Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

As of October 28, 2002 there were 106,457,801 shares of the Registrant's Common Stock outstanding, par value $0.00125.

UTSTARCOM, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share data)

UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands, except per share data)

UTSTARCOM, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)

UTSTARCOM, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The accompanying unaudited condensed consolidated financial statements include the accounts of UTStarcom, Inc. (the "Company") and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the preparation of the condensed consolidated financial statements. The minority interests in consolidated subsidiaries and equity in affiliated companies are shown separately in the condensed consolidated financial statements. Investments in affiliated companies are accounted for using the cost or equity method, as applicable.

The accompanying financial data as of September 30, 2002 and for the three and nine months ended September 30, 2002 and 2001 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The December 31, 2001 balance sheet was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles. These condensed consolidated financial statements should be read in conjunction with the Company's audited December 31, 2001 financial statements, including the notes thereto, and the other information set forth in the Company's Annual Report on Form 10K/A.

In the opinion of management, the accompanying condensed consolidated financial statements reflect all adjustments (consisting of only normal recurring adjustments) considered necessary for a fair presentation of the Company's financial condition, the results of its operations and its cash flows for the periods indicated. The results of operations for the three and nine months ended September 30, 2002 are not necessarily indicative of the operating results for the full year.

Revenues from sales of telecommunication equipment are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is reasonably assured. The majority of the Company's revenue is recognized upon the receipt of final acceptance certificates. Where multiple elements exist in an arrangement, revenue is allocated to the different elements based upon verifiable objective evidence of the fair value of the elements. Revenues from sales of telecommunication equipment involving significant modification or customization of the product or where services being provided are deemed to be essential to the functionality of the product are recognized using the percentage completion method if the project cost can be reasonably estimated. If the cost cannot be reasonably estimated, the completed contract method is applied. Any payments received prior to revenue recognition are recorded as deferred revenue.

Revenues from sales of telecommunication equipment incorporating software not considered incidental to the product as a whole ("software contracts") are recognized when persuasive evidence of an agreement exists, the product has been delivered, the fee is fixed or determinable and collectibility is probable. Revenues from software contracts with multiple elements are recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements regardless of any separate prices stated within the contract for each

element. If the fee due from the customer is not fixed or determinable due to extended payment terms, revenue is recognized as payments become due from the customer, assuming all other criteria for revenue recognition is met.

Revenues from engineering service contracts are recognized upon completion of the project, or using the percentage of completion method where project costs can be reasonably estimated.

Basic earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares of the Company's common stock outstanding during the period. Diluted earnings per share is determined in the same manner as basic earnings per share except that the numbers of shares is increased by potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of employee stock options and warrants.

The following table presents the calculation of basic and diluted earnings per share (in thousands, except per share data):

Certain potential shares outstanding during the three and nine months ended September 30, 2002 and 2001 were excluded in the diluted per share computations, since their exercise prices were greater than the average market price of the common shares during the period and, accordingly, their effect is anti-dilutive. For the three months ended September 30, 2002, these shares totaled 6.7 million at a weighted average exercise price of $21.20 per share, compared to 2.0 million with a weighted average exercise price of $23.11 per share for the corresponding period in 2001. For the nine months ended September 30, 2002, these shares totaled 2.2 million at a weighted average exercise price of $24.17 per share, compared to 1.9 million with a weighted average exercise price of $23.17 per share for the corresponding period in 2001.

The reconciliation of net income to comprehensive income for the three and nine months ended September 30, 2002 and 2001 is as follows (in thousands):

All of the Company's cash equivalents and short-term investments are classified as available-for-sale. At September 30, 2002, $162.4 million of available-for-sale securities were included in cash equivalents and $58.9 million of available-for-sale securities were included in short-term investments. At December 31, 2001, $162.2 million of available-for-sale securities were included in cash equivalents and $86.2 million of available-for-sale securities were included in short-term investments. These available-for-sale securities consist of government-backed notes, commercial paper, floating rate corporate bonds and fixed income corporate bonds. These investments are recorded at fair value. Any unrealized holding gains or losses are reported as a component of comprehensive income.

Inventories as of September 30, 2002 and December 31, 2001 consist of the following (in thousands):

	September 30, 2002			December 31, 2001
Raw materials	$	85,992		$	59,409
Work-in-process		28,485			33,887
Finished goods		201,228			156,098

		315,705			249,394
Less allowance for obsolete inventory		(30,097	)		(20,344	)

	$	285,608		$	229,050

On April 19, 2002, the Company completed the purchase of Issanni Communications, Inc. ("Issanni"). The Company's investment in Issanni was $2.0 million prior to the acquisition. The purchase consideration for all the outstanding shares of Issanni, other than those already held by the Company prior to the acquisition, was $2.1 million, $0.5 million of which is held in escrow for, among other things, any undisclosed liabilities or contingencies incurred by Issanni prior to closing. In addition, $2.0 million will be payable in the form of an earnout to all Issanni shareholders of record at closing, subject to the completion of certain performance milestones during 2002, 2003 and 2004. This earnout will be recorded as additional purchase price when earned. Furthermore, the Company issued 39,876 shares of restricted common stock valued at $1.0 million to Issanni employees who will continue to perform services for the Company. These shares vest at the earlier of five years or upon the achievement of certain performance milestones. The Company records this amount as compensation

expense ratably over the vesting period and will accelerate the amortization if the milestones are met. The amount of the purchase price allocated to in-process research and development of $0.7 million was charged to the Company's results of operations, as no alternative future uses existed at the acquisition date. Issanni develops RAS (remote access server) and local access technology, which the Company incorporates into one of its products. The results of operations of Issanni are included in the Company's results of operations beginning on April 19, 2002.

The following represents the allocation of the purchase price and prior investment in Issanni under the purchase method of accounting (in thousands):

In September 1996, the Company purchased a 49% interest in Guangdong UTStarcom, Ltd. ("GUTS"), one of the Company's two primary manufacturing facilities. In February 1998, the Company acquired an additional 2% interest in GUTS, increasing its ownership interest to 51%. This investment was accounted for using the equity method prior to the Company's acquisition of the remaining 49% ownership interest in GUTS in May 2002, as the Company did not have voting control over significant matters. On December 18, 2001, the Company entered into an agreement to acquire the remaining 49% ownership interest in GUTS for a total consideration of $3.6 million in cash. The cash consideration was paid in the first quarter of 2002 and final government approvals were received in May 2002. GUTS is now a wholly-owned subsidiary of the Company and its results of operations are included in the Company's consolidated financial statements beginning June 1, 2002.

The following represents the allocation of the purchase price for the remaining 49% ownership interest in GUTS under the purchase method of accounting (in thousands):

In July 1997, the Company, as part of its business operations in China, acquired an 88% interest in UTStarcom (Hangzhou) Communication Co., Ltd, which has since changed its name to UTStarcom Telecom Co., Ltd. ("HUTS"), one of the Company's primary manufacturing facilities. On January 21, 2002, the Company entered into an agreement to acquire the remaining 12% ownership interest in the joint venture company for a total consideration of $14.5 million in cash. Cash consideration of $7.3 million was paid in January 2002, and the remaining consideration was paid in the second quarter of fiscal 2002. Final government approvals were received in May 2002.

The following represents the allocation of the purchase price for the remaining 12% ownership interest in HUTS under the purchase method of accounting (in thousands):

Had the acquisitions of Issanni and the remaining interests in HUTS and GUTS, which were recorded in the second quarter of fiscal 2002, occurred on January 1, 2002, proforma net income for

the nine months ended September 30, 2002 would have been $74.7 million, or $0.68 per share basic, and $0.65 per share fully diluted. Proforma revenues would have been $682.8 million for the nine months ended September 30, 2002. Proforma adjustments include the amortization of fixed asset step-ups and intangible assets as if the transactions had occurred on January 1, 2002.

The following represents the outstanding borrowings at September 30, 2002 and December 31, 2001 (in thousands):

All outstanding debt was repaid in September 2002, and there were no gains or losses on the early retirement of this debt. The Company has unutilized borrowing facilities of $343.3 million as of September 30, 2002.

	September 30, 2002		December 31, 2001
Investment in GUTS	$	—	$	750
Investment in Softbank China		7,829		8,314
Investment in Issanni Communication		—		2,001
Investment in Cellon International		5,000		2,000
Investment in Restructuring Fund No. 1		1,981		—
Investment in Global Asia Partners L.P.		1,000		—
Investment in Fiberxon Inc.		2,000		—
Investment in InterWave Communications International Ltd.		3,000		—
Investment in others		2,284		4,753

Total	$	23,094	$	17,818

The Company has invested $10.0 million in Softbank China, an investment fund established by SOFTBANK CORP. focused on investments in Internet companies in China. This investment permits the Company to participate in the anticipated growth of Internet-related businesses in China. SOFTBANK CORP. and its related companies are significant stockholders of the Company. The Company's investment constitutes 10% of the funding for Softbank China, with SOFTBANK CORP.

contributing the remaining 90%. The Company is a passive investor and has no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund. Many of the fund's investments are and will be in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products the companies have under development are typically in the early stages and may never materialize. During the three and nine months ended September 30, 2002, based upon a review of the carrying value of this investment, impairment charges of $0.0 million and $0.5 million, respectively, were recognized to provide for the decline in the fair value below the carrying value of this investment. Impairment charges of $0.4 million and $1.6 million, respectively, were recognized in the corresponding periods in fiscal 2001. These investment impairment charges are included in Other Expenses Net in the condensed consolidated statements of operations. The balance remaining in this investment as of September 30, 2002 was $7.8 million.

The Company has also invested directly in a number of private technology-based companies in the early stages of development. The Company continually evaluates the carrying value of these investments for possible impairment based on the achievement of business objectives and milestones, the financial condition and prospects of these companies and other relevant factors. During the three and nine months ended September 30, 2002, impairment charges in respect of these private technology investments were $1.7 million and $2.3 million, respectively. These investment impairment charges are included in Other Expenses Net in the condensed consolidated statements of operations. There were no impairment charges in respect of these investments in the corresponding periods in 2001.

During the first quarter of fiscal 2002, the Company invested $2.0 million in Restructuring Fund No. 1, a venture capital investment limited partnership established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., is a significant stockholder of the Company. The fund will focus on leveraged buyout investments in companies in Asia undergoing restructuring or bankruptcy procedures. The total fund offering is expected to be between approximately $150.0 million and $226.0 million, with each investor contributing a minimum of $0.8 million. The Company is a passive investor and has no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund. The Company accounts for this investment under the equity method of accounting.

In June 2002, the Company invested $1.0 million in Global Asia Partners L.P., with a commitment to invest up to a maximum of $5.0 million. The remaining amount is due at such times and in such amounts as shall be specified in one or more future capital calls to be issued by the general partner. The fund size is anticipated to be $100 million and was formed to make private equity investments in private or pre-IPO technology and telecommunications companies. The fund's geographic focus is on technology investments in Asia, in particular India and China. The Company accounts for this investment under the equity method of accounting.

During the third quarter of fiscal 2002, the Company purchased approximately 5.8 million shares of common stock of InterWave Communications Inc., a technology company listed on NASDAQ, for approximately $3.0 million. In addition the Company received warrants to purchase 2.0 million shares of InterWave's common stock at $0.21 cents per share. The Company will review and potentially adjust the carrying value of these marketable securities in accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and Equity Securities."

	September 30, 2002			December 31, 2001
Goodwill	$	57,628		$	47,636
Purchased technology		7,570			4,340

		65,198			51,976
Less accumulated amortization:
Goodwill		(12,823	)		(12,823	)
Purchased technology		(1,925	)		(161	)

	$	50,450		$	38,992

Amortization expense was $0.6 million and $2.0 million for the three months ended September 30, 2002 and September 30, 2001, respectively, and $1.8 million and $5.4 million for the nine months ended September 30, 2002 and September 30, 2001, respectively. Expected amortization expense for the next five fiscal years, beginning the year ended December 31, 2003, is $2.5 million, $2.4 million, $0.4 million, $0.0 million and $0.0 million, respectively.

Goodwill increased by $10.0 million during the nine months ended September 30, 2002. Goodwill totaling $6.3 million was recorded on the acquisition of the remaining 12% ownership interest in HUTS, goodwill of $3.3 million was recorded on the acquisition of the remaining 49% ownership in GUTS, and goodwill of $0.4 million was recorded on the acquisition of Issanni. Intangible assets increased by $3.2 million during the nine months ended September 30, 2002. This increase was due to purchased technology that was recorded on the acquisition of Issanni. The estimated useful life of purchased technology is three years.

In July 2001, the Financial Accounting Standards Board (the "FASB") issued SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."

SFAS No. 142 was adopted by the Company on January 1, 2002. SFAS No. 142 had the effect of eliminating amortization of goodwill commencing January 1, 2002; however, impairment reviews may result in future periodic write-downs. The Company completed the required transitional assessment of goodwill during the first quarter of fiscal 2002. Based on this assessment, there was no transition goodwill impairment charge. The Company plans to perform its annual impairment review in the fourth quarter of each year.

The reconciliation of net income to adjusted net income as if there had been no goodwill amortization for the three and nine months ended September 30, 2001 is as follows (in thousands):

(In thousands)	Three Months Ended September 30, 2001		Nine Months Ended September 30, 2001
Reported net income	$	18,797	$	40,419
Add back: goodwill amortization		1,943		5,336

Adjusted net income	$	20,740	$	45,755

Basic earnings per share:
Reported net income	$	0.18	$	0.41
Goodwill amortization		0.02		0.05

Adjusted net income	$	0.20	$	0.46

Diluted earnings per share:
Reported net income	$	0.17	$	0.38
Goodwill amortization		0.02		0.05

Adjusted net income	$	0.19	$	0.43

Average number of shares outstanding:
Basic		104,031		99,261

Diluted		110,601		106,898

The Company provides telecommunications equipment through an integrated suite of network access systems, optical transmission products and subscriber terminal products. The Company primarily operates in two geographic areas, China and other regions. The chief operating decision makers evaluate performance, make operating decisions, and allocate resources based on consolidated financial data. Gross profit, operating income and income taxes are not allocated to specific individual departments within the organization. In accordance with SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information", the Company is considered a single reportable segment. The Company is required to disclose certain information about product revenues, information about geographic areas, information about major customers, and information about long-lived assets. During the three months ended September 30, 2002, the provincial-level telecommunications service entity in the Zhejiang province of China began to consolidate telecommunications purchasing decisions for that province. As a result of this trend in the Zhejiang province, the Company has grouped all customers in Zhejiang province together and has treated these as one customer. At September 30, 2002, the Company had approximately 25 such customers in Zhejiang province. For the three months ended September 30, 2002, sales to Zhejiang province, BB Technologies Corporation and Kunming PTB accounted for 16%, 15% and 11% of net sales, respectively. For the three months ended September 30, 2001, sales to Zhejiang province, Fitel and Jinhua PTB accounted for 31%, 22% and 12% of net sales, respectively. For the nine months ended September 30, 2002, sales to Zhejiang province and BB Technologies Corporation accounted for 21% and 14% of net sales, respectively. For the nine months ended September 30, 2001, sales to Zhejiang province accounted for 32% of net sales. Revenue attributable to Japan was primarily due to sales to BB Technologies Corporation. Sales to BB Technologies Corporation were $39.8 million for the three months ended September 30, 2002 and $96.7 million for the nine months ended September 30, 2002.

Revenue attributable to the United States of America was insignificant during the three and nine months ended September 30, 2002 and 2001.

