-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MVSOXQL4uot1/b/wAyucrXIQI2ET53QepLOAB0TJNH0MDlUVIXok3vqqX6dV4O7M yl4cSFvZvVGqAnes5U19tw== 0001012870-02-000470.txt : 20020414 0001012870-02-000470.hdr.sgml : 20020414 ACCESSION NUMBER: 0001012870-02-000470 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020211 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UTSTARCOM INC CENTRAL INDEX KEY: 0001030471 STANDARD INDUSTRIAL CLASSIFICATION: COMMUNICATIONS EQUIPMENT, NEC [3669] IRS NUMBER: 521782500 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-29661 FILM NUMBER: 02534815 BUSINESS ADDRESS: STREET 1: 1275 HARBOR BAY PARKWAY STREET 2: STE 100 CITY: ALAMEDA STATE: CA ZIP: 94502 BUSINESS PHONE: 5108648800 MAIL ADDRESS: STREET 1: 1275 HARBOR BAY PARKWAY STREET 2: STE 100 CITY: ALAMEDA STATE: CA ZIP: 94502 10-K/A 1 d10ka.txt AMENDMENT NO. 1 TO FORM 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K/A AMENDMENT NO. 1 TO FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 2001. OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to . COMMISSION FILE NUMBER 000-29661 ----------------- UTSTARCOM, INC. (Exact name of Registrant as specified in its charter) ----------------- DELAWARE 52-1782500 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 1275 HARBOR BAY PARKWAY, ALAMEDA, CALIFORNIA 94502 (Address of principal (Zip Code) executive offices) Registrant's telephone number, including area code: (510) 864-8800 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.00125 par value ----------------- 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 [X] No [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] The aggregate market value of voting stock held by non-affiliates of the registrant as of January 31, 2002, was approximately $1,370,189,831 based upon the closing price of $25.92 reported for such date on The Nasdaq National Market. For purposes of this disclosure, shares of Common Stock held by persons who hold more than 5% of the outstanding shares of Common Stock and shares held by officers and directors of the registrant, have been excluded in that such persons may be deemed to be affiliates. This determination is not necessarily conclusive. As of January 31, 2002, registrant had outstanding 109,577,835 shares of Common Stock. ----------------- DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Annual Meeting of Shareholders to be held on May 10, 2002 are incorporated herein by reference in Part III. ================================================================================ This Amendment No. 1 to the Annual Report on Form 10-K/A is being filed solely for the purpose of including the last 43 pages of the document that, as a result of technical difficulties, were inadvertently not transmitted with the original filing of the Form 10-K on February 11, 2002. 1 UTSTARCOM, INC. TABLE OF CONTENTS
Page ---- PART I. Item 1. Business............................................................................. 3 Item 2. Facilities........................................................................... 20 Item 3. Legal Proceedings.................................................................... 21 Item 4. Submission of Matters to a Vote of Security Holders.................................. 21 Executive Officers................................................................... 21 PART II. Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 24 Item 6. Selected Financial Data.............................................................. 25 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 26 Item 7A. Quantitative and Qualitative Disclosures About Market Risks.......................... 53 Item 8. Financial Statements and Supplementary Data.......................................... 53 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. 86 PART III. Item 10. Directors and Executive Officers of the Registrant................................... 86 Item 11. Executive Compensation............................................................... 86 Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 86 Item 13. Certain Relationships and Related Transactions....................................... 86 PART IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 86 Exhibit Index........................................................................ 87 Signatures........................................................................... 93
2 PART I FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K 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 those concerning the following: 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 that there will be fluctuations in our overall gross profit, gross margin, product mix 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-K. 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-K. ADDITIONAL INFORMATION UTStarcom is registered as a trademark in the United States. UTStarcom and PAS are registered as trademarks in China. We have applied to register the mSwitch and Netman trademarks in China. This prospectus also includes product names, trade names and trademarks of other companies. All other product names, trade names and trademarks appearing in this prospectus are the property of their respective holders. In this Annual Report on Form 10-K, references to and statements regarding China refer to mainland China, references to "U.S. dollars" or "$" are to United States Dollars, and references to "Renminbi" are to Renminbi, the legal currency of China. Unless specifically stated, information in this Annual Report on Form 10-K assumes an exchange rate of 8.3 Renminbi for one U.S. dollar, the exchange rate in effect as of December 31, 2001. ITEM 1--BUSINESS Overview We design, manufacture and market wireline and wireless broadband access and switching equipment that enables migration to next generation IP-based networks. Historically, substantially all of our sales have been to service providers in China, however we are currently expanding to include other growing communications markets outside of China. Our integrated suite of products provides migration to next generation networks and allows service providers to offer efficient and expandable voice, data and Internet access services. Because our systems are based on widely adopted international communications standards, service providers can easily 3 integrate our systems into their existing networks and deploy our systems in new broadband, Internet Protocol and wireless network rollouts. Internet Protocol, or IP, refers to a set of rules developed for communicating information over the Internet. We provide a range of network service solutions based on three principle technology platforms: mSwitch, PAS and AN-2000. mSwitch is an IP-based, multiservice softswitch designed to provide voice and data switching and gateway functions either integrated with PAS or AN-2000 or on a standalone basis. PAS allows service providers to offer voice, data and value-added services over mobile and fixed wireless networks using specially designed PAS handsets. As of December 31, 2001, we had sold approximately 6.6 million lines of PAS equipment servicing approximately 3.0 million subscribers in 210 cities in China. Based on our knowledge of China's communications market, we believe that PAS is the most widely deployed wireless local access system in China. In the Taiwan market, there were approximately 160,000 subscribers using our PAS systems as of December 31, 2001. For wireline networks, we provide a broadband-ready platform called AN-2000. As of December 31, 2001, approximately 3.2 million lines of our wireline AN-2000 access platform have been deployed in China, including deployments in the six largest regional communications markets. Another 800,000 lines of our AN-2000 access platform have been deployed in markets outside of China. Industry Background Growth in China's Communications Market. China has one of the fastest growing communications markets in the world. Growth in China's communications equipment and services markets is being driven by the government of China's commitment to developing a communications infrastructure, strong demand for communications services and robust economic growth. China's demand for communications services is highlighted by its relatively low teledensity rate, which is a measure of the number of lines per hundred people. The International Telecommunication Union reported as of January 2001 that China, with a population of approximately 1.3 billion, had a fixed-line teledensity rate of only 11.2%. In contrast, according to the International Telecommunication Union, fixed-line teledensity rates in 2001 for the United Kingdom, France, Hong Kong and the United States were 58.2%, 58.0%, 57.8% and 70.0%, respectively. While growth in China's communications market is currently driven predominantly by voice services, the increasing demand for data services also presents a growing opportunity both in China and in other international markets. The Gartner Group estimates that Internet users in China will grow from 20.0 million in 2001 to 51.0 million in 2004, representing a compound annual growth rate of 36.6%. In order to support this anticipated growth in data traffic, service providers in China must continue to expand their networks. We believe this is best achieved by deploying IP-based equipment. China's ability to invest heavily in its communications infrastructure is fueled by the country's strong economic activity. According to the Economist Intelligence Unit, China's gross domestic product, or GDP, grew 7.3% in 2001. The Economist Intelligence Unit also estimates that China's GDP will grow at a compound annual growth rate of 7.5% from 2001 to 2005. Communications Needs of Developing Countries. Demand for voice and data communications services in developing countries continues to grow rapidly and is driven by both public sector infrastructure investment and private sector business growth. The governments of many developing countries have identified the development of a communications infrastructure as a key driver of modernization and economic growth. According to a 2001 report by the International Telecommunication Union, in 1999 developing countries invested $55.9 billion in communications infrastructure, representing 29.6% of all communications infrastructure spending worldwide. Governments are increasingly implementing and funding infrastructure development through privatization of state-owned telecommunications service providers. These service providers, in turn, are deploying advanced networks for voice and data services. In addition, increasingly affluent businesses and residential consumers in the highest growth regions of these countries are demanding state-of-the-art voice and data communications solutions to interact and compete on a global basis. 4 Communications Network Architecture in China. The development of China's communications infrastructure involves installing a nationwide network of high-bandwidth fiber-optic backbone networks and connecting each business and residential subscriber to this backbone. The wireline and wireless systems that link local subscribers to these backbone networks are referred to as the last mile or the local access network. The high growth rate, geographic dispersion and diverse communications needs of residences and businesses in China means that the direct wiring of subscribers to the backbone network using traditional copper connections is a lengthy, costly and inefficient process. Direct wiring of subscribers to traditional telephone switches often locks those subscribers into a limited set of communications services and limits expandability and migration to other services. In contrast, service providers in China require communications equipment that allows them to provide services quickly, efficiently and cost-effectively. Given the relative absence of a legacy communications infrastructure in China, these service providers are less constrained and thus often seek to deploy the latest best-of-breed systems with the flexibility to handle voice and data services. Needs of Service Providers. Voice and data service providers require network solutions that address all of their access needs and offer easy migration to next generation networks. These service providers require products that enable them to quickly, and with minimal incremental investment, address the changing demands of their subscribers for expanded or more advanced services. Given the rapid growth in emerging communications markets such as China, network solutions must be scalable so that the same architecture can provide an affordable entry level solution to initially serve a few hundred subscribers, yet economically scale to serve several hundred thousand subscribers over time. In addition, service providers require the following: . IP-Based Networks. An increasing amount of voice and data traffic travels across IP-based networks instead of traditional circuit-based networks. The principal advantages of IP-based networks over circuit-based networks are lower cost, higher speed and the support of multiple applications, including e-mail, short-messaging, Internet access, video and voice in a single network. Because of these advantages, investment in IP-based networks is increasing while investment in circuit-based networks is decreasing. . Return on Investment. As competition intensifies, service providers require the ability to offer advanced and flexible services to their customers. Service providers must ensure these new services drive subscriber growth and ultimately revenue and profitability. As a result, service providers are focused on return on investment, enabling them to deploy technology that provides increased services today while also providing a cost-effective migration path to future expansion and functionality. . Integrated Voice and Data Solutions. Service providers are increasingly looking to expand their service offerings beyond traditional voice services to provide data and other value-added services. As advanced high speed data networks are deployed, service providers will require solutions that can be upgraded to adapt to new technologies while preserving the investment in their existing infrastructure. These networks will enable service providers to differentiate their service offerings, build customer loyalty and generate incremental revenue. . Rapid Deployment. Given the rapid growth in emerging communications markets such as China, service providers are focused on quickly deploying solutions to meet customer needs. Wireless access solutions allow for rapid deployment of relatively inexpensive networks that give service providers significant revenue potential and cost advantages over wireline networks. In addition, service providers require wireless networks that will allow for convergence of voice and data and migration to third generation networks, referred to as 3G networks. . Commitment to Local Markets. Service providers value equipment vendors that have made a strong commitment to their local markets. This commitment includes direct sales forces and local service organizations to respond to the needs of service providers and their subscribers. Although markets such as China represent substantial opportunities for communications equipment vendors, few companies have delivered products that have the ability to smoothly migrate to next generation technologies, coupled with the local presence that service providers require. 5 The UTStarcom Solution We design, manufacture and market wireline and wireless broadband access and switching equipment that enables migration to next generation IP-based networks. We believe our key competitive advantages are: Migration to Next Generation IP Networks. Our products are designed with the flexibility to allow service providers to deliver voice and data services over today's circuit-based networks and offer the ability to migrate to next generation broadband wireline and wireless networks based on IP and open standards. As a result, service providers can preserve their investment in existing networks and generate significant incremental revenue from their investment in our products while migrating to next generation networks over time. Our products enable service providers to effectively time their network equipment expenditures, expand voice and data capacity and rapidly introduce new services as demand warrants. Cost-Effective Solutions. Our products are designed to provide operators with a high return on their investment. By reducing network complexity, integrating high performance capabilities and providing a flexible migration path to next generation networks, our products cost less to deploy and maintain than most alternative technologies. Convergence of Voice and Data Services. We have designed our systems to offer a high degree of flexibility in terms of subscriber capacity and types of traffic delivered. Our equipment can be flexibly configured to offer a variety of services in response to subscriber demand. This flexibility is particularly important in China, as the communications services market is undergoing rapid change and growth. As Internet usage achieves greater penetration in China, we believe service providers will desire systems that are designed to deliver high-speed data capability. Our access systems allow service providers to quickly and cost-effectively implement upgrades for new services, including high-speed data capability, compared to alternative solutions which may require the purchase of an entirely new system to provide these services. Wireless Access Networks. Our wireless access solutions are ideally suited for the requirements of service providers in emerging communications markets. Service providers can deploy our products quickly to cost-effectively meet customer demand. Our systems allow service providers to rapidly add new subscribers and to scale network capacity in response to demand. Our IP-based wireless access solutions also provide a platform for service providers to migrate to 3G mobile networks. Local Presence. We have established a strong local presence in China that allows us to be responsive to the needs of service providers and their subscribers. We manufacture our products primarily at our facility in Hangzhou in Zhejiang province. By using local facilities in China, we have helped create new jobs within the provinces and have strengthened our relationships with the Telecommunications Administrations in some of China's most modern and rapidly growing provinces. We also maintain 15 sales and customer support sites in China that allow us to deploy a customer support representative onsite anywhere in China within 24 hours. Our sales force develops direct relationships with decision makers at both the provincial and local levels through pre-sales design and consulting services. Additionally, through our relationships at the national, provincial and local levels we receive a flow of information regarding market changes and insight into unique service provider needs and related opportunities. As part of this strategy to develop a local presence in markets that we serve, we also have sales, support and engineering personnel in Taiwan and India. Strategy Our objective is to be a leading provider of wireline and wireless broadband access and switching equipment. The principal elements of our strategy are as follows: Capitalize on the Emerging IP-based Switching Market. We believe the increase in Internet usage, particularly voice over IP traffic, has resulted in a market need for a next-generation, IP-based switching platform. Accordingly, we are making a substantial investment in developing our mSwitch platform, which is 6 designed to integrate with our existing products and can be scaled in response to increased demand. We believe that mSwitch can deliver value to service providers, both as a stand-alone system and in combination with our PAS system and AN-2000 platform. We intend to incorporate additional functionality into the mSwitch platform in the future, which we believe will enable us to enter new markets in China and around the world. Leverage Our Installed Base to Capitalize on Demand for Wireless and Wireline Broadband Services. We believe we are well positioned to leverage our installed base of systems and service provider relationships to capitalize on an increasing demand for data and broadband services. To meet this demand, we intend to: . leverage our installed base of AN-2000 platforms and our working relationships with providers to offer our wireless access systems; . continue to enhance functionality and increase features of our mSwitch IP-based, multiservice softswitch platform, which is designed to enable geographically dispersed gateways and servers to interact over high speed IP networks to serve millions of subscribers; . enhance our PAS systems and handsets to enable the provisioning of high-speed data services over 128 Kilobits per second, or Kbps, wireless links; . focus our development efforts on products that enable migration to 3G wireless technologies; . continue to provide broadband upgrades to our installed base of AN-2000 platforms to enable the delivery of broadband services over copper connections through digital subscriber line, or xDSL, technologies; . broaden our PAS systems to enable value-added services, such as wireless content and applications which our customers offer in China under the brand name C-Mode and in Taiwan under the brand name MiMi; and . work with original equipment manufacturers to offer service providers a complete solution for IP-based networks. Expand Our Presence in China. We intend to further capitalize on favorable market conditions in China, including its large population, low teledensity and strong demand for communications services. Since our inception, we have focused our engineering, product development and sales and marketing efforts primarily on communications equipment for China. This focus has enabled us to be a leader in this market by quickly identifying the needs of service providers in China and rapidly developing market-specific products to address those needs. We intend to expand our presence in this market by: . increasing the number of sales and support staff and offices in China; . developing new products to address the demands of our existing and future customer base; . migrating our installed base from voice to data and from wireline to wireless as market demand warrants; and . increasing our local research and development and manufacturing capabilities. Penetrate Other Growing Communications Markets Worldwide. We have started offering our products in other growing communications markets outside of mainland China. We anticipate penetrating these markets in several ways, through direct sales offices located in key market regions, by licensing our technology to local manufacturers where import taxation favors this approach, through the development of local sales agency and distributor relationships within specific market regions, and through original equipment manufacturer sales relationships. Our sales division is currently targeting expansion into Africa, Europe, India, Japan, Latin America, Taiwan, and other Pacific Rim markets. We have established regional offices to focus on non-China market development with sales and customer support operations in Hanoi, Manila, Miami, New Delhi, New Jersey, Shanghai, Taipei, Tel Aviv, and Tokyo and plan to establish local direct sales representative offices in 7 key regions around the world. To date, we have deployed our products in a number of growing communications markets outside of mainland China, including India, Japan and Taiwan. Products We provide communications equipment for service providers that operate wireless and wireline networks. Our wireless and wireline access networks and IP-based switching systems use our three principal technology platforms: . mSwitch--our IP-based multiservice softswitch; . PAS--our wireless access system which includes handsets; and . AN-2000--our broadband access platform. Each comprises multiple hardware and software subsystems that can be offered in various combinations to suit individual customer needs. In addition, through original equipment manufacturer relationships, we provide customers in China with equipment for deployment in metropolitan area networks. Our IP-Based Multiservice Softswitch (mSwitch) mSwitch is an IP-based, multiservice softswitch designed to replace traditional central office switches. mSwitch provides voice over IP gateway functions, broadband and narrowband remote access services and associated billing, provisioning and service management operations support systems. mSwitch combines softswitch functionality with our wireless technology to provide highly scalable, mobile switching centers, which can operate with