 2003                                       |       | (21,060    | )          |               | (8,014     | )                     |       |   | (6,382 | ) |   |
| Totals through  December 31, 2003     |       | (115,354   | )          |               | (42,562    | )                     |       |   | (36,639 | ) |   |
| 2004                                       |       | (104,965   | )          |               | (27,241    | )                     |       |   | (18,594 | ) |   |
| 2005                                       |       | (58,232    | )          |               | (27,863    | )                     |       |   | (42,433 | ) |   |
| 2000 - 2005 Total                          |       | (278,551   | )          |               | (97,666    | )                     |       |   | (97,666 | ) |   |
|                                            |            |            |            |                    |            |                       |            |  |  |  |  |  |  |  |  |  |

 

| **2006 quarter ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| March 31                    |       | 5,410      |       |       | 1,360      |       |       |       | 1,360      |   |   |
| June 30                     |       | 2,380      |       |       | (371       | )          |       |       | (371       | ) |   |
| Total China Sales  Restatement   |       | $          | (270,761   | )          |       | $          | (96,677    | )          |       |   | $ | (96,677 | ) |   |
|                                  |            |            |            |            |            |            |            |            |            |  |  |  |  |  |  |  |

 

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The cumulative effect of all of the China salesrestatement adjustments to our consolidated balance sheet as ofDecember 31, 2003 resulted in a decrease in retained earnings of $36.6million, an increase in deferred revenue of $115.4 million to account forpreviously recognized sales, an increase in deferred costs of $75.7 million toaccount for previously recognized cost of net sales, and an increase indeferred tax assets of $3.0 million. In our consolidated balance sheet atDecember 31, 2006, deferred revenue is $275.7 million, of which $35.6million is classified as current and $240.1 million as non-current, and thedeferred costs balance is $176.6 million. These amounts will be recognized inour consolidated statements of operations over the estimated remaining periodof post contract support.

Upon completing its investigation, the Audit Committeeconcluded that the conditions and practices relating to systems contractsprevalent in the Western Region resulted primarily from the failure to preventor detect instances of override related to controls in China over customer agreements,lack of proper management oversight, unclear record retention policies andprocedures relating to systems contracts, and inadequate employee training. TheInvestigating Team and the Audit Committee also concluded that with respect tofour regions other than the Western Region there was no evidence of fraud ormisconduct or reason to suspect such occurred. The Investigating Team and theAudit Committee also concluded that there was no credible evidence of knowledgeby senior management in China or the United States of the conditions andpractices related to the Western Region of China that were discovered in theinvestigation. The Audit Committee concluded that local management in severalof the sales offices in the Western Region of China did not submit appropriateinformation to the Company’s senior management in China and the United States.Therefore, in prior years, neither the Company’s management nor the Company’s independentregistered accounting firm were able to properly evaluate the effect of thatinformation on revenue recognition. The Audit Committee also concluded thatcertain members of management in China bear varying degrees of responsibilityfor inadequate oversight of activities. As a result, certain employees in Chinahave either been terminated or placed on suspension for failure to provideadequate oversight of activities.

We have restructured themanagement of the Western Region sales organization and are working to identifyand implement changes to our policies and procedures and enhance employeetraining to improve internal control consciousness and lessen the possibilityof accounting errors occurring in the future.

***Stock Option Accounting***

In November 2006, we announced we had commenced avoluntary review of historical stock option practices under the leadership ofthe Governance Committee following a preliminary review by management whichidentified potential deficiencies and discrepancies in the documentation ofstock option grants. The review considered all option grant awards made in theperiod from February 29, 2000, shortly before the initial public offeringof our Common Stock, through August 2006 (“Review Period”) for compliancewith the various stock-based compensation accounting standards applicableduring the Review Period as well as the rules of our stock option plans.The Governance Committee engaged independent outside legal counsel to assist inthe review who, in turn, engaged forensic accountants. (Separate law firms andseparate forensic accounting firms were engaged by the Audit Committee and theGovernance Committee for the China sales investigation and the stock optionaccounting review.) In the rest of this discussion, this group collectively isreferred to as the Stock Option Review Team and their actions and activitiesare referred to as the Stock Option Review. The Stock Option Review Teammembers spent over 11,000 hours in this review, and the Governance Committeemet with the Stock Option Review Team on more than a dozen occasions toreceive, discuss, and consider the Stock Option Review Team’s information andfindings.

At the time the review commenced, the GovernanceCommittee consisted of three members of the Board of Directors, all of whom areindependent directors. The Committee decided to delegate supervision of thereview to Mr. Jeff Clarke, its Chairman, who joined our Board in 2005 andhad not 

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served on the CompensationCommittee of the Board of Directors (“Compensation Committee”) during theperiod under review. The Governance Committee also consisted of two otherindependent directors, Mr. Larry D. Horner and Mr. Thomas Toy, whoalso serve on the Board’s Compensation Committee. Mr. Allen Lenzmeier wasappointed to the Governance Committee on April 27, 2007.

Review proceduresincluded:

·       interviewsof individuals involved with granting, advising, administering, or accountingfor stock options, including current and former: management, members of theBoard of Directors, employees, and non-employee professionals;

·       reviewof relevant stock administration, human resource, legal, and finance departmentfiles and records;

·       reviewof stock option grant information in select employee personnel files;

·       reviewby at least 30 attorneys and 15 forensic accountants of approximately 250,000potentially relevant e-mails and documents in electronic format selectedthrough electronic discovery techniques from over 1.8 million electronicdocuments processed;

·       reviewof the electronic database of the Company’s stock option activity maintained bya third party along with communications to and from this service provider;

·       reconciliationof grant activity from approval documents executed by the CompensationCommittee with the electronic database;

·       reconciliationof stock option grant, exercise, and cancellation information from SEC filingswith select employee personnel files and the electronic database;

·       statisticaland judgmental pattern analysis;

·       follow-upon matters raising questions about the option granting process and its history,conduct of those involved with granting, advising, administering, or accountingfor stock options, or the accounting treatment for stock options; and

·       follow-upon items or issues requested or identified by management or the Company’sindependent registered public accounting firm.

The Stock Option Review Team, management, and theGovernance Committee decided to group stock option grants into six awardcategories based on differences in what constituted substantive approval foreach category under our stock option granting practices as well as givingconsideration to the risk of intentional misstatement of the grant date.Guidance in a September 19, 2006 letter publicly issued by the SEC’s ChiefAccountant focuses on the concept that a measurement date under AccountingPrinciples Board Opinion No. 25 *Accounting for StockIssued to Employees*(“APB 25”), the accounting standard governingour stock option accounting through 2005, does not occur until the number ofshares an individual employee is entitled to receive and the exercise price isdetermined with finality (i.e., no longer subject to change). This is the dateon which substantive approval occurred, and depending on a company’s facts andcircumstances the guidance from the SEC discussed above recognizes a companymay determine that the measurement date for some stock option grants may occurbefore all required granting actions have occurred—such as final approval bythe Compensation Committee. This alternative is available only when a review ofall facts and circumstances supports a conclusion that substantive approvaloccurs earlier than when all required granting actions have occurred and thereis no evidence of fraudulent or manipulative conduct in the company’s optiongranting practices.

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In determining themeasurement date to be used, the Stock Option Review Team, management, and theGovernance Committee agreed to use the following definitions as constitutingthe proper measurement date, and generally these dates were used in testing thestated grant dates or establishing corrected measurement dates:

| **Discretionary Director and Officer Grants** |   | The date of a Compensation Committee meeting where the grant was approved or  the date the final Compensation Committee signer approved the grant when  approval occurred through unanimous written consent documents (“UWC”).                                                                                                                                                                                                                                                           |
|----------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Automatic Director  Grants**                     |   | The date specified in  the relevant stock option plan.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| **Broadbase**                                      |   | The date the grantee  list, including the allocation of shares to individual grantees, was  complete. Compensation Committee approval was considered perfunctory due to  delegation of authority to management.                                                                                                                                                                                                                                                                                    |
| **Acquisition**                                    |   | The first Compensation  Committee meeting following the acquisition, provided grantees had received  employment offer letters stating the number of stock options to be granted  before such date, because this was the date at which the option exercise  price was established. Compensation Committee approval was considered  perfunctory due to delegation of authority to management.                                                                                                        |
| **New Hire**                                       |   | The first scheduled  Compensation Committee meeting following the first day of employment, because  this was the date at which the option exercise price was established. The  number of options was based on either grant amounts specified in an  employment offer letter or, in some cases, on a matrix that assigned grant  amounts based on position and level within the Company. Compensation  Committee approval was considered perfunctory due to delegation of authority  to management. |
| **Other Merit**                                    |   | The date the grantee  list, including the allocation of shares to grantees, was substantially  complete. Compensation Committee approval was considered perfunctory due to  delegation of authority to management.                                                                                                                                                                                                                                                                                 |

 

For 12 tested grant dates where a correctedmeasurement date was required, the Stock Option Review Team and management wereunable to locate sufficient evidence to establish a corrected measurement dateusing our established criteria for the applicable option grant type. In thesesituations alternative available evidence was used to establish the correctedmeasurement date.

During the period covered by the Stock Option Review,we granted stock options on approximately 34 million shares of our Common Stockat 197 grant dates. The review specifically examined the appropriateness of thestated grant date for approximately 90% of the stock options granted, includingall stock option grants made to directors and officers, all broadbase grantsand all option grants made in connection with business acquisitions.

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Thefindings of this review are summarized as follows:

| ** **                                 | ** ** | ** **         | ** ** | ** ** | ** ** | ** **         | ** ** | **Measurement date changed** | ** ** |
|--------------------------------------------|------------|--------------------|------------|------------|------------|--------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | ** **         | ** ** | ** ** | ** ** | ** **         | ** ** | **additional**                         | ** ** | **no additional** | ** ** |
| ** **                                 | ** ** | **Number of** | ** ** | **Grants** | ** ** | **No change** | ** ** | **compensation**                       | ** ** | **compensation** | ** ** |
| **Grant Type**                        | ** ** | ** **         | ** ** | **grants** | ** ** | **tested**         | ** ** | **required**                           | ** ** | **expense required** | ** ** | **expense required** (1) | ** ** |
| Discretionary  Director & Officer |       |               | 16         |       |       |               | 16         |                                   |       |   | 8 |   |   |   | 4 |   |   |   | 4 |   |   |
| Automatic  Director                        |       |               | 5          |       |       |               | 5          |                                   |       |   | 5 |   |   |   | — |   |   |   | — |   |   |
| Broadbase                                  |       |               | 8          |       |       |               | 8          |                                   |       |   | — |   |   |   | 6 |   |   |   | 2 |   |   |
| Acquisition                                |       |               | 10         |       |       |               | 10         |                                   |       |   | 10 |   |   |   | — |   |   |   | — |   |   |
| New Hire                                   |       |               | 166        |       |       |               | 48         |                                   |       |   | 48 |   |   |   | — |   |   |   | — |   |   |
| Other Merit                                |       |               | 96         |       |       |               | 41         |                                   |       |   | 4 |   |   |   | 21 |   |   |   | 16 |   |   |
| Total                                      |       |               | 301        | (2)        |       |               | 128        |                                   |       |   | 75 |   |   |   | 31 |   |   |   | 22 |   |   |
|                                            |            |                    |            |            |            |                    |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          Under APB 25 there is noexpense adjustment arising from using the corrected measurement date for thesegrants because the amount the employee would have to pay to exercise thesestock option grants exceeded the quoted market price of our Common Stock at thecorrected measurement date, and therefore, these stock option grants containedno intrinsic value at the corrected measurement date.

(2)          The number of grantsexceeds the number of grant dates because on certain grant dates more than onecategory of stock option grants were approved.

In late January 2007 the Governance Committeereported its interim findings concerning the use of incorrect measurement datesin our stock option accounting under APB 25 to our Board of Directors. OnFebruary 1, 2007, the Audit Committee of the Board of Directors thenconcluded, in consultation with and upon the recommendation of management, thatwe should correct for errors in previously reported stock-based compensationexpense through restatement of our previously issued financial statements andthat our previously issued financial statements for all periods should nolonger be relied upon. We communicated this decision in a February 1, 2007public announcement.

A non-cash compensation charge, to be recognized as anexpense over a grantee’s service period, arises under APB 25 if a stock optionhas intrinsic value at its measurement date. This intrinsic value is measured bythe excess, if any, of the fair value at the date of grant of the underlyingcommon stock over the stock option’s exercise price. Our practice has been togrant stock options with exercise prices equal to the closing price of ourCommon Stock at each grant date, to use the grant date as the measurement datefor stock-based compensation purposes, and as such previously we had determinedthe granted stock options had no intrinsic value at their grant dates and nocompensation expense was recognized. However, APB 25 states the measurementdate does not occur until all essential actions necessary to grant the optionare completed, including the final determination of both the number of sharesto be granted to each employee or director and the exercise price, and theoption grant is approved by those with requisite authority. This is reinforcedby the September 19, 2006 letter issued by the SEC’s Chief Accountantwhich focuses on the need for the number of shares and exercise price of anaward to an individual to be finalized to have a measurement date. This letterclarifies the SEC staff’s view that if it is possible that those terms couldchange, a measurement date has not occurred, even if the award’s terms are notactually changed.

Based on theavailable evidence, the review found that the number of shares an individualemployee was entitled to receive and/or the exercise price was not determinedwith finality at the stated grant date on 53 tested grant dates, and we shouldhave used a later date as the measurement date. The principal reasons for thestated grant date not qualifying as the measurement date under APB 25 include:

·       certainlistings of grantees, below officer level, were incomplete and added to ormodified by stock option administration personnel after the grant was approvedby the Compensation Committee;

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·       forcertain grants where Compensation Committee approval was not consideredperfunctory, the date a UWC document was sent to Compensation Committee membersfor approval was used as the stated grant date for some discretionary officerand director grants rather than the date the UWC was signed by all CompensationCommittee members and therefore became effective;

·       theStock Option Review Team was unable to locate contemporaneous documentation of somedirector and officer, broadbase, new hire, and other merit grants.

During the review the Company also discovered a stockoption grant to a former officer that was modified in 1998 in connection withhis termination of employment. This change was never included in the Company’sstock option grant records and the additional compensation expense resultingfrom the change in the option’s terms (approximately $1.2 million) was notrecorded previously. This discovery is consistent with the Stock Option ReviewTeam’s finding that in certain instances there was a lack of formaldocumentation in the stock option granting process and/or expecteddocumentation is missing from the stock option administration files. Inaddition, the Stock Option Review Team found that, in many instances, there wasa lack of self-authenticating evidence to corroborate that cash exercises werecontemporaneous. As a result, the findings on the issue of backdating of cashexercises were inconclusive.

We are restating our consolidated financial statementsto recognize additional non-cash stock-based compensation expense arising fromusing corrected measurement dates for certain stock option grants made duringthe years 2000 through 2005 and to reflect the modification of the 1998 grant describedabove. Consistent with our historical accounting policy this additionalstock-based compensation expense is being recognized on an accelerated basis bytreating each vesting tranche as a separate stock option grant (gradedvesting).

Our accounting for stock-based compensation changed toa fair value based method in 2006 when, as required by accounting standards, weceased accounting for stock-based compensation under the intrinsic value methodpursuant to APB 25 and began accounting for stock-based compensation underStatement of Financial Accounting Standards 123(R) *Share-BasedPayments*(“SFAS 123(R)”). Under this method all stock option grantshave a fair value determined using an option pricing model, and such fair valueis used to recognize non-cash stock-based compensation expense. We arerestating our unaudited condensed consolidated financial statements for thefirst and second fiscal quarters of 2006, included in Exhibit 99.1, torecognize changes in non-cash stock-based compensation expense that arose froma re-determination of the fair value of stock options granted in 2005 and priorwhere the Governance Committee’s review resulted in a corrected measurementdate. By January 1, 2006, of the 17.9 million options granted in 2000 - 2005where corrections were made to the measurement dates in the Stock OptionReview, 4.4 million options with corrected measurement dates granted in2000 and 2001 had fully vested. Therefore, the fair values of the outstandingand unvested portion of the remaining 13.5 million stock options granted in2002 - 2005 with incorrect measurement dates were recalculated.We are also recording additional non-cash stock-based compensation expense inthe first two quarters of 2006 arising from correcting the measurement date forstock option grants to three individuals in this period. We recognize stockcompensation expense on a straight-line basis under SFAS 123(R).

Those stock option grants with corrected measurementdates have also been restated using the fair value based measurement principlesof Statement of Financial Accounting Standards 123 *Accountingfor Stock-Based Compensation*(“SFAS 123”) to present, in Note 2, “Restatement of FinancialStatements” of Notes to Consolidated Financial Statements contained in Item 8of this Annual Report, the pro forma effect on stock-based compensationexpense, net income (loss), and earnings (loss) per share amounts in 2004 and2005 of using the fair value based method to determine stock-based compensationexpense rather than using APB 25’s intrinsic value method. Such disclosure isrequired in financial statements for periods prior to the adoption of SFAS123(R).

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In addition to restating the consolidated financialstatements in response to the Governance Committee’s findings, we are recordingadditional non-cash adjustments to account for the modification in 1998 of astock option grant to a former officer in connection with his termination ofemployment and to record in the first two quarters of 2006 corrections relatingto accounting for performance related stock options and restricted stockgrants, all of which were previously identified and considered immaterial.

Correcting the measurement date for previously grantedstock options in some cases results in additional taxable income to employeeson which additional payroll taxes are due from the employees as well as us. Wehave provided for all additional payroll taxes plus related penalties andinterest arising from the restatement of stock-based compensation, includingamounts otherwise payable by stock option recipients, and our restatedfinancial statements include an accrual in all affected years of approximately$1.5 million for all estimated payroll tax related expenses.

Thecorrections for the stock option restatement are to increase (reduce)previously reported non-cash compensation expense, payroll taxes, income taxesand net income by the following amounts (in thousands of dollars):

| **Year ended December 31,** | ** ** | ** ** | ** ** | **Non-cash stock  compensation** | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
|--------------------------------------------|------------|------------|------------|---------------------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| 1998                                       |       |       | $          | 1,244                                 |       |                   |       | $                     | —     |                |       |   | $ | (448 | ) |   |   | $ | (796 | ) |   |
| 1999                                       |       |       | —     |                                  |       |                   | —     |                  |       |                | —     |   |   |   | — |   |   |
| 2000                                       |       |       | 556        |                                  |       |                   | —     |                  |       |                | (104       | ) |   |   | (452 | ) |   |
| 2001                                       |       |       | 4,870      |                                  |       |                   | —     |                  |       |                | (942       | ) |   |   | (3,928 | ) |   |
| 2002                                       |       |       | 8,110      |                                  |       |                   | —     |                  |       |                | (1,550     | ) |   |   | (6,560 | ) |   |
| 2003                                       |       |       | 12,470     |                                  |       |                   | 900        |                  |       |                | (2,281     | ) |   |   | (11,089 | ) |   |
| Totals through  December 31, 2003     |       |       | 27,250     |                                  |       |                   | 900        |                  |       |                | (5,325     | ) |   |   | (22,825 | ) |   |
| 2004                                       |       |       | (410       | )                                     |       |                   | 541        |                  |       |                | 250        |   |   |   | (381 | ) |   |
| 2005                                       |       |       | (1,290     | )                                     |       |                   | 60         |                  |       |                | 4,083      |   |   |   | (2,853 | ) |   |
| 2000 - 2005  Total                         |       |       | 25,550     |                                  |       |                   | 1,501      |                  |       |                | (992       | ) |   |   | (26,059 | ) |   |

 

| **2006 quarter ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| March 31                    |       |       | 662        |       |       |       | 9          |       |       |       | —     |   |   |   | (671 | ) |   |
| June 30                     |       |       | 504        |       |       |       | 6          |       |       |       | —     |   |   |   | (510 | ) |   |
|                             |       |       | $          | 26,716     |       |       |       | $          | 1,516      |       |       |   | $ | (992 | ) |   |   | $ | (27,240 | ) |   |
|                                  |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The Governance Committee’s review found 17.9 millionstock options of the 28.8 million options granted on our Common Stock during2000 through 2005 had incorrect measurement dates. Using the correctedmeasurement dates, 7.6 million stock options had exercise prices that exceededthe closing price of our Common Stock and therefore had no intrinsic value tobe accounted for under APB 25, and 10.3 million stock options hadintrinsic value because their exercise prices were below the closing price ofour Common Stock. These 10.3 million stock options resulted in an increase inadditional non-cash stock-based compensation expense of $24.3 million, and anadditional $1.5 million of payroll tax related expenses during 2000 - 2005partially offset by $0.5 million of income tax benefit as shown in the abovetable. Of the 10.3 million stock options resulting in additional non-cashstock-based compensation expense, 2.0 million options were granted to officersand directors and resulted in $6.1 million of additional non-cash stock-basedcompensation expense.

Upon completing its review, the Governance Committeeconcluded it found no evidence of intent to manipulate the Company’s operatingresults or financial statements. A key finding of the Governance Committee wasthat there were deficiencies with the process by which stock options weregranted during the period from our initial public offering in 2000 through atleast 2005, which resulted in accounting errors. The Governance Committeeconcluded that certain members of management bear varying degrees 

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of responsibility for thedeficiencies in the process by which options were granted. The GovernanceCommittee’s review also concluded that none of the current or former employeesor directors of the Company engaged in intentional wrongdoing.

In determining the aboverestatement amounts, management used all reasonably available relevantinformation to form conclusions it believes are reasonable as to the mostlikely option granting actions that occurred, the dates when such actionsoccurred, and the determination of grant dates for financial accountingpurposes based on when the requirements of the accounting standards were met.In light of significant judgment used in establishing revised measurementdates, alternative approaches to those used by the Stock Option Review Team andmanagement could have resulted in different compensation charges than thoserecorded in the restatement. The Stock Option Review Team and managementconsidered various alternatives throughout the course of the review andrestatement, and management believes the adjustments to measurement dates usedin our review of stock option grant accounting and restatement of our financialstatements are reasonable and appropriate in our circumstances.

***Summary of Restatement Amounts***

Thefollowing table presents the decrease in net earnings from the restatement foreach restated year:

| ** **                                 | ** ** | **Net income**             | ** ** | **Restatement adjustments** | ** **                         | ** **                     | ** **                         |
|--------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------------------------------|--------------------------------|------------------------------------|
| ** **                                 | ** ** | **(loss),  as previously** | ** ** | **China  Sales**                 | **     ** | ** Stock  Options ** | **     ** | **Total** | ** ** | **Net income  (loss),** | ** ** |
| **Year ended December 31,** | ** ** | ** **                      | ** ** | **reported**                     | ** **                         | **(Decrease) Increase**   | ** **                         | **as restated** | ** ** |
| ** **                                 | ** ** | ** **                      | ** ** | **(in thousands)**          | ** **                         | ** **                     | ** **                         |
| 1998                                       |       |                            |       |                             |                               | $                              | —                             |   | $ | (796 | ) | $ | (796 | ) |   |   |
| 1999                                       |       |                            |       |                             |                               | —                         |                               | — |   | — |   |   |   |
| 2000                                       |       |                            |       |                             |                               | (4,781                         | )                                  | (452 | ) | (5,233 | ) |   |   |
| 2001                                       |       |                            |       |                             |                               | (5,779                         | )                                  | (3,928 | ) | (9,707 | ) |   |   |
| 2002                                       |       |                            | $          | 107,862                          |                               |                           | (19,697                            | ) | (6,560 | ) | (26,257 | ) | $ | 81,605 |   |
| 2003                                       |       |                            | $          | 209,856                          |                               |                           | (6,382                             | ) | (11,089 | ) | (17,471 | ) | $ | 192,385 |   |
| Totals through  December 31, 2003     |       |                            |       |                             |                               | (36,639                        | )                                  | (22,825 | ) | (59,464 | ) |   |   |
| 2004                                       |       |                            | $          | 69,824                           |                               |                           | (18,594                            | ) | (381 | ) | (18,975 | ) | $ | 50,849 |   |
| 2005                                       |       |                            | $          | (487,359                         | )                                  |                           | (42,433                            | ) | (2,853 | ) | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005 Total                          |       |                            |       |                             |                               | (97,666                        | )                                  | (26,059 | ) | (123,725 | ) |   |   |
|                                            |            |                                 |            |                                  |                                    |                                |                                    |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| **2006 quarter ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| 2006 Q1                          |       |       |       |       |       | 1,360      |       | (671       | )          | 689        |       |       |       |
| 2006 Q2                          |       |       |       |       |       | (371       | )          | (510       | )          | (881       | )          |       |       |
|                             |       |       |       |       |       | $          | (96,677    | )          | $          | (27,240    | )          | $          | (123,917   | )          |       |   |
|                                  |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |  |  |  |

 

Theeffect these corrections on diluted earnings (loss) per share for 2002 to 2005are as follows:

| ** **                                 | ** ** | **Diluted earnings**       | ** ** | ** **                       | ** ** | ** **                | ** ** | ** **         | ** ** | ** **             | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|---------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **(loss) per share,** | ** ** | **Restatement amounts**     | ** ** | **Diluted earnings** | ** ** |
| **Year ended December 31,** | ** ** | ** **                      | ** ** | **as previously  reported** | ** ** | **China  sales**          | ** ** | **Stock  options** | ** ** | **Total  restatement** | ** ** | **(loss) per share,  as restated** | ** ** |
| 2002                                       |       |                            | 0.94       |                             |       | (0.17                     | )          |               | (0.06      | )                      |       |   | (0.23 | ) |   |   | 0.71 |   |   |
| 2003                                       |       |                            | 1.70       |                             |       | (0.05                     | )          |               | (0.09      | )                      |       |   | (0.14 | ) |   |   | 1.56 |   |   |
| 2004                                       |       |                            | 0.54       |                             |       | (0.14                     | )          |               | (0.00      | )                      |       |   | (0.14 | ) |   |   | 0.40 |   |   |
| 2005                                       |       |                            | (4.16      | )                                |       | (0.36                     | )          |               | (0.03      | )                      |       |   | (0.39 | ) |   |   | (4.55 | ) |   |
|                                            |            |                                 |            |                                  |            |                           |            |                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

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Thecumulative effect on stockholders’ equity at December 31, 2003 from theabove corrections is as follows (in thousands):

| Increase  (decrease) in additional paid-in capital and deferred stock compensation: |   |    |    |
|-------------------------------------------------------------------------------------|--------|---------|---------|
| Values assigned to stock options                                                    |   | $       | 27,250  |   |
| Reduction of previously recorded income tax benefits  from stock  options           |   | (1,278  | )       |
| Net increase in additional paid-in capital and  deferred stock  compensation        |   | 25,972  |    |
| (Increase) decrease in retained earnings:                                           |   |    |    |
| Revenue and related cost of sales deferral for China  system sales                  |   | (36,639 | )       |
| Additional non-cash compensation expense from stock  options                        |   | (27,250 | )       |
| Payroll taxes for values assigned to stock options                                  |   | (900    | )       |
| Income tax benefit from additional compensation and  payroll tax  expense           |   | 5,325   |    |
| Net increase in retained earnings                                                   |   | (59,464 | )       |
| Net decrease in stockholders’ equity at  December 31, 2003                |   | $       | (33,492 | ) |

 

***SEC Filings to Report Restatements***

This Annual Report includes restatements of thefollowing previously filed financial statements and related information: (1) ourconsolidated financial statements as of December 31, 2005 and for thefiscal years ended December 31, 2004 and 2005; (2) unauditedQuarterly Financial Data for the first two quarters in the fiscal year ended December 31,2006 and for all quarters in the fiscal year ended December 31, 2005; (3) SegmentData and Management’s Discussion and Analysis of Financial Condition andResults of Operations for these periods; and (4) Selected ConsolidatedFinancial Data as of and for the years ended December 31, 2005, 2004, 2003and 2002. All financial information in this Annual Report also gives effect toprior restatements of our financial statements reported in our Annual Reportsfor 2003 and 2005.

Concurrently with the delayed filing of this AnnualReport with the SEC, we are also filing our Quarterly Report on Form 10-Qfor the quarter ended September 30, 2006 which has not been filedpreviously. We expect to file our currently delinquent Quarterly Reports on Form 10-Qfor the quarters ended March 31, 2007 and June 30, 2007 shortly.These Form 10-Q quarterly reports will include complete restatedfinancial statements for the three and nine month periods ended September 30,2005; the three month period ended March 31, 2006, and the three and sixmonth periods ended June 30, 2006, respectively. Additionally, Exhibit 99.1of this Annual Report contains restated condensed consolidated balance sheetsand statements of operations as of and for the three month and year to dateperiods ended June 30, 2006, March 31, 2006, September 30, 2005,June 30, 2005 and March 31, 2005. Exhibit 99.1 also containsrestated condensed consolidated statements of cash flows for the three monthsended March 31, 2006 and the six months ended June 30, 2006, whichgive effect to the corrections for the aforementioned 2006 error in theclassification of certain time deposits, the restated condensed consolidatedstatement of operations for the three month period ended December 31,2005, and the restated condensed consolidated balance sheet at December 31,2004. This follows guidance issued by the SEC concerning presenting informationabout the effects of restating previously issued financial statements for theeffects of correcting errors in prior stock option accounting. Pursuant to thisguidance we do not intend to amend any of our previously filed Annual Reportson Form 10-K or Quarterly Reports on Form 10-Q for theperiods affected by the restatements and such reports should not be reliedupon.

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**PART I**

**ITEM 1—BUSINESS**

**OVERVIEW**

We design, manufacture and sell telecommunicationsinfrastructure, handsets and customer premise equipment and provide servicesassociated with their installation, operation, and maintenance. Our productsare sold primarily to telecommunications service providers or operators. Wesell an extensive range of products that are designed to enable voice, data andvideo services for our operator customers and their subscribers around theworld. While historically the vast majority of our sales have been to serviceproviders in China, we have expanded our focus to build a significant presencein many global markets and currently sell our products in several establishedand emerging growth markets, which include North America, Japan, India, Centraland Latin America, Europe, the Middle East, Africa and Southeast and NorthAsia.

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

**OUR OBJECTIVE**

Our objective is to be aleading global provider of Internet Protocol (“IP”) -based communicationsproducts and services. We seek to differentiate ourselves by developinginnovative, first-to-market products that are designed to integratemultiple functionalities and deliver multiple revenue-generating serviceson a single technology platform, reduce network complexity, and enable a migrationto a new generation of network technologies. Our products and software aredesigned to make carrier deployments, maintenance and upgrades both economicaland efficient, allowing operators to earn a high return on their investment.

**OUR STRATEGY**

Because ourproducts are IP-based, our customers can more easily integrate ourproducts with other industry standard hardware and software. Additionally, webelieve we can introduce new features and enhancements that can be costeffectively added to our customers’ existing networks. IP-based devicescan be changed or upgraded in modules, saving our customers the expense ofreplacing their entire system installation. Our strategy is built upon thefollowing key concepts:

·       identifykey technology shifts and trends before our competitors;

·       developdifferentiated products, which are designed to offer new and innovative revenue-generatingfeatures and enhanced functionality for our customers;

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

·       develop tailored productsand services to suit customers’ current needs and to anticipate future needs.

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**KEY STRENGTHS**

Our key strengths in theimplementation of our strategy include the following factors:

**A History of Technology Innovation**

Since our inception, wehave focused on the development of new innovative communications technologiesand products that are designed to differentiate us from our peers and createnew market opportunities for our carrier customers. For example, we helpedcreate a new market for wireless telephony in China based upon the developmentof our Personal Access Service and IP-based Personal Access Service(collectively “PAS”) products offering a low-power, low-costalternative to traditional mobile telephony. We believe PAS became successfulwith traditional wireline carriers because it enabled them to build upon theirexisting fixed-line networks to offer their consumers wireless mobileservices. This service, while limited in range to each specific city or regionin which it was offered, afforded a low-cost alternative to moreexpensive traditional cellular services. The rapid rate of adoption for PASpositioned us as one of the leading wireless infrastructure and handsetproviders in China and to date over 52 million subscribers are usingservices supported by our technology.

**A Significant Customer Base and Leverage in China**

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

**A Commitment to Carrier Value**

We believe we have beenable to develop strong relationships with our customers by delivering completeproduct lines that are designed to enable carriers to capitalize on economiesof scale and to easily customize and extend their service offerings. To ensureour products deliver the most value, the UTStarcom product architecture isdesigned to allow carriers to offer a full range of services over multipleaccess networks, whether wireless or wireline. Our wireless products support abroad range of frequencies for cost-effective deployment worldwide andour broadband products support both copper- and fiber-based access.To help ensure we offer high value solutions at a low cost, we leverage ourdesign, development, and manufacturing facilities in China.

**A Focused Global Market Diversification Initiative**

In 2006, we continued tofocus on the diversification of our global customer base and marketpenetration. Our diversification strategy involves a combination of internalefforts and strategic acquisitions. In order to better address new marketsoutside of China we introduced a number of new products including ourContinuityTM solutions for the Fixed Mobile Convergence market; the F3000portable WiFi handset; and Evolution Voice Data Only rev A capability forMovingMedia 2000.

Our acquisition of selected assets of the wirelesshandset division of Audiovox Corporation in November of 2004 enhanced ourability to gain access to some of the largest and most stable operatorsworldwide, particularly in the United States. As a result of this acquisition,the United States has become our largest market, representing 55% of net salesin 2006.

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In addition to the large telecommunications serviceproviders in well-established markets, we also target carriers inemerging markets, such as Philippines Long Distance Telephone Company in thePhilippines, Vonage Holdings Corporation in the United States, RelianceInfocomm Ltd. in India and Brazil Telecom in Brazil, which have all focusedtheir network deployments on IP-based voice, data and video services.

We believe emergingmarkets present significant opportunities for growth. We believe that manydeveloping regions see a correlation between increased teledensity and improvedeconomic growth, recognizing the need to invest in a telecommunicationsinfrastructure in order to compete globally and overcome economic disparities.Our strategy is to develop products and design services to meet the needs andlevel of affordability of these emerging-market service providers andtheir customers. In addition, we recognize that to be successful in emergingmarkets, it is often important to commit to establishing a local presence inareas such as research and development, manufacturing, sales and support. Wecontinue to explore major growth potential in global markets outside of Chinaand believe that many of these markets are ideal candidates for our products andservices.

**MARKETS ANDCUSTOMERS**

Our products and servicesare being deployed and implemented in regions throughout the world in marketsincluding China, Japan, India, Central and Latin America, Europe, Africa, NorthAmerica, Asia and the Middle East. Historically, China has been our largestmarket, representing 32%, 30%, and 79% of our net sales in 2006, 2005 and 2004,respectively. With the acquisition of selected assets from Audiovox Corporationin November 2004, sales in the United States have grown to 55% of netsales in 2006 compared to 46% and 13% in 2005 and 2004, respectively.Additional markets and customer information is included in the discussion ofbusiness segments below.

**Global Customers**

Our customers, typicallytelecommunications service providers, enable delivery of wireless and broadbandaccess services including data, voice, and/or video to their subscribers. Theyinclude, but are not limited to, local, regional, national and internationaltelecommunications carriers, including broadband, cable, Internet, wireline andwireless providers. Telecommunications service providers typically requireextensive proposal review, product certification, test and evaluation, networkdesign, and, in most cases, are associated with long sales cycles. Ourcustomers’ networking requirements are influenced by numerous variables,including their size, the number and types of subscribers that they serve, therelative teledensity of the geography served, their subscriber demand forwireless and wireline communications, and access services in the servedgeography.

**Global Sales andService**

Our worldwide salesorganization consists of managers, sales representatives, network consultantsand technical support personnel. We have field sales offices in various locationsincluding China, Japan, India, Central and Latin America, Europe, Africa, NorthAmerica, Asia and the Middle East. We operate six retail facilities for end-userdevices under the name Quintex® and license the trade name Quintex® to sixoutlets in selected markets in the United States. We continue to increase ourpenetration of these markets in several ways:

·       throughdirect sales offices located in key market regions;

·       bylicensing our technology to local manufacturers;

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

·       byestablishing sales relationships with original equipment manufacturers.

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We continue to aggressively build regional in-countrysales offices with local direct sales staff in order to provide support for ourexpanding global operations.

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

**Competition**

We compete in the telecommunications equipment market,providing infrastructure products, consumer products and services fortransporting data, voice and video traffic across traditional and IP-basednetworks.

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

We believe our competitive strengths are derived fromthree main principles: our early entry and commitment to the development of allIP-based communications technologies; our experience in high-volume,low-cost manufacturing and large-scale technology deployments inChina; and our commitment to developing comprehensive, complete productofferings for our carrier customers that allow them to capitalize on economies ofscale and differentiate their service offerings.

By contrast, ourcompetitive disadvantages include our relatively smaller size in terms ofrevenues and working capital, and number of employees as compared to many ofour competitors, our lack of history and experience in selling to many of thelargest carriers in well-established markets and our lack of consumerbrand recognition in markets outside of China.

**TECHNOLOGY ANDPRODUCTS**

Our technology focus centers on an IP-basedsoftswitch core network architecture that creates a single platform fordelivering multiple services to the end user of the telecommunications network.A softswitch is a software-based system for handling call managementfunctionality that has historically been handled by a large hardware switchdevice in a traditional telephone network. Our IP-based softswitch is atechnological approach to telephony networking where all of the capability forthe delivery of telephone services resides in easily adaptable IP-basedsoftware. A softswitch is designed to reduce the cost of long distance andlocal exchange switching and to create new differentiated voice, data and videoservices. In contrast, legacy networks are based on the delivery of a singleservice, such as voice or data. If a service provider operating a traditionalnetwork wanted to offer multiple services, it would have to build, run andmaintain a separate network for each service, including separate billing,network management and support functionalities, adding significant costs to thecarrier’s operating model. A multi-service, IP-based core networkis designed so that all services can be converged onto one platform with onebilling, network management and support function for all services. In addition,because it is largely software-based, an IP network is by designmore cost-effective to run and maintain than traditional infrastructuretechnologies. All of our products are interoperable and can be integrated intoa single IP-based network. We intend to continue to support our IP-basedwireless and broadband services and enhance their functionality for deploymentin all global markets. We also intend to continue our research and developmentefforts on future IP-based access services.

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Our IP-basedsoftswitch architecture (“mSwitch”) is a diverse assembly of software andhardware-based networking elements designed to replace traditionalcentral office telephone switches. Our mSwitch enables the delivery of a commonset of features and services over a variety of access networks, whetherwireless or wireline. Our products are designed to support a variety ofservices, including broadband and narrowband access, call control of telephoneand data communications and delivery of next generation features not offered bythe traditional fixed line switching infrastructure, including IP-basedtelevision (“IPTV”).

**mSwitch Platform**

Our mSwitch® is aflexible IP-based platform designed to provide voice communications over an IP network.The mSwitch® product family supports three primary solutions:

·       IP-basedPersonal Access System (“iPAS”) Wireless Local Service;

·       NextGeneration Network (“NGN”) Voice over Internet Protocol (“VoIP”); and

·       FixedMobile Convergence.

mSwitch® enablesservice providers to migrate from existing circuit platforms to a nextgeneration IP-based packet switch architecture, or to launch newapplications in a greenfield environment. Our mSwitch® portfolio is acarrier-class next generation switching product family that enables serviceproviders to:

·       Deploya converged core switching network that supports both wireline and wirelessendpoints;

·       Enableapplication delivery across diverse access points;

·       Maintainconsistent end user experience regardless of method of access to theapplications;

·       Protectinvestment in their core infrastructure;

·       Deploya scalable, modular system; and

·       Enjoy the benefits of anOperation Support System /Network Management System suite designed to integrateseamlessly with the service provider’s existing network.

**Business Segments**

In organizing ourextensive product portfolio, we have created four individual operating units:Network Solutions, Personal Communication Division (“PCD”), Handsets and GlobalServices & Support International (“Services”).

·       NetworkSolutions: Our Network Solutions operating unit provides is products andservices through two reporting segments; Broadband Infrastructure and WirelessInfrastructure. Our Wireless Infrastructure segment designs, builds and sellssoftware and hardware products that enable end users to send and receive voiceand data communication in either a fixed or mobile environment. Our BroadbandInfrastructure segment designs, builds and sells software and hardware productsthat enable end users to access high-speed, cost effective wireline data,voice and media communication.

·       PersonalCommunications Division: Our Personal Communications Division markets, sellsand supports handsets other than PAS handsets for markets other than China.Most of our handset sales in 2005 and 2004 were designed and built by othermanufacturers, however, in 2005 we began shipping handsets designed andmanufactured by us and for the 2006 fiscal year handsets manufactured by usmade up approximately 36% of the total unit sales.

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·       Handsets:Our Handset segment designs, builds and sells consumer devices that allowcustomers to access wireless services. All handset revenues within China areincluded in this segment.

·       Services:Our Services segment provides service and support for Wireless Infrastructureand Broadband Infrastructure customers in the areas of planning, deployment,operations and ongoing maintenance.

Our products within eachof these categories, excluding services, include multiple hardware and softwaresubsystems that can be offered in various combinations to suit individualcarrier needs. Our system products are based on widely adopted globalcommunications standards and are designed to allow service providers to quicklyand cost-efficiently integrate our systems into their existing networksand deploy our systems in new broadband, IP and wireless network rollouts. Ourproducts are also designed for quick and cost-effective transition tofuture network technologies, enabling our customers to make the best use oftheir existing infrastructure. See Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Net Sales,” for adiscussion of our net sales by business segment.

**NETWORK SOLUTIONS**

**WirelessInfrastructure**

The products in ourWireless Infrastructure segment are based on a variety of leading worldwidemobile interface standards, including: Personal Handyphone System (“PHS”) andCDMA2000. Our Wireless Infrastructure business accounted for approximately 17%,15% and 49% of revenues in 2006, 2005 and 2004, respectively. All of our wirelessproducts are designed to offer a full suite of integrated, customizable, voiceand value-added services, including text messaging services, webbrowsing, e-mail, voice mail, and Internet access.

***Personal Access System***

Our Personal Access System family of wireless coreinfrastructure equipment, based on the PHS standards developed by TheAssociation of Radio Industries and Telecommunication Technology Committee inJapan, is designed to help our customers create new revenue opportunities withhigh quality wireless voice and data services. Approximately 79% of ourWireless Infrastructure revenue is derived from our PAS product.

With the UTStarcom iPAS wireless access network,operators can migrate their current wireline network to an IP-based PHSwireless network that provides wireless voice and data services within a cityor community. With this new system, service providers can offer new wirelessservices, such as citywide mobility, same-number wireless extension, email,mobile Internet access, text messaging and location-based services.

The iPAS wirelessaccess network offers several advantages:

·       Common platform for bothwireline and wireless—offers a complete set of wireline and wireless services:Plain Old Telephone Service, Integrated Services Digital Network, citywidemobility, text messaging, email, location-based services, mobile Internetaccess.

·       Flexible deployments—integratesiPAS into the existing public network or deploy it as an independent networkover a unified IP-based core network with advanced softswitch architecture. Asa result, service providers can cost-effectively deploy services to meetsubscriber demands.

·       High-performance softswitchplatform—scales an iPAS network to support from 10,000 to more than fivemillion subscribers with a softswitch server cluster and multi protocolgateways. With its softswitch architecture, customers can migrate seamlessly toThird-Generation Cell-Phone Technology services over a unified IP-based corenetwork.

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·       Centralized Web-basedoperations support system—simplifies network operations by concentrating allsupporting functions, such as subscriber management, service provisioning,network management, billing processing, and customer care, into one centralizednetwork operation center. With the Web-based interface, maintenance personnelor subscribers can access the service remotely over the Internet.

·       Wide selection of subscriber devices—allowscustomers to choose the easiest access: a PHS handset or personal station forcitywide mobility, a fixed subscriber unit for fixed wireless access, aPersonal Handyphone System Internet Access Forum Standard data suite device forhigh-speed Internet access, or any combination of these.

***CDMA 2000 Wireless Voice and Data Products***

CDMA stands for Code Division Multiple Access and isone of the main technologies currently used in digital wireless communicationsnetworks. CDMA 2000 is popularly referred to as the third-generation (“3G”)technology for CDMA and has greater voice capacity, data capacity and dataspeed than CDMA. Additionally, CDMA 2000 technology enables a range of newfeatures including broadband Internet access, music downloads, push-to-talkcommunications, streaming video and remote corporate access.

In the fall of 2004, weintroduced MovingMedia 2000, the first IP-based infrastructure productfor CDMA 2000 designed to offer cost effective CDMA coverage in urban, ruraland campus environments. The MovingMedia 2000 product line provides mobileoperators with end-to-end IP-based infrastructure enabling voice and dataservices to end-users. Based on Third Generation Partnership Project (“3GPP2”)standards specifications, we believe our MovingMedia 2000 is an ideal solutionfor both incumbent and greenfield CDMA operators. MovingMedia 2000 allows CDMAoperators to transition to an all IP-based network, resulting in significantbackhaul cost savings and the ability to offer new value-add services.

***Fixed Mobile Convergence***

Our ContinuityTM Fixed Mobile Convergence productprovides a way for users to inter-connect to either a wireline or cellularnetwork regardless of which network they are currently on. With our ContinuityTMsolution, users can access their services seamlessly regardless of theirlocation, device, or network access method.

ContinuityTM has been designedfor all types of carriers but in particular, for wireline carriers that want toprovide mobility services by utilizing their lower cost wireline assets.ContinuityTM allows wireline operators to enter the mobile service market usingWireless Fidelity (“WiFi”) as a complementary alternative to a traditionalcellular network. ContinuityTM is also intended for mobile operators to providetheir users with the same value-added features as wireline providers and tofurther improve their cellular coverage by using lower cost WiFi technology.

*Markets andCustomers*

In 2006, our largest market for WirelessInfrastructure products was China, which equaled approximately 80% of revenuesfor the segment. We believe that China continues to be one of the largest andmost important wireless markets in the world with GDP growth of more than 9%over the past several years and a relatively low fixed and mobile teledensityrate of just 28% and 35%, respectively. China is currently undergoing anevolution of wireless technology, as their regulatory authority, the Ministryof Information Industry, is preparing to issue new 3G operating licenses. Assuch, wireless infrastructure spending is expected to shift from traditionalPAS and other second generation technologies to new 3G technology over thenext several years. This caused a decline in spending for our PAS productswhich led to an overall decline in Wireless Infrastructure product revenues by2% and 66% in 2006 and 2005, 

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respectively. In 2006,sales in the Jiangsu Province and in the Zhejiang Province accounted forapproximately 15% and 10%, respectively, of sales for the WirelessInfrastructure segment.

Outside of China, key markets we are targeting forWireless Infrastructure include India, Japan, Latin America, Europe and theUnited States. Combined sales to these regions were approximately 20% of totalwireless infrastructure sales in 2006, but are expected to increase over timeas we put more focus in these regions. In 2006, we continued to expand ourpresence in Europe, the Middle East and Africa, with both orders from newcustomers and additional sales and service operations.

Southeastern Asia isanother region with a large population base and relatively low teledensityrate. We have established an office for sales and services operations tosupport various countries in this region including, but not limited to,Vietnam, Thailand and Taiwan. At the close of 2006, our customers had over1.2 million PAS subscribers in Vietnam and Taiwan utilizing our networkinfrastructure. Key customers in the region include FITEL and Chunghwa TelecomCo. Ltd. in Taiwan, and Vietnam Post and Telecommunications Corporation inVietnam.

*Competition*

The WirelessInfrastructure market is marked by intense competition worldwide from numerousglobal and regional competitors, including some of the world’s largestcompanies. Pricing, payment terms and brand recognition are key considerationsfor our customers. Specific competitors in this segment include:Alcatel-Lucent, LM Ericsson Telephone Company, Huawei Technology Co., Ltd.,InterDigital Communications Corp, Motorola, Inc., Nokia Corporation,Nortel Networks Corporation, Samsung Electronics Co. Ltd., Siemens AG andZhongxing Telecommunications Equipment Corporation, Inc.

**BroadbandInfrastructure**

Our BroadbandInfrastructure products are designed to satisfy customer demand for high speedand cost effective wireline-based data, voice and multimedia services. Revenuesfrom this segment accounted for approximately 9%, 18% and 9% of total sales in2006, 2005 and 2004, respectively. Our wireline technology enables high-speedvoice, video and data transmissions over broadband IP-based networks. OurBroadband Infrastructure segment includes digital subscriber line products,multi-service access node products, fiber optics products and IPTV.

***Digital Subscriber Line Products***

Digital subscriber line (“DSL”) technology allows high-speeddata and content transfer while providing simultaneous telephone communicationsover the same fixed copper line. Our IP-based DSL AccessMultiplexers (“IP-DSLAMs”) incorporate the latest DSL technologiescombined with a range of form factors to enable high-speed access anddeliver services to residential and commercial subscribers using broadbandnetworks.

Our AN-2000 product is intended for operatorswith an existing copper telephone network seeking to expand into offeringbroadband data to their customers. An all-IP network allows our customersto more easily add features such as video streaming and IP multicast inaddition to traditional broadband services. To date, we have deployed more thanseven million IP-DSLAM lines globally.

Our DSL products includecustomer premise equipment (“CPE”) such as various DSL modems, set-topboxes and voice over the internet devices that allow residential and businesscustomers to access voice, data and video services. Our products are designedto be rich in functionality, simple to set up, easy to install and easy tomanage. The diversity and flexibility of our CPE offerings allows them to workwith both our own infrastructure equipment as well as with other vendors’infrastructure equipment.

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***Multi-Service Access Node***

A Multi-ServiceAccess Node (“MSAN”) is a single device which delivers a mix of broadband,traditional voice and data services, and media gateway functionality via copperor fiber. The iAN8K Multimedia Network Edge product line embodies ourcommitment to providing end-to-end IP connectivity. The iAN8K product family isour next generation access platform that integrates the feature sets of the iAN-8000MSAN platform with the Broadband Data Access functionality provided by the AN-2000B820 IP-DSLAM product line which allows service providers to convergeseamlessly from legacy Time Division Multiplexing based networks to IP-basedNext Generation Networks. The iAN-8000 MSAN integrates thestandalone functionalities of a traditional Digital Loop Carrier, anext-generation VoIP Media Gateway and an IP-DSLAM in a single convenient,multi-service access platform.

***Optical Products***

Our optical productsinclude transport products based upon internationally defined opticaltransmission standards and access products. Our products convert and translatedata, video, voice, or other traffic into an optical signal which istransmitted over glass fiber. The product platform includes a multi-servicemanagement system which simultaneously processes multiple speeds ranging from155 Megabits per second for traditional voice service to 10 Gigabits persecond for data intensive services.

*Gigabit EthernetPassive Optical Network (“GEPON”)*

In 2004, we introduced our GEPON product. A passiveoptical network is a system configuration that brings optical fiber all the wayto the end user using unpowered optical splitters that enable a single opticalfiber to serve multiple premises. Our GEPON platform is designed to providehigh subscriber density and low cost of entry, making it a compellingalternative to traditional telephone or broadband solutions.

Our GEPON family includesboth the telecommunications provider’s central office and CPE which handlespeeds of up to one Gigabit per second of bandwidth to residential and businesscustomers. By integrating more functionality into the product, we haveeliminated the need for carriers to deploy additional switching and routingequipment.

*Multi-ServiceTransport Product (“MSTP”)*

We introduced our NetRingTM MSTP optical product linein December 2003. While our GEPON product is designed to provideservices to individual customers, our NetRingTM products are designed for thehigh bandwidth needs of a service area. Our NetRingTM 600 products provide voiceand data services for multi-tenant buildings, office buildings, andenterprise campus applications. Our mid-range NetRingTM 2500 productsoffer voice and data transport when more bandwidth and greater capacity isrequired. Our high-end NetRingTM 10000 products provide service forregional transport applications, when maximum bandwidth and capacity isrequired. In each application, the optical fiber is looped through the servicearea and connected back upon itself, providing full redundancy in the eventthat the fiber is severed. NetRingTM provides a broad range of functions forcarriers to manage voice, data and video traffic with network managementfunctions previously available only on multiple independent platforms.

Video content is increasingly being viewed bytelecommunications providers as a new source of revenue. Our IPTV system,RollingStreamTM (formerly “mVision”), includes both central office and customerpremises equipment for delivering television and multimedia over carriernetworks based on IP technology. Our RollingStreamTM products and servicesenable a service provider to deliver broadcast television and on-demandvideo services to residential and commercial premises over a switched networkarchitecture. It is a carrier-class product that is designed to scale tosupport millions of users and hundreds 

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of thousands of contenthours. We believe RollingStreamTM is the first solution designed to enablecarriers to deploy very-large-scale streaming video content over aswitched network.

The RollingStreamTM product family includes a storageand streaming device (“MediaSwitch”); a device for combining different videosignals onto a unified distribution system (“Content Engine”); a deviceresiding at the user’s home or place of business; and a network managementsystem that enables system wide operation. The current version of theRollingStreamTM products has been designed to function over standard coppertelephone lines. Future versions may operate over cable or optical transmissionlines.

RollingStreamTM is designedto allow carriers to offer new, revenue-generating television and multi-mediaservices. The system is also designed to help providers attract customers ofcable and satellite operators by offering a more comprehensive and interactivesuite of services. We continue to see industry and customer enthusiasm with keycustomer deployments announced at Softbank in Japan; China Telecom and ChinaNetcom in China; MTNL in India; and over 40 trial networks deployed globally.

*Markets andCustomers*

Our Broadband Infrastructure segment also targetsseveral large markets and customers worldwide. In 2006, our largest broadbandinfrastructure customer was Softbank Corp. and affiliates in Japan (“SBB”),representing approximately 54% of total broadband sales. SBB, which is arelated party to UTStarcom, is a parent company to several of our key serviceprovider customers in Japan, including Yahoo! BB and Japan Telecom. Accordingto the Japan Ministry of Public Management, Yahoo! BB is the leading providerof broadband service in Japan with over 5 million IP-based DSL linesas of December 31, 2006. Yahoo! BB continues to expand and deploy our AN-2000and iAN-8000 equipment in support of their Voice over Broadband andvarying speed DSL services. Additionally, Yahoo! BB and UTStarcom officiallylaunched the UTStarcom RollingStreamTM IPTV products in July of 2005.

In addition to the Japanese market, we have targetedother key markets such as China, India, Europe, the Middle East, Africa,Central America and Latin America for the deployment of our BroadbandInfrastructure products. In 2006, those markets contributed approximately 46% tototal Broadband Infrastructure revenues. We believe these markets provide asignificant amount of opportunity going forward given their relatively lowbroadband penetration rates and strong consumer demand for new broadbandservices.

For example, according to the Department ofTelecommunications of India as of November 2006, India had a population of1.1 billion and a low fixed line teledensity of approximately 16.3%. Wecurrently offer our AN-2000, iAN8K, IPTV and NetRingTM products andservices in India. With over one million access lines deployed today, weanticipate that we will continue to implement and deploy our products andconduct trials with several operators, including Reliance Infocomm Ltd. andBharat Sanchar Nigam Ltd.

We also saw significantgrowth in 2006 in Central America and Latin America. Our target markets inCentral and Latin America include, but are not limited to, countries likeBrazil, Mexico, Panama, Haiti, Honduras and Guatemala. We have shipped our AN-2000to service providers and continue to perform extensive testing andcertification for telecommunications carriers for other key products such asRollingStreamTM within these regions. In 2006, key customers in Central andLatin America included Telefonos de Mexico, S.A. in Mexico, Brazil Telecom inBrazil and Telefonica del Sur in Chile.

*Competition*

The BroadbandInfrastructure market is marked by intense competition worldwide from numerousglobal and regional competitors, including some of the world’s largestcompanies. The principal methods of competition include pricing, payment termsand pre-existing relationships. Specific competitors in this segmentinclude Alcatel-Lucent, Datang Telecom Technology Co. Ltd, LM EricssonTelephone Company, 

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HuaweiTechnology Co., Ltd., Motorola, Inc., Siemens AG, Tellabs, Inc., andZhongxing Telecommunications Equipment Corporation, Inc.

**HANDSETS**

We design and sell avariety of handsets to support our business in China, primarily our sales ofPAS products. Our Handsets business accounted for approximately 16%, 16%and 29% of revenues in 2006, 2005 and 2004, respectively. The products rangefrom basic, low-cost units to high-functionality, higher-costmodels. Today we feature handsets with cameras, video recorders and players,high-resolution color displays, multiple ring tones, text messagingservice and high speed Internet access and email capability.

**PAS Handsets**

We currently offer a widevariety of PAS handset models from high-end, data-capable andfeature-rich models to low-cost value models. According to a December 2006report by the industry research firm GfK Ltd., we have a 48% market share andare the market leader for PAS handsets in China, which is the largest handsetmarket in the world according to its Ministry of Information Industry. We shippedmore than 7.8 million PAS handsets in 2006.

**CDMA, WiFi andMulti-Mode Handsets**

In 2004, we announced ourentry into the CDMA and WiFi handset markets in China. We offer carriers a wideselection of price ranges and handset features by providing a broad range ofmodels supporting each of these technologies.

*Markets andCustomers*

In 2006, our primarymarket for the Handsets segment was in China with approximately 98% of revenuein 2006 attributed to the China market. In 2006, sales in the Jiangsu Province,the Zhejiang Province and in the Guangdong Province accounted for approximately20%, 15% and 13%, respectively, of sales for the Handsets segment.

*Competition*

The Handset businesssegment faces significant competition from numerous global competitors. Theprincipal methods of competition include pricing and brand recognition.Specific competitors in this segment include: Alcatel-Lucent; China PTICInformation Industry Corporation; Zhongxing Telecommunications EquipmentCorporation, Inc.; Amoi Electronics Company, Ltd.; Huawei Technologies Co,Ltd; Kyocera Corporation; Nippon Electric Corporation and Sanyo ElectricCompany, Ltd.

**PERSONALCOMMUNICATIONS DIVISION**

We acquired the PersonalCommunications Division (“PCD”) from Audiovox Corporation in November 2004.Revenues from this segment represented approximately 55%, 48% and 11% of ourtotal sales in 2006, 2005 and 2004, respectively. Our PCD segment marketswireless handsets and accessories through international wireless carriers andtheir agents, independent distributors and retailers. We sell an array ofdigital handsets, hand-held computing devices and accessories in avariety of technologies, principally utilizing the CDMA radio air interface. Wegenerally market our wireless products under the UTStarcom brand name or co-brandour products with our carrier customers. In addition to handsets, we sell acomplete line of accessories that includes batteries, hands-free kits,battery eliminators, cases and data cables. In 2007, we intend to continue tobroaden our digital product offerings by supplying handsets 

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withenhanced features such as two and three megapixel resolution for video andcamera products, music on demand, MP3 music players and improved internetcapabilities.

**ProductDevelopment, Warranty and Customer Service**

Although the PCDsegment does not have its own manufacturing facilities, it works closely withboth customers and suppliers in feature design, development and testing ofproducts. In particular, PCD:

·       withits wireless customers, determines future market feature requirements;

·       workswith its suppliers to develop products containing those features;

·       participatesin the design of the features and aesthetics of its wireless products;

·       testsproducts in its own facilities to ensure compliance with PCD standards;

·       supervisestesting of the products in its carrier markets to ensure compliance withcarrier specifications.

We believe customerservice is an important tool for enhancing our brand name and relationship withcarriers. In order to provide full service to our customers, we provide awarranty on our handset products for periods ranging from twelve tofifteen months. To support our warranties, we work with approximately 2,800independent warranty centers throughout North and South America and haveexperienced technicians in our warranty repair stations at our PCD headquartersfacility. We have experienced customer service representatives who interactdirectly with both end-users and our customers. These representatives aretrained to respond to questions on handset operation and warranty and repairissues.

**Suppliers**

Our PCD segment purchasesits wireless products from several manufacturers located in Pacific rimcountries, including Japan, China, South Korea and Taiwan. In selecting suppliers,we consider quality, price, service, market conditions and reputation. Wegenerally purchase our products under short-term purchase orders and donot enter into long-term contracts. During 2006 and 2005, three vendorsaccounted for approximately 88% and 97% of purchases, respectively. In September 2006,we entered into a Strategic Alliance Agreement with one of these vendorswhereby we were appointed exclusive distributor in certain territories. Additionally,we plan to extend our supplier base by introducing more models of our owndesign and expanding our relationships with other manufacturers.

*Markets andCustomers*

We sell our wireless handsets and accessories towireless carriers and the carrier’s respective agents, distributors andretailers. Our largest market for the PCD segment is North America, whichrepresents approximately 94% of PCD net sales during 2006. Our five largestwireless customers in 2006 were Verizon Wireless, T-Mobile USA, SprintSpectrum, Virgin Mobile USA and Cricket Communications. Verizon Wireless,T-Mobile and Sprint Spectrum accounted for approximately 25%, 20% and 18%,respectively, of net sales for the segment during 2006. In addition, we promoteour products through trade and consumer advertising, participation at trade showsand direct personal contact by our sales representatives. We also assistwireless carriers with their marketing campaigns by scripting telemarketingpresentations, funding co-operative advertising campaigns, developing andprinting custom sales literature, logistic services, conducting in-housetraining programs for wireless carriers and their agents and providingassistance in market development.

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We operate six retailfacilities under the name Quintex. Quintex also serves as an agent (inactivating cell phone numbers) for the following carriers in selected areas:Boost, Nextel, Sprint Spectrum, and T-Mobile. For fiscal 2006, revenuesfrom Quintex were approximately 2% of total PCD revenues.

*Competition*

The market for wireless handsets and accessories is highlycompetitive and is characterized by intense price competition, significantprice erosion over the life of a product whose life cycle has continued toshorten, demand for value-added services, rapid technological developmentand industry consolidation of both customers and manufacturers. Currently, ourprimary competitors for wireless handsets include LG, Motorola, Samsung,Kyocera, Nokia and Sanyo.

We also compete with numerous established and newmanufacturers and distributors, some of whom sell the same or similar productsdirectly to our customers. Historically, our competitors have also includedsome of our own suppliers and customers. Many of our competitors offer moreextensive advertising and promotional programs than we do. We compete for salesto carriers, agents and distributors on the basis of our products, services andprice. As our customers are requiring greater value-added logisticservices, we believe that competition will continually be required to supportan infrastructure capable of providing these services. Our ability to continueto compete successfully will largely depend on our ability to perform thesevalue-added services at a reasonable cost.

Our products competeprimarily on the basis of price, features and reliability. There have been, andwill continue to be, several periods of extreme price competition in thewireless industry, particularly when one or more of our competitors has soughtto sell off excess inventory by lowering prices significantly or carrierscanceling or modifying sales programs. As a result of global competitivepressures, there have been significant consolidations in the domestic wirelessindustry, which has caused extreme price competition. These consolidations mayresult in greater competition for a smaller number of large customers and mayfavor one or more of our competitors.

**SERVICES**

In addition to our productofferings, we provide a broad range of service offerings, including technicalsupport services. Our service offerings complement our products with a range ofconsulting, technical, project, quality and maintenance support-levelservices including 24-hour support through technical assistance centers.Technical support services are designed to help ensure that our productsoperate efficiently, remain highly reliable, and benefit from the most up-to-datesystem software. These services enable customers to protect their networkinvestments and minimize downtime for systems running mission-criticalapplications. Our Services segment accounted for approximately 3%, 3%, and 2%of revenues in 2006, 2005 and 2004, respectively.

**OPERATIONS**

**Employees**

As of December 31,2006, we employed a total of approximately 6,000 full-time employees. Wealso from time to time employ part-time employees and hire contractors.Of the total number of full-time employees at December 31, 2006,approximately 2,600 were in research and development, approximately 800 were inmanufacturing, approximately 1,400 were in marketing, sales and support, andapproximately 1,200 were in administration. We had approximately 4,600employees located in China, approximately 700 employees located in theUnited States, and approximately 700 employees in other countries. Ouremployees are not represented by any collective bargaining agreement, and wehave never experienced a work stoppage. We believe that we have good employeerelations.

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**Sales, Marketingand Customer Support**

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

Our sales efforts inmarkets outside of China combine direct sales, original equipmentmanufacturers, distributors, resellers, agents and licensees. We maintain 43sales and customer support offices in 25 countries covering the U.S.,Canada, Latin America, the Caribbean, Europe, the Middle East, Africa, India,and the Asia-Pacific regions.

**Manufacturing,Assembly and Testing**

We manufacture or engagein the final assembly and testing of our mSwitch, PAS systems, handsets and AN-2000products at our manufacturing facility in the Chinese province of Zhejiang. Themanufacturing operations consist of circuit board assembly, final systemassembly, software installation and testing. We assemble circuit boardsprimarily using surface mount technology. Assembled boards are individuallytested prior to final assembly and tested again at the system level prior tosystem shipment. We use internally developed functional and parametric testsfor quality management and process control and have developed an internalsystem to track quality statistics at a serial number level.

Our manufacturing facilityis ISO 9001-2000 certified. ISO 9001-2000 certification requiresthat the certified entity establish, maintain and follow an auditable qualityprocess including documentation requirements, development, training, testingand continuous improvement which is periodically audited by an independent externalauditor.

We contract with thirdparties in China to perform high volume assembly and manufacturing of ourhandsets and some high volume single boards for AN-2000, PAS and mSwitchsystems. We conduct final assembly, testing and packaging at our own facilitiesand generally use third parties for high volume assembly of circuit boards.

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

**Research and Development**

We believe it is essential to continue to develop andintroduce new and enhanced products if we are to maintain our competitiveposition. While we use competitive analyses and technology trends as factors inour product development plans, the primary input for new products and productenhancements comes from soliciting and analyzing information about serviceproviders’ needs. Our relationships with China’s Ministry of InformationIndustry and Telecommunications Administration and individualtelecommunications bureaus and our full-service post-sale customersupport in China provide our research and development organization with insightinto trends and developments in the marketplace. The insights provided fromthese relationships allow us to develop market-driven products such asPAS, mSwitch and IP-DSLAM. We maintain a strong relationship between ourresearch centers in the U.S. and China. We rotate engineers between the U.S.and China to further integrate our research and development operations. We havebeen able to cost-effectively hire highly skilled technical employeesfrom a large pool of qualified candidates in China. We also have a developmentcenter in India to take advantage of the talent pool available there, and tosupport our operations in India. Our research and development centers are ISO9001-2000 certified.

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In the past we have made,and expect to continue to make, significant investments in research anddevelopment. Our research and development expenditures totaled $182.9 millionin 2006, $246.8 million in 2005, and $219.1 million in 2004.

**IntellectualProperty**

Our ability to compete is dependentin part on our proprietary technology. We rely on a combination of patent,copyright, trademark and trade secret laws, as well as confidentialityagreements and licensing arrangements, to establish and protect our proprietaryrights. We hold U.S. and foreign patents for our existing products expiringbetween 2014 and 2023, and have patents pending in both the U.S. and in foreigncountries. In addition, we have, from time to time, chosen to abandonpreviously filed applications. Patents may not be issued and any patents issuedmay not cover the scope of the claims sought in the applications. Additionally,issued patents may be found to be invalid or unenforceable in the courts ofthose countries where we hold or have filed for patents. Our U.S. patents donot afford any intellectual property protection in China or other internationaljurisdictions. Additionally, patents that we hold in countries other than theUnited States do not afford any intellectual property protection in the UnitedStates. Please refer to the discussion of risks associated with ourintellectual property in “Item 1A-Risk Factors—Factors Affecting FutureOperating Results.”

**Seasonality**

Our revenues and earningshave not demonstrated consistent seasonal characteristics. While we experiencesome seasonality typical of the telecommunications industry, such as seasonallyweak first quarters, that is often offset by other mitigating factors such ascustomer concentration and timing of revenue recognition.

**ITEM 1A—RISKFACTORS**

**FACTORS AFFECTINGFUTURE OPERATING RESULTS**

**RISKS RELATED TOOUR COMPANY**

*The restatement of our consolidated financialstatements following the Nominating and Corporate Governance Committee’s andmanagement’s review of our past stock option granting practices and the AuditCommittee’s and management’s review of certain sales in China has resulted inexpanded litigation and regulatory proceedings and may result in futurelitigation which could harm our financial results*

Our review of our historic option granting practicesand certain sales in China has required us to incur substantial expensesfor legal, accounting, tax and other professional services, has diverted ourmanagement’s attention from our business, and could in the future harm ourbusiness, financial condition, results of operations and cash flows.

The Audit Committee of our Board of Directors (“AuditCommittee”) engaged independent counsel to conduct an investigation of sales inChina. The independent counsel engaged forensic accountants. The China salesinvestigation, which commenced in February 2007 and was completed inSeptember 2007, covered each of the seven years in the period endedDecember 31, 2006. As a result of the review, management concluded andrecommended to the Audit Committee that our previously issued financial statementsshould be restated to defer the system sales contract revenue and the relatedcost of net sales for certain sales arrangements in one region of China foundto contain post-contract support obligations and recognize such amounts in ourconsolidated statements of operations over the estimated period ofpost-contract support. The Audit Committee concurred with management’srecommendation.

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In November 2006 we announced that the Nominatingand Corporate Governance Committee of our Board of Directors (“GovernanceCommittee”), comprised of independent directors, was conducting a voluntaryreview, with the assistance of independent legal counsel and forensicaccounting experts (the “Option Grant Review Team”), of our historic optiongranting practices, the timing of option grants and related accountingmatters. The review considered all option grant awards made in the periodfrom February 29, 2000, shortly before the initial public offering of ourCommon Stock, through August 2006 for compliance with the variousstock-based compensation accounting standards applicable as well as the rules ofour stock option plans. Upon completion of the review, management concluded theadjustments to correct errors in stock option accounting in our previouslyissued financial statements for the years ended December 31, 1998 and 2000through 2005, and the quarterly periods of 2005, as well as in the quarterlyperiods ended March 31 and June 30, 2006 that are reflected in ourconsolidated financial statements included in Exhibit 99.1 in this AnnualReport on Form 10-K should be made.

In determining the restatement adjustments inconnection with the review of our historical option granting practices,management used all reasonably available relevant information to formconclusions it believes are reasonable as to the most likely option grantingactions that occurred, the dates when such actions occurred, and the determinationof grant dates for financial accounting purposes based on when the requirementsof the accounting standards were met. The Option Grant Review Team andmanagement considered various alternatives throughout the course of the reviewand restatement; management believes the adjustments to measurement dates usedin our restatement of our financial statements are reasonable and appropriatein our circumstances.

Our restatement ofpreviously issued financial statements to correct revenue recognition for certainsales in China and for the effects of past stock options granting practices hasexposed us to greater risks associated with litigation and regulatoryproceedings. We have voluntarily provided information about the conduct of ourindependent investigation and review, the findings of the reviews, and ourconclusions to the staff of the Securities and Exchange Commission (“SEC”), andare cooperating, and will continue to cooperate fully with the SEC. Inaddition, as described in Part I, Item 3, “Legal Proceedings,” ofthis Form 10-K, several derivative complaints have been filedagainst certain of our current and formerofficers and directors pertaining to allegations relating to stockoption grants. However, our judgments may be challenged in legal proceedings orregulatory reviews, and we could be subject to adverse findings that couldrequire us to again restate our financial statements, to pay damages orpenalties, or have other remedies imposed upon us that could harm our business,financial condition, results of operations and cash flows. We may also beexposed to legal proceedings in connection with the results of ourinvestigation of certain sales in China. We cannot guarantee that new lawsuitsrelated to the matters resulting in the restatements will not be filed, and wecannot predict the outcome of any current or potential future litigation orregulatory proceeding against the Company or our current and former directorsor officers.

*The matters relating to the Audit Committee’sinvestigation of revenue recognition in China, the Governance Committee’sreview of our past stock option granting practice, and the restatement of ourconsolidated financial statements may otherwise adversely impact our business.*

As a result of our delayed filing of our QuarterlyReports on Form 10-Q for the quarters ended September 30, 2006,March 31, 2007 and June 30, 2007, as well as this Form 10-K,we will be ineligible to register our securities on Form S-3 forsale by us or resale by others until we have been current in our SEC filingsfor 12 calendar months. We may use Form S-1 to raise capital, butdoing so could increase transaction costs and the time required to completesuch transactions.

Employees who were awardedoptions at a discount from fair market value and were totally or partiallyunvested as of December 31, 2004, may be subject to a penalty tax underInternal Revenue Code Section 409A (“Section 409A”) and correspondingstates taxes upon exercise of these stock options. We are considering certainactions, which we believe would be in the best interests of our stockholdersand 

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employeesthat might substantially reduce or eliminate the federal and state penaltytaxes. However, there is no guarantee that we will be successful in developingeffective measures to address employees’ adverse tax consequences, and any suchmeasures may cause us to incur additional cash or noncash compensation expense.Furthermore, such measures, or the failure of such measures, may require theCompany to incur substantial expenses for legal, accounting, tax and otherprofessional services and may divert management’s attention from our business,which could in the future harm our business, financial condition, results ofoperations and cash flows.

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

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

·       thetiming and size of the orders for our products;

·       consumeracceptance of new products we may introduce to market;

·       changesin the growth rate of customer purchases of communications services;

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

·       revenuerecognition, which is based primarily on customer acceptance of deliveredproducts, is unpredictable;

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

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

·       cashcollection cycles in China and other emerging markets;

·       relianceon product, software and component suppliers who may constitute a sole sourceof supply or may have going concern issues;

·       thedecline in business activity we typically experience during the Chinese LunarNew Year, which leads to decreased sales and collections during our first fiscalquarter;

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

·       shiftsin our product mix or market focus.

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

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

We have experiencedintense competition in the past years, and we believe that we will continue toface intense competition from both domestic and international companies in ourtarget markets, many of which may operate under lower cost structures or may begiven preferential treatment by applicable governmental regulators and policiesand have much larger sales forces than we do. Additionally, other 

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companiesnot presently offering competing products may also enter our target markets. Manyof our competitors have significantly greater financial, technical, productdevelopment, sales, marketing and other resources than we do. As a result, ourcompetitors may be able to respond more quickly to new or emerging technologiesand changes in service provider requirements. Our competitors may also be ableto devote greater resources than we can to the development, promotion and saleof new products. These competitors may be able to offer significant financingarrangements to service providers, which may give them a competitive advantagein selling systems to service providers with limited financial resources. Inmany of the developing markets in which we operate or intend to operate,relationships with local governmental telecommunications agencies are importantto establish and maintain. In many such markets, our competitors may have or beable to establish better relationships with local 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. Moreover, the telecommunications and datatransmission industries have experienced significant consolidation, and weexpect this trend to continue. If we have fewer significant customers, we maybe more reliant on such large customers and our bargaining position and profitmargins may suffer. Increased competition is likely to result in pricereductions, reduced gross profit as a percentage of net sales and loss of marketshare, any one of which could materially harm our business, cash flows andfinancial condition, including potential impairment in value of our tangibleand intangible assets and goodwill if extended losses were incurred.

*We have incurred net losses in the past and will needto renew our lines of credit in China, refinance our convertible subordinatednotes, and transfer cash from our subsidiaries in China to have sufficient cashresources and liquidity. Our ability to accomplish these actions is not assured,and our ability to raise funds for other purposes is uncertain.*

At December 31, 2006, we had cash and short-terminvestments of $671.2 million to meet our liquidity requirements of which$483.7 million was held by our subsidiaries in China. China imposes currencyexchange controls on transfers of funds outside of China; such controls limittransfers of approximately $200 million of our net assets outside of Chinawithout first obtaining the consent of the Chinese government. While webelieved the China subsidiaries could freely transfer at least $200 million asof December 31, 2006, the amount of cash available for transfer from theChina subsidiaries is limited both by the liquidity needs of the subsidiariesin China and by the Chinese government requirements that the China subsidiariesretain adequate capital levels in China to protect creditors and to have fundsavailable for mandated employee benefits. Additionally, available creditfacilities in China at December 31, 2006 totaled $698.3 million, ofwhich $357.5 million was available for working capital purposes and $340.8million was available for use in support of letters of credit and corporateguarantees. These credit facilities expire principally in November and December 2007,and we had borrowed $102.5 million at December 31, 2006 under the workingcapital portion of the available credit lines, and such borrowings increased to$140.1 million at September 30, 2007. We also have outstanding long-termdebt outside of China in the form of our convertible subordinated notes with aprincipal balance of $274.6 million that mature in March 2008 (the “Notes”).

During the ninemonths ended September 30, 2007 our China subsidiaries have made transfersof funds out of China to the Company totaling $150 million. Although we believethe Company now has sufficient amount of cash resources to finance the Company’santicipated working capital and capital expenditure requirements for the next12 months, we do not have enough cashoutside of China to also repay the convertible notes maturing in March 2008,and we expect our recent financial performance and financial position will cause the lenders to reduce the totalavailable credit facilities when we negotiate renewals of the lines of creditin China in late 2007. Management’s liquidity plans include a partial orcomplete refinancing of the convertible notes, renewal of the lines of creditin China, transfers of additional 

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cash from its subsidiaries in China to the extentnecessary, and, if needed, liquidation of certain investments and/or seekingnew financing arrangements. In addition, it may be necessary for us to makesignificant changes to our business plan to maintain adequate liquidity for atleast the next 12 months in the event of various matters, such as:

·       changesin financial market conditions or our business condition that could limit ouraccess to existing credit facilities or make planned re-financings more costlyor even unfeasible;

·       changesin China’s currency exchange control regulations that could limit our abilityto access cash in China to meet liquidity requirements outside of China; and

·       inabilityto achieve planned operating results that could increase liquidity requirementsbeyond those considered in our financial plans.

We may desire to raiseadditional funds for purposes not presently included in our financial planssuch as to develop new or enhanced products, respond to competitive pressures,take advantage of acquisition opportunities or raise capital for strategic purposes.There is no assurance that additional financing for these or other purposeswould be available on acceptable terms or at all. If we raise additional fundsthrough the issuance of equity securities, our stockholders will experiencedilution of their ownership interest, and the newly issued securities may haverights superior to those of common stock. If we raise additional funds byissuing debt, our ability to meet our debt service obligations will bedependent upon our future performance, which will be subject to financial,business and other factors affecting our operations, many of which are beyondour control, we may be subject to limitations on our operations, and ourleverage may increase. The degree to which we are leveraged could materiallyand adversely affect our ability to obtain financing for working capital,acquisitions or other purposes and could make us more vulnerable to industrydownturns and competitive pressures.

*Our ability to meet our obligations under the terms ofour outstanding convertible notes and to continue operations may be compromisedif we are unable to transfer funds from our China operations as needed.*

During the nine monthsended September 30, 2007 our China subsidiaries have made transfers offunds out of China to the Company totaling $150 million. Although we believethe Company now has sufficient amount of cash resources to finance the Company’santicipated working capital and capital expenditure requirements for the next12 months, we do not have enough cashoutside of China to also repay the convertible notes aggregating $275 million maturingon March 1, 2008.Because we are limited by the Chinese government’s imposition of currencycontrols on transfer of funds outside of China, it may be time-consuming,difficult and /or expensive for us to transfer funds from China to repay theNotes. As a result, if an Event of Default on the Notes were to occur, we maynot have sufficient cash resources to repay the Notes and to continue operationswithout seeking new financing arrangements. We cannot be certain thatadditional financing for these purposes would be available on acceptable termsor at all, and if such financing is not available, our business could beseriously harmed. See the risk factor entitled “*We face a variety of risks related to our convertiblesubordinated notes”*for a further description of our obligationsunder the Notes, our recent consent solicitation of the noteholders and ourcompliance with certain covenants under the Indenture.

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*Sales in China have historically accounted for amaterial portion of our total sales, and our business, financial condition andresults of operations are to a significant degree subject to economic,political and social events, and the performance of our senior management teamin China.*

Approximately $785.5million, or 32%, $870.6 million, or 30%, and $2,028.2 million, or79%, of our net sales for fiscal years 2006, 2005 and 2004, respectively,occurred in China. While we have expanded into other markets, we have madesubstantial investments in China and, therefore, our business, financialcondition and results of operations are to a significant degree subject toeconomic, political, legal and social developments and other events in China. Inaddition, we have had significant changes within our senior management team inChina recently, and our current senior management team as a whole does not havethe same degree of experience in China as our senior management team had in thepast. (See the risk factor entitled “*Oursuccess is dependent on continuing to hire and retain qualified personnel,including for senior management positions, and if we are not successful inattracting and retaining these personnel and in managing key employee turnover,our business will suffer”)*. If our current senior management inChina cannot maintain and /or establish key relationships with customers,governmental entities and others in China, our business in China may declinesignificantly. If our business in China declines, our financial condition andresults of operations may be significantly harmed.

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

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

·       increasedcompetition;

·       aggressiveprice reductions by competitors;

·       rapidtechnological change; and

·       constantchange in customer buying behavior and market trends.

The average selling prices of our products maycontinue to decrease in the future in response to product introductions by usor our competitors or other factors, including price pressures from customers. Certainof our products, including wireless handsets, have historically had low grossprofit margins, and any further deterioration of our profit margins on suchproducts could result in losses with respect to such products. Therefore, wemust continue to develop, source and introduce new products and enhancements toexisting products that incorporate features that can be sold at higher averageselling prices. Failure to do so or the failure of consumers or our directcustomers to accept such new products could cause our revenues and gross profitto decline.

Our cost reduction effortsinitiated in 2005 and our subsequent efforts in the second half of 2007 andearly 2008 may not allow us to keep pace with competitive pricing pressures orlead to improved 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.

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

The market forcommunications equipment is characterized by rapid technological developments,frequent new product introductions, changes in consumer preferences andevolving industry and regulatory standards. Our success will depend in large parton our ability to enhance our technologies and develop and introduce newproducts and product enhancements that anticipate changing service providerrequirements, technological developments and evolving consumer preferences. Wemay need to make substantial capital expenditures and incur significantresearch and development costs to develop and introduce new products andenhancements. If we fail to develop and introduce new products or enhancementsto existing products that effectively respond to technological change on atimely basis, our business, financial condition and results of operations couldbe materially adversely affected. Certain of our products, including wirelesshandsets, have a short product life. Moreover, from time to time, our competitorsor we may announce new products or product enhancements, technologies orservices that have the potential to replace or shorten the life cycles of ourproducts and that may cause customers to defer purchasing our existingproducts, resulting in charges for inventory obsolescence reserves. Futuretechnological advances in the communications industry may diminish or inhibitmarket acceptance of our existing or future products or render our productsobsolete. Even if we are able to develop and introduce new products, they maynot gain market acceptance. Market acceptance of our products will depend onvarious 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;

·       thecompatibility of our products with legacy technologies and standards existingin previously deployed network equipment;

·       ourability to attract customers who may have pre-existing relationships with ourcompetitors;

·       productpricing relative to performance;

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

·       thetiming of new product introductions meeting demand patterns.

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

*We depend on some sole source and key suppliers forhandsets, base stations, components and materials used in our products. If wecannot secure adequate supplies of high quality products at competitive pricesor in a timely manner from these suppliers or sources, or if the supplierssuccessfully market their products directly to our customers, our competitiveposition, reputation and business could be harmed.*

We have contracts with a limited group of suppliers topurchase some components and materials used in our products. If any supplier isunwilling or unable to provide us with high-quality components and materials inthe quantities required and at the costs specified by us, we may not be able tofind alternative sources on favorable terms, in a timely manner, or at all. Further,a supplier could market its products directly to our customers. The possibilityof a supplier marketing its own products would create direct competition andmay affect our ability to obtain adequate supplies. Our inability to obtain orto develop alternative sources if and as required could result in delays or reductionsin manufacturing or product shipments. From time to time, there could beshortages of certain products or components. Moreover, our suppliers may supplyus with inferior quality products. If an inferior product supplied by a thirdparty is 

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embedded in our endproduct and causes a problem, it might be difficult to identify the source ofthe problem as being due to the component parts. If any of these events occur,our competitive position, 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, patentinfringement claims, import duties and licensing requirements. As an example, arecent court case between a third party and one of our suppliers involved apatent dispute potentially restricting the importation of handsets into the U.S.While this case has been resolved in the supplier’s favor at the trial courtlevel, our supply of products could be affected by similar cases in the future.Moreover, import duties on such components increase the cost of our productsand may make them less competitive.

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

Many of our products arehighly complex and may have quality deficiencies resulting from the design ormanufacture of such product, or from the software or components used in theproduct. For example, during 2005 we recorded warranty charges of$70.6 million, including special warranty charges of $11.7 millionfor certain asynchronous digital subscriber line (“ADSL”) products,$4.0 million for NetRingTM equipment and $14.9 million for GEPONequipment sold to SBBC, an affiliate of SOFTBANK CORP and SOFTBANKAmerica Inc., during 2003 and 2004. Often these issues are identifiedprior to the shipment of the products and may cause delays in market acceptanceof our products, delays in shipping products to customers, or the cancellationof orders. In other cases, we may identify the quality issues after theshipment of products. In such cases, we may incur unexpected expenses anddiversion of resources to replace defective products or correct problems. Suchpre-shipment and post-shipment quality issues could result in delays in therecognition of revenue, loss of revenue or future orders, and damage to ourreputation and customer relationships. In addition, we may be required to paydamages for failed performance under certain customer contracts, and mayreceive claims from customers related to the performance of our products. Suchpre-shipment and post-shipment quality issues could result in delays in therecognition of revenue, loss of revenue or future orders, and damage to ourreputation and customer relationships. In addition, we may be required to paydamages for failed performance under certain customer contracts and may receiveclaims from customers related to the performance of our products.

*Our global diversification strategy and growth hasstrained our resources, adversely affected our reported gross margins, and ifwe are unable to manage this growth, our future operating results will befurther negatively affected.*

Over the last four years we have experienced a rapidexpansion of our international operations and anticipate that we must continueto transform our operations to address market demands and potential marketopportunities globally.

Competition in international markets for new serviceprovider customers and for new infrastructure deployments is particularlyintense and increasingly focused on price. To meet competitive offerings we mayaccept contracts with low profitability or even enter into contracts withanticipated losses if we believe it is necessary to establish a relationshipwith a customer or a presence in a market that we consider important to ourinternational expansion strategy. We believe these decisions will facilitatethe development of our international business, but we can provide no assurancethat they will. Accepting a contract with an anticipated loss requires us to arecognize a provision for the entire loss in the period in which it becomesevident rather than in later periods in which contract performance occurs.Accepting 

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contracts with low grossmargins adversely affects our reported results when the revenues from suchcontracts are recognized; in some cases revenue recognition must be deferreduntil all revenue recognition criteria have been met, and this would result inrecognizing the adverse effects of low gross margin contracts in periodssubsequent to when contract performance occurred.

Our transformationto a global focus will place a significant strain on our management,operational, financial and other resources. To manage this transformationeffectively, we will need to take various actions, including:

·       enhancingmanagement information systems, including forecasting procedures;

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

·       managingour working capital and sources of financing;

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

·       retaining,training and managing our employee base;

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

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

·       improvingand sustaining our supply chain capability; and

·       managingboth our direct and indirect sales channels in a cost-efficient and competitivemanner.

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

*Any failure by us to execute planned cost reductionssuccessfully could result in total costs and expenses that are greater thanexpected.*

From time to time we haveundertaken restructuring plans to bring operational expenses to appropriatelevels for each of our businesses, while simultaneously implementing extensivenew company-wide expense-control programs. For example, in 2005, weannounced workforce restructurings. These programs resulted in the terminationof approximately 1,595 employees worldwide through December 31, 2005. Weanticipate making further workforce reductions and taking additionalrebalancing actions in the future. In October 2007, our Board of Directorsapproved a restructuring plan which includes a worldwide reduction in force ofapproximately 11% of the Company’s headcount, or approximately 700 employees. Weexpect cost savings from planned restructuring activities to be used to offsetmarket forces or to be reinvested in our businesses to strengthen ourcompetitiveness, but we cannot be certain that we will be successful in theseefforts. Significant risks associated with these actions and other workforcemanagement issues that may impair our ability to achieve anticipated costreductions or may otherwise harm our business include delays in implementationof anticipated workforce reductions in highly regulated locations outside ofthe United States, particularly in Europe and Asia, redundancies amongrestructuring programs, decreases in employee morale and the failure to meetoperational targets due to the loss of employees, particularly sales employees.

*Our success is dependent on continuing to hire andretain qualified personnel, including for senior management positions, and ifwe are not successful in attracting and retaining these personnel and inmanaging key employee turnover, our business will suffer.*

The success of our business depends in significantpart upon the continued contributions of key technical and senior managementpersonnel, many of whom would be difficult to replace. In particular, 

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our success dependsin large part on the knowledge, expertise and services of Hong Liang Lu, ourChief Executive Officer, Peter Blackmore, our President and ChiefOperating Officer, Francis P. Barton, Executive Vice President and ChiefFinancial Officer and Philip Christopher, President and Chief Executive Officerof our Personal Communications Division. The loss of any key employee, thefailure of any key employee to perform satisfactorily in his or her currentposition or our failure to attract and retain other key technical and seniormanagement employees could have a significant negative impact on our operations.We have had significant changes within our senior management team recently, andour current senior management team as a whole does not have the same degree ofexperience in China as our senior management had in the past. If our currentsenior management cannot maintain and/or establish key relationships withcustomers, governmental entities and others in China, our business in China maydecline significantly and our financial condition and results of operations maybe significantly harmed.

Notwithstanding ourworkforce restructurings, to effectively manage our operations, we will need torecruit, train, assimilate, motivate and retain qualified employees bothlocally and internationally. Competition for qualified employees is intense,and the process of recruiting personnel in all fields, including technology,research and development, sales and marketing, administration and managementwith the combination of skills and attributes required to execute our businessstrategy can be difficult, time-consuming and expensive. As we grow globally,we must implement hiring and training processes that are capable of quicklydeploying qualified local residents to knowledgeably support our products andservices. Alternatively, if there is an insufficient number of qualified localresidents available, we might incur substantial costs importing expatriates toservice new global markets. For example, we have historically experienceddifficulty finding qualified accounting personnel knowledgeable in both U.S.and Chinese accounting standards who are Chinese residents. If we fail toattract, hire, assimilate or retain qualified personnel, our business would beharmed. Competitors and others have in the past, and may in the future, attemptto recruit our employees. In addition, companies in the telecommunicationsindustry whose employees accept positions with competitors frequently claimthat the competitors have engaged in unfair hiring practices. We may be thesubject of these types of claims in the future as we seek to hire qualifiedpersonnel. Some of these claims may result in material litigation anddisruption to our operations. We could incur substantial costs in defendingourselves against these claims, regardless of their merit.

*Any acquisitions and divestitures that we undertakecould be difficult to integrate, disrupt our business, dilute our stockholdersand harm our operating results.*

We have acquired anddivested certain businesses, products and technologies. Anticipated benefits ofthese acquisitions and divestitures may not be realized. We have in the pastand will continue to evaluate acquisition prospects that would complement ourexisting product offerings, augment our market coverage, enhance ourtechnological capabilities, or that may otherwise offer growth opportunities. Acquisitionsmay result in dilutive issuances of equity securities, use of our cash resources,the incurrence of debt and the amortization of expenses related to intangibleassets. In addition, acquisitions involve numerous risks, includingdifficulties in the assimilation of operations, technologies, products andpersonnel of the acquired company, diversion of management’s attention fromother business concerns, risks of entering markets in which we have no director limited prior experience, the potential loss of key employees of theacquired company, unanticipated costs and, in the case of the acquisition offinancially troubled businesses, challenges as to the validity of suchacquisitions from third party creditors of such businesses. For example, in thefourth quarter 2004, we encountered difficulties in integrating Hyundai Syscomm, Inc.(“HSI”) legacy operations into our operations and determined to abandon asubstantial amount of HSI’s legacy operations. As a result, in the fourthquarter 2004, we wrote off the entire goodwill and intangibles associated withHSI.

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

We rely on a combinationof patents, copyrights, trademarks, trade secret laws and contractualobligations to protect our technology. We have applied for patents in theUnited States and internationally. Additional patents may not be issued fromour pending patent applications, and our issued patents may not be upheld. Inaddition, we have, from time to time, chosen to abandon previously filed patentand trademark applications. Moreover, we may face difficulties in registeringour existing trademarks in new jurisdictions in which we operate, and we may beforced to abandon or change product or service trademarks because of theunavailability of our existing trademarks or because of oppositions filed orlegal challenges to our trademark filings. We cannot guarantee that theintellectual property protection measures that we have taken will be sufficientto prevent misappropriation of our technology or trademarks or that ourcompetitors will not independently develop technologies that are substantiallyequivalent or superior to ours. In addition, the legal systems of many foreigncountries do not protect or honor intellectual property rights to the sameextent as the legal system of the United States. For example, in China, thelegal system in general, and the intellectual property regime in particular,are still in the development stage. It may be very difficult, time-consumingand costly for us to attempt to enforce our intellectual property rights inthese jurisdictions.

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

The industry in which we compete is moving towardsaggressive assertion, licensing, and litigation of patents and otherintellectual property rights. From time to time, we have become aware of thepossibility or have been notified that we may be infringing certain patents orother intellectual property rights of others. Regardless of their merit,responding to such claims could be time consuming, divert management’sattention and resources and cause us to incur significant expenses. Inaddition, although some of our supplier contracts provide for indemnificationfrom the supplier with respect to losses or expenses incurred in connectionwith any infringement claim, certain contracts with our key suppliers do notprovide for such protection. Moreover, certain of our sales contracts providethat we must indemnify our customers against claims by third parties forintellectual property rights infringement related to our products. There are nolimitations on the maximum potential future payments under these guarantees. Therefore,we may incur substantial costs related to any infringement claim, which maysubstantially harm our results of operations and financial condition.

We have been and may in the future become subject tolitigation to defend against claimed infringements of the rights of others orto determine the scope and validity of the proprietary rights of others. Futurelitigation may also be necessary to enforce and protect our patents, tradesecrets and other intellectual property rights. Any intellectual propertylitigation or threatened intellectual property litigation could be costly, andadverse determinations or settlements could result in the loss of ourproprietary rights, subject us to significant liabilities, require us to seeklicenses from or pay royalties to third parties which may not be available oncommercially reasonable terms, if at all, and/or prevent us from manufacturingor selling our 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 proprietary rights on commerciallyreasonable terms and conditions, our business, results of operations andfinancial condition could be materially and adversely impacted.

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***Ourmultinational operations subject us to various economic, political, regulatoryand legal risks.***

We market and sellour products globally, with a significant portion of our sales made in China.The expansion of our existing multinational operations and entry into newmarkets will 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 party distributorsand agents to effectively market and sell our products;

·       unusualcontract terms required by customers in developing markets;

·       changesin local governmental control or influence over our customers;

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

·       theburden of compliance with complex and varying taxation requirements of multiplejurisdictions;

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

·       reducedprotection for intellectual property rights in some countries;

·       unprovenbusiness operation models developed or operated in specific countries orregions;

·       longeraccounts receivable collection periods; and

·       difficulties and costs ofstaffing, monitoring and managing multinational operations, including but notlimited to internal controls and compliance.

***We do business in markets that arenot 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;

·       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

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

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In particular, thesefactors create the potential for physical loss of inventory andmisappropriation of operating assets. We have in the past experienced cases ofvandalism and armed theft of our equipment that had been or was being installedin the field. If disruptions for any of these reasons become too severe in anyparticular market, it may become necessary for us to terminate contracts andwithdraw from that market and suffer the associated costs and lost revenue.

***Our wireless handset products aresubject to a wide range of environmental, health and safety laws, and mayexpose us to potential health and environmental liability claims.***

Our handset products are subject to a wide range ofenvironmental, health and safety laws, including laws relating to the use,disposal and clean up of, and human exposure to hazardous substances. In theUnited States, these laws often require parties to fund remedial actionregardless of fault. Factors such as the discovery of additional contaminants,the extent of remediation and compliance expenses, and the imposition ofadditional clean up obligations could cause us to incur substantial costsrelating to remediation activities. Compliance with existing or futureenvironmental, health and safety laws could also cause us to incur substantialcosts relating to such compliance, including the expense of modifying productdesigns and manufacturing processes. In addition, restrictions on the use ofcertain materials in our facilities or products in the future could have anegative impact on our operations.

Additionally, there have been claims made alleging alink between the use of wireless handsets and the development or aggravation ofcertain cancers, including brain cancer. The scientific community is divided onwhether there is a risk from wireless handset use, and if so, the magnitude ofthe risk. Even if there is no link established between wireless handset use andcancer, the negative publicity and possible litigation could have a materialadverse effect on our business. In the past, several plaintiffs’ groups havebrought class actions against wireless handset manufacturers and distributors,alleging that wireless handsets have caused cancer. To date, we have not beennamed in any of these actions and none of these actions has been successful. Inthe future we could incur substantial costs in defending ourselves againstsimilar claims, regardless of their merit. Also, claims may be successful inthe future and may have a material adverse effect on our business.

Furthermore, there havebeen claims made alleging a link between the use of Bluetooth enabled mobilephone handsets and noise-induced hearing loss. To date, we have not been namedin any of these actions. In the future we could incur substantial costs indefending ourselves against similar claims, regardless of their merit. Also,claims may be successful in the future and may have a material adverse effecton our business.

***We are subject to a wide range ofenvironmental, health and safety laws and efforts to comply with such laws maybe costly and may adversely impact our financial performance.***

Our operations and theproducts we manufacture and/or sell are subject to a wide range of globalenvironmental, health and safety laws. Compliance with existing or futureenvironmental, health and safety laws could subject us to future costs,liabilities, impact our production capabilities, constrict our ability to sell,expand or acquire facilities and generally impact our financial performance.Some of these laws relate to the use, disposal, clean up of, and exposure tohazardous substances. In the United States, laws often require parties to fundremedial studies or action regardless of fault. Over the last several years,the European Union (the “EU”) countries have enacted environmental lawsregulating electronic products. For example, beginning July 1, 2006, ourproducts have been subject to laws that mandate the recycling of waste in electronicproducts sold in the EU and that limit or prohibit the use of certainsubstances in electronic products. Other countries outside of Europe areexpected to adopt similar laws. We may incur additional expenses to comply withthese laws.

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***Currencyrate fluctuations and exchange controls may adversely affect our cash flow andoperating results.***

Because a significant percentage of our sales are madein foreign countries and denominated in local currency, we are exposed tomarket risk for changes in foreign exchange rates on our foreign currencydenominated accounts and notes receivable balances. Historically, the majorityof our sales have been made in China and denominated in Renminbi. Prior toJuly 2005, the impact of currency fluctuations of Renminbi wereinsignificant as it was fixed to the U.S. dollar. However, in July 2005,China uncoupled the Renminbi from the U.S. dollar and let it float in a narrowband against a basket of foreign currencies. The move revalued the Renminbi by2.1% against the U.S. dollar; however, it is uncertain what further adjustmentsmay be made in the future. The Renminbi-U.S. dollar exchange rate could float,and the Renminbi could appreciate relative to the U.S. dollar. For example, theRenminbi-U.S. dollar exchange rate was 8.28 to the U.S. dollar prior to thefloat of the Renminbi in July 2005 and 7.80 Renminbi to the U.S. dollar atDecember 31, 2006. Any significant revaluation of the Renminbi maymaterially and adversely affect our cash flows, revenues, operating results andfinancial position.

Outside of China, our primary foreign currencyexposures have related to non-dollar denominated sales and purchases in Japan,Europe and Canada. Additionally, we have exposures to emerging marketcurrencies, which can have extreme currency volatility. We have experiencedmaterial adverse impacts on our results of operations from fluctuations incurrency exchange rates and may continue to do so in the future.

We may, from time to time,enter into foreign exchange forward contracts to minimize the short-term impactof foreign currency fluctuations on certain foreign currency receivables andpayables. Our attempts to hedge against these risks may not be successful,resulting in an adverse impact on our results of operations. Moreover, some ofthe foreign countries in which we do business might impose currencyrestrictions that may limit the ability of our subsidiaries and joint venturesin such countries to obtain and remit foreign currency necessary for thepurchase of imported components and may limit our ability to obtain and remitforeign currency in exchange for foreign earnings. For example, China employscurrency controls restricting Renminbi conversion, limiting our ability toengage in currency hedging activities in China. Various foreign exchangecontrols may also make it difficult for us to repatriate earnings, which couldhave a material adverse effect on our ability to conduct business globally.

***Businessinterruptions could adversely affect our business.***

Our operations are vulnerableto interruption by fire, earthquake, power loss, telecommunications failure,external interference with our information technology systems, incidents ofterrorism and other events beyond our control. For example, our Hangzhoumanufacturing facility’s ability to produce sufficient products is dependentupon a continuous power supply. However, the Hangzhou facility has in the pastbeen subject to power shortages, which has affected our ability to produce andship sufficient products. Also, our operations in Alameda, California arelocated in an area prone to earthquakes. We do not have a detailed disasterrecovery plan, and the occurrence of any events like these that disrupt ourbusiness could harm our business and operating results.

***Wemay suffer losses with respect to equipment held at customer sites, which couldharm our business.***

We face the risk of loss relating to our equipmentheld at customer sites. In some cases, our equipment held at customer sites isunder contract, pending final acceptance by the customer. We generally do nothold title or risk of loss on such equipment, as title and risk of loss aretypically transferred to the customer upon delivery of our equipment. However,we do not recognize revenue and accounts receivable with respect to the sale ofsuch equipment until we obtain acceptance from the customer. If we do notobtain final acceptance, we may not be able to collect the contract price andrecover this equipment or its associated costs. In other cases, particularly inChina, where governmental approval is 

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required to finalizecertain contracts, inventory not under contract may be held at customer sites.We hold title and risk of loss on this inventory until the contracts arefinalized and, as such, are subject to any losses incurred resulting from anydamage 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 contract is damaged prior to contract finalization. If we incura loss relating to inventory for any of the above reasons, our financialcondition, cash flows, and operating results could be harmed.

***Restrictionson the use of handsets while driving could affect our future growth.***

Several foreigngovernments and U.S. state and local governments have adopted or areconsidering adopting legislation that would restrict or prohibit the use ofwireless handsets while driving. Widespread legislation that restricts orprohibits the use of wireless handsets while driving could negatively affectour future growth.

***We have been named as a defendantin securities litigation and other lawsuits, as well as lawsuits in theordinary course of business.***

Currently, we are adefendant in securities litigation class action lawsuits, as well as otherlawsuits. Additionally, from time to time we are plaintiffs or defendants inother lawsuits including lawsuits in the ordinary course of our business. Thepursuit or defense of these lawsuits may divert our management’s attention, andwe may incur significant expenses in pursuing or defending these lawsuits. Inaddition, we may be required to pay judgments or settlements that could have amaterial adverse effect on our results of operations, financial condition andliquidity.

***Weface risks related to pending governmental inquiries.***

In September 2005, we received notice of a formalinquiry by the staff of the Securities & Exchange Commission (“SEC”)into certain aspects of our financial disclosures during prior reportingperiods and certain other issues. In addition, in December 2005, the U.S.Embassy in Mongolia informed us that it had forwarded to the Department ofJustice (“DOJ”) allegations that an agent of our Mongolia joint venture hadoffered payments to a Mongolian government official in possible violation ofthe Foreign Corrupt Practices Act (the “FCPA”). We, through our AuditCommittee, authorized an independent investigation into possible violations ofthe FCPA, and we have been in contact with the DOJ and SEC regarding theinvestigation. The investigation has identified possible FCPA violations inMongolia, Southeast Asia, India and China, as well as possible violations ofU.S. immigration laws. The DOJ has requested that the Company voluntarilyproduce documents related to the investigation and the SEC has subpoenaed theCompany for documents. The Company has executed tolling agreements extendingthe statute of limitations for the FCPA issues under investigation by the SECand the DOJ and the immigration issues under investigation by the DOJ. Atthis time, we cannot predict when any inquiry will be completed or what theoutcome of any inquiry will be. These inquiries could harm relationships withexisting customers and our ability to obtain new customers and partners. If theSEC or the DOJ makes a determination that we have violated federal laws, we mayface sanctions including, but not limited to, fines, disgorgement and aninjunction. Additionally, such a determination by the SEC or the DOJ couldadversely affect our business, results of operations, financial position andcash flow, and ultimately our stock price.

We have also been in communication with the SEC regardingour voluntary review of our historical option grant awards grant practices andour review of certain historical sales contracts in China. Although 

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we have now completed bothof those voluntary reviews, it is possible that the SEC may question the findingsof our reviews or initiate its own review into related matters.

It is possible that thefindings and outcome of any of these inquiries may affect other lawsuits thatare pending. These inquiries could divert management attention and resources,which could harm our business.

***Failure to achieve and maintaineffective internal controls in accordance with Section 404 of the Sarbanes-OxleyAct of 2002 could have a material adverse effect on our business and stockprice.***

Section 404 of theSarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”) requires that weestablish and maintain an adequate internal control structure and proceduresfor financial reporting and include a report of management on our internalcontrol over financial reporting. Our annual report on Form 10-Kmust contain an assessment by management of the effectiveness of our internalcontrol over financial reporting and must include disclosure of any materialweaknesses in internal control over financial reporting that we haveidentified. In addition, our independent registered public accounting firm mustattest to and report on management’s assessment of the effectiveness of ourinternal control over financial reporting.

We have identifiedmaterial weaknesses in our internal control over financial reporting. See “Item 9A—Controlsand Procedures—Management’s Report on Internal Control Over FinancialReporting.”  As of the date of thisannual report on Form 10-K, we are still in the process ofimplementing remedial measures related to the material weaknesses identified in2004 through 2006. If our efforts to remediate the weaknesses we identified arenot successful, our business and operating results could be harmed and thereliability of our financial statements could be impaired, which could adverselyaffect our stock price. The requirements of Section 404 of the Sarbanes-OxleyAct are ongoing and also apply to future years. We expect that our internalcontrol over financial reporting will continue to evolve as we continue in ourefforts to transform our business. Although we are committed to continue toimprove our internal control processes and we will continue to diligently andvigorously review our internal control over financial reporting in order toensure compliance with the Section 404 requirements, any control system,regardless of how well designed, operated and evaluated, can provide onlyreasonable, not absolute, assurance that its objectives will be met. Inaddition, successful remediation of the noted control deficiencies is dependenton the Company’s ability to hire and retain qualified personnel. Therefore, wecannot be certain that in the future additional material weaknesses orsignificant deficiencies will not exist or otherwise be discovered.

**RISKS RELATED TO CONDUCTING BUSINESS IN CHINA**

***China’s governmental and regulatoryreforms may impact our ability to do business in China.***

Since 1978, the Chinese government has been in a stateof evolution and reform. The reforms have resulted in and are expected tocontinue to result in significant economic and social development in China.Many of the reforms are unprecedented or experimental and may be subject tochange or readjustment due to a variety of political, economic and socialfactors. Multiple government bodies are involved in regulating andadministering affairs in the telecommunications and information technologyindustries, among which the Ministry of Information Industry (“MII”), theNational Development and Reform Commission (“NDRC”), the State-ownedAssets Supervision and Administration Commission (“SASAC”) and the StateAdministration of Radio, Film and Television (“SARFT”) play the leading roles.These government agencies have broad discretion and authority over all aspectsof the telecommunications and information technology industry in China,including but not limited to, setting the telecommunications tariff structure,granting carrier licenses and frequencies, approving equipment and products,granting product licenses, approving of the form and content of transmitteddata, specifying technological standards as well as appointing carrierexecutives, all of which may impact our ability to do business in China.

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Any of thefollowing changes in China’s political and economic conditions and governmentalpolicies 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;

·       therestructuring of telecommunications carriers in China, including policy makinggoverning 3G network infrastructure and licensing;

·       restrictionson IPTV license grants, which could limit the potential market for ourproducts;

·       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 laws, rules or regulations affecting the direct or indirectnationalization of assets controlled by non-governmental persons or entities;

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

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

In addition to modifying the existingtelecommunications regulatory framework, the Chinese government is currentlypreparing a draft of a standard, national telecommunications law(“Telecommunications Law”) to provide a uniform regulatory framework for thetelecommunications industry. Currently a draft of the law has been finished anddelivered to the National People’s Congress for discussion. We do not yet knowthe final nature or scope of the regulations that would be created if theTelecommunications Law is passed. Accordingly, we cannot predict whether itwill have a positive or negative effect on us or on some or all aspects of ourbusiness.

Under China’s currentregulatory structure, the communications products that we offer in China mustmeet government and industry standards. In addition, a network access licensefor the equipment must be obtained. Without a license, telecommunicationsequipment is not allowed to be connected to public telecommunications networksor sold in China. Moreover, we must ensure that the quality of thetelecommunications equipment for which we have obtained a network accesslicense is stable and reliable, and will not negatively affect the quality orperformance of other installed licensed products.

***China’schanging economic environment may impact our ability to do business in China.***

Since 1978, the Chinesegovernment has been reforming the economic system in China to increase theemphasis placed on decentralization and the utilization of market forces in thedevelopment of China’s economy. These reforms have resulted in significanteconomic growth. However, any economic reform policies or measures in China mayfrom time to time be modified or revised by the Chinese government. While wemay be able to benefit from the effects of some of these policies, thesepolicies and other measures taken by the Chinese government to regulate theeconomy could also have a significant negative impact on economic conditions inChina, which would result in a negative impact on our business.

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*China’s entry into the World Trade Organization andrelaxation of trade restrictions have led to increased foreign investment inChina’s telecommunications industry and may lead to increased competition inour markets which may have an adverse impact on our business.*

China’s economic environment has been changing as aresult of China’s entry, in December of 2001, into the World TradeOrganization (“WTO”). Foreign investment in the telecommunications sector isregulated by the “Provisions on Administration of Foreign InvestedTelecommunications Enterprises” promulgated by the State Council in December 2001and effective as of January 1, 2002. The provisions brought foreign equitylimits into conformity with China’s WTO commitments, allowing foreign investorsto own equity generally up to 49% for basic telecom services enterprises and upto 50% for value-added telecom services enterprises. Furthermore, China isgradually introducing a market oriented pricing mechanism for telecommunicationservices. On July 13, 2005, China’s Ministry of Information Industry(“MII”) and National Development and Reform Commission (“NDRC”) approved thelaunch of plan-based pricing for fixed-line telephone service by China’s twofixed-line operators, China Telecom and China Netcom. In August 2005, MIIand NDRC endorsed a “Circular on the Changes in Administration of TelecomService Pricing,” which became effective on October 1, 2005 and furtherrelaxed the pricing administration on certain telecom services.  As China gradually relaxes such legalprovisions, international telecommunication service vendors may seize this opportunityto adjust their China strategy, increasing their investment in China andconverting some of their joint-ventures into fully-ownedenterprises.

As the existinginternational vendors increase their investment in China, and more vendorsenter the China market, the competition in the telecommunication equipmentmarket may increase, and as a result, our business may suffer. If China’s entryinto the WTO results in increased competition or has a negative impact onChina’s economy, our business could suffer. In addition, although China isincreasingly according foreign companies and foreign investment enterprisesestablished in China the same rights and privileges as Chinese domesticcompanies as a result of its admission into the WTO, special laws, administrativerules and regulations governing foreign companies and foreign investmententerprises in China may still place foreign companies at a disadvantage inrelation to Chinese domestic companies and may adversely affect our competitiveposition.

***Uncertaintieswith respect to the Chinese legal system may adversely affect us.***

We conduct our business inChina primarily through our wholly owned subsidiaries incorporated in China.Our subsidiaries are generally subject to laws and regulations applicable toforeign investment in China. Accordingly, our business might be affected byChina’s developing legal system. Since 1978, many new laws and regulationscovering general economic matters have been promulgated in China, andgovernment 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 regarding theinterpretation and enforcement of laws, rules and policies in China.Governmental authorities have broad discretion in the interpretation andenforcement of the laws, regulations and rules. The Chinese legal system isbased on written statutes, and prior court decisions have limited precedentialvalue. Because many laws and regulations are relatively new and the Chineselegal system is still evolving, the interpretations of many laws, regulationsand rules are not always uniform. Moreover, the relative inexperience ofChina’s judiciary in many cases creates additional uncertainty as to theoutcome of any litigation, and the interpretation of statutes and regulationsmay be subject to government policies reflecting domestic political changes.Finally, enforcement of existing laws or contracts based on existing law may beuncertain and sporadic, and it may be difficult to obtain swift and equitableenforcement, or to obtain enforcement of a judgment by a court of anotherjurisdiction. Any litigation in China may be protracted and result insubstantial costs and diversion of resources and management’s attention.

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

On March 16, 2007, China’s top legislature, theNational People’s Congress, passed the China Corporate Income Tax Law (“CITLaw”). CIT Law will be effective on January 1, 2008. Under the CIT Law,China’s dual tax system for domestic enterprises and foreign investmententerprises (“FIEs”) would be effectively replaced by a unified system. The newlaw establishes a tax rate of 25% for most enterprises and a reduced tax rateof 15% for certain qualified high technology enterprises.

Prior to this change in tax law, certain subsidiariesand joint ventures located in China enjoyed tax benefits in China which aregenerally available to FIEs.  The taxholidays/incentives for FIEs were applicable or potentially applicable toUTStarcom ChongQing Telecom Co. Ltd. (“CUTS”), UTStarcom Telecom Co., Ltd. (“HUTS”),Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”) and UTStarcom China Co.,Ltd. (“UTSC”), our active subsidiaries in China, because these entities mayqualify as accredited technologically advanced enterprises.