	September 30, 2002		December 31, 2001
China	$	79,409	$	41,289
U.S.		43,789		41,645

Total long-lived assets	$	123,198	$	82,934

The Company, some of its directors and officers and various underwriters for its IPO have been named as defendants in a putative shareholder action filed in United States District Court for the Southern District of New York, captioned In re UTStarcom, Inc. Sec. Litig., Civil Action No. 01-CV-9604. Plaintiffs generally allege undisclosed improper underwriting practices concerning the allocation of IPO shares in exchange for excessive brokerage commissions or agreements to purchase shares at higher prices in the aftermarket, in violation of the Securities Act of 1933 and the Securities Exchange Act of 1934. The complaint seeks unspecified damages on behalf of a purported class of purchasers of the Company's common stock between March 2, 2000 and December 6, 2000. Substantially similar actions have been filed concerning the initial public offerings for more than 300 different issuers, and the cases have been coordinated as In re Initial Public Offering Securities Litigation, 21 MC 92. Defendants have filed motions to dismiss. The Company believes that it has meritorious defenses to this lawsuit and intends to defend this lawsuit vigorously.

In June 2002, the Company invested $1.0 million in Global Asia Partners L.P. The fund size is anticipated to be $100 million and was formed to make private equity investments in private or pre-IPO technology and telecommunications companies in Asia. The Company has a commitment to invest up to a maximum of $5.0 million. The remaining amount is due at such times and in such amounts as shall be specified in one or more future capital calls to be issued by the general partner.

The Company has entered into transactions with several companies that are stockholders or are affiliated with one of the Company's stockholders as follows:

During 2000 and 2001, the Company entered into engineering services agreements with Matsushita Communication Industrial Co., Ltd. ("Matsushita"), a stockholder of the Company. The Company recognized $2.3 million and $0.0 million in revenues in connection with these agreements during the three months ended September 30, 2002 and September 30, 2001, and $5.7 million and $0.0 million during the nine months ended September 30, 2002 and September 30, 2001, respectively. In addition, the Company purchases telecommunications equipment from Matsushita and a subsidiary of Matsushita. Purchases of equipment from Matsushita and its subsidiaries during the three and nine months ended September 30, 2002 were $0.7 million and $7.6 million, respectively. Purchases of equipment from Matsushita and it's subsidiaries during the three and nine months ended September 30, 2001 were $6.6 million and $84.0 million, respectively. Matsushita owns less than 1% of our common stock at September 30, 2002.

On July 5, 2002, the Company entered into a joint venture agreement with Matsushita Communication Industrial Co., Ltd., a stockholder of the Company, and Matsushita Electric Industrial Co., Ltd., a subsidiary of such stockholder, to jointly design and develop, manufacture and sell telecommunication products. The Company has a 49% ownership interest in the joint venture company, which has a registered share capital of $10.0 million. The cash consideration of $4.9 million payable by the Company was paid in October 2002. As the Company does not have voting control over significant matters of the joint venture company, the investment in and results of operations of the joint venture company will be accounted for using the equity method of accounting.

During 2001, the Company entered into an engineering services agreement with Mitsubishi Electric Corporation ("MEI"), a stockholder of the Company. The Company recognized no revenue in connection with this agreement during the three and nine months ended September 30, 2002 and 2001, respectively. In addition the Company purchases telecommunications equipment from MEI. Purchases of equipment from MEI during the three and nine months ended September 30, 2002 were $49.6 million and $102.8 million, respectively. Purchases of equipment from MEI during the three and nine months ended September 30, 2001 were $20.4 million and $27.1 million, respectively. During June 2002, the Company entered into a technical services agreement with MEI. The Company paid $3.0 million and $0.0 million in connection with this agreement during the three and nine months ended September 30, 2002 and September 30, 2001. Mitsubishi owns less than 1% of our common stock at September 30, 2002.

The Company recognized revenue of $39.8 million and $96.7 million during the three and nine months ended September 30, 2002, respectively, and $0.0 million during the three and nine months ended September 30, 2001, with respect to sales of telecommunications equipment to BB Technologies Corporation ("BBTC"), an affiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., is a significant stockholder of the Company. BBTC offers asynchronous digital subscriber line ("ADSL") coverage throughout Japan, which is marketed under the name YAHOO. The Company provides ADSL technology to BBTC. The contract was competitively bid and the terms of this contract were on terms no more favorable than those with unrelated parties.

Included in accounts receivable at September 30, 2002 is $39.5 million related to this agreement. There were no amounts included in deferred revenue in respect of this agreement at September 30, 2002. Included in accounts receivable in respect of this agreement at December 31, 2001 was $13.5 million. There were no amounts included in deferred revenue in respect of this agreement at December 31, 2001.

During 2000, the Company invested $8.0 million and during 2001, the Company invested an additional $2.0 million in Softbank China, an investment fund established by SOFTBANK CORP. focused on investments in Internet companies in China. This investment permits the Company to participate in the anticipated growth of Internet-related businesses in China. The Company's investment constitutes 10% of the funding for Softbank China, with SOFTBANK CORP. contributing the remaining 90%. The Company is a passive investor and has no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund. Many of the fund's investments are and will be in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products the companies have under development are typically in the early stages and may never materialize. During the three and nine months ended September 30, 2002, based upon a review of the carrying value of this investment, impairment charges of $0.0 million and $0.5 million, respectively, were recognized to provide for the decline in the fair value below the carrying value of this investment. Impairment charges of $0.4 million and $1.6 million, respectively, were recognized in the corresponding periods in fiscal 2001. The balance remaining in this investment as of September 30, 2002 was $7.8 million. SOFTBANK CORP. owns 21.3% of our common stock at September 30, 2002.

During the first quarter of fiscal 2002, the Company invested $2.0 million in Restructuring Fund No. 1, a venture capital investment limited partnership, established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANK CORP. The fund focuses on leveraged buyout investments in companies in Asia undergoing restructuring or bankruptcy procedures. The total fund offering is expected to be between approximately $150.0 million and $226.0 million, with each investor contributing a minimum of $0.8 million. The Company is a passive investor and has no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund.

On August 29, 2002, the Company completed the repurchase of six million shares of the Company's common stock for $72.9 million from its largest shareholder, SOFTBANK Corp. As part of this transaction, SOFTBANK signed a voluntary "lock up" agreement stipulating that it will not sell any of the Company's common stock within the next six months. This lock up agreement will end on March 1, 2003, which coincides with the start of the Company's "blackout period." in which insiders are not permitted to sell shares. The blackout period begins March 1, 2003 and ends commencing at the close of business on the second trading day following the public release of our first quarter fiscal 2003 results in April 2003. We have booked the proportionate share of the cost of the common stock repurchased and the related transaction costs of $36.4 million to additional paid in capital and common stock and the remainder of $36.5 million to retained earnings in accordance with Accounting Principles Board (APB) Opinion No. 6.

Approximately 82% and 83% of the Company's sales for the three and nine months ended September 30, 2002, respectively, and 78% and 91% for the three and nine months ended September 30, 2001, respectively, were made in China. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environment in China, and by the general state of China's economy. The Company's operations in China are subject to special considerations and significant risks not typically associated with companies in the United

States. These include risks associated with, among others, the political, economic and legal environments and foreign currency exchange. The Company's results may be adversely affected by, among other things, changes in the political, economic and social conditions in China, and by changes in governmental policies with respect to laws and regulations, changes in China's telecommunications industry and regulatory rules and policies, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation.

Under China's current regulatory structure, the communications products that the Company offers in China must meet government and industry standards, and a network access license for the equipment must be obtained. Without the license, the equipment is not allowed to be connected to public telecommunications networks or sold in China. Moreover, the Company must ensure that the quality of the telecommunications equipment for which it has obtained a network access license is stable and reliable, and may not lower the quality or performance of other installed licensed products. The State Council's product quality supervision department, in concert with the Ministry of Information Industry, performs spot checks to track and supervise the quality of licensed telecommunications equipment and publishes the results of such spot checks.

The regulations implementing these requirements are not very detailed, have not been applied by a court and may be interpreted and enforced by regulatory authorities in a number of different ways. The Company obtained the required network access licenses for its AN-2000 platform. The Company applied for, but has not yet received, a network access license for its PAS systems and handsets. Based upon conversations with the Ministry of Information Industry, the Company understands that its PAS systems and handsets are considered to still be in the trial period and that sales of the Company's PAS systems and handsets may continue to be made during this trial period, but a license will ultimately be required. Network access licenses will also be required for most additional products that the Company is selling or may sell in China, including the mSwitch platform. If the Company fails to obtain the required licenses, the Company could be prohibited from making further sales of the unlicensed products, including the PAS systems and handsets, in China, which would substantially harm its business, financial condition and results of operations. The Company's counsel in China has advised that China's governmental authorities may interpret or apply the regulations with respect to which licenses are required and the ability to sell a product while a product is in the trial period in a manner that is inconsistent with the information received by such counsel in China, either of which could have a material adverse effect on the Company's business and financial condition.

Approximately 16% and 15% of the Company's sales for the three and nine months ended September 30, 2002, respectively, and 0% for the three and nine months ended September 30, 2001, respectively, were made in Japan. Accordingly, the Company's business, financial condition and results of operations may be influenced by the political, economic and legal environment in Japan, and by the general state of Japan's economy.

In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS No. 141 also specifies the criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets."

The Company adopted SFAS No. 141 in July 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and was adopted by the Company on January 1, 2002. The Company completed the required transitional assessment of goodwill impairment during the first quarter of fiscal 2002. Based on this assessment, it was determined that there was no impairment of goodwill and thus no transition goodwill impairment charge.

On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and amends APB 30 "Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business." SFAS No. 144 also requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. The Company adopted SFAS No. 144 on January 1, 2002, and the adoption had no impact on the Company's consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which addresses the measurement, timing of recognition and reporting of costs associated with exit or disposal activities and restructuring activities. SFAS No. 146 requires that a liability for costs associated with exit or restructuring activities be recognized only when the liability is incurred as opposed to at the time a company formally approves and commits to an exit plan as set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not expect the adoption to have any impact on its consolidated financial statements.

On October 16, 2002, we acquired the assets and intellectual property of Shanghai Yi Yun Telecom Technology Co. Ltd., a provider of synchronous digital hierarchy ("SDH") transmission equipment for an initial consideration of $0.2 million in cash. In addition we will grant equity instruments to Shanghai Yi Yun Telecom Technology Co. Ltd. employees who will continue to perform services for the Company. These equity instruments will be granted over a period of three years subject to the achievement of certain performance milestones. The cash consideration will be paid in the fourth quarter of fiscal 2002. The acquisition will be accounted for as an asset purchase.

ITEM 2—MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS

This Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These statements are based on information that is currently available to management. We intend such forward-looking statements to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and we are including this statement for purposes of complying with those provisions. The forward-looking statements include, without limitation, those concerning the following: our expectations as to the nature of possible trends, the manner in which customers in Chinese provinces negotiate for the purchase of our products, our expectation regarding continued growth in our business and operations; our expectation that our PAS network access system will continue to be allowed in China's county-level cities and counties; our expectation that there will be no penalties or fines for our non-compliance with the licensing requirements in China for our PAS system and other products; our expectation concerning the anticipated cost and completion date of our new Hangzhou manufacturing facility, our expectation that there will be fluctuations in our overall gross profit, gross margin, product mix, quarter to quarter results, customer base and selling prices; our plans for expanding the direct sales organization and our selling and marketing campaigns and activities; our expectation that we may use part of the net proceeds of our initial and follow on public offerings to acquire or invest in complementary businesses, technologies or product offerings; our expectation that there will be increases in selling, marketing, research and development, general and administrative expenses; our expectation that we will continue to invest significantly in research and development; our expectation that we will fill the majority of our current backlog orders; our expectation regarding our future investments, particularly in Softbank China; and our expectation that existing cash and cash equivalents will be sufficient to finance our operations for at least the next 12 months. Additional forward-looking statements may be identified by the words, "anticipate," "expect," "believe," "intend," "will" and similar expressions, as they relate to us or our management. Investors are cautioned that these forward-looking statements are inherently uncertain. These statements are subject to risks and uncertainties that may cause actual results and events to differ materially. For a detailed discussion of these risks and uncertainties, see the "Factors Affecting Future Operating Results" section of this Form 10-Q. We do not guarantee future results and undertake no obligation to update the forward-looking statements to reflect events or circumstances occurring after the date of this Form 10-Q.

We design, manufacture and market wireline and wireless broadband access and switching equipment that enables migration to next generation IP-based networks. Our operations are conducted primarily by our foreign subsidiaries that manufacture, distribute and support our products, principally in China. Our systems and products allow service providers to offer cost-efficient and expandable voice, data and Internet access services. Because our systems are based on widely adopted international communications standards, service providers can easily integrate our systems into their existing networks and deploy our systems in new broadband, Internet Protocol and wireless network rollouts.

We incorporated in Delaware in 1991. Since our incorporation, we have focused our resources on developing products for China's communications market. We shipped our first network access products in 1993. In 1995, we acquired StarCom Network Systems, Inc. and changed our name to UTStarcom, Inc. In 1996, we introduced our advanced, V5.1 and V5.2 compliant, multi-service network access platform, the AN-2000. Late in 1996, we introduced our PAS wireless access system. In December 1999, we completed the acquisition of the portion of our Wacos, Inc. subsidiary owned by the minority shareholders. Wacos, Inc. is a research and development subsidiary that develops IP-based switching systems. In November 2001, we completed the acquisition of Advanced Communications

Devices Corporation, or ACD, for $21.3 million. ACD is a system on chip semi-conductor company focusing on LAN and IP switching technology. On April 19, 2002, the Company completed the purchase of Issanni Communications, Inc. ("Issanni"). Our investment in Issanni was $2.0 million prior to the acquisition. The purchase consideration for all the outstanding shares of Issanni, other than those already held by us prior to the acquisition, was $2.1 million. In addition, $2.0 million will be payable in the form of an earnout to all Issanni shareholders of record at closing, subject to the completion of certain performance milestones during 2002, 2003 and 2004. On December 18, 2001, we entered into an agreement to acquire the remaining 49% ownership interest in GUTS, one of our two primary manufacturing facilities in China, for a total consideration of $3.6 million in cash, in order to achieve 100% ownership in the joint venture. On January 21, 2002, we entered into an agreement to acquire the remaining 12% ownership interest in HUTS, our other manufacturing facility, for a total consideration of $14.5 million in cash. As a result of the GUTS and HUTS transactions, which closed in the second quarter of 2002, we now conduct our operations in China through wholly owned subsidiaries.

We have derived most of our revenues from sales of telecommunications equipment to service providers in China. However, we continue to expand our sales to service providers in other growing communications markets outside of China, including Japan, Vietnam, India and Latin America. Our customers often make a large initial purchase of our equipment followed by supplemental purchases of enhancements and upgrades. As a result, our largest revenue-producing customers typically vary from period to period. The evaluation period for our products by potential customers may span a year or more and our business generally depends on a relatively small number of large deployments. We sell our products in China through a direct sales force.

Approximately 82% and 83% of our net sales for the three and nine months ended September 30, 2002 and approximately 78% and 91% of our net sales for the three and nine months ended September 30, 2001 were made in China. Accordingly, our business, financial condition and results of operations are likely to be influenced by the political, economic and legal environment in China, and by the general state of China's economy. Our results may be adversely affected by, among other things, changes in the political, economic, competitive and social conditions in China, including changes in governmental policies with respect to laws and regulations, changes in telecommunications industry and regulatory rules and policies, anti-inflationary measures, currency conversion and remittance abroad, and rates and methods of taxation. We extend credit to our customers in China without requiring collateral. We monitor our exposure for credit losses and maintain allowances for doubtful accounts.