our PAS system. mSwitch networks are distributed, which means that many geographically dispersed gateways and servers can interact over a high speed, IP-based network to serve millions of subscribers. Gateways provide hardware resources to process voice and data and support widely used interface protocols. Servers provide functions like call routing, accounting, authorization, billing, provisioning, fault monitoring and recovery. We have developed an advanced and comprehensive operations support system for management of mSwitch equipment, billing for mSwitch services and customer care for mSwitch subscribers. This operations support system uses an online Internet-based user interface, which enables service provider personnel and individual subscribers to access provisioning and billing information through the Internet from an ordinary web-browser. We are also working to develop a set of capabilities including mobile switching center, radio network controller and general packet radio service node in support of 3G wireless technologies. To that end, in November 2001, UTStarcom was selected by China's Ministry of Information Industry, or MII, as one of a select group of participants in China's technical trial of 3G mobile networks based on the 3GPP WCDMA standard. mSwitch applications are also being developed to provide wireline local exchange functionality, voice over IP gateways to enable legacy public networks to connect to low-cost IP-based long distance trunk lines, and also to provide modem and fax pools that would allow mSwitch to act as a remote access server for dial-up users who wish to access IP networks. We are also developing IP routing capabilities to integrate in our mSwitch platform to further improve functionality and reduce cost to our customers. We intend to continue to enhance mSwitch with many applications in response to evolving market requirements and technology trends. Our Wireless Access System (PAS) PAS is a wireless access system that uses microcellular radios and specialized handsets to offer mobile and fixed access. When compared to macrocellular systems like GSM and CDMA, PAS offers lower costs, easier radio planning, higher traffic capacity, better voice quality, faster data transmission speeds, lighter handsets with lower power requirements and better support of advanced information services. PAS is a low mobility system, 8 which means it is designed for deployment in high capacity urban and suburban areas, rather than larger regional areas covered by GSM and CDMA system deployments. For additional coverage or capacity, PAS can easily be deployed in indoor spaces such as office buildings, airports and shopping malls. PAS can provide wireless mobile phone service at densities of upwards of 15,000 subscribers per square kilometer. The PAS wireless access network employs a mobile switching network based on our AN-2000 platform. The wireless access network formed by PAS components connects to the central office switch to provide local and long distance telephone service over a standard digital interface or an analog 2-wire interface. These open interfaces to the central office allow PAS to access any of the operator's installed switching capacity and to deliver existing switch based services, such as caller ID, call forwarding, and voice mail, to wireless subscribers. IP-based PAS uses the mSwitch platform instead of the AN-2000 platform. This eliminates the dependence on an existing local exchange switch and permits PAS to be installed in a greenfield environment where existing switching capacity is not available. IP-based PAS also brings many important benefits associated with our mSwitch platform, including scalability. Both PAS and IP-based PAS support 64Kbps mobile Internet access along with voice. In 2001, we deployed 1.2 million lines of mSwitch-based PAS systems in several cities in China, and two locations outside of China. We also design and manufacture handsets that are specifically configured to support PAS services. In 2001, we introduced a new PAS handset primarily designed by UTStarcom. We expect to continue to invest in this area and introduce several additional handset models in 2002. We also manufacture several models based on designs licensed from other handset manufacturers. We compliment our handset design and manufacturing capabilities with additional handset models directly from leading vendors. Our strategy of designing, licensing, manufacturing and direct sourcing of handset components provides us with the flexibility to meet demand, and allows us to offer the broadest line of PAS handsets in China. In conjunction with our PAS system, we enable wireless content and applications similar to NTT DoCoMo's iMode service. To date, this service has been launched by our customers in Xian and Hangzhou in China and in Taipei, Taiwan. This service, known in China as C-mode and in our Taiwan market as Mobile Information, Mobile Internet, or MiMi, utilizes a high function handset with expanded LCD display that can be used to browse the worldwide web, and send and receive e-mail and short messages. Chinese as well as English characters are supported, and local content providers in Taiwan and China are accumulating hundreds of information services including news, stock quotes and sports results, job postings, dating services, chat rooms, and fortune telling. MiMi can accurately determine a user's location and can list local restaurants, hospitals or other location-sensitive information when queried. Our Netman network management system, which is integrated with our network access products, provides for centralized management of our PAS products. Netman provides the ability to manage individual network components and to report on the status of the network as a whole. With Netman, a service provider can add and drop subscribers and continuously monitor all access network elements, providing for real-time reporting and alarms in addition to performance management, optimization and distribution of software updates. Netman uses scalable client/server architecture in a Windows NT environment. Server hardware may be scaled to handle several thousand nodes. Netman can also be installed on a portable personal computer and may be used as the local onsite maintenance terminal wherever remote nodes are installed. As of December 31, 2001, service providers have installed our PAS system in 210 locations in China, representing a total installed capacity of approximately 6.6 million lines with approximately 3.0 million subscribers. In Taiwan, the number of subscribers using PAS systems reached approximately 160,000 as of December 31, 2001. Our Broadband Access Platform (AN-2000) AN-2000 is a broadband access platform supporting a mix of services that include: . traditional analog voice; 9 . voice and data in digital format over integrated services digital network, or ISDN, lines; . analog and digital leased lines; . business data over integrated digital subscriber lines, or IDSL, and high-data-rate digital subscriber lines, or HDSL; and . high-performance, always-on Internet access for residential and business subscribers using advanced asymmetric digital subscriber line, or ADSL, technology. Our AN-2000 platform contains both central office terminals and remote terminals that are linked together by fiber, microwave radio or copper to form a digital access network. The remote terminals are located close to the subscribers and offer last-mile wireline connections for voice and data services to the subscribers. Each remote terminal, which is scalable from 16 to 1,520 lines, can be connected into a ring to form a metropolitan access network of up to 23,000 subscriber lines. By connecting multiple metropolitan access networks, a metropolitan service network can potentially service hundreds of thousands of subscribers. The AN-2000 platform offers a V5.2 exchange interface that benefits service providers by shifting network intelligence out into the access network, reducing reliance on costly proprietary distributed central office switch architectures. For service providers whose switches are not yet V5.2 compliant, we provide a migration capability whereby the AN-2000 terminates analog and ISDN ports in the central office, effectively creating a V5.2 interface to the remote AN-2000 platforms. For broadband services based on ADSL, the AN-2000 platform has integral multiplexing capability for up to 384 users to share 155Mbps of Asynchronous Transfer Mode, or ATM, bandwidth to the Internet or, alternatively, 1.6Gbps in our IP over Ethernet version. The AN-2000 platforms can serve as a multi-service access node in which ADSL is delivered from a remote location combined with voice and leased line services or it can be configured as a pure central-office based Digital Subscriber Loop Access Multiplexer (DSLAM). Other DSLs including HDSL and G.SHDSL are also available. We also offer a Broadband Remote Access Server (B-RAS) to provide service management features, including authorization, accounting, virtual networking, and protocol translation. As with PAS, our integrated Netman network management system provides centralized management of the AN-2000 platforms. The ADSL service is compatible with most customer premise modems provided by third-party vendors. As of December 31, 2001, service providers have deployed approximately 4.0 million AN-2000 lines worldwide. In 2001, we introduced our IP-DSLAM product, based on an extension of our AN-2000 technology. This product, which began shipping in the fourth quarter of 2001 to a customer in Japan, provides extremely high density and high functionality at a very attractive price. This product represents a new generation of DSLAM, which does not require ATM networking, and is therefore compatible with IP-based networks. Our IP-DSLAM lowers operator costs by eliminating the need for traditional high cost ATM-based networks. Our OEM Products for Metropolitan Area Networks (MANS) We partner with original equipment manufacturers, or OEMs, which allows us to offer our customers a broader range of products. This OEM strategy allows us to provide benefits to our customers and also allows us to learn about specific technologies and market segments that may help us to shape our overall strategic planning. One such initiative is our program to penetrate China's Metropolitan Area Networks, or MANs, to provide Layer2/Layer3 switches. Our ACD Products In addition, we now have in-house system-on-chip (SoC) and application specific integrated circuit (ASIC) design capabilities focusing on LAN and IP switching technology to enhance our network switching and broadband access IC technologies. These capabilities will enable us to continue to develop leading carrier class broadband access solutions. 10 Markets and Customers We provide our communications equipment to local Telecommunications Bureaus in a wide variety of provinces of China. Market opportunities within China's 31 provinces vary greatly by region, with the more densely populated coastal provinces experiencing the strongest economic development. To date, we have focused primarily on the eastern coastal regions of China including Guangdong, Zhejiang, Fujian, Shandong, Jiansu, and Shanghai. These provinces and municipalities represent a disproportionately high percentage of China's telecommunications subscribers, and influence adoption of technology elsewhere in China. According to a report published by the Ministry of Information Industry, China's 10 eastern provinces and municipalities accounted for approximately 47.7% of China's total telecom investment for the six months ended June 30, 2001. More recently we have expanded our marketing focus to include several inland provinces. While each of the Telecommunications Bureaus is part of the China Telecom system and subject to its ultimate control, equipment purchasing decisions are generally made at the individual Telecommunications Bureau level. The following table is a list of our customers who purchased more than $1.0 million of our products in 2001. Beijing Municipality Heilongjiang Province Shanxi Province Beijing Telecommunication Haerbin Telecommunication Taiyuan Telecommunication Bureau Bureau Bureau Wuzhong Telecommunication Fujian Province Henan Province Bureau Hezhou Telecommunication Jiaozuo Telecommunication Xian Telecommunication Bureau Bureau Bureau Meizhou Telecommunication Xinxiang Bureau Telecommunication Bureau Sichuan Province Putian Telecommunication Xinhui Telecommunication Bureau Hubei Province Bureau Quanzhou Huzhou Telecommunication Telecommunication Bureau Bureau Xinjiang Autonomous Province Guangdong Province Hunan Province Hami Telecommunication Dongguan Zhangzhou Bureau Telecommunication Bureau Telecommunication Bureau Hechi Telecommunication Fuoshan Telecommunication Bureau Bureau Nei Mon Gol Autonomous Shihezi Telecommunication Guangdong UT Starcom Province Bureau Jiangmen Huhehaote Telecommunication Bureau Telecommunication Bureau Yunnan Province Luoyang Telecommunication Banna Telecommunication Bureau Jiangsu Province Bureau Qingyuan Lianyungang Chuxiong Telecommunication Bureau Telecommunication Bureau Telecommunication Bureau Shanwei Telecommunication Qinghua Ziguan Biwei Net Dali Telecommunication Bureau Corp.--Taian Bureau Shaoguan Xuzhou Telecommunication Diqing Telecommunication Telecommunication Bureau Bureau Bureau Shenzhen Yancheng Kunming Telecommunication Telecommunication Bureau Telecommunication Bureau Bureau Yunfu Telecommunication Yancheng Zhongxin Lijiang Telecommunication Bureau Communication Ind. Bureau Zhaoqing Lincang Telecommunication Telecommunication Bureau Jiangxi Province Bureau Zhongshan Shangrao Nujiang Telecommunication Telecommunication Bureau Telecommunication Bureau Bureau Zhuhai Telecommunication Yunan Telecommunication Bureau Jilin Province Bureau Siping Telecommunication Guangxi Autonomous Bureau Zhejiang Province Province Fuyang Telecommunication Guangxi Baise Liaoning Province Bureau Telecommunication Bureau Benxi Telecommunication Hangzhou Guilin Telecommunication Bureau Telecommunication Bureau Bureau Liaoyang Jiaxing Telecommunication Qinhzhou Telecommunication Bureau Bureau Telecommunication Bureau Jinhua Telecommunication Wuzhou Telecommunication Ningxia Autonomous Bureau Bureau Province NingBo Telecommunication Liuzhou Telecommunication Shizuishan Bureau Bureau Telecommunication Bureau Quzhou Telecommunication Yinchuan Bureau Hainan Province Telecommunication Bureau Ruian Telecommunication Haikou Telecommunication Bureau Bureau Shaanxi Province Shaoxing Qiongshan Kuitun Telecommunication Telecommunication Bureau Telecommunication Bureau Bureau Taizhou Telecommunication Sanya Telecommunication Bureau Bureau Shandong Province Wenzhou Telecommunication Dongying Bureau Hebei Province Telecommunication Bureau Wenzhou Zongheng Corp. Baoding Telecommunication Jinan Telecommunication Xiaoshan Bureau Bureau Telecommunication Bureau Dongsheng Taizhou Telecommunication Yuhang Telecommunication Telecommunication Bureau Bureau Bureau Qinhuangdao Zhejiang Telecommunication Bureau Telecommunication Bureau Xingtai Telecommunication Bureau Outside Mainland China Zhangjiakou BB Technologies Telecommunication Bureau Corporation First International Telecom Corp. Himichal Futuristic Communications Ltd. NEC USA Mitsubishi Electric Corporation 11 For the year ended December 31, 2001, no single customer accounted for more than 10% of our net sales. However, approximately 89.9% of our net sales during 2001 were to entities affiliated with the government of China. We also sell our network access equipment to service providers in high growth communications markets outside of China. These markets accounted for approximately 9.7% of our net sales in 2001. We have shipped equipment to service providers in Bangladesh, India, Japan, Mauritius, Russia, Taiwan, Thailand and Venezuela. We have also begun trial deployments in the United States and Vietnam. As of December 31, 2001, our backlog totaled approximately $360.7 million, compared to approximately $191.2 million as of December 31, 2000. We include in our backlog contracts and purchase orders for which we anticipate delivery to occur within 12 months and products delivered but for which final acceptance has not yet been received. Because contracts and purchase orders are generally subject to cancellation or delay by customers with limited or no penalty, our backlog is not necessarily indicative of future revenues or earnings. Sales, Marketing and Customer Support We pursue a direct sales and marketing strategy in China, targeting sales to individual Telecommunications Bureaus and to manufacturers or equipment distributors with closely associated customers. We maintain sales and customer support sites in Beijing, Chengdu, Fuzhou, Guangzhou, Hangzhou, Jinan, Kunming, Nanning, Nanjing, Nei Mon Gol, Shanghai, Shenyang, Wuhan, Xian, and Zhengzhou. We also sell through relationships with regional government-owned telecommunications manufacturing companies, which act as agents in the sale of our products to Telecommunications Bureaus. We believe our customer support services in China allow us to distinguish ourselves from competing equipment providers and build customer loyalty. Our customer service operation in Hangzhou is co-located with our manufacturing joint venture and serves as both a technical resource and liaison to our product development organization. In China, customer service technicians are distributed in the regional sales and customer support sites to provide a local presence. We provide additional support on a 24-hour, 365-day basis from our customer support center in Hangzhou in the form of field dispatch personnel, who also provide training on installation, operation and maintenance of equipment. As of December 31, 2001, we employed over 800 people in sales, marketing and customer support in China. Our sales efforts in markets outside of mainland China combine direct sales, original equipment manufacturers, distributors, resellers, agents and licensees. We maintain sales and customer support sites in Iselin, New Jersey to address North American markets; in Tokyo, Japan to address the Japan market; in New Delhi, India to address the Indian market; in Miami, Florida to address Latin American markets; in Tel Aviv, Israel to address European and African markets; in Manila, the Philippines to address the Philippine market; in Taipei, Taiwan to address the Taiwan market; in Hanoi, Vietnam to address the Vietnam market; and in Shanghai, China to address other Pacific Rim markets. Our customer service operations in the U.S. and Hangzhou, China support our customers outside of mainland China with training, project supervision and problem resolution. We maintain and will continue to expand our staff of local personnel near customers who require support on a 24-hour, 365-day basis. In many cases our local in-country sales partners also provide customer support. Technology We believe the following key technologies have been instrumental in our ability to provide leading broadband wireline and wireless access networks and IP-based switching systems. 12 X-over-IP. X-over-IP refers to the transmission of various forms of traffic, including voice, video, fax, music and broadcast, over IP networks. An X-over-IP network requires the following equipment: . media gateways at the edge of the network that convert legacy media like telephone lines, fax and data modems, or other non-IP data interfaces to IP and incorporate quality of service functionality designed to avoid delay and packet loss due to congestion; . softswitching servers that perform address translation, service monitoring and assurance, billing, authorization, supplementary services like call forwarding, conferencing, and other signaling translations; and . an IP network that provides high speed IP routing and transmission. Our mSwitch platform provides the media gateway and the softswitching server and, when combined with industry-standard IP routers, creates a complete X-over-IP network. The mSwitch gateway converts incoming TDM formats from POTS, ISDN, SS7 and leased lines into packetized voice over IP. The packetization process utilizes programmable digital signal processors that can code voice, fax and standard 56Kbps modem signals into IP. The gateway also terminates the associated TDM format signaling protocols and generates IP based signaling protocols like H.323, MGCP and SIP. The mSwitch gateway also provides IP routing functions that allow the IP packets to penetrate deeper into the core network with queuing, and route selection, consistent with the desired quality of service for each particular call. The mSwitch softswitch provides switching intelligence to manage the calls in the network as they progress from gateway to gateway. The mSwitch operations support system provides the database management for service provisioning, authorization and flexible billing. Service providers are increasingly offering X-over-IP services to reduce costs, reduce obsolescence, provide easier upgrades and generate incremental revenue through value-added voice and data services. Softswitch Mobility Management. We are a founding member of the International Softswitch Consortium, an industry group formed to promote compatibility and interoperability of softswitch technologies. Based on our knowledge of the industry, we believe we are one of the first companies to develop a softswitch architecture to support mobile applications. Softswitches control the signaling and call management functions in an X-over-IP network. Of the many possible types of softswitching services, mobile telephony and information delivery services are among the most demanding and complex. Mobile networks must track subscribers' locations dynamically whether or not they are on a call. They must provide real-time handovers between base stations, perform authorization of roaming visitors, provide real-time billing for pre-paid services and flexible routing to its roamers in foreign networks and support messaging, file transfer and assignment of data bandwidths. Based on our knowledge of the industry, we believe that our mSwitch platform is one of the first systems to provide mobile switching functionality. mSwitch employs our proprietary, object oriented signaling protocol for mobility, known as SNSP, which we believe provides advantages over other similar protocols. mSwitch is commercially deployed with mobility support for our PAS wireless infrastructure. The mSwitch gateway is also being developed to support the future WCDMA and TD-SCDMA radio network control protocols as well as the payload protocols for 3G. mSwitch will serve as an IP-based, mobile switching center and IP-based radio network controller. With this focus on mobility services, mSwitch is targeting one of the most complex and commercially important segments of softswitch applications. PAS Value-Added Services. PAS offers a full suite of integrated value added services, which are easily customized, including short message services, location services, web browsing, e-mail, voice mail, and 64Kbps 13 Internet access. As part of our current research and development efforts, we are focusing on developing 128Kbps and 256Kbps packet mode wireless data delivery. We have licensed certain protocols and architectures that support the web browsing functions from KDDI, a Japanese service provider, and have optimized them for performance, hardware simplicity and Chinese character support as well as integrated them with PAS. We have developed additional protocols and architecture used in this technology. Research and Development We believe that continued and timely development and introduction of new and enhanced products are essential if we are to maintain our competitive position. While we use competitive analyses and technology trends as factors in our product development plans, the primary input for new products and product enhancements comes from soliciting and analyzing information about service providers' needs. Our Ministry of Information Industry, Telecommunications Administration and Telecommunications Bureau relationships and full-service post-sale customer support provide our research and development organization with insight into trends and developments in the marketplace. The insight provided from these relationships allows us to develop market-driven products such as PAS and mSwitch. We maintain a strong relationship between our research centers in the U.S. and China. Projects are typically designed and developed in the United States by one team and tested in China by another, allowing us to conduct research and development activities 24 hours a day. We rotate engineers between the U.S. and China to further integrate our research and development operations. We have been able to cost-effectively hire highly skilled technical employees from a large pool of qualified candidates in China. In the past we have made, and expect to continue to make, significant investments in research and development. Our research and development expenditures totaled $59.8 million in 2001, $41.5 million in 2000 and $18.6 million in 1999. Manufacturing, Assembly and Testing We manufacture or engage in the final assembly and testing of our mSwitch, PAS systems and handsets and AN-2000 products at the facilities of our two manufacturing joint ventures in the Chinese provinces of Guangdong and Zhejiang. These manufacturing operations consist of circuit board assembly, final system assembly, software installation and testing. We assemble circuit boards primarily using surface mount technology. Assembled boards are individually tested prior to final assembly and tested again at the system level prior to system shipment. We use internally developed functional and parametric tests for quality management and process control and have developed an internal system to track quality statistics at a serial number level. Both the Guangdong and the Zhejiang manufacturing facilities are ISO 9002 certified. ISO 9002 certification requires that the certified entity establish, maintain and follow an auditable quality process including documentation requirements, development, training, testing and continuous improvement and which is periodically audited by an independent outside auditor. We have recently entered into agreements with both our Guangdong and Zhejiang joint venture partners to acquire their respective interests in the joint ventures. Pending final approval by relevant Chinese governmental regulatory authorities, we anticipate these transactions to be completed during 2002. We contract with third parties in China to undertake high volume assembly and manufacturing of our handsets and we conduct final assembly, testing and packaging at our own facilities. In addition, we generally use third parties for high volume assembly of circuit boards. HonXun Electrical Industry in Hangzhou, a subsidiary of Foxconn Group, manufactures our PAS handsets; Eastcom Communications manufactures our PAS handsets; and Shanghai Jingling Electronic manufactures line cards for our IP-ADSL product. 