CIT Law targets certain industries for the reduced 15%tax rate for certain qualified high technology enterprises.   For FIEs established before the promulgationof the new law who currently enjoy lower tax rates, any increase in their taxrates would be gradually phased in over five years. Significant regulationsregarding the interpretation and implementation of the new tax law are stillpending. There is potential risk that our subsidiaries may not qualify for thereduced 15% tax rate. Therefore, the new law may have an adverse impact on ourfuture tax expense in China.

Moreover, the Chinesecentral government may review and audit tax benefits granted by local orprovincial authorities and could determine to disallow such benefits. Certainof our subsidiaries and joint ventures located in China enjoy tax benefits inChina that are generally available to foreign investment enterprises. If thesetax benefits are reduced, disallowed or repealed due to changes in tax laws ordetermination by the Chinese government, our business could suffer.

***Our ability to continue successfuldeployment of PAS system and sales of PAS handsets are limited by certainfactors, including the following:***

*Maturing PAS marketand increased competition in handsets and tariffs.*

The market for PAS exceeded 96 million users asof the end of fiscal year 2006 and is available in most of the provincesthroughout China. We believe the PAS market has matured. For example, duringfiscal year 2005, net sales of the PAS/iPAS system and the wirelessinfrastructure market declined significantly as compared to fiscal year 2004.This decline continued through fiscal year 2006, and the first quarter of 2007.If additional handset competitors enter the market, or if competitors decide tofurther reduce pricing, our sales of PAS handsets may be adversely impacted.

Furthermore, competitionfrom mobile operators, such as China Mobile and China Unicom, has increased incities where PAS is deployed. Mobile operators offering special promotionalpricing or incentives to customers, such as free incoming calls or freemobile-to-mobile calls, have harmed the ability of our customers, China Telecomand China Netcom, to compete effectively. The continued use of such incentiveprograms by mobile operators may adversely impact China Telecom and ChinaNetcom’s ability to increase PAS subscriptions. Due to our relationships withChina Telecom and China Netcom, reduced subscription growth at these carriersmay have a material adverse effect on our pricing and harm our business orresults of operations.

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

China’s media sources havewidely reported that the MII may grant 3G mobile licenses to China Telecom orChina Netcom, or to both in 2007. If China Telecom or China Netcom obtains 3Gmobile 

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licenses,they may re-allocate capital expenditures to construct 3G networks, and as aconsequence, may significantly reduce capital expenditures relating to PASnetworks that utilize our existing products. In addition, it is possible thatcurrent PAS frequency bands utilized by PAS networks may be reallocated for useby 3G networks, resulting in the restriction of or shutting down of PASnetworks. If this were to occur, we could lose current and potential futurecustomers of our products, and our financial condition and results ofoperations could be significantly harmed.

*We only have triallicenses for the PAS system and handsets in China.*

We only have triallicenses for our PAS systems and handsets. We have applied for, but have notyet received, a final official network access license for our PAS systems andhandsets. Based upon communication with the MII, we understand that our PASsystems and handsets are considered to still be in the trial period and salesof our PAS systems and handsets may continue to be made by us during this trialperiod, but that licenses will ultimately be required. If we fail to obtain therequired licenses, we could be prohibited from making further sales of theunlicensed products, including our PAS systems and handsets, in China, whichwould substantially harm our business, financial condition and results ofoperations. The regulations implementing these requirements are not verydetailed, have not been applied by a court and may be interpreted and enforcedby regulatory authorities in a number of different ways. Our external legalcounsel in China has advised us that China’s governmental authorities mayinterpret or apply the regulations with respect to which licenses are requiredand the ability to sell a product while a product is in the trial period in amanner that is inconsistent with the information received by our legal counselin China, and either of these conditions could have a material adverse effecton our business, financial condition and results of operations.

*Increasing centralization of purchasing decision-makingby carriers may lead to customer concentration and affect the results of ourbusiness.*

Most Chinese carriers havethree levels of operations: the central headquarters level, the provinciallevel and the local city/county level. Both central and provincial levels areindependent legal persons and have their own corporate mandate. The purchasingdecision-making process may take various forms for different projects andmay also differ significantly from carrier to carrier. In the case of PASsystems, we negotiate and enter into all China Netcom contracts with theprovincial operators. However, the central headquarters of China Telecom haschosen to exert its influence in the purchasing decision-making processby negotiating contractual terms, such as purchase price, payment terms, andacceptance clauses at the central level. The provincial operator then furthernegotiates the contract based on the guidelines provided by the headquarters.We enter into final contracts with the provincial operator. However, if thistrend of centralized decision-making expands to unified purchasing,resulting in the negotiation and execution of contracts at the centralheadquarter level, there may be a concentration of customers which could have asignificant impact on our business. If China Netcom follows China Telecom andexerts the headquarters’ influence in price negotiation, it may give downwardpressure to the margin of our PAS system products to China Netcom.

*Television over the internet is a new business inChina and laws regulating the business have not been fully developed and may beunpredictable. Unfavorable regulation of the industry may adversely affect ourIPTV operations in China and negatively impact our business.*

Broadcasting televisionover the internet has only recently begun in China. The State Administration ofRadio, Film and Television (SARFT), the central government’s regulatory body,issued a measure in July 2004 to regulate the broadcasting of audio-visualprograms through the information network, which includes our Internet Protocoltelevision (IPTV) business. SARFT categorized the information network into themobile telecommunication network, fixed communications network, microwavecommunication 

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network,cable television network, satellite or other metropolitan area network, widearea network, local area network and other information networks categories. Thereceiving terminal equipment includes computers, television sets, mobile phonesand other electronic products. While regulating the IPTV business, SARFT isencouraging development in China of the digital television business, a businessthat may be competitive with IPTV in the target market. The digital televisionand IPTV target complementary markets and it is not clear the extent of supportSARFT will provide for IPTV in setting regulations. For example, the GuangzhouAdministration of Radio, Film, and Television, the municipal regulatory body inthe city of Guangzhou, issued a notice to stop all IPTV business in Guangzhouon December 25, 2005. The Zhejiang Administration of Radio, Film, andTelevision, the local regulatory body in the province of Zhejiang, issued asimilar notice on January 10, 2006. In both instances, SARFT had notformally endorsed the launch of commercial IPTV services in those localities.Because the IPTV industry relates to both television and telecom sectors, itmay be subject to regulation by different governmental authorities, includingthe Ministry of Information Industry (MII). At the end of 2005, an official ofMII declared that MII and SARFT would jointly administer the IPTV industry inthe coming years. However, due to a lack of uniform regulation on thedevelopment of the IPTV industry, we cannot predict that our IPTV business willoperate smoothly in China. Our business may suffer if the law or policy inChina does not encourage the IPTV industry.

*We currently do not have a license to engage in the IPTVoperator service business in China and development of our IPTV business dependsupon the cooperation of IPTV license holder(s) and network operators. Ifwe are unable to work cooperatively with license holder(s) and networkoperators, our business may suffer.*

Under the measures issuedby SARFT in July 2004, entities intending to engage in the IPTV operatorservice business should obtain a license from SARFT and foreign investmententerprises are prohibited from engaging in the IPTV operator service business.In practice, SARFT only grants such licenses to state-owned companies.Since we are the technical service and equipment provider in this field, ourbusiness development will depend on the cooperation of license holders andnetwork operators. Our business may suffer if we fail to cooperate with licenseholders or network operators, or if the license holder(s) we’recooperating with lose their licenses.

**RISKS RELATED TOOUR STOCK PERFORMANCE AND CONVERTIBLE DEBT SECURITIES**

***Ourstock price is highly volatile.***

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

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

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

·       changesin governmental regulations or policies in China;

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

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

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

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

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

***SOFTBANK CORP. with its relatedentities, including SOFTBANK America Inc., has significant influence overour management and affairs, which it could exercise against the best interestsof our stockholders.***

SOFTBANK CORP. andits related entities, including SOFTBANK America Inc. (collectively, “SOFTBANK”),beneficially owned approximately 12% of our outstanding stock as of December 31,2006. 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;

·       ourmerger or consolidation with or into another entity; 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 us, which could decrease the market price of our common stock.

***Delaware law and our charterdocuments contain provisions that could discourage or prevent a potentialtakeover, even if the transaction would benefit our stockholders.***

Other companies mayseek to acquire or merge with us. Our acquisition or merger could result inbenefits to our stockholders, including an increase in the value of our commonstock. Some provisions of our Certificate of Incorporation and Bylaws, as wellas provisions of Delaware law, may discourage, delay or prevent a merger oracquisition that a stockholder may consider favorable. These provisionsinclude:

·       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

·       establishing advance noticerequirements for nominations for election to the board of directors and forproposing matters that can be acted on by stockholders at stockholder meetings.

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***W***e face a variety of risks related to our convertiblesubordinated notes.

We face a varietyof risks with respect to our convertible subordinated notes due in 2008 (“Notes”),including the following:

·       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;

·       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; and

·       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 our common stock.

In addition, we are subject to various covenantspursuant to the terms of the indenture governing the Notes (the “Indenture”).Should we fail to comply with certain covenants in the Indenture, includingcovenants requiring us to file certain reports required to be filed pursuant tothe Exchange Act (the “SEC Reports”) with the Securities and ExchangeCommission (the “SEC”) and to provide the trustee for the notes (the “Trustee”)with copies of such reports and certain certificates regarding our compliancewith our obligations under the Indenture, the Trustee or the holders of 25% ofthe aggregate principal amount of the Notes outstanding (the “25% Holders”)could accelerate the maturity of the Notes and the Notes could becomeimmediately due and payable. In the past, there have been delays in filing suchreports: For example, as of November 9, 2006 and continuing through thedate hereof there has been a delay in the filing of our Quarterly Report on Form 10-Qfor the quarter ended September 30, 2006 (the “2006 Q3 Form 10-Q”),our Annual Report on Form 10-K for the fiscal year ended December 31,2006 (the “2006 Form 10-K”), our Quarterly Report on Form 10-Q forthe quarter ended March 31, 2007 (the “2007 Q1 Form 10-Q”), and ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2007(the “2007 Q2 Form 10-Q,” and together with the 2006 Q3 Form 10-Q,the 2006 Form 10-K, and the 2007 Q1 Form 10-Q, the “Delayed Reports”).We received a notice from the Trustee on May 31, 2007, asserting that ourfailure to file the 2006 Q3 Form 10-Q, the 2006 Form 10-K and the2007 Q-1 Form 10-Q had resulted in a default under the Indenture, and thatif we failed to file such reports within 60 days, an event of default wouldarise under the Indenture.

In July 2007, wesought and obtained the requisite consents from holders of the Notes to certainamendments to the Indenture, which provide that (i) any failure by us tofile SEC Reports with the SEC and provide copies of such reports andcertain certificates to the Trustee prior to 5:30 p.m. New York City timeon October 15, 2007 (the “Expiration Date”) will not cause a default underthe Indenture, (ii) any such failure continuing after the Expiration Datewould cause a default under the Indenture, which would be deemed to haveoccurred as of the Expiration Date, and (iii) we will pay additionalinterest on the Notes of (a) 6.75% annually from January 9, 2007 toand including July 25, 2007, and (b) 10.0% annually from andincluding July 26, 2007 to the date the Notes are paid, prepaid, converted,redeemed or otherwise cease to be outstanding (in each case, in addition tointerest of 7¤8%annually, as provided by the Indenture, without regard to any amendments).Thus, if we fail to file the SEC Reports and deliver copies of such reports andcertain certificates to the Trustee on or prior to October 15, 2007, theTrustee or the 25% Holders may give notice to us asserting that such failurecaused a default under the Indenture, which, if not cured within 60 days afterthe date the notice is effective, would cause an event of default under theIndenture. If an event of default were to occur, the Trustee or the 25% Holderswould have the right to accelerate the maturity of the Notes and declare allunpaid principal and accrued interest on the Notes then outstanding to beimmediately due and payable, as described above. No assurance can be given thatwe would be able to obtain the requisite consents of the Holders to a furtheramendment to the Indenture, providing for a waiver of compliance with covenantsin the Indenture relating to the filing of SEC Reports, on acceptable terms orat all. If an event of default under the Indenture were to occur, and thematurity of 

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theNotes were accelerated, and all unpaid principal and accrued interest is declaredimmediately due and payable, our business would be seriously harmed. If we havenot filed the SEC Reports, our ability to raise additional capital may belimited, and specifically, we would not be able to refinance indebtedness underthe Notes from the proceeds of an issuance of new convertible notes. Inaddition, if we are able to raise capital to refinance indebtedness under theNotes by issuing new convertible notes, the terms of such notes may besignificantly less favorable than the terms of the Notes, and may cause greaterdilution to holders of our common stock.

***Our failure to timely file periodicreports with the Securities and Exchange Commission could result in thedelisting of our common stock from the NASDAQ Stock Market.***

As a result of our failure to timely file ourQuarterly Report on Form 10-Q for the period ended September 30, 2006(“Q3 2006 Form 10-Q”), this Annual Report on Form 10-K for the yearended December 31, 2006, our Quarterly Report on Form 10-Q for theperiod ended March 31, 2007 (“Q1 2007 Form 10-Q”) and our QuarterlyReport on Form 10-Q for the period ended June 30, 2007 (“Q2 2007 Form 10-Q”),we have not been in full compliance with NASDAQ Marketplace Rule 4310(c)(14),which requires us to make, on a timely basis, all filings with the Securitiesand Exchange Commission required by the Securities Exchange Act of 1934. Althoughwe have now filed our Q3 2006 10-Q and this Form 10-K, we have not yetfiled our Q1 2007 Form 10-Q and Q2 2007 Form 10-Q and thus continuenot to be in full compliance with this rule. We are required to comply withNASDAQ Marketplace Rule 4310(c)(14) as a condition for our common stock tocontinue to be listed on the NASDAQ Stock Market.

In connection with our failure to timely file ourperiodic reports, we received four NASDAQ Staff Determination letters, dated November 15,2006, March 7, 2007, May 16, 2007 and August 13, 2007,respectively, stating that, as a result of each of these non-timely filings, wewere not in compliance with the requirements of Marketplace Rule 4310(c)(14)and, therefore, that our stock was subject to delisting from the NASDAQ StockMarket. We appealed the November 15, 2006 determination to the NasdaqListing Qualifications Panels (the “Panel”) and were granted a conditionalextension to our request for continued listing until April 16, 2007. On April 17,2007 the Panel extended the deadline for filing our Q3 2006 Form 10-Q to May 14,2007. The Panel also extended the deadline for filing our 2006 Form 10-Kuntil July 16, 2007. On May 2, 2007, we asked the NASDAQ Listing andHearing Review Council (“Listing Council”) to review the April 17, 2007decision of the Panel. On May 14, 2007, the Listing Council called thePanel’s decision for review and requested that we provide an update on ourefforts to file our delinquent filings. We have continued and continue tocomply with that request. In addition, the Listing Council stayed the Panel’sdecision that required us to file our Q3 2006 Form 10-Q by May 14,2007, and to file our 2006 Form 10-K by July 16, 2007. On August 23,2007, the Listing Council granted the Company an extension until October 22,2007 to file our delinquent periodic reports and restatements.

If we are unable tomaintain compliance with the conditions for continued listing required byNASDAQ, then our shares of common stock may be subject to delisting from theNASDAQ Stock Market. If our shares of common stock are delisted from the NASDAQStock Market, they may not be eligible to trade on any national securitiesexchange or the over-the counter market. If our common stock is no longertraded through a market system, the liquidity of our common stock may begreatly reduced, which could negatively affect its price. In addition, we maybe unable to obtain future equity financing, or use our common stock asconsideration for mergers or other business combinations. A delisting from theNASDAQ Stock Market may also have other negative implications, including thepotential loss of confidence by suppliers, customers and employees, the loss ofinstitutional investor interest, and fewer business development opportunities.

**ITEM 1B—UNRESOLVEDSTAFF COMMENTS**

None.

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**ITEM 2—PROPERTIES**

Our headquarters are located on a leased site inAlameda, California. Additionally, we operate facilities in the United States,China and globally consisting of office, research and development, warehousingand manufacturing sites primarily used jointly by our reporting segments.

The headquarters for our China operations is locatedin Hangzhou. In 2001, we purchased the rights to use 49 acres of land locatedin Zhejiang Science and Technology Industry Garden of Hangzhou Hi-techIndustry Development Zone and have built a 2.7 million square footfacility on this site. The facility was occupied in October 2004 and isused for manufacturing operations, research and development and administrativeoffices. At the end of 2006, approximately two-thirds of the facility wasbeing utilized.

We lease approximately 1.5 million square feet ofproperty, of which 0.8 million square feet are properties in China and0.5 million square feet are properties in North America. We maintain 43sales and customer support offices in 25 countries covering the United States,Canada, Latin America, the Caribbean, Europe, the Middle East, India, and theAsia-Pacific region. We lease sales offices in 24 locations inChina.

We believe our facilitiesare suitable and adequate to meet our current needs.

**ITEM 3—LEGALPROCEEDINGS**

*Securities Class ActionLitigation*

Beginning in October 2004, several shareholderclass actions alleging federal securities violations were filed against us andvarious officers and directors of our company. The actions have been consolidated in UnitedStates District Court for the Northern District of California under the caption*In re UTStarcom, Inc. Securities Litigation*,Master File No. C-04-4908-JW(PVT). The lead plaintiffs in the case filed aFirst Amended Consolidated Complaint on July 26, 2005. The First AmendedComplaint alleged violations of the Securities Exchange Act of 1934, and wasbrought on behalf of a putative class of shareholders who purchased our stockafter April 16, 2003 and before September 20, 2004. On April 13,2006, the lead plaintiffs filed a Second Amended Complaint adding newallegations and extending the end of the class period to October 6, 2005. Inaddition to the companydefendants, the plaintiffs are also suing Softbank. Plaintiffs’ complaint seeksrecovery of damages in an unspecified amount.

On June 2, 2006, we and the individual defendantsfiled a motion to dismiss the Second Amended Complaint. On March 21, 2007,the Court granted defendants’ motion and dismissed plaintiffs’ Second AmendedComplaint. The Court granted plaintiffs leave to file a Third AmendedComplaint, which plaintiffs filed on May 25, 2007. On July 13, 2007,we and the individual defendants filed a motion to dismiss and a motion tostrike the Third Amended Complaint.

On September 4, 2007, a second shareholder classaction complaint captioned *Peter Rudolph v.UTStarcom, et al.*, Case No. C-07-4578 SI, was filed in theUnited States District Court for the Northern District of California against usand some of our current and former directors and officers. The complaintalleges violations of the Securities Exchange Act of 1934 through undisclosedimproper accounting practices concerning our historical equity award grants. Plaintiffseeks unspecified damages on behalf of a purported class of purchasers of ourcommon stock between July 24, 2002 and September 4, 2007.

Due to the preliminarystatus of these lawsuits and uncertainties related to litigation, we are unableto evaluate the likelihood of either a favorable or unfavorable outcome. Accordingly,we are unable atthis time to estimate the effects of these complaints on our financial position, results ofoperations, or cash flows.

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*GovernmentalInvestigations*

In September 2005, wereceived notice of a formal inquiry by the staff of the Securities &Exchange Commission (“SEC”) into certain aspects of our financial disclosures during priorreporting periods and certain other issues. In addition, in December 2005,the U.S. Embassy in Mongolia informed us that it had forwarded to theDepartment of Justice (“DOJ”) allegations that an agent of our Mongolia jointventure had offered payments to a Mongolian government official in possibleviolation of the Foreign Corrupt Practices Act (the “FCPA”). We, through ourAudit Committee, authorized an independent investigation into possibleviolations of the FCPA, and we have been in contact with the DOJ and SECregarding the investigation. The investigation has identified possible FCPAviolations in Mongolia, Southeast Asia, India, and China, as well as possible violations of U.S. immigration laws. The DOJ has requested that we voluntarily producedocuments related to the investigation and the SEC has subpoenaed us fordocuments. We have executed tolling agreements extending the statute oflimitations for the FCPA issues under investigation by the SEC and DOJ and theimmigration issues under investigation by the DOJ. At this time, wecannot predict when any inquiry will be completed or what the outcome of anyinquiry will be.

*ShareholderLitigation*

On November 17, 2006, a shareholder derivativecomplaint captioned *Ernesto Espinoza v. YingWu et al.*, Case No. RG06298775, was filed against certain ofour current and former officers and directors in the Superior Court of theCounty of Alameda, California. The complaint alleges that the individualdefendants, among other things, breached their duties, were unjustly enriched,and violated the California Corporations Code in connection with the timing ofstock option grants. The complaint names us as a nominal defendant and seeksunspecified monetary damages against the individual defendants and variousforms of injunctive relief. On February 2, 2007, we and the individualdefendants filed demurrers against the complaint. On April 11, 2007, theCourt sustained the individual defendants’ demurrer, overruled our demurrer,ordered the plaintiff to file an amended complaint, and ordered us to answerthe original complaint. The plaintiff filed an amended complaint and we have filed an answer to the amendedcomplaint. On August 21, 2007, the individual defendants filed demurrersagainst the amended complaint. The Court sustained the individual defendants’demurrers and ordered the plaintiff to file a second amended complaint.

Due to the preliminarystatus of this complaint and uncertainties related to litigation, we are unableto evaluate the likelihood of either a favorable or unfavorable outcome. Accordingly,we are unable at this time to estimate the effects of this complaint on ourfinancial position, results of operations, or cash flows.

*IPO Allocation*

On October 31, 2001,a complaint was filed in United States District Court for the Southern Districtof New York against us, some of our directors and officers and various underwriters for our initialpublic offering. Substantially similar actions were filed concerning theinitial public offerings for more than 300 different issuers, and the caseswere coordinated as *In re Initial PublicOffering Securities Litigation*, 21 MC 92 for pretrialpurposes. In April 2002, a consolidated amended complaint was filed in thematter against us, captioned *In reUTStarcom, Initial Public Offering Securities Litigation*, CivilAction No. 01-CV-9604. Plaintiffs allege violations of theSecurities Act of 1933 and the Securities Exchange Act of 1934 throughundisclosed improper underwriting practices concerning the allocation of IPOshares in exchange for excessive brokerage commissions, agreements to purchaseshares at higher prices in the aftermarket and misleading analyst reports. Plaintiffsseek unspecified damages on behalf of a purported class of purchasers of ourcommon stock between March 2, 2000 and December 6, 2000. Ourdirectors and officers have been dismissed without prejudice pursuant to astipulation. On February 19, 2003, the Court granted in part and denied inpart a motion to dismiss brought by defendants including us. The orderdismissed all claims against us except for a claim brought under Section 11of the Securities Act of 1933, 

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whichalleges that the registration statement filed in accordance with the IPO wasmisleading. In June 2004, a stipulation of settlement and release ofclaims against the issuer defendants, including us, was submitted to the courtfor approval. The terms of the settlement, if approved, would have dismissedand released all claims against the participating defendants (including us). InAugust 2005, the Court preliminarily approved the settlement. In December 2006,the Court of Appeals for the Second Circuit reversed the Court’s October 2004order certifying a class in six test cases that were selected by theunderwriter defendants and plaintiffs in the coordinated proceedings. Our case is not one of the testcases. Because class certification was a condition of the settlement, it wasunlikely that the settlement would receive final Court approval. On June 25,2007, the Court entered an order terminating the proposed settlement based on astipulation among the parties to the settlement. Plaintiffs have filed amendedmaster allegations and amended complaints in the six test cases. It is unclearwhether there will be any revised or future settlement. If the litigationproceeds, we believe that we have meritorious defenses and intend to defend theaction vigorously. The total amount of the loss associated with the abovelitigation is not determinable at this time. Therefore, we are unable tocurrently estimate the loss, if any, associated with the litigation.

*Passave Litigation*

In November 2005, wefiled suit in the Superior Court of California, County of Santa Clara, againstPassave, Inc. (“Passave”) for breaches of contract and warranties inconnection with a semiconductor device sold by Passave, Ltd. (Passave’s wholly-­owned subsidiary) to us. OurComplaint alleges that the Passave device, known as the PAS5001M3 chip, hasexhibited certain operational malfunctions within some of our Fiber-to-the-Homeproduct line, and has thereby caused damage to us. The parties entered into asettlement agreement, dated August 7, 2007, and have since dismissed allclaims with prejudice.

*UTStarcom, Inc.v. Starent Patent Infringement Litigations*

We brought suit against Starent Networks Corporation (“Starent”)for patent infringement in the U.S. District Court for the NorthernDistrict of California. The Complaint was filed on March 22, 2004, andlater amended. In this action, we asserted that Starent infringed our patent U.S. Reg. No. 6,628,671 through the manufacture, use, offer, for sale, andsale of Starent’s ST-16 Intelligent Mobile Gateway. We sought damages andinjunctive relief. Starent filed its answer to the Amended Complaint andcounterclaims, denying our allegations and seeking a declaration that thepatent-in-suit is not infringed, is invalid, and is unenforceable. A motion fora preliminary injunction against the making, using or selling of infringingproducts and methods was brought, but the Court denied it on June 17, 2005.After a claims construction hearing and order, on September 20, 2005,Starent filed a motion for summary judgment of non-infringement and we filed amotion for summary judgment that Starent is estopped from asserting invalidityand unenforceability. On December 6, 2005, the Court granted Starent’smotion for summary judgment. On February 2, 2006, the Court enteredjudgment in favor of Starent and dismissed the case. On March 2, 2006 wefiled an appeal to the Federal Circuit. On April 6, 2007, after reviewingthe parties’ briefs and hearing oral argument on April 2, 2007, theFederal Circuit, without a written opinion, affirmed the District Court’sjudgment and dismissal of the case. Althoughthe Federal Circuit ruled against the Company, this decision will not have amaterial adverse effect on the business, financial condition, or results of itsoperations.

On February 16, 2005, we filed a second suitagainst Starent for patent infringement in the U.S. District Court for theNorthern District of California. In the Complaint, we assert that Starentinfringes UTStarcom patent U.S. Reg. No. 6,829,473 (“the ‘473 patent”)through Starent’s development and testing of a software upgrade for itscustomer’s installed ST-16 Intelligent Mobile Gateways. We seek declaratory andinjunctive relief. Starent subsequently filed its answer and counterclaims,denying our allegations and seeking a declaration that the patent-in-suit isnot infringed, is invalid, and is 

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unenforceable. On June 16,2005, we filed a motion to strike Starent’s affirmative defense and dismissStarent’s counterclaim alleging inequitable conduct. On July 19, 2005, theparties stipulated that Starent would file an amended answer and counterclaimby July 27, 2005 and that we would withdraw our motion to strike. On August 10,2005, we responded to Starent’s amended counterclaim filed on July 27,2005. In early December 2006, we fileda reissue application for the ‘473 patent with the United States Patent andTrademark Office. Starent has also filed for reexamination of the ‘473 patent. Thereexamination and reissue are currently copending. The litigation is still in apreliminary stage and its outcome cannot be predicted, although we believe thelitigation has merit. Nonetheless, we believe that any adverse judgment onStarent’s counterclaims will not have a material adverse effect on ourbusiness, financial condition, or results of operations.

On May 8, 2007, wefiled a third suit against Starent and sixteen individual defendants (who wereall former employees of 3Com’s CommWorks division which we acquired certainassets of in May of 2003) in the Northern District of Illinois. The causesof action include claims for patent infringement, misappropriation of tradesecrets, intentional interference with business relations and prospectiveeconomic advantage and declarations of ownership of certain patent rights. Inits Complaint, we assert that Starent infringes UTStarcom patents U. S. Reg.Nos. 7,173,905; 6,978,128; 6,963,582; 6,975,900; and 6,684,256 through themanufacture, use, offer, for sale, and sale of Starent’s ST16 IntelligentMobile Gateway and ST40 multimedia code platform, that the individualDefendants and Starent have misappropriated valuable Company trade secrets byimproperly taking and using our confidential and proprietary information forthe benefit of Starent, that the individual defendants and Starent haveinterfered with our business relations and prospective economic advantage byusing the misappropriated information to obtain and enhance sales of Starent’sproducts, and that several of Starent’s patent applications and one issuedpatent are based on information obtained by the former employees while at theCompany (CommWorks) and on that basis belong to UTStarcom. We seek compensatorydamages, punitive damages and injunctive relief. After the court denied thedefendants motion to dismiss the misappropriation of trade secrets claims, on August 30, 2007, Starent answered our complaint, denying ourallegations and asserting a number of affirmative defenses and counterclaims,including non-infringement of the subject patents and alleged tortiousinterference with prospective economic advantage. We have filed a motion todismiss most of the counterclaims and the court has ordered appointment of aspecial master to handle discovery, which is just beginning. We believe thatany adverse judgment on Starent’s counterclaims will not have a materialadverse effect on our business, financial condition or results of operations.

*Telemetrix, Inc.Arbitration*

On October 19, 2006,Telemetrix, Inc. (“Telemetrix”) filed a formal Request for Arbitrationagainst us to the World Intellectual Property Organization (“WIPO”) in Geneva,Switzerland. The Request for Arbitration sought unspecified damages arising from a contract betweenTelemetrix and Telos Technology, Inc., dated October 22, 2003. Weassumed Telos’ rights and obligations under this contract pursuant to our purchase of Telos’ assets on May 19,2004. Telemetrix alleged nine causes of action, including breach of contract,fraud, negligent misrepresentation, interference with contractual relations,and interference with prospective economic advantage. In December 2006, wefiled a formal response to the Request for Arbitration, denying all material factualallegations asserted by Telemetrix. An arbitrator was selected by the parties, and, on August 2, 2007, the arbitrator granted a pleading motion in favor of us due toTelemetrix’s failure to allege sufficient facts in support of a majority of itscauses of action. On August 17, 2007, Telemetrix filed an AmendedStatement of Claim, alleging six causes of action, including breach ofcontract, fraud, interference with contractual relations and interference withprospective economic advantage. The previous hearing date of December 11-13has been vacated. No hearing date has been rescheduled. Discovery has begun.

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*Telos Technology,Inc. Litigation*

On November 22, 2005,plaintiffs Telos Technology, Inc., Telos Technology (Canada), Inc.,Telos Technology (Bermuda) Ltd., and Telos Engineering Limited(collectively, the “Telos Plaintiffs”) filed a Complaint against the Company inthe Superior Court of California, County of Santa Clara. The Complaint allegesfive causes of action, including breach of contract, breach of the impliedcovenant of good faith and fair dealing, fraudulent inducement, intentionalmisrepresentation and negligent misrepresentation, all of which arise from theAsset Purchase Agreement between the parties dated April 21, 2004. TheTelos Plaintiffs assert that the Company breached the express and implied termsof the Asset Purchase Agreement and made representations to the TelosPlaintiffs during negotiations that it never intended to fulfill. The TelosPlaintiffs sought at least $19 million in damages, unspecified punitivedamages and attorneys’ fees. The parties executed a settlement agreement in theamount of $4.5 million on August 20, 2007 and the case was dismissed on September 26,2007 with prejudice.

*Other Litigation*

We are a party to otherlitigation matters and claims that are normal in the course of operations, andwhile the results of such litigation matters and claims cannot be predictedwith certainty, we believe that the final outcome of such matters will not havea material adverse impact on our financial position or results of operations.

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

None.

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**PART II**

**ITEM5—MARKET FOR UTSTARCOM, INC.’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, ANDISSUER PURCHASES OF EQUITY SECURITIES**

| ** **         | ** **   | **High**     | ** **   | **Low**      | ** **   |
|--------------------|--------------|--------------|--------------|--------------|--------------|
| ***Fiscal  2005*** | *** *** | *** *** | *** *** | *** *** | *** *** |
| First Quarter      |         | $            | 22.20        |         | $            | 10.95 |   |
| Second Quarter     |         | 11.11        |         | 6.84         |         |
| Third Quarter      |         | 9.09         |         | 7.27         |         |
| Fourth Quarter     |         | 8.91         |         | 5.26         |         |
| ***Fiscal  2006*** | *** *** | *** *** | *** *** | *** *** | *** *** |
| First Quarter      |         | $            | 8.06         |         | $            | 5.86 |   |
| Second Quarter     |         | 7.79         |         | 5.92         |         |
| Third Quarter      |         | 9.06         |         | 6.61         |         |
| Fourth Quarter     |         | 10.78        |         | 8.60         |         |

 

Our common stock has been traded on The NASDAQ StockMarket, LLC (“NASDAQ”) under the symbol UTSI since our initial public offeringon March 2, 2000. The preceding table sets forth the high and low closingsales prices per share of our common stock as reported on NASDAQ for theperiods indicated. As of September 30, 2007, we had approximately 180stockholders of record.

To date, we have not paidany cash dividends on our common stock. We currently anticipate that we willretain any available funds to finance the growth and operation of our businessand we do not anticipate paying any cash dividends in the foreseeable future.Certain present or future agreements may limit or prevent the payment ofdividends on our common stock. For example, our convertible debt requires thatwe have to provide notice of our intent to pay certain dividends. Additionally,our cash held in foreign countries may be subject to certain controllimitations or repatriation requirements, limiting our ability to use this cashto pay dividends.

**COMPANY’S STOCKPERFORMANCE**

Set forth below is a line graph comparing the annualpercentage change in the cumulative return to the stockholders of our commonstock with the cumulative return of the NASDAQ composite (U.S. and foreign)index and the S&P Wireless Telecommunication Services index for the periodcommencing on December 31, 2001 and ending on December 31, 2006. Theinformation contained in the performance graph shall not be deemed to be“soliciting material” or to be “filed” with the SEC, nor shall such informationbe incorporated by reference into any future filing under the Securities Act orthe Exchange Act, except to the extent we specifically incorporate it byreference into such filing.

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Thegraph assumes that $100 was invested on December 31, 2001 in our commonstock and in each index (based on the sales closing price of $28.50 per shareon December 31, 2001), and that all dividends were reinvested. No cashdividends have been declared or paid on our common stock. Stockholder returnsover the indicated period should not be considered indicative of future stockholderreturns. We operate on a 52-week fiscal year that ended on Sunday,December 31, 2006. Under the assumptions stated above, over the periodfrom December 31, 2001 to December 31, 2006 the total return on aninvestment in our common stock would have been—69.3% as compared to 27.52% forthe NASDAQ composite (U.S. and foreign) index and 11.80% for the S&PWireless Telecommunication Services index shown below.

**COMPARISONOF 5 YEAR CUMULATIVE TOTAL RETURN***AmongUTStarcom, Inc., The NASDAQ Composite IndexAnd The S & P Wireless Telecommunication Services Index

| ** **                                          | ** ** | **Period Ending** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|
| **Index**                                           | ** ** | ** **             | ** ** | **12/01** | ** ** | **12/02** | ** ** | **12/03** | ** ** | **12/04** | ** ** | **12/05** | ** ** | **12/06** | ** ** |
| UTSTARCOM, INC.                                     |       | $                      | 100.00     |   | $ | 69.58 |   | $ | 130.07 |   | $ | 77.72 |   | $ | 28.28 |   | $ | 30.70 |   |
| NASDAQ STOCK  MARKET (U.S. & FOREIGN)      |       | $                      | 100.00     |   | $ | 68.85 |   | $ | 101.86 |   | $ | 112.16 |   | $ | 115.32 |   | $ | 127.52 |   |
| S & P WIRELESS  TELECOMMUNICATION SERVICES |       | $                      | 100.00     |   | $ | 40.30 |   | $ | 71.62 |   | $ | 112.68 |   | $ | 114.81 |   | $ | 111.80 |   |
|                                                     |            |                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Thefollowing table summarizes our stock repurchase activity for the three monthsended December 31, 2006:

**ISSUERPURCHASES OF EQUITY SECURITIES**

| **Period**       | ** ** | ** ** | ** ** | **Total number of shares  (or Units) Purchased** (1)  | ** ** | **Average price  paid per share  (or Unit)** | ** ** | **Total number of shares  (or Units) purchased as  part of publicly annouced  plans or programs** | ** ** | **Approximate dollar value  of shares that may yet  be purchased under the  plans or programs** | ** ** |
|------------------|------------|------------|------------|------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **       | ** ** | ** ** | ** ** | ** **                                                                               | ** ** | ** **                                                       | ** ** | **($ million)**                                                                                                                                     | ** ** |
| **10/1-31/2006** |       |       | —     |                                                                                     |       |                                                             | $          | —                                                                                                                                                   |       |                                                                                                                                                   |       | — |   |   |   | $ | — |   |   |
| **11/1-30/2006** |       |       | —     |                                                                                     |       |                                                             | $          | —                                                                                                                                                   |       |                                                                                                                                                   |       | — |   |   |   | $ | — |   |   |
| **12/1-31/2006** |       |       | 4,468      |                                                                                     |       |                                                             | $          | 8.84                                                                                                                                                     |       |                                                                                                                                                   |       | — |   |   |   | $ | — |   |   |

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(1)          Duringthe fourth quarter of 2006, the Company acquired 4,468 shares of common stockthat employees presented to the Company to satisfy withholding taxes inconnection with the vesting of restricted stock awards.

**EQUITY COMPENSATIONPLAN INFORMATION**

Thefollowing table sets forth information, as of December 31, 2006, withrespect to compensation plans under which the Company’s equity securities areauthorized to be issued:

| **Plan category** (1)                         | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                   | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                          | ** ** | **(c)**                                                                                                     | ** ** |
| Equity  compensation plans approved by security holders |       |       | 18,712,967 | (2)                                                                                                                                              |       |                                                                                                        | 14.36      |                                                                                                                                                                                                             |       |   | 13,152,829 | (3) |   |
| Equity compensation plans not approved by security  holders  |       |       | 909,310    | (4)                                                                                                                                              |       |                                                                                                        | 28.55      |                                                                                                                                                                                                             |       |   | — | (5) |   |
| Total                                                        |       |       | 19,622,277 |                                                                                                                                             |       |                                                                                                        | 15.02      |                                                                                                                                                                                                             |       |   | 13,152,829 |   |   |

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(1)          See Note 15 to ourConsolidated Financial Statements for a description of our equity compensationplans.

(2)          Includes shares ofcommon stock to be issued upon exercise of options granted under our 2006 StockPlan, our 1997 Stock Plan and our 2001 Director Option Plan.

(3)          Includes 1,914,934shares of common stock available for issuance under our 2000 Employee StockPurchase Plan and 11,237,895 shares of common stock available for issuanceunder our 2006 Plan.

(4)          Includes shares ofcommon stock to be issued upon exercise of options granted under our 2003 Non-StatutoryStock Option Plan. Upon implementation of the 2006 Stock Plan theremaining securities available for future issuance under the 2003 Non-StatutoryStock Option Plan were rolled into the 2006 Stock Plan. Does not include 6,051shares and 5,522 shares of common stock subject to outstanding options with aweighted-average exercise price of $2.54 that were assumed in ouracquisitions of Advanced Communication Devices Corporation, and RollingStreamsSystems, Ltd., respectively.

(5)          Does not include 212shares and 743 shares remaining available for future issuance under equitycompensation plans related to our acquisitions of Advanced CommunicationDevices Corporation, and RollingStreams Systems Ltd., respectively.

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**ITEM 6—SELECTEDFINANCIAL DATA**

Theselected financial data for the years ending December 31, 2006, 2005 and2004, and as of December 31, 2006 and 2005 is derived from our auditedconsolidated financial statements, which are included elsewhere in this AnnualReport on Form 10-K. As discussed in the Explanatory Note at thebeginning of this Report and in Note 2, “Restatement of Financial Statements”of Notes to Consolidated Financial Statements contained in Item 8 of thisAnnual Report, the selected consolidated financial data as of and for the yearsended December 31, 2005, 2004, 2003 and 2002 have been restated to correctour past accounting for stock options and revenue recognition for certain salescontracts in China. 

| ** **                                      | ** ** | **Years ended December 31,**                           | ** ** |
|-------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                      | ** ** | **2006**                                                              | ** ** | **2005(4)** | ** ** | **2004(4)** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                      | ** ** | ** **                                                            | ** ** | **As restated** | ** ** | **As restated** | ** ** | **As restated** | ** ** | **As restated** | ** ** |
| ** **                                      | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:** |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| Net sales(1)                                    |       | $                                                                     | 2,458,861  |   | $ | 2,871,110 |   | $ | 2,579,415 |   | $ | 1,920,161 |   |   | $ | 917,074 |   |   |
| Gross profit                                    |       | 385,744                                                               |       | 435,836 |   | 569,532 |   | 607,927 |   |   | 322,548 |   |   |
| Operating (loss) income(2)                      |       | (138,160                                                              | )          | (456,714 | ) | 16,885 |   | 230,966 |   |   | 114,928 |   |   |
| (Loss) income from continuing operations(3)     |       | (117,345                                                              | )          | (532,645 | ) | 50,849 |   | 192,385 |   |   | 81,605 |   |   |
| (Loss) earnings  per share:                     |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |
| —Basic                                     |       | $                                                                     | (0.97      | ) | $ | (4.55 | ) | $ | 0.45 |   | $ | 1.86 |   |   | $ | 0.74 |   |   |
| —Diluted                                   |       | $                                                                     | (0.97      | ) | $ | (4.55 | ) | $ | 0.40 |   | $ | 1.56 |   |   | $ | 0.71 |   |   |

 

| ** **                            | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                    | ** ** | **2005(4)** | ** ** | **2004(5)** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                            | ** ** | ** **                                  | ** ** | **As restated** | ** ** | **As restated** | ** ** | **As restated** | ** ** | **As restated** | ** ** |
| ** **                            | ** ** | **(in thousands)**                     | ** ** |
| **Consolidated Balance Sheet  Data:** |       |                                        |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents             |       | $                                           | 661,623    |   | $ | 645,571 |   | $ | 562,532 |   | $ | 377,747 |   | $ | 231,944 |   |
| Working capital                       |       | 793,544                                     |       | 834,126 |   | 1,083,097 |   | 859,963 |   | 545,784 |   |
| Total assets                          |       | 2,373,950                                   |       | 2,551,331 |   | 3,517,605 |   | 2,345,995 |   | 1,372,206 |   |
| Total short-term debt                 |       | 102,758                                     |       | 198,826 |   | 351,183 |   | 1 |   | — |   |
| Total long-term debt                  |       | 275,161                                     |       | 274,900 |   | 402,500 |   | 402,500 |   | — |   |
| Total  stockholders’ equity      |       | 774,360                                     |       | 826,649 |   | 1,302,891 |   | 854,166 |   | 738,755 |   |
|                                       |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Set forthbelow is a schedule which presents the detailed effects of the restatement of2003 and 2002 which is not included in the Consolidated Financial Statementsalthough the description of the errors giving rise to the restatement and theamount of the adjustments by year are included in Note 2 to those financialstatements. This data should be read in conjunction with Note 2 of the Notes tothe Consolidated Financial Statements in Item 8, “Financial Statements andSupplementary Data” and Item 7, “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” in this Report.

| ** **                                           | ** ** | **Years ended December 31,**                           | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2003**                                                              | ** ** | **2002** | ** ** |
| ** **                                           | ** ** | **As previously  reported**                                      | ** ** | **Adjustments** | ** ** | **As restated** | ** ** | **As previously  reported** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                           | ** ** | **(in thousands, except per share amounts)** | ** ** |
| **Consolidated Statement  of Operations Data:** |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                                            |       |                                                                  | $          | 1,941,221 |   |   |   | $ | (21,060 | ) |   | $ | 1,920,161 |   |   | $ | 981,806 |   |   |   | $ | (64,732 | ) |   | $ | 917,074 |   |
| Gross profit                                         |       |                                                                  | 615,942    |   |   |   | (8,015 | ) |   | 607,927 |   |   | 345,472 |   |   |   | (22,924 | ) |   | 322,548 |   |
| Operating income                                     |       |                                                                  | 252,351    |   |   |   | (21,385 | ) |   | 230,966 |   |   | 145,962 |   |   |   | (31,034 | ) |   | 114,928 |   |
| Income from continuing operations                    |       |                                                                  | 209,856    |   |   |   | (17,471 | ) |   | 192,385 |   |   | 107,862 |   |   |   | (26,257 | ) |   | 81,605 |   |
| Earnings per  share:                                 |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| —Basic                                          |       |                                                                  | $          | 2.02 |   |   |   | $ | (0.16 | ) |   | $ | 1.86 |   |   | $ | 0.98 |   |   |   | $ | (0.24 | ) |   | $ | 0.74 |   |
| —Diluted                                        |       |                                                                  | $          | 1.70 |   |   |   | $ | (0.14 | ) |   | $ | 1.56 |   |   | $ | 0.94 |   |   |   | $ | (0.23 | ) |   | $ | 0.71 |   |
| **Consolidated  Balance Sheet Data:**                |       |                                                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                            |       |                                                                  | $          | 377,747 |   |   |   | $ | — |   |   | $ | 377,747 |   |   | $ | 231,944 |   |   |   | $ | — |   |   | $ | 231,944 |   |
| Working capital                                      |       |                                                                  | 874,449    |   |   |   | (14,486 | ) |   | 859,963 |   |   | 568,215 |   |   |   | (22,431 | ) |   | 545,784 |   |
| Total assets                                         |       |                                                                  | 2,262,610  |   |   |   | 83,385 |   |   | 2,345,995 |   |   | 1,305,552 |   |   |   | 66,654 |   |   | 1,372,206 |   |
| Total short-term debt                                |       |                                                                  | 1          |   |   |   | — |   |   | 1 |   |   | — |   |   |   | — |   |   | — |   |
| Total long-term debt                                 |       |                                                                  | 402,500    |   |   |   | — |   |   | 402,500 |   |   | — |   |   |   | — |   |   | — |   |
| Total  stockholders’ equity                     |       |                                                                  | 887,655    |   |   |   | (33,489 | ) |   | 854,166 |   |   | 766,395 |   |   |   | (27,640 | ) |   | 738,755 |   |

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(1)           On November 1, 2004, we completed our acquisitionof selected assets of Audiovox Communications Corporation. Revenue for theyears ended December 31, 2006, 2005 and 2004 from this acquisition was$1,339.0 million, $1,369.3 million and $277.4 million,respectively.

(2)           The operating loss for the year ended December 31,2006 includes a $12.3 million gain on sale of assets. The operating (loss)income for the years ended December 31, 2005 and 2004 included $218.1million and $12.7 million, respectively, of charges associated with theimpairment of various long-lived assets including goodwill, intangibleassets and certain property plant and equipment. The operating loss for theyear ended December 31, 2005 also contained $35.3 million ofrestructuring charges, including $29.7 million in operating expenses and$5.6 million in cost of goods sold. Operating (loss) income for the yearsended December 31, 2005 and 2004 included charges of $0.7 million and$1.4 million, respectively, for in-process research and developmentassociated with various acquisitions. See Notes 5, 10 and 21 of Notes toConsolidated Financial Statements contained in Item 8 of this Annual Report.

(3)           Loss from continuing operations for the year endedDecember 31, 2006 includes a $13.5 million charge associated with theother-than-temporary impairment of a long-term investment. Loss from continuingoperations for the year ended December 31, 2005 included a gain of$47.2 million from the sale of a long term investment to Softbank Corp., arelated party. Income from continuing operations for the year endedDecember 31, 2005 also included a $31.4 million gain on extinguishmentof subordinated notes and income tax expense of $136.5 million, whichincluded a valuation allowance of $237.3 million on our net deferred taxassets.

(4)           See Note 2, “Restatement of Financial Statements”, ofNotes to Consolidated Financial Statements in Item 8 of this Annual Report forthe effect of the restatement adjustments on income (loss) from continuingoperations for the years ended December 31, 2005 and 2004 and on theconsolidated balance sheet at December 31, 2005. The restatement adjustmentsdecreased net income $45.3 million and $19.0 million for the years endedDecember 31, 2005 and 2004, respectively.

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(5)           At December 31, 2004 working capital decreased by$20.1 million, total assets increased by $169.2 million, long-termdeferred revenue increased by $196.4 million and total stockholders equitydecreased by $53.2 million as a result of the restatement adjustments.

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

**FORWARD-LOOKINGSTATEMENTS    **

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 regardingour compliance with SEC reporting requirements and NASDAQ listing requirements;our expectations as to the nature of possible market trends; our expectationsregarding continued growth in our business and operations; our expectationsregarding fluctuations in gross profit; our plans regarding payment of cashdividends; our expectations regarding recognition of certain compensationcosts; our plans regarding legal proceedings; our expectations regarding theeffect of legal proceedings and government inquiries; our expectationsregarding the functionality, performance and features of our products; our expectationsregarding Softbank’s continued service of certain modems and modem rentalagreements; our plans and expectations regarding relationships with vendors andsuppliers; our plan to fulfill the purchase commitment under various ordersfrom our suppliers; our expectations regarding the exchange rate risks withrespect to accountable receivables and payables in Renminbi, Japanese Yen andEuros; our plans regarding the use of financial instruments to hedge againstcertain foreign currency exchange rate risks; our plans regarding the use ofderivative financial instruments for speculative trading purposes; our plansregarding the discounting of certain bank notes and commercial notes; ourexpectations regarding our ability to raise funds, including the impact of thelate filing of our reports with the Securities and Exchange Commission on our abilityto raise funds; our expectations regarding the availability of funding underthe account receivable financing program with Citibank, N.A. and our plan tocontinue service the accounts receivable; our expectations regarding ourinvestment in Global Asia Partners L.P.; our expectations regarding our rightto intellectual property embedded in our products; our expectations regardingour ability to protect our intellectual property; our expectations regardingthe effect of market risks on our operating results; our plans to implementmeasures to remediate material weaknesses; our expectations regarding theeffectiveness of remediation measures; our plans to continue to review internalcontrols; our expectations regarding competition and the competitive advantagesof our competitors; our expectations regarding consolidation of thetelecommunications industry; our expectations regarding the development andintroduction of new and more advanced products; our expectations regardingdeployment of our products; our plans and expectations regarding our workforcerestructurings; our expectations regarding the adoption of environmental,health and safety laws by countries world-wide; our expectations regarding theeffect of the Sarbanes-Oxley Act on our corporate governance anddisclosure practices; our expectations regarding the expenses associated withcompliance with the Sarbanes-Oxley Act; our expectations regarding theimpact of the restatement of our consolidated financial statements; ourexpectations regarding the maturation of the PAS market and correspondingdecrease in PAS subscriber growth; our expectations regarding the long-termdemand for our PAS products; our expectations regarding our ability to offsetthe decline in PAS sales through pursuing other products; our expectationsregarding PAS system spending; our plan to improve PCD gross margins bysupplying CDMA handsets we design and manufacture; our plan to pursueopportunities for our wireless infrastructure products in multiple markets; ourexpectations regarding our investment in and development of the IPTV market;our expectations regarding product margins; our expectations regarding theimpact of our initiatives on our revenue plan; our expectations regarding ourannual effective tax rate; our expectations regarding the likelihood to realizethe tax benefits in the U.S. and other countries; our expectations regardingthe effect of the China Corporate Income Tax Law on our future tax expenses;our expectations regarding valuation allowance on our net deferred tax assetsand its impact; our expectations regarding the reporting of net lossesthroughout 2007; our expectations regarding 

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ourlevel of capital expenditures in China; our plans to maintain adequateliquidity levels through at least the next 12 months; our expectationsregarding the availability and sufficiency of credit lines from lenders; ourplans to issue new debt instruments, sell investments and assets; ourexpectations regarding refinancing of the convertible notes and access to cashin our China subsidiaries to meet our liquidity requirements outside of China;our expectations regarding interest rates; our expectations regardingsufficiency of cash resources; our expectations regarding our ability toreceive licenses for our products; our expectation that our business, financialcondition and results of operations will continue to be significantlyinfluenced by the political, economic, legal and social environment in Chinaand other international markets, including Japan, India and Europe; ourexpectations regarding the nature of political, economic and legal reform inChina; our expectations regarding the continued importance of the Chinesemarket for our technologies and development and the importance of sales inChina to our operating results; our expectations regarding future salesgenerated from China as a percentage of total sales; our expectations regardingthe impact of our receiving the license to sell GSM and CDMA handsets in Chinaon our ability to meet future market demands; our expectations regardingsubscriber growth in China; our expectations regarding global expansion ofsales outside of China; our plan to extend our supplier base by introducingmore models of our own design and expanding relationships with moremanufacturers; our plans to pursue opportunities to divest additional non-coreassets; our expectation that research and development expenses will be stable;our expectations regarding future amortization expenses; our expectationsregarding the impact of product defects or performance quality issues; ourexpectations regarding the impact of international expansion on our management,operational, financial and other resources; our expectations regarding theimpact of legislation that restricts or prohibits the use of wireless handsetswhile driving on our future sales; our expectations regarding days salesoutstanding; our plans regarding improvement of our internal supply chain andinventory management processes; our expectations regarding our product costreduction efforts; our expectations regarding the reliability of stock-basedcompensation valuation models and the impact of SFAS 123(R); and ourexpectations regarding our ability to implement and enhance our administrativeinfrastructure. Additional forward-looking statements may be identifiedby the words “anticipate,” “expect,” “believe,” “intend,” “will,” “may,” andsimilar expressions, as they relate to us or our management, or by the words “designed,”“intended” and similar expressions, as they relate to our products and services.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 Item 1A, “Risk Factors”section of this Form 10-K. We do not guarantee future results andundertake no obligation to update the forward-looking statements toreflect events or circumstances occurring after the date of this Form 10-K.

**RESTATEMENT OFCONSOLIDATED FINANCIAL STATEMENTS**

Our consolidated financialstatements and financial information in this Annual Report on Form 10-Kfor accounting periods prior to the third quarter of 2006 have been restated.

***Summary***

In July 2007, the Company announced the AuditCommittee was conducting an independent investigation of historical sales withcertain customers in China and stated that it could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in previously issuedfinancial statements. In September 2007, the Company announced theinvestigative phase of the Audit Committee’s investigation had been completed.After consultation with and upon the recommendation of management, the AuditCommittee determined revenue in the Company’s Western Region of China wasrecognized earlier than it should have been and that the financial statementsfor the affected periods should be restated. The Company also announced thatits previously issued financial statements for each of the fiscal years ended December 31in the period 2000 through 2005, the financial statements for the interimperiods contained in the Quarterly Reports on 

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Form 10-Q filedwith respect to each of these years, and the quarterly reports on Form 10-Qfiled with respect to each of the quarterly periods ended March 31 and June 30,2006 should not be relied upon. In this Annual Report we have corrected for the effects of net sales andrelated costs of net sales that were recorded earlier than they should havebeen. The net effect at December 31, 2005 was to reduce and deferpreviously recognized revenue and gross profit of $278.6 million and $97.7million, respectively.

We alsoconducted a voluntary review of historical stock option practices underthe direction of the Nominating and Corporate Governance Committee of our Boardof Directors (“Governance Committee”). This review considered all option grantawards made in the period from February 29, 2000, shortly before theinitial public offering of our Common Stock, through August 2006 forcompliance with the various stock-based compensation accounting standardsapplicable during this period as well as the rules of our stock optionplans. We found that in a number of instances we did not use the proper date asthe measurement date in determining whether stock options had been issued withexercise prices below the fair value of our common stock. Therefore, we haverestated our previously issued financial statements for the years ended December 31,1998 through 2005 to account for an additional $25.5 million of stock compensationexpense that should have been recognized over the period together with an equalincrease in additional paid-in capital to recognize the intrinsic valueassigned to these issuances of equity securities. Related adjustments ofpayroll and income taxes resulted in an additional $0.5 million of expensebeing recognized for the 1998 through 2005 period and total stockholders’equity being reduced by a total of $2.1 million at December 31, 2005.During the first six months of 2006 an additional $1.2 million of stockcompensation expense was recognized, which reduces our previously reportedoperating results for this period.

In restating our previously issued financialstatements for the investigations described above, we also corrected otherpreviously reported amounts. We correctedour reporting for $80.3 million of net sales to certain third party resellersand $41.2 million of associated cost of net sales in 2005 to classify theseamounts as related party net sales and related party cost of net sales classifications,respectively, because in 2006 we determined that sales to these entities were,in substance, sales to one of our significant shareholders, SOFTBANK CORP. Theaccounts receivable from these sales was similarly reclassified into accountsreceivable from related parties in our 2005 balance sheets. We also correctedour reporting of $6.3 million of time deposits at March 31 and June 30,2006 because they did not mature within three months. Formerly the timedeposits had been reported in error as cash equivalents, but now these amountsare included in short-term investments in these balance sheets and in thestatements of cash flows for the March and June 2006 reportingperiods. The corrections for all 2006 and 2005 interim periods have been recordedin the condensed consolidated financial statements included in Exhibit 99.1of this Annual Report.

None of these restatements has any effect on any ofour December 31 cash balances; however, cash equivalents were reduced inthe March and June 2006 periods due to the reclassificationsdescribed above.

Additional informationabout these restatements and their effects on our financial statements ispresented below as well as in the Notes to Consolidated Financial Statements.

***China Sales Investigation***

The Audit Committee of theCompany’s Board of Directors (“Audit Committee”) engaged independent counsel toconduct an investigation of sales in China following a determination by theInternal Audit group that allegations of improper activities in a sales office inthe Western Region were credible. The allegations were made by a Companyemployee using the Company’s whistle blower program. The independent counselengaged forensic accountants, and this group is collectively referred to as theInvestigating Team in the rest of this discussion.

In conducting its procedures,the Investigating Team found instances where the customer contracts thatevidenced the arrangement contained obligations for the Company to deliversoftware upgrades when 

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andif made available for the equipment sold for no additional consideration andfor an unspecified period that could extend over the term of the contract. Thisadditional contract obligation is an element of “post contract support.” Inthese cases, the Investigating Team found that the contract documentation forthe same transaction submitted by the sales office to the Company’s Chinaheadquarters for accounting purposes and utilized by the Company in determiningthe amount of revenue recognized did not include evidence of such post contractsupport obligations.

Accounting standards governingrevenue recognition for system sales require all revenue to be deferred whilethere are undelivered elements under the arrangement unless the seller hasestablished vendor specific objective evidence (“VSOE”) of fair value for suchcontract elements. Because these arrangements included such undeliveredelements, revenue should be deferred based on the VSOE of the fair value of theunderlying elements. VSOE of fair value represents the price charged when thesame element is sold separately. Since the Company does not sell this elementseparately, it has not established VSOE for such undelivered elements, and assuch the revenue from such contracts is required to be deferred and recognizedover the period the Company is obligated to provide the post contract support.

The China sales investigation covered each of theseven years in the period ended December 31, 2006 and included:  investigating approximately 1,200 contractsin all of our five regions in China; reviews of the electronic files of 45employees; and formal interviews of 96 employees in China. Additionally, theChina sales investigation included reviewing contract files, performing variousfinancial analyses including comparison of payments received per our accountingrecords to the contract terms, and computer forensic procedures wheredestruction of electronic documents was suspected. In the aggregate, theInvestigating Team expended approximately 25,000 hours in conducting thisinvestigation, which commenced in February 2007 and was completed in September 2007when the independent counsel and forensic accountants presented their finalreport to the Audit Committee. In July 2007, we announced the AuditCommittee was conducting an independent investigation of historical sales withcertain customers in China and we stated that we could not rule out thepossibility that the outcome of the investigation could impact revenuerecognized for certain of such contracts as recorded in our previously issuedfinancial statements.

Upon completion ofthe investigative phase of the independent investigation by the AuditCommittee, our management:

·       conductedfollow-up procedures to attempt to locate any additional relevant informationto ensure the Company considered all available information and documents;

·       evaluatedthe accounting for identified system sales using the contract template anddocumentation found in the sales contract files from the Western Region offices.This included calculating the financial statement effects of correcting theaccounting for all system sales where the contract template found at our salesoffices contained post contract support obligations to recognize revenue andcost of net sales over estimated period of post contract support;

·       concludedthat as a result of the existence of this undelivered post contract supportobligation our previously issued financial statements should be restated todefer system sales contract revenue and the related cost of net sales over theestimated period of post contract support when a contract contained unspecifiedsoftware upgrade rights.

The Audit Committee concurred with management’sdecisions.

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Theeffect of correcting improperly recognized revenue and cost of net sales is to(reduce) increase previously reported net sales, gross profit and net income bythe following amounts (in thousands of dollars):

| **Year ended December 31,** | ** ** | ** ** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
|--------------------------------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|---------------------|------------|
| 2000                                       |       | $          | (12,408    | )                  |       | $                     | (5,294     | )                   |       |   | $ | (4,781 | ) |   |
| 2001                                       |       | (17,154    | )          |               | (6,330     | )                     |       |                | (5,779     | ) |   |
| 2002                                       |       | (64,732    | )          |               | (22,924    | )                     |       |                | (19,697    | ) |   |
| 2003                                       |       | (21,060    | )          |               | (8,014     | )                     |       |                | (6,382     | ) |   |
| Totals through  December 31, 2003     |       | (115,354   | )          |               | (42,562    | )                     |       |                | (36,639    | ) |   |
| 2004                                       |       | (104,965   | )          |               | (27,241    | )                     |       |                | (18,594    | ) |   |
| 2005                                       |       | (58,232    | )          |               | (27,863    | )                     |       |                | (42,433    | ) |   |
| 2000 - 2005 Total                          |       | (278,551   | )          |               | (97,666    | )                     |       |                | (97,666    | ) |   |
|                                            |            |            |            |                    |            |                       |            |                     |            |  |  |  |  |  |  |  |

 

| **2006 quarter ended** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| March 31                    |       | 5,410      |       |       | 1,360      |       |       |       | 1,360      |   |   |
| June 30                     |       | 2,380      |       |       | (371       | )          |       |       | (371       | ) |   |
| Total China Sales  Restatement   |       | $          | (270,761   | )          |       | $          | (96,677    | )          |       |   | $ | (96,677 | ) |   |
|                                  |            |            |            |            |            |            |            |            |            |  |  |  |  |  |  |  |

 

The cumulative effect of all of the China salesrestatement adjustments to our consolidated balance sheet as of December 31,2003 resulted in a decrease in retained earnings of $36.6 million, an increasein deferred revenue of $115.4 million to account for previously recognizedsales, an increase in deferred costs of $75.7 million to account for previouslyrecognized cost of net sales, and an increase in deferred tax assets of $3.0million. In our consolidated balance sheet at December 31, 2006, deferredrevenue is $275.7 million, of which $35.6 million is classified as currentand $240.1 million as non-current, and the deferred costs balance is $176.6million. These amounts will be recognized in our consolidated statements ofoperations over the estimated remaining period of post contract support.

Upon completing its investigation, the Audit Committeeconcluded that the conditions and practices relating to systems contractsprevalent in the Western Region resulted primarily from the failure to prevent ordetect instances of override related to controls in China over customeragreements, lack of proper management oversight, unclear record retentionpolicies and procedures relating to systems contracts, and inadequate employeetraining. The Investigating Team and the Audit Committee also concluded thatwith respect to four regions other than the Western Region there was noevidence of fraud or misconduct or reason to suspect such occurred. TheInvestigating Team and the Audit Committee also concluded that there was nocredible evidence of knowledge by senior management in China or the UnitedStates of the conditions and practices related to the Western Region of Chinathat were discovered in the investigation. The Audit Committee concluded thatlocal management in several of the sales offices in the Western Region of Chinadid not submit appropriate information to the Company’s senior management inChina and the United States. Therefore, in prior years, neither the Company’smanagement nor the Company’s independent registered accounting firm were ableto properly evaluate the effect of that information on revenue recognition. TheAudit Committee also concluded that certain members of management in China bearvarying degrees of responsibility for inadequate oversight of activities. As aresult, certain employees in China have either been terminated or placed onsuspension for failure to provide adequate oversight of activities.

We have restructured themanagement of the Western Region sales organization and are working to identifyand implement changes to our policies and procedures and enhance employeetraining to improve internal control consciousness and lessen the possibilityof accounting errors occurring in the future.

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***Stock Option Accounting***

In November 2006, we announced we had commenced avoluntary review of historical stock option practices under the leadership ofthe Governance Committee following a preliminary review by management whichidentified potential deficiencies and discrepancies in the documentation ofstock option grants. The review considered all option grant awards made in theperiod from February 29, 2000, shortly before the initial public offeringof our Common Stock, through August 2006 (“Review Period”) for compliancewith the various stock-based compensation accounting standards applicableduring the Review Period as well as the rules of our stock option plans.The Governance Committee engaged independent outside legal counsel to assist inthe review who, in turn, engaged forensic accountants. (Separate law firms andseparate forensic accounting firms were engaged by the Audit Committee and theGovernance Committee for the China sales investigation and the stock optionaccounting review.) In the rest of this discussion, this group collectively isreferred to as the Stock Option Review Team and their actions and activitiesare referred to as the Stock Option Review. The Stock Option Review Teammembers spent over 11,000 hours in this review, and the Governance Committeemet with the Stock Option Review Team on more than a dozen occasions toreceive, discuss, and consider the Stock Option Review Team’s information andfindings.

At the time the review commenced, the GovernanceCommittee consisted of three members of the Board of Directors, all of whom areindependent directors. The Committee decided to delegate supervision of thereview to Mr. Jeff Clarke, its Chairman, who joined our Board in 2005 andhad not served on the Compensation Committee of the Board of Directors (“CompensationCommittee”) during the period under review. The Governance Committee alsoconsisted of two other independent directors, Mr. Larry D. Horner and Mr. ThomasToy, who also serve on the Board’s Compensation Committee. Mr. AllenLenzmeier was appointed to the Governance Committee on April 27, 2007.

Review proceduresincluded:

·       interviewsof individuals involved with granting, advising, administering, or accountingfor stock options, including current and former:  management, members of the Board ofDirectors, employees, and non-employee professionals;

·       reviewof relevant stock administration, human resource, legal, and finance departmentfiles and records;

·       reviewof stock option grant information in select employee personnel files;

·       reviewby at least 30 attorneys and 15 forensic accountants of approximately 250,000potentially relevant e-mails and documents in electronic format selectedthrough electronic discovery techniques from over 1.8 million electronicdocuments processed;

·       reviewof the electronic database of the Company’s stock option activity maintained bya third party along with communications to and from this service provider;

·       reconciliationof grant activity from approval documents executed by the CompensationCommittee with the electronic database;

·       reconciliationof stock option grant, exercise, and cancellation information from SEC filingswith select employee personnel files and the electronic database;

·       statisticaland judgmental pattern analysis;

·       follow-upon matters raising questions about the option granting process and its history,conduct of those involved with granting, advising, administering, or accountingfor stock options, or the accounting treatment for stock options; and

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·       follow-upon items or issues requested or identified by management or the Company’sindependent registered public accounting firm.

The Stock Option Review Team, management, and theGovernance Committee decided to group stock option grants into six awardcategories based on differences in what constituted substantive approval foreach category under our stock option granting practices as well as givingconsideration to the risk of intentional misstatement of the grant date.Guidance in a September 19, 2006 letter publicly issued by the SEC’s ChiefAccountant focuses on the concept that a measurement date under AccountingPrinciples Board Opinion No. 25 *Accounting for StockIssued to Employees*(“APB 25”), the accounting standard governingour stock option accounting through 2005, does not occur until the number ofshares an individual employee is entitled to receive and the exercise price isdetermined with finality (i.e., no longer subject to change). This is the dateon which substantive approval occurred, and depending on a company’s facts andcircumstances the guidance from the SEC discussed above recognizes a companymay determine that the measurement date for some stock option grants may occurbefore all required granting actions have occurred—such as final approval bythe Compensation Committee. This alternative is available only when a review ofall facts and circumstances supports a conclusion that substantive approvaloccurs earlier than when all required granting actions have occurred and thereis no evidence of fraudulent or manipulative conduct in the company’s optiongranting practices.

Indetermining the measurement date to be used, the Stock Option Review Team,management, and the Governance Committee agreed to use the followingdefinitions as constituting the proper measurement date, and generally thesedates were used in testing the stated grant dates or establishing correctedmeasurement dates:
| **Discretionary Director and Officer Grants** |   | The date of a Compensation Committee meeting where the grant was approved or  the date the final Compensation Committee signer approved the grant when  approval occurred through unanimous written consent documents (“UWC”).                                                                                                                                                                                                                                                           |
|----------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Automatic Director Grants**                      |   | The date  specified in the relevant stock option plan.                                                                                                                                                                                                                                                                                                                                                                                                                                             |
| **Broadbase**                                      |   | The date the  grantee list, including the allocation of shares to individual grantees, was  complete. Compensation Committee approval was considered perfunctory due to  delegation of authority to management.                                                                                                                                                                                                                                                                                    |
| **Acquisition**                                    |   | The first  Compensation Committee meeting following the acquisition, provided grantees  had received employment offer letters stating the number of stock options to  be granted before such date, because this was the date at which the option  exercise price was established. Compensation Committee approval was  considered perfunctory due to delegation of authority to management.                                                                                                        |
| **New Hire**                                       |   | The first  scheduled Compensation Committee meeting following the first day of  employment, because this was the date at which the option exercise price was  established. The number of options was based on either grant amounts  specified in an employment offer letter or, in some cases, on a matrix that  assigned grant amounts based on position and level within the Company.  Compensation Committee approval was considered perfunctory due to delegation  of authority to management. |
| **Other Merit**                                    |   | The date the grantee  list, including the allocation of shares to grantees, was substantially  complete. Compensation Committee approval was considered perfunctory due to  delegation of authority to management.                                                                                                                                                                                                                                                                                 |

 

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For 12 tested grant dates where a correctedmeasurement date was required, the Stock Option Review Team and management wereunable to locate sufficient evidence to establish a corrected measurement dateusing our established criteria for the applicable option grant type. In thesesituations alternative available evidence was used to establish the correctedmeasurement date.

During the period covered by the Stock Option Review,we granted stock options on approximately 34 million shares of our CommonStock at 197 grant dates. The review specifically examined the appropriatenessof the stated grant date for approximately 90% of the stock options granted,including all stock option grants made to directors and officers, all broadbasegrants and all option grants made in connection with business acquisitions.

Thefindings of this review are summarized as follows:

| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **             | ** ** | **Measurement date changed** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|------------------------|------------|----------------------------------------|------------|
| **Grant Type**                        | ** ** | ** ** | ** ** | **Number of  grants** | ** ** | **Grants tested** | ** ** | **No change  required**           | ** ** | **additional  compensation  expense required** | ** ** | **no additional  compensation  expense required** (1) | ** ** |
| Discretionary  Director & Officer |       |       | 16         |                       |       |                   | 16         |                                   |       |   | 8 |   |   |   | 4 |   |   |   | 4 |   |   |
| Automatic  Director                        |       |       | 5          |                       |       |                   | 5          |                                   |       |   | 5 |   |   |   | — |   |   |   | — |   |   |
| Broadbase                                  |       |       | 8          |                       |       |                   | 8          |                                   |       |   | — |   |   |   | 6 |   |   |   | 2 |   |   |
| Acquisition                                |       |       | 10         |                       |       |                   | 10         |                                   |       |   | 10 |   |   |   | — |   |   |   | — |   |   |
| New Hire                                   |       |       | 166        |                       |       |                   | 48         |                                   |       |   | 48 |   |   |   | — |   |   |   | — |   |   |
| Other Merit                                |       |       | 96         |                       |       |                   | 41         |                                   |       |   | 4 |   |   |   | 21 |   |   |   | 16 |   |   |
| Total                                      |       |       | 301        | (2)                        |       |                   | 128        |                                   |       |   | 75 |   |   |   | 31 |   |   |   | 22 |   |   |
|                                            |            |            |            |                            |            |                        |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Under APB 25 there is noexpense adjustment arising from using the corrected measurement date for thesegrants because the amount the employee would have to pay to exercise thesestock option grants exceeded the quoted market price of our Common Stock at thecorrected measurement date, and therefore, these stock option grants containedno intrinsic value at the corrected measurement date.

(2)          The number of grantsexceeds the number of grant dates because on certain grant dates more than onecategory of stock option grants were approved.

In late January 2007 the Governance Committeereported its interim findings concerning the use of incorrect measurement datesin our stock option accounting under APB 25 to our Board of Directors. On February 1,2007, the Audit Committee of the Board of Directors then concluded, inconsultation with and upon the recommendation of management, that we shouldcorrect for errors in previously reported stock-based compensationexpense through restatement of our previously issued financial statements andthat our previously issued financial statements for all periods should nolonger be relied upon. We communicated this decision in a February 1, 2007public announcement.

A non-cash compensation charge, to be recognized as anexpense over a grantee’s service period, arises under APB 25 if a stock optionhas intrinsic value at its measurement date. This intrinsic value is measuredby the excess, if any, of the fair value at the date of grant of the underlyingcommon stock over the stock option’s exercise price. Our practice has been togrant stock options with exercise prices equal to the closing price of ourCommon Stock at each grant date, to use the grant date as the measurement datefor stock-based compensation purposes, and as such previously we had determinedthe granted stock options had no intrinsic value at their grant dates and nocompensation expense was recognized. However, APB 25 states the measurementdate does not occur until all essential actions necessary to grant the optionare completed, including the final determination of both the number of sharesto be granted to each employee or director and the exercise price, and theoption grant is approved by those with requisite authority. This is reinforcedby the September 19, 2006 letter issued by the SEC’s Chief Accountantwhich focuses on the need for the number of shares and exercise price of anaward to an individual to be finalized 

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to have a measurementdate. This letter clarifies the SEC staff’s view that if it is possible thatthose terms could change, a measurement date has not occurred, even if theaward’s terms are not actually changed.

Based on theavailable evidence, the review found that the number of shares an individualemployee was entitled to receive and/or the exercise price was not determinedwith finality at the stated grant date on 53 tested grant dates, and we shouldhave used a later date as the measurement date. The principal reasons for thestated grant date not qualifying as the measurement date under APB 25 include:

·       certainlistings of grantees, below officer level, were incomplete and added to ormodified by stock option administration personnel after the grant was approvedby the Compensation Committee;

·       forcertain grants where Compensation Committee approval was not consideredperfunctory, the date a UWC document was sent to Compensation Committee membersfor approval was used as the stated grant date for some discretionary officerand director grants rather than the date the UWC was signed by all CompensationCommittee members and therefore became effective;

·       theStock Option Review Team was unable to locate contemporaneous documentation ofsome director and officer, broadbase, new hire, and other merit grants.

During the review the Company also discovered a stockoption grant to a former officer that was modified in 1998 in connection withhis termination of employment. This change was never included in the Company’sstock option grant records and the additional compensation expense resultingfrom the change in the option’s terms (approximately $1.2 million)  was not recorded previously. This discoveryis consistent with the Stock Option Review Team’s finding that in certaininstances there was a lack of formal documentation in the stock option grantingprocess and/or expected documentation is missing from the stock optionadministration files. In addition, the Stock Option Review Team found that, inmany instances, there was a lack of self-authenticating evidence to corroboratethat cash exercises were contemporaneous. As a result, the findings on theissue of backdating of cash exercises were inconclusive.

We are restating our consolidated financial statementsto recognize additional non-cash stock-based compensation expense arising fromusing corrected measurement dates for certain stock option grants made duringthe years 2000 through 2005 and to reflect the modification of the 1998 grantdescribed above. Consistent with our historical accounting policy thisadditional stock-based compensation expense is being recognized on anaccelerated basis by treating each vesting tranche as a separate stock optiongrant (graded vesting).

Our accounting for stock-based compensation changed toa fair value based method in 2006 when, as required by accounting standards, weceased accounting for stock-based compensation under the intrinsic value methodpursuant to APB 25 and began accounting for stock-based compensation underStatement of Financial Accounting Standards 123(R) *Share-BasedPayments*(“SFAS 123(R)”). Under this method all stock option grantshave a fair value determined using an option pricing model, and such fair valueis used to recognize non-cash stock-based compensation expense. We arerestating our unaudited condensed consolidated financial statements for thefirst and second fiscal quarters of 2006, included in Exhibit 99.1, torecognize changes in non-cash stock-based compensation expense that arose froma re-determination of the fair value of stock options granted in 2005 and priorwhere the Governance Committee’s review resulted in a corrected measurementdate. By January 1, 2006, of the 17.9 million options granted in 2000 - 2005where corrections were made to the measurement dates in the Stock OptionReview, 4.4 million options with corrected measurement dates granted in 2000and 2001 had fully vested. Therefore, the fair values of the outstanding andunvested portion of the remaining 13.5 million stock options granted in 2002 -2005 with incorrect measurement dates were recalculated. We are also recordingadditional non-cash stock-based compensation expense in the first two quartersof 2006 arising from correcting the measurement date for stock option grants tothree individuals in this period. We recognize stock compensation expense on astraight-line basis under SFAS 123(R).

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Those stock option grantswith corrected measurement dates have also been restated using the fair valuebased measurement principles of Statement of Financial Accounting Standards 123*Accounting for Stock-Based Compensation*(“SFAS123”) to present, in Note 2, “Restatement of Financial Statements” of Notes toConsolidated Financial Statements contained in Item 8 of this Annual Report,the pro forma effect on stock-based compensation expense, net income (loss),and earnings (loss) per share amounts in 2004 and 2005 of using the fair valuebased method to determine stock-based compensation expense rather than usingAPB 25’s intrinsic value method. Such disclosure is required in financialstatements for periods prior to the adoption of SFAS 123(R).

In addition to restatingthe consolidated financial statements in response to the Governance Committee’sfindings, we are recording additional non-cash adjustments to account for themodification in 1998 of a stock option grant to a former officer in connectionwith his termination of employment and to record in the first two quarters of2006 corrections relating to accounting for performance related stock optionsand restricted stock grants, all of which were previously identified andconsidered immaterial.

Correcting the measurementdate for previously granted stock options in some cases results in additionaltaxable income to employees on which additional payroll taxes are due from theemployees as well as us. We have provided for all additional payroll taxes plusrelated penalties and interest arising from the restatement of stock-basedcompensation, including amounts otherwise payable by stock option recipients,and our restated financial statements include an accrual in all affected yearsof approximately $1.5 million for all estimated payroll tax related expenses.

Thecorrections for the stock option restatement are to increase (reduce)previously reported non-cash compensation expense, payroll taxes, income taxesand net income by the following amounts (in thousands of dollars):

| **Year ended December 31,**  | ** ** | ** ** | ** ** | **Non-cash  stock  compensation** | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
|--------------------------------------------------|------------|------------|------------|-----------------------------------|------------|------------------------|------------|-----------------------|------------|---------------------|------------|
| 1998                                             |       |       | $          | 1,244                             |       |                   |       | $                     | —     |                |       |   | $ | (448 | ) |   |   | $ | (796 | ) |   |
| 1999                                             |       |       | —     |                              |       |                   | —     |                  |       |                | —     |   |   |   | — |   |   |
| 2000                                             |       |       | 556        |                              |       |                   | —     |                  |       |                | (104       | ) |   |   | (452 | ) |   |
| 2001                                             |       |       | 4,870      |                              |       |                   | —     |                  |       |                | (942       | ) |   |   | (3,928 | ) |   |
| 2002                                             |       |       | 8,110      |                              |       |                   | —     |                  |       |                | (1,550     | ) |   |   | (6,560 | ) |   |
| 2003                                             |       |       | 12,470     |                              |       |                   | 900        |                  |       |                | (2,281     | ) |   |   | (11,089 | ) |   |
| Totals through  December 31, 2003           |       |       | 27,250     |                              |       |                   | 900        |                  |       |                | (5,325     | ) |   |   | (22,825 | ) |   |
| 2004                                             |       |       | (410       | )                                 |       |                   | 541        |                  |       |                | 250        |   |   |   | (381 | ) |   |
| 2005                                             |       |       | (1,290     | )                                 |       |                   | 60         |                  |       |                | 4,083      |   |   |   | (2,853 | ) |   |
| 2000 - 2005  Total                               |       |       | 25,550     |                              |       |                   | 1,501      |                  |       |                | (992       | ) |   |   | (26,059 | ) |   |

 

| 2006 quarter ended | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| March 31                |       |       | 662        |       |       |       | 9          |       |       |       | —     |       |       |       | (671       | )          |       |
| June 30                 |       |       | 504        |       |       |       | 6          |       |       |       | —     |       |       |       | (510       | )          |       |
|                         |       |       | $          | 26,716     |       |       |       | $          | 1,516      |       |       |       | $          | (992       | )          |       |       | $          | (27,240    | ) |   |
|                              |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |  |  |  |  |

 

The Governance Committee’s review found 17.9 millionstock options of the 28.8 million options granted on our Common Stock during2000 through 2005 had incorrect measurement dates. Using the correctedmeasurement dates, 7.6 million stock options had exercise prices that exceededthe closing price of our Common Stock and therefore had no intrinsic value tobe accounted for under APB 25, and 10.3 million stock options hadintrinsic value because their exercise prices were below the closing price of ourCommon Stock. These 10.3 million stock options resulted in an increase inadditional non-cash stock-based compensation expense of $24.3 million, and anadditional $1.5 million of payroll tax related expenses 

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during 2000 - 2005partially offset by $0.5 million of income tax benefit as shown in the abovetable. Of the 10.3 million stock options resulting in additional non-cashstock-based compensation expense, 2.0 million options were granted toofficers and directors and resulted in $6.1 million of additional non-cashstock-based compensation expense.

Upon completing its review, the Governance Committeeconcluded it found no evidence of intent to manipulate the Company’s operatingresults or financial statements. A key finding of the Governance Committee wasthat there were deficiencies with the process by which stock options weregranted during the period from our initial public offering in 2000 through atleast 2005, which resulted in accounting errors. The Governance Committeeconcluded that certain members of management bear varying degrees ofresponsibility for the deficiencies in the process by which options weregranted. The Governance Committee’s review also concluded that none of thecurrent or former employees or directors of the Company engaged in intentionalwrongdoing.

In determining the aboverestatement amounts, management used all reasonably available relevantinformation to form conclusions it believes are reasonable as to the mostlikely option granting actions that occurred, the dates when such actionsoccurred, and the determination of grant dates for financial accountingpurposes based on when the requirements of the accounting standards were met.In light of significant judgment used in establishing revised measurementdates, alternative approaches to those used by the Stock Option Review Team andmanagement could have resulted in different compensation charges than thoserecorded in the restatement. The Stock Option Review Team and managementconsidered various alternatives throughout the course of the review andrestatement, and management believes the approaches used were the mostappropriate in the circumstances, and the choices of measurement dates used inour review of stock option grant accounting and restatement of our financial statementswere reasonable and appropriate in our circumstances.

***Summary of Restatement Amounts***

Thefollowing table presents the decrease in net earnings from the restatement foreach restated year:

| ** **                                 | ** ** | **Net income**             | ** ** | **Restatement adjustments** | ** ** | ** **                   | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **(loss),  as previously** | ** ** | **China  Sales**                 | ** ** | **Stock  Options**           | ** ** | **Total** | ** ** | **Net income  (loss),** | ** ** |
| **Year ended December 31,** | ** ** | ** **                      | ** ** | **reported**                     | ** ** | **(Decrease) Increase** | ** ** | **as restated** | ** ** |
| ** **                                 | ** ** | ** **                      | ** ** | **(in thousands)**          | ** ** | ** **                   | ** ** |
| 1998                                       |       |                            |       |                             |       | $                            | —     |   | $ | (796 | ) | $ | (796 | ) |   |   |
| 1999                                       |       |                            |       |                             |       | —                       |       | — |   | — |   |   |   |
| 2000                                       |       |                            |       |                             |       | (4,781                       | )          | (452 | ) | (5,233 | ) |   |   |
| 2001                                       |       |                            |       |                             |       | (5,779                       | )          | (3,928 | ) | (9,707 | ) |   |   |
| 2002                                       |       |                            | $          | 107,862                          |       |                         | (19,697    | ) | (6,560 | ) | (26,257 | ) | $ | 81,605 |   |
| 2003                                       |       |                            | $          | 209,856                          |       |                         | (6,382     | ) | (11,089 | ) | (17,471 | ) | $ | 192,385 |   |
| Totals through  December 31, 2003     |       |                            |       |                             |       | (36,639                      | )          | (22,825 | ) | (59,464 | ) |   |   |
| 2004                                       |       |                            | $          | 69,824                           |       |                         | (18,594    | ) | (381 | ) | (18,975 | ) | $ | 50,849 |   |
| 2005                                       |       |                            | $          | (487,359                         | )          |                         | (42,433    | ) | (2,853 | ) | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005 Total                          |       |                            |       |                             |       | (97,666                      | )          | (26,059 | ) | (123,725 | ) |   |   |
|                                            |            |                                 |            |                                  |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

| **2006 quarter ended**  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| 2006 Q1                                |       |       |       |       |       | 1,360      |       | (671       | )          | 689        |       |       |       |
| 2006 Q2                                |       |       |       |       |       | (371       | )          | (510       | )          | (881       | )          |       |       |
|                                   |       |       |       |       |       | $          | (96,677    | )          | $          | (27,240    | )          | $          | (123,917   | )          |       |   |
|                                        |            |            |            |            |            |            |            |            |            |            |            |            |            |            |            |  |  |  |

 

 

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The effect thesecorrections on diluted earnings (loss) per share for 2002 to 2005 are asfollows:

| ** **                                 | ** ** | **Diluted earnings**       | ** ** | ** **                       | ** ** | ** **                | ** ** | ** **         | ** ** | ** **             | ** ** |
|--------------------------------------------|------------|---------------------------------|------------|----------------------------------|------------|---------------------------|------------|--------------------|------------|------------------------|------------|
| ** **                                 | ** ** | **(loss) per share,** | ** ** | **Restatement amounts**     | ** ** | **Diluted earnings** | ** ** |
| **Year ended December 31,** | ** ** | ** **                      | ** ** | **as previously  reported** | ** ** | **China  sales**          | ** ** | **Stock  options** | ** ** | **Total  restatement** | ** ** | **(loss) per share,  as restated** | ** ** |
| 2002                                       |       |                            | 0.94       |                             |       | (0.17                     | )          |               | (0.06      | )                      |       |   | (0.23 | ) |   |   | 0.71 |   |   |
| 2003                                       |       |                            | 1.70       |                             |       | (0.05                     | )          |               | (0.09      | )                      |       |   | (0.14 | ) |   |   | 1.56 |   |   |
| 2004                                       |       |                            | 0.54       |                             |       | (0.14                     | )          |               | (0.00      | )                      |       |   | (0.14 | ) |   |   | 0.40 |   |   |
| 2005                                       |       |                            | (4.16      | )                                |       | (0.36                     | )          |               | (0.03      | )                      |       |   | (0.39 | ) |   |   | (4.55 | ) |   |
|                                            |            |                                 |            |                                  |            |                           |            |                    |            |                        |            |  |  |  |  |  |  |  |  |  |  |

 

The cumulative effect onstockholders’ equity at December 31, 2003 from the above corrections is asfollows (in thousands):

| Increase (decrease) in additional  paid-in capital and deferred stock compensation: |   |    |    |
|-------------------------------------------------------------------------------------|--------|---------|---------|
| Values assigned to stock options                                                    |   | $       | 27,250  |   |
| Reduction of previously recorded income tax benefits  from stock options            |   | (1,278  | )       |
| Net increase in additional paid-in capital and  deferred stock compensation         |   | 25,972  |    |
| (Increase)  decrease in retained earnings:                                          |   |    |    |
| Revenue and related cost of sales deferral for China  system sales                  |   | (36,639 | )       |
| Additional non-cash compensation expense from stock  options                        |   | (27,250 | )       |
| Payroll taxes for values assigned to stock options                                  |   | (900    | )       |
| Income tax benefit from additional compensation and  payroll tax expense            |   | 5,325   |    |
| Net increase in retained earnings                                                   |   | (59,464 | )       |
| Net decrease in  stockholders’ equity at December 31, 2003                     |   | $       | (33,492 | ) |

 

In restating our previously issued financial statementswe also corrected other previously reported amounts. We corrected our reportingfor $80.3 million of net sales to certain third party resellers and $41.2 millionof associated cost of net sales in 2005 to classify these amounts as relatedparty net sales and related party cost of net sales classifications,respectively, because in 2006 we determined that sales to these entities were,in substance, sales to one of our significant shareholders, SOFTBANK CORP. Theaccounts receivable from these sales was similarly reclassified into accountsreceivable from related parties in our 2005 balance sheets. We also correctedour reporting of $6.3 million of time deposits at March 31 andJune 30, 2006 because they did not mature within three months. Formerlythe time deposits had been reported in error as cash equivalents, but now theseamounts are included in short-term investments in these balance sheets and inthe statements of cash flows for the March and June 2006 reportingperiods.

**ALL AMOUNTS IN THE FOLLOWING SECTIONS OF THISMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS, EXCEPT THOSE IDENTIFIED “AS PREVIOUSLY REPORTED” IN TABLES WITHINTHE QUARTERLY DATA (UNAUDITED), AS RESTATED CAPTION, REFLECT THE EFFECTS OF THERESTATEMENT OF OUR FINANCIAL STATEMENTS TO CORRECT OUR REVENUE RECOGNITION FORCERTAIN SALES CONTRACTS IN CHINA AND OUR HISTORICAL STOCK OPTION ACCOUNTING, ASWELL AS CERTAIN 2005 SALES, COST OF SALES AND ACCOUNTS RECEIVABLES AMOUNTSDISCOVERED TO BE RELATED PARTY TRANSACTIONS AND THE CORRECTION OF THECLASSIFICATION OF A TIME DEPOSIT FROM CASH TO SHORT-TERM INVESTMENTS IN THEFIRST TWO QUARTERS OF 2006.**

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**Late SEC Filingsand NASDAQ Delisting Proceedings**

As a result of the Nominating and CorporateGovernance’s Committee’s review of our historical stock option accounting andthe resulting restatements, we did not timely file our Quarterly Report onForm 10-Q for the quarter ended September 30, 2006 (“Q3 2006Form 10-Q”), our Annual Report on Form 10-K for the fiscalyear ended December 31, 2006 (“2006 Form 10-K”), and ourQuarterly Report on Form 10-Q for the quarter ended March 31,2007 (“Q1 2007 Form 10-Q”) with the Securities and ExchangeCommission. In addition, as a result of the Audit Committee’s review of certainhistorical sales contracts in China, we did not timely file our QuarterlyReport on Form 10-Q for the quarter ended June 30, 2007 (“Q22007 Form 10-Q”) with the Securities and Exchange Commission.

In connection with our failure to timely file our periodicreports, we received four NASDAQ Staff Determination letters, datedNovember 15, 2006, March 7, 2007, May 16, 2007 andAugust 13, 2007, respectively, stating that, as a result of each of thesenon-timely filings, we were not in compliance with the requirements ofMarketplace Rule 4310(c)(14) and, therefore, our stock was subject todelisting from the NASDAQ Stock Market. We appealed the November 15, 2006determination to the NASDAQ Listing Qualifications Panel (the “Panel”) and weregranted a conditional extension to our request for continued listing untilApril 16, 2007. On April 17, 2007, the Panel extended the deadlinefor filing our Q3 2006 Form 10-Q to May 14, 2007. The Panelalso extended the deadline for filing our 2006 Form 10-K untilJuly 16, 2007.

On May 2, 2007, weasked the NASDAQ Listing and Hearing Review Council (“Listing Council”) toreview the April 17, 2007 decision of the Panel. On May 14, 2007, theListing Council called the Panel’s decision for review and requested that weprovide an update on our efforts to file our delinquent filings. We havecontinued and continue to comply with that request. In addition, the ListingCouncil stayed the Panel’s decision that required us to file our Q3 2006Form 10-Q by May 14, 2007, and to file our 2006 Form 10-Kby July 16, 2007. On August 23, 2007, the Listing Council granted theCompany an extension until October 22, 2007 to file our delinquentperiodic reports and restatements. As of the date of the filing of thisForm 10-K (which is filed concurrently with our Q3 2006 Form 10-Q),we will have two periodic reports still outstanding, our Q1 2007 Form 10-Qand our Q2 2007 Form 10-Q. We expect to be able to complete thefiling of our outstanding reports as soon as practicable.

**OVERVIEW**

We design, manufacture andsell telecommunications equipment and handset products and provide servicesassociated with their operation. Our telecommunication equipment products aredeployed and installed globally primarily by wireless and wirelinetelecommunications service providers. We provide an extensive range of productsfor transportation of voice, data and video traffic for these serviceproviders. We differentiate ourselves with products designed to reduce networkcomplexity, integrate high performance capabilities and allow a simpletransition to next generation networks.

*PersonalCommunications Division*

The Personal Communications Division (“PCD”) is ourdistribution channel into the Code Division Multiple Access (“CDMA”) handsetmarket. PCD was established with the acquisition of the assets of the wirelesshandset division of Audiovox Corporation (ACC) in November 2004 (see Note5, “Acquisitions and Sale of Assets”, of Notes to Consolidated FinancialStatements contained in Item 8 of this Annual Report). We acquired ACC’s sales,service and support infrastructure, its CDMA handset brand, access to supply-chainchannels, product marketing expertise and key relationships with CDMA operatorsin North and South America. We believe this distribution channel strengthensour position in the handset market by providing additional sales volume ofUTStarcom designed products to benefit economies of scale in manufacturing,sourcing and development.

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In 2005, PCD became our largest segment on the basisof net sales, generating 48% of our total sales. This was primarily due to thefact that in 2005 a full year of PCD operations were reflected in our resultsas compared to 2004 where approximately two months of PCD revenues wereincluded. At the same time, sales in our Network Solutions segment declinedsignificantly. In 2006, PCD continued to be our largest segment on the basis ofnet sales, generating $1,339.5 million, or 55%, of our total sales. The grossmargins on PCD distribution and marketing services are much lower than themargins traditionally realized in our other operating segments. We plan toimprove PCD gross margins by supplying CDMA handsets we design and manufacture.We introduced three CDMA handset models in 2006, and plan to introduce sixadditional models in 2007.

Historically, PCD hasrelied upon a limited number of third party vendors to supply its handsetproducts. During 2006 and 2005, three vendors accounted for approximately 88%and 97% of purchases, respectively. In September 2006, we entered into astrategic alliance agreement with one of these vendors whereby we wereappointed exclusive distributor in certain territories. Additionally, during2006 we extended our supplier base by introducing more models of our own designand expanding our relationships with other manufacturers.

*WirelessInfrastructure and Handsets*

Our Personal Access Service (“PAS”) infrastructure andhandset products are primarily sold in China. Historically, China has been ourlargest market and we believe that it will continue to be an important marketfor our current and future technologies. The percentage of our sales generatedin China has declined to 32% and 30% of total sales in 2006 and 2005,respectively compared with 79% in 2004. This decline is due to maturation ofthe PAS market coupled with proportionally increased sales outside of Chinathrough organic growth and acquisitions.

In 2006 and 2005, our sales of Wireless Infrastructureproducts declined by $8.6 million, or 2%, and $832.8 million, or 66%,respectively, compared with the previous year. The decline in our sales ofWireless Infrastructure products is primarily due to our customers in China reducingtheir capital spending in anticipation of next generation technology networkswhile shifting their PAS investments from geographical extension to expandingthe capacity and improving the quality of the existing networks.

In 2006 and 2005, our sales for Handset productsdeclined by $77.7 million, or 16%, and $275.6 million, or 37%, respectively,compared with the previous year, primarily due to declines in both the totalmarket size and average selling price. The decline in handset market size is a resultof lower subscriber growth in 2006, which was driven by lower marketing effortsby service providers. Despite competitive pressures, the margin rate onhandsets improved by 18 percentage points from 2005 to 2006 as the Chinahandset business focused on higher end products and cost reductions rather thanincrease in volume. We will continue to focus on product cost reductionsthrough the increased sale of handset models with lower cost chipsets as wellas higher end products including dual mode handsets.

Despite the marketconditions experienced in 2006, we expect long-term demand for our PASproducts will continue as we believe PAS will remain an important technologyand market in China for the foreseeable future. According to China’s Ministryof Information Industry, the mobile phone teledensity rate was 35% at the endof 2006, which is still far behind most developed countries in the world. Thismeans almost 65% of China’s 1.3 billion population still did not havemobile phone service. As China’s economic growth and urbanization continues inthe coming years, we believe this represents a huge market demand for cost-effectivecommunication services, the addressable market of PAS. At the end of fiscalyear 2006, the number of PAS subscribers exceeded 96 million users, anincrease of 10% over the prior year. Positioned as an extension of fixed-lineservice and an affordable city-wide mobile phone service, PAS has asignificant cost advantage over the 2nd and 3rd generation mobile phonetechnologies, in terms of the existing infrastructure of the network and lowerservice tariffs.

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*Restructuring Programs*

Over the past few years,we have undertaken a significant globalization program and we intend tocontinue to build our global sales outside of China. We intend to continue toenhance our manufacturing capabilities and improve our internal supply chainand inventory management processes to ensure timely deliveries of qualityproducts. We also intend to continue to implement and enhance ouradministrative infrastructure to assist our globalization.

As part of this program,we reviewed our corporate wide operations with the aim of narrowing ourstrategic focus with regard to market concentration, product portfolioselection, and resources allocation. In the second quarter of fiscal 2005, weannounced and initiated a restructuring plan to rationalize our cost structurein response to the decline in demand for certain products and to aligninvestments with key growth opportunities. The primary goal of these improvementsis to optimize our cost structure and enable us to deliver consistent andsustainable profitability for our stockholders.

During 2005, we incurredapproximately $35.3 million in restructuring expenses consisting of$15.2 million in severance payments to approximately 1,595 employeesterminated in workforce reduction programs, $14.5 million in assetimpairments to write-off equipment and licenses associated withdiscontinued products, and a $5.6 million inventory write-off fordiscontinued products. Restructuring expense related to severance and assetimpairments are reported in operating expense, while the inventory write-offis reported in cost of sales in the consolidated statements of operations (seeNote 21, “Restructuring Costs,” to Notes to Consolidated FinancialStatements contained in Item 8 of this Annual Report).

During 2006, no additionalrestructuring expenses were incurred and approximately $1.1 million of accruedexpenses were settled. The remaining $0.1 million of accrued expenses as of December 31,2006 relate to a facility lease and will be settled in 2007.

On October 2, 2007,our Board of Directors approved a restructuring plan (the “Plan”) to reduceoperating costs, which includes a worldwide reduction in force of approximately11% of the Company’s headcount, or approximately 700 employees. The workforcereduction will be based primarily in the United States and China and, to alesser degree, other international locations. Management expects the Plan to becompleted in the fourth quarter of fiscal year 2007. We expect to incur arestructuring charge in connection with the Plan of approximately $10 million,comprised largely of cash payments associated with one-time severance benefits,with the majority of the charge to be taken in the fourth quarter of 2007. Inaddition, the Company expects to realize annual cost savings in salary andcompensation related expenses of approximately $21 million on an annualizedbasis.

We will continue ourefforts to evaluate certain operations and will actively pursue opportunitiesto divest additional non-core assets and may incur additional costsassociated with future actions to further align our business operations andstreamline our business processes.

*Debt Extinguishment and Supplemental IndentureAgreements*

During 2005, we enteredinto agreements to exchange 4,988,100 shares of our common stock with a fairvalue of approximately $37.6 million and approximately $57.1 millionin cash for $127.9 million aggregate principal amount of our outstandingconvertible subordinated notes due 2008 (“Notes”) with five of our Noteholders. These exchanges are considered early extinguishments of debt in whichthe aggregate fair value of the common stock and cash is less than the carryingvalue of the Notes. Accordingly, we recorded gains of $31.4 million on theexchanges during 2005.

Effective January 9,2007, we entered into a Supplemental Indenture Agreement with the holders ofour Notes, providing that any failure by us to comply with certain provisionsof the original agreement will not result in a default or an event of default.In accordance with this supplemental indenture agreement, the Notes will accruean additional 6.75% per annum (as compared to the 7¤8% annual interestprovided for 

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underthe original indenture related to the Notes) in special interest beginningJanuary 9, 2007 to the maturity date of the Notes, unless the Notes areearlier repurchased or converted. On July 26, 2007, we entered into aSecond Supplemental Indenture after receiving consent from holders of more than50% of the outstanding aggregate principal amount of the convertiblesubordinated notes in connection with our consent solicitation announcedJuly 19, 2007. Under the Second Supplemental Indenture, the convertiblesubordinated notes will accrue an aggregate of an additional 10% per annum (ascompared to the 7¤8%annual interest provided for under the original indenture related to the Notes)in special interest from and including July 26, 2007 to the March 1,2008 maturity date of the notes unless the notes are earlier repurchased orconverted. The special interest rate represents an increase of 3.25% per annumover the previous special interest rate of 6.75% per annum in the First SupplementalIndenture. As a result of the Second Supplemental Indenture, the convertiblesubordinated notes now bear a stated interest rate of 10.875% (seeNote 11, “Debt”, to Notes to Consolidated Financial Statements containedin Item 8 of this Annual Report).

*Asset Impairment and Valuation Allowance on DeferredTax Assets*

Management held a seriesof planning meetings in September 2005 to assess the current businessforecast for all of our reporting units. This assessment analyzed variousfactors including a reduction in the rate of growth of PAS subscribers, a delayof the expected granting of 3G licenses in China and Japan, challenges withproduct quality primarily in our Broadband reporting unit, a narrowing of ourstrategic focus related to our product offering and greater than expectedrevenue and margin decline due to continued pricing pressures for several ofour key markets. We determined that certain circumstances have changedsufficiently to indicate that the fair value of certain of our reporting unitsmay be below their book values. As a result, we conducted an evaluation of ourlong-lived assets including goodwill, intangible assets, and certainproperty plant and equipment for impairment and recorded impairment charges.

Based upon this analysisas discussed further in Results of Operations below, during 2005 we recordedimpairment charges totaling $218.1 million consisting of$192.9 million of goodwill, $1.7 million of intangible assets, and$23.5 million of property, plant and equipment (see Note 8 and Note 10 ofNotes to Consolidated Financial Statements contained in Item 8 of this AnnualReport).

Management also evaluatedthe expected realization of deferred tax assets during 2005 and recorded a non-cashcharge of $237.3 million to provide a full valuation allowance on the netdeferred tax assets at December 31, 2005 in the United States and China.

No additional assetimpairment charges were recorded in fiscal 2006.

*Softbank China*

In December, 2005, we soldour 10% ownership interest in Softbank China Holdings PTE LTD (“SoftbankChina”) to SOFTBANK CORP., a related party and owner of the remaining 90% ofSoftbank China for $56.9 million. As a result, we recorded in other incomea gain of $47.2 million after management fees, transaction expenses andnet of the investment’s carrying value.

**RESULTS OF OPERATIONS**

We reorganized ourbusiness based principally upon product families and realigned our businessinto four operating units: (i) Network Solutions , (ii) PCD,(iii) Handsets and (iv) Services. The Network Solutions operatingunit provides its products and services through two reporting segments;Broadband Infrastructure and Wireless Infrastructure. We aligned our reportingby business segment with this reorganization because, in accordance with SFASNo. 131, “Disclosures about Segments of an Enterprise and RelatedInformation,” this is the basis on which our management evaluated and managedour business during the period through December 31, 2006.

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Broadband infrastructureis primarily comprised of the iAN-8000, IP-Based Digital SubscriberLine Access Multiplexer, GEPON, NetRingÔ,RollingStreamÔ, and other wireline products. Wirelessinfrastructure is primarily comprised of the PAS and CDMA products. Handsets isprimarily comprised of PAS handsets. PCD is primarily comprised of CDMAhandsets and digital devices. We also provide installation and certainmaintenance services. For each of the periods presented, total services salesaccounted for less than 10% of net sales.

**NET SALES**

| ** **                 | ** ** | **Years Ended December 31, ** | ** ** |
|----------------------------|------------|---------------------------------------------------|------------|
| ** **                 | ** ** | **2006**                                          | ** ** | **% of net  sales** | ** ** | **2005** | ** ** | **% of net  sales** | ** ** | **2004** | ** ** | **% of net  sales** | ** ** |
| ** **                 | ** ** | ** **                                        | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | **(in thousands)**                           | ** ** |
| ***Net Sales by Segment*** |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure   |       | $                                                 | 219,557    |   |   | 9 | % |   | $ | 507,978 |   |   | 18 | % |   | $ | 232,442 |   |   | 9 | % |   |
| Wireless Infrastructure    |       | 427,400                                           |       |   | 17 | % |   | 436,016 |   |   | 15 | % |   | 1,268,850 |   |   | 49 | % |   |
| Network Solutions          |       | 646,957                                           |       |   | 26 | % |   | 943,994 |   |   | 33 | % |   | 1,501,292 |   |   | 58 | % |   |
| PCD                        |       | 1,339,496                                         |       |   | 55 | % |   | 1,369,324 |   |   | 48 | % |   | 277,410 |   |   | 11 | % |   |
| Handsets                   |       | 395,812                                           |       |   | 16 | % |   | 473,472 |   |   | 16 | % |   | 749,073 |   |   | 29 | % |   |
| Services                   |       | 76,596                                            |       |   | 3 | % |   | 84,320 |   |   | 3 | % |   | 51,640 |   |   | 2 | % |   |
|                       |       | $                                                 | 2,458,861  |   |   | 100 | % |   | $ | 2,871,110 |   |   | 100 | % |   | $ | 2,579,415 |   |   | 100 | % |   |
| ***Net Sales by Region***  |       |                                              |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| United States              |       | $                                                 | 1,351,839  |   |   | 55 | % |   | $ | 1,332,213 |   |   | 46 | % |   | $ | 341,517 |   |   | 13 | % |   |
| China                      |       | 785,525                                           |       |   | 32 | % |   | 870,612 |   |   | 30 | % |   | 2,028,194 |   |   | 79 | % |   |
| Japan                      |       | 136,877                                           |       |   | 6 | % |   | 479,114 |   |   | 17 | % |   | 156,416 |   |   | 6 | % |   |
| Other                      |       | 184,620                                           |       |   | 7 | % |   | 189,171 |   |   | 7 | % |   | 53,288 |   |   | 2 | % |   |
|                       |       | $                                                 | 2,458,861  |   |   | 100 | % |   | $ | 2,871,110 |   |   | 100 | % |   | $ | 2,579,415 |   |   | 100 | % |   |

 

*Fiscal 2006 vs. 2005*

Net sales decreased by 14%to $2.5 billion in 2006 compared with 2005. While revenues were lower inall operating segments, the 57% decrease in net sales of the BroadbandInfrastructure segment contributed over half of the total net sales decrease. BroadbandInfrastructure revenues in 2005 were driven by sales of iAN-8000equipment to Japan Telecom, an affiliate of SOFTBANK CORP. and a related party.In 2006, Broadband Infrastructure sales to Softbank and affiliates decreased by$333.0 million as Softbank completed its initial investment in fixed linebusinesses and changed its focus to wireless business following its acquisitionof Vodafone Japan. The decrease in Wireless Infrastructure revenues and  Handsets revenues reflect the lower demand inthe China market for our PAS systems and handsets as PAS subscriber growthdeclined to 10% in 2006 compared with 31% in 2005 and 70% in 2004. PCD netsales remained relatively consistent with a decrease in the average sellingprice offset by a 6% increase in the number of units sold. During 2006, VerizonWireless and  T-Mobile, respectively,accounted for approximately 14% and 11% of our total net sales.

The demand for our PASproducts has weakened as telecommunication service providers have reducedexpenditures for deploying PAS systems and promoting PAS handsets inanticipation of the introduction of new technology for next generationtelecommunication equipment. However, we expect long-term demand for ourPAS products will continue as we believe PAS will remain an importanttechnology and market in China for the foreseeable future. Due to a mix ofhigher growth in our other segments and geographies with declining revenues inour PAS dominated Wireless Infrastructure and Handsets segments, the revenuesfrom customers in China now represent only 32% of total Company revenues. Noindividual province sales accounted for over 10% of total Company revenues in2006 or 2005. During 2005, the Company recorded restatement adjustments todefer $49.6 million of revenue as all conditions necessary for revenuerecognition had not been achieved. Net sales during the year ended 

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December31, 2006 include approximately $44.7 million of the revenue deferred as part ofthe 2005 restatement adjustments. For additional discussion of our businesssegments, see “Segment Reporting.”

In 2007, we expect thatrevenues from PAS products and infrastructure will continue to decline withincreased competition but will be partially offset by revenues from higher endPAS products including dual mode PAS handsets, dual mode CDMA and Softswitchproducts in multiple markets, though we do not anticipate that these sales willfully offset the decline in PAS sales. We currently offer and have initialmarket acceptance of our RollingStreamÔIPTV products in China, Japan and other geographic regions. We believe that theIPTV market presents a meaningful growth opportunity in these regions as wellas other regions we have targeted to expand our IPTV offerings, including India.

*Fiscal 2005 vs. 2004*

Revenues increased by 11%to $2.9 billion in 2005 driven by higher PCD revenues in the United Statesand Broadband Infrastructure revenues in Japan, offset by declining WirelessInfrastructure and Handsets revenue in China.

PCD was established fromthe selected assets and liabilities acquired from Audiovox in November 2004.In 2005, PCD revenues for the 12 month period increased by $1.1 billioncompared to revenues for the two month post acquisition period in 2004. Due toPCD, our revenues in the United States almost quadrupled and represent 46%of total Company revenues in 2005. Additionally, Verizon Wireless accounted for12% of total Company revenues in 2005.

Broadband Infrastructurerevenues more than doubled in 2005 driven by sales of iAN-8000 equipmentto Japan Telecom, an affiliate of SOFTBANK CORP. and a related party. SOFTBANKCORP. and affiliates accounted for 89% of Broadband Infrastructure revenues and17% of total Company revenues in 2005.

We experienced a 66%decline in Wireless Infrastructure revenues and a 37% decline in Handsetsrevenues due to lower demand in the China market for our PAS systems andhandsets as PAS subscriber growth declined from over 70% in 2004 to 31% in 2005.In 2004, the Guangdong and Jiangsu provinces accounted for 13% and 10% of ournet sales, respectively.

**GROSS PROFIT**

| ** **                    | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------|------------|---------------------------------------------|------------|
| ** **                    | ** ** | **2006**                                    | ** ** | **Gross  profit %** | ** ** | **2005** | ** ** | **Gross  profit %** | ** ** | **2004** | ** ** | **Gross  profit %** | ** ** |
| ** **                    | ** ** | ** **                                  | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                    | ** ** | **(in thousands)**                     | ** ** |
| ***Gross profit by Segment*** |       |                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Broadband Infrastructure      |       | $                                           | (3,019     | ) |   | (1 | )% |   |   | $ | 157,890 |   |   |   | 31 | % |   |   | $ | 45,585 |   |   |   | 20 | % |   |
| Wireless Infrastructure       |       | 206,193                                     |       |   | 48 | % |   |   | 121,077 |   |   |   | 28 | % |   |   | 364,028 |   |   |   | 29 | % |   |
| Network Solutions             |       | 203,174                                     |       |   | 31 | % |   |   | 278,967 |   |   |   | 30 | % |   |   | 409,613 |   |   |   | 27 | % |   |
| PCD                           |       | 39,932                                      |       |   | 3 | % |   |   | 52,812 |   |   |   | 4 | % |   |   | 11,866 |   |   |   | 4 | % |   |
| Handsets                      |       | 118,459                                     |       |   | 30 | % |   |   | 58,166 |   |   |   | 12 | % |   |   | 131,708 |   |   |   | 18 | % |   |
| Services                      |       | 24,179                                      |       |   | 32 | % |   |   | 45,891 |   |   |   | 54 | % |   |   | 16,345 |   |   |   | 32 | % |   |
|                          |       | $                                           | 385,744    |   |   | 16 | % |   |   | $ | 435,836 |   |   |   | 15 | % |   |   | $ | 569,532 |   |   |   | 22 | % |   |

 

Cost of sales consists primarily of material and laborcosts associated with manufacturing, assembly and testing of products, costsassociated with installation and customer training, warranty costs, fees toagents, inventory and contract loss provisions and overhead. Cost of sales alsoincludes import taxes and tariffs on components and assemblies. Some componentsand materials used in our products are purchased from a single supplier or alimited group of suppliers and, in some cases, are subject to our obtainingChinese import permits and approvals. We also rely on third party manufacturersto manufacture and assemble most of our CDMA handsets.

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Our gross profit has beenaffected by average selling prices, material costs, product mix, the impact ofwarranty charges and contract loss provisions, as well as inventory reservesand release of deferred revenues and related cost pertaining to prior years. Inaddition, the acquisition of PCD in November 2004 has resulted in a higherpercentage of revenue associated with product offerings at lower margins. Ourgross profit, as a percentage of net sales, varies among our product families.We expect that our overall gross profit, as a percentage of net sales, willfluctuate in the future as a result of shifts in product mix, stage of productlife cycle, anticipated decreases in average selling prices and our ability toreduce cost of sales.

*Fiscal 2006 vs. 2005*

Gross profit declined inabsolute dollars but remained relatively constant as a percentage of net salesat 16% in 2006 compared to 15% in 2005. Our Wireless and Handsets segmentscontributed to the increase in gross profit in absolute dollars, primarily as aresult of a shift in product mix and a reduction in production costs. Theabsolute decrease in gross profit dollars was primarily the result of thedecline in gross profit from the Broadband segment resulting from a 57% declinein segment sales and a reduced profit as a percentage of segment sales due toadditional inventory reserves and a $32.1 million provision for anticipatedlosses on an infrastructure deployment contract entered into in the fourthquarter of 2006. In addition, the increased percentage of our revenue derivedfrom the lower margin PCD segment resulted in a decrease in our total grossprofit as a percentage of net sales. For additional discussion of our businesssegments, see “Segment Reporting.”