We have historically considered local telecommunications service providers serving municipalities and counties to be our primary customers in China. Recently, however, the provincial-level telecommunications service entity in the Zhejiang province of China has begun to consolidate telecommunications purchasing decisions for that province. As a result of this trend in the Zhejiang province, we have grouped all customers in Zhejiang province together and have treated these as one customer for the three and nine months ended September 30, 2002. Giving effect to this treatment, for the three months ended September 30, 2002, sales to Zhejiang province, BB Technologies Corporation and Kunming PTB accounted for 16%, 15% and 11% of net sales, respectively. For the three months ended September 30, 2001, sales to Zhejiang province, Fitel and Jinhua PTB accounted for 31%, 22% and 12% of net sales, respectively. For the nine months ended September 30, 2002, sales to Zhejiang province and BB Technologies Corporation accounted for 21% and 14% of net sales, respectively. For the nine months ended September 30, 2001, sales to Zhejiang province accounted for 32% of net sales. Without giving effect to this treatment, at September 30, 2002, we would have had approximately twenty-five customers in Zhejiang province.

entities in the other Chinese provinces in which we operate have centralized this process at this time. However, the nature of negotiations in China is still evolving. If a trend toward consolidation of purchasing decisions into the control of provincial-level telecommunications service entities in China does emerge, it could possibly take a variety of forms. For example, some provincial-level telecommunications service entities could simply coordinate purchase decisions to be made by local telecommunications service providers, with local service providers retaining ultimate control over purchasing decisions. In other cases, however, provincial-level entities could wield greater control over the decision of whether or not to purchase the Company's products. In any event, such a trend could streamline the negotiation process within Chinese provinces, but it could also place downward pressure on the prices the Company can charge for its products. The Company will continue to monitor business practices in China closely, and to the extent that any of these changes affect the manner in which our customers make their decisions about whether or not to purchase our products, we will reevaluate what entities may best be described as our customers.

Under China's current regulatory structure, the communications products that we offer in China must meet government and industry standards, and a network access license for the equipment must be obtained. Without the license, the equipment is not allowed to be connected to public telecommunications networks or sold in China. Moreover, we must ensure that the quality of the telecommunications equipment for which we have obtained a network access license is stable and reliable, and may not lower the quality or performance of other installed licensed products. The State Council's product quality supervision department, in concert with the Ministry of Information Industry, performs spot checks to track and supervise the quality of licensed telecommunications equipment and publishes the results of such spot checks.

The regulations implementing these requirements are not very detailed, have not been applied by a court and may be interpreted and enforced by regulatory authorities in a number of different ways. We have obtained the required network access licenses for our AN-2000 platform. We have applied for, but have not yet received, a network access license for our PAS systems and handsets. Based upon conversations with the Ministry of Information Industry, we understand that our PAS systems and handsets are considered to still be in the trial period and that sales of our PAS systems and handsets may continue to be made by us during this trial period, but a license will ultimately be required. Network access licenses will also be required for most additional products that we are selling or may sell in China, including our mSwitch platform. If we fail to obtain the required licenses, we could be prohibited from making further sales of the unlicensed products, including our PAS systems and handsets, in China, which would substantially harm our business, financial condition and results of operations. Our counsel in China has advised us that China's governmental authorities may interpret or apply the regulations with respect to which licenses are required and the ability to sell a product while a product is in the trial period in a manner that is inconsistent with the information received by our counsel in China, either of which could have a material adverse effect on our business and financial condition and results of operations.

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

Additionally, business activity in China and many other countries in Asia declines considerably during the first quarter of each year in observance of the Lunar New Year. As a result, sales during the first quarter of our fiscal year have typically been lower than sales during the fourth quarter of the preceding year, and we expect this trend to continue.

Revenues from sales of telecommunications equipment are recognized when persuasive evidence of an agreement exists, delivery of the product has occurred as evidenced by customer acceptance, the fee is fixed or determinable and collectibility is reasonably assured. The majority of our revenue is recognized upon receipt of final acceptance certificates. Where multiple elements exist in an arrangement, revenue is allocated to the different elements based upon verifiable objective evidence of the fair value of the elements. Revenues from sales of telecommunications equipment involving significant production, modification or customization of the product or where services being provided are deemed to be essential to the functionality of the product are recognized using the percentage of completion method if the project cost can be reasonably estimated. If the cost cannot be reasonably estimated, the completed contract method is applied. Any payments received prior to revenue recognition are recorded as deferred revenue.

Revenues from sales of telecommunications equipment incorporating software not considered incidental to the product as a whole ("software contracts") are recognized when persuasive evidence of an agreement exists, the product has been delivered as evidenced by customer acceptance, the fee is fixed or determinable and collectibility is probable. Revenues from software contracts with multiple elements are recognized using the residual method when there is vendor specific objective evidence of the fair value of all undelivered elements in an arrangement but vendor specific objective evidence of fair value does not exist for one or more of the delivered elements in an arrangement. Under the residual method, the fair value of the undelivered elements, as indicated by vendor specific objective evidence, is deferred and the difference between the total arrangement fee and the amount deferred for the undelivered elements is recognized as revenue related to the delivered elements regardless of any separate prices stated within the contract for each element. If the fee due from the customer is not fixed or determinable due to extended payment terms, revenue is recognized as payments become due from the customer, assuming all other criteria for revenue recognition are met. Revenues from engineering service contracts are recognized upon completion of the project, or using the percentage of completion method when project costs can be reasonably estimated.

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

Our gross profit has been affected by product mix, average selling prices and material costs. Our gross profit, as a percentage of net sales, varies among our product families. The gross profit, as a percentage of net sales, on our handsets is low compared to our other products. We expect that our overall gross profit, as a percentage of net sales, will fluctuate from period to period as a result of shifts in product mix, anticipated decreases in average selling prices and our ability to reduce cost of sales.

Selling, general and administrative expenses include compensation and benefits, professional fees, sales commissions, provision for doubtful accounts receivable and travel and entertainment costs. A large percentage of our costs are fixed and are difficult to quickly reduce in periods of reduced sales. We intend to pursue aggressive selling and marketing campaigns and to expand our direct sales organization, and, as a result, our sales and marketing expenses will increase in future periods. We also expect that in support of our continued growth, general and administrative expenses will continue to increase for the foreseeable future.

Research and development expenses consist primarily of salaries and related costs of employees engaged in research, design and development activities, the cost of parts for prototypes, equipment

depreciation and third party development expenses. A large percentage of our costs are fixed and are difficult to quickly reduce in periods of reduced sales. We believe that continued investment in research and development is critical to our long-term success. Accordingly, we expect that our research and development expenses will increase in future periods.

Net deferred stock compensation represents the difference between the fair value of common stock and the option exercise price for the options at the date of grant. Deferred compensation is presented as a reduction of stockholders' equity, with amortization recorded over the vesting period of the option, which is generally four years. No net deferred compensation expense was recorded in connection with the grant of stock options to our employees during the three and nine months ended September 30, 2002 and 2001, respectively. We recorded stock compensation expense of approximately $0.5 million and $2.4 million during the three and nine months ended September 30, 2002, respectively and $0.9 million and $3.2 million, respectively, during the corresponding periods in 2001. At September 30, 2002, approximately $4.7 million of deferred stock compensation remained to be amortized.

In connection with the acquisition of Issanni Communications Inc. in April 2002, 39,876 shares of restricted common stock valued at $1.0 million were issued to Issanni employees, who will continue to perform services for us. These shares vest at the earlier of five years or upon the achievement of certain performance milestones. We will record this as compensation expense ratably over the vesting period and will accelerate the amortization if the milestones are met. We completed the acquisition of Advanced Communications Devices Corporation ("ACD"), in November 2001. In connection with the acquisition, we issued 208,594 shares of restricted common stock valued at $5.0 million to ACD employees who will continue to perform services for us. We record this amount as compensation expense over a period of five years or upon the achievement of certain performance milestones. The first milestone was met in December 2001, resulting in a charge of $1.3 million to operations in 2001. The second milestone was met in March 2002, resulting in a charge of $0.8 million to operations during the nine months ended September 30, 2002.

Amortization of intangible assets consists primarily of the amortization of intangible assets associated with acquisitions in China, our acquisition of a minority interest in Wacos, Inc. and our acquisitions of Stable Gain International Ltd. and ACD.

Consolidated equity in net income (loss) of affiliated companies comprised our 51% share of the earnings from Guangdong UTStarcom, Ltd. ("GUTS"), our Guangdong manufacturing subsidiary, which we accounted for using the equity method prior to our acquisition of the remaining 49% ownership interest in GUTS in May 2002. We previously accounted for this under the equity method because we did not have voting control over significant matters.

Under current regulations in China, foreign investment enterprises that have been accredited as technologically advanced enterprises are entitled to additional tax incentives. These tax incentives vary in different locales and could include preferential national enterprise income tax treatment at 50% of the usual rates for different periods of time. All of our active subsidiaries in China were accredited as technologically advanced enterprises. The tax holidays applicable to our wholly-owned subsidiaries UTStarcom China and UTStarcom Telecom Co., Ltd. ("HUTS"), which together accounted for approximately 90.1% of our revenues in 2001, will expire at the end of 2002. At that time, the tax rates for these two subsidiaries will increase from 7.5% to 15%, and from 10% to 15%, respectively, which will negatively impact our financial condition and results of operations by increasing our tax rate. Additionally, the Chinese government is considering the imposition of a "unified" corporate income tax that would phase out, over time, the preferential tax treatment to which foreign-funded enterprises, such as UTStarcom, are currently entitled. We cannot be certain whether the government will implement such a unified tax structure, or if implemented whether it will adversely affect our financial results.

Minority interest in (earnings) loss of consolidated subsidiaries represented the share of earnings in HUTS, our Zhejiang manufacturing joint venture, attributable to our joint venture partner, prior to our acquisition of the remaining 12% ownership interest in HUTS in May 2002.

As of December 31, 2001, we employed a total of 2,435 full-time employees. We also from time to time employ part-time employees and hire contractors. Of the total number of full-time employees at December 31, 2001, 1,049 were in research and development, 282 in manufacturing, 862 in marketing, sales and support, and 242 in administration. We had 2,049 employees located in China, 331 employees located in the United States, and 55 employees in other countries. In addition to our total full-time employees, GUTS, our manufacturing joint venture had 110 employees at December 31, 2001. Our employees are not represented by any collective bargaining agreement, and we have never experienced a work stoppage. We believe that our employee relations are good.

On August 29, 2002, we completed the repurchase of six million shares of our common stock for $72.9 million from our largest shareholder, SOFTBANK Corp. As part of this transaction, SOFTBANK has signed a voluntary "lock up" agreement stipulating that it will not sell any of our common stock within the next six months. This lock up agreement will end on March 1, 2003, which coincides with the start of our "blackout period" in which insiders are not permitted to sell shares. The blackout period begins March 1, 2003 and ends commencing at the close of business on the second trading day following the public release of our first quarter fiscal 2003 results in April 2003. We have booked the proportionate share of the cost of the common stock repurchased and the related transaction costs of $36.4 million to additional paid in capital and common stock and the remainder of $36.5 million to retained earnings in accordance with Accounting Principles Board (APB) Opinion No. 6.

The financial condition and results of operations of the Company are based on certain critical accounting policies, which include judgments, estimates, and assumptions on the part of management. Estimates are based on historical experience, knowledge of economic and market factors and various other assumptions that management believes to be reasonable under the circumstances. Actual results may differ from those estimates. The following summary of critical accounting policies highlights those areas of significant judgment in the application of our accounting policies that affect our financial condition and results of operations.

We recognize revenue from sales of telecommunication equipment when persuasive evidence of an agreement exists, delivery of the product has occurred, the fee is fixed or determinable and collectibility is reasonably assured. For transactions where we have yet to obtain customer acceptance, revenue is deferred until the terms of acceptance are satisfied. A sales reserve is established based on historical trends in sales returns. If actual future sales returns do not reflect the historical data, our revenue could be affected. Historically, the level of sales returns and our collection history have been within our expectations.

We also maintain allowances for doubtful accounts based on our assessment of the collectibility of our accounts receivable. We continually monitor collections from our customers and maintain allowances for doubtful accounts based upon the age of outstanding invoices and any specific customer collection issues. Historically, doubtful accounts or credit losses have been within our expectations, and our doubtful account allowances have been adequate. Our accounts receivable are concentrated in China. Therefore, a material adverse change in economic, political and social conditions in China could

have an adverse effect on the collectibility of our accounts receivable, resulting in the need for additional doubtful account allowances.

We provide a warranty on our equipment and handset sales for a period not greater than one year. We provide for the expected cost of product warranties at the time that we recognize revenue, based on our assessment of past warranty experience. We continually monitor the level of our warranty expenses. If, however, there were a material adverse change in our product failure rates, an additional warranty provision would be required. Historically, our warranty experience has been within our expectations.

Our inventories are stated at the lower of cost or net realizable value, net of a reserve for excess, slow moving and obsolete inventory. The reserve is based on our assumptions about future market conditions and customer demand. We continually monitor our inventory reserve. Historically, the level of inventory reserves, our inventory turnover, and obsolescence experience have been within our expectations. Our sales are, however, concentrated in China. Therefore a material adverse change in economic, political and social conditions in China could have an adverse effect on expected future market conditions and demand from our customers, resulting in the need for additional inventory reserves.

Our research and development costs are charged to expense as incurred in accordance with Statement of Financial Accounting Standards (SFAS) No. 2. We capitalize costs incurred in the development of software that will ultimately be sold when technological feasibility has been attained. Management judgment is required in assessing expected future revenues and changes in product technologies, and the ultimate recoverability of our capitalized software development costs. Our business is concentrated in China. Therefore, a material change in market conditions in China could significantly impact these assessments and assumptions, and require an adjustment to our capitalized software development costs.

We recognize deferred income taxes as the difference between the tax bases of assets and liabilities and their financial statement amounts based on enacted tax rates. Management judgment is required in the assessment of the recoverability of our deferred tax assets based on our assessment of projected taxable income. Although we are recently profitable, numerous factors could affect our results of operations in the future. If there were a significant decline in our future operating results, our assessment of the recoverability of our deferred tax asset would need to be revised, and any such adjustment to our deferred tax asset would be charged to income in that period.

We have recorded goodwill and intangible assets in connection with our business acquisitions. Management judgment is required in the assessment of the related useful lives, assumptions regarding our ability to successfully develop and ultimately commercialize acquired technology, and assumptions regarding the fair value and the recoverability of these assets. Historically, there have been no circumstances that resulted in revised assumptions or impairment charges. We completed the required transitional assessment of goodwill during the first quarter of fiscal 2002. Based on this assessment, there was no transition goodwill impairment charge. We plan to perform our annual impairment review in the fourth quarter of each year. Our business is concentrated in China. Therefore, a material change

in market conditions in China could significantly impact these assessments and assumptions, and result in impairment in our recorded goodwill and intangible assets.

We have invested in a fund focused on investments in Internet companies in China and a fund focused on investments in companies in Asia undergoing restructuring or bankruptcy procedures. We have also invested directly in a number of private technology-based companies in the early stages of development and in a publicly traded technology company traded on NASDAQ. Management judgment is required in evaluating the carrying value of the private company investments for possible impairment based on the achievement of business objectives and milestones, the financial condition and prospects of these companies and other relevant factors. We continually monitor these investments for impairment, and charge to income any impairment amounts in the period such a determination is made.

We have entered into transactions with several companies that are stockholders or are affiliated with one of our stockholders as follows:

During 2000 and 2001, we entered into engineering services agreements with Matsushita Communication Industrial Co., Ltd. ("Matsushita"), a stockholder of the Company. We recognized $2.3 million and $0.0 million in revenues in connection with these agreements during the three months ended September 30, 2002 and September 30, 2001, and $5.7 million and $0.0 million during the nine months ended September 30, 2002 and September 30, 2001, respectively. In addition, we purchase telecommunications equipment from Matsushita and a subsidiary of Matsushita. Purchases of equipment from Matsushita and its subsidiaries during the three and nine months ended September 30, 2002 were $0.7 million and $7.6 million, respectively. Purchases of equipment from Matsushita and it's subsidiaries during the three and nine months ended September 30, 2001 were $6.6 million and $84.0 million, respectively. Matsushita owns less than 1% of our common stock at September 30, 2002.