14 We have also contracted with Matsushita Electric Industrial Co., Ltd., which distributes products under the Panasonic brand, to manufacture the PAS wireless infrastructure components and handsets for distribution under the UTStarcom label. Other suppliers include Wistron NeWeb Corporation, Japan Radio Co., Ltd., Kyocera Corporation and Sanyo Electric Co., Ltd., which provide handsets under the UTStarcom label, and Sharp Corporation, which provides handsets and repeaters under the UTStarcom label. Our AN-2000 product line integrates some third party products for subscriber premises equipment and testing. In China, we undertake final assembly and test our wireless infrastructure products at our own facilities and have recently begun to manufacture some of these products ourselves. Structure and Regulation of the Telecommunications Industry in China Structure of China's Telecommunications Industry. Historically, the China Telecom system was the sole provider of public telecommunications services in China. In 1993, the State Council, in an effort to promote competition, began issuing licenses to new telecommunications operators including China United Telecommunications Corporation, or Unicom, a provider of mobile communication services, and Jitong Communications Co., Ltd., a provider of data communications and Internet access services. In February 1999, the State Council approved a restructuring plan for the China Telecom system. The plan separated the telecommunications operations of the China Telecom system along four business lines: fixed line, mobile, paging and satellite communications services. Under the new structure, a new state-owned company, China Mobile, holds and operates the nationwide mobile communications assets. China Mobile also controls China Mobile (Hong Kong) Limited, a public company, that operates cellular services in thirteen of China's provinces. A new state-owned company, China Satellite, holds and operates the satellite assets. The paging operations have been merged into Unicom. China Telecom holds and operates the fixed line telephone and data communications assets. The Ministry of Information Industry confirmed in December 2001 that the State Council had approved a plan to restructure China Telecom. The Ministry of Information Industry has been authorized to execute the plan. China Telecom will be split into two regional entities. The assets of the present China Telecom in North China's Beijing and Tianjin municipalities, the Inner Mongolia Autonomous Region and Hebei and Shanxi provinces, Northeast China's Liaoning, Jilin and Heilongjiang provinces, Central China's Henan Province and East China's Shandong Province will merge with China Netcom Co. Ltd. and China Jitong Network Communications Co. Ltd. The new company will be named China Netcom Group Corp., or New CNC. China Telecom's assets in the other 21 provinces, municipalities and autonomous regions will retain the brand name and intangible assets of the old China Telecom. We refer to this entity as the New China Telecom. The New CNC will inherit 30% of the old China Telecom's national backbone network, with the rest going to the New China Telecom. As the announcement of this change is very recent and its implementation is ongoing, we cannot be certain what impact the restructuring will have on our business operations. However, we may experience a decline in orders and related revenues during such restructuring as a result of uncertainty among our customers presently operating under China Telecom. New CNC and New China Telecom will continue to operate through each of their own regional networks of approximately 2,400 local level telephone companies called Telecommunications Bureaus. Telecommunications Bureaus are responsible for purchasing, installing and operating the voice and data communications services in their local markets. Local telephone companies are funded by their own operational revenue from local telephone charges, a portion of shared long distance revenue through settlement, and headquarter allocation and cross subsidy, particularly in remote and poor regions. Among the funding sources, local revenue accounts for the majority of the revenue for local telephone companies. Government Regulation of the Telecommunications Industry. The China telecommunications industry is regulated at the national, provincial and local levels. At the national level, the Ministry of Information Industry regulates the industry. The Ministry of Information Industry was established in March 1998 to assume the regulatory, administrative and other governmental duties of the former Ministry of Posts and Telecommunications. The Ministry of Information Industry has broad discretion and authority to regulate all 15 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. Based on our industry experience, we believe that the Ministry of Information Industry's general telecommunications equipment strategy is to ensure that China's infrastructure is based on advanced open architectures that are expandable, cost efficient and quickly deployed. The Ministry of Information Industry also oversees the 33 Telecommunications Administrations that have regulatory responsibility over the telecommunications industry in their respective provinces. In China today, each Telecommunications Administration approves a subset of telecommunications products that meet Ministry of Information Industry standards from which Telecommunications Bureaus can then select the specific products they purchase, install and operate. Although historically the Ministry of Information Industry has shared regulation and operation of China's telecommunications industry with the China Telecom system, as part of the Chinese government's industry restructuring, the regulatory functions of the Ministry of Information Industry and the Telecommunications Administrations have been separated from the operational functions of the state-owned Telecommunications Bureaus under their control. The Ministry of Information Industry acts exclusively as the industry regulator and the local Telecommunications Bureaus act exclusively as operators. Given the multi-level regulatory environment, equipment providers in China must generally market intensively to all three levels of the communications industry. Statutory Framework. China does not yet have a national telecommunications law. However, with China's recent entry into the World Trade Organization, or 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. In order to comply with the WTO, subsets of draft telecommunications regulations were published in December 2001. One of the most significant of the draft regulations is the "Regulation of Foreign Investment over Telecom Enterprises." In December 2001, the State Council promulgated the Provisions on the Regulation of Foreign Invested Telecommunications Enterprises, which lifts the restrictions on foreign investment in the telecommunication industry, subject to certain equity ratio and geographic limitations. Also in December 2001, the Ministry of Information Industry issued the Measures on Regulation of Telecommunication Business Operation Permits, which details the procedures for obtaining permits for the operation of telecommunications businesses and makes it possible for those conducting telecommunications business to obtain the relevant permits. As we provide equipment rather than services, these two regulations should not have a direct effect on our business. Nevertheless, as the two regulations came into effect only recently, we are uncertain whether we will be indirectly affected by the impact of the two regulations on telecom service providers. Currently, the governing regulation over telecommunications in China is the Telecommunications Regulations of the People's Republic of China issued by the State Counsel in September 2000. This set of regulations is known as the Telecom Regulations. The Telecom Regulations govern telecommunications services and market regulations, pricing, interconnection and connection, as well as telecommunications construction and security issues. These regulations 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. As with the Telecommunications Law, we are uncertain what effect, if any, the Telecom Regulations will have on our business as presently conducted. Licenses for Communication Equipment. Beginning January 1, 1999, China's government required that all telecommunications equipment connected to public or private telecommunications networks within China, which includes equipment that we sell in China, be approved by the Ministry of Information Industry, and the manufacturer of the equipment obtain a network access license for each of its products. Subsequently, the State Council issued the Telecom Regulations in September 2000. In May 2001, the Ministry of Information Industry issued the Administrative Measures of Network Access Licenses, known as the Access License Measures, to 16 implement the Telecom Regulations and to replace the old access license regulation. Both the Telecom Regulations and the Access License Measures require the government to implement license systems for telecommunications terminal equipment, wireless communications equipment and equipment used in network interconnection that is connected to public telecommunications networks. The above equipment 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 networks or sold in China. The Telecom Regulations require that manufacturers ensure that the quality of the telecommunications equipment for which they have obtained a network access license is stable and reliable, and they 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 telecommunications equipment for which a network access license has been obtained 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 system. Based upon conversations with the Ministry of Information Industry, we understand that our PAS system is considered to still be in the trial period and that sales of our PAS system 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 system, 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 information received by our counsel in China, either of which could have a material adverse effect on our business, financial condition and results of operations. Software Registration. On October 27, 2000, the Ministry of Information Industry issued the Administrative Regulations on Software Products, known as the Software Regulations, to enhance software product management and stimulate the development of the software industry in China. Under the Software Regulations, the government imposes a registration and filing system on software and products incorporating software. Software cannot be produced and sold in China without registration and filing. The developers and producers of the software are responsible for the registration and filing of domestic software products. Registration under the Software Regulations is valid for five years and can be renewed upon expiration. The Ministry of Information Industry is responsible for the overall management of software. The local offices of the Ministry of Information Industry at the provincial level are responsible for the management and examination of and approval for the registration of the domestic software within their own territories. The designated agencies authorized by these local offices are responsible for acceptance for registration of software. Before registration is approved by the government agencies, software products need to be tested by the authorized testing institutions. We are in the process of applying for registration for our software. Based upon verbal advice received from the Ministry of Information Industry, we believe that we will be able to continue to sell our products incorporating our software during the period in which these regulations are being implemented and our application is pending. However, this implementation period may not last long enough for us to complete the registration of our software. Moreover, the Chinese government may interpret or apply the Software 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 our software, we could be prohibited from making further sales of products incorporating the unregistered software in China, which could substantially harm our business and financial condition. 17 Competition We face intense competition in our target markets and expect competition to increase. Our principal competitors in our various product lines include: . mSwitch: Alcatel Alsthom CGE, S.A.; Cisco Systems, Inc.; Clarent Corporation; Ericsson LM Telephone Co.; Huawei Technology Co., Ltd.; Lucent Technologies, Inc.; Motorola, Inc.; Nokia Corporation; Nortel Networks Corporation; Nuera Communications, Inc.; Siemens AG; Sonus Networks, Inc.; and Zhongxing Telecommunications Equipment. . PAS systems and handsets: Lucent Technologies, Inc. and Zhongxing Telecommunications Equipment. . AN-2000: Advanced Fibre Communications, Inc.; Alcatel Alsthom CGE, S.A.; Datang Telecom Technology Co. Ltd.; Huawei Technology Co., Ltd.; Lucent Technologies, Inc.; and Zhongxing Telecommunications Equipment. We are increasingly facing competition from domestic companies in China. We believe that our strongest competition comes 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 WTO. Many of our existing and potential competitors may 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 and offer significant discounts on handsets or other 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 foreign 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 Bureaus and other local organizations, to increase their ability 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 in China. We may not be able to compete successfully against current or future competitors. In addition, competitive pressures in the future may materially adversely affect our business, financial condition and results of operations. We believe that the principal competitive factors affecting the market for our network access products include: . total initial cost of solution; . for PAS, the availability, cost and functionality of our handsets; . short delivery and installation intervals; . design and installation support; 18 . ease of integration with the backbone network; . flexibility in supporting multiple interfaces and services; . operational cost and reliability; and . manageability of the solution and scalability. We may not be able to compete effectively against current and future competitors based on these or any other competitive factors in the future, and the failure to do so would have a material adverse affect on our business, financial condition and results of operations. Intellectual Property Our success and ability to compete is dependent in part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements and licensing arrangements, to establish and protect our proprietary rights. To date, we have relied primarily on proprietary processes and know-how to protect our intellectual property. We presently hold three U.S. patents for existing products. The terms of one of these patents will expire in 2016, while the terms of the remaining two patents will expire in 2019. We have submitted 12 additional U.S. patent applications and 27 foreign patent applications. In addition, we have, from time to time, chosen to abandon previously filed applications. Patents may not issue and any patents issued may not cover the scope of the claims sought in the applications. Our U.S. patents do not afford any intellectual property protection in China or other international jurisdictions. Moreover, we have applied for but have not yet obtained patents in China and Taiwan. We may not be able to obtain patents in China on our products or the technology that we use to manufacture our products. KDDI, a Japanese service provider, has licensed key technology to us that serves as the base for the MiMi service in Taiwan. Our joint ventures in China rely upon our trademarks, technology and know-how to manufacture and sell our products. Under the terms of our joint venture agreements, any modifications or enhancements to or derivatives of our intellectual property developed by the joint ventures will be owned by the joint ventures. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenues. Despite our efforts to protect our proprietary rights, existing patent, copyright, trademark and trade secret laws afford only limited protection. In addition, the legal systems of some foreign countries, including China, do not protect our proprietary rights to the same extent as does the legal system of the United States. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technology or deter others from developing similar technology. Furthermore, policing the unauthorized use of our products is difficult. Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and diversion of resources and could significantly harm our business. The communications industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. From time to time, third parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our business. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could significantly harm our business. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In the event a claim against us was successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our products to avoid infringement, our business would be significantly harmed. 19 ITEM 2--FACILITIES
Square Date of Location Functions Footage Lease Expiration - -------- --------- ------- ---------------- HEADQUARTERS Alameda, CA Administration, Sales/Customer Support and Research and Development 25,576 January, 2003 Alameda, CA Research and Development 7,534 January, 2004 Fremont, CA Research and Development 9,688 May 2005 Iselin, NJ Sales/Customer Support and Research and Development 43,409 July, 2004 Shenzhen, China Research and Development 107,596 November, 2004 Shenzhen, China Research and Development 10,764 February, 2002 Shenzhen, China Research and Development 18,678 May, 2003 Hefei, China Research and Development 3,606 June, 2002 Hefei, China Research and Development 3,767 July, 2002 Hangzhou, China Administration, Sales/Customer Support, Engineering and Manufacturing 83,926 March, 2002 Hangzhou, China Administration, Sales/Customer Support, Research and Development, and Manufacturing 89,340 February, 2002 Hangzhou, China Administration, Sales/Customer Support, Research and Development, and Manufacturing 168,444 December, 2003 Beijing, China UTSC Headquarters Administration, Sales/Customer Support 16,695 July, 2003 Shanghai, China Sales/Customer Support 8,214 April, 2003 Wuhan, China Sales/Customer Support 1,066 April, 2003 Chengsha, China Sales/Customer Support 592 March, 2002 Guangzhou, China Sales/Customer Support 11,964 April, 2004 Chengdu, China Sales/Customer Support 1,851 December, 2002 Jinan, China Sales/Customer Support 3,229 March, 2002 Kunming, China Sales/Customer Support 2,676 February, 2003 Xian, China Sales/Customer Support 4,155 December, 2002 Shenyang, China Sales/Customer Support 3,122 May, 2003 Fuzhou, China Sales/Customer Support 6,030 June, 2002 Zhengzhou, China Sales/Customer Support 2,422 October, 2002 Taipei, Taiwan Sales/Customer Support 7,769 September, 2004 Hong Kong, China Sales/Customer Support 800 June, 2002 NanNing, China Sales/Customer Support 2293 August, 2003 NanJing, China Sales/Customer Support 3014 May, 2002 Nei Mon Gol, China Sales/Customer Support 500 December, 2002 Gurgaon, India Sales/Customer Support 5,722 June, 2004 Herzlia, Israel Sales/Customer Support 969 May, 2002 Miramar, Florida Sales/Customer Support 4796 April, 2006 Tokyo, Japan Sales/Customer Support 3217 February, 2004 Hanoi, Vietnam Sales/Customer Support 732 September, 2003
We purchased the rights to use approximately 49 acres of land located in Zhejiang Science and Technology Industry Garden of Hangzhou Hi-tech Industry Development Zone for a period of 50 years. We completed the design layout and the construction cost estimate for a new manufacturing facility. Construction of the new manufacturing facility is expected to be completed in late 2003. In addition, as we expand into markets outside of China, our facility needs may increase according to business needs. 20 ITEM 3--LEGAL PROCEEDINGS On October 31, 2001, a complaint captioned Lacek v. UTStarcom, Inc., et. al., Civil Action No. 01-CV-9604, was filed in United States District Court for the Southern District of New York against our company, some of our directors and officers and various underwriters for our initial public offering. Plaintiffs 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. 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. The complaint against us seeks unspecified damages on behalf of a purported class of purchasers of our common stock between March 2, 2000 and December 6, 2000. We believe that we have meritorious defenses to this lawsuit and will defend this lawsuit vigorously. ITEM 4--SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. EXECUTIVE OFFICERS Our executive officers and directors, and their ages as of December 31, 2001, are as follows:
Name Age Position - ---- --- -------- Masayoshi Son...... 44 Chairman of the Board of Directors Hong Liang Lu...... 47 President, Chief Executive Officer and Director Ying Wu............ 42 Vice Chairman of the Board of Directors, Executive Vice President and Chief Executive Officer, China Operations Michael Sophie..... 44 Vice President of Finance, Chief Financial Officer and Assistant Secretary Bill Huang......... 39 Senior Vice President and Chief Technology Officer Shao-Ning J. Chou.. 39 Senior Vice President and Chief Operating Officer, China Operations Paul Berkowitz..... 49 Vice President, International Sales Gerald Soloway..... 53 Senior Vice President, Engineering Thomas J. Toy...... 47 Director Chauncey Shey...... 44 Director Larry D. Horner.... 67 Director Howard Kwock....... 52 Vice President, Engineering