*Fiscal 2005 vs. 2004*

Gross profit declined bothin absolute dollars and as a percentage of net sales in 2005, compared to 2004.The absolute decrease in gross profit dollars was primarily the result of a 67%decline in Wireless operating segment gross profit reflective of the maturingPAS market in China, offset by higher absolute gross profit dollars forBroadband and PCD. We primarily attribute the decrease in gross profit, as apercentage of sales, to the impact of PCD margins and lower Handsets marginsdue to declines in PAS handset average selling prices, offset by higherBroadband Infrastructure gross margins achieved on our iAN8000 productsrelating to sales to Japan Telecom in the first quarter. PCD contributed$52.8 million in gross margin in 2005 and contributed only$11.9 million in 2004 because we did not acquire PCD until November 2004.The gross profit in 2005 was negatively affected by a $5.6 millioninventory write-off associated with discontinued products.

**OPERATING EXPENSES(INCOME)**

Thefollowing table summarizes our operating expenses:

| ** **                                     | ** ** | **Years Ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                    | ** ** | **% of net  sales** | ** ** | **2005** | ** ** | **% of net  sales** | ** ** | **2004** | ** ** | **% of net  sales** | ** ** |
| ** **                                     | ** ** | ** **                                  | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                                     | ** ** | **(in thousands)**                     | ** ** |
| Selling, general and  administrative           |       | $                                           | 334,455    |   |   | 14 | % |   |   | $ | 371,461 |   |   |   | 13 | % |   |   | $ | 303,911 |   |   |   | 12 | % |   |
| Research and development                       |       | 182,869                                     |       |   | 7 | % |   |   | 246,813 |   |   |   | 8 | % |   |   | 219,079 |   |   |   | 8 | % |   |
| Amortization of  intangible assets             |       | 18,871                                      |       |   | 1 | % |   |   | 25,853 |   |   |   | 1 | % |   |   | 15,551 |   |   |   | 1 | % |   |
| Gain on sale of  semiconductor   design assets |       | (12,291                                     | )          |   | -1 | % |   |   | — |   |   |   | 0 | % |   |   | — |   |   |   | 0 | % |   |
| Impairment of long-lived  assets               |       | —                                      |       |   | 0 | % |   |   | 218,094 |   |   |   | 8 | % |   |   | 12,706 |   |   |   | 0 | % |   |
| Restructuring costs                            |       | —                                      |       |   | 0 | % |   |   | 29,669 |   |   |   | 1 | % |   |   | — |   |   |   | 0 | % |   |
| In-process research and   development          |       | —                                      |       |   | 0 | % |   |   | 660 |   |   |   | 0 | % |   |   | 1,400 |   |   |   | 0 | % |   |
|                                           |       | $                                           | 523,904    |   |   | 21 | % |   |   | $ | 892,550 |   |   |   | 31 | % |   |   | $ | 552,647 |   |   |   | 21 | % |   |

 

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Selling, general andadministrative expenses (“SG&A”) include compensation and benefits,professional fees, sales commissions, provision for doubtful accountsreceivable and travel and entertainment costs. Research and developmentexpenses consist primarily of compensation and benefits of employees engaged inresearch, design and development activities, costs of parts for prototypes,equipment depreciation and third party development expenses. A portion of ourcosts are fixed and are difficult to quickly reduce in periods of lower sales.However, during the second quarter of 2005, we announced and initiated arestructuring plan which resulted in the reduction of certain SG&A andresearch and development costs. We believe that continued investment inresearch and development is critical to our long-term success. Althoughthe total absolute expenditures in research and development in 2006 was lowerthan in 2005, we streamlined R&D activities and focused on high valuestrategic projects for our businesses.

*SELLING, GENERALAND ADMINISTRATIVE*

*Fiscal 2006 vs.2005*

Selling, general andadministrative expenses decreased $37.0 million, or 10%, in fiscal 2006 ascompared to fiscal 2005. This decrease is primarily due to a $27.8 milliondecrease in our provision for doubtful accounts in 2006 compared to 2005resulting from strong cash collection of fully reserved receivables  in China. Days sales outstanding was 60 daysat December 31, 2006 as compared to 66 days outstanding at December 31,2005 due to strong cash collections in the fourth quarter of 2006 and the highpercentage of fourth quarter revenue derived from our PCD segment, whichgenerally has experienced a shorter collection period on related receivables. In2007, we expect the days sales outstanding to increase in line with historicaltrends. In addition, sales and marketing personnel costs decreasedapproximately $16.7 million as a result of cost saving resulting from reducedsales and marketing headcount, offset partially by increased stock-basedcompensation charges. The reduction in sales and marketing headcount wasprimarily due to the shift during 2006 of approximately 477 employeespreviously providing sales and support services towards generating revenue fromsupport arrangements. Other cost savings in sales and marketing, primarilyrelated to the 2005 restructuring and cost containment measures, included a$12.0 million decrease in depreciation, facility and equipment costs, a$10.1 million decrease in travel expenses and a $4.0 million decrease inprofessional services. These cost savings in sales and marketing expenses werepartially offset by an increase in general and administrative costs. Primaryfactors in the increased general and administrative costs include: (i) anincrease of $21.3 million in general and administrative personnel costs due toincreased stock-based compensation charges and additional finance andinformation technology resources hired to improve processes and controls and (ii) $7.9million of  value added tax expenseresulting from an audit of 2003 through 2005 tax years by China tax authoritiesand (iii) a $4.7 million write-off of net assets in connection with thetermination of a joint venture. In 2006, selling, general and administrativecosts included approximately $10 million of stock-based compensation as aresult of adoption of SFAS 123(R).

*Fiscal 2005 vs.2004*

Selling, general andadministrative expenses increased $67.5 million or 22% in fiscal 2005 ascompared to fiscal 2004. The increase in SG&A was primarily due toi) increased headcount and overhead of $19.9 million which includesour PCD operations that did not exist until November 2004,ii) increased professional services fees of $18.5 million in 2005 from2004 associated with supply chain management, system integration, Sarbanes-OxleyAct compliance projects and audit fees, iii) increased litigation andlegal costs of $13.3 million, and iv) an increase in facilitiesexpense of $12.4 million for the Hangzhou, China office placed in servicein October 2004.

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*RESEARCH ANDDEVELOPMENT*

*Fiscal 2006 vs.2005*

Research and development (“R&D”)expenses decreased $63.9 million, or 26%, in fiscal 2006 compared with 2005.The decrease was primarily due to i) a decrease of $30.6 million indepreciation, facility and equipment costs as a result of the restructuring andwrite-down of R&D equipment in 2005, ii) a decrease in personnel expenses of approximately$16.4 million attributed to a decrease in headcount due to therestructuring activities and the transfer of engineers as part of the sale ofour semiconductor design operations to Marvell Technology and the transfer ofour non-PAS wireless research and development in China to Cellon, andiii) a decrease in professional costs of $9.3 million associated withthe decrease in outsourced projects. R&D expenses were approximately 7% and8% of net sales in 2006 and 2005, respectively. We expect R&D expenses tobe stable as we continue to streamline R&D activities and invest in productlines that improve our long-term profitability and growth.

*Fiscal 2005 vs.2004*

R&D expenses in fiscal2005 were approximately 8% of net sales in 2005, as compared to 8% of net salesin 2004. In absolute amounts, R&D expenses increased $27.7 million or13% compared to the prior year. The absolute increase was primarily due toi) an increase in personnel expenses by approximately $19.8 millionattributed to a 15% increase in average head count from 2,757 to 3,170employees due to the retention of personnel from various acquisitions as wellas the hiring of personnel to support product enhancements and developmentprimarily in the Broadband and Handsets segments, and ii) an increase inprofessional costs of $3.2 million associated with outsourced projects drivenby product development projects primarily in the Handsets segment.

*IN-PROCESSRESEARCH AND DEVELOPMENT*

*Fiscal 2005 vs.2004*

The $0.7 million and$1.4 million charges to in-process research and development in 2005and 2004, respectively, were related to our acquisitions of Pedestal Networksand TELOS. All charges to IPR&D were based, in part, upon independentvaluations. In assessing IPR&D projects, we considered key productcharacteristics including each product’s development stage at the acquisitiondate, each product’s life cycle and each product’s future prospects. We alsoconsidered the rate at which technology changes in the relevant industry, theindustry’s competitive environment and the economic market outlook.

*AMORTIZATION OFINTANGIBLE ASSETS*

*Fiscal 2006 vs.2005*

Amortization of intangibleassets expenses decreased $7.0 million in 2006 as compared to 2005. Thedecrease in the amortization of intangible assets was due to several intangibleassets being fully amortized during the preceding twelve months.  Amortization expenses for the next five years,beginning with the year ending December 31, 2007, are expected to amountto $16.0 million, $12.7 million, $6.9 million, $5.1 millionand $5.1 million, respectively.

*Fiscal 2005 vs.2004*

Amortization of intangibleassets expenses increased $10.3 million in 2005 as compared to 2004. Theincrease in the amortization of intangible assets in 2005 was due to theintangibles recorded as a result of the acquisitions of TELOS in May 2004,ACC in November 2004 and Giga in January 2005, which are in theresults of the 2005 fiscal year but were only amortized for a portion of theprior year in the case of ACC and TELOS.

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*GAIN ON SALEOFSEMICONDUCTOR DESIGN ASSETS*

*Fiscal 2006*

In February 2006, wesold substantially all of the assets and selected liabilities of oursemiconductor design operations, including the assets related to the prioracquisition of Advanced Communications Devices Corporation to MarvellTechnology Group Ltd. We recognized a $12.3 million gain on sale of theseassets in the third quarter of 2006 upon achieving the defined milestones.

*RESTRUCTURING COSTS*

*Fiscal 2006*

The restructuring planinitiated in 2005 was completed by December 31, 2005 and no majorrestructuring effort was undertaken in 2006. During 2006 we settledapproximately $1.1 million of accrued expenses, and the remaining $0.1 millionof accrued expenses will be settled in 2007.

*Fiscal 2005*

In the second quarter offiscal 2005, we announced and initiated a restructuring plan to rationalize ourcost structure in response to the decline in demand for certain of ourproducts. In 2005, we incurred approximately $29.7 million in operatingexpenses in relation to the restructuring plan actions, primarily consisting of$15.2 million related to severance payments and $14.5 million inasset impairments primarily related to the impairment of equipment and licensesassociated with discontinued products. Included in the restructuring costs of$29.7 million are non-cash charges of $13.4 million in assetimpairments. We made cash payments of $16.6 million for severance andother benefits in 2005. As part of the restructuring plan, we recorded a$5.6 million inventory write-off associated with discontinuedproducts in 2005. Restructuring expense related to the inventory write-offis included in cost of sales in the consolidated statements of operations. Asof the end of 2005 approximately 1,595 employees had been terminated or placedin workforce reduction programs.

*ASSET IMPAIRMENT*

*Fiscal 2005*

In the third quarter of 2005, we determined thatcertain circumstances had changed sufficiently to indicate that the fair valueof certain of our reporting units may be below their book values. As a result,we conducted an evaluation of our long-lived assets including goodwill, intangibleassets, and certain property plant and equipment for impairment and recordedimpairment charges.

Intangible assets classified as goodwill and thosewith indefinite lives are not amortized. Intangible assets with determinablelives are amortized over their estimated useful lives. We perform an annualimpairment test of our goodwill as of November 1st of each year. We alsotest for impairment between annual tests if a “triggering” event occurs thatmay have the effect of reducing the fair value of a reporting unit below theirrespective carrying values. When conducting the goodwill impairment analysis,we calculate impairment charges based on the two-step test prescribed inSFAS 142, “Goodwill and Other Intangible Assets” (“SFAS 142”) and using the estimatedfair value of the respective reporting units. We use the present value offuture cash flows from the respective reporting units to determine theestimated fair value of the reporting unit and the implied fair value ofgoodwill. We also test long-lived assets in all of our asset groups forpotential impairment in accordance with SFAS 144, “Accounting for theImpairment or Disposal of Long- lived Assets.” Our long-livedassets are tested for recoverability based on undiscounted cash flows, and ifimpaired, written down to fair value based on either discounted cash flows orappraised values.

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Management held a series of planning meetings in September 2005to assess the current business forecast for all reporting units. Thisassessment analyzed various factors including a reduction in the rate of growthof PAS subscribers in the third quarter, a delay of the expected granting of 3Glicenses in China and Japan, challenges with product quality primarily in ourBroadband reporting unit, a narrowing of our strategic focus related to ourproduct offering and greater than expected revenue and margin decline due tocontinued pricing pressures for several of our key markets. Managementconcluded these factors combined represented a triggering event.

Due to the existence ofthe triggering event in September 2005, we determined that there weresignificant adverse changes in the business outlook which could indicate thecarrying value of certain of our long lived assets groups may not berecoverable and could indicate the fair value of our reporting units may bebelow their fair value. As a result, we performed interim impairment tests ongoodwill and certain other long lived tangible and intangible assets.

**Goodwill:**

We performed an impairment analysis pursuant to SFAS142 as of September 30, 2005 for all of our reporting units. We comparedthe fair value of the reporting units to their carrying value. We determinedthe fair value of each reporting unit using both present value and comparablecompany techniques based, in part, upon an independent valuation. The fairvalues of the reporting units were reconciled to our overall marketcapitalization at September 30, 2005.

Based on the impairmentassessment noted above, a goodwill impairment charge of $192.9 million wasestimated and recorded during the three months ended September 30,2005 to write off the full value of goodwill for the Wireless, Broadband,Handsets and PCD business units. The second step of the goodwill impairmenttest for Broadband and Handsets segments was completed in the third quarter andfor the Wireless and PCD units was performed in the fourth quarter of 2005,which reaffirmed the estimate from the third quarter that the goodwill wasfully impaired. As such, there was no adjustment from the amount previouslyrecorded.

**Long-livedAssets:**

We also tested our long-lived assets in all ofour asset groups for potential impairment during the third quarter of 2005 inaccordance with SFAS 144, “Accounting for the Impairment or Disposal of Long-livedAssets.” Based on this analysis, we determined that the undiscounted expectedfuture cash flows for the broadband and handset asset groups were less than thecarrying value of the net assets.

We determined the relative estimated fair value oftangible assets through a comparison of similar assets, and wherever practical,based on quoted market prices taking into consideration the asset type, age,condition, and physical location of the asset. As a result of this analysis, werecorded an impairment charge of $14.1 million for long-livedtangible assets related to the Broadband asset group and $9.4 million forlong-lived tangible assets related to the Handset asset group.

In addition, we determined that the fair value oftechnology-related intangible assets within the Handset asset group ascalculated using the discounted future cash flows was less than the carryingvalue of the net assets and as such, we recorded a net asset write-off of$1.7 million.

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Thefollowing table summarizes the impairment charges incurred during 2005:

| ** ** | ** ** | **Goodwill  Impairment** | ** ** | **Intangible  Impairment** | ** ** | **PP&E  Impairment** | ** ** | **Total** | ** ** |
|------------|------------|--------------------------|------------|----------------------------|------------|--------------------------|------------|-----------|------------|
| ** ** | ** ** | **(in thousands)**  | ** ** |
| Handsets   |       |                     | $          | 89,337                     |       |                     |       | $         | 1,678      |   |   |   | $ | 9,417 |   |   | $ | 100,432 |   |
| Wireless   |       |                     | 55,670     |                       |       |                     | —     |      |       |   | — |   |   | 55,670 |   |
| PCD        |       |                     | 24,712     |                       |       |                     | —     |      |       |   | — |   |   | 24,712 |   |
| Broadband  |       |                     | 23,210     |                       |       |                     | —     |      |       |   | 14,070 |   |   | 37,280 |   |
| Total      |       |                     | $          | 192,929                    |       |                     |       | $         | 1,678      |   |   |   | $ | 23,487 |   |   | $ | 218,094 |   |

 

*Fiscal 2004*

During the second quarterof 2004, we consummated the acquisition of Hyundai Syscomm, Inc. (“HSI”) inorder to gain a foothold in the CDMA infrastructure market. We encountereddifficulties integrating the HSI operations into our CDMA operations after theacquisition. In the fourth quarter of 2004, we decided to wind-down thelegacy operations and transfer employees to support handset engineering inKorea. The decision to substantially abandon the operations occurred withinnine months of the acquisition and before the HSI operations wereintegrated. Therefore, we have written off all of the remaining values of theintangible assets associated with this acquisition, totaling $12.7 millionduring the year ended December 31, 2004.

**OTHER INCOME(EXPENSE)**

*INTEREST INCOME*

*Fiscal 2006 vs.2005*

Interest income was$14.8 million in 2006 compared to $7.1 million in 2005. Higheraverage cash balances in 2006 was the primary reason for the increase. Inaddition, an increase in the average interest rate, due in part to thegeographic location of the cash balances, also had a favorable impact oninterest income. 

*Fiscal 2005 vs.2004*

Interest income was$7.1 million in 2005 compared to $6.2 million in 2004. An increase inaverage cash and short-term investment balances in 2005 as compared to2004, coupled with an increase in the average interest rate resulted in an increasein interest income.

*INTEREST EXPENSE*

*Fiscal 2006 vs.2005*

Interest expense was$11.7 million in 2006 compared to $16.8 million in 2005. The decreasein interest expense was primarily attributable to the decrease in short-termborrowings in China in the form of bank loans and the extinguishment oflong-term debt during 2005. The average quarterly borrowings outstanding were$400.6 million and $570.7 million during 2006 and 2005, respectively,and the average interest rate thereon was 2.9% during both 2006 and 2005. Weexpect interest expense will increase significantly in 2007 as a result of theFirst Supplemental Indenture agreement entered into in January 2007 whichincreased the interest rate on the subordinated notes to 7.625% beginning January 9,2007, and the Second Supplemental Indenture agreement entered into in July 2007which increased the interest rate on the subordinated notes to 10.875%beginning July 26, 2007.

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*Fiscal 2005 vs.2004*

Interest expense was$16.8 million in 2005 compared to $6.9 million in 2004. The increasein interest expense was attributable to an increase in the average short-termborrowings in China in the form of bank loans, which had relatively higherinterest rates. The average quarterly borrowings outstanding were $570.7 millionand $534.5 million during 2005 and 2004, respectively, and the averageinterest rates thereon were 2.9% and 1.3% during 2005 and 2004, respectively.

*GAIN ONEXTINGUISHMENT OF DEBT*

*Fiscal 2005*

Gain on extinguishment ofdebt, net of write-off of unamortized issuance expenses, was$31.4 million in 2005. In the year ended December 31, 2005, 4,988,100shares of our common stock with a fair value of approximately$37.6 million and approximately $57.1 million in cash were exchangedfor $127.9 million aggregate principal amount of our outstandingconvertible subordinated notes due 2008.

*OTHER INCOME(EXPENSES)*

*Fiscal 2006 vs.2005*

Other income was $1.1million in 2006 compared to $43.7 million in 2005. Other income in 2006consisted primarily of foreign exchange gains of $7.6 million, a gain on thesale of an asset of $2.5 million, dividend income of $2.1 million andmiscellaneous other income of $2.1 million, offset by a $13.5 millionimpairment charge on a long-term investment.

*Fiscal 2005 vs.2004*

Other income was $43.7million in 2005 compared to $15.4 million in 2004. Other income in 2005primarily consisted of a gain on sale of Softbank China of $47.2 millionand a $6.0 million consumption tax refund in Japan, partially offset by aforeign exchange loss of $10.0 million. In December 2005, we sold our10% ownership in Softbank China Holdings PTE LTD (“Softbank China”) to SOFTBANKCORP., a related party and owner of the remaining 90% of Softbank China for$56.9 million. Accordingly, we recorded in other income a gain of$47.2 million after management fees, transaction expenses and net of theinvestment carrying value. The foreign exchange losses primarily consisted oflosses attributed to the appreciation of the US dollar on Japanese Yendenominated cash and accounts receivable, offset by gains for the Company’sChina subsidiaries attributed to the appreciation of the Chinese Renminbi on USdollar denominated short-term debt and payables. Yen-denominatedsales were significantly higher during 2005 as compared to 2004.

*INCOME TAX EXPENSE(BENEFIT)*

*Fiscal 2006 vs.2005*

Income tax benefit was $15.0 million in 2006 comparedto tax expense of $136.5 million in 2005.

The Company is subject to income taxes in both theUnited States and numerous foreign jurisdictions. Significant judgment isrequired in evaluating our tax positions and determining our provision forincome taxes. During the ordinary course of business, there are manytransactions and calculations for which the ultimate tax determination isuncertain. The Company establishes reserves for tax-related uncertainties basedon estimates of whether, and the extent to which, additional taxes and interestwill be due. These reserves are established when, despite the Company’s beliefthat its tax return positions are fully supportable, the Company believes thatcertain positions are likely to be challenged and may not be sustained onreview by tax authorities. The Company adjusts these reserves in light ofchanging facts and 

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circumstances, such as theclosing of a tax audit. The provision for income taxes includes the impact ofreserve provisions and changes to reserves that are considered appropriate, aswell as the related net interest. In 2006, we recorded a $29.0 million incometax benefit related to the settlement of a tax audit in China for the 2003through 2005 tax years for UTStarcom Telecom Co., Ltd. (“HUTS”) and HangzhouUTStarcom Telecom Co., Ltd (“HSTC”), two of our subsidiaries in China and theacceptance of our tax holiday for HSTC.

Without the $29.0 million tax benefit, the Companywould have a negative 10% effective tax rate. There are two primary reasons forthe negative 10% effective tax rate. First, the Company has not provided anytax benefit on the current years losses incurred and tax credits generated inthe United States and other countries, because the Company believes it is morelikely than not that the tax benefit associated with these losses will not berealized. Second, the Company continues to accrue tax expense in jurisdictionswhere the Company has been historically profitable.

In 2005, as discussedbelow, we incurred a $237.3 million non-cash charge to provide a full valuationallowance on our net deferred tax assets at December 31, 2005 in theUnited States and China. Also, we recorded a $11.9 million increase in taxexpense in 2005 due to the revaluation of deferred tax assets in China becauseof statutory rate changes for certain of the Company’s subsidiaries in China.

*Fiscal 2005 vs.2004*

In establishing our deferred income tax assets andliabilities, we make judgments and interpretations based on the enacted taxlaws and published tax guidance applicable to our operations as well as theamount and jurisdiction of future taxable income. We record deferred tax assetsand liabilities and evaluate the need for valuation allowances to reduce thedeferred tax assets to realizable amounts. During 2005, we did not believe itwas more likely than not that we would generate a sufficient level and propermix of taxable income within the appropriate period to utilize all the deferredtax assets. As a result of the review undertaken, we concluded that it wasappropriate to establish a full valuation allowance for the net deferred taxassets in China and the United States wherein the cumulative losses weighheavily in the overall assessment. Accordingly, we recorded a$237.3 million non-cash charge in the United States and China.

Income tax expense was$136.5 million in 2005 compared to a benefit of $20.3 million in2004. The increase in income tax expense was primarily attributable to a$237.3 million non-cash charge to provide a full valuation allowanceon our net deferred tax assets at December 31, 2005 in the United Statesand China. Also, we recorded a $11.9 million increase in tax expense due to therevaluation of deferred tax assets in China because of statutory rate changesfor certain of the Company’s subsidiaries in China. In addition, we did notprovide any tax benefit on the 2005 losses incurred and tax credits generatedin the United States and China. These are the three primary reasons for thenegative 34% effective income tax rate for 2005, despite the pretax loss forthe year.

*EQUITY IN LOSS OFAFFILIATED COMPANIES*

*Fiscal 2006 vs.2005*

Equityin loss of affiliated companies was $0 in 2006 compared to $5.5 millionin 2005 as our joint venture investment with Matsushita CommunicationIndustrial Co., Ltd. (“Matsushita”) was liquidated in 2005.

*Fiscal 2005 vs.2004*

Equity in loss ofaffiliated companies was $5.5 million in 2005 compared to $1.3 million in2004. During 2005 we incurred a loss from our joint venture investment withMatsushita of $4.8 million and a 

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gain of$0.7 million from our investment in Restructuring Fund No. 1. Theloss in 2004 was attributable to our joint venture investment with Matsushita.In December 2005, the venture partners agreed to liquidate this venture.

**SEGMENT REPORTING**

We historically managed our business as a singlereportable segment. Effective with the fourth quarter of 2004, it wasdetermined that our chief operating decision makers, in accordance with SFAS No. 131,“Disclosures about Segments of an Enterprise and Related Information,” wereevaluating performance, making operating decisions and allocating resourcesbased on two operating segments, (i) China and (ii) all other regionsreferred to as International (“International”).

On November 1, 2004, we acquired selected assetsof the wireless handset division of Audiovox Corporation. The acquired businesshas been integrated into our operation as a separate and distinct operatingdivision referred to as the Personal Communications Division, (“PCD”). As aresult, as of December 31, 2004, we were organized, principally based ongeographical market locations, in three operating segments, China,International and PCD. Each segment consisted of one reporting unit.

Effective in the first quarter of 2005, the Companyelected to reorganize its business based principally upon product family andrealigned its business into five operating units, (i) BroadbandInfrastructure, (ii) Wireless Infrastructure, (iii) Handsets, (iv) PersonalCommunications Division (“PCD”), and (v) Services. The Company announcedthat effective July 1, 2006, a newly created operating unit; NetworkSolutions would begin offering products and services through the combination ofthe Broadband Infrastructure and the Wireless Infrastructure reporting segments.Each reporting segment and operating unit is responsible for managing its ownperformance.

Each operating unitrepresents its own reporting segment and each operating unit is responsible forits own production and sales management. We currently evaluate the operatingperformance of and allocate resources to the reporting segments based onsegment gross profit. Cost of sales and direct expenses in relation toproduction are assigned to the reporting segments. The accounting policies usedin measuring segment assets and operating performance are the same as thoseused at the consolidated level.

***Network Solutions***

*Broadband Infrastructure*

| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                     | ** ** |
| Net sales                                   |       | $                                           | 219,557    |   |   | $ | 507,978 |   |   |   | $ | 232,442 |   |   |
| Gross profit                                |       | $                                           | (3,019     | ) |   | $ | 157,890 |   |   |   | $ | 45,585 |   |   |
| Gross profit as a  percentage of net  sales |       | (1                                          | )%         |   | 31 | % |   |   | 20 | % |   |

 

*Fiscal 2006 vs.2005*

Our largest Broadband Infrastructure customer isSoftbank and affiliates, including Japan Telecom, representing approximately54% and 89% of total Broadband Infrastructure sales in 2006 and 2005,respectively. Due to the customer concentration in this segment, revenuesfluctuate based upon the magnitude and timing of revenue recognition on certaincontracts. During 2006 sales to Softbank declined by $333.0 million as Softbankcompleted its initial investment in fixed line businesses and changed its focusto wireless business following its acquisition of Vodafone Japan.

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The decline in gross profit as a percentage of netsales from 31% in 2005 to negative 1% in 2006 was due primarily to decreasedrevenues of our high margin iAN8000 products which included $271.9 millionrelating to the Japan Telecom agreements in the first quarter 2005. Grossprofit in 2006 and 2005 also was negatively impacted by additional warrantyreserves for ADSL, GEPON and NetRingTM products sold to Softbank in 2003 and2004. These special warranty charges approximated $5.6 million and $30.6million in 2006 and 2005, respectively. Further contributing to the grossprofit decline in 2006 was a $32.1 million provision for anticipated losses onan infrastructure deployment contract entered into in the fourth quarter of2006. We accepted this contract because we felt it would allow us to develop arelationship with a customer we consider important to the internationalexpansion of our broadband infrastructure business. Both our experience ofincurring higher warranty costs in our Broadband Infrastructure segment as wehave introduced new products and the requirement to adjust contract lossesprovisions as additional information becomes available may potentially havenegative impacts on our future gross margins. 

We believe that the IPTVmarket presents a meaningful growth opportunity. We currently offer and haveinitial market acceptance of our RollingStreamTM IPTV products in China, Japanand other geographic regions. In addition to the investments we have made todevelop and market our Broadband products, in 2005 we loaned $12.4 million to aChina based company to support the development of a technical serviceinformation and networking technology venture in China. The loan is partiallysecured by an indirect ownership interest in the venture. This venture’scontinuing viability will also be heavily dependent on our future provisioningof equipment. As such, we determined that we are the primary beneficiary of theventure and consolidated the venture’s results of operations into our resultsfor the years ended December 31, 2006 and 2005. We expect that we willcontinue to invest in the development of this important market in the future.

*Fiscal 2005 vs.2004*

In 2005, Broadband Infrastructure net sales more thandoubled primarily due to two large transactions with Softbank;$271.9 million of revenue recognized in the first quarter on certainagreements entered into with Japan Telecom primarily for the iAN8000 product;and $57.7 million of revenue recognized in the fourth quarter on ourRolling StreamTM internet protocol television (“IPTV”) product launched withYahoo! BB. During the fourth quarter of 2004, approximately $79.1 millionof revenue was recognized on sales of primarily GEPON and NetRingTM products toSoftbank.

The gross profitimprovement, both in absolute dollars and as a percentage of net sales, waslargely due to (i) the margins on our iAN8000 products relating to theJapan Telecom agreements in the first quarter 2005; (ii) low margins inthe fourth quarter of 2004 on GEPON and NetRingTM products; and (iii) offsetby higher warranty costs in 2005 for ADSL, GEPON and NetRingTM products. We haveexperienced higher warranty costs in our Broadband Infrastructure segment as wehave introduced new products. 

*Wireless Infrastructure*

| ** **                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                     | ** ** |
| Net sales                                  |       | $                                           | 427,400    |   |   | $ | 436,016 |   |   | $ | 1,268,850 |   |
| Gross profit                               |       | $                                           | 206,193    |   |   | $ | 121,077 |   |   | $ | 364,028 |   |
| Gross profit as a  percentage of net sales |       | 48                                          | %          |   | 28 | % |   | 29 | % |

 

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*Fiscal 2006 vs.2005*

Net sales declined 2% in2006 compared with 2005, primarily due to decreased sales of PAS systems inChina. In 2006, approximately 79% of our Wireless Infrastructure sales wereattributed to PAS systems in China compared with 85% in 2005. The decrease inPAS system sales was primarily the result of our customers in Chinatransitioning from new system installations to system expansions as PAS systemsreach product maturity. 

Gross profit as apercentage of net sales increased by 20 percentage points in 2006 compared to2005, due to a number of factors, including: (i) the margins on PASinfrastructure improved due to a shift in product mix towards higher margincell sites as well as a reduction in product discounts given; (ii) animprovement in inventory management and product quality resulting in a decreasein excess inventory write-downs and scrap; and (iii) sales of voiceand data networks software totaling $16.1 million which typically havegross margins of approximately 90%.

We expect future PASinfrastructure spending to decline further in 2007 compared with 2006 levels asChina prepares for 3G launch. However, we expect the revenue decline will bemoderate, as most of 2007 revenue is expected to come from existing backlogbased on current projection of receiving final acceptance. We plan toaggressively pursue opportunities for our Packet PAS products (for broadbandwireless data market based on PAS technology), high end PAS products includingdual mode, CDMA products and Softswitch products in multiple markets;though we do not anticipate that these sales will fully offset the decline inPAS sales in 2007.

*Fiscal 2005 vs. 2004*

In 2005, approximately 85%of our Wireless Infrastructure sales were attributed to PAS systems in China. Netsales declined 66% as demand decreased due to (i) product maturationresulting in transition from new system installations to system expansions and (ii) ourcustomers reduced fiscal capital spending in anticipation of next generationtechnology.

Gross margin as apercentage of net sales declined by one percentage point primarily due to theimpact of our China customers shifting their investments on PAS fromgeographical extension to expanding the capacity and improving the quality ofthe existing network. Compared with building networks in new areas, the cost ofexpanding capacity is much lower. Additionally, there was less competition andpricing pressure in PAS network expansion contracts. Included in cost of goodssold in 2005 is an inventory write-off of $5.6 million, which had anegligible effect on the gross profit as a percentage of sales.

***PCD***

| ** **                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                     | ** ** |
| Net sales                                  |       | $                                           | 1,339,496  |   | $ | 1,369,324 |   |   | $ | 277,410 |   |   |
| Gross profit                               |       | $                                           | 39,932     |   | $ | 52,812 |   |   | $ | 11,866 |   |   |
| Gross profit as a  percentage of net sales |       | 3                                           | %          | 4 | % |   | 4 | % |   |

 

*Fiscal 2006 vs.2005*

Net sales for the PCD operating segment were$1,339.5 million in 2006, a decrease of 2% compared to net sales of$1,369.3 million in 2005. The relatively consistent net sales was the result ofa decrease in the overall average selling price, offset by a 6% increase in thenumber of units sold. In 2006, a greater percentage of revenue was derived frominternally manufactured handsets and we expect this trend to continue in thefuture.

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The gross profit as apercentage of net sales recognized on handset sales through PCD declined by onepercentage point in 2006 compared with 2005. Gross profit was negativelyimpacted by inventory write-downs to market of certain slow moving models. Partiallyoffsetting these inventory charges were higher margins on UTStarcom brandeddevices sold during 2006. The gross profit as a percentage of net sales istypically lower than that realized on PAS systems based handsets sold in theChina market. As the percentage of UTStarcom designed and manufactured productsincreases, we expect the PCD margin to increase in the future.

*Fiscal 2005 vs. 2004*

Revenue for the PCDoperating segment was $1,369.3 million in 2005 compared to $277.4 millionin 2004. Revenues for PCD were significantly greater in 2005 than 2004 sincethe acquisition of the wireless handset division of Audiovox Corporation andthe creation of PCD did not occur until November 2004. Revenues for 2005are consistent with 2004 pro forma revenues (see Note 5, “Acquisitions and Saleof Assets”, of Notes to Consolidated Financial Statements contained in Item 8of this Annual Report). The gross profit as a percentage of net salesrecognized on handset sales through PCD was consistent at 4% for 2005 and 2004.

***Handsets***

| ** **                                  | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                     | ** ** |
| Net sales                                   |       | $                                           | 395,812    |   |   | $ | 473,472 |   |   |   | $ | 749,073 |   |   |
| Gross profit                                |       | $                                           | 118,459    |   |   | $ | 58,166 |   |   |   | $ | 131,708 |   |   |
| Gross profit as a  percentage of net  sales |       | 30                                          | %          |   | 12 | % |   |   | 18 | % |   |

 

*Fiscal 2006 vs. 2005*

Net sales declined 16%primarily due to a volume decrease for our PAS handsets in China as the unitssold declined to 7.8 million in 2006 compared to 10.2 million in2005. The 25% volume decline was primarily attributed to lower demand forour PAS handsets resulting from slower subscriber growth. In 2006, PASsubscriber growth was 10% compared to 31% in 2005 and 70% in 2004 as serviceproviders reduced marketing efforts for PAS handsets in anticipation of nextgeneration technology. The average selling price per unit (“ASP”) improved 10%due to a shift in product mix to sales of higher-end models, as well as theintroduction of new PAS/GSM dual mode product line in 2006. This shift inproduct mix more than offset declining prices of other models due tocompetitive pricing pressures in the PAS market, which we have experienced inthe China telecommunications market since the latter part of 2003. We expectcumulative PAS subscriber growth to continue at lower growth rates in futureperiods. 

Gross profit as apercentage of sales for our handsets segment increased by 18 percentage pointsin 2006, as compared to 2005. A portion of the improvement in the gross profitpercentage relates to shifting most of our products to the use of chip-setswith greater functionality in PAS handsets that reduce the overall componentcosts of each unit. Additionally, we have had a shift in product mix towardshigher margin products such as our PAS/GSM dual mode and ultra-thin high-endPAS handsets. Additional factors leading to the improvement in gross profit area reduction in scrap, variances and warranty costs.

In 2007 and beyond, wecontinue to expect lower cumulative growth rates of PAS subscribers. At thesame time, we anticipate the market demand for PAS/GSM dual mode to increase.We will continue to develop unique high-end models which have higher grossmargin and average selling price. We will continue to focus on product costreductions efforts through supply chain improvements and R&D improvement.

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*Fiscal 2005 vs.2004*

Net sales declined 37% primarily due to decreases inboth volume and price for our PAS handsets in China as the units sold declinedto 10.2 million compared to 14.0 million in 2004. The 27% volumedecline was primarily attributed to (i) lower demand for our PAS handsetsresulting from slower subscriber growth. In 2005, PAS subscriber growth slowedto 31% from over 70% in 2004 as service providers reduced marketing efforts forPAS handsets in anticipation of next generation technology networks and (ii) ourinability to supply product to our customers during the fourth quarter due tocomponent shortages. As a result of shortages of key components (such as printedcircuit boards, flash memory and radio frequency components) in the fourthquarter, we were unable to fill our customers’ orders for Chinese New Yearsales promotions.

The average selling price per unit declined 18% due toa combination of competitive pricing pressures during the first half of theyear, and a shift in product mix to sales of lower-end models. We havealso experienced continuing pricing pressure in the China telecommunicationsmarket since the later part of 2003, which has driven average unit sellingprices lower. 

Our gross profit as apercentage of sales decreased by 6 percentage points, primarily due to adecline in the PAS handset average unit price, offset by lower material costsas we renegotiated prices with vendors, and a shift in product mix to lower-end,higher margin models. 

***Services***

| ** **                                 | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                 | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                 | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                     | ** ** |
| Net sales                                  |       | $                                           | 76,596     |   |   | $ | 84,320 |   |   |   | $ | 51,640 |   |   |
| Gross profit                               |       | $                                           | 24,179     |   |   | $ | 45,891 |   |   |   | $ | 16,345 |   |   |
| Gross profit as a  percentage of net sales |       | 32                                          | %          |   | 54 | % |   |   | 32 | % |   |

 

*Fiscal 2006 vs.2005*

Our Services segment’s net sales decreased by $7.7million, or 9%, for 2006 compared to 2005. The decrease in net sales isprimarily due to delays associated with receiving final acceptance fromexisting projects that were completed. During 2006, we focused on the revenueopportunities with respect to support in China. Approximately 477 employeespreviously providing sales and support services were shifted towards generatingrevenue from support arrangements, resulting in additional cost of goods soldfor 2006 of $15.0 million, and a corresponding decrease to operatingexpenses. Additionally, revenues of $9.7 million from WirelessInfrastructure and $0.7 million from Broadband segment sales in China wereallocated to the Services segment during 2006. The allocation was made oncertain completed contracts for which the service element was not separatelypriced. Our gross profit as a percentage of sales decreased by 22 percentagepoints, primarily due to a one time service charge for marketing services toSoftbank during 2005 that was not repeated in 2006.

In order to succeed in today’s multi-servicesconvergence environment, operators need to differentiate their subscriberofferings, make their operations more efficient and cost effective, enhanceproductivity, grow their businesses, and increase revenues. Our new solutionsmethodology is designed to let operators concentrate on their business modeland their end-customers while we provide complete end to end support forimplementing and managing their multi-vendor networks. These are primarily non-core business processes and activities thatmany service providers feel can be outsourced to their infrastructure vendorpartners such as UTStarcom.

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Our new Value AddedService portfolio aims to extend its solution-oriented approach from supplyingplatforms to all aspects of planning for, deploying, and managing bothplatforms and services. We are targeting newgeographies and customers with an end-to-end solution approach. We expect thisinitiative to significantly improve our revenue plan during 2007.

*Fiscal 2005 vs.2004*

The increase in Services segment revenue was due tothe continuing development of our service product offerings and the $12.6million of revenue and gross profit associated with promotional services forJapan Telecom recognized in the first quarter of 2005.

The increase in absolutegross profit and gross profit as a percentage of sales was due to an increasein overall net sales for this segment performed by a relatively consistentheadcount as well as an increase in China services that have lower associatedcosts. The $12.6 million of revenue and gross profit associated withpromotional services for Japan Telecom recognized in the first quarter of 2005contributed significantly to the total gross profit for the year ended December 31,2005.

**TRANSACTIONS WITHRELATED PARTIES AND OTHERINFORMATION**

*Softbank*

We recognized revenue of $130.8 million, $475.3million and $143.7 million during the years ended December 31, 2006,2005 and 2004, respectively, with respect to sales of telecommunicationsequipment to affiliates of SOFTBANK CORP. (“Softbank”), a significantstockholder of our company. Softbank offers asynchronous digital subscriberline (“ADSL”) coverage throughout Japan, which is marketed under the name “YAHOO!BB.” In 2006, we determined that certain sales to third party resellers were,in substance, sales to Softbank and therefore, we have included these amountsin related party sales. Prior year amounts have been reclassified to conform tothe current period presentation. We support Softbank’s fiber-to-the-homeservice through sales of our carrier class Gigabit Ethernet Passive OpticalNetwork (“GEPON”) product as well as our multi-service optical transportproduct (“NetRingTM”). In addition, we support Softbank’s new internet protocoltelevision (“IPTV”), through sales of our RollingStreamTM product. Included inrevenue for the year ended December 31, 2006 is a fee of $31.2 millioncharged for the cancellation of orders for broadband products and $10.0 millioncharged for the cancellation of orders for wireless infrastructure products.

Included in accounts receivable at December 31,2006 and December 31, 2005 were $29.9 million and $83.4 million,respectively, related to these transactions. During 2006 and 2005, sales toSoftbank include a three year service period and a penalty clause if productfailure rates exceed a certain level over a seven year period. There was $11.5million and $19.6 million included in long term deferred revenue with respectto these agreements at December 31, 2006 and 2005, respectively.Additionally, there was $11.6 million and $8.0 million included in currentdeferred revenue at December 31, 2006 and 2005, respectively. As ofDecember 31, 2005, $5.4 million was included in customer advances relatedto other Softbank agreements.

During August 2004, we entered into severalagreements with Japan Telecom Co., Ltd (“JT”), a wholly owned subsidiary ofSoftbank. These agreements relate to the sale of *i*AN-8000 equipment with specified value and deliverydates, as well as an oral agreement which subsequently converted into specificservice contracts to manage a sales promotional program for JT. We determinedthat the service activities revenue should be recorded net of expectedpromotional spending.

Because we had not provided these activities in thepast and could not estimate the fair value of these services, we determinedunder the guidance of SAB 104 that all revenue related to these agreementscould not be recognized until all goods and services were delivered. Wedelivered and received final acceptance for all equipment contemplated underthese agreements in the quarter ended March 31, 2005.

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The promotional services discussed above involvedcontracting with third party promotional vendors, who in turn, facilitated themarketing and subscriber recruitment for the JT fiber-to-the-homeprogram. During the fourth quarter of 2004, we determined that we would end ourinvolvement with the JT promotional program after completion of the contractdiscussed above. Accordingly, late in the fourth quarter of 2004 and during thefirst quarter of 2005, we either cancelled or assigned to another party all thirdparty contracts with promotional vendors related to the JT contract. Suchtermination or assignment of all third party promotional agreements, as well aseffective satisfaction of our obligations with JT under such agreements,satisfied the revenue recognition criteria for these agreements and as such,the net value of the promotional services and the value of equipment delivered,which totaled $204.8 million, was reported in the quarter ended March 31,2005.

We also entered into an agreement with JT during thethird quarter of 2004 to supply chassis equipment. The equipment shipped underthis agreement is considered linked to the *i*AN-8000sale noted above and as such, was also deferred until the completion of theabove-mentioned promotional activities. The revenue recognition criteriarelated to the sale of the *i*AN-8000 equipment was satisfied in the first quarter of 2005 and as such, therevenue related to the chassis sale of $66.5 million was reported in thequarter ended March 31, 2005. During the years ended December 31,2006 and 2005, sales to Softbank included $6.7 million and $280.1 million,respectively, with regards to sales of telecommunications equipment and servicesold to JT, and none for 2004.

We invested in Restructuring Fund No.1, a venturecapital investment limited partnership established by Softbank. The partnershipwas dissolved in July 2006 with a total cash distribution of $3.0 millionto us during 2006. We have recorded a gain on investment of $1.4 million and$0.7 million, respectively, for the year ended December 31, 2006 and 2005.We recorded an immaterial equity loss for the year ended December 31,2004.

On July 17, 2003, we entered into a MezzanineLoan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate of SOFTBANKCORP. Under the terms of the agreement, we loaned BB Modem $10.1 million at aneffective interest rate of 12.01% per annum, for the purpose of investing in aportfolio of ADSL modems and associated modem rental agreements, from Softbank.Softbank will continue to service such modems and modem rental agreements. Ourloan was subordinated to certain senior lenders of BB Modem, and repaymentswere payable to us over a 42-month period through January 31, 2007,with a substantial portion of the principal amount of the loan repaid duringthe last 16 months of this period During the year ended 2006, 2005 and2004, we recorded $0.6 million, $1.3 million and 1.3 million, respectivelyin interest income in respect to this loan. The loan receivable at December 31,2006 was approximately $1.0 million, included in other current assets. At December 31,2005, the loan balance was approximately $9.0 million and was included inother long-term assets. The note receivable was paid in full in January 2007.

As of December 31,2006, Softbank beneficially owned approximately 12% of our outstanding stock.

*Acoustek Int’lCorp.*

In 2005 and 2006, wereceived consulting services from Acoustek Int’l Corp. (“Acoustek”), whichemployed Minnie Huang, spouse of William Huang, our former Senior VicePresident and Chief Technology Officer. Mr. Haung’s employment with theCompany terminated on December 31, 2006. We paid $0.1 million in each ofthe years of 2006 and 2005 for consulting services provided by Acoustek.

*Audiovox*

One of our officers also servesas a director for Audiovox Corporation (“Audiovox”). During the year ended 2006and 2005, we paid approximately $1.4 million and $0.7 million, respectively,for IT services from Audiovox.

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*Cellon*

In September 2001, we invested $2.0 millionin Cellon International Holdings Corporation (“Cellon”) and made additionalinvestments of $3.0 million each in April and December 2002. Cellondesigns wireless terminals and related technology for handset manufacturers andprivate distributors. In November 2005, we entered into an agreement withCellon under which we received consideration in the form of preferred stock andwarrants of Cellon valued at $5.5 million in exchange for the transfer offixed assets with a net book value of $3.0 million, a facilities lease anda workforce in place consisting of 156 employees. This transaction wascompleted on May 31, 2006 and a gain on sale of assets of$2.5 million was recorded in other income. As of December 31, 2006,with the additional shares obtained in this transaction, we had an 11%ownership interest in Cellon. In the fourth quarter of 2006, our review of thisinvestment included, but was not limited to, a review of Cellon’s cashposition, recent financing activities, financing needs, earnings/revenueoutlook, operational performance, management/ownership changes, and competition.Based on the deterioration of Cellon’s financial condition, we determined thatthe carrying value of the investment was at an amount above the fair value ofthe investment, and the decline was other-than temporary. During the fourthquarter of 2006, we recorded a $13.5 million other-than-temporary impairmentcharge for this investment in other income, net.

In November 2005, weentered into a Development Service Agreement with Cellon in which $5.0 millionwas prepaid in exchange for future product development. Approximately $2.0million of the prepaid amount was used in year ended December 31, 2006 aspayments for design services. We may also use the prepayment in satisfaction ofroyalties Cellon may earn from sales by us of products Cellon designs under theDevelopment Services Agreement. This agreement also obligates Cellon to pay usa royalty if certain technology shared by us to Cellon is used in productsdeveloped and sold to customers other than us through November 2007.During 2006, no royalty was earned by us related to product developed and soldto customers other than us. During the fourth quarter of 2006, we recorded anoperating expense of $3.0 million to write-off this prepayment in connectionwith our assessment of the financial condition of Cellon as discussed above. OnJune 18, 2007, a meeting of Cellon’s shareholders was held where aresolution was passed to place Cellon in voluntary liquidation.

*Fiberxon*

We had an outstanding purchasecommitment with Fiberxon, in which we have a 7% ownership interest, to purchasecomponent parts for optical networking products. In addition, we provided aletter of credit for $5.0 million to purchase raw materials for themanufacture of these component parts. This commitment expired during 2005.There was no such commitment arrangement for 2006. Purchases from Fiberxontotaled $2.6 million, $9.7 million and $15.1 million during the yearsended December 31, 2006, 2005 and 2004, respectively and we had $0.4million and $0.3 million in accounts payable to Fiberxon at December 31,2006 and 2005, respectively.

*GCT Semiconductor*

We have an outstandingpurchase commitment with GCT Semiconductor, Inc. (“GCT”), in which we havea 2% ownership interest, to purchase component parts. Purchases from GCTtotaled $6.3 million and $1.9 million for the years ended December 31,2006 and 2005, respectively. We had $1.1 million in accounts payable to GCT ateach December 31, 2006 and 2005.

*Global AsiaPartners L.P.*

Global Asia Partners L.P.is a venture capital fund formed to make private equity investments in privateor pre-IPO technology and telecommunications companies in Asia. The generalpartner of this fund was also a sales agent of ours until the third quarter of2006. Between June 2002 and April 2005, we 

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investeda total of $2.6 million in the fund. As of December 31, 2006 we owned49% of the fund’s outstanding partnership units. We had a commitment to investup to a maximum of $5.0 million, but as the result of a reorganization ofcapital contributions by the partners, reached in April 2005, our capitalcontribution of $0.6 million in April 2005 was the final capitalcontribution to be made. In addition, the agreement allows the partnership tore-invest up to $2.5 million that otherwise would have been available to us asfuture distributions.

*Matsushita JointVenture*

In July 2002, weentered into a joint venture agreement with Matsushita Communication IndustrialCo., Ltd. to jointly design and develop, manufacture and sell telecommunicationproducts. We had a 49% ownership interest in the joint venture company. Weperformed engineering services for the joint venture for approximately$2.8 million which was recognized as revenue during 2005. As of December 31,2005, we had a receivable of $0.1 million. In December 2005, the partnersagreed to dissolve the joint venture and the dissolution was completed during2006.

*MDC Holding, Ltd.*

We had an outstandingaccounts receivable balance with MDC Holding, Inc. (“MDC”) related to aPAS system purchase of $1.3 million at December 31, 2006. There was noaccounts receivable balance at December 31, 2005. Certain of our employeeswere shareholders of MDC as of December 31, 2006. MDC is in the businessof providing value-added services, such as short message, voicemail orring-tone services for PAS telecom networks.

*ORG, Inc.*

We have a 49% ownership inGlobal Asia Partners L.P. which in turn is a significant shareholder in ORG, Inc.We had sales of $1.6 million and $0.5 million to ORG, Inc. during2006 and 2005, respectively. We had accounts receivable of $1.0 million and$0.2 million from ORG, Inc. as of December 31, 2006 and 2005,respectively. There was no deferred revenue at December 31, 2006 and therewas $0.1 million in deferred revenue at December 31, 2005.

*Starcom Products, Inc.*

We obtain engineeringconsulting and employee placement services from Starcom Products, Inc. (“Starcom”),which is 31% owned by an individual related to one of our former officers whowas also a member of our Board of Directors. We paid less than $0.1 million in2006, $0.7 million in 2005 and $1.1 million in 2004 for engineeringconsulting and employee placement services provided by Starcom.

*Xalted Networks*

In May 2005 and August 2005,we invested $2.0 million and $1.0 million, respectively, in XaltedNetworks (“Xalted”). In March 2006 we invested an additional$0.3 million in Xalted. Xalted is a development stage company providingtelecommunication operator customers with a comprehensive set of network systems,software solutions and service offerings, in which we have an 11% ownershipinterest. We received purchase orders from Xalted Networks totalingapproximately $1.3 million in 2005 for telecommunications equipment thatis for product not typically sold by us to other customers. We charge a tenpercent procurement fee to Xalted for obtaining and reselling these products.The equipment was delivered during 2005 but revenue has not been recognized asthe revenue recognition process has not yet been completed.

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**Liquidity andCapital Resources**

*OperatingActivities*

*2006*

Net cash provided by operating activities for the yearended December 31, 2006 was $66.1 million. Cash from operating activitieswas positively affected by changes in accounts receivable, deferred costs andcustomer advances, partially offset by the net loss as well as changes ininventories, payables and other current liabilities.

The decrease in accounts receivable resulting fromimproved cash collections in 2006 compared to 2005 provided cash of $133.1million. Days sales outstanding was 60 days at December 31, 2006 ascompared to 66 days outstanding at December 31, 2005 due to strong cashcollections in the fourth quarter of 2006 and the high percentage of fourthquarter revenue derived from our PCD segment, which generally has experienced ashorter collection period on related receivables. In 2007, we expect the dayssales outstanding to increase in line with historical trends.

Customer advances increased by $38.4 million at December 31,2006. Customer advances represent cash deposits we have received from ourcustomers for orders that have not yet received final acceptance. Uponsubsequent receipt of final acceptances and revenue recognition, customeradvances are reduced and revenue and cost of sales is recorded.

The decrease in payables and other current liabilitiesprimarily resulted from a decrease in accounts payable of $22.3 million, adecrease in income taxes payable of $28.9 million, and a decrease in othercurrent liabilities of $27.6 million. The decrease in other current liabilitiesincluded decreases in payroll and other taxes payable, accrued contract costs,which relate to purchase of goods and services for which invoices have not beenreceived, and warranty costs, offset by a $32.1 million increase in othercurrent liabilities related to a loss contract reserve.

Non-cash charges for theyear ended December 31, 2006 included $68.0 million of depreciationand amortization, $16.6 million of stock-based compensation expense, and a$13.5 million other-than-temporary charge related to impairment of a long-terminvestment. The net gain on sale of assets of $9.6 million, included thegain of $12.3 million related to the sale of the semiconductor design businessdivision to Marvell Technology Group, Ltd.

*2005*

Net cash provided by operating activities for the yearended December 31, 2005 was $218.4 million. Operating cash wasaffected by changes in accounts receivable, inventories, income taxes payableand accounts payable.

The $268.2 million decrease in accountsreceivable was primarily attributable to increased collections in the finalquarter of 2005 as compared to the final quarter of 2004. Days salesoutstanding was 66 days at December 31, 2005 as compared to 113 days at December 31,2004. The shorter days sales outstanding was primarily a result of a shift insales from China, which typically has a long collection cycle, to the United States,which typically has a shorter collection cycle. The decrease in inventorybalance of $165.9 million, primarily a result of a shift in sales to the PCDsegment which has faster inventory turnover, has also contributed to ourincrease in operating cash.

Customer advances decreased by $150.3 millionduring the year ended December 31, 2005. Upon subsequent receipt of finalacceptances and revenue recognition, customer advances are reduced and revenueand cost of sales is recorded. Income taxes payable decreased by$110.2 million due to the losses incurred during 2005. In addition,accounts payable decreased by $87.8 million due to lower inventory andlower forecast sales. All of these factors contributed to a decrease inoperating cash.

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The reduction of customeradvances in 2005 was primarily due to the completion of the revenue earningprocess for most of the agreements with Japan Telecom, Inc. (“JT”), anaffiliate of Softbank Corp., as well as the decline in sales and thecorresponding cash advances for products sold in China. All cash received fromJT in advance of revenue recognition and in advance of spending for promotionalactivities was reflected as customer advances in prior periods. Revenue forcertain of these agreements has been recognized during the year ended December 31,2005. For additional information, see Note 20, “Related Party Transactions”, ofNotes to Consolidated Financial Statements contained in Item 8 of this AnnualReport.

*2004*

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

The $453.9 million increase in accountsreceivable was attributable to increased sales, and longer collection periodsexperienced during 2004. The increase in accounts receivable was, in part, dueto the addition of the PCD business of Audiovox Communications Corporation.Approximately 14.4% of the accounts receivable balance outstanding at December 31,2004 was attributable to PCD. Inventory increased by $175.9 million in2004 and includes $156.0 million of inventory attributable to the PCDacquisition. Customer advances decreased by $116.9 million for the yearended December 31, 2004. Upon receipt of final acceptances, customeradvance is reduced and revenue and cost of sales is recorded. The reduction ofcustomer advances and deferred costs for inventory at customer sites in 2004 islargely a result of our customers in China transitioning from new systeminstallations to system expansions, which generally requires a shorter periodbetween customer advance and acceptance. Our working capital of $1.1 billionincreased in proportion to the growth of our business in addition to the$175.0 million increase associated with our acquisition of ACC.

Offsetting the activitythat decreased operating cash for the period were net income and non-cashcharges including a $12.7 million provision for long-lived assetimpairment, $76.2 million in depreciation and amortization, a$21.3 million provision for doubtful accounts, and a $18.3 milliondeferred cost provision. Accounts payable increased by $97.7 million,consistent with increased inventory purchasing. Inventories at customer sitesunder contracts awaiting final acceptance are classified as deferred costs,separate from what was historically considered inventory. The title and risk ofloss of this inventory is transferred to the customer. Revenue and costs ofsales are recorded when final acceptance is received from the customer.Deferred costs decreased by $207.4 million from December 31, 2003 to December 31,2004. The decrease in deferred costs resulted from a greater number of customeracceptances, corresponding to the decrease in customer advances.

*InvestingActivities*

*2006*

Net cash provided byinvesting activities in fiscal 2006 totaled $36.1 million. Cash inflows frominvesting activities included $36.0 million received from the sale of oursemiconductor design operations to Marvell Technology Group, Ltd., $4.0million of net proceeds from the sale of short-term investments and $20.9million in changes to restricted cash. Cash used for additions to property,plant and equipment totaled $26.3 million.

*2005*

Net cash provided byinvesting activities in fiscal 2005 was $70.1 million. This was mainly dueto net proceeds from the sale of investments of $181.7 million, includingthe $56.9 million received on the sale of 

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theSoftbank China Restructuring Fund No. 1 and $124.8 million of netsales of our other investment holdings, partially offset by $64.4 millionof property, plant and equipment purchases and $24.3 million of for ouracquisitions of Giga Telecom, Inc. and Pedestal Networks.

*2004*

Net cash used in investingactivities was $468.0 million for the year ended December 31, 2004.The most significant components of our investing activities are businessacquisitions, additions to property, plant and equipment and the net investmentin short-term securities. Cash used for business acquisitions totaled$217.8 million during 2004, including approximately $178.3 millionfor selected assets of ACC, $30.0 million for substantially all assets andliabilities of TELOS, and $9.1 million for HSI. Cash used for the purchaseof property, plant and equipment, including $57.1 million for theconstruction of our Hangzhou facility, totaled $135.6 million. Net cashused for the purchase of short-term investments was $82.8 million.

*FinancingActivities*

*2006*

Net cash used in financingactivities was $99.5 million, primarily consisting of a net repayment ofshort-term borrowings in excess of new borrowings.

*2005*

Net cash used in financingactivities in fiscal 2005 was $202.8 million. This was primarily due tonet repayments of $216.4 million on borrowings including $57.1 millioncash payment in connection with early debt extinguishments.

*2004*

Net cash provided byfinancing activities was $742.7 million for the year ended December 31,2004. This was primarily due to proceeds raised from the sale of12.1 million shares of common stock at $39.25 per share to Banc of AmericaSecurities, LLC, in January 2004 for net proceeds of approximately$474.6 million. In addition, we incurred net borrowing of$350.0 million during the year from existing lines of credit in China tofund our operations needs in China. We also received $25.7 million for theissuance of common stock through stock option and warrant exercises. Offsettingcash provided by financing activities, during the first and second quarter of2004, we used a portion of the capital raised to repurchase a total of3.6 million shares of our common stock at an average price of $30.25 pershare for a total cost of $107.6 million, including transaction fees.

*Liquidity*

We reported net losses in each quarter in the periodbeginning April 1, 2005 and continuing through December 31, 2006,which has resulted in an accumulated deficit of $494.2 million and totalstockholders’ equity being reduced to $774.4 million at December 31, 2006.Additionally, at December 31, 2006, we had short-term debt in China underlines of credit to our China subsidiaries of $102.5 million maturing in 2007and long-term debt outside of China in the form of 7¤8% convertiblesubordinated notes with a principal balance of $274.6 million that matures in March 2008.

Our working capital was $793.5 million and$834.1 million at December 31, 2006 and 2005, respectively, andincludes cash on hand of $661.6 million and $645.6 million and short terminvestments of $9.5 million in and $13.3 million, respectively in 2006 and2005. Planned capital expenditures include an increase in the level of ourcapital expenditures in China in 2007 by approximately $40 million to support 

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wire line telephonecarriers in China who utilize our products and services to provide televisionservice to their customers using the IPTV protocol.

Credit facilities in China at December 31, 2006totaled $698.3 million, with $357.5 million of this amount available forworking capital purposes, of which we had drawn $102.5 million in outstandingborrowings with interest rates up to 5.51%, and $340.8 million was availablefor use in support of letters of credit and corporate guarantees. Thesefacilities expire primarily in November andDecember of 2007. We believethat based upon our recent financial performance and financial position ourlenders may reduce the total available credit when it negotiates renewals ofthese lines. Furthermore, each borrowing under the credit facilities is subjectto the bank’s current favorable opinion of the credit worthiness of the Company’sChina subsidiaries, as well as the bank having funds available for lending andother Chinese banking regulations. However, we believe the amounts of creditour lenders may make available and the borrowings made under the renewed linesof credit will be sufficient to meet planned uses of these credit facilities.

As of September 30, 2007 our outstandingborrowings under the credit facilities in China total $140.1 million, withinterest rates of up to 6.67%, and with varying maturity dates through September 2008.The Company’s practice in China is to draw new loans under the creditfacilities prior to either the maturity of our borrowings or expiration of ourfacilities to ensure we maintain adequate liquidity to re-pay the existingborrowings at maturity, or to effectively lengthen the credit facility periodto the latest maturity date of the underlying borrowings.

Of our total cash and short-term investments at December 31,2006 of $671.2 million, a total of $483.7 millionis held in China. To meet liquidity needs outside of China, oursubsidiaries in China have the ability to transfer cash to the Company in theUnited States under China’s current exchange control regulations. The amount ofcash available for transfer from the China subsidiaries is limited both byliquidity needs of the subsidiaries in China and by Chinese governmentrequirements that the China subsidiaries retain adequate capital levels inChina to protect creditors and to have funds available for mandated employeebenefits. We believed the China subsidiaries could freely transfer at least$200 million as of December 31, 2006, and during the nine months ended September 30,2007 our China subsidiaries have made such transfers of funds out of China tothe Company totaling $150 million.

Although management believes we now have a sufficientamount of cash resources to finance our anticipated working capital and capitalexpenditure requirements for the next 12 months, we do not have enough cashoutside of China to repay the convertible notes due on March 1, 2008.Management’s liquidity plans include a partial or complete refinancing of theconvertible notes, renewal of the lines of credit in China, transfers of morecash from its subsidiaries in China to the extent necessary, and, if needed,liquidation of certain investments and/or seeking new financing arrangements.Our ability to maintain sufficient liquidity is also dependent on achievingprojected sales and operating margin forecasts.

The convertible notes were issued in March 2003when we completed an offering of $402.5 million of 7¤8%convertible subordinated notes due March 1, 2008 to qualifiedinstitutional buyers. The notes are convertible into our common stock at aconversion price of $23.79 per share and are subordinated to all of our presentand future senior debt. Concurrent with the issuance of the convertible notes,we entered into a convertible bond hedge and a call option transaction withrespect to our common stock. Both the bond hedge and call option transactionsmay be settled at our option either in cash or net shares and expire on March 1,2008. During 2005, we completed exchanges of approximately 5.0 millionshares of our common stock and approximately $57.1 million in cash for$127.9 million aggregate principal amount of outstanding notes. As aresult of the early extinguishment, we also amended the convertible bond hedgeand call option transactions to reflect the change in principal amount of theunderlying notes.

If an event of default were to occur and becontinuing, the Trustee or the holders of at least 25% in aggregate principalamount of the notes then outstanding could declare all unpaid principal andaccrued 

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interest on the Notes thenoutstanding to be immediately due and payable. Therefore as a result of ourinability to timely file our Quarterly Report on Form 10-Q for theperiod ended September 30, 2006, because the independent review by theGovernance Committee of the Company’s historic stock option accounting was notcompleted, after receiving a purported notice of default from the trusteeasserting that the delay in filing and a failure to comply with certaincovenants had caused a default under the indenture, we solicited and receivedthe requisite consents from the holders of the notes to a waiver of anydefaults which may have occurred to and including January 9, 2007, causedby a delay in filing SEC Reports and entered into a First SupplementalIndenture with the trustee, dated January 9, 2007, which provided that anyfailure by us to comply with certain provisions of the original agreement willnot result in a default or an event of default through May 31, 2007. Afterreceiving a notice of default from the trustee asserting that our inability totimely file SEC Reports and comply with certain covenants as of May 31,2007 had caused a default under the indenture, we solicited and received therequisite consents from the holders of the notes to a waiver of any defaultswhich may have occurred to and including July 26, 2007 and entered into aSecond Supplemental Indenture with the trustee, after receiving consent fromholders of more than 50% of the outstanding aggregate principal amount of theconvertible subordinated notes in connection with our consent solicitationannounced July 19, 2007. The Second Supplemental Indenture provides that (i) duringthe period from and including July 26, 2007 to and including October 15,2007 (“Covenant Reversion Date”), any failure by us to comply with thecovenants contained in the original indenture agreement related to the requiredfiling of reports with the SEC, and the furnishing of copies of the SEC reportsand certain compliance certificates to the Trustee, will not constitute adefault, and that (ii) if, but for the Second Supplemental Indenture, adefault would be deemed to have occurred as a result of a failure to complywith such covenants and such default remains uncured and is continuing as ofthe Covenant Reversion Date, such default will be deemed to have occurred onthe Covenant Reversion Date.

Under the Second Supplemental Indenture, theconvertible subordinated notes accrue an additional 6.75% per annum in specialinterest from and after January 9, 2007 to and including July 25,2007, and an additional 10% per annum in special interest from and after July 26,2007 to the date the notes are paid, prepaid, redeemed, converted or otherwisecease to be outstanding. The special interest rate accruing on the notes after July 26,2007 represents an increase of 3.25% per annum over the previous specialinterest rate of 6.75% per annum provided by the First Supplemental Indenture.As a result of the Second Supplemental Indenture, the convertible subordinatednotes now bear a stated interest rate of 10.875%. Accordingly, we will have $22.0 million of additional annual interestexpense in 2007 while the convertible subordinated notes are outstanding. Paymentsof special interest will be made in addition to, and at the same time and inthe same manner as, regularly scheduled payments of interest to holdersentitled to such regularly scheduled payments of interest.

If additional sources of liquidity were needed, theCompany would consider new debt or equity offerings or obtaining cash fromasset sales, but there is no assurance that such transactions could beconsummated on acceptable terms or at all. Failure to raise sufficient capitalwhen needed could have a material adverse effect on the business, results ofoperations and financial position of the Company.

Our China sales are generally denominated in localcurrency, and we accept commercial notes receivable with maturity dates ofbetween three and six months from our customers in China in the normalcourse of business. Notes receivable available for sale was $5.1 millionand $2.1 million at December 31, 2006 and 2005, respectively. We maydiscount these notes with banking institutions in China. Any notes that havebeen sold are not included in our consolidated balance sheets as the criteriafor sale treatment established by Statement of Financial Accounting Standards No. 140,“Accounting for Transfers and Servicing of Financial Assets and Extinguishmentof Liabilities” (“SFAS 140”) have been met.

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Due to the limitations on converting Renminbi, we arelimited in our ability to engage in foreign currency hedging activities inChina. We cannot guarantee that fluctuations in foreign currency exchange ratesin the future will not have a material adverse effect on revenues frominternational sales and, correspondingly, on our business, financial condition,results of operations and cash flows. We have contracts negotiated in JapaneseYen and we maintain bank accounts in Japanese Yen for purchasing portions ofour inventories and supplies. The balance of these Japanese Yen accounts atDecember 31, 2006 was approximately $13.1 million.

On August 1, 2005, we entered into a 364-day$100.0 million committed receivables purchase facility with a financialinstitution. In March 2007, the agreement was amended and restated toreflect that the purchase of trade receivables shall be at the sole discretionof the financial institution. The agreement was also extended to the earlier of(i) March 28, 2008 or (ii) upon 90 days written notice bythe financial institution. Pursuant to the terms of the receivable purchasefacility, we may sell certain receivables arising from the sale oftelecommunications equipment to this financial institution. No receivables hadbeen sold pursuant to this arrangement.

We have not guaranteed anydebt that is not included in the consolidated balance sheet.

*Income taxes*

Certain subsidiaries and joint ventures located inChina enjoy tax benefits in China which are generally available to foreign investmententerprises, including full exemption from national enterprise income tax fortwo years starting from the first profit-making year and/or a 50% reduction innational income tax rate for the following three years. In addition, localenterprise income tax is often waived or reduced during this taxholiday/incentive period. Under current regulations in China, foreigninvestment enterprises that have been accredited as technologically advancedenterprises are entitled to additional tax incentives. These tax incentivesvary in different locales and could include preferential national enterpriseincome tax treatment at 50% of the usual rates for different periods of time.The tax holidays/incentives discussed above are applicable or potentiallyapplicable to UTStarcom ChongQing Telecom Co. Ltd. (“CUTS”), UTStarcom TelecomCo., Ltd. (“HUTS”), Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”) and UTStarcomChina Co., Ltd. (“UTSC”), our active subsidiaries in China, because theseentities may qualify as accredited technologically advanced enterprises.

During the second quarter of 2005, HUTS received approval for aKnowledge Intensive, Technology Intensive Certificate (“the Certificate”) whichsubjects the company to a reduced national tax rate of 15%. In the firstquarter of 2005, the Company recorded a reduction in tax expense attributableto an increase in deferred tax assets arising from the assessment of a localincome tax for HUTS and HSTC in China. The approval of the Certificatecurrently has no effect on the local taxation of HUTS.

*Off balance sheetarrangements*

On August 1, 2005 we entered into a 364-daycommitted receivables purchase facility with Citibank, N.A., whichprovides for the sale of up to $100.0 million of trade accounts receivableof our PCD segment. On March 30, 2007, the agreement was amended andrestated to reflect that the purchase of trade receivables shall be at the solediscretion of Citibank, N.A. Sales of the accounts receivables to Citibank,N.A. under this program will result in a reduction of total accounts receivablein our consolidated balance sheet. The remaining accounts receivables not soldto Citibank, N.A. will be carried at their net realizable value, including anallowance for doubtful accounts. We did not sell any receivables pursuant tothis facility during 2006 and 2005. We believe that available funding under ouraccounts receivable financing program provides us increased flexibility tomanage working capital requirements, and that there are sufficient tradeaccounts receivable to support the U.S. financing programs. Under the program,we will continue to service the accounts receivable.

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At December 31, 2006,we have no other off balance sheet arrangements

*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:

| ** **                       | ** ** | ** **              | ** ** | **Less than** | ** ** | **1 - 3** | ** ** | **3 - 5** | ** ** | **More than** | ** ** |
|----------------------------------|------------|-------------------------|------------|--------------------|------------|---------------------|------------|---------------------|------------|--------------------|------------|
| ** **                       | ** ** | **Total**               | ** ** | **1 year**    | ** ** | **years**           | ** ** | **years**           | ** ** | **5 years**   | ** ** |
| ** **                       | ** ** | **(in thousands)** | ** ** |
| **Contractual Obligations**      | ** ** | ** **              | ** ** | ** **         | ** ** | ** **          | ** ** | ** **          | ** ** |               | ** ** | ** ** |   |
| Bank loans                       |       | $                       | 102,510    |               | $          | 102,510             |       | $                   | —     |               | $          | — |   |   | $ | — | ** ** |   |
| Convertible subordinated notes   |       | $                       | 274,600    |               | $          | —              |       | $                   | 274,600    |               | $          | — |   |   | $ | — | ** ** |   |
| Interest payable on debt         |       | $                       | 35,216     |               | $          | 30,239              |       | $                   | 4,977      |               | $          | — |   |   | $ | — | ** ** |   |
| Capital leases                   |       | $                       | 923        |               | $          | 286                 |       | $                   | 533        |               | $          | 104 |   |   | $ | — | ** ** |   |
| Operating leases                 |       | $                       | 38,200     |               | $          | 15,340              |       | $                   | 18,765     |               | $          | 3,230 |   |   | $ | 865 | ** ** |   |
| **Other Commercial Commitments** | ** ** | ** **              | ** ** | ** **         | ** ** | ** **          | ** ** | ** **          | ** ** |               | ** ** | ** ** |   |
| Letters of credit                |       | $                       | 56,569     |               | $          | 40,100              |       | $                   | 16,469     |               | $          | — |   |   | $ | — | ** ** |   |
| Purchase  commitments            |       | $                       | 154,364    |               | $          | 150,587             |       | $                   | 3,777      |               | $          | — |   |   | $ | — | ** ** |   |

 

*Bank loans*

At December 31, 2006,we had loans with various banks totaling $102.5 million with interestrates ranging from 5.02% to 5.51% per annum. These bank loans mature during2007 and are included in short-term debt. There are no significantcovenants associated with these loans.

*Convertiblesubordinated notes*

Our convertible subordinated notes, due March 1,2008, are convertible into our common stock at a conversion price of $23.79 pershare and are subordinated to all our present and future senior debt. Theprincipal is due only at maturity of the notes.

Effective January 9,2007, the Company and the holders of the remaining $274.6 million ofconvertible subordinated notes entered into a First Supplemental Indenture,providing that any failure by us to comply with certain provisions of theoriginal agreement will not result in a default or an event of default through May 31,2007. The convertible subordinated notes accrue an additional 6.75% per annumin special interest from and after January 9, 2007 to the March 1,2008 maturity date of the notes, unless the notes are earlier repurchased orconverted. On July 26, 2007, we entered into a Second SupplementalIndenture providing that the convertible subordinated notes will accrue anadditional 10% per annum in special interest from and after July 26, 2007to the March 31, 2008 maturity date of the notes unless the notes areearlier repurchased or converted. The special interest rate represents anincrease of 3.25% per annum over the previous special interest rate of 6.75%per annum in the First Supplemental Indenture. As a result of the SecondSupplemental Indenture, the convertible subordinated notes now bear a statedinterest rate of 10.875%. Interest is payable semiannually on March 1 and September 1,and payments of the special interest are made in addition to and at the sametime and in the same manner as regularly scheduled payments of interest toholders entitled to such regularly scheduled payments of interest. For moreinformation regarding the notice of default on May 31, 2007 and theCompany’s Second Supplemental Indenture, see the “Liquidity” section of thisAnnual Report.

*Leases*

We lease certainfacilities under non-cancelable operating leases that expire at variousdates through 2013.

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*Letters of credit*

We issue standby lettersof credit primarily to support international sales activities outside of China.When we submit a bid for a sale, often the potential customer will require thatwe issue a bid bond or a standby letter of credit to demonstrate our commitmentthrough the bid process. In addition, we may be required to issue standbyletters of credit as guarantees for advance customer payments upon contractsigning or for performance guarantees. The standby letters of credit usuallyexpire without being drawn by the beneficiary thereof. Finally, we may issuecommercial letters of credit in support of purchase commitments.

*Purchasecommitments*

We are obligated topurchase raw materials and work-in-progress inventory under various orders fromour suppliers, all of which are expected to be fulfilled, with no adverseconsequences material to our operations or financial condition. Purchasecommitments exclude agreements that are cancelable without penalty.

*Accounts receivabletransferred to notes receivable*

We accept commercial notesreceivable from our customers in China in the normal course of business. Thenotes are typically non-interest bearing, with maturity dates betweenthree and six months. Notes receivable available for sale were$5.1 million and $2.1 million at December 31, 2006 and December 31, 2005,respectively. We may discount these notes with banking institutions in China. Asale of these notes is reflected as a reduction of notes receivable and theproceeds of the settlement of these notes are included in cash flows fromoperating activities in the consolidated statement of cash flows. During theyear ended December 31, 2005 we sold notes receivable totaling$13.0 million. There were no notes receivable sold during the year ended December 31,2006. Any notes that have been sold are not included in our consolidatedbalance sheets as the criteria for sale treatment established by Statement ofFinancial Accounting Standards No. 140, “Accounting for Transfers andServicing of Financial Assets and Extinguishment of Liabilities,” (“SFAS 140”)has been met. The costs of settling or transferring these notes receivable were$0.7 million for the year ended December 31, 2005, and were includedin other income (expense), net in the consolidated statements of operations.

*Investmentcommitments*

As of December 31,2006, we had invested a total of $2.6 million in Global Asia PartnersL.P., a fund formed to make private equity investments in private or pre-IPOtechnology and telecommunications companies in Asia. We had a commitment toinvest up to a maximum of $5.0 million, but as the result of areorganization of capital contributions by the partners, reached in April 2005,our capital contribution of $0.6 million in April 2005 was the finalcapital contribution to be made. In addition, the agreement allows thepartnership to re-invest up to $2.5 million that otherwise would have beenavailable to us as future distributions.

*Intellectualproperty*

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.

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**QUARTERLY FINANCIAL DATA (UNAUDITED), AS RESTATED ANDDISCUSSION AND ANALYSIS OF QUARTERLY RESULTS OF OPERATIONS**

The following tables setforth some of the key quarterly unaudited financial information. See Note 2,“Restatement of Financial Statements”, of Notes to Consolidated FinancialStatements contained in Item 8 of this Annual Report and Exhibit 99.1for further details of the impact of the restatement on these quarterlyresults.

**UTSTARCOM,INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(In thousands, except per share amounts)**

| ** **                                                                                  | ** ** | **Three months ended  December 31, 2006** | ** ** | **Three months ended  September 30, 2006** | ** ** | **Three months ended  June 30, 2006** | ** ** | **Three months ended  March 31, 2006** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | ** **                                                    | ** ** | ** **                                                     | ** ** | **(As restated)**                                    | ** ** | **(As restated)**                                     | ** ** |
| Net sales                                                                                   |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Unrelated party                                                                             |       |                                                          | $          | 685,718                                                        |       |                                                      |       | $                                                          | 569,826    |   |   |   | $ | 513,898 |   |   |   | $ | 557,037 |   |   |
| Related party                                                                               |       |                                                          | 18,738     |                                                           |       |                                                      | 31,073     |                                                       |       |   | 37,628 |   |   |   | 44,944 |   |   |
|                                                                                        |       |                                                          | 704,456    |                                                           |       |                                                      | 600,899    |                                                       |       |   | 551,526 |   |   |   | 601,981 |   |   |
| Cost of net sales                                                                           |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Unrelated party                                                                             |       |                                                          | 609,386    |                                                           |       |                                                      | 503,618    |                                                       |       |   | 414,113 |   |   |   | 461,585 |   |   |
| Related party                                                                               |       |                                                          | 16,867     |                                                           |       |                                                      | 22,480     |                                                       |       |   | 28,463 |   |   |   | 16,605 |   |   |
| Gross profit(1)                                                                             |       |                                                          | 78,203     |                                                           |       |                                                      | 74,801     |                                                       |       |   | 108,950 |   |   |   | 123,791 |   |   |
| Operating expenses (income):                                                                |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Selling, general  and administrative                                                        |       |                                                          | 87,547     |                                                           |       |                                                      | 80,076     |                                                       |       |   | 83,109 |   |   |   | 83,724 |   |   |
| Research and  development                                                                   |       |                                                          | 43,559     |                                                           |       |                                                      | 46,305     |                                                       |       |   | 46,603 |   |   |   | 46,402 |   |   |
| Amortization of  intangible  assets                                                         |       |                                                          | 4,304      |                                                           |       |                                                      | 4,821      |                                                       |       |   | 4,821 |   |   |   | 4,925 |   |   |
| Gain on sale of  semiconductor design assets                                                |       |                                                          | —     |                                                           |       |                                                      | (12,291    | )                                                          |       |   | — |   |   |   | — |   |   |
| Total operating  expenses                                                                   |       |                                                          | 135,410    |                                                           |       |                                                      | 118,911    |                                                       |       |   | 134,533 |   |   |   | 135,051 |   |   |
| Operating loss                                                                              |       |                                                          | (57,207    | )                                                              |       |                                                      | (44,110    | )                                                          |       |   | (25,583 | ) |   |   | (11,260 | ) |   |
| Interest income                                                                             |       |                                                          | 4,136      |                                                           |       |                                                      | 3,214      |                                                       |       |   | 3,947 |   |   |   | 3,532 |   |   |
| Interest expense                                                                            |       |                                                          | (2,402     | )                                                              |       |                                                      | (2,620     | )                                                          |       |   | (3,166 | ) |   |   | (3,500 | ) |   |
| Other (expense)  income, net                                                                |       |                                                          | (11,198    | )                                                              |       |                                                      | 1,835      |                                                       |       |   | 6,887 |   |   |   | 3,568 |   |   |
| Loss before income  taxes,  minority interest and equity in loss of affiliated companies(2) |       |                                                          | (66,671    | )                                                              |       |                                                      | (41,681    | )                                                          |       |   | (17,915 | ) |   |   | (7,660 | ) |   |
| Income tax  (expense) benefit                                                               |       |                                                          | 23,991     |                                                           |       |                                                      | (1,459     | )                                                          |       |   | (4,669 | ) |   |   | (2,839 | ) |   |
| Minority interest  in losses of consolidated subsidiaries                                   |       |                                                          | 651        |                                                           |       |                                                      | 92         |                                                       |       |   | 259 |   |   |   | 556 |   |   |
| Net loss                                                                                    |       |                                                          | $          | (42,029                                                        | )          |                                                      |       | $                                                          | (43,048    | ) |   |   | $ | (22,325 | ) |   |   | $ | (9,943 | ) |   |
| Loss per share:                                                                             |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| —Basic                                                                                 |       |                                                          | $          | (0.35                                                          | )          |                                                      |       | $                                                          | (0.36      | ) |   |   | $ | (0.19 | ) |   |   | $ | (0.08 | ) |   |
| —Diluted                                                                               |       |                                                          | $          | (0.35                                                          | )          |                                                      |       | $                                                          | (0.36      | ) |   |   | $ | (0.19 | ) |   |   | $ | (0.08 | ) |   |

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(1)           Gross profit in the fourth quarter of 2006was unfavorably impacted by a $32.1 million loss contract provision.

(2)           Loss from continuing operations for thefourth quarter of 2006 included a $13.5 million other than temporary impairmentcharge for a long-term investment.

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**UTSTARCOM, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)(In thousands, except per share amounts)**

| ** **                                                                                       | ** ** | **Three months ended  December 31, 2005** | ** ** | **Three months ended  September 30, 2005** | ** ** | **Three months ended  June 30, 2005** | ** ** | **Three months ended  March 31, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **(As restated)**                                        | ** ** | **(As restated)**                                         | ** ** | **(As restated)**                                    | ** ** | **(As restated)**                                     | ** ** |
| Net sales                                                                                        |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Unrelated party                                                                                  |       |                                                          | $          | 600,403                                                        |       |                                                      |       | $                                                          | 584,072    |   |   |   | $ | 649,390 |   |   |   | $ | 561,432 |   |   |
| Related party                                                                                    |       |                                                          | 80,689     |                                                           |       |                                                      | 13,363     |                                                       |       |   | 51,123 |   |   |   | 330,637 |   |   |
|                                                                                             |       |                                                          | 681,092    |                                                           |       |                                                      | 597,435    |                                                       |       |   | 700,513 |   |   |   | 892,069 |   |   |
| Cost of net sales                                                                                |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Unrelated party                                                                                  |       |                                                          | 541,346    |                                                           |       |                                                      | 548,686    |                                                       |       |   | 573,134 |   |   |   | 523,972 |   |   |
| Related party                                                                                    |       |                                                          | 77,091     |                                                           |       |                                                      | 10,862     |                                                       |       |   | 24,525 |   |   |   | 135,657 |   |   |
| Gross profit                                                                                     |       |                                                          | 62,655     |                                                           |       |                                                      | 37,887     |                                                       |       |   | 102,854 |   |   |   | 232,440 |   |   |
| Operating expenses:                                                                              |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                                              |       |                                                          | 74,073     |                                                           |       |                                                      | 86,414     |                                                       |       |   | 103,087 |   |   |   | 107,886 |   |   |
| Research and development                                                                         |       |                                                          | 54,515     |                                                           |       |                                                      | 60,817     |                                                       |       |   | 65,650 |   |   |   | 65,831 |   |   |
| Amortization of intangible assets                                                                |       |                                                          | 5,462      |                                                           |       |                                                      | 6,643      |                                                       |       |   | 6,776 |   |   |   | 6,972 |   |   |
| Impairment of long-lived assets                                                                  |       |                                                          | —     |                                                           |       |                                                      | 218,094    |                                                       |       |   | — |   |   |   | — |   |   |
| Restructuring                                                                                    |       |                                                          | 11,164     |                                                           |       |                                                      | 3,378      |                                                       |       |   | 15,127 |   |   |   | — |   |   |
| In-process research and development                                                              |       |                                                          | —     |                                                           |       |                                                      | —     |                                                       |       |   | 660 |   |   |   | — |   |   |
| Total operating expenses                                                                         |       |                                                          | 145,214    |                                                           |       |                                                      | 375,346    |                                                       |       |   | 191,300 |   |   |   | 180,689 |   |   |
| Operating (loss) income                                                                          |       |                                                          | (82,559    | )                                                              |       |                                                      | (337,459   | )                                                          |       |   | (88,446 | ) |   |   | 51,751 |   |   |
| Interest income                                                                                  |       |                                                          | 2,617      |                                                           |       |                                                      | 1,673      |                                                       |       |   | 1,452 |   |   |   | 1,349 |   |   |
| Interest expense                                                                                 |       |                                                          | (3,900     | )                                                              |       |                                                      | (3,876     | )                                                          |       |   | (4,711 | ) |   |   | (4,278 | ) |   |
| Gain on extinguishment of subordinated notes                                                     |       |                                                          | —     |                                                           |       |                                                      | 20,297     |                                                       |       |   | 11,095 |   |   |   | — |   |   |
| Other income (expense), net                                                                      |       |                                                          | 45,388     |                                                           |       |                                                      | 7,352      |                                                       |       |   | (2,228 | ) |   |   | (6,847 | ) |   |
| (Loss) income before income taxes, minority interest  and equity in loss of affiliated companies |       |                                                          | (38,454    | )                                                              |       |                                                      | (312,013   | )                                                          |       |   | (82,838 | ) |   |   | 41,975 |   |   |
| Income tax (expense) benefit                                                                     |       |                                                          | (2,501     | )                                                              |       |                                                      | (125,222   | )                                                          |       |   | (3,290 | ) |   |   | (5,530 | ) |   |
| Minority interest in losses of consolidated  subsidiaries                                        |       |                                                          | 598        |                                                           |       |                                                      | 3          |                                                       |       |   | 313 |   |   |   | (222 | ) |   |
| Equity in loss of affiliated companies                                                           |       |                                                          | (3,645     | )                                                              |       |                                                      | (786       | )                                                          |       |   | (574 | ) |   |   | (459 | ) |   |
| Net (loss) income                                                                                |       |                                                          | $          | (44,002                                                        | )          |                                                      |       | $                                                          | (438,018   | ) |   |   | $ | (86,389 | ) |   |   | $ | 35,764 |   |   |
| (Loss) earnings per  share:                                                                      |       |                                                          |       |                                                           |       |                                                      |       |                                                       |       |   |   |   |   |   |   |   |   |
| —Basic                                                                                      |       |                                                          | $          | (0.37                                                          | )          |                                                      |       | $                                                          | (3.70      | ) |   |   | $ | (0.75 | ) |   |   | $ | 0.31 |   |   |
| —Diluted                                                                                    |       |                                                          | $          | (0.37                                                          | )          |                                                      |       | $                                                          | (3.70      | ) |   |   | $ | (0.75 | ) |   |   | $ | 0.27 |   |   |

 

107

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**NET SALES**

| ** **               | ** **   | **Three months ended  March 31, 2006** | ** **     | **Three months ended  June 30, 2006** | ** ** | **Three months ended  September 30, 2006** | ** **     |
|--------------------------|--------------|------------------------------------------------------------|----------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|----------------|
| ** **               | ** **   | **As previously  reported**                           | ** **     | **As restated**                                      | ** ** | **% of net  sales**                                  | ** **     | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** | ** ** | ** ** | ** ** | ** ** | **% of net  sales** | ** ** |
| ** **               | ** **   | **(in thousands)**                                    | ** **     | ** **                                                | ** ** | **(in thousands)**                                        | ** **     | ** ** | ** ** | **(in thousands)** | ** ** |
| ***Sales by Segment***   | *** *** |                                                       | *** ***   | *** ***                                              |       |                                                           | *** ***   | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   |   |   |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband Infrastructure |         |                                                       | $ 57,156  | *** ***                                              |       |                                                           | $ 57,251  | *** *** |   |   | 10 | % |   |   | $ 44,674 | *** *** |   |   | $ 44,769 | *** *** |   |   | 8 | % |   |   |   |   |   |   | $ 50,754 | *** *** |   |   | 8 | % |   |
| Wireless Infrastructure  |         |                                                       | 100,433        | *** ***                                              |       |                                                           | 105,733        | *** *** |   |   | 18 | % |   |   | 113,680 | *** *** |   |   | 115,965 | *** *** |   |   | 21 | % |   |   |   |   |   |   | 110,299 | *** *** |   |   | 18 | % |   |
| Network Solutions        |         |                                                       | 157,589        | *** ***                                              |       |                                                           | 162,984        | *** *** |   |   | 28 | % |   |   | 158,354 | *** *** |   |   | 160,734 | *** *** |   |   | 29 | % |   |   |   |   |   |   | 161,053 | *** *** |   |   | 26 | % |   |
| PCD                      |         |                                                       | 322,995        | *** ***                                              |       |                                                           | 322,995        | *** *** |   |   | 54 | % |   |   | 266,247 | *** *** |   |   | 266,247 | *** *** |   |   | 49 | % |   |   |   |   |   |   | 328,701 | *** *** |   |   | 55 | % |   |
| Handsets                 |         |                                                       | 99,019         | *** ***                                              |       |                                                           | 99,034         | *** *** |   |   | 16 | % |   |   | 107,069 | *** *** |   |   | 107,069 | *** *** |   |   | 19 | % |   |   |   |   |   |   | 93,163 | *** *** |   |   | 16 | % |   |
| Service                  |         |                                                       | 16,968         | *** ***                                              |       |                                                           | 16,968         | *** *** |   |   | 2 | % |   |   | 17,476 | *** *** |   |   | 17,476 | *** *** |   |   | 3 | % |   |   |   |   |   |   | 17,982 | *** *** |   |   | 3 | % |   |
|                     |         |                                                       | $ 596,571 | *** ***                                              |       |                                                           | $ 601,981 | *** *** |   |   | 100 | % |   |   | $ 549,146 | *** *** |   |   | $ 551,526 | *** *** |   |   | 100 | % |   |   |   |   |   |   | $ 600,899 | *** *** |   |   | 100 | % |   |

 

| ** **               | ** **   | **Three months ended  March 31, 2005** | ** **     | **Three months ended  June 30, 2005** | ** ** | **Three months ended  September 30, 2005** | ** **     |
|--------------------------|--------------|-------------------------------------------------------|----------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|----------------|
| ** **               | ** **   | **As previously  reported**                      | ** **     | **As restated**                                      | ** ** | **% of net  sales**                                  | ** **     | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** | **As previously**

**reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **               | ** **   | **(in thousands)**                               | ** **     | ** **                                                | ** ** | **(in thousands)**                                        | ** **     | ** ** | ** ** | **(in thousands)** | ** ** |
| ***Sales  by Segment***  | *** *** |                                                  | *** ***   | *** ***                                              |       |                                                           | *** ***   | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband Infrastructure |         |                                                  | $ 326,307 | *** ***                                              |       |                                                           | $ 326,396 | *** *** |   |   | 37 | % |   |   | $ 56,644 | *** *** |   |   | $ 56,734 | *** *** |   |   | 8 | % |   |   | $ 30,927 | *** *** |   |   | $ 31,018 | *** *** |   |   | 5 | % |   |
| Wireless Infrastructure  |         |                                                  | 109,437        | *** ***                                              |       |                                                           | 99,533         | *** *** |   |   | 11 | % |   |   | 152,925 | *** *** |   |   | 133,589 | *** *** |   |   | 19 | % |   |   | 113,188 | *** *** |   |   | 77,586 | *** *** |   |   | 13 | % |   |
| Network Solutions        |         |                                                  | 435,744        | *** ***                                              |       |                                                           | 425,929        | *** *** |   |   | 48 | % |   |   | 209,569 | *** *** |   |   | 190,323 | *** *** |   |   | 27 | % |   |   | 144,115 | *** *** |   |   | 108,604 | *** *** |   |   | 18 | % |   |
| PCD                      |         |                                                  | 315,552        | *** ***                                              |       |                                                           | 315,552        | *** *** |   |   | 35 | % |   |   | 342,263 | *** *** |   |   | 342,263 | *** *** |   |   | 49 | % |   |   | 363,637 | *** *** |   |   | 363,637 | *** *** |   |   | 61 | % |   |
| Handsets                 |         |                                                  | 128,083        | *** ***                                              |       |                                                           | 128,083        | *** *** |   |   | 14 | % |   |   | 143,879 | *** *** |   |   | 143,879 | *** *** |   |   | 21 | % |   |   | 105,394 | *** *** |   |   | 106,294 | *** *** |   |   | 18 | % |   |
| Service                  |         |                                                  | 22,505         | *** ***                                              |       |                                                           | 22,505         | *** *** |   |   | 3 | % |   |   | 24,048 | *** *** |   |   | 24,048 | *** *** |   |   | 3 | % |   |   | 18,900 | *** *** |   |   | 18,900 | *** *** |   |   | 3 | % |   |
|                     |         |                                                  | $ 901,884 | *** ***                                              |       |                                                           | $ 892,069 | *** *** |   |   | 100 | % |   |   | $ 719,759 | *** *** |   |   | $ 700,513 | *** *** |   |   | 100 | % |   |   | $ 632,046 | *** *** |   |   | $ 597,435 | *** *** |   |   | 100 | % |   |

 

| ** **                | ** **   | **Six months ended June 30, 2006** | ** **           | **Six months ended June 30, 2005** | ** ** |
|---------------------------|--------------|-------------------------------------------------------------|----------------------|-------------------------------------------------------------|------------|
| ** **                | ** **   | **As previously  reported**                            | ** **           | **As restated**                                        | ** ** | **% of net  sales** | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **                | ** **   | **(in thousands)**                                     | ** **           | ** **                                                  | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Sales  by Segment***   | *** *** |                                                        | *** ***         | *** ***                                                |       |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |
| Broadband  Infrastructure |         |                                                        | $  101,830 | *** ***                                                |       |   | $  102,020 | *** *** |   |   | 9 | % |   |   | $  382,951 | *** *** |   | $  383,130 |   |   | 24 | % |   |
| Wireless  Infrastructure  |         |                                                        | 214,113              | *** ***                                                |       |   | 221,698 | *** *** |   |   | 19 | % |   |   | 262,362 | *** *** |   | 233,122 |   |   | 15 | % |   |
| Network Solutions         |         |                                                        | 315,943              | *** ***                                                |       |   | 323,718 | *** *** |   |   | 28 | % |   |   | 645,313 | *** *** |   | 616,252 |   |   | 39 | % |   |
| PCD                       |         |                                                        | 589,242              | *** ***                                                |       |   | 589,242 | *** *** |   |   | 51 | % |   |   | 657,815 | *** *** |   | 657,815 |   |   | 41 | % |   |
| Handsets                  |         |                                                        | 206,088              | *** ***                                                |       |   | 206,103 | *** *** |   |   | 18 | % |   |   | 271,962 | *** *** |   | 271,962 |   |   | 17 | % |   |
| Services                  |         |                                                        | 34,444               | *** ***                                                |       |   | 34,443 | *** *** |   |   | 3 | % |   |   | 46,553 | *** *** |   | 46,554 |   |   | 3 | % |   |
|                      |         |                                                        | $ 1,145,717     | *** ***                                                |       |   | $ 1,153,506 | *** *** |   |   | 100 | % |   |   | $ 1,621,643 | *** *** |   | $ 1,592,583 |   |   | 100 | % |   |

 

| ** **                | ** **   | **Nine months ended September 30, 2006** | ** **   | **Nine months ended September 30, 2005** | ** ** |
|---------------------------|--------------|-------------------------------------------------------------------|--------------|-------------------------------------------------------------------|------------|
| ** **                | ** **   | ** **                                                        | ** **   | ** **                                                        | ** ** | ** % of net  sales** | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **                | ** **   | ** **                                                        | ** **   | **(in thousands)**                                           | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Sales  by Segment***   | *** *** |                                                              | *** *** | *** ***                                                      |       |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |
| Broadband  Infrastructure |         |                                                              |         | *** ***                                                      |       |   | $  152,774 |   |   |   | 9 | % |   |   | $  413,878 | *** *** |   | $  414,148 |   |   | 19 | % |   |
| Wireless  Infrastructure  |         |                                                              |         | *** ***                                                      |       |   | 331,997 |   |   |   | 19 | % |   |   | 375,550 | *** *** |   | 310,708 |   |   | 14 | % |   |
| Network Solutions         |         |                                                              |         | *** ***                                                      |       |   | 484,771 |   |   |   | 28 | % |   |   | 789,428 | *** *** |   | 724,856 |   |   | 33 | % |   |
| PCD                       |         |                                                              |         | *** ***                                                      |       |   | 917,943 |   |   |   | 52 | % |   |   | 1,021,452 | *** *** |   | 1,021,452 |   |   | 47 | % |   |
| Handsets                  |         |                                                              |         | *** ***                                                      |       |   | 299,266 |   |   |   | 17 | % |   |   | 377,356 | *** *** |   | 378,256 |   |   | 17 | % |   |
| Service                   |         |                                                              |         | *** ***                                                      |       |   | 52,426 |   |   |   | 3 | % |   |   | 65,453 | *** *** |   | 65,454 |   |   | 3 | % |   |
|                      |         |                                                              |         | *** ***                                                      |       |   | $ 1,754,406 |   |   |   | 100 | % |   |   | $ 2,253,689 | *** *** |   | $ 2,190,018 |   |   | 100 | % |   |

 

108

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**NET SALES**

*Three months endedMarch 31, 2006 and 2005*

Net sales decreased by 33%to $602.0 million during the quarter ended March 31, 2006 compared tothe same period in 2005. The decrease is primarily due to a decrease in salesin the Broadband segment by 82% from March 31, 2005 to March 31,2006. The greater Broadband segment sales during the three months endedMarch 31, 2005 included sales of $271.9 million to Japan Telecom, anaffiliate of Softbank, primarily for the iAN8000 product. Due to the customerconcentration in the Broadband segment, revenues fluctuate based upon themagnitude and timing of revenue recognition on certain contracts. Additionally,Handset sales declined by $29.0 million, or 23%. As we have beenexperiencing in recent quarters, the demand of our PAS/iPAS products includingPAS/iPAS system based handsets in the China market continued to mature whichresulted in lower demand and average selling price. Net sales increased in ourPCD and Wireless segments and declined in the Services segment in the threemonths ended March 31, 2006, compared to the corresponding quarter infiscal 2005.

*Three and sixmonths ended June 30, 2006 and 2005*

Net sales decreased by 21% to $551.5 millionduring the quarter ended June 30, 2006 compared to the same period in2005. The decline in sales occurred across each operating segment equally, aseach segment reported sales were between 13% and 27% lower during the threemonths June 30, 2006 than the same period in the prior year. Broadbandsegment sales are concentrated with one customer, Softbank in Japan, and assuch fluctuate based upon the magnitude and timing of revenue recognition oncertain contracts. The decline in Broadband segment revenue is the result of adecline in sales to Softbank during the three months ended June 30, 2006as compared to the same period in the prior year. As we have been experiencingin the recent quarters, our PAS/iPAS wireless infrastructure products as wellas our PAS/iPAS based handsets in the China market continued to mature whichresulted in lower unit demand. In our PCD operating segment, our unit salesduring the three months ended June 30, 2006 have remained substantiallyunchanged from the comparable period in the prior year, but our average priceper unit has declined from the prior year.

Net sales were$1,153.5 million in the six months ended June 30, 2006, a decrease of28% from $1,592.6 million in the corresponding period of 2005. The overalldecrease in net sales was largely due to a decrease in sales in the Broadbandsegment of 73%, from June 30, 2005 to June 30, 2006. Broadbandsegment sales during the six months ended June 30, 2005 included one largetransaction with Softbank totaling $271.9 million of revenue on certainagreements entered into with Japan Telecom primarily for iAN8000 product. As wehave been experiencing in the recent quarters, our PAS/iPAS wirelessinfrastructure products and our PAS/iPAS based handsets in the China marketcontinued to mature, which resulted in lower unit demand. This led to adecrease in our wireless infrastructure and handset segment sales of 5% and24%, respectively, from June 30, 2005 to June 30, 2006. In our PCDoperating segment, our unit sales during the six months ended June 30,2006 did not change significantly from the comparable period in the prior year,but our average price per unit has declined leading to a 10% decline in segmentrevenue.

*Three and ninemonths ended September 30, 2006 and 2005*

Net sales increased by 1% to $600.9 millionduring the quarter ended September 30, 2006 compared to the same period in2005. While net sales increased 48% in the Network Solutions segment, salesdeclined in all other operating segments. The reported sales of the remainingsegments were between 5% and 12% lower during the three months endedSeptember 30, 2006 than the same period in the prior year. Broadbandsegment sales are concentrated with one customer, Softbank in Japan, and assuch fluctuate based upon the magnitude and timing of revenue recognition oncertain contracts. As we have been 

109

----

experiencing in the recentquarters, our PAS/iPAS wireless infrastructure products as well as our PAS/iPASbased handsets in the China market continued to mature which resulted in lowerunit demand. In our PCD operating segment, net sales decreased 10% during thethree months ended September 30, 2006 from the comparable period in theprior year, due to a decline in the number of handsets sold, partially offsetby an increase in our average price per unit.

Net sales were $1,754.4 million in the ninemonths ended September 30, 2006, a decrease of 20% from$2,190.0 million in the corresponding period of 2005. The overall decreasein net sales was largely due to a decrease in sales in the Broadband segment of63%, from September 30, 2005 to September 30, 2006. Broadband segmentsales during the nine months ended September 30, 2005 included one largetransaction with Softbank totaling $271.9 million of revenue on certainagreements entered into with Japan Telecom primarily for iAN8000 product. As wehave been experiencing in the recent quarters, our PAS/iPAS wirelessinfrastructure products and our PAS/iPAS based handsets in the China marketcontinued to mature, which resulted in lower unit demand. This led to adecrease in our handset segment sales of 21% from September 30, 2005 toSeptember 30, 2006. In our PCD operating segment, our unit sales andaverage price per unit declined during the nine months ended September 30,2006 from the comparable period in the prior year, leading to a 10% decline insegment revenue.

Net sales revenue bygeography shifted in comparison to the corresponding period of 2005. Revenuederived from China remained relatively constant, accounting for approximately34% of our net sales revenue in the nine months ended September 30, 2006,in comparison to approximately 30% in the corresponding period last year.Revenue derived from the United States accounted for approximately 52% of ournet sales revenue in the nine months ended September 30, 2006, incomparison to approximately 45% in the corresponding period last year. Due tothe completion of a large contract during 2005, revenue from Japan accountedfor approximately 7% of our net sales revenue in the nine months ended September 30,2006, in comparison to approximately 18% for the comparable period in the prioryear.

**GROSS PROFIT**

| ** **                     | ** **   | **Three months ended  March 31, 2006** | ** **     | **Three months ended  June 30, 2006** | ** ** | **Three months ended  September 30, 2006** | ** **     |
|--------------------------------|--------------|------------------------------------------------------------|----------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|----------------|
| ** **                     | ** **   | **As previously  reported**                           | ** **     | **As restated**                                      | ** ** | **% of net  sales**                                  | ** **     | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** | ** ** | ** ** | ** ** | ** ** | **% of net  sales** | ** ** |
| ** **                     | ** **   | **(in thousands)**                                    | ** **     | ** **                                                | ** ** | **(in thousands)**                                        | ** **     | ** ** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** | *** *** |                                                       | *** ***   | *** ***                                              |       |                                                           | *** ***   | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband Infrastructure       |         |                                                       | $ 22,957  | *** ***                                              |       |                                                           | $ 23,086  | *** *** |   |   | 40 | % |   |   | $   4,852 | *** *** |   |   | $   4,889 | *** *** |   |   | 11 | % |   |   |   |   |   |   | $   (837 | ) |   |   | (2 | )% |   |
| Wireless Infrastructure        |         |                                                       | 49,517         | *** ***                                              |       |                                                           | 50,761         | *** *** |   |   | 48 | % |   |   | 54,240 | *** *** |   |   | 53,857 | *** *** |   |   | 46 | % |   |   |   |   |   |   | 54,217 |   |   |   | 49 | % |   |
| Network Solutions              |         |                                                       | 72,474         | *** ***                                              |       |                                                           | 73,847         | *** *** |   |   | 45 | % |   |   | 59,092 | *** *** |   |   | 58,746 | *** *** |   |   | 37 | % |   |   |   |   |   |   | 53,380 |   |   |   | 33 | % |   |
| PCD                            |         |                                                       | 14,434         | *** ***                                              |       |                                                           | 14,389         | *** *** |   |   | 4 | % |   |   | 12,322 | *** *** |   |   | 12,321 | *** *** |   |   | 5 | % |   |   |   |   |   |   | (7,057 | ) |   |   | (2 | )% |   |
| Handsets                       |         |                                                       | 31,599         | *** ***                                              |       |                                                           | 31,613         | *** *** |   |   | 32 | % |   |   | 32,894 | *** *** |   |   | 32,896 | *** *** |   |   | 31 | % |   |   |   |   |   |   | 24,012 |   |   |   | 26 | % |   |
| Services                       |         |                                                       | 3,947          | *** ***                                              |       |                                                           | 3,942          | *** *** |   |   | 23 | % |   |   | 4,978 | *** *** |   |   | 4,987 | *** *** |   |   | 29 | % |   |   |   |   |   |   | 4,466 |   |   |   | 25 | % |   |
|                           |         |                                                       | $ 122,454 | *** ***                                              |       |                                                           | $ 123,791 | *** *** |   |   | 21 | % |   |   | $ 109,286 | *** *** |   |   | $ 108,950 | *** *** |   |   | 20 | % |   |   |   |   |   |   | $ 74,801 |   |   |   | 12 | % |   |

 

| ** **                     | ** **   | **Three months ended  March 31, 2005** | ** **     | **Three months ended  June 30, 2005** | ** ** | **Three months ended  September 30, 2005** | ** **     |
|--------------------------------|--------------|------------------------------------------------------------|----------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|----------------|
| ** **                     | ** **   | **As previously  reported**                           | ** **     | **As restated**                                      | ** ** | **% of net  sales**                                  | ** **     | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **                     | ** **   | **(in thousands)**                                    | ** **     | ** **                                                | ** ** | **(in thousands)**                                        | ** **     | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** | *** *** |                                                       | *** ***   | *** ***                                              |       |                                                           | *** ***   | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband Infrastructure       |         |                                                       | $ 164,057 | *** ***                                              |       |                                                           | $ 164,076 | *** *** |   |   | 50 | % |   |   | $ 16,739 | *** *** |   |   | $ 16,757 | *** *** |   |   | 30 | % |   |   | $ (13,971 | ) |   |   | $ (13,875 | ) |   |   | (45 | )% |   |
| Wireless Infrastructure        |         |                                                       | 29,670         | *** ***                                              |       |                                                           | 24,667         | *** *** |   |   | 25 | % |   |   | 45,964 | *** *** |   |   | 36,662 | *** *** |   |   | 27 | % |   |   | 32,381 |   |   |   | 16,332 |   |   |   | 21 | % |   |
| Network Solutions              |         |                                                       | 193,727        | *** ***                                              |       |                                                           | 188,743        | *** *** |   |   | 44 | % |   |   | 62,703 | *** *** |   |   | 53,419 | *** *** |   |   | 28 | % |   |   | 18,410 |   |   |   | 2,457 |   |   |   | 2 | % |   |
| PCD                            |         |                                                       | 13,692         | *** ***                                              |       |                                                           | 13,692         | *** *** |   |   | 4 | % |   |   | 15,990 | *** *** |   |   | 15,990 | *** *** |   |   | 5 | % |   |   | 13,199 |   |   |   | 13,199 |   |   |   | 4 | % |   |
| Handsets                       |         |                                                       | 14,539         | *** ***                                              |       |                                                           | 14,539         | *** *** |   |   | 11 | % |   |   | 20,800 | *** *** |   |   | 20,800 | *** *** |   |   | 14 | % |   |   | 12,746 |   |   |   | 13,633 |   |   |   | 13 | % |   |
| Services                       |         |                                                       | 15,466         | *** ***                                              |       |                                                           | 15,466         | *** *** |   |   | 69 | % |   |   | 12,645 | *** *** |   |   | 12,645 | *** *** |   |   | 53 | % |   |   | 8,599 |   |   |   | 8,598 |   |   |   | 45 | % |   |
|                           |         |                                                       | $ 237,424 | *** ***                                              |       |                                                           | $ 232,440 | *** *** |   |   | 26 | % |   |   | $ 112,138 | *** *** |   |   | $ 102,854 | *** *** |   |   | 15 | % |   |   | $ 52,954 |   |   |   | $ 37,887 |   |   |   | 6 | % |   |

 

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| ** **                     | ** **   | **Six months ended  June 30, 2006** | ** **   | **Six months ended  June 30, 2005** | ** **   |
|--------------------------------|--------------|---------------------------------------------------------|--------------|---------------------------------------------------------|--------------|
| ** **                     | ** **   | **As previously  reported**                        | ** **   | **As restated**                                    | ** **   | **% of net  sales** | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **                     | ** **   | **(in thousands)**                                 | ** **   | ** **                                              | ** **   | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** | *** *** |                                                    | *** *** | *** ***                                            |         |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband  Infrastructure      |         |                                                    | $            | 27,809                                                  | *** *** |   |   | $ | 27,975 | *** *** |   |   | 27 | % |   |   | $ | 180,796 | *** *** |   |   | $ | 180,833 | *** *** |   |   | 47 | % |   |
| Wireless  Infrastructure       |         |                                                    | 103,757      | *** ***                                            |         |   | 104,618 | *** *** |   |   | 47 | % |   |   | 75,634 | *** *** |   |   | 61,329 | *** *** |   |   | 26 | % |   |
| Network Solutions              |         |                                                    | 131,566      | *** ***                                            |         |   | 132,593 | *** *** |   |   | 41 | % |   |   | 256,430 | *** *** |   |   | 242,162 | *** *** |   |   | 39 | % |   |
| PCD                            |         |                                                    | 26,756       | *** ***                                            |         |   | 26,710 | *** *** |   |   | 5 | % |   |   | 29,682 | *** *** |   |   | 29,682 | *** *** |   |   | 5 | % |   |
| Handsets                       |         |                                                    | 64,493       | *** ***                                            |         |   | 64,509 | *** *** |   |   | 31 | % |   |   | 35,339 | *** *** |   |   | 35,339 | *** *** |   |   | 13 | % |   |
| Services                       |         |                                                    | 8,925        | *** ***                                            |         |   | 8,929 | *** *** |   |   | 26 | % |   |   | 28,111 | *** *** |   |   | 28,111 | *** *** |   |   | 60 | % |   |
|                           |         |                                                    | $            | 231,740                                                 | *** *** |   |   | $ | 232,741 | *** *** |   |   | 20 | % |   |   | $ | 349,562 | *** *** |   |   | $ | 335,294 | *** *** |   |   | 21 | % |   |

 

| ** **                     | ** **   | **Nine months ended  September 30, 2006** | ** **   | **Nine months ended  September 30, 2005** | ** ** |
|--------------------------------|--------------|---------------------------------------------------------------|--------------|---------------------------------------------------------------|------------|
| ** **                     | ** **   | ** **                                                    | ** **   | ** **                                                    | ** ** | **% of net  sales** | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** | **% of net  sales** | ** ** |
| ** **                     | ** **   | ** **                                                    | ** **   | **(in thousands)**                                       | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** | *** *** |                                                          | *** *** | *** ***                                                  |       |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband  Infrastructure      |         |                                                          |         | *** ***                                                  |       |   | $ | 27,138 | *** *** |   |   | 18 | % |   |   | $ | 166,825 | *** *** |   |   | $ | 166,958 | *** *** |   |   | 40 | % |   |
| Wireless  Infrastructure       |         |                                                          |         | *** ***                                                  |       |   | 158,835 | *** *** |   |   | 48 | % |   |   | 108,015 | *** *** |   |   | 77,661 | *** *** |   |   | 25 | % |   |
| Network Solutions              |         |                                                          |         | *** ***                                                  |       |   | 185,973 | *** *** |   |   | 38 | % |   |   | 274,840 | *** *** |   |   | 244,619 | *** *** |   |   | 34 | % |   |
| PCD                            |         |                                                          |         | *** ***                                                  |       |   | 19,653 | *** *** |   |   | 2 | % |   |   | 42,881 | *** *** |   |   | 42,881 | *** *** |   |   | 4 | % |   |
| Handsets                       |         |                                                          |         | *** ***                                                  |       |   | 88,521 | *** *** |   |   | 30 | % |   |   | 48,085 | *** *** |   |   | 48,972 | *** *** |   |   | 13 | % |   |
| Services                       |         |                                                          |         | *** ***                                                  |       |   | 13,395 | *** *** |   |   | 26 | % |   |   | 36,710 | *** *** |   |   | 36,709 | *** *** |   |   | 56 | % |   |
| ** **                     |         |                                                          |         | *** ***                                                  |       |   | $ | 307,542 | *** *** |   |   | 18 | % |   |   | $ | 402,516 | *** *** |   |   | $ | 373,181 | *** *** |   |   | 17 | % |   |

 

*Three months ended March 31,2006 and 2005*

Gross profit was$123.8 million, or 21% of net sales, in the three months ended March 31,2006, compared to $232.4 million, or 26% of net sales, in thecorresponding quarter of 2005. The overall gross profit decrease is due to adecline in sales and lower gross profit percentages in the Broadband segment.Broadband Infrastructure net sales during the three months ended March 31,2005 included one large transaction with Softbank totaling $271.9 millionof revenue on certain agreements entered into with Japan Telecom primarily forthe iAN8000 product in 2005. Gross profit percentages improved in the Wirelessand Handset segments, declined in the Broadband and Services segments, andremained the same in PCD. Gross profit as a percentage of sales in the WirelessInfrastructure segment increased by 23 percentage points in the threemonths ended March 31, 2006, as compared to the corresponding quarter in2005 due to a number of factors, including: (i) The margins on PASinfrastructure improved due to a shift in product mix towards higher margincell sites as well as a reduction in product discounts given; (ii) animprovement in inventory management resulting in a decrease in excess inventorywrite-downs; and (iii) sales of voice and data networks softwaretotaling $8.6 million which has nearly 100% gross margins. Gross profit asa percentage of sales for our handsets segment increased by 21 percentagepoints in the three months ended March 31, 2006, as compared to thecorresponding quarter in 2005. A portion of the improvement in the gross profitpercentage relates to increased use of chip-sets with greater functionality inPAS handsets that reduce the overall component costs of each unit. Additionalfactors leading to the improvement in gross profit is a reduction in scrap,variances and warranty costs.