On July 5, 2002, we entered into a joint venture agreement with Matsushita Communication Industrial Co., Ltd., one of our stockholders, and Matsushita Electric Industrial Co., Ltd., a subsidiary of such stockholder, to jointly design, develop, manufacture and sell telecommunication products. We will have a 49% ownership interest in the joint venture company, which will have a registered share capital of $10.0 million. The cash consideration of $4.9 million was paid in October 2002. As we do not have voting control over significant matters of the joint venture company, the investment in and results of operations of the joint venture company will be accounted for using the equity method of accounting.

During 2001, we entered into an engineering services agreement with Mitsubishi Electric Corporation ("MEI"), a stockholder of the Company. We recognized no revenue in connection with this agreement during the three and nine months ended September 30, 2002 and 2001, respectively. In addition we purchase telecommunications equipment from MEI. Purchases of equipment from MEI during the three and nine months ended September 30, 2002 were $49.6 million and $102.8 million, respectively. Purchases of equipment from MEI during the three and nine months ended September 30, 2001 were $20.4 million and $27.1 million, respectively. During June 2002, we entered into a technical services agreement with MEI. We paid $3.0 million and $0.0 million in connection with this agreement during the three and nine months ended September 30, 2002 and September 30, 2001. Mitsubishi owns less than 1% of our common stock at September 30, 2002.

We recognized revenue of $39.8 million and $96.7 million during the three and nine months ended September 30, 2002, respectively, and $0.0 million during the three and nine months ended September 30, 2001, respectively, with respect to sales of telecommunications equipment to BB

Technologies Corporation ("BBTC"), an affiliate of SOFTBANK CORP. SOFTBANK America Inc., an entity affiliated with SOFTBANK CORP., is a significant stockholder of the Company. BBTC offers asynchronous digital subscriber line ("ADSL") coverage throughout Japan, which is marketed under the name YAHOO. We provide ADSL technology to BBTC. The contract was competitively bid and the terms of this contract were on terms no more favorable than those with unrelated parties. Included in accounts receivable at September 30, 2002 is $39.5 million related to this agreement. There were no amounts included in deferred revenue in respect of this agreement at September 30, 2002. Included in accounts receivable in respect of this agreement at December 31, 2001 was $13.5 million. There were no amounts included in deferred revenue in respect of this agreement at December 31, 2001. SOFTBANK CORP. owns 21.3% of our common stock at September 30, 2002.

During 2000, we invested $8.0 million and during 2001, we invested an additional $2.0 million in Softbank China, an investment fund established by SOFTBANK CORP. focused on investments in Internet companies in China. This investment permits us to participate in the anticipated growth of Internet-related businesses in China. Our investment constitutes 10% of the funding for Softbank China, with SOFTBANK CORP. contributing the remaining 90%. We are a passive investor and have no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund. Many of the fund's investments are and will be in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky as the market for the technologies or products the companies have under development are typically in the early stages and may never materialize. During the three and nine months ended September 30, 2002, based upon a review of the carrying value of this investment, impairment charges of $0.0 million and $0.5 million, respectively, were recognized to provide for the decline in the fair value below the carrying value of this investment. Impairment charges of $0.4 million and $1.6 million, respectively, were recognized in the corresponding periods in fiscal 2001. The balance remaining in this investment as of September 30, 2002 was $7.8 million. Due to the risky nature of this investment, we may experience further losses in connection with this investment in Softbank China.

During the first quarter fiscal 2002, we invested $2.0 million in Restructuring Fund No. 1, a venture capital investment limited partnership, established by SOFTBANK INVESTMENT CORP., an affiliate of SOFTBANK CORP. The fund focuses on leveraged buyout investments in companies in Asia undergoing restructuring or bankruptcy procedures. The total fund offering is expected to be between approximately $150.0 million and $226.0 million, with each investor contributing a minimum of $0.8 million. We are a passive investor and have no decision-making authority with respect to investments by the fund. The fund has a separate management team, and none of the Company's employees are employed by the fund. Due to the risky nature of this investment, we may experience losses in connection with our investment in Restructuring Fund No. 1.

For the three months ended September 30, 2002, net income increased 64% to $30.7 million as compared to net income of $18.8 million for the three months ended September 30, 2001. Net income for the three months ended September 30, 2002 reflects the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. With the adoption of SFAS No. 142, goodwill is no longer amortized, but rather tested annually for impairment. The Company completed its transition impairment test during the first quarter of fiscal 2002, and no impairment charge was required. Had SFAS No. 142 been in effect during the three months ended September 30, 2001, net income reported for that period would have been $20.7 million.

Our net sales increased 56% to $265.5 million for the three months ended September 30, 2002 from $170.5 million for the corresponding period in 2001. Sales of telecommunications equipment for the three months ended September 30, 2002 were $164.7 million, an increase of $37.6 million or 30% as compared to the three months ended September 30, 2001. Sales of subscriber handsets for the three months ended September 30, 2002 were $100.8 million, an increase of $57.4 million or 132%, as compared to the three months ended September 30, 2001. Sales of telecommunications equipment and sales of subscriber handsets increased due to the continued growth in spending on telecommunications infrastructure in China, which accounted for 82% and 78% of our net sales for the three months ended September 30, 2002 and 2001, respectively. International sales of telecommunication equipment increased to $47.3 million for the three months ended September 30, 2002 as compared to $37.2 million for the three months ended September 30, 2001, primarily driven by sales of equipment to BB Technologies Corporation ("BBTC") in Japan to support its ADSL rollout and sales of equipment to Fitel in Taiwan. During the three months ended September 30, 2002, the provincial-level telecommunications service entity in the Zhejiang province of China began to consolidate telecommunications purchasing decisions for that province. As a result of this trend in the Zhejiang province, we have grouped all customers in Zhejiang province together and have treated these as one customer. At September 30, 2002, we had approximately 25 such customers in Zhejiang province. For the three months ended September 30, 2002, sales to Zhejiang province, BBTC and Kunming PTB accounted for 16%, 15% and 11% of our net sales, respectively. For the three months ended September 30, 2001, sales to Zhejiang province, Fitel and Jinhua PTB accounted for 31%, 22% and 12% of our net sales, respectively.

Gross profit increased by 44% to $92.8 million for the three months ended September 30, 2002 from $64.3 million for the corresponding period in 2001. Gross profit, as a percentage of net sales, was 35% for the three months ended September 30, 2002 and 38% for the three months ended September 30, 2001. Gross profit, as a percentage of net sales, decreased primarily due to a higher level of lower margin handset sales, which comprised 38% and 25% of our sales for the three months ended September 30, 2002 and 2001, respectively. We believe our lower margin handset sales will increase somewhat during future periods. In addition, we believe that there will be continued competitive market pricing pressures on our other products in line with current trends in the industry. However, we believe that cost efficiencies arising from the continued cost reduction, manufacturing efficiencies and redesign of our products for our PAS systems will partially offset the impact of these factors on our gross profit as a percentage of net sales. We will also continue to focus our efforts on the efficient management of our operating expenses.

Selling, general and administrative expenses increased 31% to $28.6 million for the three months ended September 30, 2002 from $21.8 million for the corresponding period in 2001. The increase in

selling, general and administrative expenses was primarily due to increased sales and administrative personnel and related expenses, including sales commissions, associated with the growth in net sales and the expansion of our overall level of business activities. Selling, general and administrative expenses as a percentage of net sales were 11% and 13% for the three months ended September 30, 2002 and 2001, respectively. We expect our selling, general and administrative expenses to increase in absolute dollar amounts in future periods as sales and marketing activities increase and we incur additional expenses related to the anticipated growth of our business and operations.

Research and development expenses increased 40% to $23.0 million for the three months ended September 30, 2002 from $16.4 million for the corresponding period in 2001. The increase in research and development expenses was primarily due to the hiring of additional technical personnel, increased prototype expenses and licensing fees to support our research and development efforts. As a percentage of net sales, research and development expenses were 9% and 10% for the three months ended September 30, 2002 and 2001, respectively. We expect our research and development expenses to increase in absolute dollar amounts in future periods as we expand our research and development organization to support new product development.

Amortization of intangible assets was $0.6 million for the three months ended September 30, 2002 and $2.0 million for the three months ended September 30, 2001. The decrease in amortization of intangible assets was primarily due to the elimination of goodwill amortization upon the adoption of SFAS No. 142 on January 1, 2002 of $1.8 million, offset by an increase in amortization of intangibles of $0.5 million. Had SFAS No. 142 been in effect during the quarter ended September 30, 2001, amortization expense would have been $0.0 million.

Net interest income was $1.3 million for the three months ended September 30, 2002 and $1.5 million for the corresponding period in 2001. The decrease was primarily due to a reduction in cash and cash equivalents and short-term investments of $4.6 million and a reduction in average interest rates on deposits from 3% to 1%, partially offset by a decline of $0.8 million in interest expense related to short term and long term debt balances which were paid off in September. At September 30, 2002, we did not have any debt.

Other net income (expense) was $(3.3) million of expense for the three months ended September 30, 2002 and $(0.2) million for the corresponding period in 2001. The current quarter's other expense was primarily due to investment impairment losses of $1.7 million, foreign currency transaction losses of $2.1 million, offset by investment income of $0.7 million.

Consolidated equity in the net loss of affiliated companies was $0.1 million for the three months ended September 30, 2002 and $0.9 million for the corresponding period in 2001. The change between the two periods was primarily due to the acquisition of the remaining 49% ownership interest in GUTS in May 2002. GUTS is now a wholly-owned subsidiary, and its results of operations are included in our consolidated financial statements beginning June 1, 2002. In the corresponding period in 2001, GUTS was accounted for using the equity method of accounting.

Income tax expense was $7.7 million for the three months ended September 30, 2002 and $5.8 million for the corresponding period in 2001. The increase in the income tax expense was due to our increasing income. The effective tax rate was 20% and 24% for the three months ended September 30, 2002 and 2001, respectively. The reduction in our effective tax rate can be attributed to the alignment of our intellectual property ownership with our sales and operations resulting in a more tax efficient structure. The future rate may vary due to a variety of factors, including but not limited to, the relevant income contribution by domestic and foreign operations, changes in statutory tax rates, the amount of tax exempt interest income generated during the year, the ability to utilize foreign tax credits and non-deductible items relating to acquisitions, or other non-recurring charges. We will continue to monitor the effective tax rate on a quarterly basis.

Minority interest in earnings of consolidated subsidiaries was $0.0 million for the three months ended September 30, 2002 and $0.1 million for the corresponding period in 2001. The decrease is due to the acquisition of the remaining 12% ownership interest in HUTS during the three months ended September 30, 2002. HUTS is now a wholly-owned subsidiary of the Company.

For the nine months ended September 30, 2002, we reported net income of $74.0 million as compared to net income of $40.4 million for the nine months ended September 30, 2001. Net income for the nine months ended September 30, 2002 reflects the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," on January 1, 2002. With the adoption of SFAS No. 142, goodwill is no longer amortized, but rather tested annually for impairment. Had SFAS No. 142 been in effect during the nine months ended September 30, 2001, net income reported for that period would have been $45.8 million.

Our net sales increased 58% to $680.7 million for the nine months ended September 30, 2002 from $429.7 million for the corresponding period in 2001. Sales of telecommunications equipment for the nine months ended September 30, 2002 were $426.5 million, an increase of $124.5 million or 41%, as compared to the nine months ended September 30, 2001. Sales of subscriber handsets for the nine months ended September 30, 2002 were $254.2 million, an increase of $126.5 million or 99%, as compared to the nine months ended September 30, 2001. Sales of telecommunications equipment and sales of subscriber handsets increased due to the continued growth in spending on telecommunications infrastructure in China, which accounted for 83% and 91% of our net sales for the nine months ended September 30, 2002 and 2001, respectively. International sales of telecommunications equipment increased to $112.8 million for the three months ended September 30, 2002 as compared to $39.6 million for the three months ended September 30, 2001, primarily driven by sales of equipment to BBTC in Japan to support its ADSL rollout. During the three months ended September 30, 2002, the provincial-level telecommunications service entity in the Zhejiang province of China began to consolidate telecommunications purchasing decisions for that province. As a result of this trend in the Zhejiang province, we have grouped all customers in Zhejiang province together and have treated these as one customer. At September 30, 2002, we had approximately 25 such customers in Zhejiang province. For the nine months ended September 30, 2002, sales to Zhejiang province accounted for 21% and sales to BBTC accounted for 14% of our net sales. For the nine months ended September 30, 2001, sales to Zhejiang province accounted for 32% of our net sales.

Gross profit increased 57% to $244.4 million for the nine months ended September 30, 2002 from $155.6 million for the corresponding period in 2001 due to increased net sales. Gross profit, as a percentage of net sales, was 36% for both the nine months ended September 30, 2002 and 2001. We believe our lower margin handset sales will increase somewhat during future periods. In addition, we believe that there will be continued competitive market pricing pressures on our other products in line with current trends in the industry. However, we believe that cost efficiencies arising from the continued cost reduction, manufacturing efficiencies and redesign of our products for our PAS systems will partially offset the impact of these factors on our gross profit as a percentage of net sales. We will also continue to focus our efforts on the efficient management of our operating expenses.

Selling, general and administrative expenses increased 49% to $81.8 million for the nine months ended September 30, 2002 from $54.7 million for the corresponding period in 2001. The increase in selling, general and administrative expenses was primarily due to increased sales and administrative personnel and related expenses, including sales commissions, associated with the growth in net sales and the expansion of our overall level of business activities. Selling, general and administrative expenses

as a percentage of net sales was 12% and 13%, for the nine months ended September 30, 2002 and 2001, respectively.

Research and development expenses increased 51% to $63.5 million for the nine months ended September 30, 2002 from $42.1 million for the corresponding period in 2001. The increase in research and development expenses was primarily due to the hiring of additional technical personnel, increased prototype expenses and licensing fees to support our research and development efforts. As a percentage of net sales, research and development expenses were 9% and 10% for the nine months ended September 30, 2002 and 2001, respectively.

In-process research and development expense was $0.7 million for the nine months ended September 30, 2002. This arose from our acquisition of Issanni on April 19, 2002 and was based on an independent appraisal. There was no in-process research and development expense during the corresponding period in 2001.

Amortization of intangible assets decreased to $1.8 million for the nine months ended September 30, 2002 from $5.4 million for the corresponding period in 2001. The decrease in amortization of intangible assets was primarily due to the elimination of amortization of goodwill upon the adoption of SFAS No. 142 on January 1, 2002 of $5.0 million, offset by an increase in amortization of intangibles of $1.4 million. Had SFAS No. 142 been in effect during the nine months ended September 30, 2001, amortization expense would have been $0.0 million.

Net interest income was $3.2 million for the nine months ended September 30, 2002 and $3.7 million for the corresponding period in 2001. The decrease was primarily due to a reduction in cash and cash equivalents and short-term investments of $4.6 million and a reduction in average interest rates on deposits from 3% to 1%, offset by a decline in interest expense of $1.6 million. In addition, short-term and long-term debt balances were paid off in September. At September 30, 2002, we did not have any debt.

Other expense net was $(4.9) million for the nine months ended September 30, 2002 compared to $(0.3) million for the corresponding period in 2001. Other expense for the nine months ended September 30, 2002 was primarily related to write-downs of long-term investments of $2.8 million and foreign exchange losses of $2.3 million offset by investment income of $0.7 million.

Consolidated equity in net loss of affiliated companies was $0.9 million for the nine months ended September 30, 2002 and $1.6 million for the corresponding period in 2001. The change between the two periods reflects the acquisition of the remaining 49% ownership interest in our Guangdong manufacturing facility. GUTS is now a wholly-owned subsidiary, and its results of operations are included in our consolidated financial statements beginning June 1, 2002. In the corresponding period in 2001, GUTS was accounted for using the equity method of accounting.