Masayoshi Son has served as our Chairman of the Board of Directors since October 1995. For more than 16 years, Mr. Son served as President and Chief Executive Officer and as a director of SOFTBANK CORP., a leading global provider of Internet content, technology and services. Mr. Son also serves as a director of BB Technologies Corporation, Yahoo Japan Corporation and Aozora Bank, Ltd. Mr. Son also serves as Chairman of the Board of Directors and Chief Executive Officer of SOFTBANK Holdings Inc. and Chairman of the Board of Directors of SOFTBANK America Inc. From April 1998 to October 1999, Mr. Son served as a director of Ziff-Davis, Inc. Mr. Son holds a B.A. in Economics from the University of California at Berkeley. Hong Liang Lu has served as our President and Chief Executive Officer and as a director since June 1991. Mr. Lu co-founded UTStarcom under its prior name, Unitech Telecom, Inc., in June 1991 which subsequently acquired StarCom Network Systems, Inc. in September 1995. From 1986 through December 1990, Mr. Lu served as President and Chief Executive Officer of Kyocera Unison, a majority-owned subsidiary of Kyocera International, Inc. From 1983 until its merger with Kyocera in 1986, he served as President and Chief Executive 21 Officer of Unison World, Inc., a software development company. From 1979 to 1983, he served as Vice President and Chief Operating Officer of Unison World, Inc. Mr. Lu holds a B.S. in Civil Engineering from the University of California at Berkeley. Ying Wu has served as our Executive Vice President and Vice Chairman of the Board of Directors since October 1995. Mr. Wu has also served as the President and Chief Executive Officer of one of our subsidiaries, UTStarcom China, since October 1995. Mr. Wu was a co-founder of, and from February 1991 to September 1995 served as Senior Vice President of, StarCom Network Systems, Inc., a company that marketed and distributed third party telecommunications equipment. From 1988 to 1991, Mr. Wu served as a member of the technical staff of Bellcore Laboratories. From 1987 through 1988, Mr. Wu served as a consultant at AT&T Bell Labs. He holds a B.S. in Electrical Engineering from Beijing Industrial University and an M.S. in Electrical Engineering from the New Jersey Institute of Technology. Michael Sophie has been our Vice President of Finance and Chief Financial Officer since August 1999. Prior to joining our company, Mr. Sophie held executive positions at P-Com, Inc. from August 1993 to August 1999 as Vice President Finance, Chief Financial Officer and Group President. From 1989 through 1993, Mr. Sophie was Vice President of Finance at Loral Fairchild Corporation. He holds a B.S. degree from California State University, Chico and an M.B.A. from the University of Santa Clara. Bill Huang has been our Chief Technology Officer since September 1999. He was appointed Senior Vice President in September 2001. From December 1996 to September 1999, he was our Vice President of Strategic Product Planning. From June 1995 to December 1996, Mr. Huang served as our Vice President, China Operations. From 1994 to June 1995, Mr. Huang was our Director, Engineering. From 1992 to 1994, he was a Member of the Technical Staff and Project Leader at AT&T Systems. Mr. Huang serves on the board of Shenzhen Gin De (Group) Ltd., a real estate investment company in China. Mr. Huang holds a B.S. in Electrical Engineering from Huazhong University of Science & Technology, and an M.S. in Electrical Engineering and Computer Sciences from the University of Illinois. Shao-Ning J. Chou has been our Executive Vice President and Chief Operating Officer of China Operations since January 1999. He was appointed Senior Vice President in September 2001. From March 1997 to December 1998, he was Vice President of China Operations and from February 1996 to March 1997, he served as Vice President of Engineering. From March 1995 to June 1996, he was Director of Engineering for wireless systems and software with Lucent Technologies Microelectronics IC group. From April 1993 to March 1995, he was a Technical Manager for the Global Wireless product group with AT&T consumer products where he led multiple development teams for handset and wireless personal base station products. From February 1985 to April 1993, Mr. Chou was team leader and a member of the technical staff for advanced digital communication research in AT&T Bell Laboratories where he led and engaged in data communication equipment and multimedia product development. Mr. Chou holds a B.S. in Electrical Engineering from City College of New York, an M.S. in Engineering from Princeton University and an M.B.A. from the State University of New Jersey, Rutgers. Paul Berkowitz has been our Vice President of International Sales since November 1998. From February 1996 to November 1998, he was our Vice President of Product Management & Planning, and from December 1995 to June 1996, he served as our Vice President of Engineering. From 1994 to 1995, Mr. Berkowitz was Director of Application Software of AT&T Network Systems where he managed, among other things, an international team in marketing, architecture, and development of software involving a portfolio of advanced GUI and client-server products for telecommunications services. Between 1992 and 1994, he led the planning and development effort for a 1 Gigabit/sec Asynchronous Transfer Mode switch support Wide Area Network services including TDM and Frame Relay in the AT&T Paradyne Unit. Mr. Berkowitz has been granted four patents and holds a B.S. and an M.S. in Electrical Engineering from Columbia University. Gerald Soloway has been our Vice President of Engineering since January 1999. He was appointed Senior Vice President of Engineering in September 2001. From April 1998 to January 1999, he served as our Director of 22 Strategic Marketing. Prior to this, Dr. Soloway worked for Lucent Technologies, formerly Bell Labs, for 29 years. At Lucent, Dr. Soloway held executive positions in Consumer Products, Business Terminal Development, PBX Systems Engineering, Key System Development and Access Systems Development. He holds a Ph.D. from Polytechnic Institute of New York, an M.S. from New York University, and a B.S. from Cooper Union, all in Electrical Engineering. Dr. Soloway also holds seven patents in communications and computer graphics technology. Thomas J. Toy has served as a director since February 1995. Since March 1999, Mr. Toy has served as Managing Director of Pacrim Venture Partners, a professional venture capital firm specializing in investments in the information technology sector. Prior to that he was a partner at Technology Funding, a professional venture capital firm, from January 1987 to March 1999. While at Technology Funding, Mr. Toy was Managing Director of Corporate Finance and headed the firm's investment committee. Mr. Toy also serves as a director of White Electronic Designs Inc. and several private companies. Mr. Toy holds B.A. and M.M. degrees from Northwestern University. Chauncey Shey has served as a director since October 1995. Mr. Shey has served as President of SOFTBANK China Holdings since December 1999. From February 1999 to December 1999, he served as President of DirecTouch Communications Limited. From October 1995 to February 1999, Mr. Shey served as our Executive Vice President in charge of Research and Development. From March to October 1995, he served as Executive Vice President of StarCom Network Systems, Inc., where he worked in research and development as well as in operation and strategy planning. From March 1991 to March 1995, he served as Executive Vice President of StarCom Products, Inc., a consulting business that developed software products and provided expertise in the fields of computers and telecommunications. In that position he was responsible for operations, financial management and marketing. From December 1990 to December 1991, Mr. Shey served as a consultant at Bell Labs. He holds a B.S. in Electrical Engineering from Shanghai Jiao Tong University and an M.S. in Computer Science from the State University of New York at New Paltz. Larry D. Horner has served as a director since January 2000. From 1994 until June 2001, Mr. Horner served as Chairman of Pacific USA Holdings Corp. and as Chairman of the Board and Chief Executive Officer of Asia Pacific Wire & Cable Corporation Limited. He is a director of Phillips Petroleum Company, Atlantis Plastics, Inc. and Newmark Homes Corp. Mr. Horner formerly served as Chairman and Chief Executive Officer of KPMG Peat Marwick from 1984 to 1990. Mr. Horner is a Certified Public Accountant, holds a B.S. from the University of Kansas and is a graduate of the Stanford Executive Program. Howard Kwock was appointed our Vice President of Engineering in September 2001. From March 2001 to September 2001, he served as our Senior Director of Engineering. From February 2000 to February 2001, Mr. Kwock worked as Director of Engineering at Zhone Technologies. From June 1995 to January 2001, Mr. Kwock served as Director of Engineering at Lucent Technologies, formerly Ascend Communications. Mr. Kwock holds a B.A. in Business Administration from California State University, Fullerton. 23 PART II ITEM 5--MARKET FOR UTSTARCOM, INC.'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Fiscal 2000 High Low ----------- ------ ------ First Quarter (from March 3, 2000)............... $93.50 $41.00 Second Quarter................................... 77.63 16.75 Third Quarter.................................... 32.88 18.00 Fourth Quarter................................... 23.00 12.31 Fiscal 2001 ----------- First Quarter.................................... $28.00 $13.56 Second Quarter................................... 27.28 12.50 Third Quarter.................................... 25.61 12.98 Fourth Quarter................................... 31.43 15.51 Fiscal 2002 ----------- First Quarter (through February 8, 2002)......... $35.66 $20.67
Our common stock has been traded on The Nasdaq Stock Market under the symbol UTSI since our initial public offering on March 3, 2000. The preceding table sets forth the high and low closing sales prices per share of our common stock as reported on The Nasdaq National Market for the periods indicated. As of December 31, 2001 we had approximately 205 stockholders of record. To date, we have not paid any cash dividends on our common stock. We currently anticipate that we will retain any available funds to finance the growth and operation of our business and we do not anticipate paying any cash dividends in the foreseeable future. Certain present or future agreements may limit or prevent the payment of dividends on our common stock. 24 ITEM 6--SELECTED CONSOLIDATED FINANCIAL DATA You should read the selected consolidated financial data set forth below in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and our Consolidated Financial Statements and the Notes thereto included elsewhere in this report. Historical results are not necessarily indicative of results that may be expected for any future period.
Year Ended December 31, -------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- ---------- (in thousands, except per share data) Consolidated Statement of Operations Data: Net sales................................................. $ 75,597 $105,167 $187,516 $368,646 $ 626,840 Gross profit.............................................. 26,802 41,025 74,813 128,181 224,548 Operating income (loss)................................... (3,390) 3,013 16,719 33,780 76,728 Income (loss) from continuing operations.................. (1,383) 593 13,119 27,993 56,954 Net income (loss) available to common stockholders........ 30 (300) (18,514) 27,013 56,954 Basic earnings (loss) per share: Income (loss) from continuing operations............... $ (0.19) 0.08 $ (1.94) $ 0.35 $ 0.56 Income (loss) from discontinued operations............. 0.19 (0.12) (0.19) -- -- Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements".......................................... -- -- -- (0.01) -- -------- -------- -------- -------- ---------- Net income (loss)...................................... $ -- $ (0.04) $ (2.13) $ 0.34 $ 0.56 ======== ======== ======== ======== ========== Diluted earnings (loss) per share: Income (loss) from continuing operations............... $ (0.19) $ 0.01 $ (1.94) $ 0.28 $ 0.52 Income (loss) from discontinued operations............. 0.19 (0.01) (0.19) -- -- Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements".......................................... -- -- -- (0.01) -- -------- -------- -------- -------- ---------- Net income (loss)...................................... $ -- $ -- $ (2.13) $ 0.27 $ 0.52 ======== ======== ======== ======== ========== Pro forma amounts assuming application of SAB 101 "Revenue Recognition in Financial Statements" is applied retroactively: Net income (loss) available to common stockholders......................................... $ 30 $ (300) $(19,494) $ 27,993 $ 56,954 ======== ======== ======== ======== ========== Earning (loss) per share: --Basic............................................ $ -- $ (0.04) $ (2.25) $ 0.35 $ 0.56 ======== ======== ======== ======== ========== --Diluted.......................................... $ -- $ -- $ (2.25) $ 0.27 $ 0.52 ======== ======== ======== ======== ========== Weighted average shares used in per-share calculations: --Basic............................................ 7,320 7,582 8,678 79,696 101,433 ======== ======== ======== ======== ========== --Diluted.......................................... 7,320 77,050 8,678 101,867 108,612 ======== ======== ======== ======== ========== As of December 31, -------------------------------------------------- 1997 1998 1999 2000 2001 -------- -------- -------- -------- ---------- (in thousands) Consolidated Balance Sheet Data: Cash and cash equivalents(1).............................. $ 35,049 $ 17,626 $ 87,364 $149,112 $ 321,136 Working capital........................................... 59,076 57,416 128,973 369,861 591,103 Total assets.............................................. 101,097 142,121 271,788 591,837 1,005,880 Total short-term debt..................................... 1,579 38,426 43,338 43,381 58,434 Total long-term debt...................................... -- -- -- 12,048 12,048 Total stockholders' equity................................ 72,513 72,336 165,720 412,319 681,887
- -------- (1) Includes restricted cash of $5.2 million as of December 31, 2001. 25 ITEM 7--MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K 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 those concerning the following: 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 that there will be fluctuations in our overall gross profit, gross margin, product mix 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-K. 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-K. Overview 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. In addition, we issued shares of restricted common stock valued at $5.0 million to ACD employees who will continue to perform services for us, vesting 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. ACD is a System- on-Chip (SoC) semiconductor company focusing on LAN and IP switching technology. We conduct our operations in China through wholly owned subsidiaries and two joint ventures. 26 We have derived substantially all of our revenues from sales of telecommunications equipment to service providers in China. However, we are currently expanding our sales to service providers in other growing communications markets outside of China. 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 90.3% of our net sales for the year ended December 31, 2001 and approximately 98.8% of our net sales for the year ended December 31, 2000 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. Our first and second largest customers accounted for 6.6% and 5.9% of our net sales for the year ended December 31, 2001, and 9.0% and 5.0% of accounts receivable, respectively, as of December 31, 2001. Our first and second largest customers accounted for 12.1% and 6.0% of our net sales, respectively, for the year ended December 31, 2000 and 7.0% and 0.2% of the accounts receivable, respectively, as of December 31, 2000. Our first and second largest customers accounted for 30.2% and 10.7% of our net sales, respectively, in 1999 and 39.0% and 6.0% of the accounts receivable, respectively, as of December 31, 1999. 89.9% of our net sales during 2001 were to entities affiliated with the government of China. Accounts receivable balances from these entities or state owned enterprises were $192.8 million as of December 31, 2001. We extend credit to our customers in China without requiring collateral. We monitor our exposure for credit losses and maintain allowances for doubtful accounts. 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 a 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, 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 27 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. We do not have the ability to forecast with any degree of certainty the impact of the decreased business activity during the Lunar New Year on our sales and operating results. 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. 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 collectability 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. Effective January 1, 2000, we adopted Staff Accounting Bulletin 101 ("SAB 101") issued by the Securities and Exchange Commission in December 1999. In light of the guidance issued in SAB 101, we changed our method of recognizing revenue for some contracts. We previously recognized revenue as contract stages were completed and accepted. We now recognize revenue upon final acceptance of the contract. In addition, some of our contracts include service requirements for which revenue was previously recognized, and costs accrued, on contractual acceptance. In consideration of SAB 101, revenues associated with these service requirements are being deferred until the service obligations are completed. We recorded a cumulative adjustment in the first quarter of fiscal 2000 of $1.0 million. The impact of the cumulative adjustment was a decrease in net income of $1.0 million or $0.01 per share, basic and diluted, for the year ended December 31, 2000. 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. 28 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 very 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. In connection with the grant of stock options to our employees, we recorded $5.0 million, $2.4 million and $15.9 million of net deferred stock compensation during the years ended December 31, 2001, 2000 and 1999, respectively. In connection with grants to non-employees during 1999, we recorded deferred compensation of $7.4 million. We recorded stock compensation expense of approximately $5.2 million during the year ended December 31, 2001, $11.6 million during the year ended December 31, 2000, and $5.6 million during the year ended December 31, 1999. At December 31, 2001, approximately $6.0 million of deferred stock compensation remained to be amortized. 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 comprises our 51.0% share of the earnings from our Guangdong manufacturing subsidiary, which is accounted for using the equity method, as we do not have voting control over all significant matters. We have entered into an agreement to purchase the remaining 49.0% equity interest and we are in the process of applying for the relevant governmental approvals. 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 subsidiary, UTStarcom China, and our joint venture, Hangzhou UTStarcom, 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. It is not certain whether the government will implement such a unified tax structure, or if implemented whether it will adversely affect our financial results. 29 Minority interest in (earnings) loss of consolidated subsidiaries represents the share of earnings in Hangzhou UTStarcom, our Zhejiang manufacturing joint venture, that is owned by our joint venture partner. Results of Operations The following table sets forth the percentage of net sales represented by certain items reflected in our consolidated statements of operations:
Years Ended December 31, -------------------------- 1999 2000 2001 ------- ------- ------- Percentage of Net Sales Net sales.............................................................. 100.0% 100.0% 100.0% Cost of sales.......................................................... 60.1 65.2 64.2 ------- ------- ------- Gross profit........................................................... 39.9 34.8 35.8 Operating expenses: Selling, general and administrative................................. 18.7 13.1 12.1 Research and development............................................ 10.0 11.2 9.5 Amortization of goodwill and intangible assets...................... 0.2 1.3 1.2 In-process research and development costs........................... 2.1 -- 0.8 ------- ------- ------- Total operating expenses........................................ 31.0 25.6 23.6 Operating income....................................................... 8.9 9.2 12.2 Interest and other income (expenses)................................... (1.2) 2.9 0.5 Equity in net income (loss) of affiliated companies.................... 0.7 (0.1) (0.2) ------- ------- ------- Income before income taxes and minority interest....................... 8.4 12.0 12.5 Income tax expense..................................................... 0.3 3.8 3.2 Minority interest in earnings of consolidated subsidiaries............. (1.1) (0.6) (0.2) ------- ------- ------- Income from continuing operations...................................... 7.0 7.6 9.1 Loss from discontinued operations...................................... (0.9) -- -- ------- ------- ------- Net income before cumulative effect of change in accounting principle.. 6.1 7.6 9.1 Beneficial conversion feature of Series F preferred stock.............. (16.0) -- -- Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"................................. -- (0.3) -- ------- ------- ------- Net income (loss) available to common stockholders..................... (9.9)% 7.3% 9.1% ======= ======= =======