*Three and sixmonths ended June 30, 2006 and 2005*

Gross profit was $109.0 million, or 20% of netsales, in the three months ended June 30, 2006, compared to$102.9 million, or 15% of net sales, in the corresponding quarter of 2005.The overall gross 

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profit increased due toimproved gross profit percentages in the Wireless Infrastructure and Handsetsegments, partially offset by a decline in sales and lower gross profitpercentages in our Broadband Infrastructure and Services segments.

Gross profit was$232.7 million, or 20% of net sales, in the six months ended June 30,2006, compared to $335.3 million, or 21% of net sales as restated, in thecorresponding period of 2005. The decline in gross profit dollars primarilyreflects an 85% decrease in the Broadband Infrastructure segment. As mentionedpreviously, revenue from the Broadband Infrastructure segment is concentratedwith one customer in Japan and a significant contract was recognized as revenueduring the first quarter of 2005. There was no similar-sized transactionin the Broadband Infrastructure segment during the six months ended June 30,2006. Gross profit percentages improved in the Wireless and Handset segments,declined in the Broadband Infrastructure and Services segments and remained thesame in PCD.

*Three and ninemonths ended September 30, 2006 and 2005*

Gross profit was $74.8 million, or 12% of net sales,in the three months ended September 30, 2006, compared to$37.9 million, or 6% of net sales in the corresponding quarter of 2005. Theoverall gross profit increased in real terms even though net sales declined,due to significant increase in gross profit percentages in our BroadbandInfrastructure, Wireless, and Handsets segments.

Gross profit was$307.5 million, or 18% of net sales, in the nine months ended September 30,2006, compared to $373.2 million, or 17% of net sales in the correspondingperiod of 2005. While the gross profit percentage remained relatively constant,Broadband Infrastructure gross profit dollars decreased $139.8 million dueto a decline in sales of $261.4 million and a decrease in the gross profitpercentage from 40% during the nine months ended September 30, 2005 to 18%in the corresponding period of 2006. As mentioned previously, revenue from theBroadband Infrastructure segment was concentrated with one customer in Japanand a significant contract was recognized as revenue during the first quarterof 2005. There was no similar-sized transaction in the BroadbandInfrastructure segment during the nine months ended September 30, 2006. Thedecrease in gross profit resulting from the Broadband Infrastructure segmentwas partially offset by increased gross profit dollars resulting fromimprovement in gross profit percentages in the Wireless Infrastructure andHandset segments.

**OPERATING EXPENSES**

| ** **                                  | ** ** | **Three months ended  March 31, 2006** | ** ** | **Three months ended  June 30, 2006** | ** ** | **Three months**        | ** ** |
|---------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **As  previously  reported**                               | ** ** | **As restated**                                      | ** ** | **As  previously  reported** | ** ** | **As restated** | ** ** | **ended  September 30,  2006** | ** ** |
| ** **                                  | ** ** | **(in thousands)**                                    | ** ** |
| Selling, general  and administrative        |       | $                                                          | 83,172     |                                                      |       | $                            | 83,724     |   |   | $ | 82,423 |   |   | $ | 83,109 |   |   |   | $ | 80,076 |   |   |
| Research and  development                   |       | 46,309                                                     |       |                                                      | 46,402     |                         |       | 46,743 |   |   | 46,603 |   |   |   | 46,305 |   |   |
| Amortization of  intangible assets          |       | 4,925                                                      |       |                                                      | 4,925      |                         |       | 4,821 |   |   | 4,821 |   |   |   | 4,821 |   |   |
| Gain on sale of semiconductor design assets |       | —                                                     |       |                                                      | —     |                         |       | — |   |   | — |   |   |   | (12,291 | ) |   |
|                                        |       | $                                                          | 134,406    |                                                      |       | $                            | 135,051    |   |   | $ | 133,987 |   |   | $ | 134,533 |   |   |   | $ | 118,911 |   |   |

 

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| ** **                           | ** ** | **Three months ended  March 31, 2005** | ** ** | **Three months ended  June 30, 2005** | ** ** | **Three months ended  September 30, 2005** | ** ** |
|--------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                           | ** ** | **As  previously  reported**                               | ** ** | **As restated**                                      | ** ** | **As  previously  reported**                                   | ** ** | **As restated** | ** ** | **As  previously  reported** | ** ** | **As restated** | ** ** |
| ** **                           | ** ** | **(in thousands)**                                    | ** ** |
| Selling, general  and administrative |       | $                                                          | 109,011    |                                                      |       | $                                                              | 107,886    |   |   | $ | 103,009 |   |   | $ | 103,087 |   |   | $ | 86,362 |   |   | $ | 86,414 |   |   |
| Research and  development            |       | 66,260                                                     |       |                                                      | 65,831     |                                                           |       | 65,621 |   |   | 65,650 |   |   | 60,797 |   |   | 60,817 |   |   |
| Amortization of  intangible assets   |       | 6,972                                                      |       |                                                      | 6,972      |                                                           |       | 6,776 |   |   | 6,776 |   |   | 6,643 |   |   | 6,643 |   |   |
| Impairment of  long-lived assets     |       | —                                                     |       |                                                      | —     |                                                           |       | — |   |   | — |   |   | 218,094 |   |   | 218,094 |   |   |
| Restructuring                        |       | —                                                     |       |                                                      | —     |                                                           |       | 15,127 |   |   | 15,127 |   |   | 3,378 |   |   | 3,378 |   |   |
| In-process  research and development |       | —                                                     |       |                                                      | —     |                                                           |       | 660 |   |   | 660 |   |   | — |   |   | — |   |   |
|                                 |       | $                                                          | 182,243    |                                                      |       | $                                                              | 180,689    |   |   | $ | 191,193 |   |   | $ | 191,300 |   |   | $ | 375,274 |   |   | $ | 375,346 |   |   |

 

| ** **                           | ** ** | **Six months ended  June 30, 2006** | ** ** | **Six months ended  June 30, 2005** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | **As  previously  reported**                            | ** ** | **As restated**                                    | ** ** | **As  previously  reported** | ** ** | **As restated** | ** ** |
| ** **                           | ** ** | **(in thousands)**                                 | ** ** |
| Selling, general  and administrative |       | $                                                       | 165,593    |                                                    |       | $ | 166,833 |   |   | $ | 212,020 |   |   | $ | 210,974 |   |   |
| Research and  development            |       | 93,052                                                  |       |                                                    | 93,005     |   |   | 131,881 |   |   | 131,481 |   |   |
| Amortization of  intangible assets   |       | 9,746                                                   |       |                                                    | 9,746      |   |   | 13,748 |   |   | 13,748 |   |   |
| Restructuring                        |       | —                                                  |       |                                                    | —     |   |   | 15,127 |   |   | 15,127 |   |   |
| In-process  research and development |       | —                                                  |       |                                                    | —     |   |   | 660 |   |   | 660 |   |   |
|                                 |       | $                                                       | 268,391    |                                                    |       | $ | 269,584 |   |   | $ | 373,436 |   |   | $ | 371,990 |   |   |

 

| ** **                                  | ** ** | **Nine months**                     | ** ** | **Nine months ended  September 30, 2005** | ** ** |
|---------------------------------------------|------------|-------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                  | ** ** | **ended  September 30,  2006** | ** ** | **As  previously  reported**                                  | ** ** | **As restated** | ** ** |
| ** **                                  | ** ** | **(in thousands)**             | ** ** |
| Selling, general  and administrative        |       |                                | $          | 246,908                                                       |       |   | $ | 298,384 |   |   | $ | 297,390 |   |   |
| Research and  development                   |       |                                | 139,310    |                                                          |       | 192,678 |   |   | 192,297 |   |   |
| Amortization of  intangible assets          |       |                                | 14,567     |                                                          |       | 20,391 |   |   | 20,391 |   |   |
| Gain on sale of semiconductor design assets |       |                                | (12,291    | )                                                             |       | — |   |   | — |   |   |
| Impairment of  long-lived assets            |       |                                | —     |                                                          |       | 218,094 |   |   | 218,094 |   |   |
| Restructuring                               |       |                                | —     |                                                          |       | 18,505 |   |   | 18,505 |   |   |
| In-process  research and development        |       |                                | —     |                                                          |       | 660 |   |   | 660 |   |   |
|                                        |       |                                | $          | 388,494                                                       |       |   | $ | 748,712 |   |   | $ | 747,337 |   |   |

 

*SELLING, GENERALAND ADMINISTRATIVE*

*Three months ended March 31,2006 and 2005*

Selling, general and administrative expenses decreased$24.2 million but increased to 14% of net sales during the three monthsended March 31, 2006 compared to 12% of net sales for the same period in2005. The decrease in SG&A expenses was primarily due to a$16.7 million decrease in our provision for doubtful accounts compared tothe same period in 2005. Approximately $4.5 million in reduction was dueto lower travel and entertainment costs, particularly in the China operations.In addition, there were reductions in expenses across all entities due toexpense controls. Days sales outstanding was 74 days at March 31,2006 as compared to 91 days at March 31, 2005. The shorter days salesoutstanding and resultant decrease in provision for doubtful accounts is theresult of improved cash collections in the first quarter of 2006 relative tothe comparable period in 2005.

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In the first quarter of2006, we decided to terminate the Mongolian joint venture arrangement and wroteoff the remaining net assets of approximately $4.7 million.

*Three and sixmonths ended June 30, 2006 and 2005*

Selling, general and administrative expenses decreased$20.0 million but remained relatively consistent as a percentage of netsales during the three months ended June 30, 2006 compared to the sameperiod in 2005. The decrease in SG&A expenses was primarily due to a$13.7 million decrease in our provision for doubtful accounts compared tothe same period in 2005. In addition, there were reductions in expenses acrossall entities due to expense controls. Days sales outstanding was 69 daysat June 30, 2006 as compared to 109 days at June 30, 2005. Theshorter days sales outstanding and resulting decrease in provision for doubtfulaccounts was the result of improved cash collections for the three months endedJune 30, 2006 relative to the comparable period in 2005.

SG&A expenses were$166.8 million and $211.0 million in the six months ended June 30,2006 and 2005, respectively. SG&A expenses as a percentage of net saleswere 14% and 13% the six months ended June 30, 2006 and 2005,respectively. The decrease in SG&A expenses was primarily due to a$30.5 million decrease in our provision for doubtful accounts compared tothe same period in 2005. In addition, there were reductions in expenses acrossall entities due to expense controls. Days sales outstanding was 72 daysat June 30, 2006 as compared to 99 days at June 30, 2005. Theshorter days sales outstanding and resulting decrease in provision for doubtfulaccounts was the result of improved cash collections in the three months ended June 30,2006 relative to the comparable period in 2005.

*Three and ninemonths ended September 30, 2006 and 2005*

Selling, general and administrative expenses decreased$6.3 million during the three months ended September 30, 2006compared to the same period in 2005. The decrease in SG&A expenses wasprimarily due to a $14.7 million decrease in our provision for doubtfulaccounts compared to the same period in 2005. Days sales outstanding was64 days at September 30, 2006 as compared to 86 days at September 30,2005. The shorter days sales outstanding and resulting decrease in provisionfor doubtful accounts was the result of improved cash collections in the threemonths ended September 30, 2006 relative to the comparable period in 2005.In addition, there were reductions in expenses due to expense controls. Thesecost savings were partially offset by a value added tax expense of $7.9 millionresulting from an audit of our 2003 through 2005 tax years by China taxauthorities.

SG&A expenses were$246.9 million and $297.4 million in the nine months ended September 30,2006 and 2005, respectively. SG&A expenses as a percentage of net saleswere 14% and 14% for the nine months ended September 30, 2006 and 2005,respectively. The decrease in SG&A expenses was primarily due to a$45.1 million decrease in our provision for doubtful accounts compared tothe same period in 2005. Days sales outstanding was 69 days at September 30,2006 as compared to 95 days at September 30, 2005. The shorterdays sales outstanding and resulting decrease in provision for doubtfulaccounts was the result of improved cash collections in the nine months ended September 30,2006 relative to the comparable period in 2005. In addition, there werereductions in expenses due to expense controls. These cost savings werepartially offset by a value added tax expense of $7.9 million resulting from anaudit of our 2003 through 2005 tax years by China tax authorities.

*RESEARCH ANDDEVELOPMENT*

*Three months ended March 31,2006 and 2005*

Research and development (“R&D”)expenses decreased by $19.4 million but increased by 1% as a percentage ofnet sales during the three months ended March 31, 2006 compared to thesame period in 2005. The absolute decrease in R&D expenses can beattributed to a decrease in headcount of 

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approximately778 employees resulting from restructuring activities and the transfer ofengineers as part of the sale of ACD. Personnel related expenses decreased by$4.7 million and facility and depreciation costs decreased by $5.6 millionas a result of restructuring and write down of R&D equipment. Additionally,professional services decreased by $3.6 million due to a decreased use ofconsultants.

*Three and sixmonths ended June 30, 2006 and 2005*

R&D expenses were $46.6 million, or 8% of netsales, in the three months ended June 30, 2006, compared to$65.7 million, or 9% of net sales, in the corresponding period of 2005. Thedecrease of $19.0 million in absolute dollars of R&D expenses canbe primarily attributed to the decreased headcount of approximately 778employees resulting from restructuring activities and the transfer of engineersas part of the sale of ACD. Personnel related expenses decreased by$5.5 million and facility and depreciation cost decreased by $6.2 millionas a result of restructuring and write down of R&D equipment. Additionally,professional services costs decreased by $2.5 million due to a decreaseduse of consultants.

R&D expenses were$93.0 million and $131.5 million or 8% and 8% of net sales, in thesix months ended June 30, 2006 and 2005, respectively. In absolute dollars, R&D expenses decreased by$38.5 million, primarily due to a decrease in facility and depreciationcosts of $11.8 million as a result of restructuring and write-down ofR&D equipment. Also, there was a decrease in personnel expenses, includingpayroll, payroll taxes and benefits totaling $10.2 million resulting fromthe decreased headcount as described above. In addition, the decrease inR&D expenses also can be attributed to decreased a professional costs of$6.0 million associated with decreased use of consultants.

*Three and ninemonths ended September 30, 2006 and 2005*

Research and development expenses were$46.3 million, or 8% of net sales, in the three months ended September 30,2006, compared to $60.8 million, or 10% of net sales in the correspondingperiod of 2005. The decrease of $14.5 million in absolute dollars ofR&D expenses can be primarily attributed to the decreased headcount ofapproximately 778 employees resulting from restructuring activities and thetransfer of engineers as part of the sale of ACD. Personnel related expensesdecreased by $3.9 million and equipment, facility and depreciation costdecreased by $8.5 million as a result of restructuring and write down ofR&D equipment.

R&D expenses were$139.3 million and $192.3 million, or 8% and 9% of net sales, in the ninemonths ended September 30, 2006 and 2005, respectively. In absolutedollars, R&D expenses decreased by $53.0 million, primarily due to adecrease in equipment, facility and depreciation costs of $25.4 million asa result of restructuring and write-down of R&D equipment. Also, there wasa decrease in personnel expenses, including payroll, payroll taxes and benefitstotaling $14.1 million resulting from the decreased headcount as describedabove. In addition, the decrease in R&D expenses can be attributed in partto a $7.1 million cost savings resulting from a decreased use ofconsultants.

*ASSET IMPAIRMENT*

*Three andnine months ended September 30, 2005*

Due to the existence ofimpairment indicators in September 2005, it was determined that there weresignificant adverse changes in the business outlook which could indicate thecarrying value of certain of our long-lived asset groups may not berecoverable and could indicate the fair value of our reporting units may bebelow their carrying value. We performed interim impairment tests on goodwilland certain other long lived assets. As a result of the impairment test, werecorded an impairment charge of long-lived assets of $218.1 millionfor the quarter ended September 30, 2005. This impairment charge consistedof $192.9 million of goodwill, $1.7 million of intangible assetsand $23.5 million of property, plant and equipment.

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*RESTRUCTURING COSTS*

*Three and sixmonths ended June 30, 2006 and 2005*

In the second quarter of the fiscal year 2005, weannounced and initiated a restructuring plan to rationalize our cost structurein response to the decline in demand for certain of our products. In addition,the restructuring plan was designed to allow us to reduce break-even revenuesfor each product line, align investments with key growth opportunities andfacilitate the process of globalization.

During the three and sixmonths ended June 30, 2005, we incurred approximately $15.1 millionin operating expenses relating to the restructuring plan actions, primarilyconsisting of $7.6 million in severance payments, $7.5 million inasset impairments primarily related to the impairment of equipment and licensesassociated with discontinued products. Included in the restructuring costs of$15.1 million are non-cash charges of $6.9 million in assetimpairments. We made cash payments of $6.3 million for severance and otherbenefits, and $2.7 million of accrued expenses. As part of the restructuringplan, during the three and six months ended June 30, 2005 we recorded$5.6 million in inventory write-off which was associated with discontinuedproducts. Restructuring expense related to the inventory write-off was includedin cost of sales in the consolidated statements of operations.

*Three andnine months ended September 30, 2005*

During the three months ended September 30, 2005,the Company incurred approximately $3.4 million in expenses in relation tothe restructuring plan actions, consisting of $2.1 million related toseverance payments and $1.2 million in asset impairments primarily relatedto the write-off of equipment and licenses associated with discontinuedproducts.

During thenine months ended September 30, 2005, the Company incurred approximately$18.5 million in operating expenses in relation to the restructuring planactions, primarily consisting of $9.8 million related to severancepayments and $8.7 million in asset impairments primarily related to theimpairment of equipment and licenses associated with discontinued products.Included in the restructuring costs of $18.5 million are non-cashcharges of $7.6 million in asset impairments. We made cash payments of$10.5 million for severance and other benefits, and $1.1 million ofaccrued expenses. As part of the restructuring plan, during thenine months ended September 30, 2005 we recorded $5.6 million ininventory write-off which is associated with discontinued products.Restructuring expense related to the inventory write-off was included incost of sales in the consolidated statements of operations. As of the end ofthe third quarter of 2005 approximately 965 employees had been terminated orplaced in workforce reduction programs.

*GAIN ONEXTINGUISHMENT OF DEBT*

*Three and sixmonths ended June 30, 2006 and 2005*

Gain on extinguishment of debt, net of write-off ofunamortized issuance expenses, was $11.1 million for the three and six monthsended June 30, 2005. In June 2005, 1,482,000 shares of our commonstock with a fair value of approximately $10.6 million and approximately $15.8million in cash were exchanged for $38.0 million aggregate principal amount ofour outstanding convertible subordinated notes due 2008. There was noextinguishment of debt during the six months ended June 30, 2006.

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*Three and nine months ended September 30, 2006and 2005*

Gain on extinguishment ofdebt, net of write-off of unamortized issuance expenses, was $20.3 million and$31.4 million for the three and nine months ended September 30, 2005,respectively. In June 2005, 1,482,000 shares of our common stock with afair value of approximately $10.6 million and approximately $15.8 million incash were exchanged for $38.0 million aggregate principal amount of ouroutstanding convertible subordinated notes due 2008. In the third quarter of2005, we completed four additional exchanges wherein we exchanged a total of3,506,100 shares of our common stock with a fair value of approximately $27.0million and approximately $41.4 million in cash for $89.9 million aggregateprincipal amount of our notes. There was no extinguishment of debt during thenine months ended September 30, 2006.

**OTHER INCOME(EXPENSE)**

*Three months endedMarch 31, 2006 and 2005*

Net other income (expense)was income of $3.6 million and expense of $6.8 million for the threemonths ended March 31, 2006 and 2005, respectively. Net other income forthe three months ended March 31, 2006 was primarily due to a$2.8 million gain on foreign currency revaluation and a $0.5 millionfinancial subsidy from the local Chinese government. Net other expense for thethree months ended March 31, 2005 was primarily due to a $7.8 millionloss on foreign currency revaluation, offset by consumption tax refunds inJapan of $1.2 million and a $0.5 million financial subsidy from thelocal Chinese government.

*Three and sixmonths ended June 30, 2006 and 2005*

Net other income was $6.9 million and net otherexpense was $2.2 million for the three months ended June 30, 2006 and2005, respectively. Net other income for the three months ended June 30,2006 primarily consisted of $2.9 million of currency exchange and$2.5 million for a gain on sales of assets. For the three months endedJune 30, 2005, net other expense consisted of foreign exchange losses of$6.8 million, partially offset by a $4.8 million Japan consumptiontax refund

Net other income was$10.5 million and net other expense was $9.1 million for the sixmonths ended June 30, 2006 and 2005, respectively. Net other income forthe six months ended June 30, 2006 primarily consisted of gains fromforeign exchange of $5.7 million and a gain on the sale of an asset of$2.5 million. Net other expense for the six months ended June 30,2005 primarily consisted of a foreign exchange loss of $14.6 million,partially offset by a $6.0 million consumption tax refund in JapanYen-denominated sales and accounts receivable were significantly higher duringthe six months ended June 30, 2005 as compared to the same period in 2004.As such, we incurred a $14.6 million unrealized loss in foreign exchange dueto the weakened Japanese Yen against the US dollar for the six months endedJune 30, 2005.

*Three and ninemonths ended September 30, 2006 and 2005*

Net other income was $1.8 million and$7.4 million for the three months ended September 30, 2006 and 2005,respectively. Net other income for the three months ended September 30,2006 primarily consisted of dividend income of $1.0 million. Net otherincome for the three months ended September 30, 2005 primarily consistedof foreign exchange gains of $7.3 million. The foreign exchange gains wereprimarily the result of gains for the company’s China subsidiaries attributedto the appreciation of the Chinese Renminbi on US dollar denominated short-termdebt and payables, offset by a loss attributed to the appreciation of the USdollar on Japanese Yen denominated cash and accounts receivable.

Net other income was$12.3 million for the nine months ended September 30, 2006 and netother expense was $1.7 million for the nine months ended September 30,2005. Net other income for the 

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nine monthsended September 30, 2006 primarily consisted of gains from foreignexchange of $6.1 million, a $2.5 million gain on the sale of assets toCellon and dividend income of $1.7 million. Net other income for the ninemonths ended September 30, 2005 primarily consisted of a $6.0 millionconsumption tax refund in Japan offset by a foreign exchange loss of$7.3 million.

**INCOME TAX EXPENSE**

*Three months endedMarch 31, 2006 and 2005*

Income tax expense was$2.8 million and $5.5 million for the three months endedMarch 31, 2006 and 2005, respectively. The Company’s 2006 annual effectivetax rate is estimated to be negative 14%. There are two primary reasons for thenegative 14% effective tax rate. First, we have not provided any tax benefit onthe forecasted current year losses incurred and tax credits generated in theUnited States and other countries, because management believes that it is morelikely than not that the tax benefit associated with these losses will not berealized. Second, we continue to accrue tax expense in jurisdictions where wehave been historically profitable. Estimates of the annual effective tax rateat the end of the interim periods are based on evaluations of possible futureevents and transactions and may be subject to subsequent refinement orrevision.

*Three and sixmonths ended June 30, 2006 and 2005*

Income tax expense was $4.7 million and$3.3 million for the three months ended June 30, 2006 and 2005,respectively. Our 2006 annual effective tax rate is estimated to be negative17%. There are two primary reasons for the negative 17% effective tax rate.First, we have not provided any tax benefit on the forecasted current yearlosses incurred and tax credits generated in the United States and othercountries, because management believes that it is more likely than not that thetax benefit associated with these losses will not be realized. Second, wecontinue to accrue tax expense in jurisdictions where we have been historicallyprofitable. Estimates of the annual effective tax rate at the end of theinterim periods are based on evaluations of possible future events andtransactions and may be subject to subsequent refinement or revision.

Income tax expense was$7.5 million and $8.8 million for the six months ended June 30,2006 and 2005, respectively. In the six months ended June 30, 2005, taxexpense consisted of $9.0 million primarily relating to the valuation ofour deferred tax assets in China.

*Three and ninemonths ended September 30, 2006 and 2005*

Income tax expense was $1.5 million and $125.2million for the three months ended September 30, 2006 and 2005,respectively. There are two primary reasons why the Company has tax expensewhile the Company has pretax losses. First, we have not provided any taxbenefit on the forecasted current year losses incurred and tax creditsgenerated in the United States and other countries, because management believesthat it is more likely than not that the tax benefit associated with theselosses will not be realized. Second, we continue to accrue tax expense injurisdictions where we have been historically profitable. Estimates of theannual effective tax rate at the end of the interim periods are based onevaluations of possible future events and transactions and may be subject tosubsequent refinement or revision. As of September 30, 2005, we did notbelieve it was more likely than not that we would generate a sufficient leveland proper mix of taxable income within the appropriate period to utilize allthe deferred tax assets. As a result of the review undertaken atSeptember 30, 2005, we have concluded that it was appropriate to establisha full valuation allowance for the net deferred tax assets which the cumulativelosses weigh heavily in the overall assessment. Accordingly, we recorded a $116.6million non-cash charge at September 30, 2005 in the United Statesand China.

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Income tax expense was$9.0 million and $134.0 million for the nine months endedSeptember 30, 2006 and 2005, respectively. In the nine months endedSeptember 30, 2005 we recorded a $116.6 million non-cash charge to providea full valuation allowance on our remaining net deferred tax assets atSeptember 30, 2005 in the United States and China.

**CRITICAL ACCOUNTINGPOLICIES 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 of operations.

***RevenueRecognition***

Revenues from sales of telecommunications equipmentand handsets are recognized when persuasive evidence of an arrangement exists,delivery has occurred, the fee is fixed or determinable and collectibility isprobable. If the payment due from the customer is not fixed or determinable dueto extended payment terms, revenue is recognized as payments become due andpayable by the customer, assuming all other criteria for revenue recognitionare met. Any payments received prior to revenue recognition are recorded ascustomer advances. Normal payment terms differ for various reasons amongstdifferent customer regions, depending upon common business practices forcustomers within a region. Billing to customers for shipping and handling are recordedas revenues and the associated costs are recorded as costs of revenues. Anyexpected losses on contracts are recognized when identified on an individualbasis in accordance with the prevailing accounting guidance for the respectivecontract.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the area of contracts with multiple deliverable elements(multiple element arrangements). Where multiple elements exist in an arrangement,the contract price is allocated to the different elements based upon and inproportion to verifiable objective evidence of the fair value of the variouselements, as governed under Emerging Issues Task Force Issue (“EITF”)No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables,” and SEC Staff Accounting Bulletin No. 104, “RevenueRecognition.” Multiple element arrangements primarily involve the sale ofequipment, installation, training and post-contract support. Revenue is recognizedas each element is earned, namely upon installation and acceptance of equipmentor delivery of handsets, provided that the fair value of the undeliveredelement(s) has been determined, the delivered element(s) has stand-alonevalue, there is no right of return on delivered element(s), and we are incontrol of the undelivered element(s). For arrangements that include serviceelements, including promotional support and installation, for which verifiableobjective evidence of the fair value does not exist, revenue is deferred untilsuch services are deemed complete, or until the time we can establishverifiable objective evidence of the fair value.

Final acceptance is required for revenue recognitionwhen installation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and we areentitled to full payment. We do not recognize revenue before final acceptanceis granted by the customer if acceptance is considered substantive to the transaction.

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,“Software Revenue Recognition,” as amended, and EITF No. 03-05,“Applicability of SOP 97-2 to Non-software Deliverables 

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Containing More ThanIncidental Software.” We allocate revenues to each element of softwarearrangements based on vendor specific objective evidence (“VSOE”) of fairvalue. VSOE of fair value of each element is based on the price charged whenthe same element is sold separately. We use the residual method to recognizerevenue when an arrangement includes one or more elements to be delivered at afuture date and VSOE of the fair value of all the undelivered elements exists.Under the residual method, the fair value of the undelivered elements isdeferred and the remaining portion of the contract price is recognized asrevenue when all other revenue recognition criteria are met. If VSOE of fairvalue of one or more undelivered elements does not exist, all revenue fordelivered and undelivered elements is deferred until delivery of all elementsoccurs or when VSOE of fair value of the undelivered elements can beestablished. In some cases we have agreed to give software upgrade rights on a“when and if made available” basis for equipment sold for no additionalconsideration and for an unspecified period which could extend over the term ofthe contract. This additional contract obligation is an element of “postcontract support.” We have not established VSOE for such contract element.Accordingly, the revenues from such contracts are recognized ratably over the periodduring which the post contract support is expected to be provided. The expectedperiod of support is generally the term of the contract. In some cases wherethere is no stated contractual term, revenue is recognized ratably over theestimated period of support. We review assumptions regarding the estimated postcontract support periods on a regular basis. If we determine that it isnecessary to revise our estimates of the support periods, the amount of revenuerecognized over the life of the contract would not be affected. However, to theextent the new assumptions regarding the post contract support periods weredifferent than original assumptions, the contract revenues would be recognizedover the remaining expected period of support.

Contract accounting is utilized for contracts thatinclude a requirement for significant software modification or customization;when utilized we generally account for such contracts using the completedcontract method of accounting, whereby no revenue is recognized prior to thecompletion of the project, because for contracts involving unique requirementswe are unable to make reasonably dependable estimates of its progress towardsmeeting contractual requirements. In the event estimated total project costsexceed estimated total project revenues, the entire estimated loss is chargedto operations in the period in which the loss becomes probable and can bereasonably estimated. The complexity of the estimation process and judgmentsabout internal and external factors including labor utilization, changes tospecifications and testing requirements, time required for performance andresulting incurrence of contract penalties, and the performance ofsubcontractors affect the estimation process. During the year ended December 31,2006, we recorded a $32.1 million loss on a fixed price contract.

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

We also sell products through resellers. Revenue isgenerally recognized when the standard price protection period, which rangesfrom 30 to 90 days, has lapsed. If collectibility cannot be reasonablyassured in a reseller arrangement, revenue is recognized upon sell through tothe end customer and receipt of cash. There may be additional obligations inreseller arrangements such as inventory rotation, or stock exchange rights onthe product. As such, revenue is recognized in accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 48, “Revenue Recognition WhenRight of Return Exists.” In most cases, we have developed reasonable estimatesfor stock exchanges based on historical experience with similar types of salesof similar products.

We have sales agreements with certain wirelesscustomers that provide for a rebate of the selling price to such customers ifthe particular product is subsequently sold at a lower price to such customersor to a different customer. The rebate period extends for a relatively shortperiod of time. Historically, the amounts of such rebates paid to customershave not been material. We estimate the amount of the rebate 

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based upon the terms ofeach individual arrangement, historical experience and future expectations ofprice reductions and then records its estimate of the rebate amount at the timeof the sale. We also enter into sales incentive programs, such as co-marketingarrangements, with certain wireless and handset customers. We record theincurred incentive as a reduction of revenue when the sales revenue isrecognized.

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 the creditworthiness of the customer. We do not request collateral from our customers. Ininternational sales, we may require letters of credit from our customers thatcan be drawn on demand if the customer defaults on its payment. If we determinethat collection of a payment is not reasonably assured, we defer revenuerecognition until collection becomes reasonably assured, which is generallyupon receipt of cash.

Occasionally, we enter into revenue sharingarrangements. Under these arrangements, we collect payment only after ourcustomer, the telecommunications service provider, collects service revenues.When we enter a revenue sharing arrangement, we do not recognize revenue untilcollection is reasonably assured.

Because of the nature ofdoing business in China and other emerging markets, our billings and/orcustomer payments may not correlate with the contractual payment terms and wegenerally do not enforce contractual payment terms prior to final acceptance.Accordingly, accounts receivable are not recorded until we recognize therelated customer revenue. Advances from customers are recognized when we havecollected cash from the customer, prior to recognizing revenue. Deferredrevenue is recorded if there are undelivered elements after final acceptancehas been obtained.

***Stock-BasedCompensation***

Prior to January 1, 2006, we accounted forshare-based payment awards under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”), andprovided the required pro forma disclosures under Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation.”In accordance with APB 25, non-cash compensation expense was recognized for anyoptions for which the exercise price was below the market price on the actualgrant date, based on the difference between the exercise price and the marketprice. The expense was recognized ratably over the associated service period,which was generally the option vesting term.

On January 1, 2006, we adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004), “Share-BasedPayment,” (“SFAS 123(R)”), using the modified prospective transitionmethod. Stock-based compensation expense recognized during the period isbased on the value of the portion of share-based payment awards that isultimately expected to vest. Stock-based compensation expense recognizedin our Consolidated Statement of Operations for the year endedDecember 31, 2006 included compensation expense for share-basedpayment awards granted prior to, but not yet vested as of December 31,2005 based on the grant date fair value estimated in accordance with the proforma provisions of SFAS 123 and compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005 based on the grantdate fair value estimated in accordance with the provisions of SFAS 123(R).On November 10, 2005, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position No. FAS 123(R)-3, “Transition ElectionRelated to Accounting for Tax Effects of Share-Based Payment Awards.” We haveelected to adopt the alternative transition method provided in the FASB StaffPosition for calculating the tax effects of stock-based compensation pursuantto SFAS 123(R). The alternative transition method includes simplifiedmethods for establishing the beginning balance of the additionalpaid-in-capital pool (“APIC pool”) related to the tax effects of employeestock-based compensation, and to determine the subsequent impact on the APICpool and Consolidated Statements of Cash Flows of the 

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tax effects of employeestock-based compensation awards that are outstanding upon adoption ofSFAS 123(R).

Determining theappropriate fair value model and calculating the fair value of share-basedpayment awards require the input of subjective assumptions, including theexpected term of the share-based payment awards and stock volatility. Weestimate an expected term of options granted based upon our historical exerciseand cancellation data for vested options. We use historical volatility asmanagement believes it is more representative of future stock price trends thanimplied volatility due to the relatively small number of actively tradedoptions on our common stock available to determine implied volatility. Theassumptions used in calculating the fair value of share-based payment awardsrepresent management’s best estimates, but these estimates involve inherentuncertainties and compensation expense could be materially different in thefuture. Because changes in the subjective assumptions can materially affect theestimated value, in management’s opinion, the existing valuation models may notprovide an accurate measure of the fair value of our employee stock options. Inaddition, we are required to estimate the expected forfeiture rate andrecognize expense only for those shares expected to vest. If our actualforfeiture rate is materially different from our estimate, the stock-basedcompensation expense could be significantly different from what we haverecorded in the current period. See Note 15, “Common Stock and Stock IncentivePlans”, of Notes to Consolidated Financial Statements contained in Item 8 ofthis Annual Report for a further discussion on stock-based compensation.

***ProductWarranty***

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

***VariableInterest Entities***

The Financial AccountingStandards Board, (“FASB”) issued FASB Interpretation No. 46(R), (“FIN 46(R)”).FIN 46(R) requires that if an entity is the primary beneficiary of avariable interest entity, (“VIE”), the assets, liabilities, and results ofoperations of the VIE should be included in the consolidated financialstatements of the entity. We adopted FIN 46(R) in the quarter endedDecember 31, 2003, and consolidated one related party deemed a VIE and forwhom we were the primary beneficiary during 2003 and 2004. During the fourthquarter of 2005, we sold our equity interest, terminated all materialcommercial arrangements, settled bank debt and determined that we are no longerthe primary beneficiary. As a result, the assets and liabilities of the entitywere not consolidated as of December 31, 2005. In 2005, we invested in twoadditional entities, each of which was considered a VIE and included theassets, liabilities and results of operations of these entities in theconsolidated financial statements for 2005. In 2006, we disassociated from oneof these VIEs and, as such, triggered a reconsideration event under FIN46(R) resulting in a determination that we were no longer the primarybeneficiary. For additional information regarding variable interest entities,see Note 22, “Variable Interest Entities”, of Notes to Consolidated FinancialStatements in Item 8 of this Annual Report.

***Receivables***

Although we evaluatecustomer credit worthiness prior to a sale, we provide an allowance fordoubtful accounts for the estimated loss on trade and notes receivable whencollection may no longer be reasonably assured. We assess collectibility ofreceivables based a number of factors including analysis of creditworthiness,our ability to collect payment and on the length of time an individualreceivable balance is outstanding. We believe that the accounting estimaterelated to the allowance for doubtful accounts is a 

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criticalaccounting estimate because of the length of the collection cycle for our Chinabased receivables and the material effect of this estimate on our results ofoperations.

***Inventories***

Inventories consist ofproduct held at our manufacturing facility and warehouses, as well as finishedgoods at customer sites for which the customer has taken possession, but basedon specific contractual terms, title has not yet passed to the customer. We mayship inventory to existing customers that require additional equipment toexpand their existing networks prior to the signing of an expansion contract.Our inventories are stated at the lower of cost or market value, net of write-downsfor excess, slow moving and obsolete inventory. Inventory is written down forestimated obsolescence or unmarketable inventory equal to the differencebetween inventory cost and the estimated market value. Write-downs arebased on our assumptions about future market conditions and customer demand,including projected changes in average selling prices resulting fromcompetitive pricing pressures. We continually monitor inventory valuation forpotential losses and obsolete inventory at our manufacturing facilities as wellas at customer sites.

***Deferredcosts***

Deferred costs consist of product shipped to thecustomer for which the rights and obligations of ownership have passed to thecustomer, but revenue has not yet been recognized. Deferred costs also includethe costs associated with third party integrators and freight. All deferredcosts are stated at cost. We periodically assess the recoverability of deferredcosts and provide reserves against deferred cost balances when recovery ofdeferred costs is not probable. Recoverability is evaluated based on variousfactors including the length of time product has been held at the customersite, the viability of payment, including assessment of product demand if arevenue sharing arrangement exists and/or the evaluation if a related transactionwill result in a gross margin loss. In a loss situation for a transaction, thedeferred cost balance is adjusted for an impairment equal to the value of theexcess of cost over the amount of revenue that will be eventually recognizedfor the transaction. Revenue and cost of sales are recorded when finalacceptance is received from the customer. With greater concentration of productat customer sites under contract with specific or individual customer, thefinancial conditions of any specific or individual customer may result inincreased concentration risk exposure for our inventory.

For any post contractsupport services where the revenue is deferred, the entire related deferreddirect costs are classified as a noncurrent asset, consistent with the definitionof a current asset per Accounting Research Bulletin No. 43, “WorkingCapital: Current Assets and Current Liabilities.”

***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 general release. Management judgment is requiredin assessing technological feasibility, expected future revenues, estimatedproduct lives and changes in product technologies, and the ultimaterecoverability of our capitalized software development costs.

***IncomeTaxes***

We are subject to income taxes in both the UnitedStates and numerous foreign jurisdictions. Significant judgment is required inevaluating our tax positions and determining our provision for income taxes.During the ordinary course of business, there are many transactions andcalculations for which the ultimate tax determination is uncertain. Weestablish reserves for tax-related uncertainties based on estimates of whether,and the extent to which, additional taxes and interest will be due. Thesereserves are 

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established when, despiteour belief that our tax return positions are fully supportable, we believe thatcertain positions are likely to be challenged and may not be sustained onreview by tax authorities. We adjust these reserves in light of changing factsand circumstances, such as the closing of a tax audit. The provision for incometaxes includes the impact of reserve provisions and changes to reserves thatare considered appropriate, as well as the related net interest.

We recognize deferred income taxes as the differencebetween the tax bases of assets and liabilities and their financial statementamounts based on enacted tax rates. Management judgment is required in theassessment of the recoverability of our deferred tax assets based on ourassessment of projected taxable income. Numerous factors could affect ourresults of operations in the future. If there was a significant decline in ourfuture operating results, our assessment of the recoverability of our deferredtax assets would need to be revised, and any such adjustment to our deferredtax assets would be charged to income in that period. If necessary, we record avaluation allowance to reduce deferred tax assets to an amount managementbelieves is more likely than not to be realized.

In 2006, due to recent developmentsin our business, we have made a determination that earnings from certainsubsidiaries were not permanently reinvested outside the United States. Weprovide U.S. taxes on foreign undistributed earnings that are not considered tobe permanently reinvested outside the United States. Under APB 23 “Accountingfor Income Taxes—Special Areas,” deferred income taxes must be provided on theunremitted earnings of foreign subsidiaries unless such earnings could bedeemed to be permanently reinvested outside the United States. Prior to 2006,we had not provided for U.S. tax on any foreign unremitted earnings because wedid not intend to repatriate such earnings. See Note 14.

***Goodwilland Intangible Assets***

We have recorded goodwilland intangible assets in connection with our business acquisitions. Managementjudgment is required in the assessment of the related useful lives, assumptionsregarding our ability to successfully develop and ultimately commercializeacquired technology, and assumptions regarding the fair value and therecoverability of these assets. We perform our annual goodwill impairmentreview in the fourth quarter of each year or when changes in circumstancesindicate a potential impairment exists. In the third quarter of 2005, wedetermined that such circumstances existed and performed an impairment reviewat the reporting unit level that resulted in an asset impairment charge. Whenassessing potential impairment to goodwill, we compare our book value to ourfair market value. Fair market value is determined based on the present valueof estimated future cash flows.

***Long-TermInvestments***

We have invested directlyin a number of private technology-based companies in the early stages ofdevelopment and in publicly listed technology and real estate companies tradedon securities exchanges. While quoted market prices are readily available todetermine the fair value of our investments in these publicly traded companies,management judgment is required to determine when losses are other-than-temporary.Furthermore, management judgment is required in evaluating the carrying valueof our private company investments for possible impairment. For our privatetechnology company investments, we assess impairment based on an evaluation ofthe achievement of business objectives and milestones, the financial conditionand prospects of these companies and other relevant factors. We continuallymonitor these investments for impairment, and charge to income any impairmentamounts in the period such a determination is made. During 2006, we recorded a$13.5 million other-than-temporary impairment charge related to one of ourinvestments.

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**RECENT ACCOUNTINGPRONOUNCEMENTS**

See Note 3, “Summary of Significant AccountingPolicies”, of Notes to Consolidated Financial Statements contained in Item 8 ofthis Annual Report for a full description of recent accounting pronouncements,including the expected dates of adoption and estimated effects on results ofoperations and financial condition, which is incorporated herein by reference.

**ITEM 7A—QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

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

*Interest Rate Risk:*

Our exposure to market risk for changes in interestrates relates primarily to our investment portfolio. The fair value of ourinvestment portfolio would not be significantly affected by either a 10%increase or decrease in interest rates due mainly to the short term nature ofmost of our investment portfolio. However, our interest income can be sensitiveto changes in the general level of U.S and China interest rates since themajority of our funds are invested in instruments with maturities of less thanone year. Our policy is to limit the risk of principal loss and to ensure thesafety of invested funds by generally attempting to limit market risk. Funds inexcess of current operating requirements are mostly invested in government-backednotes, commercial paper, floating rate corporate bonds and fixed incomecorporate bonds. 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 AAor better ratings.

Thetable below represents carrying amounts and related weighted-averageinterest rates of our investment portfolio at December 31, 2006 and 2005:

| ** **                   | ** ** | **December 31,**   | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Cash and cash  equivalents   |       | 661,623                 |       | 645,571 |   |
| Average interest rate        |       | 2.12                    | %          | 1.76 | % |
| Restricted  cash-short term  |       | 16,666                  |       | 53,680 |   |
| Average interest rate        |       | 4.81                    | %          | 3.80 | % |
| Short-term  investments      |       | 9,546                   |       | 13,266 |   |
| Average interest rate        |       | 1.91                    | %          | 1.44 | % |
| Restricted cash  long-term   |       | 16,469                  |       | 331 |   |
| Average interest rate        |       | 4.95                    | %          | 3.83 | % |
| Total investment  securities |       | 704,304                 |       | 712,848 |   |
| Average interest  rate       |       | 2.25                    | %          | 1.91 | % |

 

*Equity InvestmentRisk:*

Our investment portfolioincludes equity investments in publicly traded companies, the values of whichare subject to market price volatility. Economic events could adversely affectthe public equities market and general economic conditions may continue toworsen. Should the fair value of our publicly traded equity investments declinebelow their cost basis in a manner deemed to be other-than-temporary,our earnings may be adversely affected. We have also invested in severalprivately held companies as well as investment funds which invest primarily inprivately held companies, many of which can still be considered in the start-upor development stages. These investments are inherently risky, as the marketfor the technologies or products they have under development are typically inthe early stages and may never materialize.

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*Debt InvestmentRisk:*

At December 31, 2006our debt investment portfolio consisted of a $1.0 million note receivablefrom BB Modem, an affiliate of SOFTBANK CORP., pursuant to a Mezzanine LoanAgreement we entered into with BB Modem on July 17, 2003. The notereceivable was paid in full in January 2007.

*Foreign ExchangeRate Risk:*

We are exposed to foreign exchange rate risk becausemost of our sales in China are denominated in Renminbi and portions of ouraccounts receivable and payable are denominated in Japanese Yen. Due to thelimitations on converting Renminbi, we are limited in our ability to engage incurrency hedging activities in China. Fluctuations in currency exchange ratesin the future could have a material adverse effect on our results ofoperations. The balance of cash and short-term investments held in Chinawas $483.7 million at December 31, 2006. In July 2005, Chinauncoupled the Renminbi from the U.S. dollar and let it float in a narrow bandagainst a basket of foreign currencies. The move revalued the Renminbi by 2.1%against the U.S. dollar. Additionally, during 2005 we made significant sales inboth Japanese Yen and in Euros. We maintain Japanese yen bank accounts forpurchasing portions of our inventories and supplies.

Our revenues, earnings and cash flows are subject tofluctuations due to changes in foreign currency exchange rates. We may hedgecurrency exposures associated with certain assets and liabilities denominatedin nonfunctional currencies and certain anticipated nonfunctional currencytransactions using forward foreign currency exchange rate contracts. We havenot hedged any such transactions, and due to the limitations on converting Renminbi,we are limited in our ability to engage in currency hedging activities inChina. As a global concern, we face exposure to adverse movements in foreigncurrency exchange rates.

We have performed a sensitivity analysis as ofDecember 31, 2006, using a modeling technique that measures the change inthe fair values arising from a hypothetical 10% positive or adverse movement inthe levels of foreign currency exchange rates relative to the functionalcurrency with all other variables held constant. The analysis covers all of ourunderlying exposures for foreign currency denominated financial instruments.The foreign currency exchange rates used were based on market rates in effectat December 31, 2006. The sensitivity analysis indicated that a hypothetical10% movement in foreign currency exchange rates would result in a gain or lossin the fair values of our foreign currency denominated financial instruments of$4.4 million at December 31, 2006.

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**ITEM 8—FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

**Index to Consolidated Financial Statements andFinancial Statement Schedules**
|                                                                                                                                              | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Financial Statements:                                                                                                                        |       |     |       |   |   |
| Report of Independent  Registered Public Accounting Firm                                                                                     |       |     | 128        |   |   |
| Consolidated Balance Sheets at  December 31, 2006 and 2005 (as restated)                                                                |       |     | 132        |   |   |
| Consolidated Statements of  Operations for the years ended December 31, 2006, 2005 (as restated),  and 2004 (as restated)               |       |     | 133        |   |   |
| Consolidated Statements of  Stockholders’ Equity for the years ended December 31, 2006, 2005 (as  restated) and 2004 (as restated) |       |     | 134        |   |   |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2006, 2005 (as restated) and  2004 (as restated)                |       |     | 135        |   |   |
| Notes to Consolidated  Financial Statements                                                                                                  |       |     | 136        |   |   |
| Financial Statement  Schedules:                                                                                                              |       |     |       |   |   |
| For each of the three years in the period ended  December 31, 2006, 2005 (as restated), and 2004 (as restated)                          |       |     | 272        |   |   |
| I—Condensed Financial Information of Registrant                                                                                         |       |     | 272        |   |   |
| II—Valuation and Qualifying Accounts                                                                                                    |       |     | 280        |   |   |

 

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

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

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

We have completedintegrated audits of UTStarcom, Inc.’s consolidated financial statementsand of its internal control over financial reporting as of December 31,2006, in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidated financial statements and financial statementschedules*

In our opinion, theconsolidated financial statements listed in the accompanying index present fairly, in all material respects, thefinancial position of UTStarcom, Inc. and its subsidiaries as ofDecember 31, 2006 and 2005, and the results of their operations and theircash flows for each of the three years in the period ended December 31,2006 in conformity with accounting principles generally accepted in the UnitedStates of America. In addition, in ouropinion, the financial statement schedules listed in the accompanying indexpresent fairly, in all material respects, theinformation set forth therein when read in conjunction with the relatedconsolidated financial statements. These financial statements andfinancial statement schedules are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and financial statement schedules based on our audits. We conductedour audits of these statements in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit of financialstatements includes examining, on a test basis, evidence supporting the amountsand disclosures in the financial statements, assessing the accountingprinciples used and significant estimates made by management, and evaluatingthe overall financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

As further described in Note 1 to the consolidatedfinancial statements, the Company has $275 million principal amount ofconvertible notes maturing in March 2008 and certain credit facilitiesthat will expire in November and December 2007. Management’s plans inregard to these matters are also described in Note 1.

As discussed in Note 2 to the consolidated financialstatements, the Company has restated its 2005 and 2004 consolidated financialstatements.

As discussed in Note 3 tothe consolidated financial statements, effective January 1, 2006, theCompany changed its method of accounting for stock-based compensation.

*Internal controlover financial reporting*

Also, we have audited management’s assessment,included in Management’s Annual Report on Internal Control Over FinancialReporting appearing under Item 9A, that UTStarcom, Inc. did not maintaineffective internal control over financial reporting as of December 31,2006, because the Company did not maintain an effective control environment, because(a) the Company did not maintain effective financial reporting processes,including sufficient formalized and consistent finance and accounting policiesand procedures; nor did the Company prevent or detect instances ofnon-compliance with certain such policies and procedures that do exist, and (b) theCompany failed to prevent or detect non compliance with established policiesand procedures intended to ensure compliance with laws and regulations. Theineffective control environment also contributed to: (a) the Company’sfailure to prevent or detect instances of override related to controls in Chinaover customer agreements, (b)  the Company did not maintain effectivecontrols**at its U.S. headquarters over itsaccounting for inventory, including finished goods at customer sites, inventoryreserves and deferred cost accounts and associated cost of sales, 

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(c) the Company didnot maintain effective controls at its U.S. headquarters over its inventoryreserves for losses on customer contracts and associated cost of sales,(d) the Company did not maintain effective controls at its U.S.headquarters over its accounting for warranty reserves and associated cost ofsales, (e) the Company did not maintain effective controls over itsaccounting for and disclosure of stock-based compensation expense, and(f) the Company did not maintain effective controls at its U.S. headquarters over its process toensure the complete, accurate and timely preparation and review of itsconsolidated financial statements in accordance with generally accepted accountingprinciples (GAAP), based on criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO). The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit.

We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing suchother procedures as we consider necessary in the circumstances. We believe thatour audit provides a reasonable basis for our opinions.

A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. Acompany’s internal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

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

A material weaknessis a control deficiency, or combination of control deficiencies, that resultsin more than a remote likelihood that a material misstatement of the annual orinterim financial statements will not be prevented or detected. The followingmaterial weaknesses have been identified and included in management’sassessment as of December 31, 2006:

1.     *The Company did not maintain an effective control environment.*   Specifically,the following additional material weaknesses were identified within the controlenvironment:

a)     *The Company did not maintain effective financial reporting processes,including sufficient formalized and consistent finance and accounting policiesand procedures; nor did the Company prevent or detect instances ofnon-compliance with certain such policies and procedures that do exist.*   Specifically,the Company lacked formalized and current accounting and reporting policies andprocedures across certain of its operating locations and various businesscycles. These control 

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deficiencies resulted inadjustments, including audit adjustments, to the consolidated financialstatements for each of the quarters ended March 31, 2006, June 30,2006 and September 30, 2006 and for the year ended December 31, 2006to correct certain accounts, as further described below.

b)     *The Company failed to prevent or detect non compliance with establishedpolicies and procedures intended to ensure compliance with laws andregulations.*   Specifically, this control deficiency may havepermitted violations of certain Securities and Exchange Commission (“SEC”)regulations related to previous financial disclosures and the Foreign CorruptPractices Act (“FCPA”), related to alleged potential payments made togovernment officials.

2.     Thematerial weakness in the Company’s control environment contributed to theexistence of the following control deficiencies, each of which is considered tobe a material weakness:

a)     *The Company failed to prevent or detect instances of override relatedto controls in China over customer agreements*.   Specifically,this control deficiency permitted the override of established controls inChina’s western sales region, by allowing for the existence of undisclosedagreements with customers, which obligated the Company to provide products orperform certain services without the receipt of additional consideration. Theexistence of these agreements was not communicated to either the Company’sfinancial reporting function or its independent registered public accountingfirm. This control deficiency resulted in adjustments to restate revenue anddeferred revenue accounts, cost of sales and deferred cost accounts, relatedincome tax accounts, retained earnings, and related financial disclosures inthe Company’s consolidated financial statements for the years endedDecember 31, 2004 and 2005, each of the quarters in the year endedDecember 31, 2005, and for the first two quarters of the year endedDecember 31, 2006.

b)     *The Company did not maintain effective controls at its U.S.headquarters over its accounting for inventory, including finished goods atcustomer sites, inventory reserves and deferred cost accounts and associatedcost of sales.*   Specifically, the Company’s controls were notadequate to properly track and confirm inventory movements in the appropriateperiod, to ensure the proper classification of inventory and deferred costs(and associated accounts such as purchase price variance), and to ensure thecompleteness and accuracy of the recording of the cost of sales when revenuewas recognized. These processes were not always performed correctly or timely,there was inadequate management review, and calculation and/or posting errors occurred.This control deficiency resulted in adjustments, including audit adjustments,to the consolidated financial statements for each of the quarters endedMarch 31, 2006, June 30, 2006 and September 30, 2006 and for theyear ended December 31, 2006 to correct cost of sales and the relatedinventory, finished goods at customer sites, inventory reserves and deferredcosts accounts.

c)     *The Company did not maintain effective controls at its U.S.headquarters over its inventory reserves for losses on customer contracts andassociated cost of sales.*   Specifically, the Company’s controlswere not designed, nor did they operate effectively, to adequately identify,document and analyze its inventory reserves for losses on customer contracts toensure that all related costs were recorded in the appropriate period and thatexisting reserves were adequate. These processes were not always performedcorrectly or timely, there was inadequate management review, and calculationand/or posting errors occurred. This control deficiency resulted inadjustments, including audit adjustments, to the consolidated financialstatements for each of the quarters ended June 30, 2006 andSeptember 30, 2006 to correct inventory reserves for losses on customercontracts and the associated cost of sales.

d)     *The Company did not maintain effective controls at its U.S.headquarters over its accounting for warranty reserves and associated cost ofsales.*   Specifically, the Company’s controls failed toadequately identify, document and analyze required supporting information toensure the completeness, accuracy, valuation and adequacy of its warrantyreserves and to ensure all related costs 

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were recorded in theappropriate period. These processes were not always performed correctly ortimely, there was inadequate management review, and calculation and/or postingerrors occurred. This control deficiency resulted in adjustments, includingaudit adjustments, to the consolidated financial statements for each of thequarters ended June 30, 2006 and September 30, 2006 and for the yearended December 31, 2006 to correct warranty reserves, which are includedin other current liabilities, and the associated cost of sales.

e)     *The Company did not maintain effective controls over its accounting forand disclosure of stock-based compensation expense.*   Specifically,the Company did not maintain effective controls, including monitoring, toensure the completeness, existence, valuation and presentation of stock-basedcompensation transactions related to the granting, pricing and accounting forcertain of its stock-based compensation awards and the related financialreporting for these awards in accordance with GAAP. This control deficiencyresulted in the misstatement of the stock-based compensation expense,additional paid-in capital accounts, related income tax accounts, retainedearnings and related financial disclosures, and resulted in the restatement ofthe  consolidated financial statementsfor the years ended December 31, 2004 and 2005, each of the quarters inthe year ended December 31, 2005, and the first two quarters of the yearended December 31, 2006.

f)      *The Company did not maintain effective controls at its U.S.headquarters over its process to ensure the complete, accurate and timelypreparation and review of its consolidated financial statements in accordancewith GAAP.*   Specifically, theCompany did not have effective controls over the process for identifying,accumulating and reviewing all required supporting information to ensure thecompleteness, accuracy and timely preparation and review of its consolidatedfinancial statements and disclosures, including the statement of cash flows andsegment reporting. This control deficiency resulted in adjustments, includingaudit adjustments, to the consolidated financial statements in each of thequarters ended March 31, 2006, June 30, 2006 and September 30,2006 and for the year ended December 31, 2006, and additional disclosuresto these 2006 consolidated annual financial statements to correct theaforementioned accounts and disclosures.

Each of the material weaknesses described above couldresult in a misstatement of the Company’s consolidated financial statementsthat would result in a material misstatement to the quarterly or annualconsolidated financial statements that would not be prevented or detected. These material weaknesses were considered in determining the nature, timing, and extent ofaudit tests applied in our audit of the 2006 consolidated financial statements, and our opinion regarding theeffectiveness of the Company’s internal control over financial reporting doesnot affect our opinion on those consolidatedfinancial statements.

In our opinion,management’s assessment that UTStarcom, Inc. did not maintain effectiveinternal control over financial reporting as of December 31, 2006, isfairly stated, in all material respects, based on criteria established in *Internal Control—Integrated Framework* issued by the COSO.Also, in our opinion, because of the effects of the material weaknessesdescribed above on the achievement of the objectives of the control criteria,UTStarcom, Inc. has not maintained effective internal control overfinancial reporting as of December 31, 2006, based on criteria establishedin *Internal Control—Integrated Framework*issued by the COSO*.*

PricewaterhouseCoopers LLPSan Jose, CAOctober 10, 2007

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**UTSTARCOM, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except share data)**

| ** **                                                                                                                                                                                                 | ** ** | **December 31,** | ** ** | **December 31,**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|------------------------|------------|
| ** **                                                                                                                                                                                                 | ** ** | **2006**              | ** ** | **2005**               | ** ** |
| ** **                                                                                                                                                                                                 | ** ** | ** **            | ** ** | **(As restated)** | ** ** |
| **ASSETS**                                                                                                                                                                                                 |       |                  |       |                   |       |   |   |   |   |
| Current assets:                                                                                                                                                                                            |       |                  |       |                   |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                                 |       |                  | $          | 661,623                |       |   |   | $ | 645,571 |   |   |
| Short-term investments                                                                                                                                                                                     |       |                  | 9,546      |                   |       |   | 13,266 |   |   |
| Accounts  receivable, net of allowances for doubtful accounts of $53,894 and $67,789                                                                                                                       |       |                  | 373,762    |                   |       |   | 439,597 |   |   |
| Accounts  receivable, related parties, net of allowances for doubtful accounts of $19  and $5                                                                                                              |       |                  | 32,318     |                   |       |   | 83,367 |   |   |
| Notes receivable                                                                                                                                                                                           |       |                  | 5,060      |                   |       |   | 2,065 |   |   |
| Inventories                                                                                                                                                                                                |       |                  | 440,445    |                   |       |   | 425,955 |   |   |
| Deferred costs                                                                                                                                                                                             |       |                  | 195,393    |                   |       |   | 239,876 |   |   |
| Prepaids and other  current assets                                                                                                                                                                         |       |                  | 101,795    |                   |       |   | 99,062 |   |   |
| Short-term  restricted cash and investments                                                                                                                                                                |       |                  | 16,666     |                   |       |   | 53,680 |   |   |
| Total current assets                                                                                                                                                                                       |       |                  | 1,836,608  |                   |       |   | 2,002,439 |   |   |
| Property, plant  and equipment, net                                                                                                                                                                        |       |                  | 213,155    |                   |       |   | 233,403 |   |   |
| Long-term  investments                                                                                                                                                                                     |       |                  | 47,809     |                   |       |   | 26,023 |   |   |
| Goodwill                                                                                                                                                                                                   |       |                  | 3,063      |                   |       |   | 3,063 |   |   |
| Intangible assets,  net                                                                                                                                                                                    |       |                  | 56,443     |                   |       |   | 75,313 |   |   |
| Long-term deferred  costs                                                                                                                                                                                  |       |                  | 176,649    |                   |       |   | 185,279 |   |   |
| Other long-term  assets                                                                                                                                                                                    |       |                  | 40,223     |                   |       |   | 25,811 |   |   |
| Total assets                                                                                                                                                                                               |       |                  | $          | 2,373,950              |       |   |   | $ | 2,551,331 |   |   |
| **LIABILITIES,  MINORITY INTEREST AND STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                  |       |                   |       |   |   |   |   |
| Current liabilities:                                                                                                                                                                                       |       |                  |       |                   |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                           |       |                  | $          | 304,869                |       |   |   | $ | 320,677 |   |   |
| Short-term debt                                                                                                                                                                                            |       |                  | 102,758    |                   |       |   | 198,826 |   |   |
| Income taxes payable                                                                                                                                                                                       |       |                  | 2,483      |                   |       |   | 34,229 |   |   |
| Customer advances                                                                                                                                                                                          |       |                  | 265,812    |                   |       |   | 221,301 |   |   |
| Deferred revenue                                                                                                                                                                                           |       |                  | 95,742     |                   |       |   | 101,912 |   |   |
| Other current liabilities                                                                                                                                                                                  |       |                  | 271,400    |                   |       |   | 291,368 |   |   |
| Total current  liabilities                                                                                                                                                                                 |       |                  | 1,043,064  |                   |       |   | 1,168,313 |   |   |
| Long-term deferred  revenue                                                                                                                                                                                |       |                  | 261,014    |                   |       |   | 273,131 |   |   |
| Long-term debt                                                                                                                                                                                             |       |                  | 275,161    |                   |       |   | 274,900 |   |   |
| Other long-term  liabilities                                                                                                                                                                               |       |                  | 13,858     |                   |       |   | — |   |   |
| Total liabilities                                                                                                                                                                                          |       |                  | 1,593,097  |                   |       |   | 1,716,344 |   |   |
| Commitments and contingencies (Note 17)                                                                                                                                                                    |       |                  |       |                   |       |   |   |   |   |
| Minority interest  in consolidated subsidiaries                                                                                                                                                            |       |                  | 6,493      |                   |       |   | 8,338 |   |   |
| Stockholders’ equity:                                                                                                                                                                                 |       |                  |       |                   |       |   |   |   |   |
| Common stock: $0.00125  par value; 750,000,000 authorized shares;  121,299,113 issued and 121,294,645 outstanding at December 31, 2006;  121,018,036 issued and outstanding at December 31, 2005 |       |                  | 152        |                   |       |   | 152 |   |   |
| Additional paid-in  capital                                                                                                                                                                                |       |                  | 1,205,592  |                   |       |   | 1,192,201 |   |   |
| Deferred stock-based  compensation                                                                                                                                                                         |       |                  | —     |                   |       |   | (3,591 | ) |   |
| Accumulated deficit                                                                                                                                                                                        |       |                  | (494,244   | )                      |       |   | (376,899 | ) |   |
| Accumulated other  comprehensive income                                                                                                                                                                    |       |                  | 62,899     |                   |       |   | 14,786 |   |   |
| Treasury stock: 4,468  shares held in treasury at December 31, 2006                                                                                                                                   |       |                  | (39        | )                      |       |   | — |   |   |
| Total  stockholders’ equity                                                                                                                                                                           |       |                  | 774,360    |                   |       |   | 826,649 |   |   |
| Total liabilities, minority interest and  stockholders’ equity                                                                                                                                        |       |                  | $          | 2,373,950              |       |   |   | $ | 2,551,331 |   |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)**

| ** **                                                                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                            | ** ** | ** **                                 | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| Net sales                                                                                             |       |                                       |       |   |   |   |   |
| Unrelated party                                                                                       |       | $                                          | 2,326,478  |   | $ | 2,395,298 |   | $ | 2,434,742 |   |
| Related party                                                                                         |       | 132,383                                    |       | 475,812 |   | 144,673 |   |
|                                                                                                  |       | 2,458,861                                  |       | 2,871,110 |   | 2,579,415 |   |
| Cost of net sales                                                                                     |       |                                       |       |   |   |   |   |
| Unrelated party                                                                                       |       | 1,988,702                                  |       | 2,187,139 |   | 1,918,474 |   |
| Related party                                                                                         |       | 84,415                                     |       | 248,135 |   | 91,409 |   |
| Gross profit                                                                                          |       | 385,744                                    |       | 435,836 |   | 569,532 |   |
| Operating expenses  (income):                                                                         |       |                                       |       |   |   |   |   |
| Selling, general and administrative                                                                   |       | 334,455                                    |       | 371,461 |   | 303,911 |   |
| Research and development                                                                              |       | 182,869                                    |       | 246,813 |   | 219,079 |   |
| Amortization of intangible assets                                                                     |       | 18,871                                     |       | 25,853 |   | 15,551 |   |
| Gain on sale of semiconductor design assets                                                           |       | (12,291                                    | )          | — |   | — |   |
| Impairment of long-lived assets                                                                       |       | —                                     |       | 218,094 |   | 12,706 |   |
| Restructuring                                                                                         |       | —                                     |       | 29,669 |   | — |   |
| In-process research and development                                                                   |       | —                                     |       | 660 |   | 1,400 |   |
| Total net  operating expenses                                                                         |       | 523,904                                    |       | 892,550 |   | 552,647 |   |
| Operating (loss) income                                                                               |       | (138,160                                   | )          | (456,714 | ) | 16,885 |   |
| Interest income                                                                                       |       | 14,829                                     |       | 7,091 |   | 6,172 |   |
| Interest expense                                                                                      |       | (11,688                                    | )          | (16,764 | ) | (6,916 | ) |
| Gain on  extinguishment of subordinated notes                                                         |       | —                                     |       | 31,392 |   | — |   |
| Other income, net                                                                                     |       | 1,092                                      |       | 43,665 |   | 15,431 |   |
| (Loss) income before income taxes, minority interest  and equity in loss of affiliated companies |       | (133,927                                   | )          | (391,330 | ) | 31,572 |   |
| Income tax  benefit (expense)                                                                         |       | 15,024                                     |       | (136,544 | ) | 20,292 |   |
| Minority interest  in losses of consolidated subsidiaries                                             |       | 1,558                                      |       | 692 |   | 285 |   |
| Equity in loss of  affiliated companies                                                               |       | —                                     |       | (5,463 | ) | (1,300 | ) |
| Net (loss) income                                                                                     |       | $                                          | (117,345   | ) | $ | (532,645 | ) | $ | 50,849 |   |
| (Loss) earnings per share—Basic                                                                  |       | $                                          | (0.97      | ) | $ | (4.55 | ) | $ | 0.45 |   |
| (Loss) earnings  per share—Diluted                                                               |       | $                                          | (0.97      | ) | $ | (4.55 | ) | $ | 0.40 |   |
| Weighted average  shares used in per-share calculation:                                               |       |                                       |       |   |   |   |   |
| —Basic                                                                                           |       | 120,657                                    |       | 117,034 |   | 114,135 |   |
| —Diluted                                                                                         |       | 120,657                                    |       | 117,034 |   | 134,820 |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY(In thousands, except share data)**

|                                                                                         | ** ** | ** **            | ** ** | ** **     | ** **     | ** **          | ** ** | ** **       | ** **               | **Retained**      | ** ** | **Accumulated**         | ** **         | ** **             | ** ** | ** **        | ** **         | ** ** | ** ** | ** ** | ** **       |
|-----------------------------------------------------------------------------------------|------------|-----------------------|------------|----------------|----------------|---------------------|------------|------------------|--------------------------|-------------------|------------|-------------------------|--------------------|------------------------|------------|-------------------|--------------------|------------|------------|------------|------------------|
| ** **                                                                              | ** ** | ** **            | ** ** | ** **     | ** **     | ** **          | ** ** | **Deferred**     | ** **               | **Earnings**      | ** ** | **Other**               | ** **         | ** **             | ** ** | ** **        | ** **         | **Total**  | ** ** | ** ** | ** **       |
| ** **                                                                              | ** ** | **Common Stock** | ** ** | **Additional** | ** **     | **Stock-based**     | ** ** | **(Accumulated** | ** **               | **Comprehensive** | ** ** | **Treasury Stock** | ** **         | **Stockholders’** | ** ** | **Comprehensive** | ** **         |
| ** **                                                                              | ** ** | **Shares**            | ** ** | **Amount**     | ** **     | **Paid-in-Capital** | ** ** | **Compensation** | ** **               | **Deficit)**      | ** ** | **Income**              | ** **         | **Shares**             | ** ** | **Amount**        | ** **         | **Equity** | ** ** | **Income** | ** **       |
| **Balance at December 31,  2003, as previously reported**                          | ** ** | **104,272,477**       | ** ** |           | **$ 131** | ** **          |       |             | **$  654,483** | ** **        |       |                    | **$ (7,761**  | **)**                  |       |              | **$ 237,382** | ** ** |       |       | **$ 3,420** | ** ** |   |   | **—** | ** ** |   |   | **$ —** | ** ** |   |   | **$  887,655** | ** ** |   |   | ** ** | ** ** |   |
| Cumulative effect  of adjustments to date                                               |       | 282,878               |       |           | —         |                |       |             | 31,641                   |              |       |                    | (5,669             | )                      |       |              | (59,464            | )          |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **(33,492** | **)** |   |   | ** ** | ** ** |   |
| **Balance at December 31,  2003, as restated**                                     | ** ** | **104,555,355**       | ** ** |           | **$ 131** | ** **          |       |             | **$  686,124** | ** **        |       |                    | **$ (13,430** | **)**                  |       |              | **$ 177,918** | ** ** |       |       | **$ 3,420** | ** ** |   |   | **—** | ** ** |   |   | **$ —** | ** ** |   |   | **$  854,163** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  issued upon exercise of options                                           |       | 1,191,877             |       |           | 2              |                |       |             | 18,525                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **18,527** | ** ** |   |   | ** ** | ** ** |   |
| Common stock issued upon ESPP purchases                                                 |       | 445,844               |       |           | —         |                |       |             | 7,130                    |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **7,130** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  issued upon secondary offering, net of expenses                           |       | 12,100,000            |       |           | 15             |                |       |             | 474,539                  |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **474,554** | ** ** |   |   | ** ** | ** ** |   |
| Common stock issued upon exercise of  warrants                                          |       | 32,000                |       |           | —         |                |       |             | 80                       |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **80** | ** ** |   |   | ** ** | ** ** |   |
| Repurchase Plan,  including fees                                                        |       | (3,555,566            | )          |           | (4             | )                   |       |             | (34,544                  | )                 |       |                    | —             |                   |       |              | (73,021            | )          |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **(107,569** | **)** |   |   | ** ** | ** ** |   |
| Stock-based compensation, as restated                                                   |       |                  |       |           |           |                |       |             | (5,204                   | )                 |       |                    | 5,313              |                   |       |              |               |       |       |       |             |   |   |   | — |   |   |   | — | ** ** |   |   | **109** | ** ** |   |   | ** ** | ** ** |   |
| Cancellation of  deferred compensation charges due to employee terminations             |       |                  |       |           |           |                |       |             | (1,140                   | )                 |       |                    | 1,140              |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | **—** | ** ** |   |   | ** ** | ** ** |   |
| Tax benefits for non-qualified stock  option exercises, as restated                     |       | —                |       |           | —         |                |       |             | 3,657                    |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **3,657** | ** ** |   |   | ** ** | ** ** |   |
| Net income, as  restated                                                                |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | 50,849             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **50,849** | ** ** |   |   | **50,849** | ** ** |   |
| Other comprehensive income:                                                             |       |                  |       |           |           |                |       |             |                     |              |       |                    |               |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | **—** | ** ** |   |   | ** ** | ** ** |   |
| Unrealized holding  loss (net of tax of $516)                                           |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | (1,351           | ) |   |   | — |   |   |   | — | ** ** |   |   | **(1,351** | **)** |   |   | **(1,351** | **)** |   |
| Translation adjustment                                                                  |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | 2,744            |   |   |   | — |   |   |   | — | ** ** |   |   | **2,744** | ** ** |   |   | **2,744** | ** ** |   |
| Total comprehensive  income                                                             |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **—** | ** ** |   |   | **52,242** | ** ** |   |
| **Balance at December 31,  2004, as restated**                                     | ** ** | **114,769,510**       | ** ** |           | **144**        | ** **          |       |             | **1,149,167**            | ** **        |       |                    | **(6,977**         | **)**                  |       |              | **155,746**        | ** ** |       |       | **4,813**        | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **1,302,893** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  issued upon exercise of options                                           |       | 198,450               |       |           | 1              |                |       |             | 1,190                    |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **1,191** | ** ** |   |   | ** ** | ** ** |   |
| Common stock issued upon ESPP purchases                                                 |       | 911,976               |       |           | 1              |                |       |             | 5,760                    |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **5,761** | ** ** |   |   | ** ** | ** ** |   |
| Comon stock issued  upon debt extinguishment                                            |       | 4,988,100             |       |           | 6              |                |       |             | 37,562                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **37,568** | ** ** |   |   | ** ** | ** ** |   |
| Common stock issued upon settlement of  stock hedge                                     |       | —                |       |           | —         |                |       |             | 1,446                    |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **1,446** | ** ** |   |   | ** ** | ** ** |   |
| Stock-based  compensation, as restated                                                  |       | —                |       |           | —         |                |       |             | (2,067                   | )                 |       |                    | 2,930              |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **863** | ** ** |   |   | ** ** | ** ** |   |
| Cancellation of deferred compensation  charges due to employee terminations             |       |                  |       |           |           |                |       |             | (456                     | )                 |       |                    | 456                |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Restricted stock  compensation                                                          |       | 150,000               |       |           | —         |                |       |             | 106                      |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **106** | ** ** |   |   | ** ** | ** ** |   |
| Tax detriment for non-qualified stock  option exercises                                 |       | —                |       |           | —         |                |       |             | (507                     | )                 |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **(507** | **)** |   |   | ** ** | ** ** |   |
| Net loss, as  restated                                                                  |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | (532,645           | )          |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **(532,645** | **)** |   |   | **(532,645** | **)** |   |
| Other comprehensive income:                                                             |       |                  |       |           |           |                |       |             |                     |              |       |                    |               |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | **—** | ** ** |   |   | ** ** | ** ** |   |
| Unrealized holding  loss (net of tax of $11)                                            |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | (30              | ) |   |   | — |   |   |   | — | ** ** |   |   | **(30** | **)** |   |   | **(30** | **)** |   |
| Translation adjustment                                                                  |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | 10,003           |   |   |   | — |   |   |   | — | ** ** |   |   | **10,003** | ** ** |   |   | **10,003** | ** ** |   |
| Total  comprehensive loss                                                               |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **—** | ** ** |   |   | **(522,672** | **)** |   |
| **Balance at December 31,  2005, as restated**                                     | ** ** | **121,018,036**       | ** ** |           | **152**        | ** **          |       |             | **1,192,201**            | ** **        |       |                    | **(3,591**         | **)**                  |       |              | **(376,899**       | **)**      |       |       | **14,786**       | ** ** |   |   | **—** | ** ** |   |   | **—** | ** ** |   |   | **826,649** | ** ** |   |   | ** ** | ** ** |   |
| Common stock  issued upon exercise of options                                           |       | 106,193               |       |           | —         |                |       |             | 390                      |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **390** | ** ** |   |   | ** ** | ** ** |   |
| Elimination of deferred stock-based  compensation upon adoption of SFAS No. 123(R) |       | —                |       |           | —         |                |       |             | (3,591                   | )                 |       |                    | 3,591              |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **—** | ** ** |   |   | ** ** | ** ** |   |
| Stock-based  compensation                                                               |       | —                |       |           | —         |                |       |             | 16,647                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **16,647** | ** ** |   |   | ** ** | ** ** |   |
| Reversal of stock-based compensation due  to forfeitures upon disposal of business unit |       |                  |       |           |           |                |       |             | (2,393                   | )                 |       |                    |               |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | **(2,393** | **)** |   |   | ** ** | ** ** |   |
| Restricted stock  granted and amortization                                              |       | 174,884               |       |           |           |                |       |             | 2,338                    |              |       |                    |               |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | **2,338** | ** ** |   |   | ** ** | ** ** |   |
| Purchase of treasury shares                                                             |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | (4,468 | ) |   |   | (39 | ) |   |   | **(39** | **)** |   |   | ** ** | ** ** |   |
| Net loss                                                                                |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | (117,345           | )          |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **(117,345** | **)** |   |   | **(117,345** | **)** |   |
| Other comprehensive income:                                                             |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **—** | ** ** |   |   | ** ** | ** ** |   |
| Unrealized holding  gain (net of tax of $0)                                             |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | 32,662           |   |   |   | — |   |   |   | — | ** ** |   |   | **32,662** | ** ** |   |   | **32,662** | ** ** |   |
| Translation adjustment                                                                  |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | 15,451           |   |   |   | — |   |   |   | — | ** ** |   |   | **15,451** | ** ** |   |   | **15,451** | ** ** |   |
| Total  comprehensive loss                                                               |       | —                |       |           | —         |                |       |             | —                   |              |       |                    | —             |                   |       |              | —             |       |       |       | —           |   |   |   | — |   |   |   | — | ** ** |   |   | **—** | ** ** |   |   | **(69,232** | **)** |   |
|                                                                                         |       |                  |       |           |           |                |       |             |                     |              |       |                    |               |                   |       |              |               |       |       |       |             |   |   |   |   |   |   |   |   | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **Balance at December 31,  2006**                                                  | ** ** | **121,299,113**       | ** ** |           | **152**        | ** **          |       |             | **1,205,592**            | ** **        |       |                    | **—**         | ** **             |       |              | **(494,244**       | **)**      |       |       | **62,899**       | ** ** |   |   | **(4,468** | **)** |   |   | **(39** | **)** |   |   | **774,360** | ** ** |   |   | ** ** | ** ** |   |

 

See accompanying notes to the consolidated financial statements.

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**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                                          | ** ** | **Year ended December 31** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                  | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | ** **                                | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               |       |                                      |       |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                                   |       | $                                         | (117,345   | ) |   | $ | (532,645 | ) |   |   | $ | 50,849 |   |   |
| Adjustments to reconcile net (loss) income to net  cash provided by (used in) operating activities: |       |                                      |       |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                                      |       | 68,039                                    |       |   | 98,550 |   |   |   | 76,203 |   |   |
| Gain on sale of  semiconductor design assets                                                        |       | (12,291                                   | )          |   | — |   |   |   | — |   |   |
| Net loss on sale  of assets                                                                         |       | 2,715                                     |       |   | 2,559 |   |   |   | 2,201 |   |   |
| Impairment of  long-lived assets                                                                    |       | —                                    |       |   | 218,094 |   |   |   | 12,706 |   |   |
| Impairment of  long-term investments                                                                |       | 13,500                                    |       |   | — |   |   |   | — |   |   |
| Stock-based  compensation expense                                                                   |       | 16,592                                    |       |   | 863 |   |   |   | 109 |   |   |
| Non-cash  settlement of restructuring charges                                                       |       | —                                    |       |   | 17,250 |   |   |   | — |   |   |
| In-process  research and development                                                                |       | —                                    |       |   | 660 |   |   |   | 1,400 |   |   |
| Gain on sale of  investment                                                                         |       | —                                    |       |   | (46,576 | ) |   |   | (1,912 | ) |   |
| Provision  (recovery) for doubtful accounts                                                         |       | (9,347                                    | )          |   | 18,210 |   |   |   | 21,284 |   |   |
| Provision for  deferred costs                                                                       |       | 2,730                                     |       |   | 12,868 |   |   |   | 18,277 |   |   |
| Gain on  extinguishment of subordinated notes                                                       |       | —                                    |       |   | (31,392 | ) |   |   | — |   |   |
| Deferred income  taxes                                                                              |       | (1,223                                    | )          |   | 190,658 |   |   |   | (127,472 | ) |   |
| Other                                                                                               |       | (36                                       | )          |   | 15,897 |   |   |   | 4,909 |   |   |
| Changes in operating  assets and liabilities:                                                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Accounts receivable                                                                                 |       | 133,052                                   |       |   | 268,167 |   |   |   | (453,862 | ) |   |
| Inventories                                                                                         |       | (5,571                                    | )          |   | 165,923 |   |   |   | (175,881 | ) |   |
| Deferred costs                                                                                      |       | 52,478                                    |       |   | (49,376 | ) |   |   | 207,404 |   |   |
| Other assets                                                                                        |       | (7,490                                    | )          |   | 95,802 |   |   |   | (16,273 | ) |   |
| Accounts payable                                                                                    |       | (22,296                                   | )          |   | (87,811 | ) |   |   | 97,689 |   |   |
| Income taxes  payable                                                                               |       | (28,946                                   | )          |   | (110,209 | ) |   |   | 133,509 |   |   |
| Customer advances                                                                                   |       | 38,423                                    |       |   | (150,313 | ) |   |   | (116,917 | ) |   |
| Deferred revenue                                                                                    |       | (29,328                                   | )          |   | 80,676 |   |   |   | 126,841 |   |   |
| Other current  liabilities                                                                          |       | (27,577                                   | )          |   | 40,528 |   |   |   | 43,931 |   |   |
| Net cash provided  by (used in) operating activities                                                |       | 66,079                                    |       |   | 218,383 |   |   |   | (95,005 | ) |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |                                      |       |   |   |   |   |   |   |   |   |
| Additions to  property, plant and equipment                                                         |       | (26,274                                   | )          |   | (64,396 | ) |   |   | (135,575 | ) |   |
| Proceeds from sale  of semiconductor design assets                                                  |       | 35,965                                    |       |   | — |   |   |   | — |   |   |
| Proceeds from  disposition of investment interest                                                   |       | 775                                       |       |   | — |   |   |   | — |   |   |
| Investment in  affiliates                                                                           |       | (302                                      | )          |   | (3,550 | ) |   |   | (19,292 | ) |   |
| Purchase of  businesses, net of cash acquired                                                       |       | —                                    |       |   | (24,326 | ) |   |   | (217,751 | ) |   |
| Purchase of  intangible assets                                                                      |       | (658                                      | )          |   | (750 | ) |   |   | (4,158 | ) |   |
| Change in restricted  cash and long-term investments                                                |       | 20,882                                    |       |   | (18,418 | ) |   |   | (8,943 | ) |   |
| Purchase of  short-term investments                                                                 |       | (42,400                                   | )          |   | (165,284 | ) |   |   | (319,253 | ) |   |
| Proceeds from sale  of short-term investments                                                       |       | 46,428                                    |       |   | 346,966 |   |   |   | 236,497 |   |   |
| Other                                                                                               |       | 1,649                                     |       |   | (105 | ) |   |   | 428 |   |   |
| Net cash provided  by (used in) investing activities                                                |       | 36,065                                    |       |   | 70,137 |   |   |   | (468,047 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                              |       |                                      |       |   |   |   |   |   |   |   |   |
| Issuance of stock,  net of expenses                                                                 |       | 390                                       |       |   | 6,952 |   |   |   | 25,737 |   |   |
| Proceeds from  borrowings                                                                           |       | 100,629                                   |       |   | 436,678 |   |   |   | 390,000 |   |   |
| Payments on  borrowings                                                                             |       | (200,742                                  | )          |   | (653,123 | ) |   |   | (40,000 | ) |   |
| Repurchase of  stock                                                                                |       | (39                                       | )          |   | — |   |   |   | (107,569 | ) |   |
| Proceeds from  equity offering                                                                      |       | —                                    |       |   | — |   |   |   | 474,554 |   |   |
| Other                                                                                               |       | 253                                       |       |   | 6,689 |   |   |   | — |   |   |
| Net cash provided  by (used in) financing activities                                                |       | (99,509                                   | )          |   | (202,804 | ) |   |   | 742,722 |   |   |
| Effect of exchange  rate changes on cash and cash equivalents                                       |       | 13,417                                    |       |   | (2,677 | ) |   |   | 5,115 |   |   |
| Net increase in  cash and cash equivalents                                                          |       | 16,052                                    |       |   | 83,039 |   |   |   | 184,785 |   |   |
| Cash and cash  equivalents at beginning of year                                                     |       | 645,571                                   |       |   | 562,532 |   |   |   | 377,747 |   |   |
| Cash and cash  equivalents at end of year                                                           |       | $                                         | 661,623    |   |   | $ | 645,571 |   |   |   | $ | 562,532 |   |   |
| Supplemental disclosure  of cash flow information:                                                  |       |                                      |       |   |   |   |   |   |   |   |   |
| Cash paid:                                                                                          |       |                                      |       |   |   |   |   |   |   |   |   |
| Interest                                                                                            |       | $                                         | 9,773      |   |   | $ | 14,197 |   |   |   | $ | 5,074 |   |   |
| Income taxes                                                                                        |       | $                                         | 13,574     |   |   | $ | 11,265 |   |   |   | $ | 11,177 |   |   |
| Non-cash operating  activities                                                                      |       |                                      |       |   |   |   |   |   |   |   |   |
| Accounts  receivable transferred to notes receivable                                                |       | $                                         | 22,921     |   |   | $ | 55,065 |   |   |   | $ | 118,021 |   |   |
| Property, plant  and equipment exchanged for long-term investment                                   |       | $                                         | 5,500      |   |   | $ | — |   |   |   | $ | — |   |   |
| Non-cash financing activities                                                                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Common stock  issued in conjunction with debt extinguishment                                        |       | $                                         | —     |   |   | $ | 37,568 |   |   |   | $ | — |   |   |

 

See accompanying notes to the consolidated financial statements.

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**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1—DESCRIPTIONOF BUSINESS AND LIQUIDITY**

UTStarcom Inc. (“Company”), a Delaware corporationincorporated in 1991 with headquarters in Alameda, California, designs,manufactures and sells telecommunications infrastructure and customer premisesequipment and wireless telephone handsets to telecommunications serviceproviders or operators throughout the world. It also providestelecommunications infrastructure installation, operations, and maintenanceservices. The Company enables its customers to rapidly deploy revenue-generatingaccess services using their existing infrastructure, while providing amigration path to cost-efficient end-to-end IP networks

The Company reported net losses in each quarter in theperiod beginning April 1, 2005 and continuing through December 31,2006, which has resulted in an accumulated deficit of $494.2 million and totalstockholders’ equity being reduced to $774.4 million at December 31, 2006.Additionally, at December 31, 2006, the Company had short-term debt inChina under its lines of credit of $102.5 million maturing in 2007 andlong-term debt outside of China in the form of its 7¤8% convertiblesubordinated notes with a principal balance of $274.6 million that matures inMarch 2008. Subsequent to December 31, 2006, the Company and theholders of the convertible subordinated notes entered into two agreements toprevent covenant defaults occurring from the Company’s inability to timely filerequired periodic reports containing financial statements with the SEC; thefirst agreement increased the interest rate on the convertible subordinatednotes from 7¤8%to 7.625% effective as of January 9, 2007 and the second agreementincreased the interest rate to 10.875% effective as of July 26, 2007. Foradditional information concerning the Company’s Supplemental Indentures seeNote 23.

The Company’s cash and short-term investmentsaggregated $671.2 million (of which $483.7 million are held in China) atDecember 31, 2006.

Credit facilities in China at December 31, 2006totaled $698.3 million, with $357.5 million of this amount available forworking capital purposes, of which the Company had drawn $102.5 million inoutstanding borrowings, and $340.8 million was available for use in support ofletters of credit and corporate guarantees. These facilities expire primarilyin November and December of 2007, and the Company believes that basedupon its recent financial performance and financial position its lenders mayreduce the total available credit when it negotiates renewals of these lines.Furthermore, each borrowing under the credit facilities is subject to thebank’s current favorable opinion of the credit worthiness of the Company’sChina subsidiaries, as well as the bank having funds available for lending andother Chinese banking regulations. However, the Company believes the amounts ofcredit its lenders may make available and the borrowings made under the renewedlines of credit will be sufficient to meet planned uses of these credit facilities.

To meet liquidity needs outside of China, theCompany’s subsidiaries in China have the ability to transfer cash to theCompany under China’s current exchange control regulations. The amount of cashavailable for transfer from the Company’s China subsidiaries is limited both bythe Company’s liquidity needs in China and by Chinese government requirementsthat the China subsidiaries retain adequate capital levels in China to protectcreditors and to have funds available for mandated employee benefits. TheCompany believed the China subsidiaries could freely transfer at least $200million to the Company as of December 31, 2006, and during the nine monthsended September 30, 2007 its China subsidiaries have made such transferstotaling $150 million.

Although management believes the Company has asufficient amount of cash resources to finance the Company’s anticipatedworking capital and capital expenditure requirements for the next 12 months,the Company does not have enough cash outside of China to repay the convertiblenotes due on 

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March 1, 2008.Management’s liquidity plans include a partial or complete refinancing of theconvertible notes, renewal of the lines of credit in China, transfers of morecash from its subsidiaries in China to the extent necessary, and, if needed,liquidation of certain investments and/or seeking new financing arrangements.The Company’s ability to maintain sufficient liquidity is also dependent onachieving projected sales and operating margin forecasts.

If additional sources ofliquidity were needed, the Company would consider new debt or equity offeringsor obtaining cash from asset sales, but there is no assurance that suchtransactions could be consummated on acceptable terms or at all. Failure toraise sufficient capital when needed could have a material adverse effect onthe business, results of operations and financial position of the Company.

**NOTE 2—RESTATEMENTOF FINANCIAL STATEMENTS**

The consolidated balancesheet at December 31, 2005 and consolidated statements of operations,stockholders’ equity and cash flows for the years ended December 31, 2004and 2005 included herein have been restated from the amounts previouslyreported. The reasons for the restatement are discussed below.

***China Sales Investigation***

The Audit Committee of theCompany’s Board of Directors (“Audit Committee”) engaged independent counsel toconduct an investigation of sales in China following a determination by theInternal Audit group that allegations of improper activities in a sales officein the Western Region were credible. The allegations were made by a Companyemployee using the Company’s whistle blower program. The independent counselengaged forensic accountants, and this group is collectively referred to as theInvestigating Team in the rest of this discussion.

In conducting its procedures,the Investigating Team found instances where the customer contracts thatevidenced the arrangement contained obligations for the Company to deliversoftware upgrades when and if made available for the equipment sold for noadditional consideration and for an unspecified period that could extend overthe term of the contract. This additional contract obligation is an element of“post contract support.” In these cases, the Investigating Team found that thecontract documentation for the same transaction submitted by the sales officeto the Company’s China headquarters for accounting purposes and utilized by theCompany in determining the amount of revenue recognized did not include evidenceof such post contract support obligations.

Accounting standards governingrevenue recognition for system sales require all revenue to be deferred whilethere are undelivered elements under the arrangement unless the seller hasestablished vendor specific objective evidence (“VSOE”) of fair value for suchcontract elements. Because these arrangements included such undeliveredelements, revenue should be deferred based on the VSOE of the fair value of theunderlying elements. VSOE of fair value represents the price charged when thesame element is sold separately. Since the Company does not sell this elementseparately, it has not established VSOE for such undelivered elements, and assuch the revenue from such contracts is required to be deferred and recognizedover the period the Company is obligated to provide the post contract support.

Upon completion ofthe investigative phase of the independent investigation by the AuditCommittee, management:

·       conductedfollow-up procedures to attempt to locate any additional relevant informationto ensure the Company consideredall available information and documents;

·       evaluatedthe accounting for identified system sales using the contract template anddocumentation found in the sales contract files from the Western Regionoffices. This included calculating the financial statement effects ofcorrecting the accounting for all system sales where the contract 

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template found at thesales offices contained post contract support obligations to recognize revenueand cost of net sales over estimated period of post contract support;

·       concludedthat as a result of this undelivered post contract support obligation theCompany’s previously issued financial statements should be restated to defersystem sales contract revenue and the related cost of net sales over theestimated period of post contract support when a contract contained unspecifiedsoftware upgrade rights.

The Audit Committee concurred with management’sdecisions.

Theeffect of correcting improperly recognized revenue and cost of net sales is to(reduce) increase previously reported net sales, gross profit and net income bythe following amounts (in thousands of dollars):

| **Year ended December 31,** | ** ** | ** ** | ** ** | **Net sales** | ** ** | **Gross profit** | ** ** | **Net income** | ** ** |
|--------------------------------------------|------------|------------|------------|--------------------|------------|-----------------------|------------|---------------------|------------|
| 2000                                       |       | $          | (12,408    | )                  |       | $                     | (5,294     | )                   |       |   | $ | (4,781 | ) |   |
| 2001                                       |       | (17,154    | )          |               | (6,330     | )                     |       |                | (5,779     | ) |   |
| 2002                                       |       | (64,732    | )          |               | (22,924    | )                     |       |                | (19,697    | ) |   |
| 2003                                       |       | (21,060    | )          |               | (8,014     | )                     |       |                | (6,382     | ) |   |
| Totals through  December 31, 2003     |       | (115,354   | )          |               | (42,562    | )                     |       |                | (36,639    | ) |   |
| 2004                                       |       | (104,965   | )          |               | (27,241    | )                     |       |                | (18,594    | ) |   |
| 2005                                       |       | (58,232    | )          |               | (27,863    | )                     |       |                | (42,433    | ) |   |
| 2000 - 2005 Total                          |       | $          | (278,551   | )                  |       | $                     | (97,666    | )                   |       |   | $ | (97,666 | ) |   |

 

In the consolidatedbalance sheets at December 31, 2005 and 2006, the net reduction inpreviously recognized net sales is accounted for as deferred revenue, of which$32.9 million and $35.6 million, respectively, is classified as current, $252.1million and $240.1 million, respectively, as non-current, and the related netreduction in cost of net sales of $185.3 million and $176.6 million,respectively, is accounted for as deferred costs. These amounts will berecognized in the Company’s consolidated statements of operations over theestimated remaining period of post contract support.

*Audit CommitteeFindings*

Upon completing itsinvestigation, the Audit Committee concluded that the conditions and practicesrelating to systems contracts prevalent in the Western Region resultedprimarily from the failure to prevent or detect instances of override relatedto controls in China over customer agreements, lack of proper managementoversight, unclear record retention policies and procedures relating to systemscontracts, and inadequate employee training. The Investigating Team and theAudit Committee also concluded that with respect to four regions other than theWestern Region there was no evidence of fraud or misconduct or reason tosuspect such occurred. The Investigating Team and the Audit Committee alsoconcluded that there was no credible evidence of knowledge by senior managementin China or the United States of the conditions and practices related to theWestern Region of China that were discovered in the investigation. The AuditCommittee concluded that local management in several of the sales offices inthe Western Region of China did not submit appropriate information to theCompany’s senior management in China and the United States. Therefore, in prioryears, neither the Company’s management nor the Company’s independentregistered accounting firm were able to properly evaluate the effect of thatinformation on revenue recognition. The Audit Committee also concluded thatcertain members of management in China bear varying degrees of responsibilityfor inadequate oversight of activities. As a result, certain employees in Chinahave either been terminated or placed on suspension for failure to provideadequate oversight of activities.

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***Governance Committee Review of Historical Stock OptionAccounting***

In November 2006 the Company announced it hadcommenced a voluntary review of historical stock option practices under theleadership of the Nominating and Corporate Governance Committee of theCompany’s Board of Directors (“Governance Committee”) following a preliminaryreview by management which identified potential deficiencies and discrepanciesin the documentation of stock option grants. The review considered all optiongrant awards made in the period from February 29, 2000, shortly before theinitial public offering of the Company’s Common Stock, through August 2006(“Review Period”) for compliance with the various stock-based compensationaccounting standards applicable during the Review Period, the rules of theCompany’s stock option plans, and the guidance on stock option accountingissued by the SEC in the September 19, 2006 letter which was to beconsidered applicable to periods prior as well as subsequent to its issuance.At the time the review commenced, the Governance Committee consisted of threemembers of the Board of Directors, all of whom are independent directors.Mr. Allen Lenzmeier was appointed to the Governance Committee onApril 27, 2007. The Governance Committee engaged independent outside legalcounsel to assist in the review who, in turn, engaged forensic accountingexperts (collectively referred to herein as the “Review Team”).

The Review Team, management, and the GovernanceCommittee decided to group stock option grants into six award categories basedon differences in what constituted substantive approval for each category underthe Company’s stock option granting practices as well as giving considerationto the risk of intentional misstatement of the grant date. Guidance in theSeptember 19, 2006 letter on determining the date when substantiveapproval of a stock option grant occurs recognizes that depending on a company’sfacts and circumstances a company may determine that the measurement date forsome stock option grants may occur before all required granting actions haveoccurred—such as final approval by the Compensation Committee. This alternativeis available only when a review of all facts and circumstances supports aconclusion that substantive approval occurs earlier than when all requiredgranting actions have occurred and there is no evidence of fraudulent ormanipulative conduct in the company’s option granting practices.

In determining themeasurement date to be used, the Review Team, management, and the GovernanceCommittee agreed to use the following definitions as constituting the propermeasurement date, and generally these dates were used in testing the statedgrant dates or establishing corrected measurement dates:

| **Discretionary  Director and Officer Grants** |   | The date of a Compensation Committee meeting where the grant was approved or  the date the final Compensation Committee signer approved the grant when approval  occurred through unanimous written consent documents (“UWC”).                                                                                                                                                   |
|-----------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Automatic Director Grants**                       |   | The date specified in  the relevant stock option plan.                                                                                                                                                                                                                                                                                                                                     |
| **Broadbase**                                       |   | The date the grantee  list, including the allocation of shares to individual grantees, was complete.  Compensation Committee approval was considered perfunctory due to delegation  of authority to management.                                                                                                                                                                            |
| **Acquisition**                                     |   | The first Compensation  Committee meeting following the acquisition, provided grantees had received  employment offer letters stating the number of stock options to be granted  before such date because this was the date at which the option exercise price  was established. Compensation Committee approval was considered perfunctory  due to delegation of authority to management. |

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| **New Hire**    |   | The first  scheduled Compensation Committee meeting following the first day of  employment because this was the date at which the option exercise price was  established. The number of options was based on either grant amounts  specified in an employment offer letter or, in some cases, on a matrix that  assigned grant amounts based on position and level within the Company.  Compensation Committee approval was considered perfunctory due to delegation  of authority to management. |
|-----------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Other Merit** |   | The date the grantee  list, including the allocation of shares to grantees, was substantially  complete. Compensation Committee approval was considered perfunctory due to  delegation of authority to management.                                                                                                                                                                                                                                                                                |

 

During the Review Period, the Company granted stockoptions on approximately 34 million shares of the Company’s common stock at 197grant dates. The review specifically examined the appropriateness of the statedgrant date for approximately 90% of the stock options granted, including allstock option grants made to directors and officers, all broadbase options andall option grants made in connection with business acquisitions. The reviewincluded an extensive examination of the Company’s historical stock optionpractices—including information from stock option administration, humanresource, legal, and accounting department files and records as well as frome-mail communications, an electronic database of the Company’s stock optionactivity maintained by a third party, and information stored in Company harddrives and back-up tapes. The Review Team also conducted interviews ofindividuals involved with the granting, advising, administering, or accountingfor stock options, including current and former: management, members of theBoard of Directors, employees, and non-employee professionals.

Thefindings of this review are summarized as follows:

| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **         | ** ** | **Measurement date changed** | ** ** |
|--------------------------------------------|------------|------------|------------|----------------------------|------------|--------------------|------------|----------------------------------------|------------|
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **         | ** ** | **additional**                         | ** ** | **no additional** | ** ** |
| ** **                                 | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **         | ** ** | **compensation**                       | ** ** | **compensation** | ** ** |
| **Grant Type**                        | ** ** | ** ** | ** ** | **Number of  grants** | ** ** | **Grants  tested** | ** ** | **No change  required**           | ** ** | **expense  required** | ** ** | **expense  required(1)** | ** ** |
| Discretionary  Director & Officer |       |       | 16         |                       |       |               | 16         |                                   |       |   | 8 |   |   |   | 4 |   |   |   | 4 |   |   |
| Automatic  Director                        |       |       | 5          |                       |       |               | 5          |                                   |       |   | 5 |   |   |   | — |   |   |   | — |   |   |
| Broadbase                                  |       |       | 8          |                       |       |               | 8          |                                   |       |   | — |   |   |   | 6 |   |   |   | 2 |   |   |
| Acquisition                                |       |       | 10         |                       |       |               | 10         |                                   |       |   | 10 |   |   |   | — |   |   |   | — |   |   |
| New Hire                                   |       |       | 166        |                       |       |               | 48         |                                   |       |   | 48 |   |   |   | — |   |   |   | — |   |   |
| Other Merit                                |       |       | 96         |                       |       |               | 41         |                                   |       |   | 4 |   |   |   | 21 |   |   |   | 16 |   |   |
| Total                                      |       |       | 301        | (2)                        |       |               | 128        |                                   |       |   | 75 |   |   |   | 31 |   |   |   | 22 |   |   |
|                                            |            |            |            |                            |            |                    |            |                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

----

(1)          Under APB 25 there is noexpense adjustment arising from using the corrected measurement date for thesegrants because the amount the employee would have to pay to exercise thesestock option grants exceeded the quoted market price of the Company’s CommonStock at the corrected measurement date, and therefore, these stock optiongrants contained no intrinsic value at the corrected measurement date.

(2)          The number of grantsexceeds the number of grant dates because on certain grant dates more than onecategory of stock option grants were approved.

A non-cash compensation charge, to be recognized as anexpense over a grantee’s service period, arises under Accounting PrinciplesBoard Opinion No. 25 *Accounting for StockIssued to Employees*(“APB 25”), the accounting standardgoverning the Company’s stock option accounting through 2005, if a 

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stock option has intrinsicvalue at its measurement date. This intrinsic value is measured by the excess,if any, of the fair value at the date of grant of the underlying common stockover the stock option’s exercise price. The Company’s practice has been togrant stock options with exercise prices equal to the closing price of theunderlying Company common stock at each grant date, to use the grant date asthe measurement date for stock-based compensation purposes, and as suchpreviously the Company had determined the granted stock options had nointrinsic value at their grant dates and no compensation expense wasrecognized. However, APB 25 states the measurement date does not occur untilall essential actions necessary to grant the option are completed, includingthe final determination of both the number of shares to be granted to eachemployee or director and the exercise price, and the option grant is approvedby those with requisite authority. A September 19, 2006 letter publiclyissued by the SEC’s Chief Accountant focused companies registered with theSEC on the need for the number of shares and exercise price of an award to anindividual to be finalized to have a measurement date. This letter clarifiesthe SEC staff’s view that if it is possible that those terms could change, ameasurement date has not occurred, even if the award’s terms are not actuallychanged.

Based on availableevidence, the review found that the number of shares an individual employee wasentitled to receive and/or the exercise price for stock option grants was notdetermined with finality at the stated grant date at 53 tested grant dates, andthe Company should have used a later date as the measurement date. Theprincipal reasons for the stated grant date not qualifying as the measurementdate under APB 25 include:

·       certainlistings of grantees, below officer level, were incomplete and added to ormodified by stock option administration personnel after the grant was approvedby the Compensation Committee;

·       forcertain grants where Compensation Committee approval was not consideredperfunctory, the date a UWC document was sent to Compensation Committee membersfor approval was used as the stated grant date for some discretionary officerand director grants rather than the date the UWC was signed by all CompensationCommittee members and therefore became effective;

·       theStock Option Review Team was unable to locate contemporaneous documentation ofsome director and officer, broadbase, new hire, and other merit grants.

A total of 17.9 million stock options were granted atthe 53 tested grant dates during 2000 through 2005 where the GovernanceCommittee’s review found the Company used incorrect measurement dates. Usingthe corrected measurement dates, 10.3 million stock options had intrinsic valuebecause their exercise prices were below the closing price of the Company’sCommon Stock at the corrected measurement date, and 7.6 million stock optionshad exercise prices that exceeded the closing price of the Company’s CommonStock and therefore had no intrinsic value to be accounted for under APB 25.These 10.3 million stock options resulted in an increase in non-cashstock-based compensation expense of $24.3 million during 2000 to 2005. Of the10.3 million stock options resulting in additional non-cash stock-basedcompensations expense, 2.0 million options were granted to officers anddirectors and resulted in $6.1 million of additional non-cash stock-basedcompensation expense.

In some cases, in correcting the measurement date forpreviously granted stock options additional taxable income to employees ariseson which additional payroll taxes are due from the employee as well as theCompany. The Company has assumed responsibility for all additional payrolltaxes plus related penalties and interest arising from the restatement ofstock-based compensation, including amounts otherwise payable by stock optionrecipients, and the Company’s restated financial statements include a $1.5million accrual for this estimated expense.

Because the holders of stock options where correctionswere made to the measurement dates were not aware that improper measurementdates were used, the Company has taken certain actions and is contemplatingtaking additional actions to deal with the adverse personal income taxconsequences that 

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may be incurred by theholders of stock options with corrected measurement dates. Adverse personalincome tax consequences arise from the exercise of stock options vesting afterDecember 31, 2004 where the corrected measurement dates cause them to havean exercise price below the fair market value of Company’s common stock at themeasurement date (“409A Affected Options”). Such an exercise would subject theoption holder to a penalty tax under IRC Section 409A (and, as applicable,similar penalty taxes under California and other state tax laws). The Companyhas evaluated its stock option exercises through December 31, 2006 anddetermined there were no exercises of 409A Affected Options; accordingly, nopenalty tax has been incurred by employees exercising stock options throughthat date.

The Company is considering how to deal with exercisesof 409A Affected Options that occur in 2007 and beyond. One alternative wouldbe to offer to amend all 409A Affected Options to change the exercise price tothe fair market price of the Company’s common stock on the correctedmeasurement date. These amended options would not be subject to taxation underIRC Section 409A. Under IRS regulations, option amendments had to becompleted by December 31, 2006 for anyone who was an executive officer ormember of the Board of Directors when he or she received 409A Affected Options.Therefore, prior to December 31, 2006 eight of the Company’s current andformer executive officers and directors executed an irrevocable ProtectiveAmendment Election Form whereby any of their stock options will beautomatically amended to restate the exercise price to the fair market value ofthe Company’s common stock at the corrected measurement date if in the futuresuch stock options would otherwise be determined to be 409A Affected Options. Asimilar offer to amend all 409A Affected Options held by non-officer employeesis currently under consideration, but no decision has been reached and such anoffer cannot be made until the Company is current with its SEC reportingobligations.

During the review the Company also discovered a stockoption grant to a former officer that was modified in 1998 in connection withhis termination of employment that should have resulted in additionalcompensation expense. This change was never included in the Company’s stockoption grant records and the additional compensation expense resulting from thechange in the option’s terms (approximately $1.2 million) was not recordedpreviously. This discovery is consistent with the Review Team’s finding that incertain instances there was a lack of formal documentation in the stock optiongranting process and/or expected documentation is missing from the stock optionadministration files. In addition, the Review Team found that, in manyinstances, there was a lack of self-authenticating evidence to corroborate thatcash exercises were contemporaneous. As a result, the findings on the issue ofbackdating of cash exercises were inconclusive.

The Company’s accounting for stock-based compensationchanged to a fair value method in 2006 when, as required by accountingstandards, it ceased accounting for stock-based compensation under theintrinsic value method pursuant to APB 25 and began accounting for stock-basedcompensation pursuant to Statement of Financial Accounting Standards 123(R) Share-BasedPayments (“SFAS 123(R)”). Under this method all stock option grants have a fairvalue determined using an option pricing model, and such fair value is used torecognize non-cash stock-based compensation expense. The Company recognizes stockcompensation expense on a straight-line basis under SFAS 123(R).

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Thetable below shows the effects of correcting the consolidated financialstatements for the Governance Committee’s findings and the modification in 1998of a stock option grant to a former officer in connection with his terminationof employment. Consistent with its historical accounting policy, thisadditional stock-based compensation expense is being recognized on anaccelerated basis by treating each vesting tranche as a separate stock optiongrant (graded vesting). Additionally, the table gives effect to corrections ofthe accounting for performance related stock options and restricted stockgrants in the first two quarters of 2006, all of which were previouslyidentified and considered immaterial. The effects of correcting the errors inthe Company’s previous stock option accounting are to increase (reduce)previously reported non-cash compensation expense, payroll taxes, income taxesand net income by the following amounts (in thousands of dollars):

| ** **                                 | ** ** | **Non-cash stock** | ** ** | ** **       | ** ** | ** **             | ** ** | ** **            | ** ** |
|--------------------------------------------|------------|-------------------------|------------|------------------|------------|------------------------|------------|-----------------------|------------|
| **Year ended December 31,** | ** ** | ** **              | ** ** | **compensation** | ** ** | **Payroll taxes** | ** ** | **Income taxes** | ** ** | **Net income** | ** ** |
| 1998                                       |       |                    | $          | 1,244            |       |                   |       | $                     | —     |   |   |   | $ | (448 | ) |   |   | $ | (796 | ) |   |
| 1999                                       |       |                    | —     |             |       |                   | —     |                  |       |   | — |   |   |   | — |   |   |
| 2000                                       |       |                    | 556        |             |       |                   | —     |                  |       |   | (104 | ) |   |   | (452 | ) |   |
| 2001                                       |       |                    | 4,870      |             |       |                   | —     |                  |       |   | (942 | ) |   |   | (3,928 | ) |   |
| 2002                                       |       |                    | 8,110      |             |       |                   | —     |                  |       |   | (1,550 | ) |   |   | (6,560 | ) |   |
| 2003                                       |       |                    | 12,470     |             |       |                   | 900        |                  |       |   | (2,281 | ) |   |   | (11,089 | ) |   |
| Totals through  December 31, 2003     |       |                    | 27,250     |             |       |                   | 900        |                  |       |   | (5,325 | ) |   |   | (22,825 | ) |   |
| 2004                                       |       |                    | (410       | )                |       |                   | 541        |                  |       |   | 250 |   |   |   | (381 | ) |   |
| 2005                                       |       |                    | (1,290     | )                |       |                   | 60         |                  |       |   | 4,083 |   |   |   | (2,853 | ) |   |
| 2000 - 2005 Total                          |       |                    | 25,550     |             |       |                   | 1,501      |                  |       |   | (992 | ) |   |   | (26,059 | ) |   |
|                                            |            |                         |            |                  |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Thefollowing table shows the Company’s stock-based compensation expense aspreviously reported and the impact of the restatement (excluding payroll taxes)on stock-based compensation for periods prior to fiscal 2006, net of incometax:

| ** **                                                                                    | ** ** | **Stock-Based Compensation  Expense (Net of Tax)** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------|------------|
| **Year ended December 31,**                                                    | ** ** | ** **                                                             | ** ** | **As Reported** | ** ** | **Adjustments** | ** ** | **As Restated** | ** ** |
| ** **                                                                                    | ** ** | **(in thousands)**                                                | ** ** |
| 1998 (net of  income tax benefit/(expense) of $118, $448 and $566, respectively)         |       |                                                                   | $          | 294 |   |   |   | $ | 796 |   |   |   | $ | 1,090 |   |   |
| 1999 (net of  income tax benefit/(expense) of $1,596, $0 and $1,596, respectively)       |       |                                                                   | 3,957      |   |   |   | — |   |   |   | 3,957 |   |   |
| 2000 (net of  income tax benefit/(expense) of $3,323, $104 and $3,427, respectively)     |       |                                                                   | 8,238      |   |   |   | 452 |   |   |   | 8,690 |   |   |
| 2001 (net of  income tax benefit/(expense) of $1,495, $942 and $2,437, respectively)     |       |                                                                   | 3,706      |   |   |   | 3,928 |   |   |   | 7,634 |   |   |
| 2002 (net of  income tax benefit/(expense) of $891, $1,550 and $2,441, respectively)     |       |                                                                   | 2,209      |   |   |   | 6,560 |   |   |   | 8,769 |   |   |
| 2003 (net of  income tax benefit/(expense) of $1,212, $2,281 and $3,493, respectively)   |       |                                                                   | 3,071      |   |   |   | 10,189 |   |   |   | 13,260 |   |   |
| 2004 (net of  income tax benefit/(expense) of $149, ($250) and ($101), respectively)     |       |                                                                   | 370        |   |   |   | (160 | ) |   |   | 210 |   |   |
| 2005 (net of income tax  benefit/(expense) of $105, ($4,083) and ($3,978), respectively) |       |                                                                   | 2,154      |   |   |   | 2,793 |   |   |   | 4,947 |   |   |
|                                                                                               |            |                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*GovernanceCommittee Findings*

Upon completing itsreview, the Governance Committee concluded it found no evidence of intent tomanipulate the Company’s operating results or financial statements. A keyfinding of the Governance Committee was that there were deficiencies with theprocess by which stock options were granted during the period from theCompany’s initial public offering in 2000 through at least 2005, which resultedin accounting errors. The Governance Committee concluded that certain membersof management bear varying degrees of responsibility for the deficiencies inthe process by which options were granted. The Governance Committee’s reviewalso concluded that none of the current or former employees or directors of theCompany engaged in intentional wrongdoing.