Income tax expense was $18.8 million for the nine months ended September 30, 2002 and $13.5 million for the corresponding period in 2001. The increase in the income tax expenses was due to our increasing income. The effective tax rate was 20% and 24% for the nine months ended September 30, 2002 and 2001, respectively. The reduction in our effective tax rate resulted from the alignment of our intellectual property ownership with our sales and operations resulting in a more tax efficient structure.

Minority interest in earnings of consolidated subsidiaries was $1.2 million for the nine months ended September 30, 2002 and $1.3 million for the corresponding period in 2001. The decrease is due to the acquisition of the remaining 12% ownership interest in HUTS during the second quarter of fiscal 2002. HUTS is now a wholly-owned subsidiary.

In March 2000, we raised $189.4 million in net proceeds from our initial public offering in which we sold 11,500,000 shares of common stock. On August 3, 2001, we completed a follow on public offering and sold an aggregate of 7,400,000 shares of common stock in which we raised net proceeds of $139.9 million. On February 28, 2002, we sold 1,500,000 shares of common stock upon exercise of the underwriter's over-allotment option in connection with the resale public offering of 10,000,000 shares of our common stock by SOFTBANK America Inc., one of our stockholders. Upon such sale, we received aggregate net proceeds of approximately $28.9 million.

As of September 30, 2002, we had lines of credit totaling $343.3 million available for future borrowings. We do not have any borrowings at September 30, 2002. We are not a guarantor of any debt not included in the condensed consolidated balance sheet. As of September 30, 2002, we had working capital of $564.7 million, including $307.2 million in cash and cash equivalents and $58.9 million of short-term investments.

Net cash generated from operating activities for the nine months ended September 30, 2002 was $142.9 million higher than the 2001 level. This was primarily due to improved operating performance and accounts receivable collection efficiency. Days sales outstanding was 61 days at September 30, 2002 compared to 111 days at September 30, 2001. Net cash provided by operations for the nine months ended September 30, 2002 of $136.3 million was primarily due to net income of $74.0 million, adjusted for depreciation and amortization expense of $15.1 million, and increases in inventory reserves of $9.8 million, allowance for doubtful accounts of $6.5 million, accounts payable of $43.0 million, other accrued liabilities of $25.0 million, deferred revenue of $31.5 million and income taxes payable of $5.2 million, and a decrease in accounts receivable of $7.7 million. This was offset by an increase in inventories, deferred tax assets and other current and non-current assets of $65.6 million, $8.7 million and $18.6 million, respectively. Net cash used in operations for the nine months ended September 30, 2001 was $6.6 million, and was primarily due to increases in inventories, accounts receivable, other current and non-current assets and income taxes payable of $89.9 million, $58.7 million, $46.7 million and $3.6 million respectively. Net cash used in operations was also due to depreciation and amortization expense of $12.1 million, non-qualified stock option exercise tax benefits of $10.5 million, amortization of deferred stock compensation expense of $3.2 million and an investment impairment charge of $1.6 million. The net cash used in operations was partially offset by an increase in net income for the period, and by increases in deferred revenue, accounts payable and other current liabilities of $42.8 million, $41.5 million and $24.2 million respectively.

Net cash used in investing activities for the nine months ended September 30, 2002 of $43.6 million was primarily due to purchases of property, plant and equipment of $42.0 million of

which $12.1 million related to our new manufacturing facility in Hangzhou, business acquisitions of $17.7 million including $14.1 million relating to the purchase of the remaining interest in HUTS, $1.5 million net of cash acquired relating to the purchase of the remaining interest in GUTS and $2.1 million relating to the acquisition of Issanni and investment in affiliates of $11.0 million which comprised investments in private technology companies, offset by net sales of short-term investments of $27.0 million. Net cash used in investing activities for the nine months ended September 30, 2001 of $38.2 million was primarily due to net purchases of short-term investments of $10.7 million, the acquisition of property, plant and equipment of $18.2 million and investments in affiliates of $9.3 million.

Net cash used in financing activities for the nine months ended September 30, 2002 of $106.4 million was primarily due to the repurchase of our shares and related transaction costs for $72.9 million and net payments of $70.5 million on borrowings under our lines of credit. We paid off our short and long-term debt in September and as of September 30, 2002, we had no debt. This was offset by $36.9 million in proceeds from the sale of common stock in connection with the Softbank resale and the issuance of common stock through the exercise of stock options. Net cash provided by financing activities for the nine months ended September 30, 2001 of $171.6 million was primarily due to net proceeds of $139.9 million from the issuance of common stock through our follow on public offering, $8.4 million from the issuance of common stock through the exercise of stock options and net proceeds of $22.6 million from borrowing under our lines of credit.

Our sales in China are generally denominated in local currency. Due to the limitations on converting Renminbi, we are limited in our ability to engage in currency hedging activities in China. International sales outside China are generally denominated either in US dollars or in local currency. As of September 30, 2002, we were not engaged in any currency hedging activities and did not hold any derivative financial instruments. We cannot guarantee that fluctuations in currency exchange rates in the future will not have a material adverse effect on revenues from international sales and, correspondingly, on our business, financial condition and results of operations. We also have contracts negotiated in Japanese Yen for purchasing portions of our inventories and supplies. We have a multi-currency bank account for purchasing portions of our inventories and supplies. The balance of Japanese Yen in this account as of September 30, 2002 was approximately $21.9 million.

We believe that our existing cash and cash equivalents, short-term investments and cash from operations will be sufficient to finance our operations through at least the next 12 months.

Our principal commitments as of September 30, 2002 consist of obligations under operating and capital leases, capital expenditures relating to the construction of a new manufacturing facility, and a commitment to invest up to an additional $5.0 million in one of our investments. We lease certain of our facilities under non-cancelable operating leases, which expire at various dates through 2006. We did not have any borrowings under our lines of credit at September 30, 2002. Please refer to Note 8 of our Notes to Condensed Consolidated Financial Statements for more detailed information on our lines of credit.

In June 2002, we invested $1.0 million in Global Asia Partners L.P., with a commitment to invest up to an additional $5.0 million. The remaining amount is due at such times and in such amounts as shall be specified in one or more future capital calls to be issued by the general partner. The fund size is $100 million and was formed to make private equity investments in private or pre-IPO technology and telecommunications companies. The fund's geographic focus is on technology investments in Asia, in particular India and China.

We have purchased the rights to use 49 acres of land located in Zhejiang Science and Technology Industry Garden of Hangzhou Hi-tech Industry Development Zone. We have completed the design layout for a new manufacturing facility. We expect that construction of the new facility will be completed in 2003 at a projected cost of $95.0 million. Capital expenditures were $12.1 million for the

nine months ended September 30, 2002, and are now expected to be approximately $25.0 million during 2002. We have not engaged in any transactions or arrangements with unconsolidated entities or other persons that are reasonably likely to materially affect our liquidity or the availability of, or requirements for, capital resources.

In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS No. 141 also specifies the criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets."

We adopted SFAS No. 141 in July 2001. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001, and was adopted by the Company on January 1, 2002. We completed the required transitional assessment of goodwill impairment during the first quarter of fiscal 2002. Based on this assessment, it was determined that there was no impairment of goodwill and thus no transition goodwill impairment charge.

On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 is effective for financial statements issued for fiscal years beginning after December 15, 2001 and interim periods within those fiscal years. This statement supercedes SFAS No. 121 and amends APB 30—"Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business." SFAS No. 144 also requires that long-lived assets that are to be disposed of by sale be measured at the lower of book value or fair value less cost to sell. Additionally, SFAS No. 144 expands the scope of discontinued operations to include all components of an entity with operations that (1) can be distinguished from the rest of the entity and (2) will be eliminated from the ongoing operations of the entity in a disposal transaction. We adopted SFAS No. 144 on January 1, 2002, and the adoption had no impact on our consolidated financial statements.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" which addresses the measurement, timing of recognition and reporting of costs associated with exit or disposal activities and restructuring activities. SFAS No.146 requires that a liability for costs associated with exit or restructuring activities be recognized only when the liability is incurred as opposed to at the time that a company formally approves and commits to an exit plan as set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the adoption to have any impact on our consolidated financial statements.

Our future product sales are unpredictable, our operating results are likely to fluctuate from quarter to quarter, and if we fail to meet the expectations of securities analysts or investors, our stock price could decline significantly

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

The limited performance history of some of our products, our limited forecasting experience and processes and the emerging nature of our target markets make forecasting our future sales and operating results difficult. Our expense levels are based, in part, on our expectations regarding future sales, and these expenses are largely fixed, particularly in the short term. In addition, to enable us to promptly fill orders, we maintain inventories of finished goods, components and raw materials. As a result, we commit to considerable costs in advance of anticipated sales. In the past, a substantial portion of our sales in each quarter resulted from orders received and shipped in that quarter, and we have operated with a limited backlog of unfilled orders. Accordingly, we may not be able to reduce our costs in a timely manner to compensate for any unexpected shortfall between forecasted and actual sales. Any significant shortfall of sales may require us to maintain higher levels of inventories of finished goods, components and raw materials than we require, thereby increasing our risk of inventory obsolescence and corresponding inventory write-downs and write-offs.

Competition in our markets may lead to reduced prices, revenues, market share and gross profit as a percentage of net sales

We are increasingly facing intense competition in our target markets, especially from domestic companies in China. We believe that our strongest competition in the future may come from these companies, many of which operate under lower cost structures and more favorable governmental policies and have much larger sales forces than we do. Furthermore, other companies not presently offering competing products may also enter our target markets, particularly with the reduction of trade restrictions as a result of China's admission to the World Trade Organization, or WTO. Many of our competitors have significantly greater financial, technical, product development, sales, marketing and other resources than we do. As a result, our competitors may be able to respond more quickly to new or emerging technologies and changes in service provider requirements. Our competitors may also be able to devote greater resources than we can to the development, promotion and sale of new products. These competitors may also be able to offer significant financing arrangements to service providers, in some cases facilitated by government policies, which is a competitive advantage in selling systems to service providers with limited financial and currency resources. Increased competition is likely to result in price reductions, reduced gross profit as a percentage of net sales and loss of market share, any one of which could materially harm our business, financial condition and results of operations.

Moreover, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties, including Telecommunications Administrations, Telecommunications Companies and other local organizations, to increase the ability of their products to address the needs of prospective customers in our target markets. Accordingly, alliances among competitors or between competitors and third parties may emerge and rapidly acquire significant market share. To remain competitive, we believe that we must continue to partner with Telecommunications Administrations and other local organizations, maintain a high level of investment in research and development and in sales and marketing, and manufacture and deliver products to service providers on a timely basis and without significant defects. If we fail to meet any of these objectives, our business, financial condition and results of operations could be harmed.

The introduction of inexpensive wireless telephone service or other competitive services in China may also have an adverse impact on sales of our PAS systems and handsets in China. We may not be able to compete successfully against current or future competitors, and competitive pressures in the future may materially adversely affect our business, financial condition and results of operations.

Our business may suffer if we are unable to collect payments from our customers on a timely basis

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

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

The emerging market for telecommunications equipment in developing countries is characterized by rapid technological developments, frequent new product introductions and evolving industry and regulatory standards. Our success will depend in large part on our ability to enhance our network access and switching technologies and develop and introduce new products and product enhancements that anticipate changing service provider requirements and technological developments. We may need to make substantial capital expenditures and incur significant research and development costs to develop and introduce new products and enhancements. If we fail to timely develop and introduce new products or enhancements to existing products that effectively respond to technological change, our business, financial condition and results of operations could be materially adversely affected. From time to time, our competitors or we may announce new products or product enhancements, technologies or services that have the potential to replace or shorten the life cycles of our products and that may cause customers to defer purchasing our existing products, including the possible adoption and implementation of third generation, or 3G systems, resulting in inventory obsolescence. Future technological advances in the communications industry may diminish or inhibit market acceptance of our existing or future products or render our products obsolete.

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

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

Our business will suffer if we are unable to deliver quality products on a timely and cost effective basis

Our operating results depend on our ability to manufacture products on a timely and cost effective basis. In the past, we have experienced reductions in yields as a result of various factors, including defects in components and human error in assembly. If we experience deterioration in manufacturing performance or a delay in production of any of our products, we could experience delays in shipments and cancellations of orders. Moreover, networking products frequently contain undetected software or hardware defects when first introduced or as new versions are released. In addition, our products are often embedded in or deployed in conjunction with service providers' products, which incorporate a variety of components produced by third parties. As a result, when a problem occurs, it may be difficult to identify the source of the problem. These problems may cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers, any one of which could harm our business.

We contract with third parties in China to undertake high volume manufacturing and assembly of our handsets. In addition, we sometimes use third parties for high volume assembly of circuit boards. We do not have any long-term contracts with these third party manufacturers, and in the event that

these manufacturers are unable or unwilling to continue to manufacture our products, we may be unable to secure alternative manufacturers or could experience delays in qualifying new manufacturers.

We depend on some sole source and other key suppliers for handsets, base stations, components and materials used in our products, and if these suppliers fail to provide us with adequate supplies of high quality products at competitive prices, our competitive position, reputation and business could be harmed

Some components and materials used in our products are purchased from a single supplier or a limited group of suppliers. If any supplier is unwilling or unable to provide us with high quality components and materials in the quantities required and at the costs specified by us, we may not be able to find alternative sources on favorable terms, in a timely manner, or at all. Our inability to obtain or to develop alternative sources if and as required could result in delays or reductions in manufacturing or product shipments. Moreover, these suppliers may delay product shipments or supply us with inferior quality products. If any of these events occur, our competitive position, reputation and business could suffer.

Our ability to source a sufficient quantity of high quality components used in our products may be limited by China's import restrictions and duties. We require a significant number of imported components to manufacture our products in China. Imported electronic components and other imported goods used in the operation of our business are subject to a variety of permit requirements, approval procedures, import duties and registration requirements. Non-payment of required import duties could subject us to penalties and fines and could adversely affect our ability to manufacture and sell our products in China. In addition, import duties increase the cost of our products and may make them less competitive.

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

If we are unable to expand our direct sales operation in China and indirect distribution channels elsewhere or successfully manage our expanded sales organization, our operating results may suffer

Our distribution strategy focuses primarily on developing and expanding our direct sales organization in China and our indirect distribution channels outside of China. We may not be able to successfully expand our direct sales organization in China and the cost of any expansion may exceed the revenue generated from these efforts. Even if we are successful in expanding our direct sales organization in China, we may not be able to compete successfully against the significantly larger and better-funded sales and marketing operations of current or potential competitors. In addition, if we fail to develop relationships with significant international resellers or manufacturers' representatives, or if these resellers or representatives are not successful in their sales or marketing efforts, we may be unsuccessful in our expansion efforts outside China.

We expect average selling prices of our products to decrease which may reduce our revenues and our gross margin as a percentage of net sales, and, as a result, we must introduce new products and reduce our costs in order to maintain profitability

The average selling prices for communications access and switching systems and subscriber terminal products, such as handsets, in China have been declining as a result of a number of factors, including:

We anticipate that average selling prices of our products will decrease in the future in response to product introductions by us or our competitors or other factors, including price pressures from customers. Therefore, we must continue to develop and introduce new products and enhancements to existing products that incorporate features that can be sold at higher average selling prices. Failure to do so could cause our revenues and gross profit, as a percentage of net sales, to decline.

Our cost reduction efforts may not allow us to keep pace with competitive pricing pressures or lead to improved gross profit, as a percentage of net sales. In order to be competitive, we must continually reduce the cost of manufacturing our products through design and engineering changes. We may not be successful in these efforts or delivering our products to market in a timely manner. Any redesign may not result in sufficient cost reductions to allow us to reduce the prices of our products to remain competitive or to improve or maintain our gross profit, as a percentage of net sales.