Comparison of years ended December 31, 2001 and December 31, 2000 Net Sales. Our net sales increased 70.0% to $626.8 million in 2001 from $368.6 million in 2000. This increase was primarily due to an increase in sales volume of our PAS and IP-based PAS systems. Sales of telecommunications equipment for the year ended December 31, 2001 were $438.9 million, an increase of $176.9 million or 67.5%, as compared to the corresponding period in 2000. Sales of subscriber handsets for the year ended December 31, 2001 were $187.9 million, an increase of $81.3 million or 76.3%, as compared to the corresponding period in 2000. Sales of telecommunications equipment and subscriber handsets increased due to the continued growth in spending on telecommunications infrastructure in China, as China continues to modernize such infrastructure. In 2001, no customer accounted for more than 10% our net sales. In 2000, sales to Hangzhou Telecommunications Bureau accounted for 12.1% of our net sales. Gross Profit. Gross profit increased 75.2% to $224.5 million in 2001 from $128.2 million in 2000. Gross profit, as a percentage of net sales, increased to 35.8% in 2001 from 34.8% in 2000. The increase in gross profit, as a percentage of net sales, was primarily due to increased margins on our handsets, which comprised 30.0% of net sales in 2001 compared to 28.9% in 2000. 30 Selling, General and Administrative. Selling, general and administrative expenses increased 57.7% to $75.8 million in 2001 from $48.1 million in 2000. 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. This increase was partly offset by a decrease in non-cash stock compensation expense which decreased to $2.5 million in 2001 from $4.7 million in 2000. Selling, general and administrative expenses as a percentage of net sales decreased to 12.1% in 2001 from 13.1% in 2000. The decrease in selling, general and administrative expenses as a percentage of net sales was primarily due to economies of scale associated with the significant increases in net sales. 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 further invest in infrastructure and incur additional expenses related to the anticipated growth of our business and operations. Research and Development. Research and development expenses increased 44.3% to $59.8 million in 2001 from $41.5 million in 2000. 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, partly offset by a decrease in non-cash stock compensation expense which decreased to $2.7 million in 2001 from $6.8 million in 2000. As a percentage of net sales, research and development expenses decreased to 9.5% in 2001 from 11.2% in 2000. This reduction was attributable to the decrease in non-cash compensation expense and an increase in sales in 2001. 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. Amortization of intangible assets increased to $7.5 million in 2001 from $4.9 million in 2000. The increase in amortization of intangible assets was primarily due to the amortization of additional goodwill associated with the acquisition of Stable Gain, a software development company, for $11.0 million in the first quarter of 2001. In-Process Research and Development Costs. In-process research and development costs resulted from our acquisition of ACD in November 2001. The aggregate purchase price of ACD was approximately $21.3 million which, based upon an independent appraisal by Willamette Management Associates of the assets acquired and liabilities assumed, was allocated to the specifically identifiable tangible and intangible assets acquired. In connection with the ACD acquisition, $4.7 million of in-process research and development costs were charged to operations in November 2001. There were no in-process research and development charges in 2000. Interest Income (Expense), Net. Interest income was $8.6 million in 2001 compared to interest income of $12.2 million in 2000. Interest expense was $3.9 million in 2001 compared to $3.3 million in 2000. Interest income decreased in 2001 due to lower interest rates, which was partially offset by higher average cash balances as a result of the completion of our follow-on public offering in July 2001. Interest expense increased due to higher borrowings in 2001 as compared to 2000. Other Income (Expenses), Net. Net other expense was $2.0 million in 2001 and net other income was $1.9 million in 2000. The decrease in other income in 2001 was primarily due to impairment write-downs of $3.4 million relating to our investment portfolio. Equity in Net Income (Loss) of Affiliated Companies. Consolidated equity in net loss of affiliated companies was $1.3 million in 2001 and $0.3 million in 2000. The change between the two periods was primarily due to the increase in losses at our Guangdong manufacturing subsidiary. Income Tax Expense. Income tax expense was $19.8 million in 2001 and $14.0 million in 2000. The increase in income tax expense was due to our increasing income. Our effective tax rate improved from 32% in 2000 to 25% in 2001 primarily due to a favorable settlement with the Internal Revenue Service upon examination of our corporate income tax returns filed for the years 1997, 1998 and 1999. 31 Minority Interest in Earnings of Consolidated Subsidiaries. Minority interest in earnings of consolidated subsidiaries was $1.3 million in 2001 and $2.3 million in 2000. The change between the two periods was primarily due to the increased profitability at our Zhejiang manufacturing subsidiary. Comparison of years ended December 31, 2000 and December 31, 1999 Net Sales. Our net sales increased 96.6% to $368.6 million in 2000 from $187.5 million in 1999. This increase was primarily due to an increase in sales volume of our PAS system. Sales of telecommunications equipment for the year ended December 31, 2000 were $262.1 million, an increase of $92.7 million or 54.7%, as compared to the corresponding period in 1999. Sales of subscriber handsets for the year ended December 31, 2000 were $106.6 million, an increase of $88.5 million or 489.0%, as compared to the corresponding period in 1999. In 2000, sales to Hangzhou Telecommunications Bureau accounted for 12.1% of our net sales. In 1999, sales to Xian Telecommunications Bureau and Kunming Telecommunications Bureau accounted for 30.2% and 10.7% of our net sales, respectively. Gross Profit. Gross profit increased 71.3% to $128.2 million in 2000 from $74.8 million in 1999. Gross profit, as a percentage of net sales, decreased to 34.8% in 2000 from 39.9% in 1999. The decrease in gross profit, as a percentage of net sales, was primarily due to increases in sales of lower margin handsets, which comprised 28.9% of net sales in 2000 compared to 9.6% in 1999. Selling, General and Administrative. Selling, general and administrative expenses increased 36.8% to $48.1 million in 2000 from $35.1 million in 1999. 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 decreased to 13.1% in 2000 from 18.7% in 1999. The decrease in selling, general and administrative expenses as a percentage of net sales was primarily due to economies of scale associated with the significant increases in net sales. Research and Development. Research and development expenses increased 122.3% to $41.5 million in 2000 from $18.6 million in 1999. 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, and non-cash stock compensation expense which increased to $6.8 million in 2000 from $1.3 million in 1999. As a percentage of net sales, research and development expenses increased to 11.2% in 2000 from 10.0% in 1999. Amortization of Intangible Assets. Amortization of intangible assets increased to $4.9 million in 2000 from $0.3 million in 1999. The increase in amortization of intangible assets was due to the increase in amortization associated with our December 1999 acquisition of the portion of our Wacos, Inc. subsidiary owned by the minority shareholders. In-Process Research and Development Costs. There were no in-process research and development charges in 2000. In-process research and development costs in 1999 resulted from our acquisition of the portion of our Wacos, Inc. subsidiary owned by the minority shareholders in December 1999. The aggregate purchase price of Wacos, Inc. was approximately $28.0 million which, based upon an independent appraisal by Willamette Management Associates of all the assets acquired and liabilities assumed, was allocated to the specifically identifiable tangible and intangible assets acquired. In connection with the Wacos acquisition, $4.0 million of in-process research and development costs were charged to operations in December 1999. Interest Income (Expense), Net. Net interest income was $8.9 million in 2000 and net interest expense was $1.0 million in 1999. The increase in interest income was primarily due to increased interest income from higher average cash balances as a result of the completion of our initial public offering in March 2000 and sale of our preferred stock in November and December 1999. 32 Other Income (Expenses), Net. Net other income was $1.9 million in 2000 and net other expenses were $1.2 million in 1999. The increase in other income was primarily due to a one-time gain on non-trade receivables which related to receipts of balances previously considered doubtful. Equity in Net Income (Loss) of Affiliated Companies. Consolidated equity in net loss of affiliated companies was $0.3 million in 2000 and consolidated equity in net income of affiliated companies was $1.3 million in 1999. The change between the two periods was primarily due to the decrease in net income at our Guangdong manufacturing subsidiary. Income Tax Expense. Income tax expense was $14.0 million in 2000 and $0.6 million in 1999. The increase in the income tax expense was due to our increasing income. Minority Interest in Earnings of Consolidated Subsidiaries. Minority interest in earnings of consolidated subsidiaries was $2.3 million in 2000 and $2.1 million in 1999. The change between the two periods was primarily due to the increased profitability at our Zhejiang manufacturing subsidiary. Beneficial Conversion Feature. The issuance of Series F preferred stock in 1999 included a beneficial conversion feature pursuant to which the preferred shares converted into common shares on a one-for-one basis at a price below the expected offering price upon the completion of our initial public offering. This resulted in a charge to net income in 1999 of approximately $30.0 million, reducing diluted earnings per share available to common stockholders by $3.45. Liquidity and Capital Resources Prior to our initial public offering we financed our operations through the sales of preferred stock and, to a lesser extent, bank lines of credit. In November and December 1999, we secured private equity financing totaling $55.0 million. 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. As of December 31, 2001 we had lines of credit totaling $260.2 million of which our total borrowings were $70.5 million, with the remainder available for future borrowings. Of the amount borrowed, $12.0 million was included in long-term debt. We are not a guarantor of any debt not included in the consolidated balance sheet. As of December 31, 2001, we had working capital of $591.1 million, including $321.1 million of cash and cash equivalents, $86.2 million of short-term investments and $58.4 million of Renminbi-denominated bank borrowings. During 2000, we invested $8.0 million and during 2001, we invested an additional $2.0 million in Softbank China (the "fund"), 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. An entity affiliated with SOFTBANK CORP., SOFTBANK America Inc., is a significant stockholder in our company. Our investment constitutes 10.0% of the funding for Softbank China, with SOFTBANK CORP. contributing the remaining 90.0%. 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 our employees is employed by the fund. One of our directors serves as the Chief Executive Officer of the fund. Our Chief Executive Officer is the chairman of the board of the fund but has not participated in day-to-day management of 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 year ended December 31, 2001, based upon a review of the carrying value of this investment, an impairment charge of $1.7 million was recognized to provide for the other than temporary decline in the fair value below the carrying value of this investment. The balance remaining in this investment as of December 31, 2001 was $8.3 million. 33 We have also invested directly in a number of private technology-based companies in the early stages of development. We continually evaluate the carrying value of these investments for possible impairment based on achievement of business objectives and milestones, the financial condition and prospects of these companies and other relevant factors. During the fourth quarter of 2001, based upon a review of the carrying value of these investments, an impairment charge of $1.7 million was recognized to provide for the other than temporary decline in the fair value below the carrying value of these investments. Due to the risky nature of these investments, we may experience further losses in connection with our investment in Softbank China and our other investments in private technology companies. Net cash provided by operations in 2001 of $40.2 million was primarily due to net income of $57.0 million adjusted for depreciation and amortization expense of $18.5 million, amortization of deferred stock compensation expense of $5.2 million, non-qualified stock option exercise tax benefits of $15.3 million, inventory reserve of $11.1 million, allowance for doubtful accounts of $6.2 million and an increase in accounts payable, income taxes payable and other current liabilities and deferred revenue of $39.1 million, $3.4 million and $86.2 million, respectively. This was partially offset by an increase in inventories, accounts receivable and other current and non-current assets of $121.2 million, $39.2 million and $52.6 million, respectively. Net cash used in operations in 2000 of $46.2 million was primarily due to an increase in inventories, accounts receivable and other current and non-current assets of $63.5 million, $87.2 million and $4.9 million, respectively. The uses of cash were partially offset by net income of $27.0 million plus depreciation and amortization expense of $9.5 million, non-qualified stock option exercise tax benefits of $7.6 million, amortization of deferred stock compensation expense of $11.6 million, inventory reserve of $2.8 million, allowance for doubtful accounts of $6.0 million and an increase in accounts payable and other current liabilities and deferred revenue of $14.1 million and $28.0 million, respectively. Net cash used in investing activities in 2001 of $43.7 million was primarily due to purchases of property, plant and equipment of $30.2 million, investments in affiliates of $9.8 million, and net purchases of short-term investments of $2.1 million. Net cash used in investing activities in 2000 of $111.4 million was primarily due to the acquisition of property, plant and equipment of $19.5 million, investment in affiliates of $8.2 million, which included our $8.0 million investment in Softbank China, and net purchases of short-term investments of $83.8 million. 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. Construction of the new facility is expected to be completed in 2003 at a projected cost of $70.0 million. We have entered into agreements to purchase the remaining minority interests in two of our joint ventures. In December 2001, we agreed to acquire the remaining 49% ownership in Guangdong UTStarcom, Ltd. for a total of $3.6 million in cash payable in 2002. In January 2002, we agreed to acquire the remaining 12% ownership in UTStarcom (Hangzhou) Telecommunication Company, Ltd. for a total of $14.5 million in cash payable in 2002. Net cash provided by financing activities in 2001 of $175.5 million was primarily due to $160.6 million of proceeds from our follow-on public offering of common stock in August 2001 and exercise of stock options, and net proceeds from borrowings under our line of credit arrangements of $15.1 million. Net cash provided by financing activities in 2000 of $219.3 million was primarily due to net proceeds of $198.2 million from the issuance of common stock through our initial public offering and exercise of stock options, and net proceeds of $20.8 million from borrowing under our lines of credit. Our international sales are generally denominated in local currencies. Due to the limitations on converting Renminbi, we are limited in our ability to engage in currency hedging activities in China. As of December 31, 2001, we were not engaged in any hedging activities and did not hold any derivative financial instruments. 34 Although the impact of currency fluctuations to date has been insignificant, 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 in Japanese Yen for purchasing portions of our inventories and supplies. The balance of this Japanese Yen account as of December 31, 2001 was approximately $6.7 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. If additional financing is needed, there can be no assurance that such financing will be available to us on commercially reasonable terms, or at all. Recent Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivatives and Hedging Activities", as amended by SFAS No. 138. SFAS No. 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. We adopted SFAS No. 133 on January 1, 2001, and the adoption had no impact on our consolidated financial statements. 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 that intangible assets acquired in a 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. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS No. 121). SFAS No. 141 is effective immediately, except with regard to business combinations that were initiated prior to July 1, 2001, which we accounted for using the purchase method of accounting. SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and was adopted by us on January 1, 2002. The adoption of these accounting standards will eliminate amortization of goodwill commencing January 1, 2002. However, impairment reviews may result in future periodic write-downs. We expect, due to the elimination of goodwill amortization expense effective January 1, 2002, that net income will increase by approximately $7.3 million in 2002 because existing goodwill from the Wacos acquisition will no longer be amortized. SFAS No. 142 will also require us to perform a transitional assessment by June 30, 2002, to determine whether there is an impairment of goodwill. Any such transitional impairment loss will be recognized as a change in accounting principle in the consolidated statement of operations. We have not yet performed the initial goodwill impairment test prescribed in SFAS No. 142. However, we do not anticipate that such test will result in a significant 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 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 do not expect that the adoption of SFAS No. 144 will have a significant impact on our consolidated financial statements. 35 Risks Relating to Our Company 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. Factors that may affect our future operating results include: . the timing, number and size of orders for our products, as well as the relative mix of orders for each of our products, particularly the volume of lower margin handsets; . cancellation, deferment or delay in implementation of large contracts; . the evolving and unpredictable nature of the economic, regulatory, competitive and political environments in China and other countries in which we market or plan to market our products; . price reductions by our competitors; . changes in our customers' subscriber growth rate; . currency fluctuations; . market acceptance of our products and product enhancements; . the lengthy and unpredictable sales cycles associated with sales of our products combined with the impact of this variability on our suppliers' ability to provide us with components on a timely basis; . longer collection periods of accounts receivable in China and other countries; and . the decline in business activity we typically experience during the Lunar New Year, which leads to decreased sales during our first fiscal quarter. 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 and market share 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 36 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 Bureaus 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. Because contracts and purchase orders are generally subject to cancellation or delay by customers with limited or no penalty, our backlog is not necessarily indicative of future revenues or earnings As of December 31, 2001, our backlog totaled approximately $360.7 million, compared to approximately $191.2 million as of December 31, 2000. We include in our backlog contracts and purchase orders for which we anticipate delivery to occur within 12 months and products delivered but for which final acceptance has not yet been received. Because contracts and purchase orders are generally subject to cancellation or delay by customers with limited or no penalty, our backlog is not necessarily indicative of future revenues or earnings. In addition, we have a number of large contracts under which realization of our backlog is dependent on the successful implementation of our products by our customers and in some cases, the successful development of regional infrastructures. 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 communications 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 37 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: . our ability to obtain necessary approvals from regulatory organizations; . the perceived advantages of the new products over competing products; . our ability to attract customers who have existing relationships with our competitors; . product cost relative to performance; and . the level of customer service available to support new products. 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 currently manufacture internally only a very limited quantity of our handsets. However, if future demand for our handsets requires additional manufacturing capacity, we may invest in and build additional manufacturing facilities, most likely in China. However, new manufacturing facilities may not attain the same quality or level of efficiencies as those of our existing third party manufacturers. 38 We depend on some sole source and other key suppliers for handsets, 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, an integral component of our PAS system is the handset used by subscribers to make and receive mobile telephone calls. Our inability to obtain a sufficient number of high quality components and assemblies for handsets 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. 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, 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: . increased competition; . aggressive price reductions by competitors; and . rapid technological change. 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 39 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. As a result of a growth in sales of lower margin handsets we have experienced a decline in overall gross profit, as a percentage of net sales. We are likely to continue to experience downward pressure on our gross profit, as a percentage of net sales. 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 inability to exercise complete control over a subsidiary may be detrimental to our business A considerable portion of our operations is and will continue to be conducted through direct and indirect subsidiaries. For example, we currently own a 51.0% interest in a joint venture that operates the Guangdong manufacturing facility. However, even though we own a majority interest in this joint venture, we do not have sole power to control all of the policies and decisions of this jointly-owned subsidiary. Under the law of China governing Sino-foreign joint ventures, equity holders exercise rights primarily through the board of directors, which constitutes the highest authority of the joint venture. Although we own a majority of the Guangdong joint venture, we are only entitled to appoint a minority of the directors to the joint venture's board of directors, which prevents us from controlling the actions of the board. China law requires unanimous approval of the board of directors for some significant corporate actions, including: . amendment of the Articles of Association of the joint venture; . liquidation or dissolution of the joint venture; . any increase, decrease or transfer of equity interests of any party to the joint venture; and . a merger of the joint venture with another economic entity. 40 Our operating results and cash flow depend on the operating results and cash flow of our subsidiaries and the payment of funds by those subsidiaries to us. These subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay dividends or otherwise provide financial benefits to us. Moreover, with respect to our Guangdong manufacturing joint venture, any payment of dividends to us must be agreed to by our joint venture partner, whose interests in receiving dividend distributions may not coincide with ours. In addition, applicable law in some countries including China limits the ability of a subsidiary to pay dividends for various reasons including the absence of sufficient distributable reserves. In the event of any insolvency, bankruptcy or similar proceedings, creditors of the subsidiaries would generally be entitled to priority over us with respect to assets of the affected subsidiary. 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 and India. 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: . difficulties in designing products that are compatible with varying international communications standards; . longer accounts receivable collection periods and greater difficulty in accounts receivable collection; . unexpected changes in regulatory requirements or the regulatory environment; . changes in governmental control or influence over our customers; . changes to import and export regulations, including quotas, tariffs and other trade barriers; . delays or difficulties in obtaining export and import licenses; . potential foreign exchange controls and repatriation controls on foreign earnings; . exchange rate fluctuations and currency conversion restrictions; . the burdens of complying with a variety of foreign laws and regulations; . difficulties and costs of staffing and managing multi-national operations; . reduced protection for intellectual property rights in some countries; . potentially adverse tax consequences; and . political and economic instability. 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 multinational 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. We are subject to risks relating to currency exchange rate fluctuations 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 41 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: . enhancing management information systems and forecasting procedures; . further developing our operating, administrative, financial and accounting systems and controls; . maintaining close coordination among our engineering, accounting, finance, marketing, sales and operations organizations; . expanding, training and managing our employee base; and . expanding our finance, administrative and operations staff. We have only recently become profitable and may not be able to sustain profitability We have only recently become profitable and 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 42 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 communications 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. 