***Restatement and Impact on Financial Statements***

Thefollowing table presents the decrease in net income, by year, as a result ofrestating for the results of the China sales investigation and the historicalstock option accounting review:

| ** **                                 | ** ** | **Net income **    | ** ** | ** **                       | ** ** | ** **                   | ** ** |
|--------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                                 | ** ** | **(loss),**                  | ** ** | **Restatement adjustments** | ** ** | **Net income**          | ** ** |
| ** **                                 | ** ** | **as previously ** | ** ** | **China Sales**             | ** ** | **Stock Options**       | ** ** | **Total** | ** ** | **(loss),** | ** ** |
| **Year ended December 31,** | ** ** | ** **                   | ** ** | **reported**                     | ** ** | **(Decrease) Increase** | ** ** | **as restated** | ** ** |
| ** **                                 | ** ** | ** **                   | ** ** | **(in thousands)**          | ** ** | ** **                   | ** ** |
| 1998                                       |       |                         |       |                             |       |                         | $          | — |   |   |   | $ | (796 | ) |   | $ | (796 | ) |   |   |
| 1999                                       |       |                         |       |                             |       |                         | —     |   |   |   | — |   |   | — |   |   |   |
| 2000                                       |       |                         |       |                             |       |                         | (4,781     | ) |   |   | (452 | ) |   | (5,233 | ) |   |   |
| 2001                                       |       |                         |       |                             |       |                         | (5,779     | ) |   |   | (3,928 | ) |   | (9,707 | ) |   |   |
| 2002                                       |       |                         |       |                             |       |                         | (19,697    | ) |   |   | (6,560 | ) |   | (26,257 | ) |   |   |
| 2003                                       |       |                         |       |                             |       |                         | (6,382     | ) |   |   | (11,089 | ) |   | (17,471 | ) |   |   |
| Totals through  December 31, 2003     |       |                         |       |                             |       |                         | (36,639    | ) |   |   | (22,825 | ) |   | (59,464 | ) |   |   |
| 2004                                       |       |                         | $          | 69,824                           |       |                         |       | (18,594 | ) |   |   | (381 | ) |   | (18,975 | ) | 50,849 |   |
| 2005                                       |       |                         | $          | (487,359                         | )          |                         |       | (42,433 | ) |   |   | (2,853 | ) |   | (45,286 | ) | $ | (532,645 | ) |
| 2000 - 2005 Total                          |       |                         |       |                             |       |                         | (97,666    | ) |   |   | (26,059 | ) |   | (123,725 | ) |   |   |
|                                            |            |                              |            |                                  |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The cumulative effect ofthe restatements at December 31, 2003 was an increase to additionalpaid-in capital and deferred stock-based compensation of $26.0 million from$646.7 million to $672.7 million, and a decrease in retained earnings of $59.5million from $237.4 million to $177.9 million, and a decrease in totalstockholders’ equity of $33.5 million from $887.7 million to $854.2 million.

***Other Changes***

In restating thepreviously issued financial statements for the investigations discussed above,the Company also corrected other previously reported amounts. It corrected the reporting of $80.3 million of netsales to certain third party resellers and $41.2 million of associated cost ofnet sales in 2005 to classify these amounts as related party net sales andrelated party cost of net sales classifications, respectively, because in 2006the Company determined that sales to these entities were, in substance, salesto a significant shareholder, SOFTBANK CORP. The classification of the accountsreceivable from these sales was similarly changed to include them in accountsreceivable from related parties in the December 31, 2005 consolidatedbalance sheet.

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***Restated Financial Information***

The following tablesreflect the impact of the China sales investigation, changes in non-cashcharges for stock-based compensation expense, related additional payroll taxes,and income tax effects as well as the restatementto correct the classification of related party transactions discussed above******on:

·       theconsolidated statements of operations for the years ended December 31,2005 and 2004

·       theconsolidated balance sheet as of December 31, 2005

·       theconsolidated statements of cash flows for the years ended December 31, 2005and 2004

Stock option grants with corrected measurement datesalso are being restated in the following tables using the fair value basedmeasurement principles of SFAS 123 *Accounting for Stock-BasedCompensation*(“SFAS 123”) to present the pro forma effect onstock-based compensation expense, net income (loss), and earnings (loss) pershare amounts in 2004 and 2005 of using SFAS 123’s fair value based method todetermine stock-based compensation expense rather than using APB 25’s intrinsicvalue method. Such disclosure is required for periods prior to the adoption ofSFAS No. 123(R).

The tables also present the impact of changes inpreviously reported gross profit by segment information for the years endedDecember 31, 2005 and 2004 resulting from the restatements of salesrecognition in China and in non-cash charges for stock-based compensationexpense and related additional payroll taxes in those periods.

145

----

**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OF OPERATIONS(In thousands, except per share amounts)**

| ** **                                                                                            | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| ** **                                                                                            | ** ** | **As previously**                     | ** ** | ** ** | ** ** | ** ** | ** ** | **As previously** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                            | ** ** | **reported**                               | ** ** | **Adjustments** | ** ** | **As restated** | ** ** | **reported** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| Net sales                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrelated party                                                                                       |       |                                       | $          | 2,533,792 |   |   |   | $ | (138,494 | ) |   | $ | 2,395,298 |   |   | $ | 2,539,706 |   |   |   | $ | (104,964 | ) |   | $ | 2,434,742 |   |
| Related party                                                                                         |       |                                       | 395,551    |   |   |   | 80,261 |   |   | 475,812 |   |   | 144,673 |   |   |   | — |   |   | 144,673 |   |
|                                                                                                  |       |                                       | 2,929,343  |   |   |   | (58,233 | ) |   | 2,871,110 |   |   | 2,684,379 |   |   |   | (104,964 | ) |   | 2,579,415 |   |
| Cost of net sales                                                                                     |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Unrelated party                                                                                       |       |                                       | 2,258,824  |   |   |   | (71,685 | ) |   | 2,187,139 |   |   | 1,996,188 |   |   |   | (77,714 | ) |   | 1,918,474 |   |
| Related party                                                                                         |       |                                       | 206,902    |   |   |   | 41,233 |   |   | 248,135 |   |   | 91,409 |   |   |   | — |   |   | 91,409 |   |
| Gross profit                                                                                          |       |                                       | 463,617    |   |   |   | (27,781 | ) |   | 435,836 |   |   | 596,782 |   |   |   | (27,250 | ) |   | 569,532 |   |
| Operating expenses:                                                                                   |       |                                       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative                                                                   |       |                                       | 372,291    |   |   |   | (830 | ) |   | 371,461 |   |   | 303,822 |   |   |   | 89 |   |   | 303,911 |   |
| Research and development                                                                              |       |                                       | 247,133    |   |   |   | (320 | ) |   | 246,813 |   |   | 219,045 |   |   |   | 34 |   |   | 219,079 |   |
| Amortization of intangible assets                                                                     |       |                                       | 25,853     |   |   |   | — |   |   | 25,853 |   |   | 15,551 |   |   |   | — |   |   | 15,551 |   |
| Impairment on long-lived   assets                                                                     |       |                                       | 218,094    |   |   |   | — |   |   | 218,094 |   |   | 12,706 |   |   |   | — |   |   | 12,706 |   |
| Restructuring                                                                                         |       |                                       | 29,669     |   |   |   | — |   |   | 29,669 |   |   | — |   |   |   | — |   |   | — |   |
| In-process research and   development                                                                 |       |                                       | 660        |   |   |   | — |   |   | 660 |   |   | 1,400 |   |   |   | — |   |   | 1,400 |   |
| Total operating expenses                                                                              |       |                                       | 893,700    |   |   |   | (1,150 | ) |   | 892,550 |   |   | 552,524 |   |   |   | 123 |   |   | 552,647 |   |
| Operating (loss) income                                                                               |       |                                       | (430,083   | ) |   |   | (26,631 | ) |   | (456,714 | ) |   | 44,258 |   |   |   | (27,373 | ) |   | 16,885 |   |
| Interest income                                                                                       |       |                                       | 7,091      |   |   |   | — |   |   | 7,091 |   |   | 6,172 |   |   |   | — |   |   | 6,172 |   |
| Interest expense                                                                                      |       |                                       | (16,764    | ) |   |   | — |   |   | (16,764 | ) |   | (6,916 | ) |   |   | — |   |   | (6,916 | ) |
| Gain on extinguishment of subordinated notes                                                          |       |                                       | 31,392     |   |   |   | — |   |   | 31,392 |   |   | — |   |   |   | — |   |   | — |   |
| Other income, net                                                                                     |       |                                       | 43,665     |   |   |   | — |   |   | 43,665 |   |   | 15,431 |   |   |   | — |   |   | 15,431 |   |
| (Loss) income before income taxes, minority interest  and equity in loss of affiliated companies |       |                                       | (364,699   | ) |   |   | (26,631 | ) |   | (391,330 | ) |   | 58,945 |   |   |   | (27,373 | ) |   | 31,572 |   |
| Income tax (expense) benefit                                                                          |       |                                       | (117,889   | ) |   |   | (18,655 | ) |   | (136,544 | ) |   | 11,894 |   |   |   | 8,398 |   |   | 20,292 |   |
| Minority interest in losses of consolidated  subsidiaries                                             |       |                                       | 692        |   |   |   | — |   |   | 692 |   |   | 285 |   |   |   | — |   |   | 285 |   |
| Equity in loss of affiliated  companies                                                               |       |                                       | (5,463     | ) |   |   | — |   |   | (5,463 | ) |   | (1,300 | ) |   |   | — |   |   | (1,300 | ) |
| Net (loss) income                                                                                     |       |                                       | $          | (487,359 | ) |   |   | $ | (45,286 | ) |   | $ | (532,645 | ) |   | $ | 69,824 |   |   |   | $ | (18,975 | ) |   | $ | 50,849 |   |
| (Loss) earnings per share—Basic                                                                  |       |                                       | $          | (4.16 | ) |   |   | $ | (0.39 | ) |   | $ | (4.55 | ) |   | $ | 0.61 |   |   |   | $ | (0.17 | ) |   | $ | 0.45 |   |
| (Loss) earnings  per share—Diluted                                                               |       |                                       | $          | (4.16 | ) |   |   | $ | (0.39 | ) |   | $ | (4.55 | ) |   | $ | 0.54 |   |   |   | $ | (0.14 | ) |   | $ | 0.40 |   |

 

146

----

**UTSTARCOM, INC.CONSOLIDATED BALANCE SHEETS(In thousands, except share data)**

| ** **                                                                                                                         | ** ** | **December 31, 2005**       | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                         | ** ** | **As previously  reported** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| **ASSETS**                                                                                                                         |       |                             |       |   |   |   |   |   |   |   |   |
| Current assets:                                                                                                                    |       |                             |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                          |       |                             | $          | 645,571 |   |   |   | $ | — |   |   | $ | 645,571 |   |
| Short-term investments                                                                                                             |       |                             | 13,266     |   |   |   | — |   |   | 13,266 |   |
| Accounts receivable, net of allowances for doubtful  accounts of $67,789                                                           |       |                             | 453,671    |   |   |   | (14,074 | ) |   | 439,597 |   |
| Accounts receivable, related parties, net of  allowances for doubtful accounts of $5                                          |       |                             | 69,293     |   |   |   | 14,074 |   |   | 83,367 |   |
| Notes receivable                                                                                                                   |       |                             | 2,065      |   |   |   | — |   |   | 2,065 |   |
| Inventories                                                                                                                        |       |                             | 425,955    |   |   |   | — |   |   | 425,955 |   |
| Deferred costs                                                                                                                     |       |                             | 239,876    |   |   |   | — |   |   | 239,876 |   |
| Prepaids and other current assets                                                                                                  |       |                             | 99,062     |   |   |   | — |   |   | 99,062 |   |
| Short-term restricted cash and investments                                                                                         |       |                             | 53,680     |   |   |   | — |   |   | 53,680 |   |
| Current deferred taxes                                                                                                             |       |                             | —     |   |   |   | — |   |   | — |   |
| Total current assets                                                                                                               |       |                             | 2,002,439  |   |   |   | — |   |   | 2,002,439 |   |
| Property, plant and equipment, net                                                                                                 |       |                             | 233,403    |   |   |   | — |   |   | 233,403 |   |
| Long-term investments                                                                                                              |       |                             | 26,023     |   |   |   | — |   |   | 26,023 |   |
| Goodwill                                                                                                                           |       |                             | 3,063      |   |   |   | — |   |   | 3,063 |   |
| Intangible assets, net                                                                                                             |       |                             | 75,313     |   |   |   | — |   |   | 75,313 |   |
| Long-term deferred costs                                                                                                           |       |                             | —     |   |   |   | 185,279 |   |   | 185,279 |   |
| Other long-term assets                                                                                                             |       |                             | 25,811     |   |   |   | — |   |   | 25,811 |   |
| Total assets                                                                                                                       |       |                             | $          | 2,366,052 |   |   |   | $ | 185,279 |   |   | $ | 2,551,331 |   |
| **LIABILITIES, MINORITY INTEREST AND STOCKHOLDERS’  EQUITY**                                                                  | ** ** |                             |       |   |   |   |   |   |   |   |   |
| Current liabilities:                                                                                                               |       |                             |       |   |   |   |   |   |   |   |   |
| Accounts payable                                                                                                                   |       |                             | $          | 320,677 |   |   |   | $ | — |   |   | $ | 320,677 |   |
| Short-term debt                                                                                                                    |       |                             | 198,826    |   |   |   | — |   |   | 198,826 |   |
| Income taxes payable                                                                                                               |       |                             | 33,608     |   |   |   | 621 |   |   | 34,229 |   |
| Customer advances                                                                                                                  |       |                             | 221,301    |   |   |   | — |   |   | 221,301 |   |
| Deferred revenue                                                                                                                   |       |                             | 69,030     |   |   |   | 32,882 |   |   | 101,912 |   |
| Other current liabilities                                                                                                          |       |                             | 289,867    |   |   |   | 1,501 |   |   | 291,368 |   |
| Total current liabilities                                                                                                          |       |                             | 1,133,309  |   |   |   | 35,004 |   |   | 1,168,313 |   |
| Long-term deferred revenue                                                                                                         |       |                             | 20,958     |   |   |   | 252,173 |   |   | 273,131 |   |
| Long-term debt                                                                                                                     |       |                             | 274,900    |   |   |   | — |   |   | 274,900 |   |
| Total liabilities                                                                                                                  |       |                             | 1,429,167  |   |   |   | 287,177 |   |   | 1,716,344 |   |
| Minority interest in consolidated subsidiaries                                                                                     |       |                             | 8,338      |   |   |   | — |   |   | 8,338 |   |
| Stockholders’  equity:                                                                                                        |       |                             |       |   |   |   |   |   |   |   |   |
| Common stock: $0.00125 par value; authorized:  750,000,000 shares; issued and outstanding: 121,018,036 at December 31,  2005. |       |                             | 152        |   |   |   | — |   |   | 152 |   |
| Additional paid-in capital                                                                                                         |       |                             | 1,168,166  |   |   |   | 24,035 |   |   | 1,192,201 |   |
| Deferred stock compensation                                                                                                        |       |                             | (3,493     | ) |   |   | (98 | ) |   | (3,591 | ) |
| Accumulated deficit                                                                                                                |       |                             | (253,174   | ) |   |   | (123,725 | ) |   | (376,899 | ) |
| Accumulated other comprehensive income                                                                                             |       |                             | 16,896     |   |   |   | (2,110 | ) |   | 14,786 |   |
| Total stockholders’ equity                                                                                                    |       |                             | 928,547    |   |   |   | (101,898 | ) |   | 826,649 |   |
| Total liabilities,  minority interest and stockholders’ equity                                                                |       |                             | $          | 2,366,052 |   |   |   | $ | 185,279 |   |   | $ | 2,551,331 |   |

 

147

----

**UTSTARCOM, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(In thousands)**

| ** **                                                                                               | ** ** | **Year ended December 31, 2005** | ** ** | **Year ended December 31, 2004** | ** ** |                 |
|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------|
| ** **                                                                                               | ** ** | **As**                                               | ** ** | ** **                                           | ** ** | ** **           | ** ** | **As** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| ** **                                                                                               | ** ** | **previously**                                       | ** ** | ** **                                           | ** ** | ** **           | ** ** | **previously** | ** ** | ** ** | ** ** | ** ** | ** ** |   |
| ** **                                                                                               | ** ** | **reported**                                         | ** ** | ** **                                           | ** ** | **As restated** | ** ** | **reported** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |   |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                                   |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income                                                                                        |       |                                                 | $          | (487,359                                             | )          |                 |   | $ | (45,286 | ) |   |   | $ | (532,645 | ) |   |   | $ | 69,824 |   |   |   | $ | (18,975 | ) |   |   | $ | 50,849 |   |   |   |
| Adjustments to reconcile  net (loss) income to net cash provided by (used in) operating activities: |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                                           |       |                                                 | 98,550     |                                                 |       |                 | — |   |   |   | 98,550 |   |   |   | 76,203 |   |   |   | — |   |   |   | 76,203 |   |   |   |
| Loss on sale of  assets                                                                                  |       |                                                 | 2,559      |                                                 |       |                 | — |   |   |   | 2,559 |   |   |   | 2,201 |   |   |   | — |   |   |   | 2,201 |   |   |   |
| Impairment of  long-lived assets                                                                         |       |                                                 | 218,094    |                                                 |       |                 | — |   |   |   | 218,094 |   |   |   | 12,706 |   |   |   | — |   |   |   | 12,706 |   |   |   |
| Impairment of  long-term investments                                                                     |       |                                                 | —     |                                                 |       |                 | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   |
| Stock-based  compensation expense                                                                        |       |                                                 | 2,153      |                                                 |       |                 | (1,290 | ) |   |   | 863 |   |   |   | 519 |   |   |   | (410 | ) |   |   | 109 |   |   |   |
| Non-cash  settlement of restructuring charges                                                            |       |                                                 | 17,250     |                                                 |       |                 | — |   |   |   | 17,250 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   |
| In-process  research and development                                                                     |       |                                                 | 660        |                                                 |       |                 | — |   |   |   | 660 |   |   |   | 1,400 |   |   |   | — |   |   |   | 1,400 |   |   |   |
| (Gain) loss on  sale of investment                                                                       |       |                                                 | (46,576    | )                                                    |       |                 | — |   |   |   | (46,576 | ) |   |   | (1,912 | ) |   |   | — |   |   |   | (1,912 | ) |   |   |
| Provision for  doubtful accounts                                                                         |       |                                                 | 18,210     |                                                 |       |                 | — |   |   |   | 18,210 |   |   |   | 21,284 |   |   |   | — |   |   |   | 21,284 |   |   |   |
| Provision for  inventory reserve                                                                         |       |                                                 | 12,868     |                                                 |       |                 | — |   |   |   | 12,868 |   |   |   | 18,277 |   |   |   | — |   |   |   | 18,277 |   |   |   |
| Gain on  extinguishment of subordinated notes                                                            |       |                                                 | (31,392    | )                                                    |       |                 | — |   |   |   | (31,392 | ) |   |   | — |   |   |   | — |   |   |   | — |   |   |   |
| Deferred income  taxes                                                                                   |       |                                                 | 172,005    |                                                 |       |                 | 8,842 |   |   |   | 180,847 |   |   |   | (119,074 | ) |   |   | (2,448 | ) |   |   | (121,522 | ) |   |   |
| Other                                                                                                    |       |                                                 | 15,897     |                                                 |       |                 | — |   |   |   | 15,897 |   |   |   | 4,909 |   |   |   | — |   |   |   | 4,909 |   |   |   |
| Changes in operating  assets and liabilities:                                                            |       |                                                 |       |                                                 |       |                 | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   |
| Accounts  receivable                                                                                     |       |                                                 | 268,167    |                                                 |       |                 | — |   |   |   | 268,167 |   |   |   | (453,862 | ) |   |   | — |   |   |   | (453,862 | ) |   |   |
| Inventories                                                                                              |       |                                                 | 165,923    |                                                 |       |                 | — |   |   |   | 165,923 |   |   |   | (175,881 | ) |   |   | — |   |   |   | (175,881 | ) |   |   |
| Deferred costs                                                                                           |       |                                                 | (18,567    | )                                                    |       |                 | — |   |   |   | (18,567 | ) |   |   | 285,127 |   |   |   | — |   |   |   | 285,127 |   |   |
| Other assets                                                                                             |       |                                                 | 95,802     |                                                 |       |                 | (20,994 | ) |   |   | 74,808 |   |   |   | (16,273 | ) |   |   | (83,672 | ) |   |   | (99,945 | ) |   |
| Accounts payable                                                                                         |       |                                                 | (87,811    | )                                                    |       |                 | — |   |   |   | (87,811 | ) |   |   | 97,689 |   |   |   | — |   |   |   | 97,689 |   |   |
| Income taxes  payable                                                                                    |       |                                                 | (110,209   | )                                                    |       |                 | — |   |   |   | (110,209 | ) |   |   | 133,509 |   |   |   | — |   |   |   | 133,509 |   |   |
| Customer advances                                                                                        |       |                                                 | (150,313   | )                                                    |       |                 | — |   |   |   | (150,313 | ) |   |   | (116,917 | ) |   |   | — |   |   |   | (116,917 | ) |   |
| Deferred revenue                                                                                         |       |                                                 | 22,008     |                                                 |       |                 | 58,668 |   |   |   | 80,676 |   |   |   | 21,877 |   |   |   | 104,964 |   |   |   | 126,841 |   |   |
| Other current  liabilities                                                                               |       |                                                 | 40,464     |                                                 |       |                 | 60 |   |   |   | 40,524 |   |   |   | 43,389 |   |   |   | 541 |   |   |   | 43,930 |   |   |
| Net cash provided  by (used in) operating activities                                                     |       |                                                 | 218,383    |                                                 |       |                 | — |   |   |   | 218,383 |   |   |   | (95,005 | ) |   |   | — |   |   |   | (95,005 | ) |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                                   |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Additions to  property, plant and equipment                                                              |       |                                                 | (64,396    | )                                                    |       |                 | — |   |   |   | (64,396 | ) |   |   | (135,575 | ) |   |   | — |   |   |   | (135,575 | ) |   |
| Proceeds from sale  of assets                                                                            |       |                                                 | —     |                                                 |       |                 | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Investment in  affiliates                                                                                |       |                                                 | (3,550     | )                                                    |       |                 | — |   |   |   | (3,550 | ) |   |   | (19,292 | ) |   |   | — |   |   |   | (19,292 | ) |   |
| Issuance of note  receivable to related party                                                            |       |                                                 | —     |                                                 |       |                 | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Purchase of  businesses, net of cash acquired                                                            |       |                                                 | (24,326    | )                                                    |       |                 | — |   |   |   | (24,326 | ) |   |   | (217,751 | ) |   |   | — |   |   |   | (217,751 | ) |   |
| Purchase of  intangible assets                                                                           |       |                                                 | (750       | )                                                    |       |                 | — |   |   |   | (750 | ) |   |   | (4,158 | ) |   |   | — |   |   |   | (4,158 | ) |   |
| Change in  restricted cash and long-term investments                                                     |       |                                                 | (18,418    | )                                                    |       |                 | — |   |   |   | (18,418 | ) |   |   | (8,943 | ) |   |   | — |   |   |   | (8,943 | ) |   |
| Purchase of  short-term investments                                                                      |       |                                                 | (165,284   | )                                                    |       |                 | — |   |   |   | (165,284 | ) |   |   | (319,253 | ) |   |   | — |   |   |   | (319,253 | ) |   |
| Proceeds from sale  of short-term investments                                                            |       |                                                 | 346,966    |                                                 |       |                 | — |   |   |   | 346,966 |   |   |   | 236,497 |   |   |   | — |   |   |   | 236,497 |   |   |
| Other                                                                                                    |       |                                                 | (105       | )                                                    |       |                 | — |   |   |   | (105 | ) |   |   | 428 |   |   |   | — |   |   |   | 428 |   |   |
| Net cash provided  by (used in) investing activities                                                     |       |                                                 | 70,137     |                                                 |       |                 | — |   |   |   | 70,137 |   |   |   | (468,047 | ) |   |   | — |   |   |   | (468,047 | ) |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                                   |       |                                                 |       |                                                 |       |                 | — |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   |   |   |   |
| Issuance of stock,  net of expenses                                                                      |       |                                                 | 6,952      |                                                 |       |                 | — |   |   |   | 6,952 |   |   |   | 25,737 |   |   |   | — |   |   |   | 25,737 |   |   |
| Purchase of  convertible bond hedge and call option                                                      |       |                                                 | —     |                                                 |       |                 | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Proceeds from  borrowings                                                                                |       |                                                 | 436,678    |                                                 |       |                 | — |   |   |   | 436,678 |   |   |   | 390,000 |   |   |   | — |   |   |   | 390,000 |   |   |
| Payments on  borrowings                                                                                  |       |                                                 | (653,123   | )                                                    |       |                 | — |   |   |   | (653,123 | ) |   |   | (40,000 | ) |   |   | — |   |   |   | (40,000 | ) |   |
| Repurchase of  stock                                                                                     |       |                                                 | —     |                                                 |       |                 | — |   |   |   | — |   |   |   | (107,569 | ) |   |   | — |   |   |   | (107,569 | ) |   |
| Proceeds from  equity offering                                                                           |       |                                                 | —     |                                                 |       |                 | — |   |   |   | — |   |   |   | 474,554 |   |   |   | — |   |   |   | 474,554 |   |   |
| Other                                                                                                    |       |                                                 | 6,689      |                                                 |       |                 | — |   |   |   | 6,689 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) financing activities                                                     |       |                                                 | (202,804   | )                                                    |       |                 | — |   |   |   | (202,804 | ) |   |   | 742,722 |   |   |   | — |   |   |   | 742,722 |   |   |
| Effect of exchange  rate changes on cash and cash equivalents                                            |       |                                                 | (2,677     | )                                                    |       |                 | — |   |   |   | (2,677 | ) |   |   | 5,115 |   |   |   | — |   |   |   | 5,115 |   |   |
| Net increase in  cash and cash equivalents                                                               |       |                                                 | 83,039     |                                                 |       |                 | — |   |   |   | 83,039 |   |   |   | 184,785 |   |   |   | — |   |   |   | 184,785 |   |   |
| Cash and cash  equivalents at beginning of period                                                        |       |                                                 | 562,532    |                                                 |       |                 | — |   |   |   | 562,532 |   |   |   | 377,747 |   |   |   | — |   |   |   | 377,747 |   |   |
| Cash and cash  equivalents at end of period                                                              |       |                                                 | $          | 645,571                                              |       |                 |   | $ | — |   |   |   | $ | 645,571 |   |   |   | $ | 562,532 |   |   |   | $ | — |   |   |   | $ | 562,532 |   |   |
| Supplemental disclosure  of cash flow information:                                                       |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash paid:                                                                                               |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest                                                                                                 |       |                                                 | $          | 14,197                                               |       |                 |   | — |   |   |   | $ | 14,197 |   |   |   | $ | 5,074 |   |   |   | — |   |   |   | $ | 5,074 |   |   |
| Income taxes                                                                                             |       |                                                 | $          | 11,265                                               |       |                 |   | — |   |   |   | $ | 11,265 |   |   |   | $ | 11,177 |   |   |   | — |   |   |   | $ | 11,177 |   |   |
| Non-cash operating  activities                                                                           |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Accounts  receivable transferred to notes receivable                                                     |       |                                                 | $          | 55,065                                               |       |                 |   | — |   |   |   | $ | 55,065 |   |   |   | $ | 118,021 |   |   |   | — |   |   |   | $ | 118,021 |   |   |
| Property, plant  and equipment exchanged for long-term investment                                        |       |                                                 | $          | —                                               |       |                 |   | — |   |   |   | $ | — |   |   |   | $ | — |   |   |   | — |   |   |   | $ | — |   |   |
| Non-cash financing  activities                                                                           |       |                                                 |       |                                                 |       |                 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Common stock issued  in conjunction with debt  extinguishment                                            |       |                                                 | $          | 37,568                                               |       |                 |   | — |   |   |   | $ | 37,568 |   |   |   | $ | — |   |   |   | — |   |   |   | $ | — |   |   |
|                                                                                                          |            |                                                      |            |                                                      |            |                      |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**GROSS PROFIT BY SEGMENT, RESTATED**

| ** **                     | ** ** | **Year ended December 31, 2005** | ** **   |
|--------------------------------|------------|------------------------------------------------------|--------------|
| ** **                     | ** ** | **As previously  reported**                     | ** **   | ** ** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** | ** ** | ** ** |
| ** **                     | ** ** | ** **                                           | ** **   | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** |       |                                                 | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |   | *** *** | *** *** |   | *** *** | *** *** |
| Broadband  Infrastructure      |       |                                                 | $            | 157,781 | *** *** |   | 31 | % |   | $ | 109 |   |   |   | $ | 157,890 | *** *** |   | 31 | % |
| Wireless  Infrastructure       |       |                                                 | 149,842      | *** *** |   | 30 | % |   | (28,765 | ) |   |   | 121,077 | *** *** |   | 28 | % |
| Network Solutions              |       |                                                 | 307,623      | *** *** |   | 31 | % |   | (28,656 | ) |   |   | 278,967 | *** *** |   | 30 | % |
| PCD                            |       |                                                 | 52,812       | *** *** |   | 4 | % |   | — |   |   |   | 52,812 | *** *** |   | 4 | % |
| Handsets                       |       |                                                 | 57,291       | *** *** |   | 12 | % |   | 875 |   |   |   | 58,166 | *** *** |   | 12 | % |
| Services                       |       |                                                 | 45,891       | *** *** |   | 54 | % |   | — |   |   |   | 45,891 | *** *** |   | 54 | % |
|                           |       |                                                 | $            | 463,617 | *** *** |   | 16 | % |   | $ | (27,781 | ) |   |   | $ | 435,836 | *** *** |   | 15 | % |

 

| ** **                     | ** **   | **Year ended December 31, 2004** | ** **   |
|--------------------------------|--------------|------------------------------------------------------|--------------|
| ** **                     | ** **   | **As previously  reported**                     | ** **   | ** ** | ** ** | **Adjustments** | ** ** | **As restated** | ** ** | ** ** | ** ** |
| ** **                     | ** **   | ** **                                           | ** **   | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ***Gross  profit by Segment*** | *** *** |                                                 | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |   | *** *** | *** *** |   | *** *** | *** *** |
| Broadband Infrastructure       |         |                                                 | $            | 45,594 | *** *** |   | 20 | % |   | $ | (9 | ) |   |   | $ | 45,585 | *** *** |   | 20 | % |
| Wireless  Infrastructure       |         |                                                 | 391,253      | *** *** |   | 28 | % |   | (27,225 | ) |   |   | $ | 364,028 | *** *** |   | 29 | % |
| Network Solutions              |         |                                                 | 436,847      | *** *** |   | 27 | % |   | (27,234 | ) |   |   | 409,613 | *** *** |   | 27 | % |
| PCD                            |         |                                                 | 11,886       | *** *** |   | 4 | % |   | (20 | ) |   |   | 11,866 | *** *** |   | 4 | % |
| Handsets                       |         |                                                 | 131,704      | *** *** |   | 18 | % |   | 4 |   |   |   | 131,708 | *** *** |   | 18 | % |
| Services                       |         |                                                 | 16,345       | *** *** |   | 32 | % |   | — |   |   |   | 16,345 | *** *** |   | 32 | % |
|                           |         |                                                 | $            | 596,782 | *** *** |   | 22 | % |   | $ | (27,250 | ) |   |   | $ | 569,532 | *** *** |   | 22 | % |

 

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**PRO FORMA SFAS 123**

| ** **                                                                                                                        | ** ** | **Year ended  December 31, 2005**               | ** ** | **Year ended  December 31, 2004**               | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                                        | ** ** | **As previously  reported**                               | ** ** | **As restated**                                           | ** ** | **As previously  reported** | ** ** | **As restated** | ** ** |
| ** **                                                                                                                        | ** ** | **(in thousands, except  per share data)** | ** ** | **(in thousands, except  per share data)** | ** ** |
| Basic                                                                                                                             |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income:                                                                                                                |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                       |       |                                                           | $          | (487,359                                                       | )          |   | $ | (532,645 | ) |   | $ | 69,824 |   |   |   | $ | 50,849 |   |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                  |       |                                                           | 2,154      |                                                           |       | 4,947 |   |   | 370 |   |   |   | 210 |   |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       |                                                           | (30,588    | )                                                              |       | (23,142 | ) |   | (68,083 | ) |   |   | (82,553 | ) |   |
| Pro forma net  income (loss)                                                                                                      |       |                                                           | $          | (515,793                                                       | )          |   | $ | (550,840 | ) |   | $ | 2,111 |   |   |   | $ | (31,494 | ) |   |
| Basic (loss) earnings  per share:                                                                                                 |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                       |       |                                                           | $          | (4.16                                                          | )          |   | $ | (4.55 | ) |   | $ | 0.61 |   |   |   | $ | 0.45 |   |   |
| Pro forma                                                                                                                         |       |                                                           | $          | (4.41                                                          | )          |   | $ | (4.71 | ) |   | $ | 0.02 |   |   |   | $ | (0.28 | ) |   |
| Diluted                                                                                                                           |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| Net (loss) income:                                                                                                                |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                       |       |                                                           | $          | (487,359                                                       | )          |   | $ | (532,645 | ) |   | $ | 69,824 |   |   |   | $ | 50,849 |   |   |
| Effect of dilutive securities 7¤8%  convertible subordinated notes                                                           |       |                                                           | —     |                                                           |       | — |   |   | — |   |   |   | — |   |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                  |       |                                                           | 2,154      |                                                           |       | 4,947 |   |   | 370 |   |   |   | 210 |   |   |
| Deduct: Total compensation expense determined under  fair value based method for all awards, net of related tax effects |       |                                                           | (30,588    | )                                                              |       | (23,142 | ) |   | (68,083 | ) |   |   | (82,553 | ) |   |
| Pro forma diluted  net (loss) income                                                                                              |       |                                                           | $          | (515,793                                                       | )          |   | $ | (550,840 | ) |   | $ | 2,111 |   |   |   | $ | (31,494 | ) |   |
| Diluted (loss) earnings  per share:                                                                                               |       |                                                           |       |                                                           |       |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                                       |       |                                                           | $          | (4.16                                                          | )          |   | $ | (4.55 | ) |   | $ | 0.54 |   |   |   | $ | 0.40 |   |   |
| Pro forma                                                                                                                         |       |                                                           | $          | (4.41                                                          | )          |   | $ | (4.71 | ) |   | $ | 0.02 |   |   |   | $ | (0.28 | ) |   |

 

**NOTE 3—SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

*Basis ofPresentation:*

The accompanyingconsolidated financial statements include the accounts of the Company and itswholly and majority (over 50 percent) owned subsidiaries. All significant inter-companyaccounts and transactions have been eliminated in the preparation of theseconsolidated financial statements. Minority interest in consolidatedsubsidiaries and equity in affiliated companies are shown separately in the consolidatedfinancial statements. The Company also consolidates variable interest entitiesas defined by Financial Accounting Standards Board Interpretation No. 46, “Consolidationof Variable Interest Entities.” See Note 22.

*Use of Estimates:*

The preparation ofconsolidated financial statements in conformity with generally acceptedaccounting principles in the United States of America requires management tomake estimates and 

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assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Estimates are used for revenue recognition, allowance fordoubtful accounts and sales returns, tax valuation allowances, reserves forinventory, deferred costs, accrued product warranty costs, provisions forcontract losses, goodwill and other long-lived asset impairments, stock-basedcompensation expense, loss contingencies and restructuring expenses amongothers. Actual results could differ from those estimates.

*Cash and CashEquivalents:*

Cash and cash equivalents consist of highly liquidinstruments with maturities of three months or less at the date ofpurchase.

Of the total cash and short-terminvestment balance at December 31, 2006, $483.7 million was held in Chinawhere currency exchange controls exist. As a result, the Company’s ability tomake payments in other jurisdictions could be limited by its ability totransfer money from China to other jurisdictions. Chinese law requires that theCompany’s subsidiaries domiciled in China to obtain government consent prior tomaking certain payments to the Company. As a result, approximately $200 millionof the Company’s consolidated net assets cannot be transferred to the Companyfrom its subsidiaries in China without first obtaining the consent of theChinese government.

*Short-termInvestments:*

Short-terminvestments consist of investments with original or remaining maturities ofmore than three months but less than twelve months. In accordance with theCompany’s investment policy, all short-term investments are invested in “investmentgrade” rated securities with a minimum of A or better ratings. Currently, mostof the Company’s short-term investments have AA or better ratings.Marketable securities are classified as available-for-sale and arecarried at fair value. Unrealized holding gains and losses on securitiesclassified as available-for-sale are recorded as a separatecomponent of stockholders’ equity. Unrealized losses on securities classifiedas available-for-sale that are determined to be other-than-temporaryare reported in earnings. Realized gains and losses are reported in earnings.The fair value of investments is based on quoted market prices. AtDecember 31, 2006 and 2005, short-term investments in available-for-salesecurities consisted of:

| ** **                                   | ** ** | **December 31, 2006** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                   | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(in thousands)**         | ** ** |
| Debt securities                              |       |                            | $          | 9,546 |   |   |   | $ | — |   |   |   | $ | 9,546 |   |   |
| Total current available  for-sale securities |       |                            | $          | 9,546 |   |   |   | $ | — |   |   |   | $ | 9,546 |   |   |

 

| ** **                                   | ** ** | **December 31, 2005** | ** ** |
|----------------------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | ** **                      | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                   | ** ** | **Amortized**                   | ** ** | **Unrealized** | ** ** | **Fair** | ** ** |
| ** **                                   | ** ** | **Cost**                        | ** ** | **Gains** | ** ** | **Value** | ** ** |
| ** **                                   | ** ** | **(in thousands)**         | ** ** |
| Debt securities                              |       |                            | $          | 13,266 |   |   |   | $ | — |   |   |   | $ | 13,266 |   |   |
| Total current available  for-sale securities |       |                            | $          | 13,266 |   |   |   | $ | — |   |   |   | $ | 13,266 |   |   |

 

*Long-termInvestments:*

The Company hasinvestments in various publicly and privately held companies and investmentsfunds. Equity securities of publicly listed companies traded on securitiesexchanges are classified as available-for-sale and are carried atfair value. Unrealized holding gains and losses on securities classified 

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asavailable-for-sale are recorded as a separate component ofstockholders’ equity. Investments in less than majority-owned privatelyheld affiliates over which we exercise significant influence are accounted forunder the equity method. All other investments in affiliates are carried atcost. The Company monitors for other-than-temporary impairment and makesappropriate reductions in the carrying value if the Company determines that animpairment charge is required based on the financial, economic and operationalcondition and near-term prospects of these companies.

*RevenueRecognition:*

Revenues from sales of telecommunications equipmentand handsets are recognized when persuasive evidence of an arrangement exists,delivery has occurred, the fee is fixed or determinable and collectibility is probable.If the payment due from the customer is not fixed or determinable due toextended payment terms, revenue is recognized as payments become due andpayable by the customer, assuming all other criteria for revenue recognitionare met. Any payments received prior to revenue recognition are recorded ascustomer advances. Normal payment terms differ for various reasons amongstdifferent customer regions, depending upon common business practices forcustomers within a region. Billing to customers for shipping and handling arerecorded as revenues and the associated costs are recorded as costs ofrevenues. Any expected losses on contracts are recognized when identified on anindividual basis in accordance with the prevailing accounting guidance for therespective contract.

Sales may be generated from complex contractualarrangements that require significant revenue recognition judgments,particularly in the area of contracts with multiple deliverable elements(multiple element arrangements). Where multiple elements exist in anarrangement, the contract price is allocated to the different elements basedupon and in proportion to verifiable objective evidence of the fair value ofthe various elements, as governed under Emerging Issues Task Force Issue (“EITF”)No. 00-21, “Accounting for Revenue Arrangements with MultipleDeliverables,” and SEC Staff Accounting Bulletin No. 104, “RevenueRecognition.” Multiple element arrangements primarily involve the sale ofequipment, installation, training and post-contract support. Revenue isrecognized as each element is earned, namely upon installation and acceptanceof equipment or delivery of handsets, provided that the fair value of theundelivered element(s) has been determined, the delivered element(s) has stand-alonevalue, there is no right of return on delivered element(s), and the Company isin control of the undelivered element(s). For arrangements that include serviceelements, including promotional support and installation, for which verifiableobjective evidence of the fair value does not exist, revenue is deferred untilsuch services are deemed complete, or until the time the Company can establishverifiable objective evidence of the fair value.

Final acceptance is required for revenue recognitionwhen installation services are not considered perfunctory. Final acceptanceindicates that the customer has fully accepted delivery of equipment and theCompany is entitled to full payment. The Company does not recognize revenuebefore final acceptance is granted by the customer if acceptance is consideredsubstantive to the transaction.

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, “SoftwareRevenue Recognition,” as amended, and EITF No. 03-05, “Applicability ofSOP 97-2 to Non-software Deliverables Containing More Than Incidental Software.”The Company allocates revenues to each element of software arrangements basedon vendor specific objective evidence (“VSOE”) of fair value. VSOE of fairvalue of each element is based on the price charged when the same element issold separately. The Company uses the residual method to recognize revenue whenan arrangement includes one or more elements to be delivered at a future dateand VSOE of the fair value of all the undelivered elements exists. Under theresidual method, the fair value of the undelivered elements is deferred and theremaining portion of the contract price is recognized as revenue when all otherrevenue recognition criteria are met. If VSOE of fair 

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value of one or moreundelivered elements does not exist, all revenue for delivered and undeliveredelements is deferred until delivery of all elements occurs or when VSOE of fairvalue of the undelivered elements can be established. In some cases the Companyhas agreed to give software upgrade rights on a “when and if made available”basis for equipment sold for no additional consideration and for an unspecifiedperiod which could extend over the term of the contract. This additionalcontract obligation is an element of “post contract support.” The Company hasnot established VSOE for such contract element. Accordingly, the revenues fromsuch contracts are recognized ratably over the period during which the postcontract support is expected to be provided. The expected period of support isgenerally the term of the contract. In some cases where there is no statedcontractual term, revenue is recognized ratably over the estimated period ofsupport. The Company reviews assumptions regarding the estimated post contractsupport periods on a regular basis. If the Company determines that it isnecessary to revise the Company’s estimates of the support periods, the amountof revenue recognized over the life of the contract would not be affected.However, to the extent the new assumptions regarding the post contract supportperiods were different than original assumptions, the contract revenues would berecognized over the remaining expected period of support.

Contract accounting is utilized for contracts thatinclude a requirement for significant software modification or customization;when utilized the Company generally accounts for such contracts using thecompleted contract method of accounting, whereby no revenue is recognized priorto the completion of the project, because for contracts involving uniquerequirements the Company is unable to make reasonably dependable estimates ofits progress towards meeting contractual requirements. In the event estimatedtotal project costs exceed estimated total project revenues, the entireestimated loss is charged to operations in the period in which the loss becomesprobable and can be reasonably estimated. The complexity of the estimationprocess and judgments about internal and external factors including laborutilization, changes to specifications and testing requirements, time requiredfor performance and resulting incurrence of contract penalties, and theperformance of subcontractors affect the estimation process. During the yearended December 31, 2006, the Company recorded a $32.1 million loss on a fixedprice contract.

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

The Company also sells products through resellers.Revenue is generally recognized when the standard price protection period,which ranges from 30 to 90 days, has lapsed. If collectibility cannot bereasonably assured in a reseller arrangement, revenue is recognized upon sellthrough to the end customer and receipt of cash. There may be additionalobligations in reseller arrangements such as inventory rotation, or stockexchange rights on the product. As such, revenue is recognized in accordancewith Statement of Financial Accounting Standards (“SFAS”) No. 48, “RevenueRecognition When Right of Return Exists.” In most cases, the Company hasdeveloped reasonable estimates for stock exchanges based on historicalexperience with similar types of sales of similar products.

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

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The assessment of collectibility is also a factor indetermining whether revenue should be recognized. The Company assessescollectibility based on a number of factors, including payment history and thecredit worthiness of the customer. The Company does not request collateral fromits customers. In international sales, the Company may require letters of creditfrom its customers that can be drawn on demand if the customer defaults on itspayment. If the Company determines that collection of a payment is notreasonably assured, the Company defers revenue recognition until collectionbecomes reasonably assured, which is generally upon receipt of cash.

Occasionally, the Company enters into revenue sharingarrangements. Under these arrangements, the Company collects payment only afterits customer, the telecommunications service provider, collects service revenues.When the Company enters a revenue sharing arrangement, the Company does notrecognize revenue until collection is reasonably assured.

Because of the nature ofdoing business in China and other emerging markets, the Company’s billingsand/or customer payments may not correlate with the contractual payment termsand the Company generally does not enforce contractual payment terms prior tofinal acceptance. Accordingly, accounts receivable are not recorded until theCompany recognizes the related customer revenue. Advances from customers arerecognized when the Company has collected cash from the customer, prior torecognizing revenue. Deferred revenue is recorded if there are undeliveredelements after final acceptance has been obtained. The Company had currentdeferred revenue of $95.7 million and $101.9 million, and long-term deferredrevenue of $261.0 million and $273.1 million at December 31, 2006 and 2005,respectively.

*Product Warranty:*

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

*Accounts and NotesReceivable:*

The Company accepts banknotes and commercial notes from its customers in China in the normal course ofbusiness and estimates the collectibility of its trade receivables and notesreceivable. The notes are typically non-interest bearing, with maturitydates between three and six months. An allowance for doubtful accounts ismaintained for the estimated losses on the trade receivables and notesreceivable when collection may no longer be reasonably assured. The Companyassesses collectibility of the receivable by determining whether thecreditworthiness of the customer has deteriorated and could result in aninability to collect payment; if collectibility is doubtful, the Companyrecords an allowance against the receivable. If a customer’s financialcondition were to deteriorate, causing their ability to make payments to sufferas a result, the allowances for receivables may need to be increased. Withgreater concentration of accounts receivable with certain customers, thefinancial conditions of any specific or individual customer may result inincreased concentration risk exposure. Allowances for doubtful accounts were $53.9million and $67.8 million at December 31, 2006 and 2005, respectively, fortotal receivables, including accounts receivable from related parties.

*Inventories:*

Inventories consist ofproduct held at the Company’s manufacturing facility and warehouses, as well asfinished goods at customer sites for which the customer has taken possession,but based on specific contractual terms, title has not yet passed to the customer.The Company may ship inventory to existing 

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customersthat require additional equipment to expand their existing networks prior tothe signing of an expansion contract. Inventories are stated at the lower ofcost or market value, net of write-downs for excess, slow moving andobsolete inventory. With the exception of the handset inventory for ourPersonal Communications Division (“PCD”), which is based on weighted averagecost, inventory cost is computed using standard cost, which approximates actualcost on a first-in, first-out basis. Inventory is written down forestimated obsolescence or unmarketable inventory equal to the differencebetween inventory cost and the estimated market value.

*Deferred costs:*

Deferred costs consist of product shipped to thecustomer for which the rights and obligations of ownership have passed to thecustomer but revenue has not yet been recognized. Deferred costs also includethe costs associated with third party integrators and freight. All deferredcosts are stated at cost. Management periodically assesses the recoverabilityof deferred costs and provides reserves against deferred cost balances whenrecovery of deferred costs is not probable. Recoverability is evaluated basedon various factors including the length of time the product has been held atthe customer site, the viability of payment, including assessment of productdemand if a revenue sharing arrangement exists and/or the evaluation if arelated transaction will result in a gross margin loss. In a loss situation fora transaction, the deferred cost balance is adjusted for an impairment equal tothe value of the excess of cost over the amount of revenue that will beeventually recognized for the transaction. Revenue and cost of sales arerecorded when final acceptance is received from the customer. With greaterconcentration of product at customer sites with specific or individualcustomer, the financial conditions of any specific or individual customer mayresult in increased concentration risk exposure for our inventory.

For any post contractsupport services where the revenue is deferred, the entire related deferreddirect costs are classified as a noncurrent asset, consistent with thedefinition of a current asset per Accounting Research Bulletin No. 43, “WorkingCapital: Current Assets and Current Liabilities.”

*Research andDevelopment and Capitalized Software Development Costs:*

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

Purchased software costsand costs incurred in the development of software that will ultimately be soldare capitalized during the time between when technological feasibility has beenattained and the related product is ready for general release. During 2006,2005 and 2004, the Company capitalized $1.0 million, $6.0 million and$5.3 million of software development costs, respectively. Amortization ofcapitalized development costs was $2.1 million, $3.9 million, and$3.0 million in 2006, 2005 and 2004, respectively. Unamortized capitalizedsoftware development costs at December 31, 2006 and 2005 were $3.4 million and$6.9 million, respectively. Direct costs of software developed forinternal use are expensed during the preliminary project stage and capitalizedduring the application development stage.

155

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*Property, Plant andEquipment:*

Property,plant and equipment are recorded at cost and are stated net of accumulated depreciation.Depreciation is provided for on a straight-line basis over the estimateduseful lives of the related assets. Land use rights related to property leasedby the Company in China are amortized over the life of the lease. Leaseholdimprovements are amortized on a straight-line basis over the shorter ofthe useful life of the improvements or the term of the lease. When assets aredisposed of, the cost and related accumulated depreciation are removed from theaccounts and the resulting gains or losses are included in results ofoperations. The Company generally depreciates its assets over the followingperiods:

| ** **                                  | ** ** | **Years**                            | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|
| Furniture, test  or manufacturing equipment |       | 5                                    |       |
| Computers and  software                     |       | 2-3                                  |       |
| Buildings                                   |       | 38                                   |       |
| Automobiles                                 |       | 5                                    |       |
| Land use rights                             |       | life  of use rights                  |       |
| Leasehold improvements                      |       | Lesser of 5 or  remaining lease life |       |

 

The Company capitalizesinterest incurred related to construction of property, plant or equipment untilit is ready for use. During 2004 the Company recorded $1.4 million ofcapitalized interest applicable to the construction of its China headquartersin Hangzhou. The China headquarters facility was placed in service inOctober 2004. Capitalized interest is being 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 exists. When assessing potential impairment togoodwill, book value of a reporting unit is compared to its fair value. Fairvalue is determined based on the present value of estimated future cash flows. Inthe third quarter of 2005, the Company performed an impairment analysis as aresult of changes in the business environment. As a result of this analysis, animpairment charge was recorded during the third quarter of 2005. See Note 10.

*Impairment of Long-LivedAssets:*

Long-lived assetsare reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount may not be recoverable. If undiscountedexpected future cash flows are less than the carrying value of the assets, animpairment loss will be recognized based on the excess of the carrying amountover the fair value of the assets. Long-lived assets that are to bedisposed of by sale are measured at the lower of book value or fair value lesscost to sell. See Note 8.

*Advertising Costs:*

The Company expenses alladvertising costs as incurred. Payment to customers for marketing developmentcosts are accounted for as a reduction of the revenue associated with customersas incurred. For the years ended December 31, 2006, 2005 and 2004, advertisingcosts totaled $8.1 million, $8.2 million, and $8.0 million,respectively.

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*Stock-BasedCompensation:*

Prior to January 1, 2006, the Company accounted forshare-based payment awards under Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees” (“APB 25”), andprovided the required pro forma disclosures under Statement of FinancialAccounting Standards No. 123, “Accounting for Stock-Based Compensation.” Inaccordance with APB 25, non-cash compensation expense was recognized for anyoptions for which the exercise price was below the market price on the actualgrant date, based on the difference between the exercise price and the marketprice. The expense was recognized ratably over the associated service period,which was generally the option vesting term.

On January 1, 2006,the Company adopted Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment,” (“SFAS 123(R)”), using themodified prospective transition method. Stock-based compensation expenserecognized during the period is based on the value of the portion of share-basedpayment awards that is ultimately expected to vest. Stock-basedcompensation expense recognized in the consolidated statement of operations forthe year ended December 31, 2006 included compensation expense for share-basedpayment awards granted prior to, but not yet vested as of December 31,2005 based on the grant date fair value estimated in accordance with the proforma provisions of SFAS 123 and compensation expense for the share-basedpayment awards granted subsequent to December 31, 2005 based on the grantdate fair value estimated in accordance with the provisions ofSFAS 123(R). On November 10, 2005, the Financial Accounting StandardsBoard (“FASB”) issued FASB Staff Position No. FAS 123(R)-3, “TransitionElection Related to Accounting for Tax Effects of Share-Based Payment Awards.”The Company adopted the alternative transition method provided in the FASBStaff Position for calculating the tax effects of stock-based compensationpursuant to SFAS 123(R). The alternative transition method includes simplifiedmethods for establishing the beginning balance of the additionalpaid-in-capital pool (“APIC pool”) related to the tax effects of employeestock-based compensation, and to determine the subsequent impact on the APICpool and consolidated statements of cash flows of the tax effects of employeestock-based compensation awards that are outstanding upon adoption of SFAS123(R). The Company accounts for utilization of windfall tax benefits based ontax law ordering and considered only the direct effects of stock-basedcompensation for purposes of measuring the windfall at settlement of an award.

*ComprehensiveIncome:*

Comprehensiveincome includes all changes in equity (net assets) during a period from non-ownersources. Accumulated other comprehensive income or loss for 2006, 2005 and 2004is shown in the consolidated statement of stockholders’ equity. As ofDecember 31 of each of the years indicated below, the components ofaccumulated other comprehensive income reported in the consolidated balancesheets were as follows:

| ** **                                                           | ** ** | **2006**                | ** ** | **2005**               | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| ** **                                                           | ** ** | ** **              | ** ** | **(As restated)** | ** ** |
| ** **                                                           | ** ** | **(in thousands)** | ** ** |
| Unrealized gain (loss)  on available-for-sale securities, net of tax |       | $                       | 32,621     |                   |       | $ | (41 | ) |   |
| Foreign currency  translation                                        |       | 30,278                  |       |                   | 14,827     |   |   |
| Accumulated other comprehensive income                               |       | $                       | 62,899     |                   |       | $ | 14,786 |   |   |

 

*Income Taxes:*

The Company accounts for income taxes under theliability method, and deferred income taxes are recognized for the differencesbetween the tax bases of assets and liabilities and their financial statementamounts based on enacted tax rates. Valuation allowances are established whennecessary to reduce deferred tax assets to the amount expected to be realized.The Company is required to adjust its deferred tax asset and liabilities in theperiod when tax rates or the provisions of the income tax laws change.

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In 2006, due to recentdevelopments in its business, the Company determined that earnings from certainsubsidiaries were not permanently reinvested outside the United States. TheCompany provides U.S. taxes on foreign undistributed earnings that are not consideredto be permanently reinvested outside the United States. Under APB 23“Accounting for Income Taxes—Special Areas,” deferred income taxes must beprovided on the unremitted earnings of foreign subsidiaries unless suchearnings could be deemed to be permanently reinvested outside the UnitedStates. Prior to 2006, the Company had not provided for U.S. tax on any foreignunremitted earnings because the Company did not intend to repatriate suchearnings. See Note 14.

*Segment Reporting:*

The Company had fouroperating units : Network Solutions, Personal Communications Division (“PCD”),Handsets and Services. The Network Solutions operating unit provides itsproducts and services through two reporting segments; Broadband Infrastructure(“Broadband”) and Wireless Infrastructure (“Wireless”).

*FinancialInstruments and Derivatives:*

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

The Company may use derivative financial instrumentsto manage its exposures to foreign currency exchange rate changes. Theobjectives for holding derivatives include reducing, eliminating, andefficiently managing the economic impact of these exposures as effectively aspossible. Derivative instruments are recognized as either assets or liabilitieson the balance sheet. The Company measures those instruments at fair value andrecognizes changes in the fair value of derivatives in earnings in the periodof change unless the derivative qualifies as an effective hedge that offsetscertain exposures. Such contracts are designated at inception to the relatedforeign currency exposures being hedged. The Company has not hedged any suchtransactions in 2006 and 2005. The net gains and losses resulting from hedgingactivities for the year ended December 31, 2004 were insignificant.

Thefollowing table summarizes the Company’s carrying values and the fair values ofits other financial instruments:

| ** **                            | ** ** | **December 31,**   | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **Carrying  value**     | ** ** | **Fair  value** | ** ** | **Carrying  value** | ** ** | **Fair  value** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Included in  Assets                   |       |                    |       |   |   |   |   |   |   |
| Long-term investments                 |       | $                       | 47,809     |   | $ | 56,048 |   | $ | 26,023 |   | $ | 42,887 |   |
| Included in Liabilities               |       |                    |       |   |   |   |   |   |   |
| Bank loans                            |       | $                       | (102,510   | ) | $ | (102,510 | ) | $ | (198,826 | ) | $ | (198,826 | ) |
| Convertible debt                      |       | $                       | (274,600   | ) | $ | (257,094 | ) | $ | (274,600 | ) | $ | (229,291 | ) |
| Included in Stockholders’ Equity |       |                    |       |   |   |   |   |   |   |
| Convertible bond hedge                |       | $                       | 85,307     |   | $ | 647 |   | $ | 85,307 |   | $ | 5,335 |   |
| Written call  option                  |       | $                       | (55,430    | ) | $ | (88 | ) | $ | (55,430 | ) | $ | (2,133 | ) |

 

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The Company determines thefair value of its convertible debt and related convertible bond hedge andwritten call option using estimates of fair values at the balance sheet dateprovided by a major securities firm. The fair value of long-term investments isdetermined based on quoted market prices or available information aboutinvestees. Because of the short-term nature of the Company’s bank loans, theCompany believes carrying value approximates fair value.

*Foreign CurrencyTranslation:*

The Company’s operationsare conducted through international subsidiaries and the financial statementsof those subsidiaries are translated from their respective, functionalcurrencies into U.S. dollars. All foreign currency assets and liabilities aretranslated at the period-end exchange rate and all revenues and expensesare translated at the average exchange rate for the period. The effects oftranslating the financial statements of foreign subsidiaries into U.S. dollarsare reported as a cumulative translation adjustment, a separate component ofcomprehensive income in stockholders’ equity. The foreign currency transactionloss reported in earnings was $9.9 million in 2005 and a gain of $7.6 millionand $0.8 million, in 2006 and 2004, respectively, and are recorded inother income, net.

*Earnings Per Share(“EPS”):*

Basic EPS is computed by dividing net income (loss)available to common stockholders by the weighted average number of shares ofthe Company’s common stock outstanding during the period, which excludesunvested restricted shares. Diluted EPS presents the amount of net income (loss)available to each share of common stock outstanding during the period plus eachshare of common stock that would have been outstanding assuming the Company hadissued shares of common stock for all dilutive potential common sharesoutstanding during the period. The Company’s potential common shares includeemployee stock options, unvested restricted shares, a written call option,warrants, convertible subordinated notes and vested acquisition-relatedstock options.

Thefollowing is a summary of the calculation of basic and diluted EPS:

| ** **                                                                   | ** ** | **Year ended December 31,**                         | ** ** |
|------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                   | ** ** | ** **                                                         | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| ** **                                                                   | ** ** | **(in thousands, except per share data)** | ** ** |
| Numerator:                                                                   |       |                                                               |       |   |   |   |   |   |   |   |   |
| Net (loss) income used in basic EPS computation                              |       | $                                                                  | (117,345   | ) |   | $ | (532,645 | ) |   |   | $ | 50,849 |   |   |
| Effect of Dilutive Securities 7¤8%  Convertible subordinated notes |       | —                                                             |       |   | — |   |   |   | 2,785 |   |   |
| Net (loss) income  adjusted for dilutive securities                          |       | $                                                                  | (117,345   | ) |   | $ | (532,645 | ) |   |   | $ | 53,634 |   |   |
| Denominator:                                                                 |       |                                                               |       |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding used in basic  EPS computation           |       | 120,657                                                            |       |   | 117,034 |   |   |   | 114,135 |   |   |
| Dilutive  potential common shares              |       |                                                               |       |   |   |   |   |   |   |   |   |
| Stock options                                                                |       | —                                                             |       |   | — |   |   |   | 3,118 |   |   |
| Written call option                                                          |       | —                                                             |       |   | — |   |   |   | 262 |   |   |
| Convertible subordinated notes                                               |       | —                                                             |       |   | — |   |   |   | 16,919 |   |   |
| Warrants                                                                     |       | —                                                             |       |   | — |   |   |   | 9 |   |   |
| Other                                                                        |       | —                                                             |       |   | — |   |   |   | 377 |   |   |
| Shares used to  compute diluted EPS                                          |       | 120,657                                                            |       |   | 117,034 |   |   |   | 134,820 |   |   |
| —Basic (loss) earnings per share                                        |       | $                                                                  | (0.97      | ) |   | $ | (4.55 | ) |   |   | $ | 0.45 |   |   |
| —Diluted (loss)  earnings per share                                     |       | $                                                                  | (0.97      | ) |   | $ | (4.55 | ) |   |   | $ | 0.40 |   |   |

 

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Forthe years ended December 31, 2006 and 2005, no potential common shareswere dilutive because of the net loss in each of these years, and basic anddilutive EPS are the same. The following table summarizes the total potentialshares of common stock that were excluded from the diluted per sharecalculation, because to include them would have been anti-dilutive for theperiod.

| ** **                                    | ** ** | **Year ended December 31,**               | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                    | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** |
| ** **                                    | ** ** | ** **                                               | ** ** | **(As restated)** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                                  | ** ** |
| Stock options                                 |       |                                                     | 19,634     |   |   |   | 19,908 |   |   |
| Conversion of  convertible subordinated notes |       |                                                     | 11,543     |   |   |   | 15,123 |   |   |
| Other                                         |       |                                                     | 795        |   |   |   | 342 |   |   |
|                                          |       |                                                     | 31,972     |   |   |   | 35,373 |   |   |

 

*Recent AccountingPronouncements:*

In June 2006, the FASB issued FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109” (“FIN 48”). The interpretation contains a two-step approach torecognizing and measuring uncertain tax positions accounted for in accordancewith SFAS No. 109, “Accounting for Income Taxes.” The first step is toevaluate the tax position for recognition by determining if the weight ofavailable evidence indicates that it is more likely than not that the positionwill be sustained on audit, including resolution of related appeals orlitigation processes, if any. The second step is to measure the tax benefit asthe largest amount which is more than 50% likely of being realized uponultimate settlement. The Company adopted the provisions of FIN 48 as ofJanuary 1, 2007, by recording a $1.4 million increase to the liability foruncertain tax positions offset by a reduction to the opening balance ofretained earnings.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards No. 157, “Fair Value Measurements,” (“SFAS157”). SFAS 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands disclosuresabout fair value measurements. The provisions of this standard apply to currentaccounting pronouncements that require or permit fair value measurements. SFAS157 becomes effective for the Company on January 1, 2008. Upon adoption,the provisions of SFAS 157 are to be applied prospectively with limitedexceptions. The Company is currently evaluating the effects of SFAS 157 on itsconsolidated financial statements.

In September 2006, the Securities and ExchangeCommission issued Staff Accounting Bulletin No. 108, “Considering theEffects of  Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements” (“SAB 108”).SAB 108 requires analysis of misstatements using both an income statement(rollover) approach and a balance sheet (iron curtain) approach in assessingmateriality and provides for a one-time cumulative effect transitionadjustment. SAB 108 is effective for annual financial statements for the firstfiscal year ending after November 15, 2006. The Company adopted SAB 108during the fourth quarter of 2006. The adoption of SAB 108 had no impact on theCompany’s consolidated financial statements.

In February 2007, TheFASB issued Statement of Financial Accounting Standard No. 159, “The FairValue Option for Financial Assets and Financial Liabilities” (“SFAS 159”). Thisstatement permits, but does not require, companies to report at fair value themajority of recognized financial assets, financial liabilities and firmcommitments. Under this standard, unrealized gains and losses on items forwhich the fair value option is elected are reported in earnings at eachsubsequent reporting date. SFAS 159 becomes effective for the Company onJanuary 1, 2008. The Company is currently evaluating the effects ofSFAS 159 on its consolidated financial statements.

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**NOTE 4—RESTRICTEDCASH AND INVESTMENTS**

At December 31, 2006,the Company had short-term restricted cash and investments of $16.7 millionand long-term restricted cash of $16.5 million included in otherlong-term assets. At December 31, 2005, the Company had short-termrestricted cash and investments of $53.7 million and long-term restrictedcash of $0.3 million included in other long-term assets. These amountsprimarily collateralize the Company’s issuances of standby and commercialletters of credit.

**NOTE 5—ACQUISITIONSAND SALE OF ASSETS**

***2006***

*Sale of Assets toMarvell Technology Group Ltd:*

In February 2006, the Company sold substantiallyall of the assets and selected liabilities of its semiconductor design businessdivision to Marvell Technology Group Ltd. (“Marvell”). The Companyreceived $35.4 million in cash, net of $0.6 million of transaction costs,and an additional $4.3 million in cash was paid by Marvell to the Companyin August 2007. Included in the cash received was $16.0 million earned bythe Company as a result of achieving certain defined milestones. The Companyreceived payment of this $16.0 million in October 2006. The assets soldinclude the assets related to the prior acquisition of Advanced CommunicationsDevices Corporation in 2001, and other system-on-chip semiconductors. Inconnection with the sale of assets, the Company has entered into a supplyagreement with Marvell. Pursuant to the supply agreement, the Company hasagreed to purchase chipsets supplied by Marvell for a period of five years.These chipsets will be included in certain handset products designed andmanufactured by the Company.

The Company recognized again on this sale of assets of $12.3 million during 2006. The gain wasdetermined based upon total net proceeds less the net book value of assets soldof $2.9 million and the value of the supply agreement of $20.2 million. Thevalue allocated to the supply agreement is included in other current andlong-term liabilities and is being amortized in proportion to the quantities ofchipsets purchased under the supply agreement over the next five years. As ofDecember 31, 2006, approximately $1.7 million has been amortized againstcost of sales.

***2005***

*Pedestal*

In May 2005, the Company completed itsacquisition of substantially all of the assets and certain liabilities ofPedestal Networks, Inc. (“Pedestal”). Pedestal develops and designs aUniversal Broadband Server (“UBS”), an environmentally hardened, line-poweredremote IP-based Digital Subscriber Line Access Multiplexer (“IP DSLAM”).The acquisition was intended to assist in the Company’s expansion into digitalsubscriber line (“DSL”) and IP-based television (“IPTV”) by providing theCompany with a strong remote broadband solution that is fully US-certifiedand complements other existing DSL, IPTV and optical product families. Thetotal consideration for this transaction was $3.0 million. Approximately$2.6 million in cash was paid at the closing date and an additional$0.4 million was paid in May 2006. The acquisition was accounted forunder the purchase method of accounting.

The existing technology acquired included the entirePedestal family of IP DSLAM and UBS. The Company has integrated the Pedestalproduct line with the Company’s Triple-Play products and IPTV solutions.In addition to developed product technology, the Company acquired fixed assets,in-process research and development (“IPR&D”) and customerrelationships.

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At the acquisition, Pedestal had one project underdevelopment related to the gigabit ethernet product that qualified asIPR&D. The gigabit ethernet project is focused on supporting a majority ofPedestal’s products and was completed as of December 31, 2006. Inassessing Pedestal’s IPR&D project, the Company considered key productcharacteristics including the product’s development stage at the acquisitiondate, the product’s life cycle and the product’s future prospects. The Companyalso considered the rate at which technology changes in the broadband equipmentindustry, the industry’s competitive environment and the economic outlook forboth local and global markets. The amount of the purchase price allocated toIPR&D of $0.7 million was charged to the Company’s results ofoperations as no alternative future uses existed at the acquisition date.

The results of operations of Pedestal have beenintegrated with the “Broadband” segment and included in the Company’sconsolidated statements of operations beginning on the acquisition date of May 13,2005. The pro forma effects of this acquisition on the Company’s financialstatements are not significant.

Subsequent to the May 2005 acquisition ofPedestal, the Company completed the allocation of the purchase price based inpart upon an independent valuation. The estimated useful lives of the customerrelationships and developed technology intangible assets are two years and fiveyears, respectively.

Thefollowing table summarizes the final allocation of the purchase price forPedestal:

| ** **                                   | ** ** | **(in thousands)** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|
| Fair value of  tangible net assets           |       |                    | $          | 1,177 |   |   |
| Fair value of  liabilities assumed           |       |                    | (297       | ) |   |
| Fair value of identified  intangible assets: |       |                    |       |   |   |
| Developed  technology                        |       |                    | 1,319      |   |   |
| In-process  research and development         |       |                    | 660        |   |   |
| Customer  relations                          |       |                    | 141        |   |   |
| Total purchase price                         |       |                    | $          | 3,000 |   |   |

 

*Giga*

In October 2004, the Company entered into anasset purchase agreement with Giga Telecom, Inc. (“Giga”), a Koreancorporation that develops and designs wireless handsets. The acquisition isintended to facilitate the Company’s expansion into the CDMA handset market.The Company completed the acquisition in January 2005. At the closing,$13.0 million in cash was paid, and an additional $2.0 million waspaid into an escrow account for six months which was released in July 2005.The total consideration for the acquisition, funded from cash on hand, wasapproximately $19.0 million, including $2.0 million in acquisition-relatedtransaction costs, a $1.5 million payment made previously to be appliedagainst the purchase price and an earn-out of $0.5 million paidsubsequently upon completion of certain product design milestones.

The following tablesummarizes the allocation of the purchase price for Giga based, in part, uponan independent valuation:

| ** **                                                                                       | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of tangible  net assets                                                               |       |                    | $          | 458 |   |   |
| Fair value of identified intangible assets:                                                      |       |                    |       |   |   |
| Existing technology                                                                              |       |                    | 1,200      |   |   |
| Pre-existing royalty  agreement                                                                  |       |                    | 1,920      |   |   |
| Excess of costs of  acquiring Giga over fair value of identified net  assets acquired (goodwill) |       |                    | 15,391     |   |   |
| Total purchase price                                                                             |       |                    | $          | 18,969 |   |   |

 

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The excess of the purchase price over the fair valueof the identified net assets of approximately $15.4 million was allocatedto goodwill and assigned to the Handsets segment. The goodwill is taxdeductible. The goodwill created in this acquisition results from the decreasedtime to market and design related synergies. This goodwill was written off in September 2005as a result of the intangible and other long-lived asset impairment. Foradditional information regarding the intangible and other long-livedassets impairment, refer to Note 10, Goodwill and Intangible Assets.

In accordance with EITF No. 04-1, “Accountingfor Preexisting Relationships between the Parties to a Business Combination,” asettlement gain of $0.4 million relating to the pre-existing royaltyagreement was recognized and recorded under Research and Development expense inthe consolidated statements of operations. The purchased existing technologyand pre-existing royalty agreement has been fully amortized.

The results of operationsof Giga have been integrated with the “Handsets” segment and included in theCompany’s Consolidated Statement of Operations subsequent to the acquisition.The pro forma effects of this acquisition on the Company’s financial statementswere not significant.

***2004***

*Audiovox Communications Corporation*

In November 2004, the Company completed itsacquisition of select assets and liabilities of Audiovox CommunicationsCorporation (“ACC”), including inventories, prepaids, payables, accruedexpenses and the right to hire approximately 250 employees. The Company paid$170.8 million in cash during 2004, an additional $2.8 million incash in 2005 and incurred professional fees of $4.6 million. The Companyacquired ACC’s sales, service and support infrastructure, its code divisionmultiple access (“CDMA”) handset brand, access to supply-chain channels,product marketing expertise, and key relationships with CDMA operators in Northand South America. The goodwill created in this acquisition resulted fromdecreased time-to-market and volume related synergies. This goodwill waswritten off in September 2005 as a result of the intangible and other long-livedasset impairment. (See Note 10.) The following table summarizes the allocationof the purchase price for ACC based in part upon an independent valuation:

| ** **                                                                                      | ** ** | **(in thousands)** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of tangible  net assets:                                                             |       |                    |       |   |   |
| Property, plant  and equipment                                                                  |       |                    | $          | 873 |   |   |
| Inventory                                                                                       |       |                    | 116,254    |   |   |
| Deferred income  taxes                                                                          |       |                    | 7,739      |   |   |
| Other tangible  assets                                                                          |       |                    | 5,719      |   |   |
| Fair value of identified  intangible assets:                                                    |       |                    |       |   |   |
| Customer/dealer  relationships                                                                  |       |                    | 24,400     |   |   |
| Supplier  relationships                                                                         |       |                    | 5,300      |   |   |
| Non-compete  agreement                                                                          |       |                    | 10,800     |   |   |
| Trade names                                                                                     |       |                    | 4,000      |   |   |
| Backlog                                                                                         |       |                    | 3,200      |   |   |
| Liabilities  assumed                                                                            |       |                    | (74,159    | ) |   |
| Excess of costs  of acquiring ACC over fair value of identified net  assets acquired (goodwill) |       |                    | 74,125     |   |   |
| Total purchase price                                                                            |       |                    | $          | 178,251 |   |   |

 

The Company acquired $47.7 million of intangibleassets, principally consisting of carrier and dealer relationships and non-competeagreement. No amount was allocated to in-process research anddevelopment.

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

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

Thefollowing unaudited pro forma results of operations reflect the combinedresults of the Company and ACC for the year ended December 31, 2004 as ifthe business combination occurred at the beginning of the period. These resultsdo not purport to be indicative of what would have occurred had the acquisitionbeen made as of that date or the results of operations which may occur infuture periods.

| ** **                                     | ** ** | **2004**                                                   | ** ** |
|------------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                     | ** ** | **(As restated)**                                     | ** ** |
| ** **                                     | ** ** | **(in thousands,  except per  share data)** | ** ** |
| Pro forma  adjusted net sales                  |       |                                                       | $          | 3,664,391 |   |   |
| Pro forma  adjusted net income                 |       |                                                       | $          | 56,988 |   |   |
| Pro forma  adjusted basic earnings per share   |       |                                                       | $          | 0.50 |   |   |
| Pro forma adjusted  diluted earnings per share |       |                                                       | $          | 0.42 |   |   |

 

*TELOS Technology, Inc.*

In May 2004, the Company completed itsacquisition of substantially all of the assets and certain liabilities of TELOSTechnology, Inc. and its subsidiaries (“TELOS”). TELOS is a provider ofmobile switching products and services for voice and data communicationnetworks to developing rural, enterprise and emerging wireless markets. Thetotal consideration for the acquisition, funded from cash on hand, wasapproximately $30.0 million. The Company paid $29.0 million in cash, inaddition to $1.0 million of acquisition-related transaction costs.

The existing technology acquired included the entireTELOS product family of CDMA softswitch technology products, supporting serversand operations maintenance centers. The TELOS product line was integrated withthe Company’s suite of CDMA products, strengthening the Company’s existing CDMAproduct portfolio. In addition to developed product technology, the Companyacquired fixed assets, in- process research and development (“IPR&D”),an assembled workforce of approximately 60 employees, customerrelationships and recorded goodwill. The goodwill created in this acquisitionresulted from decreased time to market in CDMA technologies. This goodwill istax deductible.

Subsequent to the May 2004 acquisition of TELOS,the Company completed the allocation of the purchase price based in part uponan independent valuation. The amount of the purchase price allocated toIPR&D of $1.4 million was charged to the Company’s results of operations,as no alternative future uses existed at the acquisition date. The Companyrecorded goodwill of $6.4 million in connection with the acquisition. Thisgoodwill was written off in September 2005 as a result of the intangibleand other long-lived asset impairment. (See Note 10) The results ofoperations of TELOS were included in the Company’s consolidated results ofoperations beginning on the acquisition date of May 19, 2004.

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

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The projects underdevelopment were enhancements to existing products that did not affect thefunctionality of those existing products. As of December 31, 2005, bothprojects were completed.

Thefollowing table summarizes the allocation of the purchase price for TELOS basedupon the independent valuation:

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

 

The estimated useful livesof the customer relationships and existing technology intangible assets arefive years.

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

| ** **                                    | ** ** | **2004**                                                   | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                    | ** ** | **(As restated)**                                     | ** ** |
| ** **                                    | ** ** | **(in thousands,  except per  share data)** | ** ** |
| Pro forma adjusted net  sales                 |       |                                                       | $          | 2,581,104 |   |   |
| Pro forma adjusted net  income                |       |                                                       | $          | 49,407 |   |   |
| Pro forma adjusted basic  earnings per share  |       |                                                       | $          | 0.43 |   |   |
| Pro forma adjusted diluted earnings per share |       |                                                       | $          | 0.37 |   |   |

 

*Hyundai Syscomm, Inc.*

In April 2004, theCompany completed its acquisition of the assets, substantially all of theintellectual property, certain employees and certain contracts related toHyundai Syscomm, Inc.’s (“HSI”) CDMA infrastructure business for marketsoutside of Korea. Subject to the attainment of certain milestones and thetransfer of certain know-how, the total consideration for thistransaction was approximately $12.3 million excluding transaction costs of$1.8 million. Approximately $7.3 million in cash was paid at theclosing date and an additional $3.0 million in cash was paid one year fromthe closing date. The remaining purchase price was comprised of $2.0 millionthat was paid by the Company upon the completion of HSI training of the Company’smanufacturing employees in China under the terms of a Training ServicesAgreement. Not included in the purchase price was $2.0 million payableupon the completion of certain revenue milestones, however, the revenuemilestones were not met and no additional payments were due under theagreement.

In conjunction with thistransaction, the Company loaned HSI $3.2 million at an effective interestrate of 12% per annum, which was used by HSI to satisfy outstanding debtobligations. The principal amount of the loan was due in April 2005.During the year ended December 31, 2005 the Company offset HSI’s paymentobligations against the outstanding $3.0 million of the purchase price andother liabilities.

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Under the terms of thetransaction with HSI, the Company acquired existing technologies and enteredinto non-compete and licensing agreements. The existing technologiesacquired were a base transceiver station and base station controller productlines. As part of the asset purchase agreement, the Company and HSI enteredinto a training services agreement, whereby HSI employees were to providetechnical training to the Company manufacturing staff in China for the ninemonth period subsequent to the acquisition. This technology and technologicalknow-how enabled the Company to strengthen the Company’s existing CDMAproduct portfolio and the development of future CDMA technology.

In addition to acquiringexisting technology, the Company entered into non-compete and licensingagreements with HSI. The non-compete agreement prohibits HSI fromcompeting against the Company in all countries except Korea for four years fromthe consummation date. The licensing agreement requires that HSI pay theCompany 1% of revenue as royalty for the usage of the intellectual propertythat the Company acquired under the terms of the acquisition for fifteen yearssubsequent to the consummation date.

Subsequent to the April,2004 acquisition of HSI, the Company completed the allocation of the purchaseprice based in part upon an independent valuation. The Company recordedgoodwill of $7.0 million in connection with the acquisition. The resultsof operations of HSI have been included in the Company’s consolidated resultsof operations beginning on the acquisition date of April 2004.

Thefollowing table summarizes the final allocation of the purchase price for HSI:

| ** **                                                                                     | ** ** | **(in thousands)** | ** ** |
|------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Fair value of tangible net assets:                                                             |       |                    |       |   |   |
| Property, plant and  equipment                                                                 |       |                    | $          | 1,440 |   |   |
| Other tangible assets                                                                          |       |                    | 437        |   |   |
| Fair value of identified intangible assets:                                                    |       |                    |       |   |   |
| Existing technology                                                                            |       |                    | 3,559      |   |   |
| Non-compete agreement                                                                          |       |                    | 761        |   |   |
| IP License agreement                                                                           |       |                    | 891        |   |   |
| Excess of costs of  acquiring HSI over fair value of identified net assets acquired (goodwill) |       |                    | 7,042      |   |   |
| Total purchase price                                                                           |       |                    | $          | 14,130 |   |   |

 

The intangible assets haveestimated useful lives ranging from three to five years as follows: existingtechnology, five years; non-compete agreement, three years; andintellectual property license agreement, three years. The Company encountereddifficulties integrating the HSI operations after the acquisition. In thefourth quarter 2004, a decision was made to substantially abandon the acquiredoperations. Thus, the entire goodwill and all intangibles were written off in2004. The write-offs were recorded under “Selling, general andadministrative” expense in the statement of operations for the year endedDecember 31, 2004.

Thefollowing unaudited pro forma results of operations reflect the combinedresults of the Company and HSI for the year ended December 31, 2004, as ifthe business combination occurred at the beginning of the period. These resultsdo not purport to be indicative of what would have occurred had the acquisitionbeen made as of that date or the results of operations which may occur infuture periods.

| ** **                                    | ** ** | **2004**                                                   | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------------|------------|
| ** **                                    | ** ** | **(As restated)**                                     | ** ** |
| ** **                                    | ** ** | **(in thousands,  except per  share data)** | ** ** |
| Pro forma adjusted net  sales                 |       |                                                       | $          | 2,582,197 |   |   |
| Pro forma adjusted net  income                |       |                                                       | $          | 49,660 |   |   |
| Pro forma adjusted basic  earnings per share  |       |                                                       | $          | 0.44 |   |   |
| Pro forma adjusted diluted earnings per share |       |                                                       | $          | 0.37 |   |   |

 

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**NOTE 6—INVENTORIES**

As ofDecember 31, 2006 and 2005, inventories consist of the following:

| ** **      | ** ** | **December 31,**   | ** ** |
|-----------------|------------|-------------------------|------------|
| ** **      | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **      | ** ** | **(in thousands)** | ** ** |
| Raw materials   |       | $                       | 72,230     |   | $ | 70,608 |   |
| Work-in-process |       | 43,542                  |       | 27,582 |   |
| Finished goods  |       | 324,673                 |       | 327,765 |   |
|            |       | $                       | 440,445    |   | $ | 425,955 |   |

 

**NOTE 7—ACCOUNTS ANDNOTES RECEIVABLE**

The Company accepts bank notes and commercial notesreceivable from its customers in China in the normal course of business. Thenotes are typically non-interest bearing, with maturity dates betweenthree and six months. Bank notes are included in short-term investments.Commercial notes receivable available for sale were $5.1 million and$2.1 million at December 31, 2006 and 2005, respectively. The Companymay discount these notes with banking institutions in China. A sale of thesenotes is reflected as a reduction of notes receivable and the proceeds of thesettlement of these notes are included in cash flows from operating activitiesin the consolidated statement of cash flows. There were no notes receivablesold during the year ended December 31, 2006 and $73.1 million banknotes and $13.0 million in commercial notes receivable were sold duringthe year ended December 31, 2005. Any notes that are sold are not includedin the Company’s consolidated balance sheets as the criteria for sale treatmentestablished by SFAS No. 140 “Accounting for Transfers and Servicing ofFinancial Assets and Extinguishment of Liabilities,” has been met. The costs ofselling these notes receivable were $0.7 million for the year endedDecember 31, 2005.

In August 2005, theCompany entered into a Committed Receivables Purchase Agreement (“Agreement”)with a commercial bank, whereby the Company may sell up to $100.0 millionof its eligible accounts receivable, as defined in the Agreement. The Agreementcontains provisions customary in transactions of this nature including certaincommitment fees. During 2006 and 2005, no receivables were sold pursuant toprovisions of the Agreement. The Company recorded commitment fees of $0.5million and $0.2 million during the years ended December 31, 2006 and2005, respectively. In March 2007, the Agreement was amended and restatedto reflect that the purchase of trade receivables shall be at the solediscretion of the commercial bank, with no associated commitment fees.

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

As ofDecember 31, 2006 and 2005, property, plant and equipment consists of thefollowing:

| ** **                            | ** ** | **December 31**    | ** ** |
|---------------------------------------|------------|-------------------------|------------|
| ** **                            | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                            | ** ** | **(in thousands)** | ** ** |
| Buildings &  land-use rights |       | $                       | 160,500    |   | $ | 156,404 |   |
| Leasehold  improvements               |       | 18,188                  |       | 16,460 |   |
| Automobiles                           |       | 5,849                   |       | 5,742 |   |
| Software                              |       | 38,945                  |       | 37,064 |   |
| Equipment and  furniture              |       | 200,746                 |       | 188,542 |   |
| Construction in  progress             |       | 940                     |       | 2,303 |   |
|                                  |       | $                       | 425,168    |   | $ | 406,515 |   |
| Less: accumulated depreciation        |       | (212,013                | )          | (173,112 | ) |
|                                  |       | $                       | 213,155    |   | $ | 233,403 |   |

 

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In accordance with SFAS 144, “Accounting for theImpairment or Disposal of Long-Lived Assets,” (“SFAS 144”), the Companyperiodically evaluates the recoverability and estimated lives of its long-livedassets, including property and equipment, whenever events or changes incircumstances indicate that the carrying amount may not be recoverable or theuseful life has changed. For tangible assets, the Company determines therelative estimated fair value through a comparison of similar assets, andwherever practical, based on quoted market prices taking into consideration theasset type, age, condition, and physical location of the asset. The Company’sintangible assets that are subject to amortization are tested forrecoverability based on undiscounted cash flows, and if impaired, written downto fair value based on either discounted cash flows or appraised values.

In 2005, the Company determined the relative estimatedfair value of tangible assets through a comparison of similar assets, andwherever practical, based on quoted market prices taking into consideration theasset type, age condition and physical location of the asset. As a result ofthis analysis, the Company recorded an impairment charge of $14.1 million oflong-lived tangible assets related to the Broadband asset group and $9.4million for long-lived tangible assets related to the Handset asset group.

Depreciation expense was$45.1 million, $66.9 million, and $55.8 million for the years endedDecember 31, 2006, 2005 and 2004, respectively.

**NOTE 9—LONG-TERMINVESTMENTS**

TheCompany’s investments are as follows:

| ** **                     | ** ** | **December 31**    | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Gemdale                        |       | $                       | 32,781     |   | $ | 1,321 |   |
| Cellon  International          |       | —                  |       | 8,000 |   |
| Global Asia  Partners L.P.     |       | 1,700                   |       | 1,700 |   |
| Fiberxon Inc.                  |       | 3,000                   |       | 3,000 |   |
| ImmenStar                      |       | 2,000                   |       | 2,000 |   |
| GCT SemiConductor              |       | 3,000                   |       | 3,000 |   |
| Xalted Networks                |       | 3,302                   |       | 3,000 |   |
| Infinera                       |       | 1,902                   |       | 1,902 |   |
| Matsushita Joint  Venture      |       | —                  |       | 465 |   |
| Restructuring  Fund No. 1 |       | —                  |       | 1,538 |   |
| Others                         |       | 124                     |       | 97 |   |
| Total                          |       | $                       | 47,809     |   | $ | 26,023 |   |

 

*Gemdale*

In 1996, the Company invested $1.3 million in GemdaleCo., Ltd. (“Gemdale”) in return for 11 million non-negotiable shares ofGemdale. Gemdale is a real estate company that invests and develops propertiesin China, primarily in Shanghai, Beijing, Shenzhen and Wuhan. During 2004, theCompany received an additional 8.8 million non-negotiable shares in dividends.This investment was accounted for under the cost method through July 2006.

In August 2006,pursuant to a Split Share Structure Reform Agreement in China, the Companytransferred 6.0 million non-negotiable Gemdale shares to the holders ofnegotiable Gemdale shares in exchange for converting the remaining 13.8 millionnon-negotiable shares into negotiable shares, and a receivable for additionalshares valued at $1.2 million at December 31, 2006. The negotiable Gemdaleshares are traded on the Shanghai Stock Exchange. The 13.8 million negotiable sharesare subject to a transfer restriction through August 2007. As ofDecember 31, 2006 the Company had a 2% ownership 

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interestin Gemdale. The investment is classified as equity securitiesavailable-for-sale and recorded at fair value. An unrealized gain on theinvestment and related receivable totaling $32.6 million was recorded in othercomprehensive income during the year ended December 31, 2006. In 2006, theCompany recorded $0.7 million of dividends received in other income, net.

*CellonInternational*

In September 2001, the Company invested$2.0 million in Cellon International Holdings Corporation (“Cellon”) andmade additional investments of $3.0 million each in Cellon inApril and December 2002. Cellon designs wireless terminals andrelated technology for handset manufacturers and private distributors. InNovember 2005, the Company and Cellon entered into an agreement underwhich the Company received consideration in the form of preferred stock andwarrants of Cellon valued at $5.5 million in exchange for the transfer offixed assets with a net book value of $3.0 million, a facilities lease anda workforce in place consisting of 156 employees. This transaction wascompleted on May 31, 2006 and a gain on sale of assets of$2.5 million was recorded in other income, net. As of December 31,2006, with the additional shares obtained in the purchase transaction, theCompany had an 11% ownership interest in Cellon. In the fourth quarter of 2006,the Company’s review of this investment included, but was not limited to, areview of Cellon’s cash position, recent financing activities, financing needs,earnings/revenue outlook, operational performance, management/ownershipchanges, and competition. Based on the deterioration of Cellon’s financialcondition, the Company determined that the carrying value of the investment wasat an amount above the fair value of the investment, and the decline wasother-than temporary. As of December 31, 2006, the Company recorded a$13.5 million other-than-temporary impairment charge for this investment inother income, net.

In November 2005, theCompany entered into a Development Service Agreement with Cellon in which$5.0 million was prepaid in exchange for future product development.Approximately $2.0 million of the prepaid amount was used during 2006 aspayments for design services. The Company may also use the $5.0 millionprepayment in satisfaction of royalties Cellon may earn from sales by theCompany of products Cellon designs under the Development Services Agreement.This agreement also obligates Cellon to pay the Company a royalty if certaintechnology shared by the Company to Cellon is used in products developed andsold to customers other than the Company through November 2007. During thefourth quarter of 2006, the Company recorded an operating expense of $3.0million to write-off this prepayment in connection with the Company’sassessment of the financial condition of Cellon as discussed above. Foradditional information regarding the Company’s investment in Cellon see Note 23.

*Global AsiaPartners L.P.*

Global Asia Partners L.P.is a venture capital fund formed to make private equity investments in privateor pre-IPO technology and telecommunications companies in Asia. BetweenJune 2002 and April 2005, the Company invested a total of$2.6 million in the fund. As of December 31, 2006, the Company had49% of the fund’s outstanding partnership units. Prior to April 2005, theCompany had a commitment to invest up to a maximum of $5.0 million, but asthe result of a reorganization of capital contributions by the partners,reached in April 2005, our capital contribution of $0.6 million inApril 2005 was the final capital contribution to be made. In addition, theagreement allows the partnership to re-invest up to $2.5 million that otherwisewould have been available to the Company as future distributions. The Companyrecorded no equity losses for the years ended December 31, 2006 and 2005,and an equity loss of $0.5 million for the year ended December 31,2004. For additional information regarding the Company’s investment in GlobalAsia Partners L.P. see Note 23.

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*Fiberxon Inc.*

In September 2002,the Company invested $2.0 million in Fiberxon Inc. (“Fiberxon”), a companythat develops and sells optical modules and related systems. In March 2004,the Company invested an additional $1.0 million in Fiberxon. This investment isaccounted for under the cost method, and its carrying value is evaluated forpossible impairment based on the achievement of business objectives andmilestones, the financial condition and prospects of the company and otherrelevant factors. For additional information regarding the Company’s investmentin Fiberxon see Note 23.

*ImmenStar*

In September 2004,the Company invested $2.0 million in the Series A preferred stock of ImmenStar, Inc.(“ImmenStar”). ImmenStar is a development stage company that is designing achip that can be used in the Company’s products. This investment is accountedfor under the cost method. In February 2007, ImmenStar was acquired by CortinaSystems, Inc. In exchange for the Company’s investment in ImmenStar, theCompany received 4 million shares of Series D Preferred Stock of CortinaSystems, Inc., $1.8 million cash in March 2007 and is entitled toreceive an additional $0.2 million currently held in escrow. As a result of theacquisition, the Company recorded a gain on investment of $2.8 million, inother income, net, and owns 1.3% interest of Cortina Systems, Inc. on afully diluted basis.

*GCT Semiconductor*

In October 2004, theCompany invested $3.0 million in GCT Semiconductor, Inc. Thisinvestment represents approximately a 2% interest in GCTSemiconductor, Inc., which designs, develops and markets integratedcircuit products for the wireless communications industry. This investment isaccounted for under the cost method.

*Xalted Networks*

In May 2005 andAugust 2005, the Company invested $2.0 million and $1.0 million,respectively, in Xalted Networks (“Xalted”). In March 2006 the Companyinvested an additional $0.3 million in Xalted. Xalted is a developmentstage company providing telecommunication operator customers with acomprehensive set of network systems, software solutions and service offerings.The Company has an 11% ownership interest, on a fully diluted basis, in Xaltedand accounts for the investment under the cost method.

*Infinera*

In July 2004, theCompany invested $3.0 million in 1,339,285 shares of Infinera Corporation(“Infinera”) Series D Preferred Stock at $2.24 per share. The investmentrepresents an approximately 2% interest in Infinera, which develops opticaltelecommunications systems using photonic integrated circuits. This investmentis accounted for under the cost method. In September 2004, Infinera closeda Series E Preferred Stock round at $0.60 per share. As a result of the closeproximity between the Series D and Series E preferred stock financingrounds and the decrease in the share price between rounds, Infinera and theCompany entered into an exchange agreement whereby the Company exchanged669,643 shares of Series D preferred stock for 2,500,000 shares ofSeries E preferred stock. After the exchange, the Company owns a total of669,643 shares Series D and 2,500,000 shares of Series E preferredstock. For the year ended December 31, 2004, the Company recorded a lossof $1.1 million to reflect the other-than-temporary decrease in the fairvalue of its remaining Series D shares. For additional informationregarding the Company’s investment in Infinera see Note 23.

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*Matsushita JointVenture*

In July 2002, theCompany entered into a joint venture agreement with Matsushita CommunicationIndustrial Co., Ltd. to jointly design and develop, manufacture and selltelecommunication products. The Company had a 49% ownership interest in thejoint venture company, which had an original registered share capital of$10.0 million. The Company contributed $4.9 million cash inOctober 2002 and another $9.3 million (its 49% interest of the$19 million capital call) during the fourth quarter of 2004. Theinvestment in and results of operations of the joint venture company wereaccounted for using the equity method of accounting. The Company recordedequity losses of $4.8 million and $1.9 million for the years endedDecember 31, 2005 and 2004, respectively. In December 2005, the jointventure board resolved to terminate the joint venture and the Company recordeda loss of $2.9 million to reflect an other-than-temporary decline in value. In2006, the joint venture was dissolved and a final distribution was made inApril 2006 that did not materially exceed the carrying value of theinvestment.

*Restructuring FundNo. 1*

During the first quarterof fiscal 2002, the Company invested $2.0 million in Restructuring FundNo. 1, a venture capital investment limited partnership established bySOFTBANK INVESTMENT CORP., an affiliate of SOFTBANK CORP. SOFTBANKAmerica Inc., an entity affiliated with SOFTBANK CORP., is a significantstockholder of the Company. The fund focuses on leveraged buyout investments incompanies in Asia undergoing restructuring or bankruptcy procedures. The fundhad a separate management team, and none of the Company’s employees wereemployed by the fund. The Company accounted for this investment under theequity method of accounting. In 2005, the Company received $1.0 million individends. The partnership was dissolved in July 2006 with a total cashdistribution of $3.0 million to the Company during 2006. The Company hasrecorded a gain on investment of $1.4 million and $0.7 million, respectively,for the years ended December 31, 2006 and 2005. The Company recordedimmaterial equity losses for the year ended December 31, 2004.

**NOTE 10—GOODWILLAND INTANGIBLE ASSETS**

*Goodwill:*

Intangible assets classified as goodwill and thosewith indefinite lives are not amortized. The Company performs an annualimpairment test of its goodwill during the fourth quarter of each year. TheCompany also tests for impairment between annual tests if a “triggering” eventoccurs that may have the effect of reducing the fair value of a reporting unitbelow their respective carrying values. When conducting its goodwill impairmentanalysis, the Company calculates its impairment charges based on the two-steptest prescribed in SFAS 142, “Goodwill and Other Intangible Assets” (“SFAS142”). The Company uses the present value of future cash flows from therespective reporting units to determine the estimated fair value of thereporting unit and the implied fair value of goodwill.

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During 2005, managementheld a series of planning meetings in September to assess the businessforecasts for all of its reporting units. As a result of various factors,including a reduction in the rate of growth of PAS subscribers in the thirdquarter, a delay of the expected granting of 3G licenses in China and Japan,challenges with product quality primarily in the Company’s Broadband reportingunit, a narrowing of the Company’s strategic focus related to the Company’sproduct offerings and greater than expected revenue and margin decline due tocontinued pricing pressures in several of the Company’s key markets. TheCompany concluded these factors combined represented a “triggering” event. TheCompany determined that the significant adverse changes in the business outlookcould indicate the carrying value of certain of its long-lived assetsgroups may not be recoverable and could indicate the fair value of theCompany’s reporting units may be below their fair value. As a result, theCompany performed interim impairment tests on goodwill and certain other long-livedtangible and intangible assets. The Company performed an impairment analysispursuant to SFAS 142 as of September 30, 2005 for all of its reportingunits. The Company compared the fair value of the reporting units to theircarrying value. The Company determined the fair value of each reporting unitusing both present value and comparable company techniques based, in part, uponan independent valuation. Based upon the impairment assessment, the Companyrecorded goodwill impairment charges of $192.9 million in 2005. Theimpairment charges represented the excess of the carrying amount of thereporting units’ goodwill over the implied fair value of their goodwill. Theimplied fair value of goodwill is the residual fair value derived by deductingthe fair value of a reporting unit’s assets and liabilities from its estimatedfair value based on a discounted cash flow model using revenue and profitforecasts. During 2006, the Company did not identify any instances of goodwillimpairment.

Asummary of changes in the Company’s goodwill during the years ended December 31,2005 and 2006 by business segment is as follows:

| ** **        | ** ** | **January 1,**     | ** ** | ** **    | ** ** | **Exchange**          | ** ** | ** **     | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------------|------------|---------------|------------|-----------------------|------------|----------------|------------|-----------------------|------------|
| ** **        | ** ** | **2005**                | ** ** | **Additions** | ** ** | **rate changes** | ** ** | **Impairment** | ** ** | **2005**              | ** ** |
| ** **        | ** ** | **(in thousands)** | ** ** |
| Handsets          |       | $                       | 74,003     |          |       | $                     | 15,391     |           |       |                  | $          | (57 | ) |   |   | $ | (89,337 | ) |   |   | $ | — |   |   |
| Wireless          |       | 55,641                  |       |          | —     |                  |       |           | 29         |                  |       |   | (55,670 | ) |   |   | — |   |   |
| Network Solutions |       | 129,644                 |       |          | 15,391     |                  |       |           | (28        | )                     |       |   | (145,007 | ) |   |   | — |   |   |
| PCD               |       | 24,710                  |       |          | —     |                  |       |           | 2          |                  |       |   | (24,712 | ) |   |   | — |   |   |
| Broadband         |       | 23,210                  |       |          | —     |                  |       |           | —     |                  |       |   | (23,210 | ) |   |   | — |   |   |
| Service           |       | 3,063                   |       |          | —     |                  |       |           | —     |                  |       |   | — |   |   |   | 3,063 |   |   |
| Total             |       | $                       | 180,627    |          |       | $                     | 15,391     |           |       |                  | $          | (26 | ) |   |   | $ | (192,929 | ) |   |   | $ | 3,063 |   |   |

 

The amount of goodwill at December 31,2006 was unchanged from the amount reported above at December 31, 2005. Theentire amount of $3.1 million was allocated to the services operating segment.

*Intangible* Assets:

In accordance with SFAS144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS144”), the Company periodically evaluates the recoverability and estimatedlives of its intangible assets subject to amortization, whenever events orchanges in circumstances indicate that the carrying amount may not berecoverable. The Company’s intangible assets that are subject to amortizationare tested for recoverability based on undiscounted cash flows, and ifimpaired, written down to fair value based on either discounted cash flows orappraised values.

In 2005, the Companydetermined that the fair value of technology intangible assets within theBroadband and Handset asset groups as calculated using the discounted futurecash flows was less than the carrying value of the net assets and, as such, theCompany recorded a net asset write-off of $1.7 million. During 2006,the Company did not record any impairment charges related to technologyintangible assets because there were no circumstances or events that occurredwhich indicated a possible impairment.

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As of December 31,2006 and 2005, intangible assets consisted of the following:

| ** **                     | ** ** | **December 31,**   | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Existing technology            |       | $                       | 39,530     |   | $ | 39,530 |   |
| Less accumulated  amortization |       | (27,824                 | )          | (21,702 | ) |
|                           |       | $                       | 11,706     |   | $ | 17,828 |   |
| Customer relationships         |       | $                       | 57,220     |   | $ | 57,220 |   |
| Less accumulated  amortization |       | (18,544                 | )          | (12,037 | ) |
|                           |       | $                       | 38,676     |   | $ | 45,183 |   |
| Supplier relationships         |       | $                       | 5,300      |   | $ | 5,300 |   |
| Less accumulated  amortization |       | (5,300                  | )          | (3,092 | ) |
|                           |       | $                       | —     |   | $ | 2,208 |   |
| Trade names                    |       | $                       | 4,940      |   | $ | 4,940 |   |
| Less accumulated  amortization |       | (3,829                  | )          | (2,496 | ) |
|                           |       | $                       | 1,111      |   | $ | 2,444 |   |
| Non-compete agreement          |       | $                       | 10,800     |   | $ | 10,800 |   |
| Less accumulated  amortization |       | (5,850                  | )          | (3,150 | ) |
|                           |       | $                       | 4,950      |   | $ | 7,650 |   |
| Total intangible assets        |       | $                       | 56,443     |   | $ | 75,313 |   |

 

Amortization expense was$18.9 million, $25.9 million and $15.6 million for the years ended December 31,2006, 2005 and 2004, respectively. The estimated aggregate amortization expensefor intangibles for each of the five years beginning 2007 through 2011 is$16.0 million, $12.7 million, $6.9 million, $5.1 millionand $5.1 million, respectively, and is $10.6 million in the aggregatethereafter. There is no significant foreign exchange impact related tointangible assets.

Theremaining weighted average amortization period for each class of unamortizedidentifiable intangible assets include the following:

| ** **             | ** ** | **Weighted  Average Life** | ** ** |
|------------------------|------------|---------------------------------|------------|
| ** **             | ** ** | **(in years)**             | ** ** |
| Technology             |       |                            | 2.1        |   |   |
| Customer relationships |       |                            | 6.8        |   |   |
| Trade names            |       |                            | 0.8        |   |   |
| Non-compete            |       |                            | 1.8        |   |   |

 

**NOTE 11—DEBT**

The following representsthe outstanding borrowings at December 31, 2006 and 2005:

| ** **                                                                        | ** ** | **December 31,**   | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **(in thousands)** | ** ** |
| Bank loans                                                                        |       | $                       | 102,510    |   | $ | 198,826 |   |
| Other, including capital lease obligations, at 4.7%-10.0%,  due through 2011 |       | 809                     |       | 300 |   |
| Convertible subordinated notes, due March 1,  2008                           |       | 274,600                 |       | 274,600 |   |
| Total Debt                                                                        |       | $                       | 377,919    |   | $ | 473,726 |   |
| Long-term debt                                                                    |       | 275,161                 |       | 274,900 |   |
| Short-term debt                                                                   |       | $                       | 102,758    |   | $ | 198,826 |   |

 

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At December 31, 2006, the Company has loans withvarious banks totaling $102.5 million with interest rates ranging from 5.02% to5.51% per annum. These bank loans mature during 2007 and are included in short-termdebt. There are no significant covenants associated with these loans.

The Company has credit facilities totaling$698.4 million of which $571.9 million remained available forborrowing as of December 31, 2006. All of these facilities expire in 2007.There is no guarantee that these facilities will be renewed. The Company hasnot guaranteed any debt not included in the consolidated balance sheet. TheCompany had available borrowing facilities of $482.9 million as of December 31,2005.

On March 12, 2003, the Company completed anoffering of $402.5 million of 7¤8% convertiblesubordinated notes due March 1, 2008 to qualified buyers pursuant to Rule 144Aunder the Securities Act of 1933. The notes are convertible into the Company’scommon stock at a conversion price of $23.79 per share and are subordinated toall present and future senior debt of the Company. Holders of the notes mayconvert their notes only if: (i) the price of the Company’s common stockissuable upon conversion of a note reaches a specified threshold, (ii) specifiedcorporate transactions occur, or (iii) the trading price for the notesfalls below certain thresholds. At the initial conversion price, each $1,000principal amount of notes will be convertible into approximately 42.0345 sharesof common stock. Expenses associated with the convertible subordinated notesissuance were $11.7 million and have been recorded in other long-termassets and are being amortized over the life of the notes.

In 2005, the Company entered into agreements toexchange a total of 4,988,100 shares of the Company’s common stock, with a fairvalue of approximately $37.6 million and approximately $57.1 millionin cash for outstanding convertible notes with an aggregate principal amount of$127.9 million, held by five of its note holders. These exchanges wereconsidered an early extinguishment of debt in which the aggregate fair value ofthe common stock and cash was less than the carrying value of the convertiblenotes. Accordingly, the Company recorded a gain, net of write-off ofunamortized issuance expenses, of $31.4 million for the year ended December 31,2005 on such extinguishment in accordance with the provisions of AccountingPrinciples Board Opinion No. 26, “Early Extinguishment of Debt.”

Concurrent with the issuance of the convertible notes,the Company entered into a convertible bond hedge and call option transactionat a cost of $43.8 million. In 2005, the convertible bond hedge and calloption were amended as a result of the aforementioned early extinguishment ofthe convertible notes. As part of the amendment, the Company received proceedsof $1.4 million which was recorded against additional paid-incapital. The amended convertible bond hedge allows the Company to purchase11.5 million shares of its common stock at $23.79 per share from the otherparty to the agreement. The written call option allows the holder to purchase11.5 million shares of the Company’s common stock from the Company at$32.025 per share. Both the bond hedge and call option transactions may besettled at the Company’s option either in cash or net shares and expire on March 1,2008.

The Company recorded these instruments at cost, andtheir carrying value at December 31, 2005 equaled their original cost asadjusted for amendments related to the early extinguishment of debt. Theconvertible bond hedge and call option transactions are expected to reduce thepotential dilution from conversion of the notes. The options have been includedin stockholders’ equity in accordance with the guidance in EITF No. 00-19,“Accounting for Derivative Financial Instruments Indexed to, and PotentiallySettled in, a Company’s Own Stock.”

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On November 15, 2006,the Company received a notice asserting that its failure to timely file itsQuarterly Report on Form 10-Q for the period ended September 30,2006 had caused a default under the indenture related to the convertible notes,which, if not cured within 60 days, would cause an event of default. Forinformation regarding the subsequent solicitations of consents from the holdersof the notes see Note 23 entitled “Subsequent Events” below.

**NOTE 12—OTHERCURRENT LIABILITIES**

Othercurrent liabilities at December 31, 2006 and 2005 consist of thefollowing:

| ** **                        | ** ** | **December 31,**   | ** ** |
|-----------------------------------|------------|-------------------------|------------|
| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                        | ** ** | ** **              | ** ** | **As restated** | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Accrued contract  costs           |       | $                       | 45,163     |   |   | $ | 60,332 |   |   |
| Loss contract  reserve            |       | 32,061                  |       |   | — |   |   |
| Accrued payroll  and compensation |       | 66,722                  |       |   | 59,689 |   |   |
| Warranty costs                    |       | 63,900                  |       |   | 76,719 |   |   |
| Accrued other  taxes              |       | 13,469                  |       |   | 31,165 |   |   |
| Other                             |       | 50,085                  |       |   | 63,463 |   |   |
|                              |       | $                       | 271,400    |   |   | $ | 291,368 |   |   |

 

Other current liabilitiesprimarily consist of accrued contract costs, which relate to purchases ofinventory, installation services and other testing and consulting workperformed by outside vendors for which the Company has not yet receivedinvoices, loss contract reserve costs, which relate to estimated loss oncontract, 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 other taxes,which represent primarily value added and sales taxes payable.

**NOTE 13—WARRANTYOBLIGATIONS AND OTHER GUARANTEES**

Warrantyobligations are as follows (in thousands):

| Balance at  January 1, 2004                 |   | $       | 26,267 |   |
|--------------------------------------------------|--------|---------|--------|--------|
| Accruals for warranties issued during the period |   | 53,777  |   |
| Warranty obligations assumed upon acquisition    |   | 6,964   |   |
| Settlements made during the period               |   | (40,412 | )      |
| Balance at  December 31, 2004               |   | $       | 46,596 |   |
| Accruals for warranties issued during the period |   | 70,583  |   |
| Settlements made during the period               |   | (40,460 | )      |
| Balance at  December 31, 2005               |   | $       | 76,719 |   |
| Accruals for warranties issued during the period |   | 38,148  |   |
| Settlements made during the period               |   | (50,967 | )      |
| Balance at  December 31, 2006               |   | $       | 63,900 |   |

 

During 2005, the Company recorded a special warrantycharge for equipment sold to Softbank during 2003 and 2004. Since the agreementto repair these parts exceeded the Company’s normal warranty terms, the Companyrecorded additional special warranty charges of $11.7 million for certainasynchronous digital subscriber line (“ADSL”) products, $4.0 millionprimarily related to NetRing equipment and $14.9 million for GEPON equipment.All of these products are in the Broadband Infrastructure segment. During 2006,the Company recorded an additional warranty charge of $5.6 million, consistingof $2.9 million for the 

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NetRing equipment and $2.7million for the GEPON equipment sold to Softbank, based on the results of theCompany’s analysis of warranty costs incurred, and revised estimates of theremaining liability.

Certain of the Company’ssales contracts include provisions under which customers would be indemnifiedby the Company in the event of, among other things, a third-party claimagainst the customer for intellectual property rights infringement related tothe Company’s products. There are no limitations on the maximum potentialfuture payments under these guarantees. The Company has not accrued any amountin relation to these provisions as no such claims have been made and theCompany believes it has valid, enforceable rights to the intellectual propertyembedded in its products.

**NOTE 14—PROVISIONFOR INCOME TAXES**

UnitedStates and foreign income (loss) before income taxes and minority interest wereas follows for the years indicated below:

| ** **    | ** ** | **Year Ended December 31,** | ** ** |
|---------------|------------|--------------------------------------------|------------|
| ** **    | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **    | ** ** | ** **                                 | ** ** | **As restated** | ** ** | **As restated** | ** ** |
| ** **    | ** ** | **(in thousands)**                    | ** ** |
| United States |       | $                                          | (177,762   | ) | $ | (169,934 | ) |   | $ | (24,538 | ) |   |
| Foreign       |       | 43,835                                     |       | (226,859 | ) |   | 54,810 |   |   |
| ** **    |       | $                                          | (133,927   | ) | $ | (396,793 | ) |   | $ | 30,272 |   |   |

 

Thecomponents of income tax (benefit) are as follows for the years indicatedbelow:

| ** **     | ** ** | **Year Ended December 31,** | ** ** |
|----------------|------------|--------------------------------------------|------------|
| ** **     | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **     | ** ** | ** **                                 | ** ** | **As restated** | ** ** | **As restated** | ** ** |
| ** **     | ** ** | **(in thousands)**                    | ** ** |
| Current        |       |                                       |       |   |   |   |   |   |   |
| Federal        |       | $                                          | —     |   |   | $ | 35,929 |   |   | $ | (18,267 | ) |
| State/other    |       | 7                                          |       |   | 3,296 |   |   | (2,099 | ) |
| Foreign        |       | (13,808                                    | )          |   | (92,146 | ) |   | 127,321 |   |
| Total current  |       | (13,801                                    | )          |   | (52,921 | ) |   | 106,955 |   |
| Deferred       |       |                                       |       |   |   |   |   |   |   |
| Federal        |       | —                                     |       |   | 36,791 |   |   | (4,157 | ) |
| State          |       | —                                     |       |   | 5,305 |   |   | (1,055 | ) |
| Foreign        |       | (1,223                                     | )          |   | 147,369 |   |   | (122,035 | ) |
| Total deferred |       | (1,223                                     | )          |   | 189,465 |   |   | (127,247 | ) |
| Total          |       | $                                          | (15,024    | ) |   | $ | 136,544 |   |   | $ | (20,292 | ) |

 

In establishing its deferred income tax assets andliabilities, the Company makes judgments and interpretations based on theenacted tax laws and published tax guidance applicable to its operations. TheCompany records deferred tax assets and liabilities and evaluates the need forvaluation allowances to reduce the deferred tax assets to realizable amounts.The likelihood of a material change in the Company’s expected realization ofthese assets is dependent on future taxable income and its ability to useforeign tax credit carryforwards and carrybacks. Changes to the Company’sincome tax provision or in the valuation of the deferred tax assets andliabilities may affect the annual effective income tax rate.