Shifts in our product mix may result in declines in gross profit, as a percentage of net sales

Our gross profit, as a percentage of net sales, varies among our product groups. Our gross profit, as a percentage of net sales, is generally higher on our access network system products and is significantly lower on our handsets. We also anticipate that the gross profit, as a percentage of net sales, may be lower for our newly developed products due to start-up costs and may improve as unit volumes increase and efficiencies can be realized. Our overall gross profit, as a percentage of net sales, has fluctuated from period to period as a result of shifts in product mix, the introduction of new products, decreases in average selling prices for older products and our ability to reduce manufacturing costs.

Service providers sometimes evaluate our products for long and unpredictable periods which causes the timing of purchases and our results of operations to be unpredictable

The period of time between our initial contact with a service provider and the receipt of an actual purchase order may span a year or more. During this time, service providers may subject our products to an extensive and lengthy evaluation process before making a purchase. The length of these qualification processes may vary substantially by product and service provider, making our results of operations unpredictable. We may incur substantial sales and marketing expenses and expend significant management effort during this process, which ultimately may not result in a sale. These qualification processes often make it difficult to obtain new customers, as service providers are reluctant to expend the resources necessary to qualify a new supplier if they have one or more existing qualified sources.

Our multi-national operations subject us to various economic, political, regulatory and legal risks

We market and sell our products in China and other markets, including Taiwan, Japan, Vietnam, India and Latin America. The expansion of our existing multi-national operations and entry into

additional international markets will require significant management attention and financial resources. Multi-national operations are subject to inherent risks, including:

Multi-national companies are required to establish intercompany pricing for transactions between their separate legal entities operating in different taxing jurisdictions. These intercompany transactions are subject to audit by taxing authorities in the jurisdictions in which multi-national companies operate. An additional tax liability may be incurred if it is determined that intercompany pricing was not done at arm's length. We believe we have adequately estimated and recorded our liability arising from intercompany pricing, but an additional tax liability may result from audits of our intercompany pricing policies.

In markets outside of China, we rely on a number of original equipment manufacturers, or OEMs, and third-party distributors and agents to market and sell our network access products. If these OEMs, distributors or agents fail to provide the support and effort necessary to service developing markets effectively, our ability to maintain or expand our operations outside of China will be negatively impacted. We may not successfully compete in these markets, our products may not be accepted and we may not successfully overcome the risks associated with international operations.

Moreover, in less developed markets we may face additional risks, such as inconsistent infrastructure support, unstable political and economic environments, and lack of a secure environment for our personnel, facilities and equipment. We have in the past experienced cases of vandalism and armed theft of our equipment that had been or was being installed in the field. If disruptions for any of these reasons become too severe in any particular market, it may become necessary for us to terminate contracts and withdraw from that market and suffer the associated costs and lost revenue.

Due to the multi-national nature of our business and operations, we are subject to regulation in multiple governmental jurisdictions. Furthermore, as a result of the heavily regulated nature of the markets in which we operate, we are continually subject to the risk of governmental investigations regarding our compliance with the rules and regulations of such jurisdictions. Should we become subject to any such investigations, there may be significant and unanticipated expenses, and risks such

as the distraction of our key employees and disruptions to our operations. Such expenses and risks may result even in the event that such investigations are decided in our favor and no instances of non-compliance are found.

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

Our failure to meet international and governmental product standards could be detrimental to our business

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

Our recent growth has strained our resources, and if we are unable to manage and sustain our growth, our operating results will be negatively affected

We have recently experienced a period of rapid growth and anticipate that we must continue to expand our operations to address potential market opportunities. If we fail to implement or improve systems or controls or to manage any future growth and expansion effectively, our business could suffer.

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

We may not be able to remain profitable in future periods. We anticipate continuing to incur significant sales and marketing, research and development and general and administrative expenses and, as a result, we will need to generate higher revenues to remain profitable. Numerous factors could negatively impact our results of operations, including a decrease in sales, price pressures and significant fixed costs. Our past results should not be relied on as an indication of our future performance.

Our success is dependent on continuing to hire and retain qualified personnel, and if we are not successful in attracting and retaining these personnel, our business would be harmed

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

To effectively manage our recent growth as well as any future growth, we will need to recruit, train, assimilate, motivate and retain qualified employees. Competition for qualified employees is intense, and the process of recruiting personnel with the combination of skills and attributes required to execute our business strategy can be difficult, time-consuming and expensive. We are actively searching for research and development engineers and sales and marketing personnel, who are in short supply. Additionally, we have a need for and have experienced difficulty in finding qualified accounting personnel knowledgeable in U.S. and China accounting standards who are resident in China. If we fail to attract, hire, assimilate or retain qualified personnel, our business would be harmed.

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

Any acquisitions that we undertake could be difficult to integrate, disrupt our business, dilute our stockholders and harm our operating results

We may acquire complementary businesses, products and technologies. For example, in November 2001, we acquired Advanced Communication Devices Corporation, a system on chip semiconductor company. On April 19, 2002, the Company completed the purchase of Issanni Communications, Inc., a RAS (remote access server) and local access technology company, providing broadband over ADSL. On December 18, 2001, we entered into an agreement to acquire the remaining 49% ownership interest in GUTS, one of our two primary manufacturing facilities in China, in order to achieve 100% ownership in the joint venture. On January 21, 2002, we entered into an agreement to acquire the remaining 12% ownership interest in HUTS, our other manufacturing facility. Any anticipated benefits of an acquisition may not be realized. We have in the past and will continue to evaluate acquisition prospects that would complement our existing product offerings, augment our market coverage, enhance our technological capabilities, or that may otherwise offer growth opportunities. Acquisitions of other companies may result in dilutive issuances of equity securities, the incurrence of debt and the amortization of expenses related to intangible assets. In addition, acquisitions involve numerous risks, including difficulties in the assimilation of operations, technologies, products and personnel of the acquired company, diversion of management's attention from other business concerns, risks of entering markets in which we have no direct or limited prior experience, and the potential loss of key employees of the acquired company.

We may be unable to adequately protect our intellectual property and may be subject to claims that we infringe the intellectual property of others, either of which could substantially harm our business

We rely on a combination of patents, copyrights, trademarks, trade secret laws and contractual obligations to protect our technology. We have applied for patents in the United States, three of which

have been issued. We have also filed patent applications in other countries. Additional patents may not be issued from our pending patent applications and our issued patents may not be upheld. In addition, we have, from time to time, chosen to abandon previously filed applications. Moreover, we have not yet obtained, and may not be able to obtain, patents in China on our products or the technology that we use to manufacture our products. Our subsidiaries and joint ventures in China rely upon our trademarks, technology and know-how to manufacture and sell our products. We cannot guarantee that these and other intellectual property protection measures will be sufficient to prevent misappropriation of our technology or that our competitors will not independently develop technologies that are substantially equivalent or superior to ours. In addition, the legal systems of many foreign countries, including China, do not protect intellectual property rights to the same extent as the legal system of the United States. If we are unable to adequately protect our proprietary information and technology, our business, financial condition and results of operations could be materially adversely affected.

The increasing dependence of the communications industry on proprietary technology has resulted in frequent litigation based on allegations of the infringement of patents and other intellectual property. In the future we may be subject to litigation to defend against claimed infringements of the rights of others or to determine the scope and validity of the proprietary rights of others. Future litigation also may be necessary to enforce and protect our trade secrets and other intellectual property rights. Any intellectual property litigation could be costly and could cause diversion of management's attention from the operation of our business. Adverse determinations in any litigation could result in the loss of our proprietary rights, subject us to significant liabilities or require us to seek licenses from third parties which may not be available on commercially reasonable terms, if at all. We could also be subject to court orders preventing us from manufacturing or selling our products.

Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure and other events beyond our control. We do not have a detailed disaster recovery plan. Our headquarters facility in the State of California was subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts resume, they could disrupt the operations at our headquarters. In addition, we do not carry sufficient business interruption insurance to compensate us for losses that may occur and any losses or damages incurred by us could have a material adverse effect on our business.

We maintain an investment portfolio of various holdings, types, and maturities. Recently, part of this portfolio included an equity investment in a publicly traded company, the value of which is subject to market price volatility. Recent events have adversely affected the public equities market and general economic conditions may continue to worsen. Should the fair value of our publicly traded equity investments decline below their cost basis in a manner deemed to be other-than-temporary, it may become necessary for us to take an impairment charge.

We have also invested in several privately held companies as well as investment funds which invest primarily in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky, as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire initial investment in these companies and investment funds.

The Company, some of our directors and officers and various underwriters for our initial public offering have been sued in a putative shareholder class action. The complaint alleges undisclosed improper underwriting practices concerning the allocation of IPO shares, in violation of the federal securities laws. Similar complaints have been filed concerning the IPOs of more than 300 companies, and the litigation has been coordinated in federal court for the Southern District of New York as In re Initial Public Offering Securities Litigation, 21 MC 92. We believe we have meritorious defenses to the claims against us and intend to defend the litigation vigorously. However, as litigation is by its nature uncertain, an unfavorable resolution of the lawsuit could have a material adverse effect on our business, results of operations, or financial condition.

RISKS RELATING TO THE STRUCTURE AND REGULATION OF CHINA'S
TELECOMMUNICATIONS INDUSTRY

China's telecommunications industry is subject to extensive government regulation

China's telecommunications industry is heavily regulated by the Ministry of Information Industry. The Ministry of Information Industry has broad discretion and authority to regulate all aspects of the telecommunications and information technology industry in China, including managing spectrum bandwidths, setting network equipment specifications and standards and drafting laws and regulations related to the electronics and telecommunications industries. Additionally, the Ministry of Information Industry can decide what types of equipment may be connected to the national telecommunications networks, the forms and types of services that may be offered to the public, the rates that are charged to subscribers for those services and the content of material available in China over the Internet. If the Ministry of Information Industry sets standards with which we are unable to comply or which render our products noncompetitive, our ability to sell products in China may be limited, resulting in substantial harm to our operations.

At the end of May 2000, we became aware of an internal notice, circulated within the Ministry of Information Industry, announcing a review of PHS-based telecommunications equipment for future installation into China's telecommunications infrastructure. The Ministry of Information Industry requested service providers to temporarily halt new deployments of PHS-based telecommunications equipment, including our PAS systems and handsets, pending conclusion of a review by the Ministry of Information Industry. Subsequently, at the end of June 2000, the Ministry of Information Industry issued a notice stating that it had concluded its review of PHS-based equipment and that the continued deployment of PHS-based systems, such as our PAS systems and handsets, in China's county-level cities and towns and villages would be permitted. In addition, the notice stated that deployments within large and medium-sized cities would only be allowed in very limited areas of dense population, such as campuses, commercial buildings and special development zones. The notice confirmed, however, that new citywide deployments of our PAS system in large and medium cities would not be permitted. Failure of the Ministry of Information Industry to permit the sale or deployment of our PAS systems and handsets, or the sale or deployment of our other products, or the imposition of additional limitations on their sale in the future could have a material adverse effect on our business and financial condition. The Ministry of Information Industry may conduct further reviews or evaluations of PHS-based telecommunications equipment or may change its position regarding PHS-based systems in the future.

China's telecommunications regulatory framework is in the process of being developed, which has led to uncertainties regarding how to conduct our business in China

China does not yet have a national telecommunications law. However, with China's recent admission into the WTO the Ministry of Information Industry, under the direction of the State Council, must shortly present the first draft of the Telecommunications Law of the People's Republic of China for ultimate submission to the National People's Congress for review and adoption. We do not know the nature and scope of regulation that the Telecommunications Law would create. Accordingly, we cannot predict whether it will have a positive or negative effect on us or on some or all aspects of our business.

China's telecommunications regulatory framework is in the process of being developed. In September 2000, the State Council issued the Telecommunications Regulations of the People's Republic of China, known as the Telecom Regulations. The Telecom Regulations cover telecommunications services and market regulations, pricing, interconnection and connection, as well as telecommunications construction and security issues. In May 2001, the Ministry of Information Industry issued the Administrative Measures of Network Access Licenses to implement the Telecom Regulations. Regulations in this area often require subjective interpretation and, given the relative infancy of the Telecom Regulations and the implementing regulations, we do not know how the regulations will be interpreted or enforced. As a result, our attempts to comply with these regulations may be deemed insufficient by the appropriate regulatory agencies, which could subject us to penalties that adversely affect our business.

Our business may suffer as a result of the recent restructuring of China Telecom

In February 1999, the State Council approved a restructuring plan for the China Telecom system, under which the telecommunications operations of the China Telecom system were separated along four business lines: fixed line, mobile, paging and satellite communications services. Following the announcement, we observed a reduction in orders from Telecommunications Companies, which we attributed to the uncertainties surrounding the restructuring and the ultimate impact the restructuring would have on the Telecommunications Companies.

Effective in May 2002, China Telecom was split into two entities by region, northern and southern. The 10 northern provinces, municipalities and autonomous regions of China Telecom were merged with

China Netcom Co. Ltd. and China Jitong Network Communications Co. Ltd. to form a new company known as China Netcom ("China Netcom"). The remaining 21 provinces, municipalities and autonomous regions now constitute the southern entity, and have kept the name of China Telecom (the "New China Telecom"). China Netcom inherited 30% of the old China Telecom's national backbone network, with the rest going to the New China Telecom. As this change is very recent, we cannot be certain what impact the restructuring of China Telecom will have on our business operations. However, we may experience another decline in orders and related revenues similar to that which we experienced following the 1999 restructuring, resulting from uncertainty among our telecommunications company customers associated with the restructuring. Moreover, following any restructuring, China Netcom, the New China Telecom or any other entity that may replace it as a result of any subsequent restructuring may restrict or prohibit the sales of our products, which could cause substantial harm to our business.

We do not have some of the licenses we are required to have to sell our network access products in China

The regulations implementing these requirements are not very detailed, have not been applied by a court and may be interpreted and enforced by regulatory authorities in a number of different ways. We have obtained the required network access licenses for our AN-2000 platform. We have applied for, but have not yet received, a network access license for our PAS systems and handsets. Based upon conversations with the Ministry of Information Industry, we understand that our PAS systems and handsets are considered to still be in the trial period and that sales of our PAS systems and handsets may continue to be made by us during this trial period, but a license will ultimately be required. Network access licenses will also be required for most additional products that we are selling or may sell in China, including our mSwitch platform. If we fail to obtain the required licenses, we could be prohibited from making further sales of the unlicensed products, including our PAS systems and handsets, in China, which would substantially harm our business, financial condition and results of operations. Our counsel in China has advised us that China's governmental authorities may interpret or apply the regulations with respect to which licenses are required and the ability to sell a product while a product is in the trial period in a manner that is inconsistent with the information received by our counsel in China, either of which could have a material adverse effect on our business and financial condition.

We are required to register the software incorporated in our products in accordance with relevant Chinese regulations

In October 2000, the Ministry of Information Industry issued regulations which prohibit the production and sale of software products, or products incorporating software, in China unless the software is registered with the government. We have accomplished the necessary registration with regards to the software incorporated in our AN-2000 and PAS. However, additional registration is required for software incorporated in additional products that we are selling or may sell in China, including mSwitch. Based upon verbal advice received from the Ministry of Information Industry, we believe that we will be able to sell products incorporating our software while any of our applications for

registration may be pending. However, the Chinese government may interpret or apply the regulations in such a way as to prohibit sales of products incorporating our unregistered software prior to registration. If the government prohibits sales pending registration, or if we fail in our efforts to register any software required to be registered, we could be prohibited from making further sales of products incorporating our unregistered software in China, which could substantially harm our business and financial condition.