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 goodwill and other 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 43 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. Business interruptions could adversely affect our business 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 is currently subject to electrical blackouts as a consequence of a shortage of available electrical power. In the event these blackouts continue or increase in severity, 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 have been named as a defendant in securities litigation On October 31, 2001, a putative stockholder class action lawsuit was filed against our company, some of our directors and officers and various underwriters for our initial public offering. 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 44 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 Bureaus, which we attributed to the uncertainties surrounding the restructuring and the ultimate impact the restructuring would have on the Telecommunications Bureaus. On December 11, 2001, the Chinese government announced that China Telecom would be further split into two entities by region, Northern and Southern. The 10 Northern provinces, municipalities and autonomous regions of China Telecom will be merged with China Netcom Co. Ltd. and China Jitong Network Communications Co. Ltd. to form a new company which we refer to as the New CNC. The remaining 21 provinces, municipalities and autonomous regions will constitute the Southern entity, which will keep the name of China Telecom. The New CNC will inherit 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 and its implementation is ongoing, we cannot be certain what impact the restructuring 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 Bureau customers associated with the restructuring. Moreover, following any restructuring, the New CNC, 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 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 45 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. Software incorporated in our products has not been registered in accordance with relevant Chinese regulations, and our ability to sell the products incorporating the software may be affected 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 are in the process of applying for registration of our software. Based upon verbal advice received from the Ministry of Information Industry, we believe that we will be able to continue to sell products incorporating our software during the period in which the regulations are being implemented and our applications are pending. However, this implementation period may not last long enough for us to complete the registration of our software. Moreover, 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 our software, 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 are part of the China Telecom system and are subject to its ultimate control, and, following the restructuring of China Telecom, most will be part of the New China Telecom or the New CNC and will be subject to their ultimate control Our main customers in China are the local Telecommunications Bureaus, which operate under China Telecom, China's state-owned fixed line operator, and are subject to its ultimate control. The Telecommunications Bureaus will operate under the ultimate control of the New China Telecom or the New CNC after the restructuring of China Telecom. Policy statements may be issued, or decisions may be made by these entities, which govern the equipment purchasing decisions of most of our customers in China. For example, in late 1999 China Telecom prohibited all Telecommunications Bureaus 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 China Telecom and, thereafter, the New China Telecom or the New CNC, restricting or prohibiting the sales or deployment of our products could cause substantial harm to our business. 46 Our ability to sell our PAS wireless systems and handsets could be significantly impaired if China Telecom or the resulting organizations following the reorganization of China Telecom are granted or otherwise acquire mobile licenses, which will allow China Telecom or such resulting entities to deliver cellular services China Telecom holds and operates and, after the restructuring, the New China Telecom and the New CNC will hold and operate, the fixed line telephone and data communications assets in China and will be prohibited from offering cellular services. To offer wireless services to end users, the Telecommunications Bureaus 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 either one or both of the New CNC and the New China Telecom. If the Ministry of Information Industry does grant a mobile license to the New China Telecom or the New CNC, or if such entities otherwise acquire mobile licenses, local Telecommunications Bureaus 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 harmed. 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. 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. Risks Relating to Conducting Operations in China 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 $565.9 million, or 90.3%, of our net sales in fiscal 2001, $364.0 million, or 98.8%, of our net sales in fiscal 2000, and $183.6 million, or 97.9%, of our net sales in fiscal 1999, occurred in China. Additionally, a substantial portion of our fixed assets are located in China. Of our total fixed assets, approximately 75.3% as of December 31, 2001, 75.0% as of December 31, 2000, and 53.7% as of December 31, 1999 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 47 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 48 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. Governmental policies in China could impact our business 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: . new laws and regulations or the interpretation of those laws and regulations; . the introduction of measures to control inflation or stimulate growth; . changes in the rate or method of taxation; . the imposition of additional restrictions on currency conversion and remittances abroad; and . any actions which limit our ability to develop, manufacture, import or sell our products in China, or to finance and operate our business in China. Economic policies in China could impact our business 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 49 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 Hangzhou UTStarcom, accounted for approximately 90.1% of our revenues in 2001. 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, Hangzhou UTStarcom, expired in 2001 and is now subject to annual review. Consequently, its tax rate could increase from 10% to 15% if it is unable to maintain a tax holiday in 2002. If we are unable to extend this tax holiday to 2002, our financial condition and results of operations may be negatively impacted. 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. 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 50 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. Risks Relating to Our Stock Performance Our stock price is highly volatile 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: . actual or anticipated fluctuations in operating results; . changes in expectations as to future financial performance or changes in financial estimates or buy/sell recommendations of securities analysts; . changes in governmental regulations or policies in China, such as the temporary suspension of sales of our PAS systems that occurred in May and June of 2000, which caused our stock price to drop; . our, or a competitor's, announcement of new products, services or technological innovations; and . the operating and stock price performance of other comparable companies. 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 40.85% 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 51 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 acquiror 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: . election and removal of directors; . merger or consolidation of our company; and . sale of all or substantially all of our assets. 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: . authorizing the Board of Directors to issue additional preferred stock; . prohibiting cumulative voting in the election of directors; . limiting the persons who may call special meetings of stockholders; . prohibiting stockholder action by written consent; . creating a classified Board of Directors pursuant to which our directors are elected for staggered three year terms; and . establishing advance notice requirements for nominations for election to the Board of Directors and for proposing matters that can be acted on by stockholders at stockholder meetings. 52 ITEM 7A--QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK UTStarcom is exposed to the impact of interest rate changes and changes in foreign currency exchange rates. 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 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 of less than one year. Our policy is to limit the risk of principal loss and ensure the safety of invested funds by limiting market risk. Funds in excess of current operating requirements are invested in government sponsored entities' 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 our investment portfolio at December 31, 2001:
(In thousands, except interest rates) Cash and cash equivalents........................ $321,136 Average interest rate............................ 1.2% Short-term investments........................... $ 86,176 Average interest rate............................ 3.8% Total investment securities...................... $407,312 Average interest rate............................ 1.8%
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 December 31, 2001 was approximately $6.7 million. ITEM 8--FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements
Page ---- Financial Statements: Report of Independent Accountants........................................................... 54 Consolidated Balance Sheets at December 31, 2001 and December 31, 2000...................... 55 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.. 56 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999.................................................................................. 57 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999.. 59 Notes to Consolidated Financial Statements.................................................. 60
53 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of UTStarcom, Inc.: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, stockholders' equity and cash flows present fairly, in all material respects, the financial position of UTStarcom, Inc. and its subsidiaries (the Company) at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 3 to the Consolidated Financial Statements, in 2000 the Company changed its method of accounting for revenue recognition. /s/ PRICEWATERHOUSECOOPERS LLP San Francisco, California January 14, 2002 54 UTSTARCOM, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share data)
December 31, -------------------- 2001 2000 ---------- -------- ASSETS Current assets: Cash and cash equivalents.................................................... $ 321,136 $149,112 Short-term investments....................................................... 86,176 83,858 Accounts receivable, net of allowances for doubtful accounts of $19,053 and $12,835 at December 31, 2001 and 2000, respectively........................ 193,046 161,330 Receivable from related parties.............................................. 1,670 406 Inventories, net............................................................. 229,050 118,995 Other current assets......................................................... 65,397 17,674 ---------- -------- Total current assets............................................................ 896,475 531,375 Property, plant and equipment, net.............................................. 43,942 21,999 Long-term investments........................................................... 17,818 12,397 Goodwill and intangible assets, net............................................. 38,992 20,238 Other long-term assets.......................................................... 8,653 5,828 ---------- -------- Total assets............................................................. $1,005,880 $591,837 ========== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................................. $ 83,649 $ 44,564 Short-term debt.............................................................. 58,434 43,381 Income taxes payable......................................................... 10,536 7,170 Deferred revenue............................................................. 76,424 31,678 Other........................................................................ 76,329 34,721 ---------- -------- Total current liabilities....................................................... 305,372 161,514 ---------- -------- Long-term debt.................................................................. 12,048 12,048 Minority interest in consolidated subsidiaries.................................. 6,573 5,956 Commitments and Contingencies (Note 19) Stockholders' equity: Preferred stock: $.00125 par value; authorized: 5,000,000 shares; issued and outstanding: none at December 31, 2001 and 2000............................ -- -- Common stock: $.00125 par value; authorized: 250,000,000 shares; issued and outstanding: 109,302,816 at December 31, 2001 and 95,032,657 at December 31, 2000.......................................................... 138 120 Additional paid-in capital................................................... 638,697 426,665 Deferred stock compensation.................................................. (6,045) (6,491) Retained earnings (accumulated deficit)...................................... 49,146 (7,808) Notes receivable from stockholders........................................... (381) (314) Accumulated other comprehensive income....................................... 332 147 ---------- -------- Total stockholders' equity...................................................... 681,887 412,319 ---------- -------- Total liabilities and stockholders' equity............................... $1,005,880 $591,837 ========== ========
See accompanying notes to consolidated financial statements. 55 UTSTARCOM, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
Years Ended December 31, ---------------------------- 2001 2000 1999 -------- -------- -------- Net sales....................................................................................... $626,840 $368,646 $187,516 Cost of sales (includes stock compensation expense of $41, $90, and $12)........................ 402,292 240,465 112,703 -------- -------- -------- Gross profit.................................................................................... 224,548 128,181 74,813 -------- -------- -------- Operating expenses: Selling, general and administrative expenses (includes stock compensation expense of $2,499, $4,676, and $4,256)................................................................. 75,764 48,055 35,122 Research and development expenses (includes stock compensation expense of $2,660, $6,795, and $1,285)................................................................................. 59,809 41,452 18,648 Amortization of goodwill and intangible assets............................................... 7,527 4,894 332 In-process research and development costs.................................................... 4,720 -- 3,992 -------- -------- -------- Total operating expenses........................................................................ 147,820 94,401 58,094 -------- -------- -------- Operating income................................................................................ 76,728 33,780 16,719 Interest income................................................................................. 8,572 12,195 2,010 Interest expense................................................................................ (3,909) (3,311) (3,057) Other income (expense).......................................................................... (2,016) 1,945 (1,165) Equity in net income (loss) of affiliated companies............................................. (1,276) (288) 1,348 -------- -------- -------- Income before income taxes, minority interest and cumulative effect of a change of accounting principle........................................................................... 78,099 44,321 15,855 Income tax expense.............................................................................. 19,823 14,021 626 -------- -------- -------- Income before minority interest and cumulative effect of a change in accounting principle....... 58,276 30,300 15,229 Minority interest in (earnings) of consolidated subsidiaries.................................... (1,322) (2,307) (2,110) -------- -------- -------- Income from continuing operations............................................................... 56,954 27,993 13,119 Loss from discontinued operations............................................................... -- -- (1,656) -------- -------- -------- Net income before cumulative effect of a change of accounting principle......................... 56,954 27,993 11,463 Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements".......................................................................... -- (980) -- -------- -------- -------- Net income...................................................................................... 56,954 27,013 11,463 Beneficial conversion feature of Series F convertible preferred stock........................... -- -- (29,977) -------- -------- -------- Net income (loss) available to common stockholders.............................................. $ 56,954 $ 27,013 $(18,514) ======== ======== ======== Basic earnings (loss) per share: Income (loss) from continuing operations..................................................... $ 0.56 $ 0.35 $ (1.94) Loss from discontinued operations............................................................ -- -- (0.19) Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"....................................................................... -- (0.01) -- -------- -------- -------- Net income (loss)............................................................................ $ 0.56 $ 0.34 $ (2.13) ======== ======== ======== Diluted earnings (loss) per share: Income (loss) from continuing operations..................................................... $ 0.52 $ 0.28 $ (1.94) Loss from discontinued operations............................................................ -- -- (0.19) Cumulative effect on prior years of the application of SAB 101 "Revenue Recognition in Financial Statements"....................................................................... -- (0.01) -- -------- -------- -------- Net income (loss)............................................................................ $ 0.52 $ 0.27 $ (2.13) ======== ======== ======== Weighted average shares used in per-share calculations: --Basic...................................................................................... 101,433 79,696 8,678 ======== ======== ======== --Diluted.................................................................................... 108,612 101,867 8,678 ======== ======== ========
See accompanying notes to consolidated financial statements. 56 UTSTARCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (In thousands, except share data)
Convertible Deferred Retained Preferred Stock Common Stock Additional Stock Earnings ------------------ ------------------- Paid-in Compen- (Accumulated Issued Amount Shares Amount Capital sation Deficit) ----------- ------ ----------- ------ ---------- -------- ------------ Balances, December 31, 1998...................... 59,635,754 $ 74 9,172,864 $12 $ 88,848 $ (17) $(16,307) Common stock issued upon exercise of options..... 548,219 530 Reacquired common stock.......................... 7,692 (7) Stock reclassification........................... (549,448) (1) 549,448 1 Notes receivable from stockholders............... Deferred stock compensation related to grant of stock options to employees...................... 15,937 (15,937) Amortization of deferred stock compensation related to grant of stock options to employees.. 5,553 Deferred stock compensation related to grant of stock options to non-employees.................. 7,391 (7,391) Distribution to stockholders..................... (6,550) Issuance of preferred stock at $8.127 per share, net of issuance costs of $41.................... 6,767,316 9 54,950 Issuance of preferred stock for Wacos acquisition..................................... 4,523,700 6 27,616 Dividend related to beneficial conversion feature to issuance of Series F preferred stock in December 1999................................... 29,977 (29,977) Retirement of Treasury Stock..................... (1,348,386) Net income....................................... 11,463 ----------- ---- ----------- --- -------- -------- -------- Balances, December 31, 1999...................... 70,377,322 88 8,929,837 13 218,692 (17,792) (34,821) Common stock issued upon Initial Public Offering, net of expenses....................... 11,500,000 14 189,391 Conversion of preferred stock to common stock upon Initial Public Offering.................... (70,377,322) (88) 70,377,322 88 Exercise of common stock warrant................. 500,000 1 3,124 Common stock issued upon exercise of options..... 3,651,687 4 4,551 Common stock issued from ESPP.................... 73,811 1,130 Distribution to stockholders..................... 1,889 Deferred stock compensation related to grant of stock options................................... 260 (260) Amortization of deferred stock compensation...... 11,561 Tax benefits for non-qualified stock option exercises....................................... 7,628
Notes Accumulated Receivable Other Total from Compre- Stock- Compre- Stock- hensive holders' hensive holders Income Equity Income ---------- ----------- -------- ------- Balances, December 31, 1998...................... $(369) $95 $ 72,336 Common stock issued upon exercise of options..... 530 Reacquired common stock.......................... (7) Stock reclassification........................... -- Notes receivable from stockholders............... (186) (186) Deferred stock compensation related to grant of stock options to employees...................... -- Amortization of deferred stock compensation related to grant of stock options to employees.. 5,553 Deferred stock compensation related to grant of stock options to non-employees.................. -- Distribution to stockholders..................... (6,550) Issuance of preferred stock at $8.127 per share, net of issuance costs of $41.................... 54,959 Issuance of preferred stock for Wacos acquisition..................................... 27,622 Dividend related to beneficial conversion feature to issuance of Series F preferred stock in December 1999................................... -- Retirement of Treasury Stock..................... -- Net income....................................... 11,463 $11,463 ----- --- -------- ======= Balances, December 31, 1999...................... (555) 95 165,720 Common stock issued upon Initial Public Offering, net of expenses....................... 189,405 Conversion of preferred stock to common stock upon Initial Public Offering.................... -- Exercise of common stock warrant................. 3,125 Common stock issued upon exercise of options..... 4,555 Common stock issued from ESPP.................... 1,130 Distribution to stockholders..................... 1,889 Deferred stock compensation related to grant of stock options................................... -- Amortization of deferred stock compensation...... 11,561 Tax benefits for non-qualified stock option exercises....................................... 7,628
57 UTSTARCOM, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY--(Continued) (In thousands, except share data)