Deferred income taxes arise from temporary differencesbetween the tax basis of assets and liabilities and their reported amounts inthe consolidated financial statements. The Company reversed a $91.7 millioncurrent deferred tax asset in the second quarter of 2005 in relation to $217.5million of deferred revenue recorded under customer advances pertaining toseveral agreements entered into with Japan 

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Telecom Co., Ltd in 2004.The Company has delivered and received final acceptance for all equipmentcontemplated under those agreements in 2005 and, therefore, the $91.7 millioncurrent deferred tax asset recorded in 2004 was reversed with a correspondingincrease in the deferred tax provision.

Asummary of the components of net deferred tax assets is as follows for theyears indicated below:

| ** **                                             | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                   | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | ** **                                 | ** ** | **(As restated)** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                    | ** ** |
| **Deferred Tax Assets**                                |       |                                       |       |   |   |   |   |
| Allowances and  reserves                               |       | $                                          | 63,676     |   |   | $ | 52,227 |   |   |
| Deferred revenue  and customer advances, net           |       | 20,782                                     |       |   | 24,190 |   |   |
| Net operating  loss carryforward                       |       | 64,047                                     |       |   | 46,858 |   |   |
| Tax credit  carryforwards                              |       | 46,593                                     |       |   | 35,811 |   |   |
| Writedown/amortization  of intangible assets/goodwill  |       | 61,581                                     |       |   | 59,643 |   |   |
| Fixed assets                                           |       | 10,784                                     |       |   | 7,501 |   |   |
| Demo equipment  income                                 |       | 8,788                                      |       |   | 7,547 |   |   |
| Accrued  warranties                                    |       | 14,982                                     |       |   | 16,172 |   |   |
| Other                                                  |       | 8,117                                      |       |   | 8,267 |   |   |
| Total deferred tax  assets                             |       | 299,350                                    |       |   | 258,216 |   |   |
| **Deferred Tax Liabilities**                           | ** ** | ** **                                 | ** ** |   |   |   |   |
| Prepaid expense                                        |       | (2,980                                     | )          |   | (2,474 | ) |   |
| Deferred taxes on  unremitted earnings of subsidiaries |       | (43,943                                    | )          |   | 0 |   |   |
| Other                                                  |       | (8,400                                     | )          |   | (4,647 | ) |   |
| Total deferred  tax liabilities                        |       | (55,323                                    | )          |   | (7,121 | ) |   |
| Total deferred tax assets                              |       | 244,027                                    |       |   | 251,095 |   |   |
| Less: valuation allowance                              |       | (235,564                                   | )          |   | (244,204 | ) |   |
| Total net  deferred tax assets                         |       | $                                          | 8,463      |   |   | $ | 6,891 |   |   |

 

Under APB 23 “Accounting for Income Taxes—SpecialAreas,” deferred income taxes must be provided on the unremitted earnings offoreign subsidiaries unless such earnings could be deemed to be permanentlyreinvested outside the United States. Prior to 2006, the Company had notprovided for U.S. tax on any foreign unremitted earnings because the Companydid not intend to repatriate such earnings. In 2006, due to recent developmentsin its business, the Company determined that earnings from certain subsidiarieswere not permanently reinvested outside the United States. Accordingly, theCompany has recorded a U.S. deferred income tax liability of $43.9 million onforeign earnings of $206.5 million that it considers to not be permanentlyreinvested outside the United States.

As of December 31, 2006, the Company hasundistributed earnings of approximately $69.5 million from investments inforeign subsidiaries that are considered permanently reinvested. Thedetermination of the amount of deferred taxes on these earnings is notpracticable since the computation would depend on a number of factors thatcannot be known until a decision to repatriate the earnings is made.

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As of December 31, 2006, U.S. federal netoperating loss carryforwards were $102.7 million and expire in 2025 and2026. As of December 31, 2006, state net operating loss carryforwards were$87.7 million and expire in varying amounts between 2012 and 2026. Managementhas concluded that these federal and state net operating losses did not meetthe more likely than not standard contained in SFAS No. 109, “Accountingfor Income Taxes,” (“SFAS 109”) and has therefore placed a $41.1 millionvaluation allowance against the related deferred tax assets. In the event thetax benefits related to the valuation allowance are realized, an immaterialamount would be credited to paid-in capital. As of December 31, 2006, theCompany also had net operating loss carryforwards (“NOLs”) in China ofapproximately $75.3 million. The China net operating loss carryforwards willexpire in varying amounts between 2010 and 2011. Management has also concludedthat these China net operating losses did not meet the more likely than not standardcontained in SFAS 109 and has therefore placed a $13.4 million valuationallowance against the related deferred tax assets. As of December 31,2006, the Company had NOLs in countries other than the U.S. and China. TheseNOLs are approximately $54.4 million. The majority of the NOLs do not expireand can be carried forward indefinitely. However, management concluded theselosses did not meet the more likely than not standard contained in SFAS 109 andhas therefore placed a valuation allowance of $9.5 million against the relateddeferred tax assets.

As of December 31, 2006, the Company has U.S.alternative minimum tax credit carryforwards of $1.0 million which have anindefinite life. It also has U.S. research & development creditcarryforwards of $13.0 million, $11.8 million of which expire in varyingamounts between 2010 and 2026, and $1.2 million of which have an indefinitelife. The Company has U.S. foreign tax credits of $30.4 million which expire invarying amounts between 2012 and 2016. Management has concluded that these U.S.tax credit carryforwards did not meet the more likely than not standardcontained in SFAS 109 and has therefore placed a $44.4 million valuationallowance against the related deferred tax assets. As of December 31,2006, the Company has foreign research & development creditcarryforwards of $2.2 million which expire in varying amounts between 2013 and2016.

In 2005, the Company has impaired a significant amountof goodwill and intangible assets. As a result of this impairment, it hasrecorded a $59.6 million deferred tax asset for the difference between the bookbases and tax bases of the impaired assets in 2005. 

The Company’s Chinese subsidiaries were granted taxholidays, which started to phase out in 1999. Income tax exemption for two ofthe Company’s subsidiaries ended December 31, 2004. The net impact ofthese tax holidays was to decrease tax expense by approximately $16.2 millionand $38.0 million for the years ended December 31, 2004 and 2003,respectively.

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Thedifference between the Company’s tax expense (benefit) and the tax based uponfederal statutory rate is reconciled below:

| ** **                                                        | ** ** | **Year Ended December 31,** | ** ** |
|-------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                        | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                        | ** ** | ** **                                 | ** ** | **As restated** | ** ** | **As restated** | ** ** |
| ** **                                                        | ** ** | **(in thousands)**                    | ** ** |
| Federal tax  expense (benefit) at statutory rate                  |       | $                                          | (46,874    | ) | $ | (138,878 | ) |   | $ | 10,595 |   |   |
| State taxes  expense (benefit), net of federal income tax benefit |       | (6,818                                     | )          | (5,140 | ) |   | (736 | ) |   |
| Tax benefit of  convertible debentures                            |       | (6,396                                     | )          | (15,395 | ) |   | (7,905 | ) |   |
| Nondeductible  goodwill impairment                                |       | —                                     |       | 12,873 |   |   | — |   |   |
| Stock  compensation expense                                       |       | 3,577                                      |       | — |   |   | — |   |   |
| Effect of  differences in foreign tax rates                       |       | 18,133                                     |       | 47,101 |   |   | 2,813 |   |   |
| Tax on unremitted  earnings of subsidiaries                       |       | 43,943                                     |       | — |   |   | — |   |   |
| Settlement of tax  audit in China                                 |       | (28,976                                    | )          | — |   |   | — |   |   |
| Effect of tax  rate changes on deferred taxes                     |       | —                                     |       | 11,874 |   |   | (30,549 | ) |   |
| Change in  deferred tax valuation allowance                       |       | 13,918                                     |       | 237,307 |   |   | 4,572 |   |   |
| Tax credits                                                       |       | (6,466                                     | )          | (16,259 | ) |   | (5,076 | ) |   |
| Other                                                             |       | 935                                        |       | 3,061 |   |   | 5,994 |   |   |
| Total tax expense  (benefit)                                      |       | $                                          | (15,024    | ) | $ | 136,544 |   |   | $ | (20,292 | ) |   |

 

In 2006, the tax on unremitted earnings of $43.9million is attributable to recording U.S. deferred income taxes on foreignearnings of $206.5 million that the Company considers to not be permanentlyreinvested outside the United States.

In establishing its deferred income tax assets andliabilities, the Company makes judgments and interpretations based on theenacted tax laws and published tax guidance applicable to our operations aswell as the amount and jurisdiction of future taxable income. The Companyrecords deferred tax assets and liabilities and evaluates the need forvaluation allowances to reduce the deferred tax assets to realizable amounts.As of September 30, 2005, the Company did not believe it was more likelythan not that it would generate a sufficient level and proper mix of taxableincome within the appropriate period to utilize all the deferred tax assets inChina and the United States. As a result of the review undertaken at September 30,2005, the Company concluded that it was appropriate to establish a fullvaluation allowance for the net deferred tax assets in China and the UnitedStates wherein the cumulative losses weigh heavily in the overall assessment.

In 2006, the change in deferred tax valuationallowance of $13.9 million is primarily attributable to the tax expense relatedto continuing to provide a full valuation allowance on our net deferred taxassets at December 31, 2006 in the United States and China.

In 2005, the change in deferred tax valuationallowance of $237.3 million is primarily attributable to the tax expenserelated to providing a full valuation allowance on the Company’s net deferredtax assets at December 31, 2005 in the United States and China. The $11.9million increase in tax expense is due to the revaluation of deferred taxassets recorded in 2005 because of statutory rate changes for certain of theCompany’s subsidiaries in China.

In 2006, the Company recorded a $29.0 million incometax benefit related to the settlement of a tax audit in China for the 2003through 2005 tax years for UTStarcom Telecom Co., Ltd. (“HUTS”) and HangzhouUTStarcom Telecom Co., Ltd (“HSTC”), two of its subsidiaries in China and theacceptance of its tax holiday for HSTC. 

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The Company’s income tax returns for 2003 through 2005are currently under audit by the Internal Revenue Service. The Company is alsounder audit by the taxing authorities in China on a recurring basis. The Company provides tax reserves for federal,state and international exposures relating to audit results, tax planninginitiatives and compliance responsibilities. The development of these reservesrequires judgments about tax issues, potential outcomes and timing, and is acritical estimate. Although the outcome of these tax audits is uncertain, inmanagement’s opinion, adequate provisions for income taxes have been made as aresult of these reviews. If actual outcomes differ materially from theseestimates, they could have a material impact on the Company’s results ofoperations.

On March 16, 2007, China’s top legislature, theNational People’s Congress, passed the China Corporate Income Tax Law (“CIT Law”).CIT Law will be effective on January 1, 2008. Under the CIT Law,China’s dual tax system for domestic enterprises and foreign investmententerprises (“FIEs”) would be effectively replaced by a unified system. The newlaw establishes a tax rate of 25% for most enterprises and a reduced tax rateof 15% for certain qualified high technology enterprises. 

Prior to this change in tax law, certain subsidiariesand joint ventures located in China enjoyed tax benefits in China which aregenerally available to FIEs. The tax holidays/incentives for FIEs wereapplicable or potentially applicable to UTStarcom ChongQing Telecom Co. Ltd. (“CUTS”),UTStarcom Telecom Co., Ltd. (“HUTS”), Hangzhou UTStarcom Telecom Co., Ltd. (“HSTC”)and UTStarcom China Co., Ltd. (“UTSC”), the Company’s active subsidiaries inChina, because these entities may qualify as accredited technologicallyadvanced enterprises.

CIT Law targets certainindustries for the reduced 15% tax rate for certain qualified high technologyenterprises. For FIEs established before the promulgation of the new law whocurrently enjoy lower tax rates, any increase in their tax rates would begradually phased in over five years. Significant regulations regarding theinterpretation and implementation of the new tax law are still pending. Thereis potential risk that the Company’s subsidiaries may not qualify for thereduced 15% tax rate. Therefore, the new law may have an adverse impact on itsfuture tax expense in China.

**NOTE 15—COMMONSTOCK AND STOCK INCENTIVE PLANS**

***Stock Option Plans***

*2006 EquityIncentive Plan:*

The 2006 Equity Incentive Plan (“2006 Plan”) wasimplemented on July 21, 2006 after being adopted by the Board of Directorson June 6, 2006 and approved by the Company’s stockholders on July 21,2006. The 2006 Plan replaces the 1997 Plan, the 2001 Plan, and the 2003 Plan(collectively, the “Prior Plans”) and no further awards will be grantedpursuant to the Prior Plans. The 2006 Plan provides for the grant of thefollowing types of incentive awards: (i) stock options, (ii) stockappreciation rights, (iii) restricted stock, (iv) restricted stockunits, (v) performance shares and performance units, and (vi) and otherstock or cash awards (“Award,” collectively, “Awards”). Those who are eligiblefor Awards under the 2006 Plan include employees, directors and consultants whoprovide services to the Company and its affiliates.

The maximum aggregate number of shares that may beawarded and sold under the 2006 Plan is 4,500,000 shares plus (i) anyshares that have been reserved but remain unissued under the Prior Plans as of July 21,2006, and (ii) any shares subject to stock options or similar awardsgranted under the Prior Plans that expire or become exercisable without havingbeen exercised in full and shares issued pursuant to awards granted under thePrior Plans that are forfeited to or repurchased by the Company. As of December 31,2006, the number of shares transferred from the Prior Plans to the 2006 plantotaled 6,800,545. As of December 31, 2006, options to purchase 62,650shares of common stock were outstanding under the 2006 Plan.

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The Board of Directors or the Compensation Committeeof the Board (“Compensation Committee”)administers the 2006 Plan (“Administrator”).Subject to the terms of the 2006 Plan, the Administrator has the solediscretion to select the employees, consultants, and directors who will receiveAwards, determine the terms and conditions of Awards, and to interpret theprovisions of the 2006 Plan and outstanding Awards. Options granted under the 2006 Plan generally vest and becomeexercisable over four years.

Awards granted under the 2006 Plan are generally nottransferable, and all rights with respect to an Award granted to a participantgenerally may be exercised during a participant’s lifetime only by theparticipant; provided, however, that with the Administrator’s approval, aparticipant may (i) transfer an Award to a participant’s spouse or formerspouse pursuant to a court-approved domestic relations order which relates tothe provision of child support, alimony payments or marital property rights, or(ii) transfer an Award by gift to or for the benefit of the participant’simmediate family. 

The exercise price of all stock options and stockappreciation rights granted under the 2006 Plan must be at least equal to 100%of the fair market value of the Common Stock on the date of grant (or at least110% of such fair market value for an incentive stock option (“ISO”) granted toa stockholder with greater than 10% voting power of the Company’s stock). Themaximum term of a stock option granted to any participant must not exceed sevenyears from the date of grant (or five years for an ISO granted to a stockholderwith greater than 10% of the voting power of the Common Stock). TheAdministrator will determine the terms and conditions of all other Awardsgranted under the Plan. 

In the event of a “changein control” of the Company, each outstanding Award will be assumed or anequivalent option or right substituted by the successor corporation or a parentor subsidiary of the successor corporation. In the event that the successorcorporation, or the parent or subsidiary of the successor corporation, refusesto assume or substitute for the Award, the participant will fully vest in andhave the right to exercise all of his or her outstanding options or stockappreciation rights, including shares as to which such Awards would nototherwise be vested or exercisable, all restrictions on restricted stock willlapse, and, with respect to restricted stock units, performance shares andperformance units, all performance goals or other vesting criteria will bedeemed achieved at target levels and all other terms and conditions met. Inaddition, if an option or stock appreciation right is not assumed orsubstituted for in the event of a change of control, the Administrator willnotify the participant in writing or electronically that the option or stockappreciation right will be fully vested and exercisable for a period of timedetermined by the Administrator in its sole discretion, and the option or stockappreciation right will terminate upon the expiration of such period.

*Prior Plans—The1997 Stock Plan, 2001 Director Option Plan, and 2003 Non-Statutory Stock OptionPlan:*

*The 1997 Stock Plan*

Prior to the implementation of the 2006 Plan on July 21,2006, officers, employees and consultants of the Company and its affiliateswere eligible to receive options to purchase shares of common stock and stockpurchase rights under the 1997 Stock Plan (“1997 Plan”). On January 31,1997, the Board of Directors adopted, and the Company’s stockholders approved,the 1997 Plan. In December 1999, the Board of Directors amended the 1997Plan, which the Company’s stockholders approved in February 2000. The 1997Plan was terminated in July 2006 effective upon stockholder approval ofthe 2006 Plan. As of December 31, 2006, there were options to purchase18,290,317 shares of common stock outstanding under the 1997 Plan.

Options granted under the 1997 Plan prior to July 21,2006 were either ISOs intended to qualify for favorable federal income taxtreatment under the provisions of Section 422 of the Internal Revenue Codeof 1986, as amended, or non-qualified stock options (“NSOs”), which did not soqualify. The Compensation Committee oversaw the selection of eligible personsfor option grants and determined the 

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grant date, amounts,exercise prices, vesting periods and other relevant terms of the options,including whether the options would be ISOs or NSOs. The exercise price of ISOsgranted under the 1997 Plan could not be less than 100% of the fair marketvalue of common stock on the grant date (or at least 110% of such fair marketvalue for an ISO granted to a stockholder with greater than 10% voting power ofthe Company’s stock), while the exercise price of NSOs could be determined bythe Compensation Committee in its discretion. Options granted under the 1997Plan were generally not transferable during the life of the optionee.

Under the 1997 Plan, options vest and becomeexercisable as determined by the Compensation Committee, generally over fouryears. Options may generally be exercised at any time after they vest andbefore their expiration date as determined by the Compensation Committee. However,no option may be exercised more than ten years after the grant date (or fiveyears for ISOs granted to a stockholder with greater than 10% voting power ofthe Common Stock). Options will generally terminate (i) 12 monthsafter the death or permanent disability of an optionee and (ii) theremonths after termination of employment for any other reason. The aggregate fairmarket value 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.

Prior to the implementation of the 2006 Plan, theCompany could also grant stock purchase rights to eligible participants underthe 1997 Plan. Under the 1997 Plan, any shares purchased pursuant to stockpurchase rights were subject to a restricted stock purchase agreement. Unlessthe Compensation Committee determined otherwise, this agreement granted theCompany a right to repurchase the restricted stock upon the voluntary orinvoluntary termination of the employee for any reason, including death ordisability prior to vesting. The purchase price for repurchased shares was theoriginal price paid and could be paid by cancellation of any indebtedness owedto the Company. The Company’s repurchase right lapsed at a rate determined bythe Compensation Committee.

In the event the Companyis merged with or into another corporation, or all or substantially all of theCompany’s assets are sold, each outstanding option and stock purchase rightswill be assumed or an equivalent option or stock purchase right will besubstituted by the successor corporation or its parent or subsidiary. If thesuccessor corporation refuses to assume or substitute for the option or stockpurchase right, the option or right will automatically vest and becomeexercisable in full for a period of at least fifteen days, after which time theoption or right will terminate.

*2001 DirectorOption Plan:*

Prior to the implementation of the 2006 Plan on July 21,2006, those directors who were not employees of the Company (“Outside Directors”)were eligible to receive options to purchase shares of common stock under the2001 Director Option Plan (“2001 Plan”). The 2001 Plan was adopted by the Boardof Directors on March 2, 2001 and was approved by the Company’sstockholders in May 2001. In July 2001, the Board of Directorsamended the 2001 Plan. The 2001 Plan was terminated in July 2006 effectiveupon stockholder approval of the 2006 Plan. As of December 31, 2006, therewere options to purchase 360,000 shares of common stock outstanding under the2001 Plan. The Compensation Committee has been the administrator of the 2001Plan. 

Under the terms of the 2001 Plan, each Outside Directorwas automatically granted an option to purchase eighty thousand shares ofcommon stock (“First Option”) on the date on which such person first became anOutside Director (“Anniversary Date”). A director who was an employee of theCompany and ceased employment with the Company to become an Outside Directorcould receive an option to purchase twenty thousand shares of common stock (a “SubsequentOption”) at the Company’s first annual meeting of stockholders following suchconversion to an Outside Director and at each subsequent annual stockholdermeeting thereafter, provided that he or she was serving as an Outside Directoron each such 

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date. As such time as eachOutside Director’s First Option was fully vested, each Outside Director wasautomatically granted a Subsequent Option on the Anniversary Date of each yearprovided that he or she was then an Outside Director.

Under the terms of the2001 Plan, the exercise price of each option granted equaled the market valueof the common stock on the date of grant. Such options have terms of ten years,but terminate earlier if the individual ceases to serve as a director. TheFirst Option grants vest as to 25% of shares subject to the First Option oneach of the first four anniversaries of its date of grant, subject to theOutside Director continuing to serve as a director on such dates. TheSubsequent Option grants vest as to 100% of the shares subject to theSubsequent Option on the first anniversary of its date of grant.

*The 2003Nonstatutory Stock Option Plan:*

Prior to the implementation of the 2006 Plan on July 21,2006, directors, officers, employees and consultants of the Company and itsaffiliates were eligible to receive options to purchase shares of the Company’scommon stock under the 2003 Nonstatutory Stock Option Plan (“2003 Plan”). The2003 Plan was adopted by the Board of Directors on April 15, 2003. Onlynonstatutory stock options, which would not qualify for favorable federalincome tax treatment under the provisions of Section 422 of the InternalRevenue Code of 1986, as amended, could be granted under the 2003 Plan. The2003 Plan was terminated in July 2006 effective upon stockholder approvalof the 2006 Plan. As of December 31, 2006, options to purchase 909,310shares of common stock were outstanding under the 2003 Plan.

The 2003 Plan has been administered by theCompensation Committee. The Compensation Committee oversaw the selection of theeligible persons to whom options would be granted and determined the number ofshares subject to the option, exercise prices, vesting periods and other termsapplicable to each option.

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) three months after termination of an option holder’s service forany other reason other than for disability or due to the option holder’s death.No option, however, may be exercised more than ten years after the grant date.

In the event of theCompany’s “change in control,” the 2003 Plan provides for each outstandingoption to be assumed or an equivalent option or right to be substituted by thesuccessor corporation or its parent or subsidiary. If the successor corporationrefuses to assume or substitute for the option, the option will automaticallyvest and become exercisable in full for a period determined by the compensationcommittee, after which time the option will terminate.

*IssanniCommunications, Inc. Incentive Program:*

The Issanni plan was established for the issuance ofup to a total of 39,876 shares of UTStarcom’s common stock to specified formeremployees of Issanni Communications, Inc. (“Issanni”) who became UTStarcom’semployees in connection with UTStarcom’s acquisition of Issanni. The Issanniplan is administered by the Board of Directors or the Compensation Committee. 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 

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milestone is attained. Theshares subject to an award will in any event become issuable, whether or notthe milestones were achieved and whether or not the five-year vesting schedulehas elapsed, upon (i) the sale or the discontinuation of the Company orUTStarcom International Products Inc., (ii) the sale of substantiallyall or any of the technology acquired by UTStarcom InternationalProducts Inc. in connection with the acquisition of Issanni, or (iii) theemployment termination of certain Issanni principals.

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

*AdvancedCommunication Devices Corporation Incentive Program:*

In February, 2006 theCompany sold substantially all of the assets and selected liabilities of itssemiconductor design operations, including the assets related to its prioracquisition of ACD. As a result, all participants’ service with the Company wasvoluntarily terminated and all shares subject to award that were not yet earnedor distributed were cancelled.

***Stock Award and Stock Option Activity***

Asummary of activity under all Plans follows:

| ** **                                   | ** ** | ** **                | ** ** | **Number**         | ** ** | ** **                | ** ** |
|----------------------------------------------|------------|---------------------------|------------|--------------------|------------|---------------------------|------------|
| ** **                                   | ** ** | **Shares Available** | ** ** | **of shares** | ** ** | **Weighted average** | ** ** |
| ** **                                   | ** ** | **for Grant**        | ** ** | **outstanding**    | ** ** | **exercise price**   | ** ** |
| Options  Outstanding, January 1, 2004   |       |                      | 4,462,903  |               |       | 14,617,129                |       |   | $ | 18.97 |   |   |
| Options  Authorized in 2004                  |       |                      | 4,178,874  |               |       | —                    |       |   |   |   |   |
| Options Granted                              |       |                      | (5,875,197 | )                  |       | 5,875,197                 |       |   | $ | 27.48 |   |   |
| Options Exercised                            |       |                      | —     |               |       | (1,191,877                | )          |   | $ | 15.54 |   |   |
| Options Forfeited  or Expired                |       |                      | 811,503    |               |       | (811,503                  | )          |   | $ | 24.75 |   |   |
| Options  Outstanding, December 31, 2004 |       |                      | 3,578,083  |               |       | 18,488,946                |       |   | $ | 21.62 |   |   |
| Options  Authorized in 2005                  |       |                      | 4,590,555  |               |       | —                    |       |   |   |   |   |
| Options Granted                              |       |                      | (5,605,623 | )                  |       | 5,605,623                 |       |   | $ | 9.08 |   |   |
| Options Exercised                            |       |                      | —     |               |       | (348,450                  | )          |   | $ | 3.42 |   |   |
| Options Forfeited  or Expired                |       |                      | 3,782,752  |               |       | (3,838,109                | )          |   | $ | 21.96 |   |   |
| Options  Outstanding, December 31, 2005 |       |                      | 6,345,767  |               |       | 19,908,010                |       |   | $ | 18.34 |   |   |
| Options  Authorized in 2006                  |       |                      | 4,900,000  |               |       |                      |       |   |   |   |   |
| Options Granted                              |       |                      | (5,430,957 | )                  |       | 5,430,957                 |       |   | $ | 6.14 |   |   |
| Options Exercised                            |       |                      |       |               |       | (281,077                  | )          |   | $ | 1.39 |   |   |
| Options Forfeited  or Expired                |       |                      | 5,424,040  |               |       | (5,424,040                | )          |   | $ | 19.04 |   |   |
| Options Outstanding,  December 31, 2006 |       |                      | 11,238,850 |               |       | 19,633,850                |       |   | $ | 15.01 |   |   |

 

TheCompany granted restricted stock awards to its employees under the 2006 and1997 Plans. Such awards generally vest over a period of one to four years fromthe date of grant. The restricted stock awards have the voting rights of commonstock and the shares underlying the restricted stock awards are consideredissued and outstanding. The Company expenses the cost of the restricted stockawards, which is determined to be the fair market value of the shares at thedate of grant, ratably over the period during which the restrictions lapse. Thegrant of restricted stock awards is deducted from the shares available for 

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grant under the Company’s stock option plan. Nonvestedrestricted stock as of December 31, 2006 and changes during the year endedDecember 31, 2006 is summarized below:

| ** **                                                                         | ** ** | **Shares** | ** ** | **Weighted  average  grant date  fair value** | ** ** |
|------------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|
| Restricted shares  granted under 2006 and 1997 Plans                               |       |       |       |                                                    |       |   |   |
| Nonvested at December 31, 2005                                                |       | 150,000    |       |                                                    | $          | 8.15 |   |   |
| Granted                                                                            |       | 174,884    |       |                                                    | 7.69       |   |   |
| Vested                                                                             |       | (72,442    | )          |                                                    | 7.81       |   |   |
| Forfeited                                                                          |       | —     |       |                                                    | —     |   |   |
| Nonvested at December 31, 2006                                                |       | 252,442    |       |                                                    | $          | 7.93 |   |   |
| Restricted stock  related to a 2002 acquisition included in issued and outstanding |       | 282,878    |       |                                                    | $          | 17.50 |   |   |
| Total nonvested  at December 31, 2006                                         |       | 535,320    |       |                                                    | $          | 12.99 |   |   |

 

During the year ended December 31, 2005, theCompany granted 150,000 shares of restricted stock with a weighted averagegrant date fair value of $8.15, all of which was nonvested as ofDecember 31, 2005. The shares of restricted stock are subject to theCompany’s right of repurchase, which lapse over a period of one to four years.Repurchased shares are recorded as treasury stock on an average cost basis.During the year ended December 31, 2006, 174,844 shares of restrictedstock subject to such repurchase right of the Company were purchased by employeesand directors. The total intrinsic value of restricted stock vested during theyear ended December 31, 2006 was $0.6 million. The Company also grantedrights to purchase 301,133 shares of restricted stock to executive officers ofthe Company which were allowed to lapse unexercised in March 2006. Intheir place, in February 2007, the Compensation Committee of the Board ofDirectors of the Company determined that certain executive officers, based ontheir level of performance during the Company’s 2006 fiscal year, are eligibleto receive 203,000 shares of common stock in the aggregate. The Committee’sdetermination is subject to compliance with applicable law, and the Committeewill approve the issuance of the Performance Stock at a later date The PerformanceStock is included in the Company’s computation of stock-based compensationexpense for the year ended December 31, 2006.

In connection with the October 2002 acquisitionof Shanghai Yi Yun Telecom Technology Co. Ltd. (“Shanghai Yi Yun”), 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 cliff vests overfive years through 2007, with accelerated vesting upon the achievement ofspecified milestones. The Company has treated these 514,290 shares ofrestricted stock as deferred compensation. During 2003, 226,302 of these sharesvested upon achievement of specified milestones. As of December 31, 2006,5,110 shares have been forfeited resulting in 282,878 remaining sharesoutstanding. No further vesting has occurred through December 31, 2006.

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Informationregarding the stock options outstanding at December 31, 2006, issummarized below:

| ** **                                                                 | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                 | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **Outstanding**              | ** ** | **Weighted**                 | ** ** | ** ** | ** ** | **average** | ** ** | **Exercisable** | ** ** | **Weighted** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **at**                       | ** ** | **average**                  | ** ** | ** ** | ** ** | **remaining** | ** ** | **at** | ** ** | **average** | ** ** | ** ** | ** ** |
| **Range of**                                                          | ** ** | **December 31,**        | ** ** | **exercise**                 | ** ** | **Intrinsic** | ** ** | **contractual** | ** ** | **December 31,** | ** ** | **exercise** | ** ** | **Intrinsic** | ** ** |
| **exercise price**                                                    | ** ** | **2006**                     | ** ** | **price**                    | ** ** | **value** | ** ** | **life** | ** ** | **2006** | ** ** | **price** | ** ** | **value** | ** ** |
| ** **                                                                 | ** ** | ** **                   | ** ** | ** **                   | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | **(in years)** | ** ** | ** ** | ** ** | ** ** | ** ** | **(in thousands)** | ** ** |
| $0.06                                                                      |       |                         | $          | 4.50                         |       |   |   | 775,586 |   |   |   | $ | 3.78 |   |   |   | $ | 3,855 |   |   |   | 2.2 |   |   |   | 775,586 |   |   |   | $ | 3.78 |   |   |   | $ | 3,855 |   |   |
| 4.71                                                                       |       |                         | 6.25       |                         |       |   | 4,134,317 |   |   |   | 6.24 |   |   |   | 10,361 |   |   |   | 9.2 |   |   |   | 4,126 |   |   |   | 5.54 |   |   |   | 13 |   |   |
| 6.31                                                                       |       |                         | 7.50       |                         |       |   | 2,106,843 |   |   |   | 6.63 |   |   |   | 4,457 |   |   |   | 8.9 |   |   |   | 494,268 |   |   |   | 6.63 |   |   |   | 1,043 |   |   |
| 7.52                                                                       |       |                         | 11.07      |                         |       |   | 2,631,672 |   |   |   | 9.95 |   |   |   | 434 |   |   |   | 8.0 |   |   |   | 1,243,186 |   |   |   | 9.86 |   |   |   | 212 |   |   |
| 11.11                                                                      |       |                         | 16.34      |                         |       |   | 2,118,907 |   |   |   | 14.20 |   |   |   | — |   |   |   | 4.9 |   |   |   | 1,965,685 |   |   |   | 14.20 |   |   |   | — |   |   |
| 16.54                                                                      |       |                         | 20.25      |                         |       |   | 3,019,698 |   |   |   | 19.25 |   |   |   | — |   |   |   | 6.0 |   |   |   | 2,717,237 |   |   |   | 19.41 |   |   |   | — |   |   |
| 20.48                                                                      |       |                         | 26.34      |                         |       |   | 2,637,358 |   |   |   | 25.32 |   |   |   | — |   |   |   | 6.7 |   |   |   | 2,595,394 |   |   |   | 25.37 |   |   |   | — |   |   |
| 26.34                                                                      |       |                         | 37.46      |                         |       |   | 2,041,149 |   |   |   | 31.25 |   |   |   | — |   |   |   | 6.7 |   |   |   | 2,040,774 |   |   |   | 31.25 |   |   |   | — |   |   |
| 37.49                                                                      |       |                         | 43.02      |                         |       |   | 118,320 |   |   |   | 40.13 |   |   |   | — |   |   |   | 6.6 |   |   |   | 118,320 |   |   |   | 40.13 |   |   |   | — |   |   |
| 45.21                                                                      |       |                         | 45.21      |                         |       |   | 50,000 |   |   |   | 45.21 |   |   |   | — |   |   |   | 6.6 |   |   |   | 50,000 |   |   |   | 45.21 |   |   |   | — |   |   |
| $ 0.06                                                                |       |                         | $          | 45.21                        |       |   |   | 19,633,850 |   |   |   | 15.01 |   |   |   | $ | 19,107 |   |   |   | 7.2 |   |   |   | 12,004,576 |   |   |   | $ | 19.64 |   |   |   | $ | 5,123 |   |   |
| Options exercisable and expected to vest  December 31, 2006 |       |                         | 18,787,739 |                         |       |   | $ | 15.35 |   |   |   | $ | 17,536 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

The intrinsic valuerepresents the total pre-tax intrinsic value and is calculated as thedifference between the market value as reported by NASDAQ on December 31,2006 of $8.75 and the exercise price of the in-the-money shares. During theyears ended December 31, 2006, 2005 and 2004, the total pre-tax intrinsicvalue of options exercised was $0.5 million, $0.8 million and $18.6 million,respectively, determined as of the date of the exercise. The weighted averageremaining contractual life of options exercisable was 6.0 years, and theweighted average remaining contractual life of options expected to vest was 8.9years as of December 31, 2006.

*2000 Employee StockPurchase Plan:*

In February 2000, the Company’s stockholdersapproved the 2000 Employee Stock Purchase Plan (“ESPP”). The purchase plan isintended to qualify as an employee stock purchase plan under Section 423of the Internal Revenue Code.

The Company had reserved 1,914,934 shares of commonstock for sale under the stock purchase plan at December 31, 2006. Thenumber of shares reserved for sale under the plan will be increased annually onthe first day of each fiscal year beginning in 2001 by an amount equal to2.0 million shares, or 2% of the outstanding shares of the Company’scommon stock on that date, or a lesser amount determined by the Board of Directors.The stock purchase plan is administered by the Board or a committee appointedby the Board.

The stock purchase plan is implemented by concurrentoffering periods, the duration of which may not exceed 24 months. Anoffering period may contain up to four interim purchase periods. Sharespurchased under the stock purchase plan will be held in separate accounts foreach participant. The first offering period began in March 2000 and endedon the last trading day before April 30, 2002. During 2006, no purchaseswere made on the scheduled purchase dates in May and November as theCompany 

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suspended participation inthe ESPP prior to the scheduled purchase dates as a result of the Company notbeing current with its SEC filings on Form 10-K for the year endedDecember 31, 2005 and quarterly report on Form 10-Q for thequarter ended September 30, 2006, respectively. As of December 31,2006, the offering periods that commenced on November 1, 2005 andJune 29, 2006 are currently under suspension and employees who remainparticipants in their respective offering periods will resume participationonce the suspension is lifted.

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.

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 mayterminate or amend the stock purchase plan, subject to stockholder approval insome circumstances. Unless terminated earlier by the Board, the stock purchaseplan will have a term of ten years.

***Stock-Based Compensation***

SFAS 123(R) requires the use of option-pricing modelsthat were not developed for use in valuing employee stock options. The Companyhas used the Black-Scholes option pricing model (“Black-Scholes model”) methodof valuation for share-based awards granted prior to December 31, 2005,and has continued to use the Black-Scholes model for subsequent share-basedpayment awards. The Black-Scholes model was developed for use in estimating thefair value of short-lived exchange traded options that have no vestingrestrictions and are fully transferable. In addition, option pricing modelsrequire the input of highly subjective assumptions, including the expectedstock price volatility over the term of the awards, actual and projectedemployee stock option exercise behaviors, risk-free interest rate and expecteddividends. The Company uses historical volatility as management believes it ismore representative of future stock price trends than implied volatility due tothe relatively small number of actively traded options on our common stockavailable to determine implied volatility. The Company estimates an expectedterm of options granted based upon the Company’s historical exercise andcancellation data for vested options. In addition, separate groups of employeesthat have similar exercise behavior are considered separately. The expectedterm of employee stock purchase plan shares is the average of the remainingpurchase periods under each offering period. The Company bases the risk freeinterest rate used in the option valuation model on U.S. Treasury zero-couponissues with remaining terms similar to the expected term on the options. TheCompany does not anticipate paying any cash dividends in the foreseeable futureand therefore uses an expected dividend yield of zero in the option valuationmodel. The Company is required to estimate forfeitures at the time of grant andrevise those estimates in subsequent periods if actual forfeitures differ fromthose estimates. The Company uses historical data to estimate pre-vestingoption forfeitures and record stock-based compensation expense only forthose 

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awards that are expectedto vest. Prior to January 1, 2006, stock-based payment awards wereamortized on an accelerated basis by treating each vested tranche as a separatestock option grant (graded vesting). Upon adoption of SFAS 123(R) on January 1,2006 all stock-based payment awards are amortized on a straight-line basis overthe requisite service periods of the awards, which are generally the vestingperiods.

Thefair value of share based payment awards was estimated using the Black-Scholesoption pricing model with the following assumptions:

| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| **Stock Options:**                   | ** ** | ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected term in  years                   |       | 4.0                                        |       | 4.0 |   | 3.0 |   |
| Weighted average  risk-free interest rate |       | 4.66                                       | %          | 4.01 | % | 2.78 | % |
| Expected dividend  rate                   |       | 0.0                                        | %          | 0.0 | % | 0.0 | % |
| Volatility                                |       | 57                                         | %          | 61 | % | 56 | % |
|                                           |            |                                            |            |  |  |  |  |  |  |

 

| ** **                                | ** ** | **Year ended December 31,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|
| **ESPP Shares:**                     | ** ** | ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Expected term in  years                   |       | 0.5 to 2.0                                 |       | 0.5 to 2.0 |   | 0.5 to 2.0 |   |
| Weighted average  risk-free interest rate |       | 4.42                                       | %          | 2.69 | % | 1.15 | % |
| Expected dividend  rate                   |       | 0.0                                        | %          | 0.0 | % | 0.0 | % |
| Volatility                                |       | 63                                         | %          | 52 | % | 47 | % |
|                                           |            |                                            |            |  |  |  |  |  |  |

 

On December 31, 2004, a sub-committee ofthe Company’s Board of Directors (the “Board”) approved an immediate and fullacceleration of vesting of all stock options outstanding under the Company’s1997 Stock Option Plan with a per share exercise price greater than $22.15(the “Acceleration”). The Company amended all relevant option agreements toreflect the Acceleration. The Company adopted the Acceleration in anticipationof the impact of SFAS 123(R). As a result of the Acceleration, options topurchase approximately 6.4 million shares of the Company’s common stockbecame immediately exercisable as of December 31, 2004. The Accelerationhad the effect of decreasing 2004 pro forma net income by approximately $33million. The Acceleration had no impact on the financial statements as of andfor the year ended December 31, 2004. The estimated aggregate SFAS 123(R) expensethat was eliminated as a result of the Acceleration of the vesting of theseoptions was approximately $35 million, assuming no material change in employeeretention behavior.

At December 31, 2006, there was$29.9 million of total unrecognized compensation cost, as measured,related to non-vested stock options and restricted stock, which is expected tobe recognized over a weighted-average period of 2.6 years. The weightedaverage fair value of options granted under the stock option plans during theyears ended December 31, 2006, 2005 and 2004 was $3.07, $4.25 and $10.52per share, respectively.

Thetotal stock-based compensation cost recognized for the year ended December 31,2006 was as follows:

| ** **                                                    | ** ** | **Year Ended**     | ** ** |
|---------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                    | ** ** | **December 31,**   | ** ** |
| ** **                                                    | ** ** | **2006**                | ** ** |
| ** **                                                    | ** ** | **(in thousands)** | ** ** |
| Stock-based  compensation expense by type of award:           |       |                    |       |   |   |
| Employee stock options                                        |       |                    | $          | 14,108 |   |   |
| Employee stock purchase plan                                  |       |                    | 712        |   |   |
| Restricted stock                                              |       |                    | 4,165      |   |   |
| Forfeitures related to disposal of a component of a  business |       |                    | (2,393     | ) |   |
| Tax effect                                                    |       |                    | —     |   |   |
| Total                                                         |       |                    | $          | 16,592 |   |   |

 

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Stock-based compensationexpense for the year ended December 31, 2006 was reduced by $2.4 millionrelated to options forfeited in connection with the disposal of the Company’ssemiconductor design operations discussed in Note 5. As a result of adoptingSFAS 123(R) on January 1, 2006, the Company’s income before incometaxes and net income for the year ended December 31, 2006 wereapproximately $10.3 million lower than if it had continued to account for stockincentive compensation under the intrinsic value method. Had the Companycontinued to use the intrinsic value method, the effect on basic and dilutedearnings per share would have been an increase of approximately $0.09 pershare.

**NOTE 16—401(K) PLAN**

On January 1, 2000,the Company adopted the UTStarcom, Inc. 401(k) Savings Plan (“401(k) Plan”),a cash-or-deferred arrangement, which covers the Company’s eligibleemployees who have attained the age of 21. The 401(k) Plan is intended toqualify under Sections 401(a), 401(m) and 401(k) of the InternalRevenue Code of 1986, as amended (“Code”), and the 401(k) Plan trust isintended to qualify under Section 501(a) of the Code. Allcontributions to the 401(k) Plan by eligible employees or by the Company,and the investment earnings thereon, are not taxable to such employees untilwithdrawn, and any contributions the Company may make are expected to bedeductible by the Company. The Company’s eligible employees may elect to reducetheir current eligible compensation by one percent (1%) up to one hundredpercent (100%), subject to the maximum statutorily prescribed annual limit of$15,000 for participants under age 50 and $20,000 for participants age 50 andover for the year ended December 31, 2006, and to have such salaryreductions contributed on their behalf to the 401(k) Plan. The 401(k) Planpermits, but does not require, the Company to make matching contributions onbehalf of all eligible employees who make salary reduction contributions to the401(k) Plan. Commencing with the plan year beginning January 1, 2001,the Company elected to begin making matching contributions on behalf ofqualified employees who participate in the 401(k) Plan. The Company willcontribute $0.50 for each dollar contributed by qualified employees to the 401(k) Plan,to a maximum of $5,500 for the 2006 and 2005 plan years. The Company’s matchingcontributions are subject to a five-year vesting schedule based uponlongevity of employee service with the Company. Matching contributions were$2.7 million, $3.2 million, and $2.7 million for 2006, 2005, and2004, respectively.

**NOTE 17—COMMITMENTSAND CONTINGENCIES**

*Leases:*

TheCompany leases certain facilities under non-cancelable operating leasesthat expire at various dates through 2013. In addition, the Company has enteredinto non-cancelable capital leases having expiration dates through 2011. Theminimum future lease payments under the leases at December 31, 2006 wereas follows:

| ** **                                          | ** ** | **Capital** | ** ** | **Operating**           | ** ** |
|-----------------------------------------------------|------------|-------------|------------|-------------------------|------------|
| **Years ending December 31:**        | ** ** | ** **  | ** ** | **(in thousands)** | ** ** |
| 2007                                                |       |        | $          | 286                     |       |   |   | $ | 15,340 |   |   |
| 2008                                                |       |        | 286        |                    |       |   | 10,833 |   |   |
| 2009                                                |       |        | 247        |                    |       |   | 7,932 |   |   |
| 2010                                                |       |        | 57         |                    |       |   | 2,430 |   |   |
| 2011 and after                                      |       |        | 47         |                    |       |   | 1,665 |   |   |
| Total minimum  lease payments                       |       |        | $          | 923                     |       |   |   | $ | 38,200 |   |   |
| Less: amount  representing interest                 |       |        | (114       | )                       |       |   |   |   |   |
| Present value of  minimun payments                  |       |        | 809        |                    |       |   |   |   |   |
| Less: current  portion of capital lease obligations |       |        | (248       | )                       |       |   |   |   |   |
| Capital lease  obligations, non-current             |       |        | 561        |                    |       |   |   |   |   |
|                                                     |            |             |            |                         |            |  |  |  |  |  |  |  |  |

 

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Rent expense for the yearsended December 31, 2006, 2005 and 2004 was $21.3 million,$22.5 million, and $17.3 million, respectively.

*Contractualobligations and commercial commitments:*

As of December 31,2006 the Company’s obligations under contractual obligations and commercialcommitments were as follows:

| ** **                      | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|
| ** **                      | ** ** | ** **                                | ** ** | **Less than** | ** ** | **1-3** | ** ** |
| ** **                      | ** ** | **Total**                                 | ** ** | **1 year** | ** ** | **years** | ** ** |
| ** **                      | ** ** | **(in thousands)**                   | ** ** |
| Bank loans                      |       | $                                         | 102,510    |   | $ | 102,510 |   | $ | — |   |
| Convertible subordinated  notes |       | $                                         | 274,600    |   | $ | — |   | $ | 274,600 |   |
| Interest payable on debt        |       | $                                         | 35,216     |   | $ | 30,239 |   | $ | 4,977 |   |
| Letters of credit               |       | $                                         | 56,569     |   | $ | 40,100 |   | $ | 16,469 |   |
| Long-term purchase obligations  |       | $                                         | 3,777      |   | $ | — |   | $ | 3,777 |   |

 

*Letters of credit*

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 without being drawn by the beneficiarythereof. Finally, the Company may issue commercial letters of credit in supportof purchase commitments.

*Long-term purchase obligations*

At December 31, 2006,long-term purchase obligations include non-cancelable agreements to purchasecomponents, primarily in connection with last time buy agreements. As of December 31,2006, total commitments under these agreements were approximately $3.8 million.Additionally, in connection with the sale of assets to Marvell, the Company hasagreed to purchase from Marvell certain chipsets that will be included in theCompany’s PAS handsets through 2011. These chipsets will be included in certainhandset products designed and manufactured by the Company.

*Investment commitments:*

As of December 31,2006, the Company had invested a total of $2.6 million in Global AsiaPartners L.P., a fund formed to make private equity investments in privateor pre-IPO technology and telecommunications companies in Asia. The Company hada commitment to invest up to a maximum of $5.0 million, but as the resultof a reorganization of capital contributions by the partners, reached in April 2005,the Company’s capital contribution of $0.6 million in April 2005 was thefinal capital contribution to be made. In addition, the agreement allows thepartnership to re-invest up to $2.5 million that otherwise would have beenavailable to us as future distributions.

*Intellectual property:*

Certain sales contractsinclude provisions under which customers would be indemnified by us in theevent of, among other things, a third party claim against the customer forintellectual property rights infringement related to our products. There are nolimitations on the maximum potential future payments under these guarantees. TheCompany has not accrued any amounts in relation to these provisions as no suchclaims have been made and the Company believes it has valid enforceable rightsto the intellectual property embedded in its products.

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*Litigation*

*Securities Class Action Litigation*

Beginning in October 2004,several shareholder class actions alleging federal securities violations werefiled against the Company and various officers and directors of the Company. Theactions have been consolidated in United States District Court for the NorthernDistrict of California under the caption*Inre UTStarcom, Inc. Securities Litigation*, Master File No. C-04-4908-JW(PVT).The lead plaintiffs in the case filed a First Amended Consolidated Complaint onJuly 26, 2005. The First Amended Complaint alleged violations of theSecurities Exchange Act of 1934, and was brought on behalf of a putative classof shareholders who purchased our stock after April 16, 2003 and before September 20,2004. On April 13, 2006, the lead plaintiffs filed a Second Amended Complaintadding new allegations and extending the end of the class period to October 6,2005. In addition to the Company defendants, the plaintiffs are also suingSoftbank. Plaintiffs’ complaint seeks recovery of damages in an unspecifiedamount.

On June 2, 2006, theCompany and the individual defendants filed a motion to dismiss the SecondAmended Complaint. On March 21, 2007, the Court granted defendants’ motionand dismissed plaintiffs’ Second Amended Complaint. The Court grantedplaintiffs leave to file a Third Amended Complaint, which plaintiffs filed on May 25,2007. On July 13, 2007, the Company and the individual defendants filed amotion to dismiss and a motion to strike the Third Amended Complaint.

On September 4, 2007,a second shareholder class action complaint captioned *Peter Rudolph v. UTStarcom, et al.*, Case No. C-07-4578SI, was filed in the United States District Court for the Northern District ofCalifornia against the Company and some of the Company’s current and formerdirectors and officers. The complaint alleges violations of the SecuritiesExchange Act of 1934 through undisclosed improper accounting practicesconcerning the Company’s historical equity award grants. Plaintiff seeksunspecified damages on behalf of a purported class of purchasers of the Company’scommon stock between July 24, 2002 and September 4, 2007.

Due to the preliminarystatus of these lawsuits and uncertainties related to litigation, the Companyis unable to evaluate the likelihood of either a favorable or unfavorableoutcome. Accordingly, the Company is unable at this time to estimate theeffects of these complaints on the Company’s financial position, results ofoperations, or cash flows.

*Governmental Investigations*

The Company has receivednotice of a formal inquiry by the staff of the Securities & ExchangeCommission (“SEC”) into certain aspects of the Company’s financial disclosuresduring prior reporting periods and certain other issues. In addition, in December 2005,the U.S. Embassy in Mongolia informed the Company that it had forwarded to theDepartment of Justice (“DOJ”) allegations that an agent of the Company’sMongolia joint venture had offered payments to a Mongolian government officialin possible violation of the Foreign Corrupt Practices Act (the “FCPA”). TheCompany through our Audit Committee, authorized an independent investigationinto possible violations of the FCPA, and the Company has been in contact withthe DOJ and SEC regarding the investigation. The investigation has identifiedpossible FCPA violations in Mongolia, Southeast Asia, India, and China, as well as possible violations ofU.S. immigration laws. The DOJ hasrequested that the Company voluntarily produce documents related to theinvestigation and the SEC has subpoenaed the Company for documents. The Companyhas executed tolling agreements extending the statute of limitations for theFCPA issues under investigation by the SEC and DOJ and the immigrationissues under investigation by the DOJ. At this time, the Companycannot predict when any inquiry will be completed or what the outcome of anyinquiry will be.

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*ShareholderLitigation*

On November 17, 2006, a shareholder derivativecomplaint captioned *Ernesto Espinoza v. YingWu et al.*, Case No. RG06298775, was filed against certainof the Company’s current and former officers and directors in the SuperiorCourt of the County of Alameda, California. The complaint alleges that theindividual defendants, among other things, breached their duties, were unjustlyenriched, and violated the California Corporations Code in connection with thetiming of stock option grants. The complaint names the Company as a nominaldefendant and seeks unspecified monetary damages against the individualdefendants and various forms of injunctive relief. On February 2, 2007,the Company and the individual defendants filed demurrers against the complaint.On April 11, 2007, the Court sustained the individual defendants’demurrer, overruled the Company’s demurrer, ordered the plaintiff to file anamended complaint, and ordered the Company to answer the original complaint. Theplaintiff filed an amended complaint and the Company has filed an answer to theamended complaint. On August 21, 2007, the individual defendants fileddemurrers against the amended complaint. The Court sustained the individualdefendants’ demurrers and ordered the plaintiff to file a second amendedcomplaint.

Due to the preliminarystatus of this complaint and uncertainties related to litigation, the Companyis unable to evaluate the likelihood of either a favorable or unfavorableoutcome. Accordingly, the Company is unable at this time to estimate theeffects of this complaint on the Company’s financial position, results ofoperations, or cash flows.

*IPO Allocation*

On October 31, 2001,a complaint was filed in United States District Court for the Southern Districtof New York against the Company, some of the Company’s directors and officersand various underwriters for the Company’s initial public offering. Substantiallysimilar actions were filed concerning the initial public offerings for morethan 300 different issuers, and the cases were coordinated as *In re Initial Public Offering Securities Litigation*,21 MC 92 for pretrial purposes. In April 2002, a consolidated amendedcomplaint was filed in the matter against the Company, captioned *In re UTStarcom, Initial Public Offering SecuritiesLitigation*, Civil Action No. 01-CV-9604. Plaintiffsallege violations of the Securities Act of 1933 and the Securities Exchange Actof 1934 through undisclosed improper underwriting practices concerning theallocation of IPO shares in exchange for excessive brokerage commissions,agreements to purchase shares at higher prices in the aftermarket andmisleading analyst reports. Plaintiffs seek unspecified damages on behalf of apurported class of purchasers of the Company’s common stock between March 2,2000 and December 6, 2000. The Company’s directors and officers have beendismissed without prejudice pursuant to a stipulation. On February 19,2003, the Court granted in part and denied in part a motion to dismissbrought by defendants including the Company. The order dismissed all claimsagainst the Company except for a claim brought under Section 11 of theSecurities Act of 1933, which alleges that the registration statement filed inaccordance with the IPO was misleading. In June 2004, a stipulation ofsettlement and release of claims against the issuer defendants, including theCompany, was submitted to the court for approval. The terms of the settlement,if approved, would have dismissed and released all claims against theparticipating defendants (including the Company). In August 2005, theCourt preliminarily approved the settlement. In December 2006, the Courtof Appeals for the Second Circuit reversed the Court’s October 2004 ordercertifying a class in six test cases that were selected by the underwriterdefendants and plaintiffs in the coordinated proceedings. The Company’s case is not one of the test cases.Because class certification was a condition of the settlement, it was unlikelythat the settlement would receive final Court approval. On June 25, 2007,the Court entered an order terminating the proposed settlement based on astipulation among the parties to the settlement. Plaintiffs have filed amendedmaster allegations and amended complaints in the six test cases. It is unclearwhether there will be any revised or future settlement. If the litigationproceeds, the Company believes that the Company has meritorious defenses andintend to defend the action vigorously. The total amount of the loss associated

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with theabove litigation is not determinable at this time. Therefore, the Company isunable to currently estimate the loss, if any, associated with the litigation.

*Passave Litigation*

In November 2005, theCompany filed suit in the Superior Court of California, County of Santa Clara,against Passave, Inc. (“Passave”) for breaches of contract and warrantiesin connection with a semiconductor device sold by Passave, Ltd. (Passave’swholly-­ownedsubsidiary) to the Company. The Company’s complaint alleges that the Passavedevice, known as the PAS5001M3 chip, has exhibited certain operationalmalfunctions within some of our Fiber-to-the-Home product line, and has therebycaused damage to the Company. The parties entered into a settlement agreement,dated August 7, 2007, and have since dismissed all claims with prejudice.

*UTStarcom, Inc.v. Starent Patent Infringement Litigations*

The Company brought suit against Starent NetworksCorporation (“Starent”) for patent infringement in the U.S. District Court forthe Northern District of California. The Complaint was filed on March 22,2004, and later amended. In this action, the Company asserted that Starentinfringed the Company’s patent U. S. Reg. No. 6,628,671 through themanufacture, use, offer, for sale, and sale of Starent’s ST-16Intelligent Mobile Gateway. The Company sought damages and injunctive relief.Starent filed its answer to the Amended Complaint and counterclaims, denyingour allegations and seeking a declaration that the patent-in-suit is notinfringed, is invalid, and is unenforceable. A motion for a preliminaryinjunction against the making, using or selling of infringing products andmethods was brought, but the Court denied it on June 17, 2005. After a claimsconstruction hearing and order, on September 20, 2005, Starent filed amotion for summary judgment of non-infringement and the Company filed a motionfor summary judgment that Starent is estopped from asserting invalidity andunenforceability. On December 6, 2005, the Court granted Starent’s motionfor summary judgment. On February 2, 2006, the Court entered judgment infavor of Starent and dismissed the case. On March 2, 2006 the Companyfiled an appeal to the Federal Circuit. On April 6, 2007, after reviewingthe parties’ briefs and hearing oral argument on April 2, 2007, theFederal Circuit, without a written opinion, affirmed the District Court’sjudgment and dismissal of the case. Althoughthe Federal Circuit ruled against the Company, this decision will not have amaterial adverse effect on the business, financial condition, or results of itsoperations.

On February 16, 2005, the Company filed a secondsuit against Starent for patent infringement in the U.S. District Court for theNorthern District of California. In the Complaint, the Company asserts thatStarent infringes UTStarcom patent U.S. Reg. No. 6,829,473 (“the ‘473patent”) through Starent’s development and testing of a software upgrade forits customer’s installed ST-16 Intelligent Mobile Gateways. The Companyseeks declaratory and injunctive relief. Starent subsequently filed its answerand counterclaims, denying the Company’s allegations and seeking a declarationthat the patent-in-suit is not infringed, is invalid, and is unenforceable. OnJune 16, 2005, the Company filed a motion to strike Starent’s affirmativedefense and dismiss Starent’s counterclaim alleging inequitable conduct. OnJuly 19, 2005, the parties stipulated that Starent would file an amendedanswer and counterclaim by July 27, 2005 and that the Company wouldwithdraw the Company’s motion to strike. On August 10, 2005, the Companyresponded to Starent’s amended counterclaim filed on July 27, 2005. In early December 2006, the Company filed areissue application for the ‘473 patent with the United States Patent andTrademark Office. Starent has also filed for reexamination of the ‘473 patent.The reexamination and reissue are currently copending. The litigation is stillin a preliminary stage and its outcome cannot be predicted, although theCompany believes the litigation has merit. Nonetheless, the Company believesthat any adverse judgment on Starent’s counterclaims will not have a materialadverse effect on the Company’s business, financial condition, or results ofoperations.

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On May 8, 2007, theCompany filed a third suit against Starent and sixteen individual defendants(who were all former employees of 3Com’s CommWorks division which the Companyacquired certain assets of in May of 2003) in the Northern District ofIllinois. The causes of action include claims for patent infringement,misappropriation of trade secrets, intentional interference with businessrelations and prospective economic advantage and declarations of ownership ofcertain patent rights. In its Complaint, the Company asserts that Starentinfringes UTStarcom patents U. S. Reg. Nos. 7,173,905; 6,978,128; 6,963,582;6,975,900; and 6,684,256 through the manufacture, use, offer, for sale, andsale of Starent’s ST16 Intelligent Mobile Gateway and ST40 multimedia codeplatform, that the individual Defendants and Starent have misappropriatedvaluable Company trade secrets by improperly taking and using the Company’sconfidential and proprietary information for the benefit of Starent, that theindividual defendants and Starent have interfered with the Company’s businessrelations and prospective economic advantage by using the misappropriatedinformation to obtain and enhance sales of Starent’s products, and that severalof Starent’s patent applications and one issued patent are based on informationobtained by the former employees while at the Company (CommWorks) and on thatbasis belong to UTStarcom. The Company seeks compensatory damages, punitivedamages and injunctive relief. After the court denied the defendants motion todismiss the misappropriation of trade secrets claims, on August 30, 2007, Starent answered the Company’s complaint,denying the Company’s allegations and asserting a number of affirmativedefenses and counterclaims, including non-infringement of the subject patentsand alleged tortious interference with prospective economic advantage. TheCompany has filed a motion to dismiss most of the counterclaims and the courthas ordered appointment of a special master to handle discovery, which is justbeginning. The Company believes that any adverse judgment on Starent’scounterclaims will not have a material adverse effect on the Company’sbusiness, financial condition or results of operations.

*Telemetrix, Inc.Arbitration*

On October 19, 2006,Telemetrix, Inc. (“Telemetrix”) filed a formal Request for Arbitrationagainst the Company to the World Intellectual Property Organization (“WIPO”) inGeneva, Switzerland. The Request for Arbitration sought unspecified damages arisingfrom a contract between Telemetrix and Telos Technology, Inc., datedOctober 22, 2003. The Company assumed Telos’ rights and obligations underthis contract pursuant to the Company’s purchase of Telos’ assets on May 19, 2004. Telemetrix alleged ninecauses of action, including breach of contract, fraud, negligentmisrepresentation, interference with contractual relations, and interferencewith prospective economic advantage. In December 2006, the Company filed aformal response to the Request for Arbitration, denying all material factualallegations asserted by Telemetrix. An arbitrator was selected by the parties, and, on August 2, 2007, the arbitrator granted a pleading motion in favor of the Company dueto Telemetrix’s failure to allege sufficient facts in support of a majority ofits causes of action. On August 17, 2007, Telemetrix filed an AmendedStatement of Claim, alleging six causes of action, including breach ofcontract, fraud, interference with contractual relations and interference withprospective economic advantage. The previous hearing date of December 11-13has been vacated. No hearing date has been rescheduled. Discovery has begun.

*Telos Technology,Inc. Litigation*

On November 22, 2005,plaintiffs Telos Technology, Inc., Telos Technology (Canada), Inc.,Telos Technology (Bermuda) Ltd., and Telos Engineering Limited(collectively, the “Telos Plaintiffs”) filed a Complaint against the Company inthe Superior Court of California, County of Santa Clara. The Complaint allegesfive causes of action, including breach of contract, breach of the impliedcovenant of good faith and fair dealing, fraudulent inducement, intentionalmisrepresentation and negligent misrepresentation, all of which arise from theAsset Purchase Agreement between the parties dated April 21, 2004. TheTelos Plaintiffs assert that the Company breached the express and implied termsof the Asset Purchase Agreement and made representations to the TelosPlaintiffs during negotiations that it never intended to fulfill. The TelosPlaintiffs sought at least $19 million in damages, unspecified punitive 

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damagesand attorneys’ fees. The parties executed a settlement agreement in the amountof $4.5 million on August 20, 2007 and the case was dismissed onSeptember 26, 2007 with prejudice.

*Other Litigation*

The Company is a party toother litigation matters and claims that 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 the Company’s financialposition, results of operations or cash flows.

**NOTE 18—OPERATINGRISKS**

*Financial Risks:*

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash, cash equivalents, short-term investments andaccounts and notes receivable. The Company places its temporary cash and short-terminvestments with several financial institutions. Approximately$523.7 million and $523.8 million of the Company’s cash and short-terminvestments were on deposit in foreign accounts at December 31, 2006 and2005, respectively. The Company invests excess cash in highly liquidinvestments with original maturities of twelve months or less, such ascertificates of deposit, government sponsored entities notes, commercial paper,floating rate corporate bonds, fixed income corporate bonds, and money marketfunds, which the Company believes have limited exposure to risk.

*Concentration ofCredit Risk and Major Customers:*

Most Chinese carriers have three levels of operations:the central headquarters level, the provincial level and the local city/countylevel. Both central and provincial levels are independent legal entities andhave their own corporate mandate. The purchasing decision making process maytake various forms for different projects and may also differ significantlyfrom carrier to carrier. The Company groups all China customers together byprovince and treats each province as one customer since that is the level atwhich purchasing decisions are made.

At December 31, 2006 Jiangsu province had anaccounts receivable balance of approximately 11% of the total accountsreceivable for the Company. At December 31, 2005, Softbank had a balanceof approximately 16% of the Company total balance of accounts receivable. AtDecember 31, 2004, Hebei province had an account receivable balance ofapproximately 15% of the Company total accounts receivable balance.

Thefollowing customers accounted for 10% or more of the Company’s net revenues:

| ** ** | ** ** | **For the year ended December 31,** | ** ** |
|------------|------------|--------------------------------------------------------------|------------|
| ** ** | ** ** | **    2006    **     | ** ** | **    2005    ** | ** ** | **    2004    ** | ** ** |
| Verizon    |       |                                                         | 14         | % |   |   | 12 | % |   |   | — |   |   |
| T-Mobile   |       |                                                         | 11         | % |   |   | — |   |   |   | — |   |   |
| Softbank   |       |                                                         | —     |   |   |   | 14 | % |   |   | — |   |   |
| Guangdong  |       |                                                         | —     |   |   |   | — |   |   |   | 13 | % |   |
| Jiangsu    |       |                                                         | —     |   |   |   | — |   |   |   | 10 | % |   |

 

Approximately 23%, 22%,and 72% of the Company’s net sales during 2006, 2005, and 2004, respectively,were to entities affiliated with the government of China. Accounts receivablebalances from these China government affiliated entities or state ownedenterprises were $170.4 million and $268.8 million, respectively, as ofDecember 31, 2006 and 2005. The Company extends credit to its 

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customersin China generally without requiring collateral. In global sales outside ofChina, the Company may require letters of credit from its customers. TheCompany monitors its exposure for credit losses and maintains allowances fordoubtful accounts.

*Country Risks:*

Approximately 32%, 30%, and 79% of the Company’s salesfor the year ended December 31, 2006, 2005, and 2004, 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,currency conversion and remittance abroad, and rates and methods of taxation.

Approximately 5%, 17%, and6% of the Company’s sales for the year ended December 31, 2006, 2005, and2004, 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 19—SEGMENTREPORTING**

From the inception through 2003 the Company managedits business as a single reportable segment. During 2004, the Company continuedto expand its focus on markets and operations outside of China. Effective withthe fourth quarter of 2004, it was determined that the Company’s chiefoperating decision makers, in accordance with SFAS No. 131, “Disclosuresabout Segments of an Enterprise and Related Information,” were evaluatingperformance, making operating decisions and allocating resources based on twooperating segments, (i) China and (ii) all other regions referred toas International (“International”).

On November 1, 2004, the Company acquiredselected assets of the wireless handset division of Audiovox Corporation. Theacquired business has been integrated into the Company as a separate and distinctoperating division referred to as the Personal Communications Division (“PCD”).As the Company determined to evaluate performance and allocate resources tothis division, it was considered a third operating segment. As a result, as ofDecember 31, 2004, the Company was organized, principally based ongeographical market locations, in three operating segments, (i) China,(ii) International and (iii) PCD, and each segment consisted of onereporting unit.

Effective in the first quarter of 2005, the Companyelected to reorganize its business based principally upon product family andrealigned its business into five operating units, (i) BroadbandInfrastructure, (ii) Wireless Infrastructure, (iii) PersonalCommunications Division (“PCD”) (iv) Handsets, and (v) Services. TheCompany announced that effective July 1, 2006, a newly created operatingunit; Network Solutions would begin offering products and services through thecombination of the Broadband Infrastructure and the Wireless Infrastructurereporting segments. Each reporting segment and operating unit is responsiblefor managing its own performance.

The Company currently evaluates operating performanceof and allocates resources to the reporting segments based on segment grossprofit. Cost of sales and direct expenses in relation to production areassigned to the reporting segments. The accounting policies used in measuringsegment assets and operating performance are the same as those used bycorporate and are consistently applied across all segments.

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Summarizedbelow are the Company’s segment sales and gross profit for the years endedDecember 31, 2006, 2005 and 2004 based on the current reporting segmentstructure:

| ** **                 | ** **   | **Years Ended December 31,** | ** **   |
|----------------------------|--------------|---------------------------------------------|--------------|
| ** **                 | ** **   | **2006**                                    | ** **   | **% of net  sales** | ** ** | **2005** | ** ** | **% of net  sales** | ** ** | **2004** | ** ** | **% of net  sales** | ** ** |
| ** **                 | ** **   | ** **                                  | ** **   | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                 | ** **   | **(in thousands)**                     | ** **   |
| ***Net Sales by Segment*** | *** *** | *** ***                                | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   | *** *** | *** *** |   |
| Broadband Infrastructure   |         | $                                           | 219,557      |   |   | 9 | % |   | $ | 507,978 |   |   | 18 | % |   | $ | 232,442 |   |   | 9 | % |   |
| Wireless Infrastructure    |         | 427,400                                     |         |   | 17 | % |   | 436,016 |   |   | 15 | % |   | 1,268,850 |   |   | 49 | % |   |
| Network Solutions          |         | 646,957                                     |         |   | 26 | % |   | 943,994 |   |   | 33 | % |   | 1,501,292 |   |   | 58 | % |   |
| PCD                        |         | 1,339,496                                   |         |   | 55 | % |   | 1,369,324 |   |   | 48 | % |   | 277,410 |   |   | 11 | % |   |
| Handsets                   |         | 395,812                                     |         |   | 16 | % |   | 473,472 |   |   | 16 | % |   | 749,073 |   |   | 29 | % |   |
| Services                   |         | 76,596                                      |         |   | 3 | % |   | 84,320 |   |   | 3 | % |   | 51,640 |   |   | 2 | % |   |
|                       |         | $                                           | 2,458,861    |   |   | 100 | % |   | $ | 2,871,110 |   |   | 100 | % |   | $ | 2,579,415 |   |   | 100 | % |   |

 

| ** **                    | ** **   | **Years Ended December 31,** | ** **   |
|-------------------------------|--------------|---------------------------------------------|--------------|
| ** **                    | ** **   | **2006**                                    | ** **   | **Gross  profit %** | ** ** | **2005** | ** ** | **Gross  Profit %** | ** ** | **2004** | ** ** | **Gross  profit %** | ** ** |
| ** **                    | ** **   | ** **                                  | ** **   | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **                    | ** **   | **(in thousands)**                     | ** **   |
| ***Gross profit by Segment*** | *** *** | *** ***                                | *** *** |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |   | *** *** | *** *** |   |
| Broadband Infrastructure      |         | $                                           | (3,019       | ) |   | -1 | % |   |   | $ | 157,890 | *** *** |   |   | 31 | % |   |   | $ | 45,585 | *** *** |   |   | 20 | % |   |
| Wireless Infrastructure       |         | 206,193                                     |         |   | 48 | % |   |   | 121,077 | *** *** |   |   | 28 | % |   |   | 364,028 | *** *** |   |   | 29 | % |   |
| Network Solutions             |         | 203,174                                     |         |   | 31 | % |   |   | 278,967 | *** *** |   |   | 30 | % |   |   | 409,613 | *** *** |   |   | 27 | % |   |
| PCD                           |         | 39,932                                      |         |   | 3 | % |   |   | 52,812 | *** *** |   |   | 4 | % |   |   | 11,866 | *** *** |   |   | 4 | % |   |
| Handsets                      |         | 118,459                                     |         |   | 30 | % |   |   | 58,166 | *** *** |   |   | 12 | % |   |   | 131,708 | *** *** |   |   | 18 | % |   |
| Services                      |         | 24,179                                      |         |   | 32 | % |   |   | 45,891 | *** *** |   |   | 54 | % |   |   | 16,345 | *** *** |   |   | 32 | % |   |
|                          |         | $                                           | 385,744      |   |   | 16 | % |   |   | $ | 435,836 | *** *** |   |   | 15 | % |   |   | $ | 569,532 | *** *** |   |   | 22 | % |   |

 

Assetsby segment are as follows:

| ** **               | ** ** | **December 31,**   | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **               | ** ** | **(in thousands)** | ** ** |
| *Long-lived assets*      | * *   | * *                | * *   | * * | * * |
| Broadband Infrastructure |       | $                       | 43,157     |   | $ | 47,480 |   |
| Wireless Infrastructure  |       | 79,691                  |       | 87,673 |   |
| Network Solutions        |       | 122,848                 |       | 135,153 |   |
| PCD                      |       | 2,377                   |       | 1,512 |   |
| Handsets                 |       | 43,596                  |       | 47,963 |   |
| Services                 |       | 44,334                  |       | 48,775 |   |
|                     |       | $                       | 213,155    |   | $ | 233,403 |   |

 

| ** **               | ** ** | **December 31,**   | ** ** |
|--------------------------|------------|-------------------------|------------|
| ** **               | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **               | ** ** | ** **              | ** ** | ** **  (As restated)       | ** ** |
| ** **               | ** ** | **(in thousands)** | ** ** |
| *Total assets*           | * *   | * *                | * *   |   | * * | * * |   |
| Broadband Infrastructure |       | $                       | 438,190    |   |   | $ | 473,181 | * * |   |
| Wireless Infrastructure  |       | 909,450                 |       |   | 1,015,699 | * * |   |
| Network Solutions        |       | 1,347,640               |       |   | 1,488,880 | * * |   |
| PCD                      |       | 414,295                 |       |   | 420,191 | * * |   |
| Handsets                 |       | 505,693                 |       |   | 546,910 | * * |   |
| Services                 |       | 106,322                 |       |   | 95,350 | * * |   |
|                     |       | $                       | 2,373,950  |   |   | $ | 2,551,331 | * * |   |

 

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

| ** **      | ** ** | **Years ended December 31,** | ** ** |
|-----------------|------------|---------------------------------------------|------------|
| ** **      | ** ** | ** **                                  | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** | ** ** | ** ** | **% of net** | ** ** |
| ** **      | ** ** | **2006**                                    | ** ** | **sales** | ** ** | **2005** | ** ** | **sales** | ** ** | **2004** | ** ** | **sales** | ** ** |
| ** **      | ** ** | ** **                                  | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| ** **      | ** ** | **(in thousands)**                     | ** ** |
| United States   |       | $                                           | 1,351,839  |   |   | 55 | % |   | $ | 1,332,213 |   |   | 46 | % |   | $ | 341,517 |   |   | 13 | % |   |
| China           |       | 785,525                                     |       |   | 32 | % |   | 870,612 |   |   | 30 | % |   | 2,028,194 |   |   | 79 | % |   |
| Japan           |       | 136,877                                     |       |   | 6 | % |   | 479,114 |   |   | 17 | % |   | 156,416 |   |   | 6 | % |   |
| Other           |       | 184,620                                     |       |   | 7 | % |   | 189,171 |   |   | 7 | % |   | 53,288 |   |   | 2 | % |   |
| Total net sales |       | $                                           | 2,458,861  |   |   | 100 | % |   | $ | 2,871,110 |   |   | 100 | % |   | $ | 2,579,415 |   |   | 100 | % |   |

 

Long-livedassets, consisting of property, plant and equipment, by geographical area areas follows:

| ** **              | ** ** | **December 31,**   | ** ** |
|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **              | ** ** | **(in thousands)** | ** ** |
| U.S.                    |       | $                       | 14,354     |   | $ | 16,676 |   |
| China                   |       | 191,517                 |       | 204,630 |   |
| Other                   |       | 7,284                   |       | 12,097 |   |
| Total long-lived assets |       | $                       | 213,155    |   | $ | 233,403 |   |

 

**NOTE 20—TRANSACTIONSWITH RELATED PARTIES AND CERTAIN INVESTEES**

*Softbank*

The Company recognized revenue of $130.8 million,$475.3 million and $143.7 million during the years ended December 31,2006, 2005 and 2004, respectively, with respect to sales of telecommunicationsequipment to affiliates of SOFTBANK CORP. (“Softbank”), a significantstockholder of the Company. Softbank offers asynchronous digital subscriberline (“ADSL”) coverage throughout Japan, which is marketed under the name“YAHOO! BB.” In 2006, the Company determined that certain sales to third partyresellers are, in substance, sales to Softbank and therefore, the Company hasincluded these amounts in related party sales. Prior year amounts have beenreclassified to conform to the current period presentation. The Companysupports Softbank’s fiber-to-the-home service through salesof its carrier class Gigabit Ethernet Passive Optical Network (“GEPON”) productas well as its multi-service optical transport product (“NetRingÔ”).In addition, the Company supports Softbank’s new internet protocol television(“IPTV”), through sales of its RollingStreamÔproduct. Included in revenue for the year ended December 31, 2006 is a feeof $31.2 million charged for the cancellation of orders for broadband productsand $10.0 million charged for the cancellation of orders for wireless products.

Included in accounts receivable at December 31,2006 and December 31, 2005 were $29.9 million and $83.4 million,respectively, related to these transactions. During 2006 and 2005, sales toSoftbank include a three year service period and a penalty clause if productfailure rates exceed a certain level over a seven year period. There was $11.5million and $19.6 million included in long term deferred revenue with respectto these agreements at December 31, 2006 and 2005, respectively.Additionally, there was $11.6 million and $8.0 million included in currentdeferred revenue at December 31, 2006 and 2005, respectively. As ofDecember 31, 2005, $5.4 million was included in customer advances relatedto other Softbank agreements.

During August 2004, the Company entered intoseveral agreements with Japan Telecom Co., Ltd (“JT”), a wholly ownedsubsidiary of Softbank. These agreements relate to the sale of *i*AN-8000 equipment with specifiedvalue and delivery dates, as well as an oral agreement which subsequentlyconverted into 

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specific service contractsto manage a sales promotional program for JT. The Company determined that theservice activities revenue should be recorded net of expected promotionalspending.

Because the Company had not provided these activitiesin the past and could not estimate the fair value of these services, theCompany determined under the guidance of SAB 104 that all revenue related tothese agreements could not be recognized until all goods and services weredelivered. The Company delivered and received final acceptance for allequipment contemplated under these agreements in the quarter endedMarch 31, 2005.

The promotional services discussed above involvedcontracting with third party promotional vendors, who in turn, facilitated themarketing and subscriber recruitment for the JT fiber-to-the-homeprogram. During the fourth quarter of 2004, the Company determined that itwould end its involvement with the JT promotional program after completion ofthe contract discussed above. Accordingly, late in the fourth quarter of 2004and during the first quarter of 2005, the Company either cancelled or assignedto another party all third party contracts with promotional vendors related tothe JT contract. Such termination or assignment of all third party promotionalagreements, as well as effective satisfaction of the Company’s obligations withJT under such agreements, satisfied the revenue recognition criteria for theseagreements and as such, the net value of the promotional services and the valueof equipment delivered, which totaled $204.8 million, was reported in thequarter ended March 31, 2005.

The Company also entered into an agreement with JTduring the third quarter of 2004 to supply chassis equipment. The equipmentshipped under this agreement is considered linked to the *i*AN-8000 sale noted above and assuch, was also deferred until the completion of the above-mentionedpromotional activities. The revenue recognition criteria related to the sale ofthe *i*AN- 8000 equipment wassatisfied in the first quarter of 2005 and as such, the revenue related to thechassis sale of $66.5 million was reported in the quarter endedMarch 31, 2005. During the year ended December 31, 2006 and 2005,sales to Softbank included $6.7 million and $280.1 million, respectively, withregards to sales of telecommunications equipment and service sold to JT, andnone for 2004.

The Company has invested in Restructuring Fund No.1, aventure capital investment limited partnership established by Softbank. Thepartnership was dissolved in July 2006 with a total cash distribution of$3.0 million to the Company during 2006. The Company has recorded a gain oninvestment of $1.4 million and $0.7 million, respectively, for the year endedDecember 31, 2006 and 2005. The Company recorded an immaterial equity lossfor the year ended December 31, 2004.

On July 17, 2003, the Company entered into aMezzanine Loan Agreement with BB Modem Rental PLC (“BB Modem”), an affiliate ofSOFTBANK CORP. Under the terms of the agreement, the Company loaned BB Modem$10.1 million at an effective interest rate of 12.01% per annum, for thepurpose of investing in a portfolio of ADSL modems and associated modem rentalagreements, from Softbank. Softbank will continue to service such modems andmodem rental agreements. The Company’s loan is subordinated to certain seniorlenders of BB Modem, and repayments are payable to the Company over a 42-monthperiod through January 31, 2007, with a substantial portion of theprincipal amount of the loan repaid during the last 16 months of thisperiod. During the year ended 2006, 2005 and 2004, the Company recorded $0.6 million,$1.3 million and 1.3 million, respectively in interest income in respectto this loan. The loan receivable at December 31, 2006 was approximately$1.0 million included in prepaids and other current assets. AtDecember 31, 2005 the loan balance was approximately $9.0 million andwas included in other long-term assets. The note receivable was paid infull in January 2007.

As of December 31,2006, Softbank beneficially owned approximately 12% of the Company’soutstanding stock.

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*Acoustek Int’lCorp.*

In 2005 and 2006, theCompany received consulting services from Acoustek Int’l Corp. (“Acoustek”),which employed Minnie Huang, spouse of William Huang, the Company’s formerSenior Vice President and Chief Technology Officer. Mr. Haung’s employmentwith the Company terminated on December 31, 2006. The Company paid $0.1million in each of the years of 2006 and 2005 for consulting services providedby Acoustek.

*Audiovox*

One of the Company’sofficers also serves as a director for Audiovox Corporation (“Audiovox”).During the year ended 2006 and 2005, the Company paid approximately $1.4million and $0.7 million, respectively, for IT services from Audiovox.

*Cellon*

In September 2001, the Company invested$2.0 million in Cellon International Holdings Corporation (“Cellon”) andmade additional investments of $3.0 million each in April andDecember 2002. Cellon designs wireless terminals and related technologyfor handset manufacturers and private distributors. In November 2005, theCompany and Cellon entered into an agreement under which the Company receivedconsideration in the form of preferred stock and warrants of Cellon valued at$5.5 million in exchange for the transfer of fixed assets with a net bookvalue of $3.0 million, a facilities lease and a workforce in placeconsisting of 156 employees. This transaction was completed on May 31,2006 and a gain on sale of assets of $2.5 million was recorded in otherincome. As of December 31, 2006, with the additional shares obtained inthe purchase transaction, the Company had an 11% ownership interest in Cellon.In the fourth quarter of 2006, the Company’s review of this investmentincluded, but was not limited to, a review of Cellon’s cash position, recentfinancing activities, financing needs, earnings/revenue outlook, operationalperformance, management/ownership changes, and competition. Based on thedeterioration of Cellon’s financial condition, the Company determined that thecarrying value of the investment was at an amount above the fair value of theinvestment, and the decline was other-than temporary. As of December 31,2006, the Company had recorded a $13.5 million other-than-temporary impairmentcharge for this investment in other income, net.

In November 2005, theCompany entered into a Development Service Agreement with Cellon in which$5.0 million was prepaid in exchange for future product development.Approximately $2.0 million of the prepaid amount was used in year endedDecember 31, 2006 as payments for design services. The Company may alsouse the prepayment in satisfaction of royalties Cellon may earn from sales bythe Company of products Cellon designs under the Development ServicesAgreement. This agreement also obligates Cellon to pay the Company a royalty ifcertain technology shared by the Company to Cellon is used in productsdeveloped and sold to customers other than the Company throughNovember 2007. During 2006, no royalty was earned by the Company relatedto product developed and sold to customers other than the Company. During thefourth quarter of 2006, the Company recorded an operating expense of $3.0million to write-off this prepayment in connection with the Company’sassessment of the financial condition of Cellon as discussed above. Foradditional information regarding the Company’s investment in Cellon see Note23.

*Fiberxon*

The Company had anoutstanding purchase commitment with Fiberxon, in which the Company has a 7%ownership interest, to purchase component parts for optical networkingproducts. In addition, the Company provided a letter of credit for$5.0 million to purchase raw materials for the manufacture of thesecomponent parts. This commitment expired during 2005. There was no suchcommitment 

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arrangementfor 2006. Purchases from Fiberxon totaled $2.6 million, $9.7 million and$15.1 million during the years ended December 31, 2006, 2005 and2004, respectively and the Company had $0.4 million and $0.3 million inaccounts payable to Fiberxon at December 31, 2006 and 2005, respectively.For additional information regarding the Company’s investment in Fiberxon seeNote 23.

*GCT Semiconductor*

The Company has anoutstanding purchase commitment with GCT Semiconductor, Inc. (“GCT”), inwhich the Company has a 2% ownership interest, to purchase component parts.Purchases from GCT totaled $6.3 million and $1.9 million for the years endedDecember 31, 2006 and 2005, respectively. The Company had $1.1 million inaccounts payable to GCT at both December 31, 2006 and 2005.

*Global AsiaPartners L.P.*

Global Asia Partners L.P.is a venture capital fund formed to make private equity investments in privateor pre-IPO technology and telecommunications companies in Asia. The generalpartner of this fund was also a sales agent of the Company until the thirdquarter 2006. Between June 2002 and April 2005, the Company investeda total of $2.6 million in the fund. As of December 31, 2006 theCompany owned 49% of the fund’s outstanding partnership units. The Company hada commitment to invest up to a maximum of $5.0 million, but as the resultof a reorganization of capital contributions by the partners, reached inApril 2005, the Company’s capital contribution of $0.6 million inApril 2005 was the final capital contribution to be made. In addition, theagreement allows the partnership to re-invest up to $2.5 million that otherwisewould have been available to us as future distributions. For additionalinformation regarding the Company’s investment in Global Asia Partners L.P. seeNote 23.

*Matsushita JointVenture*

In July 2002, theCompany entered into a joint venture agreement with Matsushita CommunicationIndustrial Co., Ltd. to jointly design and develop, manufacture and selltelecommunication products. The Company had a 49% ownership interest in thejoint venture company. The Company performed engineering services for the jointventure for approximately $2.8 million which was recognized as revenueduring 2005. As of December 31, 2005, the Company had a receivable of $0.1million. In December 2005, the partners agreed to dissolve the jointventure and the dissolution was completed during 2006.

*MDC Holding, Ltd.*

The Company had anoutstanding accounts receivable balance with MDC Holding, Inc. (“MDC”)related to a PAS system purchase of $1.3 million at December 31, 2006.There was no accounts receivable balance at December 31, 2005. Certainemployees of the Company were shareholders of MDC as of December 31, 2006.MDC is in the business of providing value-added services, such as shortmessage, voicemail or ring-tone services for PAS telecom networks.

*ORG, Inc.*

The Company has a 49%ownership in Global Asia Partners L.P. which in turn is a significantshareholder in ORG, Inc. The Company had sales of $1.6 million and$0.5 million to ORG, Inc. during 2006 and 2005, respectively. TheCompany had accounts receivable of $1.0 million and $0.2 million fromORG, Inc. as of December 31, 2006 and 2005, respectively. There wasno deferred revenue at December 31, 2006 and there was $0.1 millionin deferred revenue at December 31, 2005.

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*StarcomProducts, Inc.*

The Company obtainsengineering consulting and employee placement services from StarcomProducts, Inc. (“Starcom”), which is 31% owned by an individual related toone of the Company’s former officers who was also a member of the Company’sBoard of Directors. The Company paid less than $0.1 million in 2006, $0.7million in 2005 and $1.1 million in 2004 for engineering consulting andemployee placement services provided by Starcom.

*Xalted Networks*

In May 2005 andAugust 2005, the Company invested $2.0 million and $1.0 million,respectively, in Xalted Networks (“Xalted”). In March 2006 the Companyinvested an additional $0.3 million in Xalted. Xalted is a developmentstage company providing telecommunication operator customers with a comprehensiveset of network systems, software solutions and service offerings, in which theCompany has a 11% ownership interest. The Company received purchase orders fromXalted Networks totaling approximately $1.3 million in 2005 fortelecommunications equipment that is for product not typically sold by theCompany to other customers. The Company charges a ten percent procurement feeto Xalted for obtaining and reselling these products. The equipment wasdelivered during 2005 but revenue has not been recognized as the revenuerecognition process had not been completed.

**NOTE 21—RESTRUCTURINGCOSTS**

In the second quarter of fiscal 2005, the Companyannounced and initiated a restructuring plan to rationalize cost structure inresponse to the decline in demand for certain products. In addition, therestructuring plan was designed to allow the Company to reduce operating costsfor each product line. The primary goal of these improvements was to lower thecost structure for the Company.

In 2005 the Company incurred $35.3 million inexpenses in relation to the restructuring plan actions, primarily consisting of(i) $15.2 million related to severance payments(ii) $14.5 million in asset impairments primarily related to thewrite-off of equipment and licenses associated with discontinuedproducts, which are included in operating expenses and(iii) $5.6 million in inventory write-off associated withdiscontinued products. Included in severance is a $1.8 million non-cashreversal of a housing allowance accrual in China. Restructuring expense relatedto the inventory write-off is included in cost of sales in theconsolidated statements of operations. As a result of these actions,approximately 1,595 employees were terminated or placed in the workforcereduction programs during fiscal 2005. As of December 31, 2005, headcountreductions from this plan were completed.

For the year ended December 31, 2006, the Companyrecorded a reduction of $1.1 million to the restructuring plan accrual,primarily consisting of (i) $0.8 million in asset impairment/exit cost and(ii) $0.3 million related to severance payments. Included in assetimpairment/exit cost is a $0.4 million non-cash reversal related to the E&Oreserve for discontinued products and $0.1 million related to higher thanexpected sublease income for the Company’s New Jersey facility. As ofDecember 31, 2006, the Company’s restructuring reserve balance of $0.1million primarily consists of the remaining lease liability for the New Jerseyfacility. The Company expects the remaining balance to be paid through fiscalyear 2007.

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Asummary of changes in the Company’s restructuring accrual during the yearsended December 31, 2006 and 2005 is as follows:

| ** **          | ** ** | **Year ended December 31, 2005** | ** ** | **Balance** | ** ** | **Year ended  December 31, 2006** | ** ** | **Balance**                                   | ** ** |
|---------------------|------------|------------------------------------------------------|------------|-------------|------------|--------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **          | ** ** | ** **                                           | ** ** | **Cash**    | ** ** | **Non-cash**                                     | ** ** | **  December 31,  ** | ** ** | **Cash** | ** ** | **Non-cash** | ** ** | **  December 31,  ** | ** ** |
| ** **          | ** ** | **Charges**                                          | ** ** | **payment** | ** ** | **settlement**                                   | ** ** | **2005**                                      | ** ** | **payment** | ** ** | **settlement** | ** ** | **2006** | ** ** |
| ** **          | ** ** | **(in thousands)**                              | ** ** |
| **Wireless**        | ** ** | ** **                                           | ** ** | ** **  | ** ** | ** **                                       | ** ** |                                          | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Severance payments  |       | $                                                    | 2,139      |        | $          | (2,559                                           | )          | $                                             | 420        |   |   | $ | — | ** ** |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | — | ** ** |   |
| Asset impairment    |       | 12,236                                               |       | (110        | )          | (12,126                                          | )          |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Inventory write-off |       | 5,543                                                |       | —      |       | (5,543                                           | )          |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Broadband**       |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | 3,472                                                |       | (3,503      | )          | 81                                               |       |                                          | 50         | ** ** |   |   | (50 | ) |   |   | — |   |   |   | — | ** ** |   |
| Asset impairment    |       | 1,095                                                |       | (50         | )          | (1,045                                           | )          |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Inventory write-off |       | 53                                                   |       | —      |       | (53                                              | )          |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Handsets**        |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | 1,056                                                |       | (1,127      | )          | 100                                              |       |                                          | 29         | ** ** |   |   | (29 | ) |   |   | — |   |   |   | — | ** ** |   |
| Asset impairment    |       | 350                                                  |       | —      |       | —                                           |       |                                          | 350        | ** ** |   |   | — |   |   |   | (350 | ) |   |   | — | ** ** |   |
| Inventory write-off |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **PCD**             |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Asset impairment    |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Inventory write-off |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Service**         |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | 2,135                                                |       | (2,488      | )          | 353                                              |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Asset impairment    |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| Inventory write-off |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Corporate**       |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | 6,342                                                |       | (6,931      | )          | 796                                              |       |                                          | 207        | ** ** |   |   | (207 | ) |   |   | — |   |   |   | — | ** ** |   |
| Asset impairment    |       | 844                                                  |       | (32         | )          | (233                                             | )          |                                          | 579        | ** ** |   |   | (352 | ) |   |   | (105 | ) |   |   | 122 | ** ** |   |
| Inventory write-off |       | —                                               |       | —      |       | —                                           |       |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Summary  Totals** |       |                                                 |       |        |       |                                             |       |                                          | ** ** | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Severance payments  |       | $                                                    | 15,144     |        | $          | (16,608                                          | )          | $                                             | 1,750      |   |   | $ | 286 | ** ** |   |   | $ | (286 | ) |   |   | $ | — |   |   |   | $ | — | ** ** |   |
| Asset impairment    |       | 14,525                                               |       | (192        | )          | (13,404                                          | )          |                                          | 929        | ** ** |   |   | (352 | ) |   |   | (455 | ) |   |   | 122 | ** ** |   |
| Inventory write-off |       | 5,596                                                |       | —      |       | (5,596                                           | )          |                                          | —     | ** ** |   |   | — |   |   |   | — |   |   |   | — | ** ** |   |
| **Total**           |       | $                                                    | 35,265     |        | $          | (16,800                                          | )          | $                                             | (17,250    | ) |   | $ | 1,215 | ** ** |   |   | $ | (638 | ) |   |   | $ | (455 | ) |   |   | $ | 122 | ** ** |   |

 

Included in the $35.3 millionrestructuring charge for the year ended December 31, 2005 was$5.6 million recorded within cost of net sales and $29.7 millionrecorded as an operating expense.

**NOTE 22—VARIABLEINTEREST ENTITIES**

The Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation No. 46(R), (“FIN 46(R)”). FIN 46(R) requiresthat if an entity is the primary beneficiary of a variable interest entity,(“VIE”), the assets, liabilities, and results of operations of the VIE shouldbe included in the consolidated financial statements of the entity.

In 2004 and 2003, the Company had consolidated arelated party deemed a VIE and with whom the Company was the primarybeneficiary. Beijing MDC Telecom Co., Ltd. (“MDC BJ”) was formed in 2001. In2002, a venture capital fund with affiliation to a shareholder of the Companymade an additional capital investment and established MDC Holding Limited (“MDCHolding”) and its affiliated entities (MDC Holding and such affiliatedentities, including MDC BJ, are referred to, collectively, as “MDC”). MDC is inthe business of providing value-added services, such as text messaging,voicemail or ring-tone services for PAS telecom networks. During 2003 and2004 the Company had consolidated MDC, a VIE, for whom 

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the Company was the primarybeneficiary. As of December 31, 2004, the consolidation resulted in a$4.2 million increase in both total assets and total liabilities andequity. During the fourth quarter of 2005, the Company sold its equityinterest, terminated material commercial arrangements, settled the bank debtand is no longer considered the primary beneficiary. As a result, the assetsand liabilities of MDC were not consolidated as of December 31, 2006 and2005.

In 2005, the Company invested in an additional entity,which was considered a VIE where the Company was the primary beneficiary anddid not hold a majority voting interest. The VIE was established to install,develop and operate a PAS network in Mongolia. The creditors of this VIE haveno recourse to the Company. In December 2005, the U.S. Embassy inMongolia informed the Company that it had forwarded to the Department ofJustice allegations that an agent of the joint venture had offered payments toa Mongolian government official, in possible violation of the Foreign CorruptPractices Act. The Audit Committee authorized an independent investigation intothe matter. As a result of the investigation, the Company wrote off$1.2 million of intangibles, recorded a $3.6 million inventory reserve forgoods shipped to the VIE and established a $2.6 million VAT liability atDecember 31, 2005. The investigation is still ongoing. The consolidationof this entity resulted in a $6.0 million increase in both total assetsand total liabilities and equity as of December 31, 2005. In the firstquarter of 2006, the Company decided to terminate the joint venture arrangementand wrote off $4.7 million net book value of fixed assets. InNovember 2006, the Board of Directors of the VIE approved dissolution ofthe joint venture. As a result, the Company ceased to be the primarybeneficiary of this VIE and the asset and the liabilities of the VIE were notconsolidated as of December 31, 2006. The $2.6 million VAT liability wasreversed accordingly as management concluded that it is remote that the Companywould be required to pay such tax for the joint venture.

During the fourth quarterof 2005, the Company provided an interest free, $12.4 million loan to aparty in China as seed capital for a venture organized to participate inproviding technical service, networking technology, and equipment to theemerging market for IPTV products in China. The loan is partially secured by anindirect ownership interest in the venture, is payable in 10 years and maybe called early without penalty. As a result of the foregoing, and the factthat the venture’s continuing viability is heavily dependent on the furtherprovision of network and terminal equipment by the Company, the Company hasdetermined that the venture is a VIE and that the Company is the primary beneficiaryof the venture. Therefore, this venture was consolidated into the Company’sfinancial statements as of December 31, 2006 and 2005. This VIE had $0.4million and insignificant revenue during 2006 and 2005, respectively, and hadnet losses of $3.5 million and $0.9 million for 2006 and 2005,respectively. The consolidation of this VIE represented $17.2 million and$18.9 million of both the total assets and total liabilities and equity ofthe Company as of December 31, 2006 and 2005, respectively. The liabilitiesof the VIE consolidated by the Company do not represent additional claims onthe Company’s general assets; rather they represent claims against the specificassets of the VIE. Likewise, the assets of the VIE consolidated by the Companydo not represent additional assets available to satisfy claims against theCompany’s general assets. The creditors’ of the VIE do not have recourse to theCompany thereby limiting the liability risks associated with the Company’svariable interests in the VIE.

**NOTE 23—SUBSEQUENTEVENTS**

**First and SecondSupplemental Indentures and Notice of Default**

After receiving the notice of default referred to inNote 11 above, the Company solicited and obtained the requisite consents fromholders of the convertible subordinated notes due in March 2008 to a waivereffective January 9, 2007 of any default which may have occurred prior tosuch date due to the delay in filing and non-compliance with certain covenants,and the Company and the trustee entered into a First Supplemental Indenture,dated January 9, 2007, providing that any failure by the Company to complywith certain covenants of the original indenture would not result in a defaultor an event of default through 

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May 31, 2007. TheFirst Supplemental Indenture provided for additional interest at a rate of6.75% per annum in special interest on the notes from and after January 9,2007 to the March 1, 2008 maturity date of the notes, unless the notes areearlier repurchased or converted. Payments of the special interest were to bemade in addition to and at the same time and in the same manner as regularlyscheduled payments of interest to holders entitled to such regularly scheduledpayments of interest. As a result of the First Supplemental Indenture, theconvertible subordinated notes accrued interest at a rate of 7.625% per annumas of January 9, 2007.

On May 31, 2007, the Company received a notice ofdefault from the trustee for the notes asserting that a default had occurreddue under the indenture, as amended by the First Supplemental Indenture (“theIndenture”) with respect to the Company’s convertible subordinated notes due inMarch 2008. The specific purported defaults referred to in the notice ofdefault were (1) the Company’s failure to file its Quarterly Report onForm 10-Q for the fiscal quarter ended September 30, 2006, itsannual report on Form 10-K for the year ended December 31, 2006and its Quarterly Report on Form 10-Q for the fiscal quarter endedMarch 31, 2007 and (2) the Company’s failure to deliver to theTrustee the officer’s certificate of compliance of the Company required by theIndenture.

Subsequently, the Company solicited and obtained therequisite consents from the holders of the notes to a waiver, effectiveJuly 26, 2007, of any default which may have occurred prior to such datedue to the delay in filing and non-compliance with certain covenants, and theCompany entered into a Second Supplemental Indenture with the trustee, datedJuly 26, 2007, after receiving consent from holders of more than 50% ofthe outstanding aggregate principal amount of the convertible subordinatednotes in connection with the Company’s consent solicitation announcedJuly 19, 2007. The Second Supplemental Indenture provides that theconvertible subordinated notes accrue additional interest at a rate of(a) 6.75% per annum in special interest from and after January 9,2007 to and including July 25, 2007, and (b) 10% per annum in specialinterest from and after July 26, 2007 to the date the notes are paid,prepaid, redeemed converted or otherwise cease to be outstanding. The specialinterest rate provided by the Second Supplemental Indenture represents anincrease of 3.25% per annum over the special interest rate of 6.75% provided bythe First Supplemental Indenture. As a result of the Second SupplementalIndenture, the convertible subordinated notes now bear a stated interest rateof 10.875%. Payments of special interest will be made in addition to, and atthe same time and in the same manner as, regularly scheduled payments ofinterest to holders entitled to such regularly scheduled payments of interest.

The Second SupplementalIndenture also provides that (i) during the period from and includingJuly 26, 2007 to and including October 15, 2007 (“Covenant ReversionDate”), any failure by the Company to comply with the covenants contained inthe original agreement related to the filing of reports required to be filedwith the SEC, and the furnishing of copies of the SEC reports and certaincompliance certificates to the Trustee, will not constitute a default, and that(ii) if, but for the Second Supplemental Indenture, a default would bedeemed to have occurred as a result of a failure to comply with such covenantsand such default remains uncured and is continuing as of the Covenant ReversionDate, such default will be deemed to have occurred on the Covenant ReversionDate.

**CommittedReceivables Agreement**

On March 30, 2007,the Company amended and restated its committed receivables purchase facilitywith Citibank, N.A., which provides for the sale of up to $100.0 millionof trade accounts receivable of our PCD segment, to reflect that thepurchase of trade receivables shall be at the sole discretion of Citibank, N.A.

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**Impairment ofInvestment in Cellon and Liquidation of Assets**

In the fourth quarter of2006, the Company reviewed its long-term investment in Cellon. The reviewincluded, but was not limited to, a review of Cellon’s cash position, recentfinancing activities, financing needs, earnings/revenue outlook, operationalperformance, management/ownership changes, and competition. Based on thedeterioration of Cellon’s financial condition that resulted from significantadverse changes in Cellon’s business in the fourth quarter of 2006, the Companydetermined that the carrying value of the investment was at an amount above thefair value of the investment, and the decline was other-than temporary. As ofDecember 31, 2006, the Company recorded a $13.5 million other-than-temporaryimpairment charge for this investment in other income, net and recorded anoperating expense of $3.0 million to write-off a prepayment to Cellon. OnJune 18, 2007, a meeting of Cellon’s shareholders was held where aresolution was passed to place Cellon in voluntary liquidation.

**Infinera InitialPublic Offering**

On June 7, 2007, Infinera Corporation(“Infinera”) closed on its initial public offering of 14,000,000 shares ofcommon stock at a price of $13.00 per share. Infinera also announced that theunderwriters of the offering exercised in full their option to purchase anadditional 2,100,000 shares of Infinera common stock, bringing the totalinitial public offering size to $209.3 million. After the initial publicoffering, the Company is entitled to convert its 669,643 shares of Series Dand 2,500,000 shares of Series E Preferred Stock into 792,410 shares ofInfinera’s common stock; subject to Rule 144 trading restrictions and 180days lock up period starting June 2007 through December 2007.

As a result of the initialpublic offering, the value of the Infinera shares owned by the Company wasreadily determinable and the investment was classified as an equity securityavailable-for-sale in accordance with SFAS No. 115, “Accounting forCertain Investments in Debt and Equity Securities.” The closing price per shareof Infinera common stock on June 29, 2007 was $24.92 and the value of theCompany’s investment was $19.7 million. In the second quarter of 2007, theCompany recorded an unrealized gain of $17.8 million, in other comprehensiveincome, representing the difference between the fair value of the investment onJune 29, 2007 and the initial investment amount of $1.9 million.

**Fiberxon mergerwith MRV Communications**

On July 1, 2007,Fiberxon, an investment in which the Company has a 7% ownership interest,completed a merger with MRV Communications (“MRV”). In exchange for theCompany’s investment in Fiberxon, the Company will receive approximately $1.5million in cash, 1.5 million shares of MRV common stock and deferredconsideration of approximately $2.7 million. The deferred consideration becomespayable upon the completion of certain milestones and may be reduced bylegitimate claims of MRV for certain matters related to the merger.

**ITEM 9—CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTSON ACCOUNTING AND FINANCIAL DISCLOSURE**

Not applicable.

**ITEM 9A—CONTROLSAND PROCEDURES**

**GovernanceCommittee Review of Historical Stock Option Accounting**

In November 2006, UTStarcom, Inc.(“UTStarcom” or the “Company”) announced it was conducting a voluntary reviewof historical stock option practices under the leadership of the Nominating andCorporate Governance Committee of the Company’s Board of Directors (“GovernanceCommittee”) following a preliminary review by management which identifiedpotential deficiencies and discrepancies in the documentation of stock optiongrants. The review considered all equity grant awards made in the 

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period fromFebruary 29, 2000, shortly before the initial public offering of theCompany’s Common Stock, through December 31, 2006 (“Review Period”) forcompliance with the various stock-based compensation accounting standardsapplicable during the Review Period. Referto “NOTE 2—RESTATEMENT OF FINANCIALSTATEMENTS” included in this Form 10-K for the effect of therestatement adjustments on stock-based compensation expense, additional paid-incapital accounts, related income tax accounts, retained earnings and relatedfinancial disclosures for each of the years ended December 31 inthe period 1998 through 2005, and the firsttwo quarters of the year ended December 31, 2006. Furtherinformation concerning the Governance Committee’s review and the resultingrestatements of the Company’s historical financial statements can be found inthe “EXPLANATORY NOTE” preceding “ITEM 1—BUSINESS,” “ITEM 6—SELECTED FINANCIAL DATA,”“ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS” and “ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” includedin this Form 10-K, which should be read for a more complete description ofthis matter.

Based on its findings, theGovernance Committee made various recommendations to the Board of Directors. Atthe Board’s direction, management has implemented and will continue toimplement remedial actions, including changes to its policies and proceduresand enhancements to controls, over its equity-based compensation program.Management has also considered and taken into account the impact of thefindings of this review in “Management’s Annual Report on Internal Control overFinancial Reporting,” as presented below.

**Audit CommitteeInvestigation of Historical Sales in China**

In July 2007, the Company announced that theAudit Committee of its Board of Directors (“Audit Committee”), with theassistance of independent counsel and forensic accountants, was conducting anindependent investigation of allegations of improprieties in certain salesoffices in China. The investigation considered sales contracts in each of theseven years in the period ended December 31, 2006. The Investigating Teamfound instances where the customer contracts that evidenced the arrangementcontained obligations for the Company to deliver software upgrades when and ifmade available for the equipment sold for no additional consideration and foran unspecified period that could extend over the term of the contract. Thisadditional contract obligation is an element of “post contract support.” Inthese cases, the Investigating Team found that the contract documentation forthe same transaction submitted by the sales office to the Company’s Chinaheadquarters for accounting purposes and utilized by the Company in determiningthe amount of revenue recognized did not include evidence of such post contractsupport obligations. Refer to “NOTE 2—RESTATEMENT OF FINANCIAL STATEMENTS”included in this Form 10-K for the effect of the restatement adjustmentson revenue and deferred revenue accounts, cost of sales and deferredcost accounts, related income tax accounts,retained earnings, and related financial disclosures in the Company’sconsolidated financial statements for the years ended December 31, 2004and 2005, each of the quarters in the year ended December 31, 2005, andfor the first two quarters of the year ended December 31, 2006. Furtherinformation concerning the Audit Committee’s investigation and the resultingrestatements of the Company’s historical financial statements can be found inthe “EXPLANATORY NOTE” preceding “ITEM 1—BUSINESS,” “ITEM 6—SELECTED FINANCIAL DATA,”“ITEM 7—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS” and “ITEM 8—FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA” includedin this Form 10-K, which should be read for a more complete description ofthis matter.

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Based on the findings, theAudit Committee has made various recommendations to the Board of Directors. Atthe Board’s direction, management has implemented and will continue toimplement remedial actions, including changes to its policies and procedures andenhancements to controls, over sales in China. Management has also consideredand taken into account the impact of the findings of this investigation in“Management’s Annual Report on Internal Control over Financial Reporting,” aspresented below.

**Evaluation ofDisclosure Controls and Procedures**

The Company maintains disclosure controls andprocedures that are designed to ensure that information required to bedisclosed in the reports the Company files or submits under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s (“SEC”) rules and forms, and that such informationis accumulated and communicated to the Company’s management, including itschief executive officer (“CEO”) and chief financial officer (“CFO”), asappropriate, to allow timely decisions regarding required financial disclosure.

In connection with the preparation of this annualreport on Form 10-K (“Form 10-K”), the Company carried out anevaluation as of December 31, 2006 under the supervision and with theparticipation of the Company’s management, including the CEO and CFO, of theeffectiveness of the design and operation of the Company’s disclosure controlsand procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) underthe Exchange Act. Based upon this evaluation, the CEO and CFO concluded that asof December 31, 2006 the Company’s disclosure controls and procedures werenot effective because of the material weaknesses described below under “Management’sAnnual Report on Internal Control over Financial Reporting.”

To address these materialweaknesses, the Company performed additional analyses and other procedures(described below under the subheading “*Interim Measures*”)to ensure that the Company’s consolidated financial statements were prepared inaccordance with generally accepted accounting principles in the United States (“GAAP”).Accordingly, Company management believes that the consolidated financialstatements included in this Form 10-K fairly present in all materialrespects the Company’s financial condition, results of operations and cashflows for the periods presented and that this Form 10-K does not containany untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodscovered by this report.

**Management’s AnnualReport on Internal Control over Financial Reporting**

Management is responsible for establishing andmaintaining adequate internal control over financial reporting for the Company,as such term is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act. Internal control over financial reporting is a processdesigned to provide reasonable assurance regarding the reliability of financialreporting and the preparation of financial statements for external reporting purposesin accordance with GAAP. Internal control over financial reporting includesthose policies and procedures that: pertain to the maintenance of records that,in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; provide reasonable assurance thattransactions are recorded as necessary to permit preparation of financialstatements in accordance with GAAP, and that receipts and expenditures of theCompany are being made only in accordance with authorizations of management anddirectors of the Company; and provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use or disposition of theCompany’s assets that could have a material effect on the consolidatedfinancial statements.

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

Management has conducted an assessment, includingtesting, of the effectiveness of the Company’s internal control over financialreporting as of December 31, 2006. In making its assessment, managementused the criteria in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (“COSO”).

A material weaknessis a control deficiency in internal control over financial reporting, or acombination of deficiencies in internal control over financial reporting, thatresults in more than a remote likelihood that a material misstatement of theannual or interim consolidated financial statements will not be prevented ordetected. The following material weaknesses in internal control over financialreporting have been identified as of December 31, 2006.

1.     *The Company did not maintain an effective controlenvironment.  *Specifically, the following additional materialweaknesses were identified within the control environment:

a)     *The Company did not maintain effective financial reporting processes,including sufficient formalized and consistent finance and accounting policiesand procedures; nor did the Company prevent or detect instances ofnon-compliance with certain such policies and procedures that do exist.*   Specifically,the Company lacked formalized and current accounting and reporting policies andprocedures across certain of its operating locations and various businesscycles. These control deficiencies resulted in adjustments, including auditadjustments, to the consolidated financial statements for each of the quartersended March 31, 2006, June 30, 2006 and September 30, 2006 andfor the year ended December 31, 2006 to correct certain accounts, asfurther described below.

b)     *The Company failed to prevent or detect non-compliance withestablished policies and procedures intended to ensure compliance with laws andregulations.*   Specifically, this control deficiency may havepermitted violations of certain Securities and Exchange Commission (“SEC”)regulations related to previous financial disclosures and the Foreign CorruptPractices Act (“FCPA”), related to alleged potential payments made togovernment officials.