Most of our customers in China have historically been part of the China Telecom system and under China Telecom's ultimate control; following the recent restructuring of China Telecom, most of our customers in China are now part of the New China Telecom or China Netcom, and are subject to their ultimate control

Our main customers in China are the local Telecommunications Companies (formerly known as Telecommunications Bureaus) which historically operated under China Telecom, China's state-owned fixed line operator, and were subject to its ultimate control. Following the recent restructuring of China Telecom, the Telecommunications Companies now operate under the ultimate control of either the New China Telecom or China Netcom. Policy statements may be issued and decisions may be made by the New China Telecom and China Netcom, which govern the equipment purchasing decisions of most of our customers in China. For example, in late 1999, China Telecom prohibited all Telecommunications Companies from purchasing PHS systems, such as our PAS systems, for implementation in large cities, even before these sales were prohibited by the Ministry of Information Industry. As most of our sales are generated from our operations in China, any decisions by the New China Telecom or China Netcom restricting or prohibiting the sales or deployment of our products could cause significant harm to our business.

Our customer base in China could effectively become increasingly concentrated if more purchasing decisions are coordinated or made by provincial or greater regional telecommunications service entities rather than by local telecommunications service providers

Whether this represents the beginning of a greater trend throughout China towards increased consolidation of negotiations and purchasing decisions into the control of provincial-level telecommunications service entities is unclear. If an increasing number of purchasing decisions and negotiations are controlled on a larger regional level in China by provincial-level telecommunications service entities, this would effectively result in a concentration of the Company's customer base. The Company's financial results may increasingly depend in significant part upon the success of a few major customers and the Company's ability to meet their future capital equipment needs. Although the composition of the group comprising the Company's largest customers may vary from period to period, the loss of a significant customer or any reduction in orders by any significant customer, including reductions due to market, economic or competitive conditions in the telecommunications industry, may have a material adverse effect on the Company's business, financial condition and results of operations. In addition to the business risks associated with dependence on major customers, significant customer concentration may also result in significant concentrations of accounts receivable. Significant and concentrated receivables would expose the Company to additional risks, including the risk of default by

one or more customers representing a significant portion of the Company's total receivables. If the Company is required to take additional accounts receivable reserves, its business, financial condition and results of operations would be materially adversely affected.

Our ability to sell our PAS wireless systems and handsets could be significantly impaired if the New China Telecom or China Netcom are granted, or if they otherwise acquire, mobile licenses allowing the New China Telecom or China Netcom to deliver cellular services

The New China Telecom and China Netcom hold and operate the fixed line telephone and data communications assets in China, and currently do not have the licenses necessary to offer cellular services. To offer wireless services to end users, the Telecommunications Companies must offer services that can be delivered over wireline networks, such as those delivered over our PAS wireless systems and handsets. China's media sources have widely reported that after the restructuring of China Telecom, the Ministry of Information Industry may grant mobile licenses to the New China Telecom or China Netcom, or to both. If the Ministry of Information Industry does grant a mobile license to the New China Telecom or China Netcom, or to both, or if such entities otherwise acquire mobile licenses, local Telecommunications Companies will be free to offer cellular services such as GSM or CDMA to their customers, and they may therefore elect not to deploy our PAS systems and handsets. If this were to occur, we could lose current and potential customers for our PAS systems and handsets, and our financial condition and results of operations could be materially adversely affected.

Changes in telecommunications rates or pricing policies may result in decreased demand for our products

In November 2000, the Ministry of Information Industry announced significant changes in rates for telecommunications services in China. While long distance, international, leased line and Internet connection fees were cut by up to 70%, the rates for local telephone services, which include certain types of wireless access services such as those offered over our PAS systems and handsets, were increased, from approximately $0.01 per minute to approximately $0.02 per minute. The increase in rates may result in a reduced demand by end users for wireless services delivered over our PAS system and a corresponding decline in demand for our products. In addition, mobile operators are offering price incentive plans that could impact demand for our products. Additionally, the Ministry of Information Industry may implement future rate changes for wireline or wireless services in China or change telecommunications pricing policies, including allowing carriers to set prices based on market conditions, any of which may lead to reduced demand for our systems and products and result in a material adverse effect on our business or results of operations.

Sales in China have accounted for most of our sales, and therefore, our business, financial condition and results of operations are to a significant degree subject to economic, political and social events in China

Approximately $218.2 million and $567.9 million, or 82% and 83%, of our net sales for the three and nine months ended September 30, 2002, and $133.3 million and $390.0 million, or 78% and 91%, of our net sales for the corresponding periods in 2001, occurred in China. Additionally, a substantial portion of our fixed assets are located in China. Of our total fixed assets, approximately 84% as of September 30, 2002 and 75% as of December 31, 2001 were in China. We expect to make further investments in China in the future. Therefore, our business, financial condition and results of operations are to a significant degree subject to economic, political and social events in China.

Devaluation in the value of the Renminbi and fluctuations in exchange rates could adversely affect our financial results

Exchange rate fluctuations could have a substantial negative impact on our financial condition and results of operations. We purchase substantially all of our materials in the United States and Japan and a significant portion of our cost of goods sold is incurred in U.S. dollars and Japanese yen. A significant portion of our operating expenses are incurred in U.S. dollars. At the same time, most of our sales are denominated in Renminbi. The value of the Renminbi is fixed by China's national government and is subject to changes in China's governmental policies and to international economic and political developments. China may choose to devalue the Renminbi against the U.S. dollar. Additionally, China's government has considered from time to time whether to partially or fully abandon the official exchange rate for Renminbi to the U.S. dollar. The abandonment of this official exchange rate policy may lead to sharp depreciation of the Renminbi against the U.S. dollar and other foreign currencies and to significantly more volatility in the Renminbi exchange rate in the future, both of which would adversely affect our financial results and make our future results more subject to fluctuation.

In the past, financial markets in many Asian countries have experienced severe volatility and, as a result, some Asian currencies have experienced significant devaluation from time to time. The devaluation of some Asian currencies may have the effect of rendering exports from China more expensive and less competitive and therefore place pressure on China's government to devalue the Renminbi. Any devaluation of the Renminbi could result in an increase in volatility of Asian currency and capital markets. Future volatility of Asian financial markets could have an adverse impact on our ability to expand our product sales into Asian markets outside of China. Moreover, due to the limitations on the convertibility of Renminbi, we are limited in our ability to engage in currency hedging activities in China and do not currently engage in currency hedging activities with respect to international sales outside of China.

Currency restrictions in China may limit the ability of our subsidiaries and joint ventures in China to obtain and remit foreign currency necessary for the purchase of imported components and may limit our ability to obtain and remit foreign currency in exchange for Renminbi earnings

China's government imposes controls on the convertibility of Renminbi into foreign currencies and, in certain cases, the remittance of currency out of China. Under the current foreign exchange control system, sufficient foreign currency may not be available to satisfy our currency needs. Shortages in the availability of foreign currency may restrict the ability of our Chinese subsidiaries to obtain and remit sufficient foreign currency to pay dividends to us, or otherwise satisfy their foreign currency denominated obligations, such as payments to us for components which we export to them and for technology licensing fees. We may also experience difficulties in completing the administrative procedures necessary to obtain and remit needed foreign currency. Our business could be substantially harmed if we are unable to convert and remit our sales received in Renminbi into U.S. dollars. Under existing foreign exchange laws, Renminbi held by our China subsidiaries can be converted into foreign currencies and remitted out of China to pay current account items such as payments to suppliers for imports, labor services, payment of interest on foreign exchange loans and distributions of dividends so long as the subsidiaries have adequate amounts of Renminbi to purchase the foreign currency. Expenses of a capital nature such as the repayment of bank loans denominated in foreign currencies, however, require approval from appropriate governmental authorities before Renminbi can be used to purchase foreign currency and then remitted out of China. This system could be changed at any time by executive decision of the State Council to impose limits on current account convertibility of the Renminbi or other similar restrictions. Moreover, even though the Renminbi is intended to be freely convertible under the current account, the State Administration of Foreign Exchange, which is responsible for administering China's foreign currency market, has a significant degree of administrative discretion in implementing the laws. From time to time, the State Administration of Foreign Exchange has used this discretion in ways which effectively limit the convertibility of current account payments and restrict remittances out of China. Furthermore, in many circumstances the State Administration of Foreign Exchange must approve foreign currency conversions and remittances. Under the current foreign exchange control system, sufficient foreign currency may not be available at a given exchange rate to satisfy our currency demands.

China subjects foreign investors in the telecommunications industry to ownership and geographic limitations

China's government and its agencies, including the Ministry of Information Industry and the State Council, regulate foreign investment in the telecommunications industry through the promulgation of various laws and regulations and the issuance of various administrative orders and decisions. Currently, foreign investors may engage in such activities only in accordance with certain ownership and geographic limitations. China may promulgate new laws or regulations, or issue administrative or judicial decisions or interpretations, which would further restrict or bar foreigners from engaging in telecommunications-related activities. The promulgation of laws or regulations or the issuance of administrative orders or judicial decisions or interpretations restricting or prohibiting telecommunications activities by foreigners could have a substantial impact on our ongoing operations.

Since 1978, China's government has been and is expected to continue reforming its economic and political systems. These reforms have resulted in and are expected to continue to result in significant economic and social development in China. Many of the reforms are unprecedented or experimental and may be subject to change or readjustment due to a number of political, economic and social factors. We believe that the basic principles underlying the political and economic reforms will continue to be implemented and provide the framework for China's political and economic system. New reforms

or the readjustment of previously implemented reforms could have a significant negative effect on our operations. Changes in China's political, economic and social conditions and governmental policies which could have a substantial impact on our business include:

The economy of China differs from the economies of most countries belonging to the Organization for Economic Cooperation and Development in various respects such as structure, government involvement, level of development, growth rate, capital reinvestment, allocation of resources, self-sufficiency, rate of inflation and balance of payments position. In the past, the economy of China has been primarily a planned economy subject to one- and five-year state plans adopted by central government authorities and largely implemented by provincial and local authorities, which set production and development targets.

Since 1978, increasing emphasis had been placed on decentralization and the utilization of market forces in the development of China's economy. Economic reform measures adopted by China's government may be inconsistent or ineffectual, and we may not in all cases be able to capitalize on any reforms. Further, these measures may be adjusted or modified in ways which could result in economic liberalization measures that are inconsistent from time to time or from industry to industry or across different regions of the country. China's economy has experienced significant growth in the past decade. This growth, however, has been accompanied by imbalances in China's economy and has resulted in significant fluctuations in general price levels, including periods of inflation. China's government has implemented policies from time to time to increase or restrain the rate of economic growth, control periods of inflation or otherwise regulate economic expansion. While we may be able to benefit from the effects of some of these policies, these policies and other measures taken by China's government to regulate the economy could also have a significant negative impact on economic conditions in China with a resulting negative impact on our business.

China's entry into the World Trade Organization creates uncertainty as to the future economic and business environments in China

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

If tax benefits available to our subsidiaries located in China are reduced or repealed, our business could suffer

Our subsidiaries and joint ventures located in China enjoy tax benefits in China which are generally available to foreign investment enterprises, including full exemption from national enterprise income tax for two years starting from the first profit-making year and/or a 50% reduction in national

income tax rate for the following three years. In addition, local enterprise income tax is often waived or reduced during this tax holiday/incentive period. Under current regulations in China, foreign investment enterprises that have been accredited as technologically advanced enterprises are entitled to additional tax incentives. These tax incentives vary in different locales and could include preferential national enterprise income tax treatment at 50% of the usual rates for different periods of time. All of our active subsidiaries in China were accredited as technologically advanced enterprises. Two of our principal subsidiaries, UTStarcom China and HUTS, accounted for approximately 95.1% of our revenues for the nine months ended September 30, 2002. The tax holidays applicable to UTStarcom China will expire at the end of 2002. At that time, the tax rate will increase from 7.5% to 15% and will negatively impact our financial condition and results of operations. The tax holiday applicable to our other principal subsidiary, HUTS, expired in 2001 and is now subject to annual review. HUTS was able to maintain the 10% rate for 2002, following its annual review. However, its tax rate could increase from 10% to 15% if it is unable to maintain a tax holiday in 2003. If we are unable to extend the tax holiday described above to 2003, our financial condition and results of operations may be negatively impacted. Additionally, the Chinese government is considering the imposition of "unified" corporate income tax that would phase out, over time, the preferential tax treatment to which foreign-funded enterprises, such as UTStarcom, are currently entitled. While it is not certain whether the government will implement such a unified tax structure or whether, if implemented, UTStarcom will be grandfathered into the new tax structure, if the new tax structure is implemented, it will adversely affect our financial condition.

We may be exposed to contingent tax liabilities in China resulting from our failure to withhold sufficient amounts for China's income tax purposes

We employ a number of U.S. citizens who work on a full time basis in China. These expatriate employees participate in our stock option plans and have exercised a number of options granted under the plans. The option exercises generated income that may be subject to personal income taxes under China's income tax laws. We did not withhold China income taxes on the option exercises, and the employees have not yet paid any taxes in China that may be due. Should the employees fail to pay the income taxes, we may be liable for such taxes in our capacity as withholding agent. In the event that it is determined that taxes are due in China, we, on behalf of our employees, will apply for a refund from the U.S. tax authorities corresponding to the amount of the foreign tax credit which would then be applicable. The refund amounts are required to be paid to us by the employees who receive them. In addition, our failure to collect and remit China withholding tax may also subject us to penalties.

China's legal system embodies uncertainties that could negatively impact our business

China has a civil law system. Decided court cases do not have binding legal effect on future decisions. Since 1979, many new laws and regulations covering general economic matters have been promulgated in China. Despite this activity to develop the legal system, China's system of laws is not yet complete. Even where adequate law exists in China, enforcement of existing laws or contracts based on existing law may be uncertain and sporadic and it may be difficult to obtain swift and equitable enforcement, or to obtain enforcement of a judgment by a court of another jurisdiction. The relative inexperience of China's judiciary in many cases creates additional uncertainty as to the outcome of any litigation. Further, interpretation of statutes and regulations may be subject to government policies reflecting domestic political changes. Moreover, government policies and internal rules promulgated by governmental agencies may not be published in time, or at all. As a result, we may operate our business in violation of new rules and policies without having any knowledge of their existence.

China has adopted a broad range of related laws, administrative rules and regulations that govern the conduct and operations of foreign investment enterprises and restrict the ability of foreign companies to conduct business in China. These laws, rules and regulations provide some incentives to

encourage the flow of investment into China, but also subject foreign companies, and foreign investment enterprises, including our subsidiaries in China, to a set of restrictions that may not always apply to domestic companies in China. As a result of its admission into the WTO, China is increasingly according foreign companies and foreign investment enterprises established in China the same rights and privileges as Chinese domestic companies. These special laws, administrative rules and regulations governing foreign companies and foreign investment enterprises may still place us and our subsidiaries at a disadvantage in relation to Chinese domestic companies and may adversely affect our competitive position. Moreover, as China's legal system develops, the promulgation of new laws, changes to existing laws and the pre-emption of local regulations by national laws may adversely affect foreign investors and companies. Many of our activities and products in China are subject to administrative review and approval by various national and local agencies of China's government. Because of the changes occurring in China's legal and regulatory structure, we may not be able to secure the requisite governmental approval for our activities and products. Failure to obtain the requisite government approval for any of our activities or products could substantially harm our business.

The trading price of our common stock has fluctuated significantly since our initial public offering in March 2000. Our stock price could be subject to wide fluctuations in the future in response to many events or factors, including those discussed in the preceding risk factors relating to our operations, as well as:

General market conditions and domestic or international macroeconomic factors unrelated to our performance may also affect our stock price. For these reasons, investors should not rely on recent trends to predict future stock prices or financial results. In addition, following periods of volatility in a company's securities, securities class action litigation against a company is sometimes instituted. This type of litigation could result in substantial costs and the diversion of management time and resources.