2.     Thematerial weakness in the Company’s control environment contributed to theexistence of the following control deficiencies, each of which is considered tobe a material weakness:

a)     *The Company failed toprevent or detect instances of override related to controls in China overcustomer agreements.*   Specifically, this control deficiencypermitted the override of established controls in China’s western sales region,by allowing for the existence of undisclosed agreements with customers, whichobligated the Company to provide products or perform certain services withoutthe receipt of additional consideration. The existence of these agreements wasnot communicated to either the Company’s financial reporting function or itsindependent registered public accounting firm. This control deficiency resulted in adjustments to restate revenueand deferred revenue accounts, cost of sales and deferred cost accounts, related income tax accounts, retained earnings,and related financial disclosures in the Company’s consolidated financialstatements for the years ended December 31, 2004 and 2005, each of thequarters in the year ended December 31, 2005, and for the first twoquarters of the year ended December 31, 2006.

b)     *The Company did not maintain effective controls at its U.S.headquarters over its accounting for inventory, including finished goods atcustomer sites, inventory reserves and deferred cost accounts and associatedcost of sales.*   Specifically, the Company’s controls were notadequate to properly track and confirm inventory movements in the appropriateperiod, to ensure the proper classification of inventory and deferred costs(and associated accounts such as purchase price variance), and to ensure 

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the completeness andaccuracy of the recording of the cost of sales when revenue was recognized.These processes were not always performed correctly or timely, there wasinadequate management review, and calculation and/or posting errors occurred.This control deficiency resulted in adjustments, including audit adjustments,to the consolidated financial statements for each of the quarters ended March 31,2006, June 30, 2006 and September 30, 2006 and for the year ended December 31,2006 to correct cost of sales and the related inventory, finished goods atcustomer sites, inventory reserves and deferred costs accounts.

c)     *The Company did not maintain effective controls at its U.S.headquarters over its inventory reserves for losses on customer contracts andassociated cost of sales.*   Specifically, the Company’s controlswere not designed, nor did they operate effectively, to adequately identify,document and analyze its inventory reserves for losses on customer contracts toensure that all related costs were recorded in the appropriate period and thatexisting reserves were adequate. These processes were not always performedcorrectly or timely, there was inadequate management review, and calculationand/or posting errors occurred. This control deficiency resulted inadjustments, including audit adjustments, to the consolidated financialstatements for each of the quarters ended June 30, 2006 and September 30,2006 to correct inventory reserves for losses on customer contracts and theassociated cost of sales.

d)     *The Company did not maintain effective controls at its U.S.headquarters over its accounting for warranty reserves and associated cost ofsales.*   Specifically, the Company’s controls failed toadequately identify, document and analyze required supporting information toensure the completeness, accuracy, valuation and adequacy of its warrantyreserves and to ensure all related costs were recorded in the appropriateperiod. These processes were not always performed correctly or timely, therewas inadequate management review, and calculation and/or posting errorsoccurred. This control deficiency resulted in adjustments, including auditadjustments, to the consolidated financial statements for each of the quartersended June 30, 2006 and September 30, 2006 and for the year ended December 31,2006 to correct warranty reserves, which are included in other currentliabilities, and the associated cost of sales.

e)     *The Company did not maintain effective controls over its accounting forand disclosure of stock-based compensation expense*.   Specifically,the Company did not maintain effective controls, including monitoring, toensure the completeness, existence, valuation and presentation of stock-basedcompensation transactions related to the granting, pricing and accounting forcertain of its stock-based compensation awards and the related financialreporting for these awards in accordance with GAAP. This control deficiencyresulted in the misstatement of the stock-based compensation expense,additional paid-in capital accounts, related income tax accounts, retainedearnings and related financial disclosures, and resulted in the restatement ofthe Company’s consolidated financial statements for the years ended December 31,2004 and 2005, each of the quarters in the year ended December 31, 2005,and the first two quarters of the year ended December 31, 2006.

f)      *The Company did not maintain effective controls at its U.S.headquarters over its process to ensure the complete, accurate and timelypreparation and review of its consolidated financial statements in accordancewith GAAP.*   Specifically, the Company did not have effectivecontrols over the process for identifying, accumulating and reviewing allrequired supporting information to ensure the completeness, accuracy and timelypreparation and review of its consolidated financial statements anddisclosures, including the statement of cash flows and segment reporting. Thiscontrol deficiency resulted in adjustments, including audit adjustments, to itsconsolidated financial statements in each of the quarters ended March 31,2006, June 30, 2006 and September 30, 2006 and for the year ended December 31,2006, and additional disclosures to these 2006 consolidated annual financialstatements to correct the aforementioned accounts and disclosures.

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Each of the material weaknesses described above couldresult in a misstatement of the Company’s consolidated financial statementsthat would result in a material misstatement to the quarterly or annualconsolidated financial statements that would not be prevented or detected.Because of these material weaknesses described above, management has concludedthat the Company did not maintain effective internal control over financialreporting as of December 31, 2006, based on criteria established in *Internal Control—Integrated Framework*issued by the COSO.

Management’s assessment ofthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2006 has been audited by PricewaterhouseCoopers LLP, anindependent registered public accounting firm, as stated in their report “Reportof Independent Registered Public Accounting Firm” which appears under “ITEM 8—FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA” of this Form 10-K.

**Management’sPlanned Remediation Initiatives and Interim Measures**

The Company plans to makenecessary changes and improvements to the overall design of its controlenvironment to address the material weaknesses in internal control overfinancial reporting described above. In particular, the Company has implementedand/or plans to implement during 2007 the specific remediation initiativesdescribed below. In addition, in connection with preparation of the 2006 annualconsolidated financial statements included in this Form 10-K, the Companyhas undertaken the additional measures described under the subheading “*Interim Measures*” below to provide reasonable assuranceregarding the reliability of financial reporting and the preparation of theCompany’s 2006 annual consolidated financial statements and to ensure thatmaterial information relating to the Company and its consolidated subsidiarieswas made known to management and included in this Form 10-K.

***Remediation Initiatives***

1.     Toremediate the materialweakness described above in “1.*TheCompany did not maintain an effective control environment*,” the Company has implemented orplans to implement the measures described below, and will continue to evaluateand may in the future implement additional measures. These measures include thefollowing:

a)     *Effective financial reporting process, including policies andprocedures*—In the fourth quarter of 2006, the Company’s financedepartment commenced an initiative to “refresh” its finance and accountingpolicies and procedures. Through this initiative, which the Company expectswill be ongoing throughout 2007 and beyond, the Company’s financial policiesand procedures will be reviewed for completeness, accuracy and adequacy,updated and brought current, and standardized globally as necessary andappropriate. A communication plan will also be developed to ensure “refreshed”policies and procedures are publicized and understood, and appropriateemployees are trained in their application, as necessary. The Company expectsthis initiative will form the foundation for the process to maintain and keepcurrent its finance and accounting policies and procedures on a go-forwardbasis. In addition, starting in the fourth quarter of 2006, the Companycommenced internal audits of, and in 2007 plans to continue to expand andincrease the scope of its efforts to monitor, controls at the Company’sdecentralized and remote operations globally, through reviews and audits ofemployee compliance with applicable policies and procedures at business units,subsidiaries and other locations.

b)     *Non-compliance with established policies and procedures intendedto ensure compliance with laws and regulations*—During the secondquarter of 2006, the Company launched a formal investigation at the directionof the audit committee of the Company’s Board of Directors (“Audit Committee”)to review alleged violations of the FCPA; refer to “*GovernmentalInvestigations*” under “ITEM3—LEGAL PROCEEDINGS” for additional information. Throughout the courseof this 

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investigation, the Companyhas taken and plans to continue to take all appropriate actions includingchanges to its training, processes and procedures related to its code ofbusiness conduct and ethics, its payment controls particularly in outlyingregions, and its due diligence evaluation of business partnerships. Uponconclusion of this investigation, the Company will review and, as necessary,further enhance its procedures to reduce the risk of ongoing controldeficiencies in this area. In addition, in the third and fourth quarters of2006, the Company provided training to personnel in offices in various regionsincluding North America, Europe, and China and, in 2007, plans to continue toprovide training and expand its coverage of personnel employed in other regionsand countries. In addition, the Company’s internal audit staff commenced auditsand plans to continue to expand and increase the scope of the Company’s effortsto monitor controls at company operations globally, through reviews and auditsof employee compliance with applicable policies and procedures at business units,subsidiaries and other locations.

c)     Inaddition to the specific measures described above to address this materialweakness in the control environment, the Company’s planned remediation measuresinclude the following:

i.       InNovember, 2006, the Company hired an assistant controller and a shared servicesmanager at its U.S. headquarters whose responsibilities include overseeing thecorporate accounting and SEC external financial reporting functions. In thefirst quarter of 2007, the Company hired a vice president of financialoperations and a vice president of financial planning and analysis to provideadditional finance personnel at its U.S. headquarters. These personnel haveappropriate qualifications, considerable technical experience and training in areasincluding accounting and SEC reporting, and in the utilization of the Oraclefinancial system modules. The Company believes the addition of these personnelimproves and strengthens the capabilities of this function.

ii.     In April 2007,the Company created the position of and hired a new chief ethics officer, toprovide focused executive leadership in the area of corporate ethics andintegrity.

iii.    TheCompany retained and intends to continue to retain the services of outsideconsultants with relevant accounting experience, skills and knowledge in theapplication of GAAP, working under the supervision and direction of the Company’smanagement, to supplement the Company’s existing corporate accounting andexternal financial reporting personnel.

iv.     The Companywill continue to hire, and has allocated resources to hire, additional financepersonnel as needs arise and to replace departures, in the areas of compliance,corporate accounting, external financial reporting, internal audit, revenueaccounting and tax, with relevant accounting experience, skills and knowledgein the application of GAAP.

v.      In thefirst quarter of 2007, the company implemented a new “management by objectives”system which will be used globally to capture corporate and executive managementgoals and articulate them throughout the organization, and to cascade and aligneach employee’s goals to support corporate objectives. The goal setting,monitoring and evaluation process will incorporate capturing employee’straining and development requirements, including training to stay current withthe application of GAAP and the company’s code of business conduct and ethics.

vi.     In thefirst quarter of 2007, the Company’s CFO, with assistance from senior financialstaff and outside consultants, reviewed and in the remainder of 2007 willcontinue to review and adapt the overall design of the Company’s financialreporting organization and structure, including the roles and responsibilitiesof each functional group within the Company.

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2.     Inaddition to the remediation measures described above, the Company hasimplemented or plans to implement the measures described below, and willcontinue to evaluate and may in the future implement additional measures.

a)     Toremediate the material weaknesses described in 2. a) over “*instances ofoverride related to controls in China over customer agreements*,” theCompany’s planned remediation measures are intended to address materialweakness in China that has the potential of misstating these balances in thefinancial statements in future financial periods. These measures include thefollowing:

i.       In theperiod from January to May 2007, the Company effected personnelchanges in the sales force in China’s western sales region, as well as certainassociated sales offices. The Company believes that these changes will enableeffective management of the China western sales region’s sales operations andenhance compliance with the Company’s policies and procedures, including theCompany’s Code of Business Conduct and Ethics.

ii.     TheCompany plans to revise its policies and procedures related to entering intosales contracts, document retention, as well the Code of Business Conduct andEthics to provide for details around the standards for entering into salesagreements and breaches to the Code of Business Conduct and Ethics.

iii.    TheCompany plans to implement mandatory training to employees in China’s salesorganization around control consciousness and ongoing training to Sales,Contract Management and Finance in China around the Company’s policies andprocedures, including revenue recognition.

iv.     TheCompany plans to review and make improvements to the sales databases to capturerelevant contract information and current status information.

v.      TheCompany plans to establish a process around organizing visits by businessoperations and the regional sales managers to the various sales offices inChina to enhance the awareness and compliance with the Company’s polices andprocedures.

b)     Toremediate the material weaknesses described in 2. b) over “*inventory,including finished goods at customer sites, inventory reserves and deferredcosts accounts and associated cost of sales,*” 2. c) over “*inventory reserves for losses on customer contracts and associated costof sales,”* and 2. d)**over *“accounting for warranty reserves and associated cost of sales*”above—The Company’s planned remediation measures are intended to addressmaterial weaknesses at its U.S. headquarters that have the potential ofmisstating these balances in the financial statements in future financialperiods. These measures include the following:

i.       In November 2006,the Company hired an assistant controller and a shared services manager at itsU.S. headquarters whose responsibilities include overseeing the international costaccounting function. These personnel have considerable experience and trainingin cost accounting and utilization of the relevant Oracle financial systemmodules. The Company believes the addition of these personnel improves andstrengthens the capabilities for the manual analyses and management reviewrequired of this function.

ii.     TheCompany plans in 2007 to enhance its processes and procedures related toproperly tracking and confirming inventory movements to ensure the properclassification of inventory, including finished goods at customer sites, anddeferred costs (and associated accounts such as Purchase Price Variances), andto ensure the completeness and accuracy of the recording of the cost of saleswhen revenue is recognized. The revised processes include involving andobtaining detailed and timely input from business unit, operations and salesoperations personnel to enhance the information available for finance toanalyze these accounts. New reports have been 

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developed and reports andprocedures will continue to be enhanced as necessary to facilitate the accuracyof accounting for these processes. In addition, finance management has placedincreased attention on reviewing in detail the accounting in this area.

c)     Toremediate the material weaknesses described in 2. e) over “*accountingfor and disclosure of stock-based compensation expense*” above—TheCompany’s planned remediation measures are intended to address materialweaknesses that have the potential of misstating these balances in the financialstatements in future financial periods. These measures include the following:

i.       In November 2006, theCompany announced a voluntary review of its historical equity awardgrant practices under the direction of the nominating and corporate governancecommittee of the board of directors. Uponthis announcement, the Company immediately suspended granting of equity awardsand no new equity awards have been granted through the date of filing of this Form 10-K.

ii.     Further, in November 2006, the Company migrated to anew vendor’s system for stock options and equity awards administration, selected in part for its improved processes,systems and controls.

iii.    In April 2007, the Company’scompensation committee of the board of directors approved an equity award grantpolicy and procedures (“Awards Policy”). Under this Awards Policy, the Companyhas adopted the following equity awards grant processes:

·       Equityawards will be made only on grant dates pre-determined in accordance with theAwards Policy.

·       Theawards committee (a committee as defined in the Awards Policy consisting ofhuman resources, legal and finance personnel, duly formed and authorized by thecompensation committee, with specific, limited authority to approve certaingrants of equity awards) will ensure completeness and accuracy of the finalequity awards grant list.

·       Allequity awards will be approved monthly, at a meeting of the awards committee,the compensation committee or the board of directors, as applicable.

·       Internalaudit will conduct periodic review of the accounting records and equity awardsgrant process.

iv.     Relevantpersonnel at the Company will be provided training in the equity awardsgranting and accounting process.

v.      In April 2007,the Company created the position of and hired a new chief ethics officer, toprovide focused executive leadership in the area of corporate ethics andintegrity.

vi.     During2007, the Company will update its record retention policy to specify retentionof equity award records.

d)     Toremediate the material weaknesses described in 2. f) over “*its processto ensure the complete, accurate and timely preparation and review of itsconsolidated financial statements in accordance with GAAP*” above—TheCompany’s planned remediation measures are intended to address materialweaknesses at its U.S. headquarters that have the potential of preventing thecomplete, accurate and timely preparation and review of the Company’sconsolidated financial statements in future financial periods. In addition tothe measures described above, these measures include the following:

i.       Duringthe fourth quarter of 2006, the Company implemented and in 2007, the Companyplans to continue to enhance and improve month and quarter-end closingprocedures 

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within its corporateaccounting function to standardize its processes for financial review to ensurethat reviewers at its U.S. headquarters analyze and monitor financialinformation in a consistent and thorough manner. In addition, the Companyimplemented and plans to continue to improve new and enhanced procedures withinits corporate accounting function to ensure that non-routine transactions areidentified and escalated to senior financial management during the closeprocess to help ensure proper accounting treatment.

ii.     During the fourth quarter of 2006, the Company implemented andin 2007, the Company plans to continue to enhance and improve the documentationand review of required information associated with the preparation of itsquarterly and annual filings under the Exchange Act.

**Interim Measures**

Management has notyet implemented all of the measures described above under the heading “*Remediation Initiatives*” and/or tested them. Nevertheless,management believes the measures identified above as having been implemented,together with other measures undertaken by the Company in connection with the2006 year end consolidated financial statement reporting process anddescribed below, address the identified control deficiencies identified abovein “Management’s Annual Report on Internal Control over Financial Reporting.”These other measures include the following:

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

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

a)     Physicalinventory counts or confirmation of existence and recoverability at asubstantial majority of its inventory locations at or near year end, andconfirmation of inventory at offsite (including customer) locations through aphysical inventory and/or confirmations.

b)     Reconciliationof inventories at customer sites to outstanding contracts as of the year endand analysis of this inventory for recoverability and potential impairment.

c)     Review ofcontract analysis reports and consolidated revenue schedules from the fourthquarter of 2006 to determine the proper recording and classification ofinventory and deferred costs and the related cost of goods sold (includingassociated accounts such as purchase price variance).

d)     Analysisof the backlog report, gross margin report and contract analysis report,enhanced discussions with business unit, operations and sales and servicespersonnel to enhance the information available for finance to analyze, andthorough review of related sales and cost information to determine the reservesfor losses on customer contracts and associated cost of sales.

e)     Analysisof actual cost reports associated with specific warranty reserves, and discussionswith business unit, operations and sales and services personnel to enhance theinformation available for finance to analyze, to determine the liabilityreserves for warranty and associated cost of sales. 

f)      A varietyof manual review procedures, such as an extensive review of journal entrypostings into the Oracle system, a thorough review of account reconciliations,and a detailed review at its U.S. headquarters of trial balances includingthose issued from decentralized locations, to ensure the completeness andaccuracy of the underlying financial information used to generate the 2006consolidated annual financial statements.

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3.     As part ofthe voluntary review of historical stock option practices, the GovernanceCommittee retained independent outside counsel and forensic accountants toreview substantially all equity grant awards made in the Review Period forcompliance with the various stock-based compensation accounting standardsapplicable during the Review Period and, as necessary to establish alternativemeasurement dates for those grants where the original measurement date wasfound to be in error. In addition, the accounting and reporting process for theconsolidated financial statements for the year ended December 31, 2006 wasextended significantly, thereby allowing the Company time to conduct additionalprocedures and analyses, to assess the adequacy and accuracy of reserves andactual expense results, and to make additional adjustments and disclosures asnecessary to ensure the accuracy of financial reporting.

4.     As part of the investigation of historical sales in China**,**the Audit Committee retained independent outside counseland forensic accountants to conduct an investigation of sales in China. Theinvestigation was expanded to consider sales contracts entered into in theperiod 2000 to 2006 in China, beyond the western region in order to provideadequate coverage percentage of the value of sales contracts entered intoduring the period. The investigation encompassed different procedures dependingon the contract type, date and region in which the contracts were executed. Inaddition, the accounting and reporting process for the consolidated financialstatements for the year ended December 31, 2006 was extendedsignificantly, thereby allowing the Company time to conduct additionalprocedures and analyses, to assess the adequacy and accuracy of the relatedbalances, and to make additional adjustments and disclosures as necessary toensure the accuracy of financial reporting.

***Management’s Conclusion***

Management believes the remediation measures describedunder “Management’s Planned RemediationInitiatives and Interim Measures” above will strengthen the Company’sinternal control over financial reporting and remediate the material weaknessesidentified in “Management’s Annual Report on Internal Control over FinancialReporting.” However, management has not yet implemented all of these measuresand/or tested them. Management believes that the interim measures describedunder “Management’s Planned Remediation Initiatives and Interim Measures” aboveprovide reasonable assurance regarding the reliability of financial reportingand the preparation of the Company’s financial statements included in thisAnnual Report on Form 10-K and has discussed this with the Company’s AuditCommittee. 

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

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**Remediation ofMaterial Weaknesses Reported in 2005**

As of December 31,2006, the Company believes it has effectively remediated the following materialweaknesses in internal control over financial reporting that were included in “Management’sReport on Internal Control over Financial Reporting” in “Item 9A—Controls andProcedures” contained in the Company’s Annual Report on Form 10-K for thefiscal year ended December 31, 2005:

1.     Maintainingan effective financial reporting organizational structure with a sufficientcomplement of financial reporting personnel commensurate to support the size,complexity, operating activities or locations of the Company. 

2.     Accountingfor revenue and deferred revenue at its U.S. headquarters and international(excluding China) locations, including policies and procedures to preventunauthorized contracts, contract amendments and side agreements that obligatedthe Company to perform services for certain customer without the receipt ofadditional consideration, which had not been communicated to the Company’slegal and financial reporting functions.

3.     Recordingof accrued expenses in the proper period.

4.     Accountingfor income taxes, including the provision and related balance sheet accounts(income taxes payable, deferred income tax assets and liabilities, otherlong-term assets, prepaids and other current assets).

5.     Segregatingduties and user access to certain automated business process applicationsassociated with its Personal Communications Division.

6.     Identifyingand accounting for related party relationships and related party transactions.

7.     Monitoring,reviewing and supervising business unit and affiliate accounting functions,more specifically those based principally in Japan, China and New York.

For additional information relating to the controldeficiencies that resulted in these material weaknesses listed above, pleasesee the discussion under “Management’s Report on Internal Control overFinancial Reporting” in “Item 9A—Controls and Procedures” contained in theCompany’s Annual Report on Form 10-K for the fiscal year ended December 31,2005.

During 2006, theCompany developed and implemented remediation measures to address the sevenmaterial weaknesses listed above. As described in the Company’s Annual Reporton Form 10-K for fiscal year 2005, the remediation measures included thefollowing:

1.     *Maintaining an effective financial reporting organizational structure*—During2006, the Company implemented control processes to address and remediatematerial weaknesses reported in 2005 related to its organizational structure.The Company has had stability in its executive financial ranks for more than ayear. The CFO, with assistance from his senior financial staff and outsideconsultants, has reviewed and will continue to review and adapt the overalldesign of the Company’s financial reporting organizational structure, includingthe roles and responsibilities of each functional group within the Company, toensure that the Company has a sufficient compliment of personnel withknowledge, experience and training in the application of GAAP commensurate withthe Company’s financial reporting requirements. During 2006, the Company’sactivities to address and remediate the material weakness in this area reportedin 2005 included: 

a)     Hiring orappointing personnel to fill open senior financial positions necessary for aneffective financial reporting organizational structure including qualified andexperienced personnel for corporate, business unit, international and regionalaccounting; cost accounting; financial planning and analysis; revenueaccounting; and tax compliance. Personnel were hired primarily into openpositions at its U.S. headquarters, in China, and in the Asia-Pacific andEurope, Middle East and 

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Africa (“EMEA”) regions. Inaddition, the Company hired or appointed personnel to fill open seniorfinancial compliance and internal audit positions at its U.S. headquarters andin China and India. The Company plans to continue to hire, and has allocatedresources to hire, additional accounting, compliance and internal auditpersonnel to fill positions remaining open, primarily in the U.S. and China,with relevant accounting experience, skills and knowledge in the application ofGAAP.

b)     Retainingthe services of outside consultants with relevant accounting experience, skillsand knowledge in the application of GAAP, working under the supervision anddirection of the Company’s management, to supplement the Company’s existingfinance personnel. 

c)     Managementreviewing and approving the financial statement disclosure checklist to ensureall required disclosure are considered and incorporated in the consolidatedfinancial statements.

2.     *Accounting for revenue and deferred revenue*—During 2006, theCompany implemented control processes at its U.S. headquarters andinternational (excluding China) locations to address and remediate materialweaknesses reported in 2005 related to revenue and deferred revenue accountsthat had the potential of misstating revenue and deferred revenue in futurefinancial periods. The Company’s remediated control processes include thefollowing:

a)     Hiring andtraining additional experienced revenue managers and supporting staff at itsU.S. headquarters to support the preparation and analysis of revenuerecognition and deferred revenue accounts.

b)     Enhancingthe contract review process to include requiring sales, operations, finance andlegal staff to provide input during the contract negotiation process to ensuretimely identification and accurate accounting treatment for non-standardcontracts.

c)     Enhancingthe policies, procedures and guidelines around recognizing and deferringrevenue, and better defining the timing and extent of a centralized and secondlevel of management review at its U.S. headquarters of revenue recognition forcertain U.S. and international (excluding China) revenue transactions. 

d)     Implementingadditional procedures at its U.S. headquarters to enhance controls aroundrecognized and deferred revenue for the U.S. and international locations(excluding China) to ensure the completeness, accuracy and validity ofrecognized and deferred revenue, including reviewing sales hold reports andfulfilled progress billing sales orders reports to ensure that revenue iscompletely recorded and a secondary review of maintenance transactions toensure the amounts are amortized accurately.

e)     Implementingenhancements to its Oracle financial system which improved its automatedprocesses and controls related to revenue and deferred revenue accounting.

f)      Increasingthe level and coverage of training conducted by revenue accounting personnelrelated to revenue recognition, including the impact of amendments and sideagreements. During the first quarter of 2006, several training seminars were conductedfor various sales and services teams in North and South America. In the secondquarter, additional revenue recognition training was provided to personnel inNorth America and training was also conducted for the EMEA sales group. In thethird quarter, training was conducted in the Philippines, and in the US forCaribbean and Latin American (“CALA”) based sales and services personnel. In October 2006,the Company’s key management participated in a seminar on the critical factorsassociated with revenue recognition. In addition, certain revenue accountingpersonnel attended various revenue recognition seminars through-out the year aspart of their on-going training. 

g)     Expanding,in the third and fourth quarters of 2006, the number of disclosures included inthe certifications to senior management with respect to identification andcommunication of contract 

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amendments, sideagreements or other matters which could have a bearing on revenue recognition,as well as the number of personnel required to perform such certifications. TheCompany also implemented additional steps to ensure appropriate members ofmanagement have reviewed and confirmed critical information necessary to ensureproper revenue recognition accounting.

3.     *Recording of accrued expenses*—During 2006, the Companyimplemented control processes at its U.S. headquarters and in China to addressand remediate a material weakness reported in 2005 related to recording ofaccrued expenses that has the potential of misstating accrued expenses and relatedincome statement accounts in future financial periods. These measures includethe following:

a)     Hiringadditional resources into the Company’s accounting and accounts payablefunctions at its U.S. headquarters and in China. In addition, in November 2006,the Company hired an assistant controller and a shared services manager at itsU.S. headquarters whose responsibilities include overseeing the accountspayable and corporate accounting functions. These personnel add considerableexperience and training in accounting and oversight for accounts payable andaccrued expenses for the consolidated financial statements and utilization ofthe relevant Oracle financial system modules. The Company believes the additionof these personnel improves and strengthens the capabilities of this function. 

b)     Enhancing,in the first and second quarters of 2006, the Company’s processes andprocedures related to properly tracking and reviewing open purchase orders andreviewing of subsequent receipts, invoices and disbursements after the end ofeach month to ensure proper recording of open purchase order commitments,accrued expenses and related income statement accounts. The Company plans tocontinue enhancing reports and procedures, as necessary, to facilitate theaccuracy of accounting for these processes. In addition, finance managementboth in China and at its U.S. headquarters have committed to place increasedattention on reviewing the accounting in this area.

4.     *Accounting for income taxes*—During 2006, the Company implementedcontrol processes to address and remediate material weaknesses reported in 2005related to the calculation of its provision for income taxes that had thepotential of misstating the provision for income taxes and related balancesheet accounts in future financial periods. The Company’s remediated controlprocesses include the following:

a)     Hiring andtraining additional experienced tax managers and supporting staff to supportthe preparation of the Company’s income tax provision and to assist in managingaudits and to monitor tax compliance in China and other foreign locations.

b)     Utilizingoutside consultants, working under Company tax management’s supervision anddirection, to assist in the analysis and calculation of the Company’s incometax expense, its provision for income taxes, and related balance sheetaccounts. The Company plans to continue to utilize outside consultants asnecessary to assist tax management personnel in its analysis of such matters infuture periods.

c)     Developing,implementing and maintaining a more formalized and comprehensive process toaccumulate and organize financial and tax data used in connection with incometax calculation and reporting.

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5.     *Segregating duties and user access*—During2006, the Company implemented control processes to address and remediatematerial weaknesses reported in 2005 related to segregation of duties and useraccess to certain J. D. Edwards business process applicationsassociated with the Company’s Personal Communications Division that had the potentialof allowing the misstatement of various accounts in future financial periods.The Company’s remediated control processes include the following:

a)     Removingaccess rights, during the first quarter of 2006, from certain employeesassociated with inappropriate segregation of duties.

b)     Expandingthe level of management oversight related to areas associated with segregationof duties issues including changes to the general ledger master file, invoiceterms, payments, and inventory.

6.     *Identifying and accountingfor related party relationships and related party transactions*—During2006, the Company implemented control processes to address and remediatematerial weaknesses reported in 2005 related to the identification of and accounting for related party relationships andrelated party transactions in accordance with GAAP that had thepotential of allowing the misstatement of various accounts in future financialperiods. The Company’s remediated control processes include the following:

a)     Conductinga number of educational seminars in the U.S., China and elsewhere with theCompany’s senior executives, key members of management, and other personnel inwhich the Company’s internal and outside legal counsel, finance, compliance andinternal audit personnel and members of the Audit Committee reviewed certainkey objectives of the Company’s code of business conduct and ethics, includingthe identification, recognition and disclosure of related party transactions.

b)     Revisingthe Company’s internal certification process concerning identification,recognition and disclosure of related party transactions, and expanding, in thethird and fourth quarters of 2006, the disclosures and the number of personnelrequired to certify to senior management with respect to the identification,recognition and disclosure of related party relationships and transactions forSEC reporting purposes.

c)     Requiringall employees globally to sign annually the Company’s code of business conductand ethics, which includes the definition of and the Company’s policy requiringdisclosure of related party relationships and transactions.

d)     Interviewing, as part of the risk assessment process, certain ofthe Company’s Audit Committee, senior executives, key members of management,and other personnel, regarding related party relationships and transactions.

7.     *Monitoring,**reviewing and supervisingbusiness unit and affiliate accounting functions—*During 2006, theCompany implemented control processes to address and remediate materialweaknesses reported in 2005 related to lack of clarity in roles andresponsibilities in certain areas affecting the Company’s financial reportingstructure which contributed to a material weakness relating to the monitoringof its business unit and affiliate accounting functions. In addition to themeasures described above in “1. *Maintaining an effectivefinancial reporting organizational structure*,” the Company’sactivities to address and remediate the material weaknesses reported in thisarea in 2005 included the following:

a)     Expandingand improving the quarterly forecasting process to include bottoms-up, legalentity forecasting of revenue and margins, collections by customer, region andproduct line, and expenses, by month.

b)     Enhancingthe weekly financial reporting package to include, compare and analyze actualquarter-to-date results for business and functional units with the annualbudget and quarterly 

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forecasts. This package isdistributed by the CFO and reviewed at the weekly the CEO and executivemanagement staff meeting.

c)     Expandingand improving the quarterly financial reporting package provided to its U.S. headquartersfrom various business units and affiliate accounting functions in order toensure it has accumulated the necessary accounting, finance and operationalinformation to effectively analyze information required for financial statementpreparation and footnote disclosures.

d)     Enhancingthe month-end and quarter-end closing procedures to standardize the processesfor financial review and to ensure that reviewers at its U.S. headquartersmonitor business unit and affiliate accounting financial information fromdecentralized locations in a consistent manner. Such procedures now includesenior finance staff in the Company’s U.S. headquarters performing a thoroughreview monthly of trial balances including those received from decentralizedlocations, and of all non-routine material transactions for decentralizedlocations (as documented by staff in such decentralized locations).

e)     Expanding the scope of the internal audit group’sresponsibilities to monitor controls within decentralized operations throughreviews and audits of such business units, subsidiaries and locations.

***Management’s Conclusion***

Management has conductedan assessment, including testing, of the effectiveness of the Company’sremediated internal control processes over financial reporting described aboveunder “Remediation of MaterialWeaknesses Reported in 2005”as of December 31, 2006. In making itsassessment, management used the criteria in *InternalControl—Integrated Framework* issued by COSO. Management believes these remediatedinternal control processes described above effectively mitigated, as of December 31, 2006, the seven materialweaknesses listed above under “Remediationof Material Weaknesses Reported in 2005.”

**Changes in InternalControl over Financial Reporting**

The discussion above under“Management’s Planned Remediation Initiatives and Interim Measures” and certainof the remediated control processes under “Remediation of Material WeaknessesReported in 2005” includes a description of the material changes to the Company’sinternal control over financial reporting during the fourth quarter of 2006 andsubsequent to December 31, 2006 that materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**ITEM 9B—OTHERINFORMATION**

None

**PART III**

**ITEM 10—DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

**IDENTIFICATION OFDIRECTORS**

We have a classified Board of Directors. The Board ofDirectors currently consists of six directors: one Class I director, two Class IIdirectors and three Class III directors. At each annual meeting ofstockholders, directors are elected for a term of three years and until theirrespective successors are duly qualified and elected to succeed those directorswhose terms expire on the annual meeting dates or such earlier date ofresignation or removal. 

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Setforth below is information regarding our directors as of the filing date of this Annual Report on Form 10-K:

| **Name of Director**  | ** ** | ** ** | ** ** | **Age**    | ** ** | **Position**                                                    | ** ** | **Director  Since** | ** ** | **Term  Expires** | ** ** |
|---------------------------------|------------|------------|------------|------------|------------|-----------------------------------------------------------------|------------|---------------------|------------|-------------------|------------|
| ***Class I  Director:***   | ** ** |       | ** ** | ** ** |       | ** **                                                      | ** ** |                | ** ** | ** **        |       |   | ** ** | ** ** |   |
| Thomas J. Toy(1)                |       |       | 52         | ** ** |       | Chairman of the Board                                           |       |                | 1995       | ** **        |       |   | 2007 | ** ** |   |
| ***Class II Directors:***  | ** ** |       | ** ** | ** ** |       | ** **                                                      | ** ** |                | ** ** | ** **        |       |   | ** ** | ** ** |   |
| Larry D. Horner                 |       |       | 73         | ** ** |       | Director                                                        |       |                | 2000       | ** **        |       |   | 2008 | ** ** |   |
| Allen Lenzmeier                 |       |       | 64         | ** ** |       | Director                                                        |       |                | 2005       | ** **        |       |   | 2008 | ** ** |   |
| ***Class III Directors:*** | ** ** |       | ** ** | ** ** |       | ** **                                                      | ** ** |                | ** ** | ** **        |       |   | ** ** | ** ** |   |
| Francis P. Barton(2)            |       |       | 60         | ** ** |       | Director, Executive Vice President  and Chief Financial Officer |       |                | 2006       | ** **        |       |   | 2009 | ** ** |   |
| Jeff Clarke                     |       |       | 46         | ** ** |       | Director                                                        |       |                | 2005       | ** **        |       |   | 2009 | ** ** |   |
| Hong Liang Lu(3)                |       |       | 52         | ** ** |       | Director, Chief  Executive Officer                              |       |                | 1991       | ** **        |       |   | 2009 | ** ** |   |

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(1)          Mr. Toy wasappointed Chairman of the Board effective as of January 1, 2007.

(2)          Mr. Barton wasappointed as a Class III Director in October 2006.

(3)          Mr. Lu served asChairman of the Board until his resignation from that position effective as of December 31,2006.

There are no family relationships between any of ourdirectors or executive officers.

*FrancisP. Barton* has served as our Executive Vice Presidentand Chief Financial Officer since August 2005 and as a director since October 2006.From May 2003 to July 2005, Mr. Barton was Executive VicePresident and Chief Financial Officer of Atmel Corporation. From May 2001to May 2003, Mr. Barton was Executive Vice President and ChiefFinancial Officer of BroadVision Inc. From 1998 to 2001, Mr. Barton wasSenior Vice President and Chief Financial Officer of Advanced Micro Devices, Inc.From 1996 to 1998, Mr. Barton was Vice President and Chief FinancialOfficer of Amdahl Corporation. From 1974 to 1996, Mr. Barton worked atDigital Equipment Corporation, beginning his career as a financial analyst andmoving his way up through various financial roles to Vice President and ChiefFinancial Officer of Digital Equipment Corporation’s Personal Computer Division.Mr. Barton holds a B.S. in Chemical Engineering from Worcester PolytechnicInstitute and an M.B.A. with a focus in finance from Northeastern University.

*JeffClarke* has served as a director since January 2005.Since May 2006, Mr. Clarke has served as Chief Executive Officer andPresident of Travelport Incorporated, a private company. From April 2004to April 2006, Mr. Clarke served as the Chief Operating Officer of CA, Inc.,a global provider of management software. From 2002 to 2004, Mr. Clarkewas Executive Vice President of Global Operations of Hewlett-Packard Company,and prior to that he was the Chief Financial Officer of Compaq ComputerCorporation. Mr. Clarke holds a B.A. in Economics from the StateUniversity of New York at Geneseo and an M.B.A. from Northeastern University.

*LarryD. Horner* has served as a director since January 2000.Mr. Horner currently serves on the board of directors of Atlantis Plastics, Inc.,Clinical Data Inc., Technical Olympic USA, Inc. and several privatecompanies. From 1994 until2001, Mr. Horner served as Chairman of Pacific USA Holdings Corp., andfrom 1997 to 2001 he served as Chairman and Chief Executive Officer of AsiaPacific Wire & Cable Corporation Limited. Mr. Horner formerlyserved as Chairman and Chief Executive Officer of 

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KPMG from 1984 to1990. Mr. Horner, a Certified Public Accountant, holds a B.S. from theUniversity of Kansas and is a graduate of the Stanford Executive Program.

*AllenLenzmeier* has served as a director since March 2005.Mr. Lenzmeier has served as the Vice Chairman of Best Buy Co. Inc. since December 2004.From 2002 to 2004, Mr. Lenzmeier served as the President and ChiefOperating Officer of Best Buy Co. Inc. Mr. Lenzmeier served as thePresident of Best Buy Retail from 2001 to 2002. From 1991 to 2001 Mr. Lenzmeierserved as the Executive Vice President and Chief Financial Officer of Best BuyCo. Inc. and began his employment with the company in 1984. Mr. Lenzmeierholds a B.S. from Minnesota State University Mankato.

*HongLiang Lu* served as our President and Chief ExecutiveOfficer and as a director from June 1991 through December 2006, andas Chairman of the Board from March 2003 to December 2006. On January 1,2007, he assumed the title of Chief Executive Officer. In June 1991, Mr. Luco-founded UTStarcom, Inc. under its prior name, Unitech Telecom, Inc.,which subsequently acquired StarCom Network Systems, Inc. in September 1995.From 1986 through December 1990, Mr. Lu served as President and ChiefExecutive Officer of Kyocera Unison, a majority-owned subsidiary of KyoceraInternational, Inc. Mr. Lu served as President and Chief ExecutiveOfficer of Unison World, Inc., a software development company from 1983until its merger with Kyocera in 1986. From 1979 to 1983, Mr. Lu served asVice President and Chief Operating Officer of Unison World, Inc. Mr. Luholds a B.S. in Civil Engineering from the University of California atBerkeley.

*Thomas J. Toy*has served as a director since February 1995, and as Chairman of the Boardsince January 2007. Since March 1999, Mr. Toy has served asManaging Director of PacRim Venture Partners, a professional venture capitalfirm specializing in investments in the information technology sector. Since2005, Mr. Toy has served as a partner of SmartForest Ventures, aprofessional venture firm specializing in the information technology sector. From1987 until 1992, Mr. Toy was employed as a Vice President at TechnologyFunding and was a partner there from 1992 until 1999. Mr. Toy also servesas a director of White Electronic Designs Corporation, Solarfun Power Holdingand several private companies. Mr. Toy holds B.A. and M.M. degrees fromNorthwestern University.

**EXECUTIVE OFFICERS**

Ourcurrent executive officers and their ages as of the filing date of this AnnualReport on Form 10-K are as follows:

| **Name**           | ** ** | ** ** | ** ** | **Age**                                                            | ** ** | **Position** |
|--------------------|------------|------------|------------|--------------------------------------------------------------------|------------|--------------|
| Hong Liang Lu      |       | 52         |       | Chief Executive Officer                                            |
| Peter Blackmore    |       | 60         |       | President and Chief  Operating Officer                             |
| Francis P. Barton  |       | 60         |       | Executive Vice President  and Chief Financial Officer              |
| Philip Christopher |       | 58         |       | President of UTStarcom  Personal Communications LLC                |
| Viraj Patel        |       | 45         |       | Vice President,  Corporate Controller and Chief Accounting Officer |
| Mark Green         |       | 39         |       | Senior Vice President,  Global Human Resources and Real Estate     |
| David King         |       | 44         |       | Senior Vice President, International Sales and  Marketing          |

 

*HongLiang Lu* has served as our President and ChiefExecutive Officer and as a director from June 1991 though December 2006,and as Chairman of the Board from March 2003 to December 2006. On January 1,2007, he assumed the title of Chief Executive Officer. In June 1991, Mr. Luco-founded UTStarcom, Inc. under its prior name, Unitech Telecom, Inc.,which subsequently acquired StarCom Network Systems, Inc. in September 1995.From 1986 through December 1990, Mr. Lu served as President and ChiefExecutive Officer of Kyocera Unison, a majority-owned subsidiary of KyoceraInternational, Inc. Mr. Lu served as President and Chief ExecutiveOfficer of Unison World, Inc., a software development company from 1983until its merger with Kyocera in 1986. From 1979 to 1983, Mr. Lu served as

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Vice President andChief Operating Officer of Unison World, Inc. Mr. Lu holds a B.S. inCivil Engineering from the University of California at Berkeley.

*PeterBlackmore* has served as our President and ChiefOperating Officer since July 2007. From 2005 until he joined the Company, Mr. Blackmoreserved as Executive Vice President in charge of world-wide sales, marketing andtechnology at Unisys Corporation. Prior to joining Unisys in 2005, he served asExecutive Vice President of the Customer Solutions Group at Hewlett-PackardCompany from 2004 and as Executive Vice President of the Enterprise SystemsGroup from 2002 through 2004. From 1991 until its acquisition by Hewlett-Packardin 2002, Mr. Blackmore served in a number of senior management positionswith Compaq Computer Corporation, most recently as its Executive Vice Presidentof worldwide sales and services from 2000 through 2002. Mr. Blackmoreholds an M.A. in Economics from Trinity College, Cambridge, U.K.

*FrancisP. Barton***has served asour Executive Vice President and Chief Financial Officer since August 2005and as a director since October 2006. From May 2003 to July 2005,Mr. Barton was Executive Vice President and Chief Financial Officer ofAtmel Corporation. From May 2001 to May 2003, Mr. Barton wasExecutive Vice President and Chief Financial Officer of BroadVision Inc. From1998 to 2001, Mr. Barton was Senior Vice President and Chief FinancialOfficer of Advanced Micro Devices, Inc. From 1996 to 1998, Mr. Bartonwas Vice President and Chief Financial Officer of Amdahl Corporation. From 1974to 1996, Mr. Barton worked at Digital Equipment Corporation, beginning hiscareer as a financial analyst and moving his way up through various financialroles to Vice President and Chief Financial Officer of Digital EquipmentCorporation’s Personal Computer Division. Mr. Barton holds a B.S. inChemical Engineering from Worcester Polytechnic Institute and an M.B.A. with afocus in finance from Northeastern University.

*PhilipChristopher* has served as President of UTStarcomPersonal Communications LLC, one of our wholly owned subsidiaries, since June 2004. Prior to joining us, Mr. Christopherwas President and CEO of Audiovox Communications Corporation and Executive VicePresident of Audiovox Corporation. Prior to our acquisition of AudiovoxCommunications Corporation, Mr. Christopher had been employed withAudiovox Corporation since 1970 and was elected to the company’s board of directorsin 1987. Mr. Christopher was a member of the White House Economic Council,and also serves on the board of directors of the Cellular TelecommunicationsIndustry Association. Mr. Christopher is also the recipient of numerousindustry and humanitarian awards and honors, including the prestigious EllisIsland Medal of Honor.

*VirajPatel***has served asour Vice President, Corporate Controller and Chief Accounting Officer since November 2005.Prior to joining us, Mr. Patel was Vice President of Finance for CeleraGroup from July 2005 to October 2005. Mr. Patel also served asVice President of Finance for Nektar Therapeutics from March 2004 until June 2005.From November 2003 to March 2004, Mr. Patel served as an interimCorporate Controller for Extreme Networks. From 1999 to 2002, Mr. Patelwas the Chief Financial Officer of Avanti Corporation. Prior to joining AvantiCorporation Mr. Patel worked for Pall Corporation from 1989 through 1999where he served as the Chief Accounting Officer. Mr. Patel began hiscareer at PricewaterhouseCoopers in 1982. Mr. Patel holds a BBA from PaceUniversity, New York. He is a Certified Public Accountant from the State of NewYork and is a member of the New York State Society of CPAs and a member of theAmerican Institute of Certified Public Accountants.

*MarkGreen* has served as our Senior Vice President ofGlobal Human Resources and Real Estate since February 2007, and our VicePresident of Human Resources from January 2006 to January 2007. Priorto joining us, Mr. Green was at Verisign Inc. from June 2005 as the Human Resources Director of VerisignSecurity Services. From 1992 to 2005, Mr. Green was at Nortel, where hejoined their Human Resources Leadership Development Program, rotating throughmultiple Human Resources areas in the U.K. and the U.S. He then moved to HongKong, as International Human Resources Services Manager for 

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the APAC region, returningto the U.S. as Senior Human Resources Business Partner for the ClarifyeBusiness-Software Applications Division, then Human Resources Director ofNortel’s Enterprise Division. Mr. Green received his BSEE from LeedsUniversity, U.K., and MSc in Human Resources Management and IndustrialRelations from the London School of Economics. He is also a graduate of theInstitute of Personnel and Development, U.K.

*David King*has served as our Senior Vice President, Sales, and Marketing &Services since March 2006. Prior to joining us, Mr. King was theChief Executive Officer for Visual Wireless AB from 2004 to 2006. From 1999 to2004, Mr. King was with Ericsson AB, initially as Vice President, Salesand Marketing for Wireline Systems, then as Vice President, Product Management &Marketing and held the position of Vice President and General Manager, WirelineSystems from 2002 to 2004. From 1996 through 1999 Mr. King was withPriceWaterhouse as a principal consultant and from 1992 to 1996 Mr. Kingwas a senior consultant with Omega Partners. Mr. King was Chairman andnon-executive board director for Ascade AB, Stockholm from 2001 to 2004. Mr. Kingserved as an officer in the Royal Marines from 1985 to 1989. He holds a BSc inElectrical Engineering from Liverpool University, and an MBA from the LondonBusiness School.

**AUDIT COMMITTEEMEMBERSHIP, FINANCIAL EXPERTISE AND INDEPENDENCE**

The Company has aseparately-designated, standing Audit Committee of the Board which currentlyconsists of four members of the Board of Directors, all of whom: (1) meetthe criteria for “independence” set forth in rule 10A-3(b)(1) underthe Securities Exchange Act of 1934, as amended; (2) have not participatedin the preparation of the financial statements of the Company or any of itscurrent subsidiaries at any time during the past three years; and (3) areable to read and understand fundamental financial statements, including acompany’s balance sheet, income statement and cash flow statement. The membersof the Audit Committee are Mr. Horner, who chairs the committee, and Messrs. Clarke,Lenzmeier and Toy. Messrs. Clarke, Horner and Lenzmeier have beendetermined by the Board to qualify as “audit committee financial experts” underapplicable SEC and NASDAQ rules.

**SECTION 16(a) BENEFICIALOWNERSHIP REPORTING COMPLIANCE**

Section 16(a) of the Securities Exchange Actof 1934 requires our directors and executive officers, and persons who own morethan 10% of a registered class of our equity securities (“Section 16 Filers”), to filewith the SEC initial reports of ownership and reports of changes in ownershipof our common stock. Such Section 16 Filers are required by SEC regulationsto furnish us with copies of all Section 16(a) forms they file.

To our knowledge, basedsolely on our review of the copies of such reports furnished to us and writtenrepresentations that no other reports were required, during the fiscal year endedDecember 31, 2006, all Section 16 Filers complied with all Section 16(a) filingrequirements except that Mr. Horner filed a Form 4 on May 2,2006 reporting one transaction late.

**CODE OF ETHICS**

We have adopted a Code of Business Conduct and Ethics(“Code of Ethics”), whichapplies to all employees including our principal executive officers. The Codeof Ethics is designed to promote: (i) honest and ethical conduct,including the ethical handling of actual or apparent conflicts of interestbetween personal and professional relationships, (ii) full, fair,accurate, timely and understandable disclosure in reports and documents that weare required to file to the SEC and in other public communications, (iii) compliancewith applicable laws, rules and regulations, (iv) the prompt internalreporting of violations of the Code of Ethics to an appropriate person orentity, and (v) accountability for adherence to the Code of Ethics.

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As a supplement to the Code of Ethics, we have alsoadopted a Code of Ethics for Chief Executive Officer and Senior FinancialOfficers (“Code of Ethics for FinancialOfficers”), which is designed to highlight the legal and ethicalobligations of the Chief Executive Officer and financial officers. The Code ofEthics for Financial Officers imposes upon applicable officers certainadditional internal reporting requirements for acts committed in violation ofthe Code of Ethics and/or the securities laws.

Copies of the Code of Ethics and the Code of Ethicsfor Financial Officers are available on our website at *http://investorrelations.utstar.com/governance.*

Any waiver of the Code ofEthics or Code of Ethics for Financial Officers pertaining to a member of ourBoard or one of our executive officers will be disclosed on our website at *http://investorrelations.utstar.com/governance*.

**ITEM 11—EXECUTIVECOMPENSATION**

**COMPENSATIONDISCUSSION AND ANALYSIS**

**Governance ofExecutive Officer Compensation Program**

*Role and Members ofthe Compensation Committee*

The Compensation Committee of the Board of Directorsis responsible for determining the Company’s executive officer compensation.The Committee is currently comprised of four members of the Board ofDirectors, Messrs. Clarke, Horner, Lenzmeier and Toy, all of whom areindependent, non-employee directors. Mr. Toy acted as chairperson ofthe Committee through April 27, 2007, at which time Mr. Lenzmeierassumed the role. Mr. Clarke was added to the Committee on April 27,2007.

The purpose of theCompensation Committee is to:

·       Approveand oversee the total compensation package for the Company’s executivesincluding their base salaries, incentives, deferred compensation, equity-basedcompensation, benefits and perquisites;

·       Reviewand approve corporate goals and objectives relevant to the compensation of theCompany’s Chief Executive Officer (the “CEO”), evaluate CEO performance, anddetermine CEO compensation based on this evaluation;

·       Reviewthe CEO’s performance evaluation of all executive officers and approve paydecisions; and

·       Reviewperiodically and make recommendations to the Board regarding any equity orlong-term compensation plans, and administer these plans.

The Compensation Committeeoperates according to a charter that details its specific duties andresponsibilities. The charter is reviewed at least annually, periodicallyrevised (most recently on February 1, 2007) by the Compensation Committee,and is available on our website in the Corporate Governance section. Thecharter sets forth the membership requirements, authority and duties of theCompensation Committee which shall consist of no fewer than three members, allof whom (i) meet the independence requirements of the Nasdaq MarketplaceRules, (ii) are “non-employee directors” under the definition of Rule 16b-3promulgated under Section 16 of the Exchange Act, and (iii) are “outsidedirectors” for purposes of the regulations promulgated under Section 162(m) ofthe Internal Revenue Code. During the fiscal year ended December 31, 2006,and currently, all members of the Compensation Committee met these criteria.

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*Process forEvaluating Named Executive Officer Performance and Compensation*

The Compensation Committee generally holds at leastfour scheduled meetings during the year and holds additional meetingsperiodically to review and discuss executive compensation issues. TheCompensation Committee may also consider and take action by written consent. In2006, the Compensation Committee met eight****times.

The Company’s HumanResources department supports the Compensation Committee in its work. TheCompensation Committee also has the authority to engage the services of outsideadvisors, experts and others for assistance. From time to time, the Committeehas directed an external advisor to work with the Human Resources department tosupport management and the Committee in matters such as (i) peer groupdevelopment, (ii) executive officer benchmarking, includingpay-for-performance analyses and tally sheet preparation, and (iii) advisingon pay levels and/or pay program design.

*OutsideCompensation Consultant*

During fiscal year 2006,the Compensation Committee did not employ an outside advisor. However, in April 2007,the Compensation Committee engaged an independent compensation consulting firm,Compensia, Inc., to advise the Compensation Committee and the Board onexecutive and equity compensation matters. The consulting firm reports directlyto the Compensation Committee, and the Compensation Committee has soleauthority to hire, fire and direct the work of the advisor.

*Role of Managementin Executive Compensation Process*

The Compensation Committeeseeks input from our Chief Executive Officer and/or other executives, includingour Chief Financial Officer and Senior Vice President, Human Resources, toobtain recommendations with respect to Company compensation programs, practicesand packages for executives and other employees. Our Chief Executive Officer’srole in the compensation-setting process consists of (i) evaluating employeeperformance; (ii) assisting in the establishment of business performancetargets and objectives; and (iii) recommending salary levels and equityawards. While the Compensation Committee may discuss our CEO’s compensationpackage with him, it meets in executive session without him present todetermine his compensation.

**ExecutiveCompensation Philosophy and Framework**

The philosophy of theCompensation Committee is to create a compensation program in which employeecompensation is tied to Company performance, market competitiveness, individualperformance and employee retention.

*CompensationObjectives*

UTStarcom’scompensation program is designed to achieve three primary objectives:

1.                Create ahigh-performance culture by linking rewards to performance;

2.                Be competitivewith the market in order to attract, retain and motivate the caliber of talentrequired to drive shareholder value; and

3.                Applyreward practices in a fair and consistent manner.

*Target Pay Position*

We primarily use three pay components to support ourcompensation objectives: base salary, annual cash incentive/bonus and equity.These are discussed in greater detail below under “Evaluation of NamedExecutive Compensation.” For each of these elements, the Compensation Committeeexamines peer 

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group compensationpractices and targets direct compensation, including base salary, incentivebonus and equity, at the 50th percentile of ourprimary peer group (as defined in the “Compensation Benchmarking” sectionbelow). These target pay positions are the same for all employees in theCompany.

The Compensation Committeehas approved compensation levels for officers above and below the target payposition, based on individual and Company performance, to ensure an appropriatepay-for-performance alignment. This pay-for-performance alignmentis further supported by our use of variable, or at-risk, compensation, which isdesigned to provide that executives receive target or above-target totalcompensation only to the extent that Company and individual performanceobjectives have been achieved.

*CompensationBenchmarking*

The Compensation Committee examines the compensationpractices of two peer groups to assess the competitiveness of executive officercompensation practices and levels. The first peer group (the “primary” peergroup) includes 107 high technology companies with between $1 billion and $3billion in revenue, as reported in Radford’s High-Technology Executive Survey. Theprofile of the primary peer group aligns with UTStarcom in terms of size, andis our primary source of comparison.

Thesecond peer group (the “secondary” peer group) includes 21 telecom companieswith more than $1 billion in annual revenue and is likewise pulled from theRadford High-Technology Executive Survey. The secondary peer group is used as asecondary reference point, and is composed of the following companies:
| ·Alcatel, USA | ·  Ericsson               | ·  Samsung Telecom America |
|--------------------|-------------------------------------|--------------------------------------|
| ·Alltel       | ·  Level 3 Communications | ·  Scientific—Atlanta |
| ·AT&T/SBC | ·  Motorola               | ·  Sprint Nextel           |
| ·Avaya        | ·  NII Holdings           | ·  T-Mobile                |
| ·Corning      | ·  Nokia—US          | ·  Tellabs                 |
| ·DirecTV      | ·  Qualcomm               | ·  Verizon Wireless        |
| ·Embarq       | ·  Qwest Communications   | ·  Virgin Mobile           |

 

Both of the Company’s peergroups are reviewed annually by the Compensation Committee, and adjustments aremade as necessary to ensure the peer groups continue to properly reflect themarket in which UTStarcom competes for talent.

**Evaluation of NamedExecutive Officer Compensation**

*Base Salary*

Base salaries areused to attract, motivate and retain highly qualified executives. Base salaryis the primary fixed compensation in the executive pay program and isdetermined by:

·       Levelof responsibility;

·       Expertiseand experience of the employee; and

·       Competitiveconditions in the industry.

Annual base salaryincreases, if any, are a reflection of:

·       Theindividual’s performance for the preceding year;

·       Theindividual’s pay level relative to similar positions in our peer group;

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·       Internalequity with respect to the rest of the executive team;

·       Anticipatedfuture contributions of the executives; and

·       Competitive conditions inthe industry.

*2006 Base SalaryActions*

Aspart of an annual process, the CEO presented his recommendations for executiveofficer base salary increases to the Compensation Committee in February, 2006. OnFebruary 28, 2006, the Committee met to evaluate Company performance,individual performance and data related to market practices for executivecompensation. The Committee then approved the following salary increases forthe Company’s named executive officers (the “Named Executive Officers” or the “NEOs”)effective February 1, 2006:  

| **Named Executive  Officer** | ** ** | ** **                                                                                                                                | ** ** | **Title** | ** ** | **Annualized  2006 Base  Salary** | ** ** | **% Increase** | ** ** |
|-----------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------------------------------------|------------|---------------------|------------|
| Hong Liang Lu                     |       | President and Chief Executive Officer                                                                                                     |       |      | $          | 700,000                                |       |                |       | 0 | % |   |
| Ying Wu                           |       | Former Executive Vice President and Vice Chairman  of the Board; former Chairman and Chief Executive Officer for China (through  5/31/07) |       |      | $          | 500,000                                |       |                |       | 0 | % |   |
| Francis P. Barton                 |       | Executive Vice President and Chief Financial Officer                                                                                      |       |      | $          | 500,000                                |       |                |       | 0 | % |   |
| William Huang                     |       | Former Senior Vice President and Chief Technology  Officer (through 12/31/06)                                                             |       |      | $          | 350,000                                |       |                |       | 15 | % |   |
| Michael Sophie                    |       | Former  Executive Vice President and Chief Operating Officer (through 5/5/06)                                                             |       |      | $          | 440,000                                |       |                |       | 10 | % |   |

 

The Committee, based onits assessment of overall Company performance, left Mr. Lu’s base salaryat $700,000, which approximates the 50th percentile of the****primary****peer group. The base salary increases for Messrs. Huangand Sophie reflect the market analysis conducted prior to the February 2006meeting. Mr. Huang’s base salary was increased to align mid-way betweenthe 50th and 75th percentile to themarket, reflecting his experience and contributions. Mr. Sophie’s basesalary was increased to meet the 50th percentile to market. Mr. Barton washired on August 1, 2005 and the Committee decided not to change his basesalary for fiscal year 2006.

*2007 Base SalaryActions*

Similarto the process undertaken in 2006, the CEO presented 2007 recommendations forbase salary increases for the NEOs to the Compensation Committee in February,2007. The Compensation Committee, after a review of individual and Companyperformance, as well as market practices for executive compensation, approvedthe following salary increases for our NEOs, effective as of the dates noted:

| **Named Executive Officer** | ** ** | ** ** | ** ** | **2007 Base  Salary** | ** ** | **% Increase** | ** ** | **Effective date** | ** **             |
|---------------------------------------|------------|------------|------------|----------------------------|------------|---------------------|------------|-------------------------|------------------------|
| Hong Liang Lu                         |       | $          | 700,000    |                       |       | 0                   | %          |                    | N/A                    |   |
| Ying Wu                               |       | $          | 550,000    |                       |       | 10                  | %          |                    | February 1,  2007 |   |
| Francis P. Barton                     |       | $          | 750,000    |                       |       | 50                  | %          |                    | January 1, 2007   |   |

 

The Committee did not increase Mr. Lu’s basesalary for 2007. The Committee increased Mr. Wu’s salary to align hiscompensation with that paid to executives with similar responsibilities who areemployed by peer companies with revenue comparable to ours. Mr. Barton’sbase salary adjustment was made in light of his assumption of substantiallygreater duties, including responsibility for the Legal and Business 

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Development departments,after the departure of Mr. Sophie. Mr. Barton’s base salary increasealso reflects the Compensation Committee’s assessment of his criticality toongoing Company success. Messrs. Huang and Sophie terminated theiremployment with the Company prior to the Committee’s review of 2007compensation levels. Mr. Huang’s employment terminated on December 31,2006 and Mr. Sophie’s employment terminated on May 5, 2006.

Mr. Wu’s employment with the Company and itssubsidiaries terminated on June 1, 2007. Mr. Wu is eligible toreceive severance benefits in accordance with the terms of his Amended andRestated Change of Control/Involuntary Termination Severance Agreement dated November 14,2006, which provides that if Mr. Wu’s employment with us terminated as aresult of a regular involuntary termination during the period of employment apartfrom a change of control, (i) Mr. Wu would be entitled to 12 monthsof base salary as in effect as of the date of such termination, payable in alump sum within 30 days of termination, and 100% of the bonus for the year inwhich termination occurred, (ii) all equity awards, including withoutlimitation option grants, restricted stock and stock purchase rights, grantedto Mr. Wu would become fully vested and/or exercisable to the extent suchequity awards were outstanding and/or unexercisable at the time of suchtermination, (iii) Mr. Wu would be permitted to exercise such vestedequity awards for the shorter period of (a) 12 months from the date oftermination and (b) the remaining term of the respective equity awards,and (iv) we would continue to provide Mr. Wu the same level of healthcoverage as in effect on the day immediately preceding the termination dateuntil the earlier of the date he is no longer eligible to receive continuationcoverage pursuant to COBRA or 12 months from the termination date. As a result,Mr. Wu is eligible to receive a total of $998,768.83 (comprised of$550,000 in base salary, $440,000 in bonus, subject to applicable withholding,and $8,768.83 for the balance of his health care premiums).

Mr. Wu has asserted that he continues to have aright to employment with one of the Company’s subsidiaries in China.

In May 2007, the Compensation Committee discussedcertain compensation arrangements to be presented to a candidate for theposition of Chief Operating Officer of the Company. In determining thecomponents of the compensation arrangements and the reasonableness thereof, theCommittee considered the candidate’s previous experience and industryknowledge, the Company’s strategic direction, the level of responsibility to beassumed by the candidate, both in the short and long term, and the availabilityof qualified candidates in the marketplace.

On May 27, 2007, the Company entered into an agreementwith Mr. Peter Blackmore (the “Blackmore Agreement”), pursuant to which Mr. Blackmorewas offered the position of President and Chief Operating Officer of theCompany. The Blackmore Agreement provides that Mr. Blackmore shall, uponcommencement of employment with the Company, receive (i) an annual salaryof $800,000, which shall never be reduced below the current level, (ii) asigning bonus of $100,000, (iii) an annual bonus equal to 100% of Mr. Blackmore’sannual salary, based upon the Company’s performance and achievement of mutuallyagreed upon performance objectives (an annual bonus for the 2007 calendar yearof 50% of Mr. Blackmore’s annual salary is guaranteed), and (iv) uponapproval of the Board of Directors of the Company, a restricted cash awardequal to $5,200,000, payable over a four (4) year period as follows: (a) $4,000,000will vest as follows: $1,000,000 will vest and become payable on each annualanniversary of Mr. Blackmore’s employment start date, subject to hiscontinuing to provide services to the Company through each applicable vestingdate, and (b) an additional $300,000 will vest and become payable on thefirst anniversary of the date of grant, and $25,000 will vest each monththereafter, subject to his continuing to provide services to the Companythrough each applicable vesting date. In the event of Mr. Blackmore’sdeath or disability all amounts under (iv) above will accelerate.

Additionally, pursuant tothe terms of the Blackmore Agreement, the Company entered into a Change ofControl/Involuntary Termination Severance Agreement with Mr. Blackmore,effective July 2, 2007. For a description of the material terms ofthis agreement, please see “Employment Contracts 

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andChange of Control Arrangements with Executive Officers Other Than NamedExecutive Officers” in the section entitled “Potential Payments UponTermination and Change on Control” included in this Annual Report on Form 10-K.

*Bonus*

UTStarcom’s annual bonus program is a discretionary,variable cash incentive program designed to reward executives (as well as allemployees) for achieving key operational goals. At the beginning of each fiscalyear, the Compensation Committee approves specific executive officer goalswhich reflect the process of “management by objective” (the “MBOs”) and whichare used to measure performance in the upcoming year for the purpose ofdetermining bonus and equity awards. In addition to measures of corporateperformance, such as bookings, revenue and margin, the Compensation Committeealso evaluates individual performance, approves weightings and makes otherappropriate adjustments. CEO performance was based fifty percent on financialresults and fifty percent on the achievement of approved MBOs in the areas ofquality, people development, customer expansion, strategic products andbusiness systems and process improvement.

Metrics for non-CEOexecutive officers are set by the CEO and approved by the CompensationCommittee. Individual performance was based fifty percent on financial results,and fifty percent on individual MBOs. Financial measures established in 2006for the NEOs other than the CEO varied, based on their position. Fifty percentof Mr. Wu’s performance was based on UTStarcom’s performance in China, asmeasured by bookings, revenue, contribution margin and cash collection. Theremaining fifty percent of Mr. Wu’s performance was measured byachievement of MBOs in the areas of quality, people development, strategicproduct sales, business systems and process improvement and compliance. Fifty percentof Mr. Barton’s performance was based on financial measures includingcorporate revenue, bookings, gross margin and operating margin, operating cashflow and inventory. The remaining fifty percent of Mr. Barton’sperformance was measured by achievement of MBOs in the areas of investorrelations, business planning and analysis, compliance, and expense control.Messrs. Huang and Sophie were not eligible to participate in the bonusprogram due to their termination of employment with the Company during fiscalyear 2006.

*2006 Bonus Payouts for 2005Performance*

Bonusesfor the 2005 performance year were determined by the Compensation Committee in February 2006,and reflect the Committee’s assessment of Company performance for the fiscalyear ended December 31, 2005. The Compensation Committee decided not topay bonuses to its executive officers other than Mr. Huang who was awarded$75,000 based upon his technical contributions and competitive market data. Bonusdecisions, other than the bonus of $250,000 paid to Mr. Barton asstipulated in his offer letter with the Company, were based on the Company’s2005 performance, current market rate data, and MBO achievement.

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*2007 Bonus Payoutsfor 2006 Performance*

In February 2007,Mr. Lu, our CEO, presented recommendations to the Compensation Committeefor bonus payments to the NEOs other than himself, based on his assessment oftheir performance. The Compensation Committee retained the authority to assess Mr. Lu’sperformance in connection with the bonus payout process. The CompensationCommittee approved the following 2006 bonus payments for the NEOs, based oncorporate and individual performance:

| **Named Executive  Officer** | ** ** | ** ** | ** ** | **2006  Annual Bonus  Target as a Percent  of Base Salary** | ** ** | **2006  Bonus Paid** | ** ** | **Bonus Paid  as Percentage  of Target** | ** ** |
|-----------------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------------------------------------|------------|
| Hong Liang Lu                     |       |       | 100        | %                                                                                         |       |                      | $          | 315,000                                                 |       |   |   | 45 | % |   |
| Ying Wu                           |       |       | 80         | %                                                                                         |       |                      | $          | 320,000                                                 |       |   |   | 80 | % |   |
| Francis P. Barton                 |       |       | 80         | %                                                                                         |       |                      | $          | 750,000                                                 |       |   |   | 187.5 | % |   |

 

Based on corporate andindividual performance, the Compensation Committee set Mr. Lu’s bonus at 45%of his target, or $315,000. The Compensation Committee determined that Mr. Wuhad achieved 80% of the performance measures relevant to his incentivebonus determination, based on individual and corporate performance and that Mr. Bartonhad achieved 100% of the performance measures relevant to his incentive bonusdetermination, based on individual and corporate performance. Also in February 2007,the Compensation Committee exercised its discretion and decided, based on Mr. Barton’sunique and extraordinary performance in 2006, to award him a cash performancebonus for 2006 of 187.5% of his 2006 annual bonus target. Messrs. Huangand Sophie were not eligible to receive bonuses since they had terminated theiremployment with the Company prior to February 1, 2007, the date on whichthe Compensation Committee determined bonus awards.

*Equity Compensation*

Officers and other employees of the Company areeligible to participate in the 2006 Equity Incentive Plan, which was adopted bythe Board of Directors and approved by the stockholders in July of 2006.They are also eligible to participate in the Company’s Employee Stock PurchasePlan, as described below.

Equity compensation is the largest component ofUTStarcom’s executive officer compensation program. We believe this is aneffective way to align the interests of our executive officers with those ofour stockholders in order to achieve long-term stock price growth. In designingthe equity program, we take into account stockholder concerns about stock usageand dilution. The Compensation Committeelimits annual net issuances of stock-based awards, subject to extraordinaryevents (e.g., acquisitions). The Compensation Committeeadjusts this target rate from year-to-year based on performance and retentionissues, and to stay in line with market practices. Our three-year annualaverage actual net issuance of stock-based awards in 2006 is 4.8% ofoutstanding common stock.

In 2006, approximately 50%of NEO equity award value was delivered in stock options and approximately 50%was delivered in stock awards, which are generally designated in restrictedstock units and settled in our common stock. Stock options were granted to theNEOs subject to performance-based, one-year cliff vesting. The number of stockoptions that vested was based on Company and individual performance. Similarly,performance-based stock awards were granted to the NEOs based on Company andindividual performance. The portion of stock awards that vested was based onCompany and individual performance. Performance for equity awards is generallymeasured against the same criteria as were discussed in the “Bonus” sectionabove.

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*2007 Equity Awardsfor 2006 Performance*

On February 28, 2006, the Compensation Committeeapproved the grant of performance-based equity awards to each of the NEOs. Thenumber of options that would vest and the number of performance shares to beissued to each NEO was to be determined by the Compensation Committee as soonas practicable following the 2006 fiscal year end, based on each executiveofficer’s achievement of certain performance goals set by the Committee on thedate of grant. The performance goals were tailored to each individual andincluded (i) achievement of corporate financial measures such as bookings,gross margin, revenue, operating profit, cash flow, inventory turns,contribution margin and cash collections, (ii) achievement of corporate objectivesrelating to quality and organization and (iii) achievement by suchexecutive officer of additional individualized performance objectives reviewedand approved by the Compensation Committee.

At itsmeeting on February 1, 2007, the Compensation Committee determined thatmost of the performance objectives set for fiscal year 2006 for the Company andthe NEOs had been met and determined the following awards for the NEOs:

| **Named Executive Officer** | ** ** | ** ** | ** ** | **Stock Option  Award Granted** | ** ** | **Stock Option  Award Vested** | ** ** | **Target  Performance  Share Award** | ** ** | **Actual  Performance  Share Award** (1) | ** ** | **Percentage  of Actual  Awards  versus  Target** | ** ** |
|---------------------------------------|------------|------------|------------|-------------------------------------------|------------|------------------------------------------|------------|-------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------------|------------|
| Hong Lu                               |       |       | 260,000    |                                      |       |                                     | 234,000    |                                      |       |                                               | 130,000    |                                                   |       |   | 117,000 |   |   |   | 90 | % |   |
| Ying Wu                               |       |       | 100,000    |                                      |       |                                     | 80,000     |                                      |       |                                               | 50,000     |                                                   |       |   | 40,000 |   |   |   | 80 | % |   |
| Francis P. Barton                     |       |       | 92,000     |                                      |       |                                     | 92,000     |                                      |       |                                               | 46,000     |                                                   |       |   | 46,000 |   |   |   | 100 | % |   |

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(1)          OnFebruary 1, 2007, the Compensation Committee determined that the namedexecutive officers would be eligible to receive the number of performanceshares set forth in this column at such time as the Committee shall approve theissuance of the performance stock in compliance with applicable law. TheCompensation Committee has not yet approved the issuance of the performancestock.

*2006 Equity Awardsfor 2005 Performance*

No equity awards weregranted to the NEOs in 2006 for 2005 performance.

*Employee StockPurchase Plan*

Our executive officers arealso eligible to participate in the Company’s Employee Stock Purchase Plan, tothe same extent as all employees. The ESPP allows employees to purchaseUTStarcom stock at a 15% discount. Up to 15% of an employee’s annual basesalary, but not more than $25,000, may be allocated to the purchase of theCompany’s common stock under this plan.

*Benefits,Perquisites and Other Compensation*

We provide medical and other benefits to executivesthat are generally available to other full-time employees, including group termlife insurance, expatriate remuneration for those employees who are assignedoverseas and who qualify under the terms of our expatriate remuneration plan, tuitionreimbursement and a 401(k) plan. The 401(k) plan is a definedcontribution plan and, after one year of service, employees are eligible toreceive a matching contribution from the Company of up to $5,500. All of ournamed executive officers participated in our 401(k) plan during 2006 andreceived matching contributions.

We also provide the NEOs and other selected executiveswith certain perquisites including financial planning services, business travelaccident insurance, and in the case of Mr. Barton, daily transportation toand from our offices.

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The Compensation Committeereviews the perquisites provided to executive officers as part of its overallreview of executive compensation. The Compensation Committee has determined thetype and amount paid in perquisites to be within the appropriate range ofcompetitive compensation practices. Details about the NEO’s perquisites,including the fiscal year 2006 cost to the Company, are shown in the SummaryCompensation Table under the “All Other Compensation” column and theaccompanying narrative.

*Post-EmploymentObligations*

During 2006, the Company wasparty to change of control and involuntary termination severanceagreements with each of the NamedExecutive Officers. For a description of the material terms of theseagreements, please see “Employment Contracts and Severance Agreements withNamed Executive Officers” in the section entitled “Potential Payments UponTermination and Change on Control” included in this Annual Report on Form 10-K.The Compensation Committeebelieves these agreements are in the best interest of the Company’s stockholders. As with any public company, thepossibility of change of control exists for UTStarcom. Such a change of controltypically means a degree of ambiguity for executives about the stability oftheir employment. The Compensation Committeebelieves these agreements help to ensure that executives will remain focusedon, and committed to, the interests of the business throughout the process ofexploring and/or executing a change of control.

For purposes of each of the agreements described abovethat contain change of control involuntary termination provisions, change ofcontrol involuntary termination includes a significant reduction in employeeresponsibilities, a substantial reduction in facilities and/or perquisites, areduction of base salary and/or benefits, a relocation of the employee of morethan 50 miles for his or her current location, or the failure of an acquirer toassume the agreements discussed in this section. In all cases, the executivecan retain his or her employment by agreeing to any of these changes.

InJune 2006, the Compensation Committee adopted the Executive InvoluntaryTermination Severance Pay Plan, which extends certain change of control andseverance benefits to some of the Company’s executive officers who are notnamed executive officers. Please see “Employment Agreements and Change ofControl Arrangements with Executive Officers Other Than Named ExecutiveOfficers” in this Annual Report on Form 10-K for a description ofthe material terms of the plan. The Compensation Committee believes that theterms of the plan is in the best interests of the Company and its stockholdersin that the plan, like the agreements with our Named Executive Officersdescribed above, helps to ensure the focus and commitment of our executive teamduring the process of exploring and/or executing a change of control.

*Reasonableness ofCompensation*

The Compensation Committeebelieves it is fulfilling UTStarcom’s compensation objectives and inparticular, rewarding executive officers in a manner that supports our strongpay-for-performance philosophy. Executive compensation is tied to ourperformance and is structured to ensure that there is an appropriate balancebetween our long-term and short-term performance, and also a balance betweenour operational performance and stockholder return. On average, the targettotal direct pay position for the Named Executive Officers in 2006 was betweenthe 50th and 75th** **percentile of the primary peergroup. The Compensation Committee believes the average target pay positionrelative to market and pay mix are reasonable and appropriate.

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**OtherConsiderations**

*Equity GrantPractices*

The Compensation Committee approves all equity grantsto our executive officers. During fiscal year 2006, the Company’s equity awardpool for awards (including new hire grants and any merit or focal awards) to bemade during that period was approved by the Board of Directors. A percentage ofthis total approved pool was designated for distribution to the companyexecutives. Functional Vice Presidents recommended annual equity grants totheir supervised employees based on individual performance, with our ChiefExecutive Officer making recommendations for his direct reports. The Company’sHuman Resources personnel then compiled the list of recommendations andpresented those recommendations to the Compensation Committee for approval. Anyrecommendation with respect to equity grants for our Chief Executive Officerwas made by the Compensation Committee. The fair market value of the optionsgranted was established as of the date on which the Compensation Committeeapproved the grants.

On April 10,2007, the Compensation Committee adopted the UTStarcom, Inc. Equity AwardGrant Policy and Procedures, which applies to all equity awards from that dateforward. In accordance with the Company’s equity award grant policy, equityawards to executive officers are considered and approved as follows:

·       Allequity awards to executive officers are to be approved by the CompensationCommittee;

·       TheCompensation Committee will use its best efforts to approve equity awards at aduly called meeting of the Compensation Committee, and awards will be made byunanimous written consent only if meetings are unable to be held;

·       Thedate of grant of any equity award will be the last trading day in the month inwhich the Compensation Committee approves the award; and

·       Forpurposes of equity awards that are to be granted at the fair market value ofthe Company’s common stock, the fair market value shall be the closing salesprice per share of the Company’s common stock on the date of grant.

Compensation Committee meetings may be held at anytime to consider the approval of equity awards proposed to be provided to newexecutive officers (including new executive officers resulting from either newhires or promotions, but other than annual focal awards, as described below),but equity awards granted by the Compensation Committee shall become effectiveas of the last trading day of the month of grant.

Compensation Committee meetings to consider theapproval of annual focal awards to executive officers shall be held during thelast two weeks of February of each year, if reasonably practicable andsubject to compliance with applicable laws, rules and regulations. If ameeting cannot be held and/or equity awards cannot be granted in accordancewith applicable laws, rules and regulations during this time period, theCompensation Committee shall determine the meeting date for the considerationand approval of focal awards. The Compensation Committee shall meet to approvefocal equity awards during an open trading window as such term is defined inthe Company’s Insider Trading Policy.

Option grants made toemployees who are not executive officers or corporate vice presidents may bemade by the Awards Committee, a management committee duly formed and authorizedby the Compensation Committee and consisting of the Company’s Chief FinancialOfficer, Senior Vice President of Human Resources, General Counsel and ChiefAccounting Officer. The Awards Committee may grant only stock options and onlythen in accordance with specific guidelines set by the Compensation Committee. Anyoption grants approved by the Awards Committee are effective as of the lasttrading day of the month of grant. Equity grants are made subject to an annualequity pool approved by the 

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CompensationCommittee. The pool consisted of 5.4 million****shares****in 2006. The Human Resources Department provides quarterlytracking updates to the Compensation Committee regarding equity usage.

*Tax Considerations*

Section 162(m) ofthe Internal Revenue Code states that public companies cannot deductcompensation paid to certain of its top executive officers in excess of $1million per officer per year. We believe it is in our best interest, to theextent practical, to have executive officer compensation be fully deductibleunder Section 162(m). However, the Compensation Committee also retains thediscretion, for competitive reasons, to provide compensation that may not befully deductible. In a few instances, a portion of our annual bonus payments tocertain of our executive officers does not currently qualify as deductible under Section 162(m).The Compensation Committee will continue to evaluate whether it is in theCompany’s best interest to qualify future incentive awards under Section 162(m).While stock options granted under our 1997 plan did not meet the requirementsof Section 162(m), future equity awards will be granted under our 2006plan, which was approved by our stockholders and therefore meets therequirements under Section 162(m). UTStarcom is currently in anon-taxpaying situation, and is not subject to tax liabilities for executivepay in excess of the $1 million limit.

*Stock OwnershipGuidelines*

Effective January 1,2006, by the decision of the Nominating and Governance Committee of the Board,the Company imposed minimum stock ownership guidelines for certain executiveofficers as well as non-executive directors of the Company. Each executiveofficer is expected to acquire the required number of shares of common stock asset forth by the guidelines (which range from 10,000 shares to 50,000 shares,depending on the level of responsibility of the officer) before the later of (i) fouryears after the effective date of the guidelines or (ii) four years afteran officer’s appointment to such executive office.

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**REPORT OF THECOMPENSATION COMMITTEE**

*The following is thereport of the Compensation Committee. The information contained in this reportshall not be deemed to be “soliciting material” or to be “filed” with the SEC,nor shall such information be incorporated by reference into any future filingunder the Securities Act of 1933, as amended, or the Securities Exchange Act of1934, as amended, except to the extent that the Company specificallyincorporates the information by reference in such filing.*

The Compensation Committee of the Board of UTStarcom, Inc.was established on January 31, 1997 and is currently comprised of fourmembers: Messrs. Clarke, Horner, Lenzmeier and Toy. Mr. Lenzmeier,the Chairman of the Compensation Committee, and Messrs. Horner and Toyserved on the Committee throughout 2006. Mr. Clarke was appointed to serveon the Compensation Committee on April 27, 2007.

During 2006, the Compensation Committee was comprisedsolely of non-employee directors who were each: (i) independent as definedunder the NASDAQ Marketplace Rules, (ii) a non-employee director forpurposes of Rule 16b-3 of the Securities Exchange Act of 1934, asamended, and (iii) an “outside director” for purposes of Section 162(m) ofthe Internal Revenue Code. During 2007, the Committee will continue to becomprised of directors who meet these same standards.

The Compensation Committeehas reviewed and discussed the “Compensation Discussion and Analysis” sectionof this Annual Report on Form 10-K with management, includingUTStarcom’s Chief Executive Officer and Chief Financial Officer. Based on thisreview and discussion, the Compensation Committee recommended to the Board thatthe “Compensation Discussion and Analysis” section be included in this AnnualReport on Form 10-K.

The Compensation Committee

Allen Lenzmeier, *Chairman*Larry D. HornerThomas J. ToyJeff Clarke*

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*       AppointedApril 27, 2007

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**COMPENSATION COMMITTEE INTERLOCKS AND INSIDERPARTICIPATION**

The Compensation Committeeconsisted of Messrs. Horner, Lenzmeier and Toy throughout the 2006 fiscalyear. All members of the Compensation Committee during 2006 were independentdirectors in accordance with the applicable independence requirements of theNASDAQ Marketplace Rules, and none were employees or officers or formeremployees of the Company. During 2006, no executive officer of the Companyserved on the compensation committee (or equivalent) or board of directors ofanother entity whose executive officer(s) served on the CompensationCommittee or Board.

**SUMMARY COMPENSATION TABLE FOR FISCAL YEAR 2006**

The following tablepresents information concerning the total compensation of our principalexecutive officer, principal financial officer and three most highlycompensated executive officers, other than our principal executive officer andprincipal financial officer, who were serving as executive officers at the endof our 2006 fiscal year (the “named executive officers”).

**SUMMARYCOMPENSATION TABLE FOR FISCAL YEAR 2006**

| **Name and principal position**                                          | ** ** | ** ** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Bonus  ($)(1)** | ** ** | **Stock  Awards  ($)(2)** | ** ** | **Option  Awards  ($)(3)** | ** ** | **All Other  Compensation  ($)(4)** | ** ** | **Total  ($)** | ** ** |
|-----------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|-----------------|------------|-------------------|------------|---------------------------|------------|----------------------------|------------|------------------------------------------|------------|----------------|------------|
| Hong Liang Lu*  Chief Executive Officer                                                 |       | 2006       |       | 700,000  |       | 315,000         |       | 930,549           |       | 1,376,655                 |       |                       | 18,345     | (4)                                      |       | 3,340,549      |       |
| Francis P. Barton  Executive Vice President and Chief Financial Officer            |       | 2006       |       | 500,000  |       | 750,000         |       | 586,326           |       | 823,294                   |       |                       | 101,769    | (5)                                      |       | 2,761,389      |       |
| Ying Wu**  Former Executive Vice President and Vice  Chairman                           |       | 2006       |       | 500,000  |       | 320,000         |       | 318,136           |       | 604,808                   |       |                       | 290,038    | (6)                                      |       | 2,032,982      |       |
| William Huang***  Former Senior Vice President and Chief Technology Officer   |       | 2006       |       | 345,833  |       | 0               |       | 0                 |       | 261,546                   |       |                       | 196,859    | (7)                                      |       | 804,238        |       |
| Michael J. Sophie****  Former Executive Vice President and Chief Operating Officer |       | 2006       |       | 153,359  | (8)        | 0               |       | 0                 |       | 0                         |       |                       | 316,917    | (9)                                      |       | 470,276        |       |

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*                     Mr. Lu served as President, ChiefExecutive Officer and Chairman of the Board until December 31, 2006. On January 1,2007, he assumed the title of Chief Executive Officer.

**               Mr. Wu’s employment as our ExecutiveVice President and Chairman and Chief Executive Officer of our subsidiary,UTStarcom China Co., Ltd., terminated on June 1, 2007.

***         Mr. Huang resigned as our Senior VicePresident and Chief Technology Officer as of December 31, 2006.

****   Mr. Sophie resigned as our ExecutiveVice President and Chief Operating Officer as of May 5, 2006.

(1)           This amount represents amounts paid or tobe paid in 2007 with respect to 2006 performance, and does not include amountspaid in 2006 with respect to performance in prior years.

(2)           Amounts showndo not reflect compensation actually received by the named executive officers. Instead, amounts shown are the dollaramounts recognized for financial statement reporting purposes for the fiscalyear ended December 31, 2006 in accordance with SFAS 123(R),including amounts for stock awards granted in and prior to 2006. Pursuant toSEC regulations, the amounts shown exclude the impact of estimated forfeituresrelated to service-based vesting conditions. The amounts include awards withperformance-based vesting conditions, with 

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compensationinitially measured under SFAS 123(R) at grant date fair value on February 28,2006 and re-measured at each financial statement reporting date. For adiscussion on the Compensation Committee’s final award determinations basedupon the performance-based vesting conditions and the cumulative dollar amountrecognized for financial statement reporting in accordance with SFAS 123(R),please see footnotes 1 and 3 to the table entitled “Grants of Plan-Based Awardsin Fiscal Year 2006” contained in this Annual Report. A discussion of thevaluation assumptions used for purposes of the SFAS 123(R) calculationis included under Note 3 to our 2006 Consolidated Financial Statements that arepart of this Annual Report.

(3)           Amounts showndo not reflect compensation actually received by the named executive officers. Instead, amounts shown are the dollaramounts recognized for financial statement reporting purposes for the fiscalyear ended December 31, 2006 in accordance with SFAS 123(R),including amounts for stock awards granted in and prior to 2006. Pursuant toSEC regulations, the amounts shown exclude the impact of estimated forfeitures relatedto service-based vesting conditions. The amounts include awards withperformance-based vesting conditions, with compensation initially measuredunder SFAS 123(R) at grant date fair value on February 28, 2006 andre-measured at each financial statement reporting date. For a discussion on theCompensation Committee’s final award determinations based upon theperformance-based vesting conditions and the cumulative dollar amountrecognized for financial statement reporting in accordance with SFAS 123(R),please see footnotes 2 and 3 to the table entitled “Grants of Plan-Based Awardsin Fiscal Year 2006” contained in this Annual Report. A discussion of thevaluation assumptions used for purposes of the SFAS 123(R) calculationis included under Note 3 to our 2006 Consolidated Financial Statements that arepart of this Annual Report.

Theexercise price of certain stock options granted under option agreementsexecuted in February 2002 increased from $20.25 per share to $22.93 pershare, and certain stock options granted under option agreements executed in July 2002increased from $15.72 per share to $20.82 per share. The incremental fairvalue, computed as of the modification date in accordance with SFAS 123(R),with respect to each such modified award is $0. For a discussion onmodifications made to outstanding equity awards held by certain named executiveofficers, please see the section entitled “Executive Compensation—Modificationsto Outstanding Equity Awards” contained in this Annual Report.

(4)           This amount consists of $12,200 forfinancial planning services for executives, a premium payment of $645 for lifeinsurance coverage under our Business Travel Accident Insurance Policy and 401(k) matchpayments in the aggregate amount of $5,500.

(5)           This amount consists of $10,000 forfinancial planning services for executives, a premium payment of $645 for lifeinsurance coverage under our Business Travel Accident Insurance Policy, $85,624for car allowance and service and 401(k) match payments in the aggregateamount of $5,500.

(6)           This amount consists of a housing allowance of $48,000paid in connection with Mr. Wu’s international work assignment, a taxassistance payment of $216,413 paid in connection with our tax equalizationpolicy whereby we provide qualified employees with tax assistance to mitigatethe tax differential arising from an employee’s international work assignment,a tax return filing fee payment of $250, $19,230 for payout of accrued butunused paid time off, a premium payment of $645 for life insurance coverageunder our Business Travel Accident Insurance Policy and 401(k) matchpayments in the aggregate amount of $5,500.

(7)           This amount consists of a housingallowance of $32,000 paid in connection with Mr. Huang’s internationalwork assignment, a tax assistance payment of $76,919 paid in connection withthe Company’s tax equalization policy whereby the Company provides qualifiedemployees with tax assistance to mitigate the tax differential arising from anemployee’s international work assignment, an education tuition allowance of$14,490 paid in connection with Mr. Huang’s international work assignment,$67,305 for accrued but unused paid time off paid in connection withtermination of employment, a premium amount of $645 for life insurance coverageunder our Business Travel Accident Insurance Policy and 401(k) matchpayments in the aggregate amount of $5,500.

(8)           This amount reflects the base salary Mr. Sophiehad earned as of May 5, 2006.

(9)           This amount consists of $12,200 for financial planningservices for executives, $220,000 which is equivalent to six months of Mr. Sophie’sbase salary, paid as part of the severance payments to him in connection withtermination of employment, $71,074 for Mr. Sophie’s accrued but unusedpaid time off and floating holiday benefits, $6,943 for six months of Mr. Sophie’sCOBRA premiums paid in a lump sum, less applicable withholdings, and 401(k) matchpayments in the aggregate amount of $6,700.

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From time to time, we enter into offer letters andother agreements with our executive officers. For a description of the materialterms of such offer letter and a description of severance and change of controlagreements entered into with certain of our executive officers, please see thesection entitled “Employment Contracts and Severance Agreements” in the “PotentialPayments Upon Termination and Change of Control” section included in thisAnnual Report on Form 10-K.

In February 2007, the Compensation Committee ofthe Board of Directors approved an increase in Mr. Barton’s annual basesalary from $500,000 to $750,000, effective January 1, 2007. In addition,the Compensation Committee approved an increase in Mr. Wu’s annual basesalary from $500,000 to $550,000, effective February 1, 2007. Mr. Wu’semployment with the Company terminated on June 1, 2007. Please see “2007Base Salary Actions” in the Compensation Discussion and Analysis included inthis Annual Report on Form 10-K for a description of the actionstaken by the Compensation Committee with respect to salaries of our namedexecutive officers for fiscal year 2007.

For a description of material modifications madeduring fiscal year 2006 to the named executive officers’ outstanding equityawards, please see the section entitled “Modifications to Outstanding EquityAwards” included in this Annual Report on Form 10-K.

For a description of theCompany’s process for determining the payment of discretionary bonuses to itsexecutive officers, please see the section entitled “Bonus” in the CompensationDiscussion and Analysis included in this Annual Report on Form 10-K.

**GRANTS OFPLAN-BASED AWARDS**

The following tablepresents information concerning grants of plan-based awards to each of thenamed executive officers during the fiscal year ended December 31, 2006.

**GRANTOF PLAN-BASED AWARDS IN FISCAL YEAR 2006**

|                         | ** ** | ** ** | ** ** | **Estimated Future Payouts Under  Equity Incentive Plan Awards** | ** ** | **Exercise  or Base  Price of  Option** | ** ** | **Grant  Date Fair  Value of  Stock and  Option** | ** ** |
|-------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|------------------------------------------------------------------|------------|
| **Name**                | ** ** | ** ** | ** ** | **Grant  Date**                                                                                | ** ** | **Threshold  (#)(4)**                             | ** ** | **Target  (#)**                                                  | ** ** | **Maximum  (#)(4)** | ** ** | **Awards  ($/Sh)** | ** ** | **Awards(3)($)** | ** ** |
| Hong Liang Lu           |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 130,000                                                          | (1)        |   | — |   |   |   | — |   |   |   | 812,337 |   |   |
|                         |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 260,000                                                          | (2)        |   | — |   |   |   | 6.25 |   |   |   | 811,200 |   |   |
| Francis P. Barton       |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 46,000                                                           | (1)        |   | — |   |   |   | — |   |   |   | 287,443 |   |   |
|                    |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 92,000                                                           | (2)        |   | — |   |   |   | 6.25 |   |   |   | 287,040 |   |   |
| Ying Wu*                |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 50,000                                                           | (1)        |   | — |   |   |   | — |   |   |   | 312,438 |   |   |
|                         |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 100,000                                                          | (2)        |   | — |   |   |   | 6.25 |   |   |   | 312,000 |   |   |
| William Huang**         |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 33,333                                                           | (1)        |   | — |   |   |   | — |   |   |   | 208,290 |   |   |
|                    |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 66,667                                                           | (2)        |   | — |   |   |   | 6.25 |   |   |   | 208,001 |   |   |
| Michael J. Sophie† |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 41,800                                                           | (1)        |   | — |   |   |   | — |   |   |   | 261,198 |   |   |
|                         |       | 2/28/2006  |       |                                                                                           | —     |                                              |       | 83,600                                                           | (2)        |   | — |   |   |   | 6.25 |   |   |   | 260,832 |   |   |
|                         |            |            |            |                                                                                                |            |                                                   |            |                                                                  |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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*                    Mr. Wu’semployment as our Executive Vice President and Vice Chairman of the Board andChairman and Chief Executive Officer of our subsidiary, UTStarcom China Co.,Ltd., terminated on June 1, 2007.

**             Mr. Huang resigned as our Senior VicePresident and Chief Technology Officer as of December 31, 2006.

†                    Mr. Sophie resigned as our Executive VicePresident and Chief Operating Officer as of May 5, 2006.

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(1)          Represents stock awardopportunity, based upon Company and individual performance objectivesestablished and tailored for each named executive officer by the CompensationCommittee for our 2006 fiscal year. These objectives included (i) achievementof corporate financial measures such as bookings, gross margin, revenue,operating profit, cash flow, inventory turns, contribution margin and cashcollections, (ii) achievement of corporate objectives relating to qualityand organization and (iii) achievement by such executive officer of additionalindividualized performance objectives reviewed and approved by the CompensationCommittee. On February 1, 2007, the Compensation Committee determined thatMr. Lu would be eligible to receive 117,000 shares of Common Stock; Mr. Wuwould be eligible to receive 40,000 shares of Common Stock; and Mr. Bartonwould be eligible to receive 46,000 shares of Common Stock. Messrs. Huangand Sophie were not eligible to receive any shares due to their priortermination of employment with us.

(2)          The options were issuedto each executive officer under the 1997 Plan. Each option has an exerciseprice of $6.25 per share, which equals the closing price of our Common Stock onthe NASDAQ Stock Market on the date of grant. The options were subject toone-year cliff vesting, in addition to vesting based upon Company andindividual performance objectives established and tailored for each executiveofficer by the Compensation Committee for our 2006 fiscal year. Theseobjectives included (i) achievement of corporate financial measures suchas bookings, gross margin, revenue, operating profit, cash flow, inventoryturns, contribution margin and cash collections, (ii) achievement ofcorporate objectives relating to quality and organization and (iii) achievementby such executive officer of additional individualized performance objectivesreviewed and approved by the Compensation Committee. On February 1, 2007,the Compensation Committee determined that the following number of sharesunderlying the performance options would vest: 234,000 shares for Mr. Lu;80,000 shares of for Mr. Wu; and 92,000 shares for Mr. Barton.Messrs. Huang and Sophie were not eligible to receive any shares due totheir prior termination of employment with us.

(3)          The value of a stock oroption award opportunity reflects the dollar amounts initially measured underSFAS 123(R) at the grant date fair value. The value of the stock awardvesting to Messrs. Lu, Wu and Barton was $1,052,854, $359,950 and$413,943, respectively, reflecting the cumulative dollar amount recognized forfinancial statement reporting purposes based on the fair value of the Company’scommon stock on February 1, 2007,the date the Compensation Committee finalized such award, determined inaccordance with SFAS 123(R). Pursuant to SEC regulations, the amounts shownexclude the impact of estimated forfeitures related to service-based vestingconditions. The value of the option awards vesting to each of Messrs. Lu,Wu and Barton was $1,243,243, $425,040 and $488,796, respectively, reflecting the cumulative dollar amountrecognized for financial statement reporting purposes based on the fair valueof the Company’s common stock on February 1,2007, the date the Compensation Committee finalized such award, determinedin accordance with SFAS 123(R). Pursuant to SEC regulations, the amountsshown exclude the impact of estimated forfeitures related to service-basedvesting conditions. A discussion of the valuation assumptions used for purposesof the SFAS 123(R) calculation is included under Note 15 to our 2006Consolidated Financial Statements that are part of this Annual Report.

The exercise price of certain stock options granted under option agreementsexecuted in February 2002 were increased from $20.25 per share to $22.93per share, and certain stock options granted under option agreements executedin July 2002 were increased from $15.72 per share to $20.82 per share. Theincremental fair value, computed as of the modification date in accordance withSFAS 123(R), with respect to each such modified award is $0. For furtherdiscussion on modifications made to outstanding equity awards held by certainnamed executive officers, please see the section entitled “ExecutiveCompensation—Modifications to Outstanding Equity Awards” contained in thisAnnual Report.

(4)          There are no thresholdsor maximums (or equivalent items) for the equity incentive plan awards.

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No amounts were paid tothe named executive officers pursuant to a non-equity incentive award plan.Please see the “Bonus” column in the Summary Compensation Table included inthis Annual Report for amounts paid as discretionary bonuses to certain named executiveofficers.

**Outstanding EquityAwards at Fiscal Year-End 2006**

Thefollowing table sets forth the outstanding equity awards for each namedexecutive officer as of December 31, 2006.

**OUTSTANDINGEQUITY AWARDS AT FISCAL YEAR-END 2006**

|                         | ** ** | **OPTION AWARDS** | ** ** | **STOCK AWARDS**                                                                  | ** ** |
|-------------------------|------------|------------------------|------------|----------------------------------------------------------------------------------------|------------|
| **Name**                | ** ** | ** **             | ** ** | **Number of  Securities  Underlying  Unexercised  Options (#)  Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options (#)  Unexercisable** | ** ** | **Equity  Incentive  Plan  Awards:  Number of  Securities  Underlying  Unexercised  Unearned  Options (#)** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration  Date** | ** ** | **Number of  Shares or  Units of  Stock That  Have Not  Vested (#)** | ** ** | **Market  Value of  Shares or  Units of  Stock That  Have Not  Vested ($)** | ** ** | **Equity  Incentive  Plan  Awards:  Number of  Unearned  Shares, Units  or Other  Rights That  Have Not  Vested (#)** | ** ** | **Equity  Incentive  Plan  Awards:  Market or  Payout  Value of  Unearned  Shares, Units  or Other  Rights That  Have Not  Vested(1)(#)** | ** ** |
| Hong Liang Lu           |       |                   | 400,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 4.50 |   |   |   | 8/31/2009 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 150,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 13.00 |   |   |   | 2/3/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 100,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 15.00 |   |   |   | 10/17/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 100,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 12.50 |   |   |   | 12/20/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 150,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 22.93 | (2) |   |   | 2/27/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 75,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 20.82 | (3) |   |   | 7/24/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 115,000    |                                                                                   |       |   | 5,000 | (4) |   |   | — |   |   |   | 19.04 |   |   |   | 2/2/2013 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 250,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 37.46 |   |   |   | 1/19/2014 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | —     |                                                                                   |       |   | 260,000 | (5) |   |   | — |   |   |   | 6.25 |   |   |   | 2/27/2016 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | —     |                                                                                   |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | 130,000 | (13) |   |   | 1,137,338 |   |   |
| Francis P. Barton       |       |                   | 133,334    |                                                                                   |       |   | 266,666 | (6) |   |   | — |   |   |   | 8.82 |   |   |   | 7/31/2015 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | —     |                                                                                   |       |   | 92,000 | (7) |   |   | — |   |   |   | 6.25 |   |   |   | 2/27/2016 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   |       |                                                                                   |       |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 46,000 | (13) |   |   | 402,443 |   |   |
|                    |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | 75,000 | (14) |   |   | 656,156 |   |   |
| Ying Wu*                |       |                   | 80,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 4.50 |   |   |   | 4/25/2009 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 75,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 13.00 |   |   |   | 2/3/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 55,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 15.00 |   |   |   | 10/17/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 55,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 12.50 |   |   |   | 12/20/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 100,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 22.93 | (2) |   |   | 2/27/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 50,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 20.82 | (3) |   |   | 7/24/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 81,459     |                                                                                   |       |   | 3,541 | (8) |   |   | — |   |   |   | 19.04 |   |   |   | 2/2/2013 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | 200,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 37.46 |   |   |   | 1/19/2014 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   | —     |                                                                                   |       |   | 100,000 | (9) |   |   | — |   |   |   | 6.25 |   |   |   | 2/27/2016 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |       |                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | 50,000 | (13) |   |   | 437,438 |   |   |
| William Huang**         |       |                   | 50,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 15.00 |   |   |   | 10/17/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 40,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 12.50 |   |   |   | 12/20/2010 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 80,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 22.93 | (2) |   |   | 2/27/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 40,000     |                                                                                   |       |   | — |   |   |   | — |   |   |   | 20.82 | (3) |   |   | 7/24/2012 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 47,917     |                                                                                   |       |   | 2,083 | (10) |   |   | — |   |   |   | 19.04 |   |   |   | 2/2/2013 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 100,000    |                                                                                   |       |   | — |   |   |   | — |   |   |   | 37.46 |   |   |   | 1/19/2014 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | 20,313     |                                                                                   |       |   | 54,687 | (11) |   |   | — |   |   |   | 8.29 |   |   |   | 11/29/2015 |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                    |       |                   | —     |                                                                                   |       |   | 66,667 | (12) |   |   | — |   |   |   | 6.25 |   |   |   | 2/27/2016 |   |   |   | — |   |   |   | — |   |   |   | 33,333 | (13) |   |   | 291,622 |   |   |
| Michael J. Sophie† |       |                   | —     |                                                                                   |       |   | — |   |   |   | — |   |   |   | — |   |   |   |   |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
|                         |            |                        |            |                                                                                        |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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                    *  Mr. Wu’semployment as our Executive Vice President and Chairman and Chief ExecutiveOfficer of our subsidiary, UTStarcom China Co., Ltd., terminated on June 1, 2007.

                **  Mr. Huangresigned as our Senior Vice President and Chief Technology Officer as ofDecember 31, 2006.

                    †  Mr. Sophie resigned as our Executive Vice Presidentand Chief Operating Officer as of May 5, 2006 and had no outstanding equityawards as of December 31, 2006.

              (1)  Value is based on the closing price of our CommonStock of $8.75 on December 29, 2006, the last trading date of fiscal year 2006,as reported on the NASDAQ Stock Market.

              (2)  The exerciseprice of the stock option was increased from $20.25 per share to $22.93 pershare. For furtherdiscussion on the repricing, please see the section entitled “ExecutiveCompensation—Modifications to Outstanding Equity Awards” contained in thisAnnual Report.

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              (3)  The exercise price of the stock option wasincreased from $15.72 per share to $20.82 per share. For further discussion on the repricing,please see the section entitled “Executive Compensation —Modifications toOutstanding Equity Awards” contained in this Annual Report.

              (4)  The optionswere granted on February 3, 2003, and became fully vested and exercisableas of February 3, 2007.

              (5)  The optionswere granted on February 28, 2006, and options for 234,000 sharesbecame fully vestedand exercisable as of February 28, 2007, as determined by the CompensationCommittee on February 1, 2007 based upon established Company and managementperformance objectives for our 2006 fiscal year. For further information onthese performance objectives, please see footnote 2 to the table entitled“Grants of Plan-Based Awards in Fiscal Year 2006” contained in this AnnualReport.

              (6)  The optionswere granted on August 1, 2005, and are exercisable in 25% annualincrements beginning August 1, 2005.

              (7)  The optionswere granted on February 28, 2006 and became fully vested and exercisable as ofFebruary 28, 2007, as determined by the Compensation Committee on February1, 2007 based upon established Company and management performance objectivesfor our 2006 fiscal year. For further information on these performanceobjectives, please see footnote 2 to the table entitled “Grants of Plan-BasedAwards in Fiscal Year 2006” contained in this Annual Report.

              (8)  The optionswere granted on February 3, 2003, and became fully vested and exercisableas of February 3, 2007.

              (9)  The optionswere granted on February 28, 2006, and options for 80,000 sharesbecame fully vestedand exercisable as of February 28, 2007, as determined by the CompensationCommittee on February 1, 2007 based upon established Company and managementperformance objectives for our 2006 fiscal year. For further information onthese performance objectives, please see footnote 2 to the table entitled“Grants of Plan-Based Awards in Fiscal Year 2006” contained in this AnnualReport.

          (10)  The optionswere granted on February 3, 2003, and were forfeited in connection with thetermination of Mr. Huang’s employment with us effective as of December 31, 2006.

          (11)  The optionswere granted on November 30, 2005, and were forfeited in connection with thetermination of Mr. Huang’s employment with us effective as of December 31, 2006.

          (12)  The optionswere granted on February 28, 2006, and were forfeited in connection with thetermination of Mr. Huang’s employment with us effective as of December 31, 2006.

          (13)  Representsstock award opportunity, based on Company and individual performance objectivesestablished and tailored for each named executive officer by the CompensationCommittee for our 2006 fiscal year. On February 1, 2007, the CompensationCommittee determined, based on Company and individual performance during the2006 fiscal year, that Mr. Lu would be eligible to receive 117,000 shares ofCommon Stock; Mr. Wu would be eligible to receive 40,000 shares of CommonStock; and Mr. Barton would be eligible to receive 46,000 shares of CommonStock. Messrs. Huang and Sophie were not eligible to receive any shares due totheir prior termination of employment with us. For further information on theseperformance objectives, please see footnote 1 to the table entitled “Grants ofPlan-Based Awards in Fiscal Year 2006” contained in this Annual Report.

          (14)  Representsrestricted stock issued upon the exercise of stock purchase rights granted toMr. Barton on August 1, 2005 in connection with commencement of Mr. Barton’semployment with us. The original award of 100,000 shares of restricted stockvests in equal installments of 25,000 shares per year on each of the first fouranniversaries of the date of grant.

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**OPTION EXERCISES ANDSTOCK VESTED IN FISCAL YEAR 2006**

Thefollowing table presents all stock options exercised and value realized uponexercise, and all stock awards vested and value realized upon vesting, by thenamed executive officers during the fiscal year ended December 31, 2006.

**OPTIONEXERCISES AND STOCK VESTED IN FISCAL YEAR 2006**

| ** **        | ** ** | **OPTION AWARDS** | ** ** | **STOCK AWARDS**                                                   | ** ** |
|-------------------|------------|------------------------|------------|-------------------------------------------------------------------------|------------|
| **Name**          | ** ** | ** **             | ** ** | **Number of   Shares  Acquired   on Exercise  (#)** | ** ** | **Value   Realized   on   Exercise   ($)** | ** ** | **Number of   Shares   Acquired   on   Vesting   (#)** | ** ** | **Value   Realized   on   Vesting(1)  ($)** | ** ** |
| Hong Liang Lu     |       |                   | —     |                                                                    |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Francis P. Barton |       |                   | —     |                                                                    |       |   | — |   |   |   | 25,000 |   |   |   | 192,969 |   |   |
| Ying Wu           |       |                   | —     |                                                                    |       |   | — |   |   |   | — |   |   |   | — |   |   |
| William Huang     |       |                   | —     |                                                                    |       |   | — |   |   |   | — |   |   |   | — |   |   |
| Michael J. Sophie |       |                   | —     |                                                                    |       |   | — |   |   |   | — |   |   |   | — |   |   |
|                   |            |                        |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          The value realized equals $7.72, the closingprice of our Common Stock on August 1, 2006 (the vesting date) multiplied bythe number of shares that vested, less the original purchase price for thenumber of vested shares of $0.00125 per share.

**POTENTIAL PAYMENTS UPON TERMINATION AND CHANGE OFCONTROL**

**EmploymentContracts and Severance Agreements with Named Executive Officers**

*HongLiang Lu.**  *Weentered into a Change of Control Severance Agreement dated January 17,2003 with Mr. Lu (“Lu Severance Agreement”). The Lu Severance Agreementprovides that if Mr. Lu’s employmentwith us terminates as a result of an involuntary termination at any time within12 months after a change of control, (i) Mr. Lu will be entitled to 24months of base salary as in effect as of the date of such termination, payablein a lump sum within 30 days of termination, and 100% of his bonus for the yearin which termination occurs, (ii) all stock options granted to Mr. Luprior to the change of control will become fully vested and/or exercisable tothe extent such equity awards are outstanding and/or unexercisable at the timeof such termination, and all stock owned by Mr. Lu that is subject to a right ofrepurchase by us at the time of termination that was purchased prior to thechange of control shall have such repurchase rights lapse with respect to allsuch shares, and (iii) we will continue to provide Mr. Lu the same levelof health coverage as in effect on the day immediately preceding thetermination date until the earlier of the date he is no longer eligible toreceive continuation coverage pursuant to the Consolidated Omnibus BudgetReconciliation Act of 1985, as amended (the “COBRA”), or 12 months from thetermination date. If Mr. Lu’semployment with us terminates other than as a result of an involuntarytermination within 12 months after a change of control, Mr. Lu shall not beentitled to receive severance or other benefits under the Lu SeveranceAgreement.

*FrancisP. Barton.*   On July 29, 2005, we enteredinto an agreement with Francis P. Barton, our Executive Vice President andChief Financial Officer of the Company (the “Barton Agreement”). The BartonAgreement provides that Mr. Barton shall initially receive an annualsalary of $500,000, a signing bonus of $250,000, an annual bonus for the 2005calendar year of up to $250,000, an option to purchase 400,000 shares of commonstock of the Company at fair market value on the date of grant and a sharepurchase right for the purchase of 100,000 shares of common stock of theCompany at par value. Twenty-five percent of the shares subject to theoption shall vest one year after the date of grant, with the 

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remaining 75% vesting on amonthly basis thereafter. The shares subject to the share purchase right shallvest in equal installments of 25% per year on each of the first fouranniversaries of the date of grant.

We entered into an Amended and Restated Change ofControl Severance/Involuntary Termination Agreement dated August 23, 2006with Mr. Barton (“Barton Severance Agreement”). The Barton Severance Agreementprovides that if Mr.Barton’s employment with us terminates as a result of an involuntarytermination at any time within 18 months after a change of control, or anyother regular involuntary termination during the period of employment,(i) Mr. Barton will be entitled to 24 months of base salary as in effectas of the date of such termination, payable in a lump sum within 30 days oftermination, and 100% of the bonus for the year in which termination occurs,(ii) all equity awards, including without limitation option grants,restricted stock and stock purchase rights, granted to Mr. Barton prior tothe change of control will become fully vested and/or exercisable to the extentsuch equity awards are outstanding and/or unexercisable at the time of suchtermination, (iii) Mr. Barton would be permitted to exercise such vested equityawards for the shorter period of (a) 12 months from the date oftermination and (b) the remaining term of the respective equity awards, and (iv) we will continue to provideMr. Barton the same level of health coverage as in effect on the dayimmediately preceding the termination date until the earlier of the date he isno longer eligible to receive continuation coverage pursuant to the COBRA, or12 months from the termination date.

The Barton Severance Agreement also provides that if Mr. Barton’s employment with usterminates as a result of a regular involuntary termination during the periodof employment apart from a change of control, (i) Mr. Barton will beentitled to 24 months of base salary as in effect as of the date of suchtermination, payable in a lump sum within 30 days of termination, and 100% ofthe bonus for the year in which termination occurs, (ii) all equityawards, including without limitation option grants, restricted stock and stockpurchase rights, granted to Mr. Barton will become fully vested and/orexercisable to the extent such equity awards are outstanding and/orunexercisable at the time of such termination, (iii) Mr. Barton would bepermitted to exercise such vested equity awards for the shorter period of (a) 12months from the date of termination and (b) the remaining term of therespective equity awards, and(iv) we will continue to provide Mr. Barton the same level of healthcoverage as in effect on the day immediately preceding the termination dateuntil the earlier of the date he is no longer eligible to receive continuationcoverage pursuant to the COBRA or 12 months from the termination date.

If Mr. Barton’s employment with us terminates other than as a result of achange of control or other involuntary termination, Mr. Barton shall not beentitled to receive severance or other benefits under the Barton SeveranceAgreement.

*YingWu.*   On November 14, 2006, we entered into anAmended and Restated Change of Control/Involuntary Termination SeveranceAgreement with Mr. Ying Wu, our then Executive Vice President, Vice Chairman ofthe Board and Chairman and Chief Executive Officer of our subsidiary, UTStarcomChina Co., Ltd. (“Wu Severance Agreement”). The Wu Severance Agreement providedthat if Mr. Wu’s employment with us terminated as a result of an involuntarytermination at any time within 18 months after a change of control,(i) Mr. Wu would be entitled to 24 months of base salary as in effect asof the date of such termination payable in a lump sum within 30 days oftermination, and 100% of the bonus for the year in which termination occurred,(ii) all equity awards, including without limitation option grants,restricted stock and stock purchase rights, granted to Mr. Wu prior to thechange of control would become fully vested and/or exercisable, to the extentsuch equity awards were outstanding and/or unexercisable at the time of suchtermination, (iii) Mr. Wu would be permitted to exercise such vested equityawards for the shorter period of (a) 12 months from the date of termination and(b) the remaining term of the respective equity awards, and (iv) we wouldcontinue to provide Mr. Wu the same level of health coverage as in effect onthe day immediately preceding the termination date until the earlier of thedate he is no longer eligible to receive continuation coverage pursuant toCOBRA, or 12 months from the termination date.

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The Wu Severance Agreement also provided that if Mr.Wu’s employment with us terminated as a result of a regular involuntarytermination during the period of employment apart from a change of control,(i) Mr. Wu would be entitled to 12 months of base salary as in effect asof the date of such termination, payable in a lump sum within 30 days oftermination, and 100% of the bonus for the year in which termination occurred,(ii) all equity awards, including without limitation option grants,restricted stock and stock purchase rights, granted to Mr. Wu would becomefully vested and/or exercisable to the extent such equity awards wereoutstanding and/or unexercisable at the time of such termination, (iii) Mr. Wuwould be permitted to exercise such vested equity awards for the shorter periodof (a) 12 months from the date of termination and (b) the remainingterm of the respective equity awards, and (iv) we would continue toprovide Mr. Wu the same level of health coverage as in effect on the dayimmediately preceding the termination date until the earlier of the date he isno longer eligible to receive continuation coverage pursuant to COBRA or 12months from the termination date.