SOFTBANK CORP. and its related entities, including SOFTBANK America Inc., has significant influence over our management and affairs, which it could exercise against your best interests

SOFTBANK CORP. and its related entities, including SOFTBANK America Inc., beneficially own 21.3% of our outstanding stock. As a result, SOFTBANK CORP. and its related entities, including SOFTBANK America Inc., have the ability to exercise significant influence over all matters submitted to our stockholders for approval and exert significant influence over our management and affairs. This concentration of ownership may delay or prevent a change of control or discourage a potential acquirer

from making a tender offer or otherwise attempting to obtain control of our company, which could decrease the market price of our common stock. Matters that could require stockholder approval include:

The interests of SOFTBANK America Inc. may not always coincide with our interests. SOFTBANK America Inc., acting through its designees on the Board of Directors and through its ownership of voting securities, will have the ability to exercise significant influence over our actions irrespective of the desires of our other stockholders or directors.

Delaware law and our charter documents contain provisions that could discourage or prevent a potential takeover, even if the transaction would benefit our stockholders

Other companies may seek to acquire or merge with us. An acquisition or merger of our company could result in benefits to our stockholders, including an increase in the value of our common stock. Some provisions of our Certificate of Incorporation and Bylaws, as well as provisions of Delaware law, may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:

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

The table below represents carrying amounts and related weighted-average interest rates of maturity of interest bearing instruments in our investment portfolio at September 30, 2002:

(In thousands, except interest rates)
Cash and cash equivalents	$	307,240
Average interest rate		1.3	%
Short-term investments		58,914
Average interest rate		1.7	%
Total investment securities		366,154
Average interest rate		1.4	%

Part of our investment portfolio has recently included an equity investment in a publicly traded company, the value of which is subject to market price volatility. Recent events have adversely affected the public equities market and general economic conditions may continue to worsen. Should the fair value of our publicly traded equity investments decline below their cost basis in a manner deemed to be other-than-temporary, it may become necessary for us to take an impairment charge. We have also invested in several privately held companies as well as investment funds which invest primarily in privately held companies, many of which can still be considered in the start-up or development stages. These investments are inherently risky, as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose our entire initial investment in these companies and investment funds.

Foreign Exchange Rate Risk. We are exposed to foreign exchange rate risk because most of our sales in China are denominated in Renminbi and portions of our accounts payable are denominated in Japanese Yen. Due to the limitations on converting Renminbi, we are limited in our ability to engage in currency hedging activities in China. Although the impact of currency fluctuations of Renminbi to date has been insignificant, fluctuations in currency exchange rates in the future may have a material adverse effect on our results of operations. We have a multi-currency bank account in Japanese Yen for purchasing portions of our inventories and supplies. The balance of this Japanese Yen account as of September 30, 2002 is approximately $21.9 million.

We completed our initial public offering ("IPO") on March 3, 2000 pursuant to a Registration Statement on Form S-1 (File No. 333-93069). In the IPO, we sold an aggregate of 11,500,000 shares of common stock (including an over-allotment option of 1,500,000 shares) at $18.00 per share.

The managing underwriters of our initial public offering were Merrill Lynch & Co., Banc of America Securities LLC, U.S. Bancorp Piper Jaffray, Merrill Lynch Japan Inc. and E-TRADE Securities Co., Ltd. The sale of the shares of common stock generated aggregate gross proceeds of approximately $207.0 million. The aggregate net proceeds was approximately $189.4 million, after deducting underwriting discounts and commissions of approximately $14.5 million and expenses of the offering of approximately $3.1 million. None of such amounts were direct or indirect payments to our directors or officers or their associates, to persons owning 10 percent or more of any class of our equity securities or to our affiliates.

We completed a follow-on public offering on August 3, 2001 pursuant to a Registration Statement on Form S-3 (File No. 333-63356). A total of 10,350,000 shares of common stock (including the underwriters' over-allotment) were registered. We sold an aggregate of 7,400,000 shares of common stock, which included the underwriters' over-allotment, at a price to the public of $20.00 per share. Selling stockholders sold an additional 2,950,000 shares of common stock in the offering.

The managing underwriter of our follow on public offering was Merrill Lynch & Co. Salomon Smith Barney, Banc of America Securities LLC, HSBC Securities (USA) Inc., and U.S. Bancorp Piper Jaffray served as co-managers of our offering. The sale of the shares of common stock generated aggregate gross proceeds of approximately $148.0 million. The aggregate net proceeds that we received was approximately $139.9 million, after deducting underwriting discounts and commissions of approximately $7.3 million and expenses of the offering of approximately $1.0 million. None of such amounts were direct or indirect payments to our directors or officers or their associates, to persons owning 10 percent or more of any class of our equity securities or to our affiliates. The aggregate gross proceeds for the selling stockholders was approximately $59.0 million.

On February 28, 2002, we sold 1,500,000 shares of common stock upon exercise of the underwriter's over-allotment option in connection with the resale public offering of 10,000,000 shares of our common stock by SOFTBANK America Inc., one of our stockholders, at a price to the public of $20.25 per share, pursuant to a Registration Statement on Form S-3 (File No. 333-82458). A total of 11,500,000 shares of common stock were registered.

The joint book-running managers of this public offering were Merrill Lynch & Co. and Credit Suisse First Boston Corporation. Salomon Smith Barney, Banc of America Securities LLC, U.S. Bancorp Piper Jaffray and HSBC Securities (USA) Inc., served as co-managers of our offering. The aggregate net proceeds we received was approximately $28.9 million, after deducting underwriting discounts and commissions and related expenses of $1.5 million. None of such amounts were direct or indirect payments to our directors or officers or their associates, to persons owning 10 percent or more of any class of our equity securities or to our affiliates. We did not receive any proceeds from the offering of the shares of our common stock by SOFTBANK America Inc. The aggregate gross proceeds for SOFTBANK America Inc., was approximately $202.5 million.

We expect to use the net proceeds from these offerings for general corporate purposes, including research and development, expansion of our sales and marketing organization and working capital and capital expenditures. The amounts actually expended for such purposes may vary significantly and will depend on a number of factors, including our future revenues and cash generated by operations and the other factors described under "Factors Affecting Future Operating Results". Accordingly, we retain broad discretion in the allocation of the net proceeds of the offerings. A portion of the net proceeds

may also be used to acquire or invest in complementary businesses, technologies or product offerings. As of October 31, 2002 we have not used any of the net proceeds from the offerings described above, and the entire amount of net proceeds from such offerings remains in our cash and cash equivalents and short-term investments accounts.

Our directors, officers, or employees have entered, and may from time to time enter, into good faith trading plans pursuant to SEC Rule 10b5-1(c).

Our audit committee has approved the performance of non-audit services by PricewaterhouseCoopers LLP.

NUMBER		EXHIBIT DESCRIPTION
10.78	*	Professional Services Agreement between UTStarcom, Inc. and N. Lohr Bangle, Jr. dated as of September 10, 2002
10.79	*	Teaming Agreement between UTStarcom, Inc. and Stellar Holdings, LLC dated as of September 10, 2002
10.80	*	Joint Venture Contract between UTStarcom Telecom Co., Ltd., Matsushita Electric Industrial Co., Ltd. and Matsushita Communication Industrial Co., Ltd. dated as of July 5, 2002
10.81	*	Amendment to OEM Agreement between UTStarcom, Inc. and Interwave Communications dated as of September 27, 2002
99.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
99.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

A current report on Form 8-K was filed on August 29, 2002 by the Company in connection with the repurchase of 6,000,000 shares of its common stock from SOFTBANK Corp.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

(Mark One)
ý	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002.
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .

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

		PAGE
PART I.	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements	3
	Condensed Consolidated Balance Sheets as of September 30, 2002 (unaudited) and December 31, 2001	3
	Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2002 and 2001 (unaudited)	4
	Condensed Consolidated Statements of Cash Flows for the nine month periods ended September 30, 2002 and 2001 (unaudited)	5
	Notes to Condensed Consolidated Financial Statements (unaudited)	6
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	56
Item 4.	Controls and Procedures	57
PART II.	OTHER INFORMATION
Item 2.	Changes in Securities and Use of Proceeds	58
Item 5.	Other Information	59
Item 6.	Exhibits and Reports on Form 8-K	59
	Signatures	60
	Certifications	61
	Exhibit Index	63

			September 30, 2002			December 31, 2001
ASSETS
Current assets:
	Cash and cash equivalents		$	307,240		$	321,136
	Short-term investments			58,914			86,176
	Accounts receivable, net of allowances for doubtful accounts of $25,524 and $19,053 at September 30, 2002 and December 31, 2001, respectively			179,239			193,046
	Inventories			285,608			229,050
	Other current assets			89,087			67,067

Total current assets				920,088			896,475
Property, plant and equipment, net				72,749			43,942
Long-term investments				23,094			17,818
Goodwill and intangible assets, net				50,450			38,992
Other long-term assets				14,239			8,653

	Total assets		$	1,080,620		$	1,005,880

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
	Accounts payable		$	129,555		$	83,649
	Debt-current portion			—			58,434
	Income taxes payable			15,693			10,536
	Deferred revenue			107,940			76,424
	Other			102,198			76,329

Total current liabilities				355,386			305,372
Long-term debt				—			12,048
Minority interest in consolidated subsidiaries				—			6,573

	Total liabilities			355,386			323,993

Commitments and contingencies (Note 12)
Stockholders' equity:
	Common stock: $0.00125 par value; authorized: 250,000,000 shares; issued and outstanding: 106,233,788 and 109,302,816 at September 30, 2002 and December 31, 2002, respectively			134			138
	Additional paid-in capital			643,507			638,697
	Deferred stock compensation			(4,688	)		(6,045	)
	Retained earnings			86,668			49,146
	Receivable from stockholders			(342	)		(381	)
	Other comprehensive income (loss)			(45	)		332

Total stockholders' equity				725,234			681,887

		Total liabilities and stockholders' equity	$	1,080,620		$	1,005,880

		Three months ended						Nine months ended
		September 30, 2002			September 30, 2001			September 30, 2002			September 30, 2001
Net sales:
	Unrelated parties	$	223,486		$	167,628		$	577,270		$	423,796
	Related parties		42,027			2,856			103,441			5,916

			265,513			170,484			680,711			429,712
Cost of sales			172,696			106,208			436,340			274,116

Gross profit			92,817			64,276			244,371			155,596

Operating expenses:
	Selling, general and administrative		28,582			21,830			81,788			54,720
	Research and development		22,958			16,381			63,525			42,079
	In-process research and development		—			—			670			—
	Amortization of intangible assets		631			1,965			1,764			5,401

Total operating expenses			52,171			40,176			147,747			102,200

Operating income			40,646			24,100			96,624			53,396
Interest income			1,356			2,478			4,384			6,570
Interest expense			(88	)		(930	)		(1,223	)		(2,850	)
Other expenses, net			(3,334	)		(220	)		(4,885	)		(254	)
Equity in (loss) of affiliated companies			(145	)		(918	)		(944	)		(1,619	)

Income before income taxes and minority interest			38,435			24,510			93,956			55,243
Income tax expense			7,686			5,849			18,790			13,533
Minority interest in (earnings) of consolidated subsidiaries			—			136			(1,156	)		(1,291	)

Net income		$	30,749		$	18,797		$	74,010		$	40,419

Basic earnings per share		$	0.28		$	0.18		$	0.67		$	0.41

Diluted earnings per share		$	0.27		$	0.17		$	0.64		$	0.38

Weighted average shares used in per-share calculation:
	—Basic		109,776			104,031			110,459			99,261

	—Diluted		113,508			110,601			115,716			106,898

			Nine months ended
			September 30, 2002			September 30, 2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income			$	74,010		$	40,419
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
	Depreciation and amortization			15,275			12,147
	Non-qualified stock option exercise tax benefits			3,323			10,466
	Net loss on sale of assets			321			468
	In-process research and development costs			670			—
	Impairment of long-term investments			2,823			1,576
	Stock compensation expense			2,291			3,220
	Allowance for doubtful accounts			6,471			6,927
	Inventory reserve			9,752			6,422
	Equity in net loss of affiliated companies			944			1,618
	Minority interest in earnings of consolidated subsidiary			1,156			585
	Changes in operating assets and liabilities:
		Accounts receivable		7,660			(58,715	)
		Inventories		(65,620	)		(89,938	)
		Other current and non-current assets		(27,358	)		(46,670	)
		Accounts payable		43,027			41,489
		Income taxes payable		5,160			(3,613	)
		Deferred revenue		31,516			42,786
		Other current liabilities		24,955			24,246

Net cash provided by (used in) operating activities				136,376			(6,567	)

CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property, plant and equipment, net				(42,027	)		(18,249	)
Investment in affiliates				(11,044	)		(9,272	)
Acquisition of businesses, net of cash acquired				(17,705	)		—
Purchase of short-term investments				(74,913	)		(89,168	)
Sales of short-term investments				101,937			78,489

Net cash used in investing activities				(43,752	)		(38,200	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of stock, net of expenses				36,982			148,725
Proceeds from borrowing				39,619			22,645
Payments for borrowing				(110,101	)		—
Repurchase of common stock				(72,921	)		—
Proceeds from stockholder receivables				39			183

Net cash provided by (used in) financing activities				(106,382	)		171,553
Effects of exchange rates on cash				(138	)		(25	)

Net increase in cash and cash equivalents				(13,896	)		126,761
Cash and cash equivalents at beginning of period				321,136			149,112

Cash and cash equivalents at end of period			$	307,240		$	275,873

	Three Months Ended September 30				Nine Months Ended September 30
	2002		2001		2002		2001
Numerator:
Net income	$	30,749	$	18,797	$	74,010	$	40,419

Denominator:
Shares used to compute basic EPS		109,776		104,031		110,459		99,261
Dilutive common stock equivalent shares:
Stock options		3,705		6,542		5,229		7,609
Warrants		27		28		28		28

Shares used to compute diluted EPS		113,508		110,601		115,716		106,898

Basic earnings per share	$	0.28	$	0.18	$	0.67	$	0.41

Diluted earnings per share	$	0.27	$	0.17	$	0.64	$	0.38

Fair value of tangible net assets acquired	$	18
Fair value of identified intangible assets		3,230
In process research and development		670
Excess of costs of acquiring Issanni over fair value of identified net assets acquired (goodwill)		379

	$	4,297

Fair value of tangible net assets acquired	$	372
Excess of costs of acquiring GUTS over fair value of identified net assets acquired (goodwill)		3,292

	$	3,664

Fair value of tangible net assets acquired	$	8,148
Excess of costs of acquiring HUTS over fair value of identified net assets acquired (goodwill)		6,320

	$	14,468

Note	Rate	Maturity	September 30, 2002		December 31, 2001
Bank of China	From 4.54% to 5.56%	From 09/02 to 10/02	$	—	$	34,338
China Merchants Bank	5.31%	03/03		—		6,024
Commercial Bank of Hangzhou	6.21%	06/10		—		12,048
CITIC Industrial Bank	6.14%	05/02		—		6,024
China Everbright Bank	4.54%	12/02		—		12,048

Total debt				—		70,482
Long-term debt				—		12,048

Short-term debt			$	—	$	58,434

	Three Months Ended September 30, 2002						Three Months Ended September 30, 2001
	Telecommunications Equipment		Subscriber Handsets		Total		Telecommunications Equipment		Subscriber Handsets		Total
Net sales:
China	$	117,405	$	100,836	$	218,241	$	89,883	$	43,407	$	133,290
Japan		42,029		—		42,029		—		—		—
Other		5,241		2		5,243		37,194		—		37,194

Total net sales	$	164,675	$	100,838	$	265,513	$	127,077	$	43,407	$	170,484

Date: November 8, 2002
		UTSTARCOM, INC. (Registrant)
		BY:
		/s/ HONG LIANG LU Hong Liang Lu President, Chief Executive Officer and Director
		/s/ MICHAEL J. SOPHIE Michael J. Sophie Chief Financial Officer and Assistant Secretary

Date: November 8, 2002
		/s/ HONG LIANG LU Hong Liang Lu Chief Executive Officer