If Mr. Wu’s employment with us terminated other thanas a result of a change of control or other involuntary termination, Mr. Wuwould not be entitled to receive severance or other benefits under the WuSeverance Agreement. The Wu Severance Agreement is filed as Exhibit 10.28 tothis Annual Report on Form 10-K.

Mr. Wu’s employment with the Company and itssubsidiaries terminated on June 1, 2007. Mr. Wu is eligible to receiveseverance benefits for involuntary termination without a change in control inaccordance with the terms of the Wu Severance Agreement as described above,such payments to total $998,768.83 (comprised of $550,000 in base salary,$440,000 in bonus, subject to applicable withholding, and $8,768.83 for healthcare premiums).

*WilliamHuang.*   We entered into an Amended and RestatedChange of Control/Involuntary Termination Severance Agreement datedAugust 21, 2006 with Mr. Huang (“Huang Severance Agreement”). TheHuang Severance Agreement had the same terms and conditions as the Wu SeveranceAgreement as described above. Mr. Huangvoluntarily resigned as our Senior Vice President and Chief Technology Officereffective on December 31, 2006. In connection with his departure,Mr. Huang did not receiveany severance payments or benefits under the Huang Severance Agreement.However, Mr. Huang was paid for his accrued but unpaid time off andfloating holiday benefits in the amount of $67,305.

*Michael J. Sophie.*   Mr. Sophieresigned as our Executive Vice President and Chief Operating Officer effectiveas of May 5, 2006. We entered into a Severance Agreement and Release datedApril 13, 2006 with Mr. Sophie (“Sophie Severance Agreement”).Pursuant to the Sophie Severance Agreement, we paid Mr. Sophie theequivalent of six months of regular base salary in a lump sum of $220,000, lessapplicable withholdings. Mr. Sophie also received payments for his accruedbut unpaid time off and floating holiday benefits in an amount of $71,074.18.In addition, we paid the approximate equivalent of six months ofMr. Sophie’s COBRA premiums in a lump sum amount of $6,943, less applicablewithholdings. Mr. Sophie’s outstanding stock options continued to vestaccording to their respective vesting schedules through May 5, 2006. Allunvested portions of Mr. Sophie’s stock options as of May 5, 2006were canceled and/or terminated on May 5, 2006 and Mr. Sophie wasentitled to exercise the vested portions of his stock options for a period of120 days after termination of his employment with us. A copy of the SophieSeverance Agreement is attached as Exhibit 10.25 to this Annual Report onForm 10-K.

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**Change of ControlProvisions in the Equity Compensation Plans**

*The1997 Stock Plan.*   The 1997 Plan provides that, inthe event of our proposed dissolution or liquidation, the Board must notifyeach optionee under the 1997 Plan as soon as practicable prior to the effectivedate of such proposed dissolution or liquidation. The Board has the discretionto allow the optionee to exercise his or her option or stock purchase rightuntil 15 days prior to the effective date of such dissolution or liquidation. Inthe event of our merger with or into another corporation, or the sale ofsubstantially all of our assets, each outstanding option or stock purchaseright under the 1997 Plan will be assumed or substituted by the successorcorporation. In case the successor corporation refuses to assume or substitutethe outstanding option or stock purchase right, such outstanding option orstock purchase right will become fully exercisable for aperiod of 15 days from the date the optionee is notifiedof such refusal by the Board.

In addition, the 1997 Plan provides, in general, thatan optionee whose status as a Service Provider (as defined in the1997 Plan) is terminated is entitled to exercise his orher option, to the extent such option has vested as of the date of termination,until the earlier of (i) expiration of the option according to its terms, (ii) expirationof a period of 3 months following termination, or (iii) expirationof a period of 12 months following termination as a result of death ordisability. The 1997 Plan allows the post-termination exercise period to extendbeyond the default term, if the stock option agreement entered into by us andthe optionee pursuant to the 1997 Plan provides for a longer term.

Under the Officer and Director Option Agreementapproved for use under the 1997 Plan in connection with awards to our directorsand officers beginning in December of 2005, if the optionee’s status as aService Provider or director is terminated following a change of control, theoptionee shall be entitled to exercise his or her option, to the extent suchoption has vested as of the date of such termination, until the earlier of (i) expirationof the option according to its terms, or (ii) expiration of a period of 12months following the termination of the optionee’s status as a Service Provideror director.

The 1997 Plan was terminated in July 2006 effective uponstockholder approval of our 2006 Equity Incentive Plan.

*The2006 Equity Incentive Plan.*   Our 2006 Equity Incentive Plan (“2006 Plan”) provides that in theevent a participant in the 2006 Plan terminates service with us and ouraffiliates, any options which have become exercisable prior to the time oftermination will remain exercisable for three months from the date oftermination, unless a shorter or longer period of time is determined by the2006 Plan administrator. If termination was caused by death or disability, anyoptions which have become exercisable prior to the time of termination willremain exercisable for 12 months from the date of termination, unless a shorteror longer period of time is determined by the 2006 Plan administrator. In noevent may a participant exercise the option after the expiration date of theoption.

In the event of our changeof control, each outstanding award will be assumed or substituted by thesuccessor corporation. In the event the successor corporation refuses to assumeor substitute awards granted under the 2006 Plan, all options and stockappreciation rights will fully vest and become exercisable, all restrictions onrestricted stock will lapse, and, with respect to restricted stock units,performance shares, and performance units, all performance goals or othervesting criteria will be deemed achieved at target levels and all other termsand conditions met. In addition, if an option or stock appreciation rightbecomes fully vested and exercisable in lieu of assumption or substitution inthe event of a change of control, the 2006 Plan administrator will notify theparticipant in writing or electronically that the option or stock appreciationright will be fully vested and exercisable for a period of time determined bythe 2006 Plan administrator in its sole discretion, and the option or stockappreciation right will terminate upon the expiration of such period.

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**EstimatedPost-Employment Payments and Benefits**

Assuming the terminationof employment of the named executive officers took place on December 31,2006, and based upon the price per share of our Common Stock of $8.75, theclosing market price as of December 29, 2006 (the last trading day offiscal year 2006), the estimated payments and benefits that each of the namedexecutive officers would be eligible to receive under various circumstances areset forth in the following charts. Please see the section above entitled “EmploymentContracts and Severance Agreements With Named Executive Officers” under “Potential Post-EmploymentPayments upon Termination and Change of Control” contained in this AnnualReport on Form 10-K for detailed descriptions of the agreements witheach of the named executive officers that govern post-employment payments andbenefits. No payments are due in the event of voluntary termination ofemployment or termination of employment for “Cause” as defined in theagreements described above.

*Hong Liang Lu*

| ** **                                             | ** ** | **Involuntary  Without Cause  Termination** | ** ** | **Termination  upon/following  Change of Control** | ** ** | **Disability** (1) | ** ** | **Death(2)** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------|------------|--------------|------------|
| Base Salary ($)                                        |       |                                             | —     |                                                         |       |                    | $          | 1,400,000    |       |   |   | $ | 192,000 |   |   | $ | 500,000 |   |
| Bonus ($)                                              |       |                                             | —     |                                                         |       |                    | $     | 700,000      | (3)        |   |   | — |   |   | — |   |
| Accelerated  Shares Underlying Outstanding Options ($) |       |                                             | —     |                                                         |       |                    | $     | 650,000      | (4)(5)     |   |   | — |   |   | — |   |
| Accelerated  Stock Awards ($)                          |       |                                             | —     |                                                         |       |                    | $          | 1,137,338    | (4)(5)     |   |   | — |   |   | — |   |
| Health Care ($)                                        |       |                                             | —     |                                                         |       |                    | $          | 13,886       |       |   |   | $ | 13,886 |   |   | — |   |
| TOTAL:                                                 |       |                                             | —     |                                                         |       |                    | $          | 3,901,224    |       |   |   | $ | 205,886 |   |   | $ | 500,000 |   |

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(1)          We provide all activefull-time employees with short and long-term disability insurance coverage. Inthe case of short-term disability, employees will receive 60% of monthlyearnings up to a maximum weekly benefit of $3,000 for up to 12 weeks. Anydisability beyond 12 weeks will be covered by the long-term disability coveragewhich provides employees with 60% of monthly earnings up to a maximum monthlybenefit of $13,000. The amount represents payments for 12 months of disabilityunder the policies; however, in the event an employee continues to meet thedefinition of “disability” under the long-term disability policy, long-termdisability benefits may continue until an employee’s Social Security NormalRetirement Age.

(2)          We provide all activefull-time employees with basic life and accidental death insurance coveragewhich provides for payment of two times annual earnings to a maximum benefit of$500,000 in the event of death.

(3)          Represents target bonusof 100% of base salary, subject to management performance objectives for our2006 fiscal year. On February 1, 2007, the Compensation Committeedetermined that Mr. Lu would receive a $315,000 bonus for fiscal year2006.

(4)          Included in theseamounts are 100% of options and stock awards opportunity subject to managementperformance objectives for our 2006 fiscal year. On February 1, 2007, theCompensation Committee determined that Mr. Lu would be eligible to receive90% of that award opportunity. For further information on these performanceobjectives, please see footnote 1 to the table entitled “Grants of Plan-BasedAwards in Fiscal Year 2006” contained in this Annual Report.

(5)          Amountsrepresent the value of unvested stock options and awards grants as of December 31,2006 for which the vesting was accelerated. The value of accelerated options ismeasured as the difference between the fair market value using the closingmarket price of the Company’s common stock as of December 29, 2006, thelast trading day of fiscal year 2006, of $8.75 multiplied by the number of all 

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stock options thatwere unvested as of December 31, 2006. For restricted stock awards, it ismeasured as the fair market value of the stock ($8.75), less the par value costbasis, multiplied by the number of shares of restricted stock that wereunvested as of December 31, 2006.

*Francis P. Barton*

| ** **                                             | ** ** | **Involuntary  Without Cause  Termination** | ** ** | **Termination  upon/following  Change of Control** | ** ** | **Disability** (1) | ** ** | **Death(2)** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------|------------|--------------|------------|
| Base Salary ($)                                        |       |                                             | $          | 1,000,000                                                    |       |                    |       | $            | 1,000,000  |   |   |   | $ | 192,000 |   |   | $ | 500,000 |   |
| Bonus ($)                                              |       |                                             | $     | 400,000                                                      | (3)        |                    |       | $       | 400,000    | (3) |   |   | — |   |   | — |   |
| Accelerated  Shares Underlying Outstanding Options ($) |       |                                             | $     | 230,000                                                      | (4)(5)     |                    |       | $       | 230,000    | (4)(5) |   |   | — |   |   | — |   |
| Accelerated  Stock Awards ($)                          |       |                                             | $     | 1,058,599                                                    | (4)(5)     |                    |       | $       | 1,058,599  | (4)(5) |   |   | — |   |   | — |   |
| Health Care ($)                                        |       |                                             | $          | 13,886                                                       |       |                    |       | $            | 13,886     |   |   |   | $ | 13,886 |   |   | — |   |
| TOTAL:                                                 |       |                                             | $          | 2,702,485                                                    |       |                    |       | $            | 2,702,485  |   |   |   | $ | 205,886 |   |   | $ | 500,000 |   |

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(1)          We provide all activefull-time employees with short and long-term disability insurance coverage. Inthe case of short-term disability, employees will receive 60% of monthlyearnings up to a maximum weekly benefit of $3,000 for up to 12 weeks. Anydisability beyond 12 weeks will be covered by the long-term disability coveragewhich provides employees with 60% of monthly earnings up to a maximum monthlybenefit of $13,000. The amount represents payments for 12 months of disabilityunder the policies; however, in the event an employee continues to meet thedefinition of “disability” under the long-term disability policy, long-termdisability benefits may continue until an employee’s Social Security NormalRetirement Age.

(2)          We provide all activefull-time employees with basic life and accidental death insurance coveragewhich provides for payment of two times annual earnings to a maximum benefit of$500,000 in the event of death.

(3)          Represents target bonusof 80% of base salary, subject to management performance objectives for our2006 fiscal year. On February 1, 2007, the Compensation Committeedetermined that Mr. Barton would receive a $750,000 bonus for fiscal year2006.

(4)          Included in theseamounts are 100% of options and stock awards opportunity subject to managementperformance objectives for our 2006 fiscal year. On February 1, 2007, theCompensation Committee determined that Mr. Barton would be eligible toreceive 100% of that award opportunity. For further information on theseperformance objectives, please see footnote 1 to the table entitled “Grants ofPlan-Based Awards in Fiscal Year 2006” contained in this Annual Report.

(5)          Amountsrepresent the value of unvested stock options and awards grants as of December 31,2006 for which the vesting was accelerated. The value of accelerated options ismeasured as the difference between the fair market value using the closingmarket price of the Company’s common stock as of December 29, 2006, thelast trading day of fiscal year 2006, of $8.75 multiplied by the number of allstock options that were unvested as of December 31, 2006. For restrictedstock awards, it is measured as the fair market value of the stock ($8.75),less the par value cost basis, multiplied by the number of shares of restrictedstock that were unvested as of December 31, 2006.

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*Ying Wu**

| ** **                                             | ** ** | **Involuntary  Without Cause  Termination** | ** ** | **Termination  upon/following  Change of Control** | ** ** | **Disability** (1) | ** ** | **Death(2)** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------|------------|--------------|------------|
| Base Salary ($)                                        |       |                                             | $     | 500,000                                                      | (3)        |                    |       | $       | 1,000,000  | (3) |   |   | $ | 192,000 |   |   | $ | 500,000 |   |
| Bonus ($)                                              |       |                                             | $     | 400,000                                                      | (4)        |                    |       | $       | 400,000    | (4) |   |   | — |   |   | — |   |
| Accelerated  Shares Underlying Outstanding Options ($) |       |                                             | $     | 250,000                                                      | (5)(6)     |                    |       | $       | 250,000    | (5)(6) |   |   | — |   |   | — |   |
| Accelerated  Stock Awards ($)                          |       |                                             | $     | 437,438                                                      | (5)(6)     |                    |       | $       | 437,438    | (5)(6) |   |   | — |   |   | — |   |
| Health Care ($)                                        |       |                                             | $          | 12,533                                                       |       |                    |       | $            | 12,533     |   |   |   | $ | 12,533 |   |   | — |   |
| TOTAL:                                                 |       |                                             | $          | 1,599,971                                                    |       |                    |       | $            | 2,099,971  |   |   |   | $ | 204,533 |   |   | $ | 500,000 |   |

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*                    Mr. Wu’semployment with the Company terminated on June 1, 2007. For a descriptionof payments made to him in connection with his termination of employment,please see the section entitled “Employment Contracts and Severance Agreementswith Named Executive  Officers—Ying Wu”contained in this Form 10-K.

(1)          We provide all activefull-time employees with short and long-term disability insurance coverage. Inthe case of short-term disability, employees will receive 60% of monthlyearnings up to a maximum weekly benefit of $3,000 for up to 12 weeks. Anydisability beyond 12 weeks will be covered by the long-term disability coveragewhich provides employees with 60% of monthly earnings up to a maximum monthlybenefit of $13,000. The amount represents payments for 12 months of disabilityunder the policies; however, in the event an employee continues to meet thedefinition of “disability” under the long-term disability policy, long-termdisability benefits may continue until an employee’s Social Security NormalRetirement Age.

(2)          We provide all activefull-time employees with basic life and accidental death insurance coveragewhich provides for payment of two times annual earnings to a maximum benefit of$500,000 in the event of death.

(3)          Mr. Wu’s basesalary was increased to $550,000 per year effective February 1, 2007.

(4)          Represents target bonusof 80% of base salary, subject to management performance objectives for our2006 fiscal year. On February 1, 2007, the Compensation Committeedetermined that Mr. Wu would receive a $320,000 bonus for fiscal year2006.

(5)          Included in theseamounts are 100% of options and stock awards opportunity subject to managementperformance objectives for our 2006 fiscal year. On February 1, 2007, theCompensation Committee determined that Mr. Wu would be eligible to receive80% of that award opportunity. For further information on these performanceobjectives, please see footnote 1 to the table entitled “Grants of Plan-BasedAwards in Fiscal Year 2006” contained in this Annual Report.

(6)          Amounts represent thevalue of unvested stock options and awards grants as of December 31, 2006for which the vesting was accelerated. The value of accelerated options ismeasured as the difference between the fair market value using the closingmarket price of the Company’s common stock as of December 29, 2006, thelast trading day of fiscal year 2006, of $8.75 multiplied by the number of allstock options that were unvested as of December 31, 2006. For restrictedstock awards, it is measured as the fair market value of the stock ($8.75),less the par value cost basis, multiplied by the number of shares of restrictedstock that were unvested as of December 31, 2006.

*WilliamHuang.*   Mr. Huangresigned as our Senior Vice President and Chief Technology Officer effective December 31,2006. In connection with his departure, Mr. Huang did not receive any severance payments orbenefits under his Change of Control/Involuntary Termination SeveranceAgreement 

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describedabove. However, Mr. Huang received payments for his accrued butunpaid time off and floating holiday benefits in an amount of $67,305. Noadditional benefits or payments were made in connection with Mr. Huang’sdeparture from the Company.

*Michael J. Sophie.*   Mr. Sophieresigned as our Executive Vice President and Chief Operating Officer effectiveas of May 5, 2006. We entered into a Severance Agreement and Release datedApril 13, 2006 with Mr. Sophie (“Sophie Severance Agreement”). Pursuantto the Sophie Severance Agreement, we paid Mr. Sophie the equivalent ofsix months of regular base salary in a lump sum of $220,000, less applicablewithholdings. Mr. Sophie also received payments for his accrued but unpaidtime off and floating holiday benefits in an amount of $71,074.18. In addition,we paid the approximate equivalent of six months of Mr. Sophie’s COBRApremiums in a lump sum amount of $6,943, less applicable withholdings.Mr. Sophie’s outstanding stock options continued to vest according totheir respective vesting schedules through May 5, 2006. All unvestedportions of Mr. Sophie’s stock options as of May 5, 2006 werecanceled and/or terminated on May 5, 2006 and Mr. Sophie was entitledto exercise the vested portions of his stock options for a period of 120 daysafter termination of his employment with us. A copy of the Sophie SeveranceAgreement is attached as Exhibit 10.25 to this Form 10-K.

**Employment Agreements and Change of ControlArrangements with Executive Officers Other Than Named Executive Officers**

*PhilipChristopher.**  *We haveentered into an employment agreement with Philip Christopher, President ofUTStarcom Personal Communications LLC, in connection with our acquisition ofAudiovox. Under the terms of the agreement with Mr. Christopher dated June 11,2004, Mr. Christopher’s employment is for a three year term commencing onthe effective date of acquisition transaction and continues until the thirdanniversary thereof; however, commencing twelve months prior to the expirationof the term, the Company and Mr. Christopher are to undertake good faithnegotiations to extend the term. His annual base salary was set at $500,000 peryear and his target bonus opportunity during the term of the agreement was setat 2% of the annual earnings before taxes of the Company’s handset division. Hewas also entitled to receive a stock option grant for 200,000 shares of theCompany’s Common Stock. In the event Mr. Christopher’s employment isterminated without Cause (as defined in his employment agreement) or he voluntarilyterminates his employment for Good Reason (as defined in his employmentagreement), he would be entitled to continuation of his base salary until theexpiration of his employment agreement, payment of his annual bonus for theyear in which the termination occurred, and payment of COBRA premiums, andcontinued vesting of his stock option grant through the date his employmentagreement expires. Any payments made pursuant to the severance provisions ofthe agreement may be reduced to 2.99 times Mr. Christopher’s “base amount”as defined in Section 280G of Internal Revenue Code in the event thatseverance and other benefits would constitute “parachute payments” under Section 280Gand would otherwise be subject to excise tax under Section 4999 of the Code.Severance benefits payable pursuant to the agreement with Mr. Christopherare in lieu of any other severance policy or plan that the Company has in placeat the time of termination of employment.  Mr. Christopher must enter into a releaseof claims with the Company before he is entitled to receive such benefits.

*PeterBlackmore.**  *OnMay 27, 2007, we entered into an offer letter with Mr. PeterBlackmore (the “Blackmore Offer Letter”), pursuant to which Mr. Blackmorewas offered the position of President and Chief Operating Officer of theCompany. The Blackmore Offer Letter provides that Mr. Blackmore shall,upon commencement of employment with the Company, receive (i) an annualsalary of $800,000, which shall never be reduced below the current level, (ii) asigning bonus of $100,000, (iii) an annual bonus equal to 100% of Mr. Blackmore’sannual salary, based upon the Company’s performance and achievement of mutuallyagreed upon performance objectives (an annual bonus for the 2007 calendar yearof 50% of Mr. Blackmore’s annual salary is guaranteed), and (iv) uponapproval of the Board of Directors of the Company, a restricted cash awardequal to $5,200,000, payable over a four (4) year period as 

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follows: (a) $4,000,000will vest as follows: $1,000,000 will vest and become payable on each annualanniversary of Mr. Blackmore’s employment start date, subject to hiscontinuing to provide services to the Company through each applicable vestingdate, and (b) an additional $300,000 will vest and become payable on thefirst anniversary of the date of grant, and $25,000 will vest each month thereafter,subject to his continuing to provide services to the Company through eachapplicable vesting date. In the event of Mr. Blackmore’s death ordisability all amounts under (iv) above will accelerate in full.

We entered into a Change of Control/InvoluntaryTermination Severance Agreement with Peter Blackmore, our President and ChiefOperating Officer, effective as of July 2, 2007 (the “Blackmore SeveranceAgreement”). The Blackmore Severance Agreement has a term of three (3) years.Following the expiration of the three-year term, Mr. Blackmore and theCompany may, but are not obligated to, enter into a new agreement. If Mr. Blackmore’semployment continues following the expiration of the three-year term, and theCompany and Mr. Blackmore do not enter into a new agreement, the terms ofthe Blackmore Severance Agreement shall continue in effect until the partiesagree otherwise.

The Blackmore Severance Agreement provides that if Mr. Blackmoreremains employed with the Company through the date that is the twelve(12)-month anniversary of the effective date of the Blackmore SeveranceAgreement (the “Trigger Date”) and he is not offered the position of ChiefExecutive Officer of the Company on or before the Trigger Date, he shall beentitled to the following benefits: (i) twelve (12) months of Mr. Blackmore’sbase salary as in effect as of the Trigger Date, less applicable withholding,payable in a lump sum within thirty (30) days of the Trigger Date; (ii) onehundred percent (100%) of Mr. Blackmore’s full annual performance targetbonus for the year of the Trigger Date, payable in a lump sum within thirty(30) days of the Trigger Date; (iii) all equity awards, including withoutlimitation stock option grants, restricted stock and stock purchase rights,granted by the Company to Mr. Blackmore shall become fully vested, or, asapplicable, released from the Company’s repurchase right and exercisable as ofthe Trigger Date to the extent such equity awards are outstanding andunexercisable or unreleased at such date; and (iv) all outstandingrestricted cash awards granted to Mr. Blackmore shall become fully vested,payable in a lump sum within thirty (30) days of the Trigger Date. The Boardand Mr. Blackmore may mutually agree in writing to extend the Trigger Datebeyond the twelve (12)-month anniversary of the effective date of the BlackmoreSeverance Agreement; provided, however, the Trigger Date cannot be extendedbeyond February 13, 2009.

The Blackmore Severance Agreement further providesthat if Mr. Blackmore’s employment with the Company is involuntarilyterminated by the Company, or terminated by Mr. Blackmore for good reason,at any time within eighteen (18) months after a change of control, heshall be entitled to the following severance benefits: (i) twenty-four(24) months of Mr. Blackmore’s base salary as in effect as of thedate of such termination, less applicable withholding, payable in a lump sumwithin thirty (30) days of the termination; (ii) two hundred percent(200%) of Mr. Blackmore’s full annual performance target bonus and amonthly pro rated amount of his full annual performance bonus for the year inwhich the termination occurs, payable in a lump sum within thirty (30) days ofthe termination; (iii) all equity awards, including without limitation stockoption grants, restricted stock and stock purchase rights, granted by theCompany to Mr. Blackmore prior to the change of control shall become fullyvested, or, as applicable, released from the Company’s repurchase right andexercisable as of the date of the termination to the extent such equity awardsare outstanding and unexercisable or unreleased at the time of suchtermination, and shall be exercisable for twelve (12) months from the dateof termination; (iv) all outstanding restricted cash awards granted to Mr. Blackmoreshall become fully vested, payable in a lump sum within thirty (30) days of thetermination; and (v) up to 12 months of continuing health coverage andbenefits.

In addition, the Blackmore Severance Agreementprovides that if Mr. Blackmore’s employment with the Company isinvoluntarily terminated by the Company, or terminated by Mr. Blackmorefor good reason, during the term of this Blackmore Severance Agreement apartfrom a change of control, he shall be entitled to the following severancebenefits: (i) twelve (12) months of Mr. Blackmore’s base salaryas in 

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effect as of the date ofsuch termination, less applicable withholding, payable in a lump sum withinthirty (30) days of the termination; (ii) one hundred percent (100%)of Mr. Blackmore’s full annual performance target bonus for the year inwhich the termination occurs, payable in a lump sum within thirty (30) days ofthe termination; (iii) all equity awards, including without limitationstock option grants, restricted stock and stock purchase rights, granted by theCompany to Mr. Blackmore shall become fully vested, or, as applicable,released from the Company’s repurchase right and exercisable as of the date ofthe termination to the extent such equity awards are outstanding andunexercisable or unreleased at the time of such termination, and shall beexercisable for twelve (12) months from the date of termination; (iv) alloutstanding restricted cash awards granted to Mr. Blackmore shall becomefully vested, payable in a lump sum within thirty (30) days of the termination;and (v) up to 12 months of continuing health coverage and benefits.

*ExecutiveInvoluntary Termination Severance Pay Plan.**  *Effective June 20, 2006, theCompensation Committee of the Board of Directors adopted the ExecutiveInvoluntary Termination Severance Pay Plan (the “Executive Plan”) which extendscertain change of control and severance benefits to certain of the Company’sexecutive officers who are not named executive officers. Messrs. Green,King and Patel are eligible to participate in the Executive Plan. Mr. Christopheris not eligible to participate in either plan since the terms of his employmentagreement govern his severance benefits in the event of termination of hisemployment. In addition, the change of control provisions in the 1997 Plan and2006 Plan apply to all executive officers.

The following descriptionsof the Executive Plan is qualified in its entirety by the actual language ofthe plan:

The Compensation Committeeadopted the Executive Plan to provide for the payment of severance benefits tocertain eligible employees whose employment with the company in involuntarilyterminated other than for Cause (as defined in the Executive Plan) or due todeath or disability. A copy of the Executive Plan is attached as Exhibit 10.39to this Annual Report on Form 10-K. Eligible employees under theExecutive Plan are generally Senior Vice President level or above and designatedby the Executive Plan administrator. The Executive Plan provides that in theevent of involuntary termination or the employee’s resignation for Good Reason(both as defined in the Executive Plan), the Company will (i) make a cashlump sum payment equal to one year of base pay plus 100% of the employee’starget bonus for the year in which the involuntary termination of employmentoccurs, payable within 30 days of the date of termination and (ii) pay upto twelve (12) months of COBRA continuation coverage premium on behalf of theemployee, if the employee elects COBRA continuation coverage. In addition, alloutstanding and unvested equity compensation awards shall vest in full. In theevent that such benefits are deemed to constitute “parachute payments” withinthe meaning of Section 280G of the Internal Revenue Code and wouldotherwise be subject to the excise tax imposed by Section 4999 of theCode, then the employee’s severance benefits payable under the Executive Planshall be paid only to the extent that the benefits would not otherwise besubject to excise tax.

Asa condition to receiving benefits under the Executive Plan, the employee isrequired to sign a waiver and release of all claims arising out of the employee’stermination of employment and a nondisparagement agreement. The benefitsprovided under this Plan are in lieu of any other severance or retention planbenefits available to the eligible employee and shall be reduced by anyseverance paid to an eligible employee under any other plan or arrangement.

**Modifications toOutstanding Equity Awards**

On February 1, 2007, the Board extended thepost-termination exercise period with respect to any vested equity awards heldby any of our terminated service providers as of such date, during the periodof time that we are not current in our filings with the SEC, rendering suchawards unexercisable, (i) for a 

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period of ninety (90) daysfrom the date we become current in our filing of periodic reports with the SEC,but not beyond December 31, 2007, or (ii) beyond December 31,2007, but in no event more than thirty (30) days from the date the Company  becomes current in its filing of periodicreports with the SEC. Mr. William Huang, our former Senior Vice Presidentand Chief Technology Officer, held vested equity awards that were included inthis extension.

In connection with our voluntary review of ourhistorical equity award grant practices, each of our independent directors, Messrs. Clark,Horner, Lenzmeier and Toy, elected to amend any of his previously granted stockoptions that may in the future be determined to be discounted stock optionsunder Section 409A of the Internal Revenue Code of 1986, as amended (“Section 409A”),by executing a Stock Option Amendment Election Form in December 2006.In the event any such previously granted stock option is determined to be adiscounted stock option under Section 409A, the affected stock optionagreement will be automatically amended to provide for an exercise price notless than the fair market value of the Common Stock subject to option on theeffective date of grant.

Additionally, certain of our named executive officers,including Messrs. Lu,Wu, Barton and Huang, executed a Protective Amendment Election Form thatamends any stock option agreements previously entered into by and between usand each of Messrs. Lu, Wu, Huang and Barton, in the event any such stockoption agreements may in the future be determined to have resulted in the aboveindividuals holding discounted stock options under Section 409A. Inthe event any such previously granted stock option is determined to be adiscounted stock option under Section 409A, the affected stock option agreement will be automatically amended toprovide for an exercise price not less than the fair market value of the CommonStock subject to option on the effective date of grant.

Eachof Messrs. Lu, Wu and Huang also executed an Amendment Election Form thatamends the terms of various stock option agreements entered into by and betweenus and Messrs. Lu, Wu and Huang in February and July of 2002. EachAmendment Election Form provides for an adjustment to the exercise priceof the applicable stock options, to the extent such options remainedunexercised at the time of the election and may constitute discounted stockoptions under Section 409A, based on preliminary estimates made solely fortax purposes in order to avoid potential adverse tax consequences to Messrs. Lu,Wu and Huang and us associated with discounted stock options under Section 409A.The exercise price of applicable stock options granted under the OptionAgreements executed in February 2002 were increased from $20.25 per shareto $22.93 per share, and grants under the Option Agreements executed in July 2002were increased from $15.72 per share to $20.82 per share.

**IndemnificationAgreements**

During 2006, we were partyto indemnification agreements with each of our named executive officers anddirectors. The form of indemnification agreement is attached as Exhibit 10.1to this Annual Report on Form 10-K.

**DirectorCompensation for Fiscal Year 2006**

Directors who are our employees receive no additionalcompensation for serving on the Board of Directors. In fiscal year 2006, ournon-employee directors received a quarterly participation fee for attendance atBoard meetings. In addition, non-employee directors received annual retainerfees for committee membership and other duties. We reimburse all directors fortravel and other related expenses incurred in connection with our business,including attending stockholder meetings and meetings of the Board or any Boardcommittee.

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Thefollowing table sets forth information concerning compensation paid or accruedfor services rendered to us in all capacities by our non-employee directors forthe fiscal year ended December 31, 2006.

| **Name**        | ** ** | ** ** | ** ** | **Fees   Earned or  Paid in   Cash   ($)** | ** ** | **Stock   Awards  ($)(1)** | ** ** | **Option   Awards   ($)**(2) | ** ** | **Total   ($)** | ** ** |
|-----------------|------------|------------|------------|---------------------------------------------------------------------|------------|---------------------------------|------------|----------------------------------------|------------|----------------------|------------|
| Jeff Clarke     |       | $          | 161,950    |                                                                | $          | 58,433                          | (3)        | $                                      | 254,293    | (4)                  | $          | 474,676 |   |
| Larry D. Horner |       | $          | 197,450    |                                                                | $          | 59,457                          | (5)        | $                                      | 105,502    | (6)                  | $          | 362,409 |   |
| Allen Lenzmeier |       | $          | 156,950    |                                                                | $          | 59,457                          | (7)        | $                                 | 214,886    | (8)                  | $          | 431,293 |   |
| Thomas J. Toy   |       | $          | 463,503    |                                                                | $          | 57,241                          | (9)        | $                                 | 103,520    | (10)                 | $          | 624,264 |   |

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       (1) Amounts shown in the “Stock Awards” column do not reflectcompensation actually received by the directors. Instead, the amounts shown arethe dollar amount recognized for financial statement reporting purposes for thefiscal year ended December 31, 2006 in accordance with Statement ofFinancial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-BasedPayment” (“SFAS 123(R)”), including amounts for stock awards granted in2006. Pursuant to SEC regulations, the amounts shown exclude the impact ofestimated forfeitures related to service-based vesting conditions. None of thenon-employee directors received stock awards prior to 2006. A discussion of thevaluation assumptions used for purposes of the SFAS 123(R) calculationis included under Note 3 to our 2006 Consolidated Financial Statements that arepart of this Annual Report.

       (2) Amounts shown in the “Options Awards” column do not reflectcompensation actually received by the directors. Instead, the amounts shown arethe dollar amount recognized for financial statement reporting purposes for thefiscal year ended December 31, 2006 in accordance with SFAS 123(R),including amounts for options granted during and prior to 2006. A discussion ofthe valuation assumptions used for purposes of the SFAS 123(R) calculationis included under Note 3 to our 2006 Consolidated Financial Statements that arepart of this Annual Report.

       (3) Reflects the compensation costs recognized by us in fiscal 2006 for11,180 shares of restricted stock approved for grant on April 27, 2006,with a grant date fair value of $77,911. As of December 31, 2006, Mr. Clarkehad 5,590 shares of unvested restricted stock outstanding.

       (4) Reflects the compensation costs recognized by us in fiscal 2006 forstock option grants with the following fair values as of the applicable grantdate: (i) $66,919 for a stock option to purchase 20,320 shares of CommonStock granted under the 1997 StockPlan ( “1997 Plan”) on April 27, 2006. As of December 31,2006, Mr. Clarke had 125,320 options outstanding.

       (5) Reflects the compensation costs recognized by us in fiscal 2006 for11,376 shares of restricted stock approved for grant on April 27, 2006,with a grant date fair value of $79,277. As of December 31, 2006, Mr. Hornerhad 5,688 shares of unvested restricted stock outstanding.

       (6) Reflects the compensation costs recognized by us in fiscal 2006 forstock option grants with the following fair values as of the applicable grantdate: (i) $68,209 for a stock option to purchase 20,675 shares of CommonStock granted under the 1997 Plan onApril 27, 2006. As of December 31, 2006, Mr. Horner had 229,175options outstanding.

       (7) Reflects the compensation costs recognized by us in fiscal 2006 for11,376 shares of restricted stock approved for grant on April 27, 2006,with a grant date fair value of $79,277. As of December 31, 2006, Mr. Lenzmeierhad 5,688 shares of unvested restricted stock outstanding.

       (8) Reflects the compensation costs recognized by us in fiscal 2006 forstock option grants with the following fair values as of the applicable grantdate: (i) $68,209 for a stock option to purchase 20,675 

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shares of Common Stockgranted under the 1997Plan on April 27, 2006. As of December 31, 2006, Mr. Lenzmeierhad 125,675 options outstanding.

       (9) Reflects the compensation costs recognized by us in fiscal 2006 for10,952 shares of restricted stock approved for grant on April 27, 2006,with a grant date fair value of $76,322. As of December 31, 2006, Mr. Toyhad 5,476 shares of unvested restricted stock outstanding.

(10) Reflects the compensation costs recognized byus in fiscal 2006 for stock option grants with the following fair values as ofthe applicable grant date: (i) $68,209 for a stock option to purchase19,905 shares of Common Stock granted underthe 1997 Plan on April 27, 2006. As of December 31, 2006, Mr. Toyhad 173,990 options outstanding.

*Cash Compensation*

Approximatelyone-third of the compensation paid to our Non-Employees Directors is comprisedof cash. On April 27, 2006, the Board approved the 2006 annual equity andcash compensation for the non-employee directors, and made certainchanges in cash compensation, effective as of April 27, 2006, as set forthbelow:

| **Annual Compensation**                      | ** ** | ** ** | ** ** | **After  April 27,  2006** | ** ** | **Prior to  April 27,  2006** | ** ** |
|---------------------------------------------------|------------|------------|------------|---------------------------------|------------|-----------------------------------------|------------|
| Director Retainer  (pro-rated and paid quarterly) |       | $          | 50,000     |                            | $          | 40,000                                  |       |
| Lead Director Fee                                 |       | $          | 22,500     |                            | $          | 20,000                                  |       |
| Audit Committee  Chair Fee                        |       | $          | 12,500     |                            | $          | 10,000                                  |       |
| Compensation  Committee Chair Fee                 |       | $          | 7,500      |                            | $          | 5,000                                   |       |
| Nominating and  Governance Committee Chair Fee    |       | $          | 7,500      |                            | $          | 5,000                                   |       |
| Audit Committee  Member Fee                       |       | $          | 5,000      |                            | $          | 3,500                                   |       |
| Compensation  Committee Member Fee                |       | $          | 4,500      |                            | $          | 3,000                                   |       |
| Nominating and  Governance Committee Member Fee   |       | $          | 3,500      |                            | $          | 2,000                                   |       |
| Credit towards Company  Products                  |       | $          | 1,000      |                            | None       |                                    |

 

Additionally, to promote and facilitate a smoothtransition of the role of Chairman of the Board, Mr. Toy assumed greaterresponsibility and was assigned additional duties on the Board prior toassuming the role as Chairman of the Board on January 1, 2007. Inconsideration for these additional services during the transition period, theBoard approved the payment to Mr. Toy of an aggregate of $106,000, inthree equal payments of approximately $35,434 on each of June 30, 2006, September 30,2006 and December 31, 2006, as compensation for his additional services tothe Company in such period. At a meeting held July 26, 2007, the Board ofDirectors of the Company, upon recommendation of the Nominating and CorporateGovernance Committee of the Board of Directors, approved an annual fee of$250,000 payable to Mr. Toy for his service as the Chairman of the Boardof Directors, effective as of January 1, 2007. Mr. Toy ceasedreceiving compensation for his services as the Lead Director upon hisappointment as independent Chairman of the Board on January 1, 2007.

On October 27, 2006,the Board approved a compensation policy for the members of a special committeeof the Board (“Special Committee”) that had been established to oversee theCompany’s exploration of strategic alternatives. The compensation consisted ofa base retainer of $15,000 per month and $2,000 per meeting attendance for theChairman of the Special Committee and $10,000 per month and $1,000 per meetingattendance for the other members of the Special Committee. The SpecialCommittee was comprised of four non-employee directors: Thomas J. Toy (Chairmanof the Special Committee), Jeff Clarke, Larry D. Horner and Allen Lenzmeier.

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*Equity Compensation*

Approximatelytwo-thirds of the compensation paid to our Non-Employee Directors is comprisedof equity:  one-third of the aggregatevalue in stock options, and one-third of the aggregate value in restricted stockpurchase rights. The number of options and shares of restricted stock grantedeach Non-Employee Director during fiscal year 2006 is set forth below:

| **Name**        | ** ** | ** ** | ** ** | **Stock Options  Granted (#)** | ** ** | **Restricted Stock  Purchase Rights  Granted (#)** | ** ** |
|-----------------|------------|------------|------------|------------------------------------------|------------|-------------------------------------------------------------------|------------|
| Jeff Clarke     |       |       | 20,320     |                                     |       |                                                              | 11,180     |   |   |
| Larry D. Horner |       |       | 20,675     |                                     |       |                                                              | 11,376     |   |   |
| Thomas J. Toy   |       |       | 19,905     |                                     |       |                                                              | 10,952     |   |   |
| Allen Lenzmeier |       |       | 20,675     |                                     |       |                                                              | 11,376     |   |   |

 

Each option has an exercise price of $7.67 per share,which equals 110% of the $6.97 closing price of the Company’s Common Stock onthe NASDAQ Stock Market on April 27, 2006, the date of grant. The optionsvested in equal monthly installments over a 12-month period beginning on April 27,2006. The restricted stock purchase rights entitled the Non-Employee Directorsto purchase the Company’s Common Stock at par value. The restricted stockissued upon exercise of the restricted stock purchase rights vested in equalquarterly installments over a 12-month period beginning on April 27,2006. The options and the restricted stock purchase rights granted to theNon-Employee Directors in 2006 were granted under the Company’s 1997 Stock Plan(the “1997 Plan”) pursuant to the form of stock option agreement approved foruse under the 1997 Plan with respect to stock option grants to the Company’sdirectors and executive officers and the form of restricted stock purchaseagreement approved for use under the 1997 Plan, each as previously filed withthe Securities and Exchange Commission.

Prior to 2006, the Company’s policy was to provideeach Non-Employee Director with an annual grant of an option to purchase 25,000shares pursuant to the 1997 Plan. The Board suspended this policy in 2006,choosing instead to issue a specific number of options as part of eachNon-Employee Director’s overall annual compensation package. Also prior to2006, Non-Employee Directors were eligible to receive stock option grants underthe 2001 Director Option Plan (the “Director Plan”). The Director Plan wasterminated in July 2006 effective upon stockholder approval of the Company’s2006 Equity Incentive Plan. Under the termsof the Director Plan, if, following a change in control of the Company, aNon-Employee Director’s status as a Director of the Company or the successorcorporation is terminated (other than as a result of voluntary resignation),the options become fully exercisable for a period of three months from the dateof such termination.

For further discussion with respect to the Company’spolicy and procedures relating to equity award grants that apply to Non-EmployeeDirectors and other service providers, please see the section entitled “CompensationDiscussion and Analysis—Other Considerations—Equity Grant Practices” containedin this Annual Report.

For further discussion with respect to change ofcontrol arrangements applicable to outstanding equity awards, please see thesection entitled “Change of Control Provisions in the Equity Compensation Plans”under “Potential Payments upon Termination and Change of Control” contained inthis Annual Report.

For further discussion with respect to modificationsmade to certain outstanding equity awards held by Non-Employee Directors,please see the section entitled “Executive Compensation—Modifications toOutstanding Equity Awards” contained in this Annual Report.

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**ITEM 12—SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

**EQUITY COMPENSATIONPLAN INFORMATION**

Thefollowing table sets forth information, as of December 31, 2006, withrespect to compensation plans under which the Company’s equity securities areauthorized to be issued:

| **Plan category** (1)                                  | ** ** | ** ** | ** ** | **Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities  reflected in column (a))** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                       | ** ** | **(a)**    | ** ** | **(b)**                                                                                                                                          | ** ** | **(c)**                                                                                                     | ** ** |                                                                                                                                                                                                         |
| Equity  compensation plans approved by security holders          |       |       | 18,712,967 | (2)                                                                                                                                              |       |                                                                                                        | 14.36      |                                                                                                                                                                                                         |       |   | 13,152,829 | (3) |   |
| Equity  compensation plans not approved by security holders |       |       | 909,310    | (4)                                                                                                                                              |       |                                                                                                        | 28.55      |                                                                                                                                                                                                         |       |   | — | (5) |   |
| Total                                                            |       |       | 19,622,277 |                                                                                                                                             |       |                                                                                                        | 15.02      |                                                                                                                                                                                                         |       |   | 13,152,829 |   |   |
|                                                                  |            |            |            |                                                                                                                                                  |            |                                                                                                             |            |                                                                                                                                                                                                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)          See Note 15 to ourConsolidated Financial Statements for a description of our equity compensationplans.

(2)          Includes shares ofcommon stock to be issued upon exercise of options granted under our 2006 StockPlan, our 1997 Stock Plan and our 2001 Director Option Plan.

(3)          Includes 1,914,934shares of common stock available for issuance under our 2000 Employee StockPurchase Plan and 11,237,895 shares of common stock available for issuanceunder our 2006 Plan.

(4)          Includes shares ofcommon stock to be issued upon exercise of options granted under our 2003 Non-StatutoryStock Option Plan. Upon implementation of the 2006 Stock Plan theremaining securities available for future issuance under the 2003 Non-StatutoryStock Option Plan were rolled into the 2006 Stock Plan. Does not include 6,051shares and 5,522 shares of common stock subject to outstanding options with a weighted-averageexercise price of $2.54 that were assumed in our acquisitions of AdvancedCommunication Devices Corporation, and RollingStreams Systems, Ltd.,respectively.

(5)          Does not include 212shares and 743 shares remaining available for future issuance under equitycompensation plans related to our acquisitions of Advanced CommunicationDevices Corporation, and RollingStreams Systems Ltd., respectively.

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**SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

Thefollowing table sets forth certain information with respect to beneficialownership of our common stock as of October 1, 2007 (except as otherwiseindicated), by: (i) each person who is known to us to own beneficiallymore than 5% of our common stock; (ii) each director and each nominee forelection as a director of UTStarcom; (iii) each named executive officer;and (iv) all of our current directors and executive officers as a group.Calculations are based on 121,294,645 shares of common stock issued andoutstanding as of October 1, 2007.

| **Name and Address of Beneficial Owner(1)**      | ** **   | ** **   | ** **   | **Shares  Beneficially  Owned(2)** | ** **   | **Percent of  Total  Outstanding(2)** | ** ** |
|---------------------------------------------------------------------------|--------------|--------------|--------------|------------------------------------|--------------|--------------------------------------------|------------|
| ***Five  Percent Stockholders:***                                         | *** *** | *** *** | *** *** |                               | *** *** | *** ***                               |       |
| Entities affiliated  with SOFTBANK CORP.(3)                               |         | 14,651,630   |         |                               | 12.08        | %                                          |       |
| Goldman Sachs  Asset Management, L.P.(4)                                  |         | 13,191,787   |         |                               | 10.88        | %                                          |       |
| Renaissance  Technologies Corp.(5)                                        |         | 10,208,234   |         |                               | 8.42         | %                                          |       |
| Brandes  Investment Partners, L.P.(6)                                     |         | 9,910,153    |         |                               | 8.17         | %                                          |       |
| Barclays Global  Investors, N.A.(7)                                       |         | 9,729,641    |         |                               | 8.02         | %                                          |       |
| Miura Global  Management, LLC(8)                                          |         | 6,615,000    |         |                               | 5.45         | %                                          |       |
| Highbridge  Capital Management LLC(9)                                     |         | 6,200,530    |         |                               | 5.11         | %                                          |       |
| ***Directors  and Named Executive Officers:***                            | *** *** | *** *** | *** *** |                               | *** *** | *** ***                               |       |
| Hong Liang Lu(10)                                                         |         | 4,350,089    |         |                               | 3.54         | %                                          |       |
| Ying Wu(11)                                                               |         | 4,720,801    |         |                               | 3.89         | %                                          |       |
| William Huang(12)                                                         |         | 1,158,410    |         |                               | *            |                                       |       |
| Michael J. Sophie                                                         |         | 0            |         |                               | 0            |                                       |       |
| Francis P.  Barton(13)                                                    |         | 417,001      |         |                               | *            |                                       |       |
| Allen  Lenzmeier(14)                                                      |         | 147,051      |         |                               | *            |                                       |       |
| Larry D.  Horner(15)                                                      |         | 272,326      |         |                               | *            |                                       |       |
| Jeff Clarke(16)                                                           |         | 96,500       |         |                               | *            |                                       |       |
| Thomas J. Toy(17)                                                         |         | 184,942      |         |                               | *            |                                       |       |
| All current directors  and executive officers as a group (11 persons)(18) |         | 5,897,518    |         |                               | 4.86         | %                                          |       |

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                 * Less than 1%.

       (1) Unless otherwise indicated, the address for all beneficial owners isc/o UTStarcom, Inc., 1275 Harbor Bay Parkway, Alameda, California 94502.

       (2) Under the SEC’s proxy rules, a person who directly or indirectly hasor shares voting power or investment power with respect to a security isconsidered a beneficial owner of the security. Voting power is the power tovote or direct the voting of shares, and investment power is the power todispose of or direct the disposition of shares. The information on beneficialownership in the table and the footnotes is based upon our records and the mostrecent Schedule 13D or 13G filed by each such person and information suppliedto us by such person. Unless otherwise indicated, each person has sole votingpower and sole investment power with respect to all shares beneficially owned,subject to community property laws where applicable. Shares subject to optionswhich are exercisable within 60 days after October 1, 2007 are deemedto be outstanding and to be beneficially owned by the person holding suchoptions for the purpose of computing the percentage ownership of such person,but are not deemed to be outstanding and to be beneficially owned for thepurpose of computing the percentage ownership of any other person.

       (3) Information based on Schedule 13G, Amendment No. 2, filed withthe SEC on March 28, 2007 by SOFTBANK CORP., SOFTBANK America, Inc, andSOFTBANK Holdings, Inc. Includes 

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14,651,630 sharesregistered in the name of SOFTBANK America Inc., a Delaware corporation.SOFTBANK America Inc. is a wholly owned subsidiary of SOFTBANK Holdings Inc., aDelaware corporation. SOFTBANK Holdings Inc. is a wholly owned subsidiary ofSOFTBANK CORP., a Japanese corporation. Softbank America Inc. has sole power tovote or direct the voting of 14,651,630 shares and sole dispositive power over14,651,630 shares. The business address for these entities is c/o SOFTBANKCORP., Tokyo Shiodome Blvd., 1-9-1, Higashi-shimbashi, Minato-ku,Tokyo 105-7303 Japan.

       (4) Information based on Schedule 13G filed with the SEC onFebruary 12, 2007 by Goldman Sachs Asset Management, L.P. Goldman SachsAsset Management, L.P. has sole power to vote or direct the voting of11,576,328 shares and sole dispositive power over 13,191,787 shares. Thebusiness address for Goldman Sachs Asset Management, L.P. is 32 Old Slip, NewYork, NY 10005.

       (5) Information based on Schedule 13G filed with the SEC onMarch 16, 2007 by Renaissance Technologies Corp. and James H. Simons.Includes 10,208,234 shares beneficially owned by Renaissance Technology Corp.and James H. Simons. Each of Renaissance Technology Corp. and James H. Simonshas sole power to vote or direct the voting of 9,671,239 shares and soledispositive power over 10,208,234 shares. The business address for RenaissanceTechnologies Corp. is 800 Third Avenue, New York, NY 10022.

       (6) Information based on Schedule 13G filed with the SEC onFebruary 12, 2007, by Brandes Investment Partners, L.P. Includes 9,910,153shares beneficially and jointly owned by Brandes Investment Partners, L.P.,Brandes Investment Partners, Inc., Brandes Worldwide Holdings, L.P.,Charles H. Brandes, Glenn R. Carlson and Jeffrey A. Busby. Each of BrandesInvestment Partners, L.P., Brandes Investment Partners, Inc., BrandesWorldwide Holdings, L.P., Charles H. Brandes, Glenn R. Carlson and Jeffrey A.Busby has shared power to vote or direct the voting of 7,383,329 shares andshared dispositive power over 9,910,153 shares. The business address forBrandes Investment Partners, L.P. is 11988 El Camino Real, Suite 500, SanDiego, CA 92130.

       (7) Information based on Schedule 13G filed with the SEC onJanuary 23, 2007 by Barclays Global Investors NA. Includes 9,729,641shares beneficially and jointly owned by Barclays Global Investors, N.A.,Barclays Global Fund Advisors, Barclays Global Investors, Ltd., Barclays GlobalInvestors Japan Ltd., and Barclays Global Investors Japan Trust and BankingCompany Limited. Barclays Global Fund Advisors has sole power to vote or directthe voting of 2,869,575 shares and sole dispositive power over 2,869,575shares. Barclays Global Investors, Ltd. has sole power to vote or direct the votingof 609,069 shares and sole dispositive power over 609,069 shares. BarclaysGlobal Investors Japan Ltd. has sole power to vote or direct the voting of432,564 shares and sole dispositive power over 432,564 shares. Barclays GlobalInvestors Japan Trust and Banking Company Limited has no sole voting power orsole dispositive power. The business address for Barclays Global Investors N.A.is 45 Fremont Street, San Francisco, CA 94105.

       (8) Information based on Schedule 13G filed with the SEC onSeptember 28, 2007 by Miura Global Management LLC and Francisco Alfaro andRichard Turnure. Includes 6,615,000 beneficially owned by Miura GlobalManagement LLC, Francisco Alfaro and Richard Turnure. Each of Miura GlobalManagement LLC, Francisco Alfaro and Richard Turnure has shared power to voteor direct the voting of 6,615,000 shares and shared power to dispose or todirect the disposition of 6,615,000 shares. The business address for MiuraGlobal Management LLC is 101 Park Avenue, 21st Floor, New York, NY 10178.

       (9) Information based on Schedule 13G filed with the SEC onJune 27, 2007 by Highbridge Capital Management LLC and related parties.Includes (i) 1,135,278 shares owned by Highbridge International LLC andoptions to purchase 2,500,000 shares held by Highbridge International LLC,(ii) 47 shares owned by Highbridge Statistically Enhanced Equity MasterFund - U.S., L.P., 

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(iii) 1,215,508shares owned by Highbridge Statistical Opportunities Master Fund, L.P.,(iv) 1,208,325 shares owned by STAR, L.P. and (v) 141,372 sharesheld by certain accounts managed by Highbridge Capital Management, LLC.Highbridge Capital Management, LLC is the trading manager of HighbridgeInternational LLC, Highbridge Statistically Enhanced Equity Master Fund—U.S.L.P., Highbridge Statistical Opportunities Master Fund, L.P. and STAR, L.P, andtherefore may be deemed the beneficial owner of the foregoing shares. Inaddition, Glenn Dubin and Henry Swieca are Co-Chief Executive Officers ofHighbridge Capital Management, LLC, and therefore may also be deemed thebeneficial owner of the foregoing shares. Henry Swieca is a Co-Chief ExecutiveOfficer of Highbridge Capital Management, LLC. Each of Highbridge CapitalManagement, LLC, Glenn Dubin and Henry Swieca disclaims beneficial ownership ofthe shares owned by Highbridge International LLC, Highbridge StatisticallyEnhanced Equity Master Fund, - U.S., L.P. and Highbridge StatisticalOpportunities Master Fund, L.P. The business address for each of HighbridgeCapital Management, LLC, Glenn Dubin and Henry Swieca is 9 West 57th Street,27th Floor, New York, NY 10019.

(10) Includes 2,401,425 owned directly plus an additional(i) 229,000 shares owned by The Lu Family Limited Partnership, of whichMr. Lu is a general partner, (ii) 130,000 shares registered in thename of Lu Charitable Remainder Trust, of which Mr. Lu is the trustee,(iii) 5,332 shares registered in the name of Mr. Lu’s son, and(iv) 5,332 shares registered in the name of Mr. Lu’s daughter.Mr. Lu may be deemed the beneficial owner of the shares held by hischildren. Also includes 1,579,000 shares issuable upon exercise of options thatare exercisable within 60 days of October 1, 2007.

(11) Includes 1,340,687 shares owned directly, plus an additional(i) 1,505,500 shares registered in the name of Wu Partners, a Californialimited partnership, of which Mr. Wu is general partner,(ii) 1,080,000 shares registered in the name of Stonybrook Investors L.P.,(iii) 4,868 shares registered in the name of Wu Living Trust, (iv) 4,873shares registered in the name of Ashley Wu Trust—1998 and (v) 4,873 sharesregistered in the name of Richard Wu Trust—1998. Ashley Wu and Richard Wu areMr. Wu’s children. Mr. Wu may be deemed the beneficial owner of theshares held by his children’s trusts. Also includes 780,000 shares issuableupon exercise of options that are exercisable within 60 days of October 1,2007. Mr. Wu’s employment as our Executive Vice President and Chairman andChief Executive Officer of our subsidiary, UTStarcom China Co., Ltd., terminatedon June 1, 2007 and Mr. Wu resigned from the Board of Directors onJuly 24, 2007. As of June 1, 2007, Mr. Wu was vested in optionsto purchase 780,000 shares of the Company’s common stock.

(12)Includes 660,980 shares owneddirectly plus an additional (i) 106,000 shares owned by the 2000 HuangFamily Limited Partnership, of which Mr. Huang is a general partner,(ii) 6,600 shares registered in the name of his son, and (iii) 6,600shares registered in the name of his daughter. Mr. Huang may be deemed thebeneficial owner of the shares held by his children. Also includes 378,230shares issuable upon exercise of options that are exercisable within 60 days ofOctober 1, 2007. Mr. Huang resigned as our Chief Technology Officerand Senior Vice President as of December 31, 2006. For a discussion onmodifications made to certain outstanding equity awards held by Mr. Huang,please see the section entitled “Executive Compensation—Modifications toOutstanding Equity Awards” contained in this Proxy Statement.

(13) Includes 100,000 shares owned directly, 50,000 of which are subjectto the Company’s right of repurchase which lapses as to 25,000 of the shares oneach of August 1, 2008 and August 1, 2009, and 317,001 sharesissuable upon exercise of options that are exercisable within 60 days ofOctober 1, 2007.

(14) Includes 61,376 shares owned directly and 85,675 shares issuableupon exercise of options that are exercisable within 60 days of October 1,2007.

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(15) Includes 41,376 shares owned directly and 1,775 shares owned byMr. Horner’s spouse. Also includes 229,175 shares issuable upon exerciseof options that are exercisable within 60 days of October 1, 2007.

(16) Includes 11,180 shares owned directly and 85,320 shares issuableupon exercise of options that are exercisable within 60 days of October 1,2007.

(17) Includes 10,952 shares owned directly and 173,990 shares issuableupon exercise of options that are exercisable within 60 days of October 1,2007.

(18) Includes 2,758,705 shares issuable uponexercise of options that are exercisable within 60 days of October 1,2007.

**ITEM 13—CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

**Policies withRespect to Review, Approval or Ratification of Transactions with RelatedPersons**

Our Audit Committeeis responsible for review, approval or ratification of “related-persontransactions” between us or our subsidiaries and related persons. Under SECrules, a related person is a director, officer, nominee for director, or 5%stockholder of UTStarcom since the beginning of the last fiscal year, and hisor her immediate family members. We have adopted written policies andprocedures that apply to any transaction or series of related transactions inwhich our company or a subsidiary is a participant, the amount involved exceeds$120,000 and a related person has a direct or indirect material interest. Pursuantto our policy, the following transactions will not be deemed to be relatedperson transactions that require Audit Committee approval:

·       *Employment of executiveofficers.  *Any employment by us of an executive officer of ourcompany if: (a) the related compensation is required to be reported in ourproxy statement under SEC compensation disclosure rules; or (b) theexecutive officer is not an immediate family member of another executiveofficer or director of our company, and the related compensation would havebeen reported in our proxy statement under SEC compensation disclosure rules ifthe executive officer was a “named executive officer,” and the CompensationCommittee approved (or recommended that the Board of Directors approve) suchcompensation.

·       *Director compensation.  *Anycompensation paid to a director if the compensation is required to be reportedin our proxy statement under SEC compensation disclosure rules.

·       *Certain transactions withother companies.  *Any transaction with another company at whicha related person’s only relationship is as an employee (other than an executiveofficer), director or beneficial owner of less than 10% of that company’sshares, if the aggregate amount involved does not exceed the greater of$1,000,000, or two percent of that company’s total annual revenues.

·       *Transactions where allshareholders receive proportional benefits.  *Any transactionwhere the related person’s interest arises solely from the ownership of a classof our equity securities and all holders of that class of our equity securitiesreceived the same benefit on a *pro rata*basis (*e*.*g*. dividends).

·       *Transactions involvingcompetitive bids.  *Any transaction involving a related personwhere the rates or charges involved are determined by competitive bids.

·       *Regulated transactions.  *Anytransaction with a related person involving the rendering of services as acommon or contract carrier, or public utility, at rates or charges fixed inconformity with law or governmental authority.

·       *Certain banking-relatedservices.  *Any transaction with a related person involvingservices as a bank depositary of funds, transfer agent, registrar, trusteeunder a trust indenture, or similar services.

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·       *Other Transactions.  *Any other transaction wheredisclosure of such transaction would not be required pursuant to Item 404 ofRegulation S-K, as may be amended from time-to-time.

**Related PartyTransactions**

During 2006, we were partyto the following related party transactions under the relevant standards:

*SOFTBANK CORP.*

SOFTBANK CORP. isan affiliate of SOFTBANK America, Inc., one of our  stockholders holding 10% or more of ourCommon stock. Since the beginning of the 2006 financial year, we engaged,continue to engage or propose to engage in the following transactions with entitiesaffiliated with SOFTBANK CORP.:

·       OnJuly 17, 2003, we entered into a Mezzanine Loan Agreement with BB ModemRental PLC (“BB Modem”), an affiliate of SOFTBANK CORP. Under the terms ofthe agreement, we loaned BB Modem $10.1 million at an effective interest rateof 12.01% per annum, for the purpose of investing in a portfolio of ADSL modemsand associated modem rental agreements, from Softbank BB Corporation (“SoftbankBB”), formerly BB Technologies, an affiliate of SOFTBANK America, Inc. Thebalance as of December 31, 2006 was $1.0 million, and the loan was paid infull in January 2007.

·       Weinvested $2.0 million in Restructuring Fund No. 1, a venture capitalinvestment limited partnership established by SOFTBANK INVESTMENT CORP., anaffiliate of SOFTBANK CORP. The limited partnership was dissolved in 2006 witha total cash distribution to us of $3.0 million.

·       We recognized aggregaterevenue of $130.8 million (includes $29.3 million sales to NEC Networks &System Integration Corp., Nippon Telecom Sales KK and Oki Electric IndustryCo., Ltd. for which Softbank was the ultimate customer) during 2006 withrespect to sales to affiliates of SOFTBANK CORP., including (i) sales oftelecommunications equipment to Softbank BB, (ii) sales of equipment andservices to Japan Telecom Co., Ltd, a wholly owned subsidiary of SOFTBANKCORP., and (iii) sales of equipment to BB Cable and BB Hikari Dept KK,affiliates of SOFTBANK CORP.

*Acoustek Int’lCorp.*

We obtain consulting services from Acoustek Int’lCorp. (“Acoustek”), which employs Minnie Huang, spouse of William Huang, theCompany’s former Senior Vice President and Chief Technology Officer. In 2006,we paid to Acoustek $134,810 for consulting services provided by Ms. Huang.

The Audit Committeereviewed and ratified each of the transactions described above.

**DirectorIndependence**

Of our six members of the Board of Directors, Messrs. Clarke,Horner, Lenzmeier and Toy have been determined by the Board to be independentas set forth in Rule 4200(a)(15) of the NASDAQ Marketplace Rules, thelisting standards of The NASDAQ Stock Market, as currently in effect. Eachmember of the Audit Committee, Nominating and Corporate Governance Committeeand Compensation Committee meets the applicable independence requirements ofthe NASDAQ Marketplace Rules and the SEC.

The Board has not established categorical standards orguidelines to make director independence determinations, but considers allrelevant facts and circumstances. The Board based its determinations 

263

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primarily on a review ofthe responses of the directors to questions regarding employment andcompensation history, affiliations, family and other relationships, and ondiscussions with our directors.

In making its independencedeterminations, the Board considered transactions between us and entitiesassociated with the independent directors or members of their immediate family.All identified transactions that appear to relate to us and a person or entitywith a known connection to a director are presented to the Board forconsideration. In making its determination that each non-employee director isindependent, the Board considered the transactions in the context of the NASDAQstandards, the special standards established by the SEC for members of auditcommittees, and the SEC and Internal Revenue Service standards for compensationcommittee members. The Board’s independence determinations included a review ofthe status of certain named executive officers as limited partners of aninvestment fund managed by Mr. Toy. In each case, the Board determinedthat, because of the nature of each of these relationships and/or amountsinvolved, the relationships did not impair Mr. Toy’s independence.

**ITEM 14—PRINCIPALACCOUNTING FEES AND SERVICES**

**PricewaterhouseCoopersLLP Fees for the Fiscal Years Ended December 31, 2006 and 2005**

Theaggregate fees billed for professional accounting services byPricewaterhouseCoopers LLP for the fiscal years ended December 31, 2006and 2005 are as follows:

| ** **             | ** ** | **Fiscal Year Ended  December 31,** | ** ** |
|------------------------|------------|----------------------------------------------------|------------|
| ** **             | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| Audit Fees(1)          |       | $                                                  | 16,253,000 |   | $ | 11,900,000 |   |
| Audit-Related  Fees(2) |       | 0                                                  |       | 1,000,000 |   |
| Tax Fees(3)            |       | 26,000                                             |       | 275,000 |   |
| All Other Fees(4)      |       | 3,000                                              |       | 7,000 |   |
| Total Fees             |       | $                                                  | 16,282,000 |   | $ | 13,182,000 |   |

 

----

(1)          Comprised of fees billedfor professional services rendered for the integrated audit of UTStarcom’sconsolidated financial statements and of its internal control over financialreporting, for review of the interim consolidated financial statements includedin quarterly reports, and for services that are normally provided byPricewaterhouseCoopers LLP in connection with statutory and regulatory filingsor engagements.  For 2006, also includesfees incurred in connection with the Company’s review of its historical stockoption granting practices and the related accounting and the review ofhistorical sales contracts in China.

(2)          For 2005, comprised ofdue diligence and other procedures performed with respect to certain of theCompany’s acquisitions, and accounting consultation.

(3)          Comprised of fees billedfor professional services for tax compliance, tax advice and tax planning.

(4)          Comprised of fees forresearch tools.

The Audit Committee hasdetermined that the provision to us by PricewaterhouseCoopers LLP of non-auditservices as listed above is compatible with PricewaterhouseCoopers LLPmaintaining its independence.

264

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**Audit CommitteePre-Approval Policies and Procedures**

The Audit Committee hasdirect responsibility for the appointment, retention, evaluation, compensation,oversight and termination of the independent registered public accounting firmemployed by us. In October 2003, the Audit Committee of the Boardestablished a Non-Audit Services Subcommittee. The Non-Audit ServicesSubcommittee, consisting of Mr. Horner, is authorized to preapprovenon-audit services to be performed by our independent public accountants inamounts not to exceed $50,000 per engagement. Non-audit services to beperformed by our independent registered public accounting firm in amounts toexceed $50,000 per engagement will be approved by the Audit Committee. For thefiscal year 2006, there were no audit-related fees, tax fees, or any othernon-audit fees that were approved by the Audit Committee pursuant to the “deminimis” exception under Regulation S-X Rule 2-01(c)(7)(i)(C).

**PART IV**

**ITEM 15—EXHIBITSAND FINANCIAL STATEMENT SCHEDULES**
| (a)    | (1) | Financial Statements—See Index to Consolidated  Financial Statements and Financial Statement Schedules at page 127 of  this Form 10-K.              |
|--------|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | (2) | Financial Statement Schedule—See Index to  Consolidated Financial Statements and Financial Statement Schedules at  page 108 of this Form 10-K. |

 

| Exhibit Number | ** ** | **Description**                                                                                                                                                                                                                | ** ** | **Form**        | ** ** | **Incorporated by   Reference From   Exhibit Number** | ** ** | **Date Filed** |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|------------------------------------------------------------|------------|----------------|
| 3.1                 |       | Thirteenth Amended and Restated Certificate of Incorporation  of UTStarcom, Inc., as amended.                                                                                                                             |       | 8-K             |       | 3.1                                                        |       | 12/12/03       |
| 3.2                 |       | First Amended and  Restated Bylaws of UTStarcom, Inc., as amended July 13, 2007.                                                                                                                                     |       | Filed  herewith |       |                                                       |       |           |
| 4.1                 |       | See exhibits 3.1  and 3.2 for provisions of the Certificate of Incorporation and Bylaws  defining the rights of holders of Common Stock.                                                                             |       | —          |       | —                                                     |       | —         |
| 4.2                 |       | Specimen Common Stock  Certificate.                                                                                                                                                                                            |       | S-1/A           |       | 4.1                                                        |       | 2/7/00         |
| 4.3                 |       | Third Amended and  Restated Registration Rights Agreement dated December 14, 1999.                                                                                                                                   |       | S-1             |       | 4.2                                                        |       | 12/20/99       |
| 4.4                 |       | Convertible Subordinated  Notes Indenture dated as of March 12, 2003 between UTStarcom, Inc.  and U.S. Bank National Association, including the form of the 7¤8%  Convertible Subordinated Notes due 2008. |       | 10-Q            |       | 4.4                                                        |       | 5/12/03        |
| 4.5                 |       | First Supplemental  Indenture, dated January 9, 2007, by and between the Company and U.S.  Bank National Association.                                                                                                     |       | 8-K             |       | 99.2                                                       |       | 1/10/07        |

265

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| 4.6    |   | Underwriting Agreement, dated January 8, 2004  between the Company and Bank of America Securities LLC, as amended on  January 14, 2004.                                                                                  |   | 10-K |   | 4.7   |   | 4/15/05  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------|--------|-------|--------|----------|
| 4.7    |   | Consent Solicitation  Statement dated December 22, 2006 related to the Company’s 7¤8%  Convertible Subordinated Notes due 2008                                                                                           |   | 8-K  |   | 99.2  |   | 12/22/06 |
| 4.8    |   | Amended Letter of  Consent related to the Company’s 7¤8%  Convertible Subordinated Notes due 2008                                                                                                                             |   | 8-K  |   | 99.3  |   | 1/8/07   |
| 4.9    |   | Supplemental Consent  Solicitation Statement dated January 8, 2007 related to the Company’s 7¤8%  Convertible Subordinated Notes due 2008                                                                                |   | 8-K  |   | 99.2  |   | 1/8/07   |
| 4.10   |   | Second Consent  Solicitation Statement dated July 19, 2007 relating to the Company’s  Convertible Subordinated Notes due 2008                                                                                                 |   | 8-K  |   | 99.2  |   | 7/19/07  |
| 4.11   |   | Letter of Consent  relating to the Company’s Convertible Subordinated Notes due 2008.                                                                                                                                              |   | 8-K  |   | 99.3  |   | 7/19/07  |
| 4.12   |   | Second Supplemental  Indenture, dated July 26, 2007, by and between the Company and U.S. Bank  National Association                                                                                                                |   | 8-K  |   | 99.1  |   | 7/30/07  |
| 10.1   |   | Form of  Indemnification Agreement.                                                                                                                                                                                                |   | S-1  |   | 10.1  |   | 12/20/99 |
| 10.2*  |   | 1997 Stock Plan, as  amended, and forms of related agreements.                                                                                                                                                                          |   | 10-K |   | 10.4  |   | 6/1/06   |
| 10.3*  |   | 2000 Employee Stock  Purchase Plan and forms of related agreements.                                                                                                                                                                     |   | S-1  |   | 10.5  |   | 12/20/99 |
| 10.4++ |   | 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-Q |   | 10.2  |   | 8/14/00  |
| 10.5*  |   | Amended 2001 Director  Option Plan and forms of related agreements.                                                                                                                                                                     |   | 10-K |   | 10.66 |   | 6/1/06   |
| 10.11* |   | UTStarcom, Inc. 2003  Nonstatutory Stock Option Plan.                                                                                                                                                                         |   | S-8  |   | 4.4   |   | 9/15/03  |

266

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| 10.12* |   | Change of Control  Severance Agreement, dated as of January 17, 2003, by and between Hong  Liang Lu and UTStarcom, Inc.                                                                                                                                     |   | 10-K |   | 10.89  |   | 3/9/04  |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------|--------|--------|--------|---------|
| 10.13+ |   | Infrastructure Equipment  License Agreement between Qualcomm Inc. and UTStarcom, Inc., dated  January 30, 2004.                                                                                                                                        |   | 10-Q |   | 10.97  |   | 5/10/04 |
| 10.14+ |   | Subscriber Unit License  Agreement between Qualcomm Inc. and UTStarcom, Inc., dated  January 30, 2004.                                                                                                                                                 |   | 10-Q |   | 10.98  |   | 5/10/04 |
| 10.15  |   | Asset Purchase Agreement  by and among Audiovox Communications Corp., Quintex Mobile Communications  Corporation, Audiovox Communications Canada Co., UTStarcom, Inc.,  UTStarcom Canada Company and Audiovox Corporation, dated as of June 11,  2004. |   | 10-Q |   | 10.101 |   | 8/16/04 |
| 10.17* |   | Agreement by and between  Francis P. Barton and UTStarcom, Inc., dated July 29, 2005.                                                                                                                                                                  |   | 8-K  |   | 10.3   |   | 9/12/05 |
| 10.18* |   | Form of Restricted  Stock Agreement for use under the Company’s 1997 Stock Plan.                                                                                                                                                                            |   | 8-K  |   | 10.1   |   | 9/12/05 |
| 10.19* |   | Form of Director  and Officer Stock Option Agreement for use under the Company’s 1997 Stock  Plan                                                                                                                                                           |   | 8-K  |   | 10.1   |   | 12/6/05 |
| 10.20* |   | UTStarcom, Inc.  2006 Equity Incentive Plan (2006 EIP).                                                                                                                                                                                                          |   | 8-K  |   | 10.1   |   | 7/27/06 |
| 10.21* |   | Form of Stock  Option Award Agreement for 2006 EIP.                                                                                                                                                                                                              |   | 8-K  |   | 10.2   |   | 7/27/06 |
| 10.22* |   | Form of Stock  Option Award Agreement for Directors and Officers for 2006 EIP.                                                                                                                                                                                   |   | 8-K  |   | 10.3   |   | 7/27/06 |
| 10.23* |   | Form of Restricted  Stock Agreement for 2006 EIP.                                                                                                                                                                                                                |   | 8-K  |   | 10.4   |   | 7/27/06 |
| 10.24* |   | Form of Restricted  Stock Unit Agreement for 2006 EIP.                                                                                                                                                                                                           |   | 8-K  |   | 10.5   |   | 7/27/06 |

267

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| 10.25* |   | Severance Agreement and  Release by and between Michael J. Sophie and UTStarcom, Inc. dated  April 13, 2006.                                                          |   | 10-Q           |   | 10.10  |   | 10/10/07 |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------|--------|--------|--------|----------|
| 10.26* |   | Amended and Restated Change of  Control/Involuntary Termination Severance Agreement by and between  William X. Huang and UTStarcom, Inc. dated August 21, 2006.  |   | 10-Q           |   | 10.15  |   | 10/10/07 |
| 10.27* |   | Amended and Restated Change of  Control/Involuntary Termination Severance Agreement by and between  Francis P. Barton and UTStarcom, Inc. dated August 23, 2006. |   | 10-Q           |   | 10.14  |   | 10/10/07 |
| 10.28* |   | Amended and Restated Change of  Control/Involuntary Termination Severance Agreement by and between Ying Wu  and UTStarcom, Inc. dated November 14,  2006.             |   | Filed herewith |   |   |   |     |
| 10.29* |   | Form of Stock Option Amendment Election Form executed by key  executive officers and directors.                                                                       |   | 8-K            |   | 10.1   |   | 1/4/07   |
| 10.30* |   | Stock Option Amendment Election  Form executed by Hong Liang Lu on December 29, 2006.                                                                                 |   | 8-K            |   | 10.2   |   | 1/4/07   |
| 10.31* |   | Stock Option Amendment Election  Form executed by Ying Wu on December 29, 2006.                                                                                       |   | 8-K            |   | 10.3   |   | 1/4/07   |
| 10.32* |   | Stock Option Amendment Election  Form executed by William X. Huang on December 29, 2006.                                                                              |   | 8-K            |   | 10.4   |   | 1/4/07   |
| 10.33* |   | Offer Letter to Viraj Patel dated  November 2, 2005.                                                                                                                       |   | 10-Q           |   | 10.6   |   | 10/10/07 |
| 10.34* |   | Offer Letter to Mark Green dated  December 19, 2005.                                                                                                                       |   | 10-Q           |   | 10.7   |   | 10/10/07 |
| 10.35* |   | Offer Letter to David King dated  April 3, 2006.                                                                                                                           |   | 10-Q           |   | 10.8   |   | 10/10/07 |
| 10.36* |   | Employment Agreement by and between Philip  Christopher and UTStarcom, Inc. dated June 11, 2004.                                                                      |   | 10-Q           |   | 10.9   |   | 10/10/07 |

268

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| 10.37++ |   | Strategic Alliance  Agreement by and between Pantech & Curitel Communications and  UTStarcom Personal Communications LLC dated September 25, 2006.                                                                                                                                                                                                                                                                                                                                                                                                              |   | 10-Q            |   | 10.11  |   | 10/10/07 |
|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------|--------|--------|--------|----------|
| 10.38*  |   | UTStarcom, Inc. Vice President Change  in Control and Involuntary Termination Severance Pay Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   | 10-Q            |   | 10.12  |   | 10/10/07 |
| 10.39*  |   | UTStarcom, Inc. Executive Involuntary  Termination Severance Pay Plan                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |   | 10-Q            |   | 10.13  |   | 10/10/07 |
| 21.1    |   | Subsidiaries of  UTStarcom.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   | Filed  herewith |   |   |   |     |
| 24.1    |   | Power of Attorney  (included on signature page).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   | Filed  herewith |   |   |   |     |
| 31.1    |   | Certification of CEO  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   | Filed  herewith |   |   |   |     |
| 31.2    |   | Certification of CFO  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   | Filed  herewith |   |   |   |     |
| 32.1    |   | Certifications Pursuant to 18 U.S.C.  Section 1350, As Adopted Pursuant To Section 906 of the Sarbanes-Oxley  Act of 2002.                                                                                                                                                                                                                                                                                                                                                                                                                                     |   | Filed herewith  |   |   |   |     |
| 99.1    |   | Restated Condensed Consolidated Statements  of Operations for the periods ended June 30, 3006, March 31, 2006,  December 31, 2005, September 30, 2005, June 30, 2005 and  March 31, 2005; Restated Condensed Consolidated Balance Sheets at  June 30, 2006, March 31, 2006, September 30, 2005, June 30,  2005, March 31, 2005, and December 31, 2004; and Restated  Condensed Consolidated Statements of Cash Flows for the six months ended  June 30, 2006 and the three months ended March 31, 2006. |   | Filed herewith  |   |   |   |     |

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*                    Managementcontract, plan or arrangement

+                Portions of theexhibit have been omitted pursuant to an order granted by the Securities andExchange Commission for confidential treatment.

++     Portions of the exhibit havebeen omitted pursuant to a request for confidential treatment filed with theSecurities and Exchange Commission.

269

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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 Annual Report on Form 10-Kfor the year ended December 31, 2006 to be signed on its behalf by theundersigned, thereunto duly authorized.
|                        | UtsTARCOM, INC. |
|------------------------|----------------------|
| Date: October 10, 2007 | By:                  | /s/  FRANCIS P. BARTON |
|                   | Name:                | Francis P. Barton |
|                   | Title:               | *Executive  Vice President and  Chief Financial Officer* |

 

**POWER OF ATTORNEY**

KNOW ALL PERSONS BY THESE PRESENT, that each personwhose signature appears below constitutes and appoints Hong Liang Lu andFrancis P. Barton, jointly and severally, his or her attorneys-in-fact,each with the power of substitution, for him in any and all capacities, to signany amendments to this report on Form 10-K, and to file the same, with exhibitsthereto and other documents in connection therewith with the Securities andExchange Commission, hereby ratifying and confirming all that each of saidattorneys-in-fact, or his substitute or substitutes may do or cause to be doneby virtue hereof. 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant and in thecapacities and on the dates indicated:
|                       | **Name** | ** **                                                    | ** ** | ** **       | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|-----------------------|----------|---------------------------------------------------------------|------------|------------------|-----------|------------|------------|------------|----------|------------|
| /s/ HONG LIANG LU     |     | Chief Executive  Officer and Director                         |       | October 10, 2007 |
| Hong Liang Lu         |     | (principal executive officer)                                 |       |             |
| /s/ FRANCIS P. BARTON |     | Executive Vice  President, Chief                              |       | October 10, 2007 |
| Francis P. Barton     |     | Financial Officer  (principal financial officer) and Director |       |             |
| /s/ VIRAJ J. PATEL    |     | Vice President,  Corporate Controller                         |       | October 10, 2007 |
| Viraj J. Patel        |     | and Chief  Accounting Officer (principal accounting officer)  |       |             |
| /s/ THOMAS J. TOY     |     | Chairman of the  Board of Directors                           |       | October 10, 2007 |
| Thomas J. Toy         |     |                                                          |       |             |
| /s/ JEFF CLARKE       |     | Director                                                      |       | October 10, 2007 |
| Jeff Clarke           |     |                                                          |       |             |
| /s/ LARRY D. HORNER   |     | Director                                                      |       | October 10, 2007 |
| Larry D. Horner       |     |                                                          |       |             |
| /s/ ALLEN LENZMEIER   |     | Director                                                      |       | October 10, 2007 |
| Allen Lenzmeier       |     |                                                          |       |             |

 

270

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**SCHEDULE I**

**UTSTARCOM, INC.(UNCONSOLIDATED—PARENT COMPANY BASIS)REGISTRANT BALANCE SHEETS(in thousands, except share data)**

| ** **                                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                         | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                         | ** ** | ** **            | ** ** | **(As restated)** | ** ** |
| **ASSETS**                                                                                                                                                                         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Current assets:                                                                                                                                                                    |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                         |       | $                     | 147,439    |   | $ | 133,203 |   |
| Accounts  receivable-unrelated party, net of allowances for doubtful accounts                                                                                                      |       | 8,368                 |       | 20,934 |   |
| Accounts  receivable-related party                                                                                                                                                 |       | 30,825                |       | 80,652 |   |
| Accounts  receivable-intercompany                                                                                                                                                  |       | 600,265               |       | 629,287 |   |
| Inventories                                                                                                                                                                        |       | 13,900                |       | 26,565 |   |
| Deferred costs                                                                                                                                                                     |       | 65,950                |       | 82,191 |   |
| Prepaids and other  current assets                                                                                                                                                 |       | 29,198                |       | 31,639 |   |
| Restricted cash and  investments                                                                                                                                                   |       | 16,194                |       | 53,308 |   |
| Total current assets                                                                                                                                                               |       | 912,139               |       | 1,057,779 |   |
| Property, plant and  equipment, net                                                                                                                                                |       | 12,549                |       | 18,141 |   |
| Investment in affiliated  companies                                                                                                                                                |       | 350,718               |       | 238,079 |   |
| Goodwill                                                                                                                                                                           |       | 3,063                 |       | 3,063 |   |
| Intangible assets, net                                                                                                                                                             |       | 31,973                |       | 41,877 |   |
| Other long-term assets                                                                                                                                                             |       | 27,856                |       | 14,501 |   |
| Total assets                                                                                                                                                                       |       | $                     | 1,338,298  |   | $ | 1,373,440 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                     |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                               |       |                  |       |   |   |
| Accounts payable-unrelated  party                                                                                                                                                  |       | $                     | 50,849     |   | $ | 31,279 |   |
| Accounts  payable-intercompany                                                                                                                                                     |       | 23,245                |       | 17,160 |   |
| Income taxes payable                                                                                                                                                               |       | 2,056                 |       | 1,591 |   |
| Customer advances                                                                                                                                                                  |       | 48,317                |       | 80,175 |   |
| Deferred revenue                                                                                                                                                                   |       | 18,078                |       | 7,989 |   |
| Other                                                                                                                                                                              |       | 115,207               |       | 112,512 |   |
| Total current  liabilities                                                                                                                                                         |       | 257,752               |       | 250,706 |   |
| Long-term deferred  revenue                                                                                                                                                        |       | 31,586                |       | 21,485 |   |
| Convertible subordinated  notes                                                                                                                                                    |       | 274,600               |       | 274,600 |   |
| Total liabilities                                                                                                                                                                  |       | 563,938               |       | 546,791 |   |
| Stockholders’ equity:                                                                                                                                                         |       |                  |       |   |   |
| Common stock:  $.00125 par value; authorized: 750,000,000 shares; issued and  outstanding: 121,299,113 and 121,018,036 at December 31, 2006 and 2005,  respectively |       | 152                   |       | 152 |   |
| Additional paid-in  capital                                                                                                                                                        |       | 1,205,592             |       | 1,192,201 |   |
| Deferred stock  compensation                                                                                                                                                       |       | —                |       | (3,591 | ) |
| Retained earnings                                                                                                                                                                  |       | (494,244              | )          | (376,899 | ) |
| Accumulated other  comprehensive income                                                                                                                                            |       | 62,899                |       | 14,786 |   |
| Treasury stock                                                                                                                                                                     |       | (39                   | )          | — |   |
| Total stockholders’  equity                                                                                                                                                   |       | 774,360               |       | 826,649 |   |
| Total liabilities and stockholders’ equity                                                                                                                                    |       | $                     | 1,338,298  |   | $ | 1,373,440 |   |

 

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

271

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**SCHEDULE I**

**UTSTARCOM,INC. (UNCONSOLIDATED—PARENT COMPANY BASIS)**

**CONDENSEDINFORMATION AS TO THE RESULTS OF OPERATIONS OF THE REGISTRANT**

**(inthousands)**

| ** **                                           | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                           | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| Net sales:                                      |       |                                        |       |   |   |   |   |   |   |   |   |
| Unrelated party                                      |       | $                                           | 131,292    |   |   | $ | 103,168 |   |   |   | $ | 100,942 |   |   |
| Related party                                        |       | 129,782                                     |       |   | 266,665 |   |   |   | 143,164 |   |   |
| Intercompany                                         |       | 129,326                                     |       |   | 140,785 |   |   |   | 571,001 |   |   |
|                                                 |       | 390,400                                     |       |   | 510,618 |   |   |   | 815,107 |   |   |
| Cost of net sales:                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| Unrelated party                                      |       | 148,015                                     |       |   | 129,737 |   |   |   | 67,704 |   |   |
| Related party                                        |       | 80,450                                      |       |   | 147,380 |   |   |   | 91,409 |   |   |
| Intercompany                                         |       | 125,920                                     |       |   | 124,372 |   |   |   | 449,199 |   |   |
| Gross profit                                         |       | 36,015                                      |       |   | 109,129 |   |   |   | 206,795 |   |   |
| Operating  expenses:                                 |       |                                        |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative                  |       | 150,170                                     |       |   | 133,411 |   |   |   | 103,784 |   |   |
| Research and development                             |       | 181                                         |       |   | 63,532 |   |   |   | 39,719 |   |   |
| Amortization of intangible assets                    |       | 9,904                                       |       |   | 11,090 |   |   |   | 12,668 |   |   |
| Impairment of long-lived assets                      |       | —                                      |       |   | 105,874 |   |   |   | — |   |   |
| Restructuring                                        |       | —                                      |       |   | 13,111 |   |   |   | — |   |   |
| In-process research and development                  |       | —                                      |       |   | 660 |   |   |   | 1,400 |   |   |
| Total operating  expenses                            |       | 160,255                                     |       |   | 327,678 |   |   |   | 157,571 |   |   |
| Operating income  (loss)                             |       | (124,240                                    | )          |   | (218,549 | ) |   |   | 49,224 |   |   |
| Interest income                                      |       | 8,327                                       |       |   | 4,559 |   |   |   | 12,349 |   |   |
| Interest expense                                     |       | (4,516                                      | )          |   | (5,469 | ) |   |   | (4,819 | ) |   |
| Gain on  extinguishment of subordinated notes        |       | —                                      |       |   | 31,392 |   |   |   | — |   |   |
| Other income  (expense), net                         |       | (52,942                                     | )          |   | (13,004 | ) |   |   | (29,943 | ) |   |
| Equity in net  (loss) income of affiliated companies |       | 60,182                                      |       |   | (273,588 | ) |   |   | (5,070 | ) |   |
| (Loss) income  before income taxes                   |       | (113,189                                    | )          |   | (474,659 | ) |   |   | 21,741 |   |   |
| Income tax  benefit (expense)                        |       | (4,156                                      | )          |   | (57,986 | ) |   |   | 29,108 |   |   |
| Net (loss) income                                    |       | $                                           | (117,345   | ) |   | $ | (532,645 | ) |   |   | $ | 50,849 |   |   |

 

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

272

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**SCHEDULE I**

**UTSTARCOM, INC.(UNCONSOLIDATED—PARENT COMPANY BASIS)CONDENSED INFORMATION AS TO THE CASH FLOWS OF THE REGISTRANT(In thousands)**

| ** **                                                                                          | ** ** | **Years ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                          | ** ** | **2006**                                    | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                          | ** ** | ** **                                  | ** ** | **(As restated)** | ** ** | **(As restated)** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                               | ** ** | ** **                                  | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net (loss) income                                                                                   |       | $                                           | (117,345   | ) |   | $ | (532,645 | ) |   |   | $ | 50,849 |   |   |
| Adjustments to reconcile  net income (loss) to net cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |   |   |   |   |
| Depreciation and amortization                                                                       |       | 23,931                                      |       |   | 29,497 |   |   |   | 34,219 |   |   |
| Stock-based  compensation expense                                                                   |       | 16,592                                      |       |   | 863 |   |   |   | 109 |   |   |
| Gain (loss) on  sale of assets                                                                      |       | (14,818                                     | )          |   | 147 |   |   |   | 1,672 |   |   |
| Impairment of  long-lived asset                                                                     |       | —                                      |       |   | 105,874 |   |   |   | — |   |   |
| Non-cash  restructuring charges                                                                     |       | —                                      |       |   | 7,948 |   |   |   | — |   |   |
| In-process  research and development costs                                                          |       | —                                      |       |   | 660 |   |   |   | 1,400 |   |   |
| Gain on sale of  investment                                                                         |       | —                                      |       |   | (48,076 | ) |   |   | — |   |   |
| Impairment of  long-term investments                                                                |       | 13,500                                      |       |   | — |   |   |   | — |   |   |
| Provision for  recovery of doubtful accounts                                                        |       | (1,150                                      | )          |   |   |   |   |   |   |   |   |
| Provision for  inventory reserve                                                                    |       | 27,154                                      |       |   | 10,173 |   |   |   | 8,640 |   |   |
| Gain on  extinguishment of debt                                                                     |       | —                                      |       |   | (31,392 | ) |   |   | — |   |   |
| Deferred income  taxes                                                                              |       | —                                      |       |   | 42,095 |   |   |   | (11,469 | ) |   |
| Equity in (net  income) loss of affiliated companies                                                |       | (60,182                                     | )          |   | 273,588 |   |   |   | 5,058 |   |   |
| Other                                                                                               |       | 2,050                                       |       |   | (2,763 | ) |   |   | 5,027 |   |   |
| Changes in operating  assets and liabilities:                                                       |       |                                        |       |   |   |   |   |   |   |   |   |
| Accounts  receivable                                                                                |       | 92,566                                      |       |   | 37,308 |   |   |   | (242,980 | ) |   |
| Inventories                                                                                         |       | 11,115                                      |       |   | (2,329 | ) |   |   | (18,960 | ) |   |
| Deferred costs                                                                                      |       | (10,913                                     | )          |   | 7,747 |   |   |   | (43,361 | ) |   |
| Other assets                                                                                        |       | (481                                        | )          |   | 26,296 |   |   |   | (34,363 | ) |   |
| Accounts payable                                                                                    |       | 25,655                                      |       |   | (36,291 | ) |   |   | 27,146 |   |   |
| Income taxes  payable                                                                               |       | 465                                         |       |   | (22,590 | ) |   |   | 20,109 |   |   |
| Customer advances                                                                                   |       | (31,858                                     | )          |   | 20,026 |   |   |   | 22,835 |   |   |
| Deferred revenue                                                                                    |       | 6,331                                       |       |   | 13,554 |   |   |   | (10,342 | ) |   |
| Other current  liabilities                                                                          |       | (4,174                                      | )          |   | 74,156 |   |   |   | 5,339 |   |   |
| Net cash provided  by (used in) operating activities                                                |       | (21,562                                     | )          |   | (26,154 | ) |   |   | (179,072 | ) |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Additions to  property, plant and equipment                                                         |       | (8,945                                      | )          |   | (9,092 | ) |   |   | (13,710 | ) |   |
| Investment in  affiliates, net of cash acquired                                                     |       | (13,179                                     | )          |   | (3,795 | ) |   |   | (57,150 | ) |   |
| Acquisition of  business, net of cash acquired                                                      |       | —                                      |       |   | (5,356 | ) |   |   | (33,185 | ) |   |
| Proceeds from sale  of semiconductor design assets                                                  |       | 35,965                                      |       |   | — |   |   |   | — |   |   |
| Purchase of  intangible assets                                                                      |       | (908                                        | )          |   | (750 | ) |   |   | (4,158 | ) |   |
| Change in  restricted cash                                                                          |       | 20,976                                      |       |   | (18,473 | ) |   |   | (12,459 | ) |   |
| Purchase of  short-term investments                                                                 |       | —                                      |       |   | (14,132 | ) |   |   | (55,379 | ) |   |
| Sales of  short-term investments                                                                    |       | —                                      |       |   | 89,770 |   |   |   | 61,086 |   |   |
| Other                                                                                               |       | 1,538                                       |       |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) investing activities                                                |       | 35,447                                      |       |   | 38,172 |   |   |   | (114,955 | ) |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Issuance of stock,  net of expenses                                                                 |       | 390                                         |       |   | 6,952 |   |   |   | 25,736 |   |   |
| Repurchase of  stock                                                                                |       | (39                                         | )          |   | — |   |   |   | (107,569 | ) |   |
| Proceeds from  equity offering                                                                      |       | —                                      |       |   | — |   |   |   | 474,554 |   |   |
| (Purchase)  settement of convertible bond hedge and call option                                     |       | —                                      |       |   | 1,445 |   |   |   | — |   |   |
| Cash paid to  extinguish debt                                                                       |       | —                                      |       |   | (57,136 | ) |   |   | — |   |   |
| Other                                                                                               |       | —                                      |       |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) financing activities                                                |       | 351                                         |       |   | (48,739 | ) |   |   | 392,721 |   |   |
| Net increase  (decrease) in cash and cash equivalents                                               |       | 14,236                                      |       |   | (36,721 | ) |   |   | 98,694 |   |   |
| Cash and cash  equivalents at beginning of period                                                   |       | 133,203                                     |       |   | 169,924 |   |   |   | 71,230 |   |   |
| Cash and cash  equivalents at end of period                                                         |       | $                                           | 147,439    |   |   | $ | 133,203 |   |   |   | $ | 169,924 |   |   |

 

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

273

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

**NOTE 1—BASIS OFPRESENTATION**

UTStarcom, Inc., aDelaware corporation, is the parent company of all UTStarcom, Inc.subsidiaries. The accompanying condensed financial statements reflect thefinancial position, results of operations and cash flows of UTStarcom, Inc.on a separate, parent company basis. All subsidiaries of UTStarcom, Inc.are reflected as investments accounted for using the equity method.Accordingly, inter-company transactions have not been eliminated.Inventory balances at December 31, 2006 and 2005 include intercompanyprofit of $2.6 million and $1.9 million, respectively. No cashdividends were paid to UTStarcom, Inc. by its subsidiaries during thethree years ended December 31, 2006. For accounting policies and otherinformation, see the Notes to Consolidated Financial Statements includedelsewhere herein.

**NOTE 2—RESTATEMENTOF FINANCIAL STATEMENTS**

The Company has restated its previously issuedconsolidated financial statements for the years ended December 31, 2005and 2004. Accordingly, the registrant’s balance sheet as of December 31,2005 and condensed information as to the registrant’s results of operations forthe years ended December 31, 2005 and 2004 have been restated from amountspreviously reported. See Note 2 to the Consolidated Financial Statements forfurther information concerning the restatement, including the impact of allrestatements adjustments reflected on the consolidated financial statementswhich have been similarly reflected in the restated condensed financial statements.Additionally, in these parent company basis financial statements, the Companyhas corrected the income tax expense for 2005 and 2004 to include the impact ofthe Company’s branch operations in foreign jurisdictions, consistent with the2006 methodology. This correction reduced both tax expense and equity in netincome of affiliated companies by $36.4 million and $0.6 million for the yearsended December 31, 2005 and 2004, respectively, with no impact on netincome. The registrant’s balance sheet at December 31, 2005 was adjustedas a result of this correction of the tax provision, reducing investment inaffiliates by $66.6 million, increasing income taxes payable by $1.0 millionand reducing other current liabilities by $67.6 million.

274

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**UTSTARCOM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)**

Thefollowing tables summarize the impact of all restatement adjustments onpreviously issued condensed information as to the results of operations of theregistrant for the years ended December 31, 2005 and 2004:

| ** **                                    | ** ** | **Year ended December 31, 2005** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **As previously  reported**                     | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                              | ** ** |
| Net sales                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Unrelated parties                             |       |                                                 | $          | 183,295 |   |   |   | $ | (80,127 | ) |   | $ | 103,168 |   |
| Related parties                               |       |                                                 | 186,404    |   |   |   | 80,261 |   |   | 266,665 |   |
| Intercompany                                  |       |                                                 | 140,785    |   |   |   | — |   |   | 140,785 |   |
|                                          |       |                                                 | 510,484    |   |   |   | 134 |   |   | 510,618 |   |
| Cost of sales                                 |       |                                                 |       |   |   |   |   |   |   |   |   |
| Unrelated parties                             |       |                                                 | 170,932    |   |   |   | (41,195 | ) |   | 129,737 |   |
| Related parties                               |       |                                                 | 106,147    |   |   |   | 41,233 |   |   | 147,380 |   |
| Intercompany                                  |       |                                                 | 124,372    |   |   |   | — |   |   | 124,372 |   |
| Gross profit                                  |       |                                                 | 109,033    |   |   |   | 96 |   |   | 109,129 |   |
| Operating expenses:                           |       |                                                 |       |   |   |   |   |   |   |   |   |
| Selling, general and administrative           |       |                                                 | 134,236    |   |   |   | (825 | ) |   | 133,411 |   |
| Research and development                      |       |                                                 | 63,854     |   |   |   | (322 | ) |   | 63,532 |   |
| Amortization of intangible assets             |       |                                                 | 11,090     |   |   |   | — |   |   | 11,090 |   |
| Impairment of long-lived assets               |       |                                                 | 105,874    |   |   |   | — |   |   | 105,874 |   |
| Restructuring                                 |       |                                                 | 13,111     |   |   |   | — |   |   | 13,111 |   |
| In-process research and development           |       |                                                 | 660        |   |   |   | — |   |   | 660 |   |
| Total operating  expenses                     |       |                                                 | 328,825    |   |   |   | (1,147 | ) |   | 327,678 |   |
| Operating (loss) income                       |       |                                                 | (219,792   | ) |   |   | 1,243 |   |   | (218,549 | ) |
| Interest income                               |       |                                                 | 4,559      |   |   |   | — |   |   | 4,559 |   |
| Interest expense                              |       |                                                 | (5,469     | ) |   |   | — |   |   | (5,469 | ) |
| Gain on  extinguishment of subordinated notes |       |                                                 | 31,392     |   |   |   | — |   |   | 31,392 |   |
| Other expense,  net                           |       |                                                 | (13,004    | ) |   |   | — |   |   | (13,004 | ) |
| Equity in net  (loss) of affiliated companies |       |                                                 | (194,800   | ) |   |   | (78,788 | ) |   | (273,588 | ) |
| (Loss) income  before income taxes            |       |                                                 | (397,114   | ) |   |   | (77,545 | ) |   | (474,659 | ) |
| Income tax  benefit (expense)                 |       |                                                 | (90,245    | ) |   |   | 32,259 |   |   | (57,986 | ) |
| Net loss                                      |       |                                                 | $          | (487,359 | ) |   |   | $ | (45,286 | ) |   | $ | (532,645 | ) |

 

275

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**UTSTARCOM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)**

** **

| ** **                                    | ** ** | **Year Ended December 31, 2004** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                    | ** ** | **As previously  reported**                     | ** ** | **Adjustments** | ** ** | **As restated** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                              | ** ** |
| Net sales                                     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Unrelated parties                             |       |                                                 | $          | 100,808 |   |   |   | $ | 134 |   |   |   | $ | 100,942 |   |   |
| Related parties                               |       |                                                 | 143,164    |   |   |   | — |   |   |   | 143,164 |   |   |
| Intercompany                                  |       |                                                 | 571,001    |   |   |   | — |   |   |   | 571,001 |   |   |
|                                          |       |                                                 | 814,973    |   |   |   | 134 |   |   |   | 815,107 |   |   |
| Cost of sales                                 |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Unrelated parties                             |       |                                                 | 67,578     |   |   |   | 126 |   |   |   | 67,704 |   |   |
| Related parties                               |       |                                                 | 91,409     |   |   |   | — |   |   |   | 91,409 |   |   |
| Intercompany                                  |       |                                                 | 449,199    |   |   |   | — |   |   |   | 449,199 |   |   |
| Gross profit                                  |       |                                                 | 206,787    |   |   |   | 8 |   |   |   | 206,795 |   |   |
| Operating expenses:                           |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Selling, general and administrative           |       |                                                 | 103,706    |   |   |   | 78 |   |   |   | 103,784 |   |   |
| Research and development                      |       |                                                 | 39,687     |   |   |   | 32 |   |   |   | 39,719 |   |   |
| Amortization of intangible assets             |       |                                                 | 12,668     |   |   |   | — |   |   |   | 12,668 |   |   |
| Impairment of long-lived assets               |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |
| Restructuring                                 |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |
| In-process research and development           |       |                                                 | 1,400      |   |   |   | — |   |   |   | 1,400 |   |   |
| Total operating  expenses                     |       |                                                 | 157,461    |   |   |   | 110 |   |   |   | 157,571 |   |   |
| Operating (loss) income                       |       |                                                 | 49,326     |   |   |   | (102 | ) |   |   | 49,224 |   |   |
| Interest income                               |       |                                                 | 12,349     |   |   |   | — |   |   |   | 12,349 |   |   |
| Interest expense                              |       |                                                 | (4,819     | ) |   |   | — |   |   |   | (4,819 | ) |   |
| Gain on  extinguishment of subordinated notes |       |                                                 | —     |   |   |   | — |   |   |   | — |   |   |
| Other expense,  net                           |       |                                                 | (29,943    | ) |   |   | — |   |   |   | (29,943 | ) |   |
| Equity in net  (loss) of affiliated companies |       |                                                 | 14,125     |   |   |   | (19,195 | ) |   |   | (5,070 | ) |   |
| (Loss) income  before income taxes            |       |                                                 | 41,038     |   |   |   | (19,297 | ) |   |   | 21,741 |   |   |
| Income tax  benefit (expense)                 |       |                                                 | 28,786     |   |   |   | 322 |   |   |   | 29,108 |   |   |
| Net income (loss)                             |       |                                                 | $          | 69,824 |   |   |   | $ | (18,975 | ) |   |   | $ | 50,849 |   |   |

 

276

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**UTSTARCOM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)**

Thefollowing table presents the impact of the restatement adjustments on thepreviously issued registrant balance sheet as of December 31, 2005:

| ** **                                                                                                                                                                              | ** ** | **Year Ended December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **As previously  reported**                     | ** ** | **Adjustments** | ** ** | **Restated** | ** ** |
| ** **                                                                                                                                                                              | ** ** | **(in thousands)**                              | ** ** |
| Current assets:                                                                                                                                                                         |       |                                                 |       |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                               |       |                                                 | $          | 133,203 |   |   |   | $ | — |   |   | $ | 133,203 |   |
| Short-term investments                                                                                                                                                                  |       |                                                 | —     |   |   |   | — |   |   | — |   |
| Accounts receivables, net of allowances for doubtful accounts                                                                                                                           |       |                                                 | 35,008     |   |   |   | (14,074 | ) |   | 20,934 |   |
| Accounts receivables, related parties                                                                                                                                                   |       |                                                 | 66,578     |   |   |   | 14,074 |   |   | 80,652 |   |
| Accounts receivables, intercompany                                                                                                                                                      |       |                                                 | 629,287    |   |   |   | — |   |   | 629,287 |   |
| Inventories                                                                                                                                                                             |       |                                                 | 26,565     |   |   |   | — |   |   | 26,565 |   |
| Deferred costs                                                                                                                                                                          |       |                                                 | 82,191     |   |   |   | — |   |   | 82,191 |   |
| Prepaids and other current assets                                                                                                                                                       |       |                                                 | 31,639     |   |   |   | — |   |   | 31,639 |   |
| Restricted cash and investments                                                                                                                                                         |       |                                                 | 53,308     |   |   |   | — |   |   | 53,308 |   |
| Total current  assets                                                                                                                                                                   |       |                                                 | 1,057,779  |   |   |   | — |   |   | 1,057,779 |   |
| Property, plant  and equipment, net                                                                                                                                                     |       |                                                 | 18,141     |   |   |   | — |   |   | 18,141 |   |
| Investment in  affiliated companies                                                                                                                                                     |       |                                                 | 404,350    |   |   |   | (166,271 | ) |   | 238,079 |   |
| Goodwill                                                                                                                                                                                |       |                                                 | 3,063      |   |   |   | — |   |   | 3,063 |   |
| Intangible assets,  net                                                                                                                                                                 |       |                                                 | 41,877     |   |   |   | — |   |   | 41,877 |   |
| Other long-term  assets                                                                                                                                                                 |       |                                                 | 13,728     |   |   |   | 773 |   |   | 14,501 |   |
| Total assets                                                                                                                                                                            |       |                                                 | $          | 1,538,938 |   |   |   | $ | (165,498 | ) |   | $ | 1,373,440 |   |
| Current  liabilities:                                                                                                                                                                   |       |                                                 |       |   |   |   |   |   |   |   |   |
| Accounts payable—unrelated party                                                                                                                                                   |       |                                                 | $          | 31,279 |   |   |   | $ | — |   |   | $ | 31,279 |   |
| Accounts payable—intercompany                                                                                                                                                      |       |                                                 | 17,160     |   |   |   | — |   |   | 17,160 |   |
| Income taxes payable                                                                                                                                                                    |       |                                                 | —     |   |   |   | 1,591 |   |   | 1,591 |   |
| Customer advances                                                                                                                                                                       |       |                                                 | 80,175     |   |   |   | — |   |   | 80,175 |   |
| Deferred revenue                                                                                                                                                                        |       |                                                 | 7,855      |   |   |   | 134 |   |   | 7,989 |   |
| Other current liabilities                                                                                                                                                               |       |                                                 | 178,583    |   |   |   | (66,071 | ) |   | 112,512 |   |
| Total current  liabilities                                                                                                                                                              |       |                                                 | 315,052    |   |   |   | (64,346 | ) |   | 250,706 |   |
| Long-term deferred revenue                                                                                                                                                              |       |                                                 | 20,739     |   |   |   | 746 |   |   | 21,485 |   |
| Convertible  subordinated notes                                                                                                                                                         |       |                                                 | 274,600    |   |   |   | — |   |   | 274,600 |   |
| Total liabilities                                                                                                                                                                       |       |                                                 | 610,391    |   |   |   | (63,600 | ) |   | 546,791 |   |
| Stockholders’ equity:                                                                                                                                                              |       |                                                 |       |   |   |   |   |   |   |   |   |
| Common stock: $0.00125 par value; authorized:  750,000,000 shares; issued and outstanding: 121,018,036 and 114,769,510 at  December 31, 2005 and 2004, respectively |       |                                                 | 152        |   |   |   | — |   |   | 152 |   |
| Additional paid-in capital                                                                                                                                                              |       |                                                 | 1,168,166  |   |   |   | 24,035 |   |   | 1,192,201 |   |
| Treasury Stock                                                                                                                                                                          |       |                                                 |       |   |   |   | — |   |   | — |   |
| Deferred stock compensation                                                                                                                                                             |       |                                                 | (3,493     | ) |   |   | (98 | ) |   | (3,591 | ) |
| Retained earnings                                                                                                                                                                       |       |                                                 | (253,174   | ) |   |   | (123,725 | ) |   | (376,899 | ) |
| Accumulated other comprehensive income                                                                                                                                                  |       |                                                 | 16,896     |   |   |   | (2,110 | ) |   | 14,786 |   |
| Total  stockholders’ equity                                                                                                                                                        |       |                                                 | 928,547    |   |   |   | (101,898 | ) |   | 826,649 |   |
| Total liabilities,  minority interest and stockholders’ equity                                                                                                                     |       |                                                 | $          | 1,538,938 |   |   |   | $ | (165,498 | ) |   | $ | 1,373,440 |   |

 

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**UTSTARCOM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)**

**NOTE 3—LONG TERMOBLIGATIONS**

On March 12, 2003, UTStarcom, Inc. completedan offering of $402.5 million of 7¤8% convertiblesubordinated notes due March 1, 2008 to qualified buyers pursuant to Rule 144Aunder the Securities Act of 1933. The notes are convertible into common stockof UTStarcom Inc. at a conversion price of $23.79 per share and aresubordinated to all present and future senior debt of UTStarcom Inc. Effective January 9,2007, UTStarcom Inc. and the holders of the remaining $274.6 million ofconvertible subordinated notes entered into a First Supplemental Indenture,providing that any failure by UTStarcom Inc. to comply with certain provisionsof the original agreement will not result in a default or an event of defaultthrough May 31, 2007. The convertible subordinated notes accrue anadditional 6.75% per annum in special interest from and after January 9,2007 to the March 1, 2008 maturity date of the notes, unless the notes areearlier repurchased or converted. Payments of the special interest are made inaddition to and at the same time and in the same manner as regularly scheduledpayments of interest to holders entitled to such regularly scheduled paymentsof interest. As a result of the First Supplemental Indenture, the convertiblesubordinated notes now bear a stated interest rate of 7.625% as of January 9,2007. See Note 11 to the Consolidated Financial Statements. For informationregarding the notice of default on May 31, 2007 and the SecondSupplemental Indenture of UTStarcom Inc., see Note 23 to the ConsolidatedFinancial Statements.

In 2005, UTStarcom Inc. entered into agreements toexchange a total of 4,988,100 common shares of UTStarcom Inc. with a fair valueof approximately $37.6 million and approximately $57.1 million incash for $127.9 million aggregate principal amount of its outstandingconvertible notes with five of its note holders. These exchanges are consideredan early extinguishment of debt in which the aggregate fair value of the commonstock and cash is less than the carrying value of the convertible notes.Accordingly, UTStarcom Inc. recorded a gain, net of write-off ofunamortized issuance expenses, of $31.4 million for the year ended December 31,2005 on such extinguishment in accordance with the provisions of AccountingPrinciples Board Opinion No. 26, “Early Extinguishment of Debt.”

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**SCHEDULE II**

**UTSTARCOM, INC.Valuation and Qualifying Accounts and ReservesFor the Years Ended December 31, 2006, 2005, and 2004**

| **Description**                                          | ** ** | ** ** | ** ** | **Balance at  beginning of  the period** | ** ** | **Charged  (credited) to  costs and  expenses** | ** ** | **Charged  (credited) to  other accounts** | ** ** | **Deductions** | ** ** | **Balance at end  of the period** | ** ** |
|----------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------------|------------|------------------------------------------------------|------------|----------------|------------|-------------------------------------------------------|------------|
| **Year ended December 31,  2006,**                  |       |       |       |                                                    |       |                                                      |       |                                                 |       |           |       |                                                  |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                          |       |       | $          | 67,794                                                  |       |                                                      |       | $                                                    | (9,730     | )              |       |                                                  | $          | — |   |   |   | $ | 4,151 |   |   |   | $ | 53,913 |   |   |
| Tax valuation allowance                                  |       |       | $          | 244,204                                                 |       |                                                      |       | $                                                    | 13,918     |           |       |                                                  | $          | (22,558 | )(1) |   |   | $ | — |   |   |   | $ | 235,564 |   |   |
| **Year ended December 31,  2005, as restated** |       |       |       |                                                    |       |                                                      |       |                                                 |       |           |       |                                                  |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                          |       |       | $          | 51,207                                                  |       |                                                      |       | $                                                    | 18,210     |           |       |                                                  | $          | — |   |   |   | $ | 1,623 |   |   |   | $ | 67,794 |   |   |
| Tax valuation allowance                                  |       |       | $          | 4,900                                                   |       |                                                      |       | $                                                    | 237,307    |           |       |                                                  | $          | 1,997 | (1) |   |   | $ | — |   |   |   | $ | 244,204 |   |   |
| **Year ended December 31,  2004, as restated** |       |       |       |                                                    |       |                                                      |       |                                                 |       |           |       |                                                  |       |   |   |   |   |   |   |   |   |
| Allowance for doubtful accounts                          |       |       | $          | 31,172                                                  |       |                                                      |       | $                                                    | 21,284     |           |       |                                                  | $          | — |   |   |   | $ | 1,249 |   |   |   | $ | 51,207 |   |   |
| Tax valuation  allowance                                 |       |       | $          | 328                                                     |       |                                                      |       | $                                                    | 4,572      |           |       |                                                  | $          | — |   |   |   | $ | — |   |   |   | $ | 4,900 |   |   |

 

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(1)          Charged against othercomprehensive income

 

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