Convertible Deferred Retained Preferred Stock Common Stock Additional Stock Earnings ------------------- ------------------ Paid-in Compen- (Accumulated Issued Amount Shares Amount Capital sation Deficit) ------------ ------ ----------- ------ ---------- -------- ------------ Repayment of notes receivable from stockholders................................... Net income...................................... 27,013 Other comprehensive income: Unrealized holding gain (loss)................ Total comprehensive Income...................... ------------ --- ----------- ---- -------- ------- ------- Balances, December 31, 2000..................... -- -- 95,032,657 120 426,665 (6,491) (7,808) Common stock issued upon exercise of options.... 5,363,601 8 18,756 Common stock issued upon ESPP purchases......... 118,223 1,866 Common stock issued related to acquisition of Stable Gain.................................... 439,810 10,700 Common stock issued upon secondary offering, net of expenses................................ 7,400,000 9 139,911 Common stock issued for ACD acquisition, net of expenses....................................... 948,525 1 20,733 ACD deferred compensation....................... 5,000 (5,000) Amortization of deferred compensation related to ACD acquisition................................ 1,250 Amortization of deferred stock compensation related to grants of stock options to employees...................................... 23 3,928 Cancellation of deferred compensation charges due to employee terminations................... (268) 268 Tax benefits for non-qualified stock option exercises...................................... 15,311 Notes receivable from stockholders.............. Net income...................................... 56,954 Other comprehensive income: Unrealized holding gain (loss)................ Translation adjustment........................ Total comprehensive income...................... ------------ --- ----------- ---- -------- ------- ------- Balances, December 31, 2001..................... -- $-- 109,302,816 $138 $638,697 $(6,045) $49,146 ============ === =========== ==== ======== ======= =======
Notes Accumulated Receivable Other Total from Compre- Stock- Compre- Stock- hensive holders' hensive holders Income Equity Income ---------- ----------- -------- ------- Repayment of notes receivable from stockholders................................... 241 241 Net income...................................... 27,013 $27,013 Other comprehensive income: Unrealized holding gain (loss)................ 52 52 52 ------- Total comprehensive Income...................... $27,065 ----- ---- -------- ======= Balances, December 31, 2000..................... (314) 147 412,319 Common stock issued upon exercise of options.... 18,764 Common stock issued upon ESPP purchases......... 1,866 Common stock issued related to acquisition of Stable Gain.................................... 10,700 Common stock issued upon secondary offering, net of expenses................................ 139,920 Common stock issued for ACD acquisition, net of expenses....................................... 20,734 ACD deferred compensation....................... -- Amortization of deferred compensation related to ACD acquisition................................ 1,250 Amortization of deferred stock compensation related to grants of stock options to employees...................................... 3,951 Cancellation of deferred compensation charges due to employee terminations................... -- Tax benefits for non-qualified stock option exercises...................................... 15,311 Notes receivable from stockholders.............. (67) (67) Net income...................................... 56,954 $56,954 Other comprehensive income: Unrealized holding gain (loss)................ 211 211 211 Translation adjustment........................ (26) (26) (26) ------- Total comprehensive income...................... $57,139 ----- ---- -------- ======= Balances, December 31, 2001..................... $(381) $332 $681,887 ===== ==== ========
See accompanying notes to the consolidated financial statements. 58 UTSTARCOM, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
Years Ended December 31, ------------------------------ 2001 2000 1999 --------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income..................................................... $ 56,954 $ 27,013 $ 11,463 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Cumulative effect of change in accounting principle......... -- 980 -- Loss from discontinued operations........................... -- -- 1,656 Gain on change in ownership interest in subsidiary.......... (277) -- -- Depreciation and amortization............................... 18,533 9,494 3,013 Non-qualified stock option exercise tax benefits............ 15,311 7,628 -- Write-off of in-process research and development costs...... 4,720 -- 3,992 Net loss on sale of assets.................................. 802 807 611 Impairment of long-term investments......................... 3,376 -- -- Stock compensation expense.................................. 5,200 11,561 5,553 Provision provided for doubtful accounts.................... 6,218 6,045 2,832 Inventory reserve........................................... 11,143 2,786 3,970 Equity in net (income) loss of affiliated companies......... 1,276 288 (1,348) Minority interest in consolidated subsidiary................ 1,322 2,307 2,110 Changes in operating assets and liabilities, net of effects from acquisitions and dispositions: Accounts receivable and receivable from related parties... (39,196) (87,177) (4,423) Inventories............................................... (121,198) (63,479) (38,530) Other current and non-current assets...................... (52,619) (4,850) (8,317) Accounts payable.......................................... 39,085 14,143 6,644 Income taxes payable...................................... 3,366 (1,721) 1,127 Other current liabilities................................. 41,407 5,659 21,024 Deferred revenue.......................................... 44,746 22,351 (13) --------- --------- -------- Net cash (used in) provided by continuing operations........... 40,169 (46,165) 11,364 Net cash (used in) by discontinued operations.................. -- -- (530) --------- --------- -------- Net cash (used in) provided by operating activities............ 40,169 (46,165) 10,834 --------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment..................... (30,199) (19,513) (3,607) Investment in affiliates, net of cash acquired................. (9,779) (8,226) (720) Purchase of minority interest.................................. (705) -- -- Proceeds from disposal of property, plant and equipment........ 214 164 997 Purchase of intangible assets.................................. (1,078) -- -- Purchase of short-term investments............................. (89,625) (124,096) -- Sales of short-term investments................................ 87,516 40,290 -- --------- --------- -------- Net cash used in continuing operations......................... (43,656) (111,381) (3,330) Net cash provided by discontinued operations................... -- -- 179 --------- --------- -------- Net cash used in investing activities.......................... (43,656) (111,381) (3,151) --------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of stock, net of expenses............................. 160,550 198,213 55,480 Proceeds from borrowing........................................ 137,108 95,179 57,832 Payments for borrowing......................................... (122,055) (74,343) (34,103) Proceeds (payments) from shareholder notes..................... (67) 245 (17,505) --------- --------- -------- Net cash provided by financing activities...................... 175,536 219,294 61,704 Effects of exchange rates on cash.............................. (25) -- -- --------- --------- -------- Net increase in cash and cash equivalents...................... 172,024 61,748 69,387 Investments and advances (to) from discontinued operations..... -- -- (351) --------- --------- -------- Net increase in cash and cash equivalents...................... 172,024 61,748 69,738 Cash and cash equivalents at beginning of period............... 149,112 87,364 17,626 --------- --------- -------- Cash and cash equivalents at end of period..................... $ 321,136 $ 149,112 $ 87,364 ========= ========= ========
See accompanying notes to consolidated financial statements. 59 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1--DESCRIPTION OF BUSINESS UTStarcom, Inc. (the Company), a Delaware corporation, designs, manufactures and markets wireline and wireless broadband access and switching equipment that enables migration to next generation IP-based networks. The Company's operations are conducted primarily by its foreign subsidiaries that manufacture, distribute and support the Company's products in international markets, principally China. The following lists the Company's active subsidiaries, its percentage ownership and the business each subsidiary operates as of December 31, 2001:
Percentage Name Owned Type of Operations - ---- ---------- ---------------------------------------- UTStarcom China Co., Ltd. (UTSC)........ 100% Marketing and sales of telecom equipment UTStarcom (Hangzhou) Communications Co., Ltd. (HUTS)........................... 88% Manufacturing of telecom equipment Advanced Communication Devices Corporation (ACD)..................... 100% Semi-conductor design and sales
The Company owns 51% of Guangdong UTStarcom, Ltd. (GUTS), which manufactures telecom equipment. This investment is accounted for under the equity method of accounting as the Company does not have voting control over all significant matters. NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation: The accompanying consolidated financial statements include the accounts of the Company and its wholly and majority (over 50 percent) owned subsidiaries, except for GUTS which is accounted for using the equity method as the Company does not have voting control over all significant matters. All significant intercompany accounts and transactions have been eliminated in the preparation of the consolidated financial statements. Minority interest in consolidated subsidiaries and equity in affiliated companies are shown separately in the consolidated financial statements. Investments in affiliated companies are accounted for using the cost method. Restatement and Reclassification: The consolidated financial statements of the Company have been restated to reflect the disposition of Nanjing UTStarcom, Ltd. (NUTS) in September 1999. (See Note 5). Accordingly, the revenues, costs and expenses, and cash flows of the discontinued operation have been excluded from the respective captions in the Consolidated Statements of Operations and Consolidated Statements of Cash Flows, and have been reported through the date of disposition as "Loss from discontinued operations" and "Net cash (used in) discontinued operations" for the year ended December 31, 1999. The Company has retroactively accounted for its December 1999 acquisition of Wacos, Inc. as if the original investment in Wacos by SOFTBANK CORP. in December 1997 had been made by the Company (See Note 7). Certain reclassifications have been made in the prior years financial statements to conform with the 2001 presentation. Such reclassifications had no impact on previously reported net income or stockholders' equity. 60 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents: Cash and cash equivalents consist primarily of highly liquid monetary instruments with a maturity of three months or less at the date of purchase. Restricted cash consists of irrevocable standby letters of credit issued by the Company's banks. Funds are generally held in certificates of deposit at the Company's banks, and have been established in favor of a third party beneficiary. The funds are released to the beneficiary in the event that the Company fails to comply with certain specified contractual obligations. Provided the Company meets these contractual obligations, the letter of credit is discharged and the Company is no longer restricted from use of the cash. Restricted cash balances are expected to be released within three months of being recorded and are treated as part of cash and cash equivalents. Restricted cash consisted of the following at December 31, 2001 and 2000:
December 31, -------------- 2001 2000 ------ ------ (in thousands) Collateral for letters of credit........................... $5,220 $3,103 Cash collateral............................................ -- 1,500 ------ ------ $5,220 $4,603 ====== ======
Short-term Investments: Short-term investments consist of investments with original maturities of less than twelve months. In accordance with the Company's investment policy, all short-term investments are invested in "investment grade" rated securities with minimum A or better ratings. Currently, most of the Company's short-term investments have AA or better ratings. Pursuant to Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," marketable securities are classified as available-for-sale and are carried at fair value. Unrealized holding gains and losses on securities classified as available-for-sale are carried as a separate component of stockholders' equity. Realized gains and losses are reported in earnings. The fair value of investments is determined based on quoted market prices. The cost of securities is based on specific identification. At December 31, available-for-sale securities consisted of (in thousands):
December 31, 2001 ----------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Government and agency obligations.............. $32,695 $173 $ -- $32,868 Other debt securities.......................... 53,218 90 -- 53,308 ------- ---- ---- ------- Total current available-for-sale securities. $85,913 $263 $ -- $86,176 ======= ==== ==== =======
61 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 2000 ----------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ---------- --------- Government and agency obligations.............. $ 4,000 $ 20 $ -- $ 4,020 Other debt securities.......................... 78,827 1,011 -- 79,838 ------- ------ ---- ------- Total current available for-sale securities. $82,827 $1,031 $ -- $83,858 ======= ====== ==== =======
Inventories: Inventories are stated at the lower of cost or market, net of an allowance for obsolescence. Cost is computed using standard cost, which approximates actual cost on a first-in, first-out basis. Revenue Recognition: 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 collectability is reasonably assured. 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. Shipping and handling costs are recorded as revenues and costs of revenues. 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 collectability 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 when project costs can be reasonably estimated. Warranty Costs: A warranty is provided under the terms of the Company's contract for a period not greater than one year. The Company provides for these costs at the time of revenue recognition based upon prior experience. 62 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Property, Plant and Equipment: Property, plant and equipment are recorded at cost and are stated net of accumulated depreciation. Depreciation is provided for on a straight-line basis over the estimated useful lives of the related assets, generally ranging from two to five years. Leasehold improvements are amortized on a straight-line basis over the shorter of the useful life of the improvements or the term of the lease. When assets are disposed of, the cost and related accumulated depreciation are removed from the accounts and the resulting gains or losses are included in results of operations. The Company generally depreciates its assets over the following periods:
Years ---------- Furniture, test or manufacturing equipment................. 5 Computers and software..................................... 2-3 Buildings.................................................. 20 Automobiles................................................ 5 Leasehold improvements..................................... 5 or remaining lease life
Goodwill and Intangible Assets: Goodwill and intangible assets include the excess of costs of acquired companies over the fair value of tangible net assets and acquired in process research and development, and are amortized on a straight-line basis generally over 3 to 5 years. The valuation of goodwill and intangible assets is based on forecasted discounted cash flows and is reassessed when circumstances warrant. Goodwill for acquisitions made after July 1, 2001 is no longer amortized. Impairment of Long-Lived Assets: Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS 121), requires that long-lived assets and certain intangible assets be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If undiscounted expected future cash flows are less than the carrying value of the assets, an impairment loss is to be recognized based on the fair value of the assets. The Company considers the requirements of SFAS 121 on an ongoing basis. Capitalized Software Development Costs: Software development costs have been accounted for in accordance with SFAS No. 86, "Accounting for Costs of Computer Software to be Sold, Leased, or Otherwise Marketed." During 2001 and 2000, the Company capitalized costs of $2.0 million and $0.6 million, respectively, upon establishment of technological feasibility. Amortization of capitalized development costs begins when the products are available for general release to customers, and is provided on a straight-line basis over the remaining estimated economic life of the product, generally three years. Amortization of capitalized development costs was $0.3 million and $0 in 2001 and 2000, respectively. Direct costs of software developed for internal use are expensed during the preliminary project stage and capitalized during the application development stage. Research and Development Costs: Research and development costs are expensed as incurred and 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. 63 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Stock-Based Compensation: The Company accounts for employee stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and has adopted the disclosure-only alternative of SFAS No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). The value of warrants, options or stock exchanged for services is expensed over the period benefited. The warrants and options are valued using the Black-Scholes option pricing model. To calculate the expense, the Company uses the fair value of the equity instruments issued. Comprehensive Income: Comprehensive income includes all changes in equity (net assets) during a period from nonowner sources. Accumulated other comprehensive income or loss is shown in the consolidated statement of stockholders' equity. Income Taxes: Deferred income taxes are recognized for the differences between the tax bases of assets and liabilities and their financial statement amounts based on enacted tax rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. The Company does not provide for U.S. Federal taxes on undistributed earnings of its foreign subsidiaries or affiliates as they are considered to be reinvested for an indefinite period. Segment Reporting: The Company operates in a single segment, providing telecommunications equipment through an integrated suite of network access systems, optical transmission products and subscriber terminal products. Disclosures About Fair Value of Financial Instruments: Financial instruments consist of cash and cash equivalents, short-term investments, accounts receivable and payable, and debt. The carrying amounts of cash and cash equivalents, short-term investments, and accounts receivable and payable approximate their fair values because of the short-term nature of those instruments. The carrying amounts of debt approximate their fair values because of their short maturities, the variable interest rates of those instruments, or the difference between the fixed interest rate payable and the current prevailing rate is not significant. Foreign Currency Translation: Operations of the Company's subsidiaries are conducted primarily in China and the financial statements of those subsidiaries are translated from China's Renminbi, the functional currency, into U.S. Dollars in accordance with SFAS No. 52, "Foreign Currency Translation." Accordingly, all foreign currency assets and liabilities are translated at the period-end exchange rate and all revenues and expenses are translated at the average exchange rate for the period. The effects of translating the financial statements of foreign subsidiaries into U.S. Dollars are reported as a cumulative translation adjustment, a separate component of comprehensive income in stockholders' equity. Foreign currency transaction gains and losses are reported in earnings and have not been material for 2001, 2000 and 1999. 64 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Earnings (Loss) Per Share: Basic earnings (loss) per share is computed by dividing income or loss available to common stockholders by the weighted average number of shares of the Company's common stock outstanding during the period. Diluted earnings (loss) per share is determined in the same manner as basic earnings (loss) per share except that the number of shares is increased by potentially dilutive common shares outstanding during the period. Potentially dilutive common shares consist of employee stock options, warrants and restricted stock. The following is a summary of the calculation of basic and diluted EPS from continuing operations:
Year Ended December 31, ------------------------------------ 2001 2000 1999 ----------- ---------- ---------- (in thousands, except per share data) Income from continuing operations.......................... $ 56,954 $ 27,993 $ 13,119 Less: Beneficial conversion feature........................ -- -- (29,977) ----------- ---------- ---------- Income (loss) available to common stockholders.......... $ 56,954 $ 27,993 $ (16,858) =========== ========== ========== Shares used to compute basic EPS........................... 101,433 79,696 8,678 Dilutive common equivalent shares: Stock options........................................... 7,151 10,157 -- Warrants................................................ 28 92 -- Preferred shares........................................ -- 11,922 -- ----------- ---------- ---------- Shares used to compute diluted EPS......................... 108,612 101,867 8,678 =========== ========== ========== Basic income (loss) from continuing operations, per share.. $ 0.56 $ 0.35 $ (1.94) Diluted income (loss) from continuing operations, per share $ 0.52 $ 0.28 $ (1.94)
For the years ended December 31, 2001, 2000 and 1999, options to purchase approximately 1,783,248, 226,200 and 104,480 shares of common stock, respectively, with exercise prices greater than the fair market value of our stock were not included in the calculation because the effect would have been antidilutive. Recent Accounting Pronouncements: The Financial Accounting Standards Board (the "FASB") issued SFAS No. 133, "Accounting for Derivatives and Hedging Activities," as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." SFAS 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The Company adopted SFAS 133 on January 1, 2001, and the adoption had no impact on the Company's consolidated financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001. SFAS 141 also specifies the criteria that intangible assets acquired in a business combination must meet to be recognized and reported apart from goodwill. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually. SFAS 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 121. 65 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) SFAS 141 is effective immediately, except with regard to business combinations that were initiated prior to July 1, 2001. SFAS 142 is effective for fiscal years beginning after December 15, 2001, and was adopted by the Company on January 1, 2002. The adoption of these accounting standards will have the impact of eliminating the amortization of goodwill commencing January 1, 2002; however, impairment reviews may result in future periodic write-downs. The Company expects, due to the elimination of goodwill amortization expense effective January 1, 2002, that net income will increase by $7.3 million in 2002 because existing goodwill from the Wacos acquisition will no longer be amortized. SFAS 142 will also require the Company to perform a transitional assessment within six months of the date of adoption, to determine whether there is an impairment of goodwill. Any such transitional impairment loss will be recognized as a change in accounting principle in the consolidated statement of operations. The Company has not yet performed the initial goodwill impairment test prescribed in SFAS 142 and has therefore not yet determined if an impairment exists. However, the Company does not anticipate that such test will result in a significant impairment charge. On October 3, 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 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 121 and amends APB 30--"Reporting the Results of Operations--Reporting the Effects of Disposal of a Segment of a Business." SFAS 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 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 does not expect that the adoption of SFAS 144 will have a significant impact on its consolidated financial statements. NOTE 3--ACCOUNTING CHANGES Effective January 1, 2000, the Company adopted Staff Accounting Bulletin 101 (SAB 101) issued by the Securities and Exchange Commission in December 1999. As a result of adopting SAB 101, the Company changed the way it recognizes revenue in certain contracts that had previously led to revenue being recognized as contract stages were completed and accepted. In light of the guidance issued in SAB 101, the Company changed its method of revenue recognition to the point of contractual final acceptance. In addition, certain contracts include service requirements for which revenue was previously recognized, and costs accrued, on contractual acceptance. In consideration of SAB 101, revenues associated with these service requirements are being deferred until the service obligations are completed. Due to these changes, the Company recorded a cumulative adjustment in the first quarter 2000 of $1.0 million (net of income taxes of $0) or $0.01 per share, basic and diluted. 66 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Adopting this new method of accounting as of January 1, 1999 would have produced the following pro forma results:
Year Ended December 31, 1999 -------------- (in thousands, except per share data) As reported: Net loss................................................ $(18,514) Net loss per share, basic............................... $ (2.13) Net income loss per share, diluted...................... $ (2.13) Pro forma: Net loss................................................ $(19,494) Net loss per share, basic............................... $ (2.25) Net loss per share, diluted............................. $ (2.25)
NOTE 4--COMPLETION OF INITIAL PUBLIC OFFERING AND FOLLOW-ON PUBLIC OFFERING On March 3, 2000, the Company completed its initial public offering (IPO) and sold 11,500,000 shares of common stock at $18.00 per share for aggregate net proceeds of approximately $189.4 million. On August 3, 2001, the Company completed a follow-on public offering and sold an aggregate of 7,400,000 shares of common stock at $20.00 per share. Selling stockholders sold an additional 2,950,000 shares of common stock in the offering. The aggregate net proceeds to the Company were $139.9 million. NOTE 5--DISCONTINUED OPERATIONS During September 1999, the Company closed Nanjing UTStarcom, Inc. (NUTS) in China. NUTS, which was 100% owned, was engaged in telephone network and internet network services unrelated to the remaining Company operations. NUTS sold substantially all of its assets prior to closure. The closure of NUTS was accounted for as a discontinued operation. The Company's previous interests in the net revenues and expenses of NUTS' operations prior to September 30, 1999 are classified separately as loss from discontinued operations in the consolidated statements of operations. The components of the loss are summarized as follows:
Year Ended December 31, 1999 -------------- (In thousands) Net sales.................................................. $ 298 Operating expenses and cost of sales....................... 1,369 ------- Operating loss............................................. (1,071) Other expenses............................................. (585) ------- Loss from discontinued operations.......................... $(1,656) =======
The Company's cash flow statements separately include the cash flows from discontinued operations. 67 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 6--SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Year Ended December 31, ----------------------- 2001 2000 1999 ------- ------ ------ (in thousands) Cash paid during the period for: Interest......................................... $ 3,798 $3,289 $3,723 Income taxes..................................... $10,832 $8,038 $1,386
Noncash investing and financing activities were as follows:
Year Ended December 31, ----------------------- 2001 2000 1999 ------- ---- ------- (in thousands) Distribution of net assets to shareholders....... $ -- $ -- $ 4,956 Issuance of shares upon the Wacos acquisition.... $ -- $ -- $27,953 Issuance of shares and vested stock options upon $20,734 $ -- $ -- the ACD acquisition............................ Issuance of shares upon the Stable Gain $10,700 $ -- $ -- acquisition.................................... Payment of stockholders' loan.................... $ -- $ -- $ 1,640 Retirement of treasury stock..................... $ -- $ -- $ 3,060
NOTE 7--ACQUISITIONS AND DIVESTITURES OF COMPANIES In February and October 1997, the Company purchased a total of 49% of the voting stock of Wacos, Inc. for approximately $0.3 million. In October and December 1997, SOFTBANK CORP. acquired a 40% voting interest in Wacos for $5.1 million. In December 1999, the Company issued 3,691,534 shares of Series G preferred stock in exchange for SOFTBANK CORP.'s 4,103,465 shares in Wacos. As a result of the common control that existed between the Company, SOFTBANK CORP. and Wacos during this period of ownership this exchange of shares was made at historic cost. The Company has retroactively accounted for its acquisition of Wacos as if the original investment by SOFTBANK CORP. had been made by the Company. In December 1999, the Company completed the purchase of the Wacos subsidiary owned by the minority shareholders with the issuance of 832,166 shares of Series G preferred stock and $9.7 million of common stock options valued using a Black-Scholes model. The aggregate purchase price of Wacos was approximately $28.0 million which, based upon an independent appraisal by Willamette Management Associates of all assets acquired and liabilities assumed, was allocated to the specifically identifiable tangible and intangible assets acquired. The allocation included approximately $4.0 million of in-process research and development which was charged to operations in December 1999, $0.2 million of assembled workforce and approximately $23.6 million of excess purchase price over the fair market values of the tangible and identified intangible assets. Goodwill and intangible assets are being amortized over periods of three to five years. The values of Wacos' in-process research and development projects were estimated by an excess income approach. Management revenue and operating expense projections were reduced by appropriate amounts to reflect a fair return on the net tangible and collateral intangible assets to be employed in realizing the forecasted net incomes. The resulting forecasted "excess" income figures were discounted to present value using a 40% rate of return, reflecting the technological, market and other risks associated with the subject technologies and future products. The discounted excess incomes were summed and then, in accordance with the methodology approved by the Securities and Exchange Commission, reduced by an appropriate percentage completion factor for each project to account for the anticipated remaining research and development factors. 68 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) At the time of the Wacos acquisition, Wacos was engaged in three distinct in-process research and development projects in relation to its Internet Protocol based switching system. These projects were in various stages of development but none had reached the point where technological feasibility had been established. The following represents the allocation of the purchase price for Wacos:
(in thousands) Purchased in-process research and development....................................... $ 3,992 Fair value of net assets acquired................................................... 83 Fair value of identified intangible assets.......................................... 240 Excess of costs of acquiring Wacos over fair value of net assets acquired (goodwill) 23,638 ------- $27,953 =======
On July 24, 2000, the Company entered into an agreement with Stable Gain International Ltd. (Stable Gain) to purchase intellectual property and certain related fixed assets, and to transfer development employees to the Company. Under the amended purchase agreement, the Company paid Stable Gain consideration of $10.7 million in the form of common stock of the Company and $0.3 million in cash. The transfer of the common stock was completed during the second quarter of fiscal 2001. The total purchase consideration of $11.0 million was allocated to property and equipment, intangible assets and goodwill under the purchase method of accounting. Goodwill totaling $7.4 million was recorded on acquisition and has an estimated life of three years. In February 1996, the Company, as part of its business operations in China, acquired a 65% ownership interest in Nan Tian (NST). On February 5, 2001, the Company entered into an agreement to acquire the remaining 35% ownership in the joint venture company for a total consideration of $1.3 million payable in cash. The purchase price was allocated to property and equipment and goodwill under the purchase method of accounting. Goodwill totaling $0.6 million was recorded on acquisition and has an estimated life of six years. On September 27, 2001, AbacusChina Inc. (AbacusChina), a wholly owned subsidiary of the Company, entered into an agreement with China Elite Limited (China Elite) to issue 17,525,708 shares of common stock of AbacusChina in exchange for the net assets of China Elite. The effect of this transaction was to reduce the Company's ownership in AbacusChina from 100% to 29%, and resulted in a gain of $0.3 million. In November 2001, the Company completed the purchase of Advanced Communication Devices Corporation (ACD) for $21.3 million, comprised of approximately 1 million shares of the Company's common stock valued at $19.9 million, $0.9 million of vested common stock options valued using the Black-Scholes pricing model, and $0.5 million of acquisition-related expenses. In addition, the Company issued shares of restricted common stock valued at $5 million to ACD employees who will continue to perform services for the Company. These shares vest at the earlier of five years or the achievement of certain performance milestones. The Company recorded the amount as deferred compensation. $1.3 million of deferred compensation was charged to operations in 2001 as the first milestone was completed in December 2001. The remaining compensation will be recorded as the rest of the milestones are met. The number of shares issued for the acquisition was calculated using the average closing price of the common stock for the five trading days ended August 13, 2001 (the date the merger agreement was signed). ACD was a System on Chip (SoC) semiconductor company focusing on LAN and IP switching technology whose then current markets included Taiwan, China and Korea. The acquisition has been accounted for as a purchase and the results of operations have been included in the Company's consolidated financial statements since the acquisition. ACD results of operations prior to the acquisition were not material to the Company's results from operations on a pro forma basis. The acquisition cost has been allocated to the assets acquired based on their respective fair values. Intangible assets are comprised of 69 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) intellectual property related to ACD Ethernet technology, which is being amortized on a straight-line basis over its estimated useful life of three years. In accordance with SFAS No. 141, the Company is not amortizing goodwill for this acquisition. The Company recorded a $4.7 million charge for purchased in-process research and development at the date of acquisition of ACD. Technological feasibility was not established on the development of ACD's Ethernet Digital Subscriber Line (EDSL) chip design. The design was approximately 15% completed at the time of acquisition. The estimated completion date for the project is March 2003. The following table represents the allocation of the purchase price for ACD:
(in thousands) Fair value of tangible net assets acquired................. $ 58 Fair value of identified intangible assets................. 4,340 In-process research and development........................ 4,720 Excess of costs of acquiring ACD over fair value of identified net assets acquired (goodwill)................ 12,215 ------- $21,333 =======
NOTE 8--DISTRIBUTION TO SHAREHOLDERS In August 1999, the Company distributed to its shareholders the net assets of a previously consolidated yet unrelated business which was acquired in 1997. This business, which operated in a dissimilar market segment, had been managed and financed, in all significant respects, as if it were autonomous from the Company. These consolidated financial statements have been prepared as if the acquired business was distributed on the original date of purchase in 1997. The original purchase price totaling $75.8 million comprised cash of $50.8 million, notes payable and other acquisition costs of $11.2 million, the issuance of 2,540,000 shares of UTStarcom common stock valued at $13.8 million and additional shares of UTStarcom stock and warrants to be determined based on the post acquisition performance of the acquired business. Common and Series E preferred stock were issued in 1998 and the terms of the Series E preferred stock were subsequently amended in 1999. A warrant to purchase common stock with a Black-Scholes value of $2.0 million was issued in 1998 and was subsequently amended in 1999, resulting in a net value of $0.4 million at December 31, 1999. The warrant was subsequently exercised in March 2000. NOTE 9--INVENTORIES As of December 31, 2001 and 2000 inventories consist of the following:
December 31, ------------------ 2001 2000 -------- -------- (in thousands) Raw materials.................................... $ 59,409 $ 41,876 Work-in-process.................................. 33,887 23,432 Finished goods................................... 156,098 62,888 -------- -------- 249,394 128,196 Less allowance for obsolete inventory............ (20,344) (9,201) -------- -------- $229,050 $118,995 ======== ========
70 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 10--PROPERTY, PLANT AND EQUIPMENT As of December 31, 2001, and 2000 property, plant and equipment consists of the following:
December 31, ----------------- 2001 2000 -------- ------- (In thousands) Buildings........................................ $ 68 $ 224 Land............................................. 7,319 7,319 Leasehold improvements........................... 4,077 2,237 Automobiles...................................... 2,952 3,035 Software......................................... 11,752 2,336 Equipment and furniture.......................... 37,858 16,362 -------- ------- 64,026 31,513 Less accumulated depreciation.................... (20,084) (9,514) -------- ------- $ 43,942 $21,999 ======== =======
Depreciation expense was $11.0 million, $4.6 million and $2.7 million for the years ended December 31, 2001, 2000 and 1999, respectively. NOTE 11--LONG-TERM INVESTMENTS The Company's investments are as follows:
December 31, --------------- 2001 2000 ------- ------- (in thousands) Investment in GUTS............................... $ 750 $ 2,026 Investment in Softbank China..................... 8,314 8,002 Investment in Issanni Communication.............. 2,001 -- Investment in Cellon International............... 2,000 -- Investment in Maple Tree......................... 1,309 -- Investment in others............................. 3,444 2,369 ------- ------- Total......................................... $17,818 $12,397 ======= =======
The Company invested $10.0 million in Softbank China (the fund), 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. One of the Company's directors serves as the Chief Executive Officer of the fund. The Company's Chief Executive Officer is the chairman of the board of the fund and has not participated in day-to-day management of 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 year ended December 31, 2001, based upon a review of the carrying value of this 71 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) investment, an impairment charge of $1.7 million was recognized to provide for the other than temporary decline in the fair value below the carrying value of this investment. The balance remaining in this investment as of December 31, 2001 was $8.3 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 fourth quarter of 2001, based upon a review of the carrying value of these investments, an impairment charge of $1.7 million was recognized to provide for the other than temporary decline in the fair value below the carrying value of these private technology company investments. In September 1996, the Company purchased a 49% interest in GUTS. In February 1998, the Company acquired an additional 2% interest in GUTS, increasing its ownership interest to 51%. However, because the Company does not have voting control over all significant matters of GUTS, the investment in and results of operations of GUTS are accounted for using the equity method as of December 31, 2001. On December 18, 2001, the Company entered into an agreement to acquire the remaining 49% ownership in GUTS for a total consideration of $3.6 million payable in cash. The cash consideration will be paid in 2002. Upon completion of this transaction, GUTS will be a wholly-owned subsidiary of the Company. Condensed combined financial information for the unconsolidated investment in GUTS is as follows:
December 31, ---------------- 2001 2000 ------- ------- (In thousands) Current assets............................................. $ 6,313 $ 9,885 Noncurrent assets.......................................... 230 516 Current liabilities........................................ (4,535) (5,503) ------- ------- Total shareholders' equity................................. 2,008 4,898 Less: Other shareholders' shares of equity....................... 984 2,400 ------- ------- UTStarcom's share of equity................................ 1,024 2,498 Elimination of intercompany profit......................... (274) (472) ------- ------- Investment in unconsolidated subsidiary.................... $ 750 $ 2,026 ======= =======
Year Ended December 31, ------------------------- 2001 2000 1999 ------- ------- ------- (In thousands) Net sales........................................ $ 8,936 $16,523 $16,004 Gross profit (loss).............................. $ (63) $ 931 $ 2,366 Operating income (loss).......................... $(2,775) $ (638) $ 1,067 Net income (loss)................................ $(2,890) $ (441) $ 820 ======= ======= ======= UTStarcom's share of net income (loss)........... $(1,474) $ (225) $ 418 Elimination of intercompany profit............... 198 (63) 930 ------- ------- ------- Equity in net income (loss) of subsidiary........ $(1,276) $ (288) $ 1,348 ======= ======= =======
Product sales to GUTS for the years ended December 31, 2001, 2000 and 1999 were $6.2 million, $13.1 million and $8.4 million, respectively. Product purchases from GUTS for the years ended December 31, 2001, 2000 and 1999 were $6.5 million, $6.8 million and $7.9 million, respectively. 72 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 12--GOODWILL AND INTANGIBLE ASSETS As of December 31, 2001 and 2000 goodwill and other acquired intangible assets consisted of the following:
December 31, ----------------- 2001 2000 -------- ------- (In thousands) Goodwill................................................... $ 46,254 $25,454 Assembled workforce........................................ 1,382 241 Purchased technology....................................... 4,340 -- -------- ------- 51,976 25,695 Less accumulated amortization.............................. (12,984) (5,457) -------- ------- $ 38,992 $20,238 ======== =======
Amortization expense was $7.5 million, $4.9 million and $0.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. NOTE 13--THIRD PARTY DEBT The following represents the outstanding borrowings at December 31, 2001 and 2000 (in thousands):
December 31, --------------- Note Rate Maturity 2001 2000 - ---- ------- ------------------- ------- ------- Bank of China(1)..................... 5.56% From 01/02 to 10/02 $34,338 $28,916 China Merchants Bank(2).............. 6.44% 03/02 6,024 3,614 Commercial Bank of Hangzhou(3)....... 6.21% 06/10 12,048 12,048 Industrial & Commercial Bank of China 5.85% 05/01 -- 6,024 China Construction Bank.............. 6.44% 06/01 -- 4,819 CITIC Industrial Bank(4)............. 6.14% 05/02 6,024 -- China Everbright Bank(5)............. 5.78% 06/02 12,048 -- Other................................ Various Various -- 8 ------- ------------------- ------- ------- Total debt........................... 70,482 55,429 Long-term debt....................... 12,048 12,048 ------- ------- Short-term debt...................... $58,434 $43,381 ======= =======
- -------- (1) Guaranteed by the Company and the minority shareholder of HUTS. This represents drawings on the Company's line of credit with the bank. This line allows for borrowings of up to $156,627. (2) Guaranteed by HUTS. This line allows for borrowings of up to $6,024 and matures on March 1, 2002. (3) Guaranteed by UTStarcom-China. This line allows for borrowings of up to $24,096 and matures in June 2010. (4) Guaranteed by HUTS. This line allows for borrowings of up to $6,024 and matures in May 2002. (5) Guaranteed by HUTS. This line allows for borrowings of up to $36,145 and matures in June 2002. The Company has additional lines of credit available up to $31.3 million which it is not borrowing against as of December 31, 2001. 73 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 14--OTHER CURRENT LIABILITIES Other current liabilities at December 31, 2001 and 2000 consist of the following:
December 31, --------------- 2001 2000 ------- ------- (In thousands) Accrued contract costs..................................... $30,217 $22,858 Accrued payroll and compensation........................... 18,055 4,500 Accrued other taxes........................................ 15,983 -- Warranty costs............................................. 6,271 3,133 Other...................................................... 5,803 4,230 ------- ------- $76,329 $34,721 ======= =======
NOTE 15--PROVISION FOR INCOME TAXES United States and foreign income (loss) before income taxes, loss on discontinued operations, and minority interest were as follows (in thousands):
Years Ended December 31, --------------------------- 2001 2000 1999 -------- ------- -------- United States.................................... $(12,237) $(9,973) $(15,664) Foreign.......................................... 90,336 54,294 31,519 -------- ------- -------- $ 78,099 $44,321 $ 15,855 ======== ======= ========
Undistributed foreign earnings at December 31, 2001 amounted to $181.6 million. The components of the provision for income taxes are as follows (in thousands):
Years Ended December 31, ------------------------- 2001 2000 1999 ------- ------- ------- Current: Federal....................................... $ 7,246 $13,369 $ 1,100 State/Other................................... 621 782 533 Foreign....................................... 21,586 6,046 1,700 Deferred: Federal....................................... (8,002) (4,433) (2,453) State......................................... (172) 2 (10) Foreign....................................... (1,456) (1,745) (244) ------- ------- ------- $19,823 $14,021 $ 626 ======= ======= =======
74 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Deferred income taxes arise from temporary differences between the tax bases of assets and liabilities and their reported amounts in the consolidated financial statements. A summary of the components of net deferred tax assets is as follows (in thousands):
U.S. China Total ------- ------ ------- December 31, 2001: Current deferred tax assets: Allowances and reserves........................ $ 5,692 $3,894 $ 9,586 Gross profit in intercompany inventory......... 2,031 -- 2,031 ------- ------ ------- Total current deferred tax assets........... $ 7,723 $3,894 $11,617 ======= ====== ======= Non current deferred tax assets: Net operating loss carryforward................ $ 5,855 $ -- $ 5,855 Future period compensation deductions.......... 1,581 -- 1,581 Tax credit carryforwards....................... 4,938 -- 4,938 Fixed assets................................... (842) -- (842) Other.......................................... 1,525 -- 1,525 ------- ------ ------- Total non current deferred tax assets....... 13,057 -- 13,057 Valuation allowances........................... (4,787) -- (4,787) ------- ------ ------- Net non current deferred tax assets..... $ 8,270 $ -- $ 8,270 ======= ====== =======
U.S. China Total ------- ------ ------- December 31, 2000: Current deferred tax assets: Allowances and reserves........................ $ 1,749 $2,438 $ 4,187 Gross profit in intercompany inventory......... 2,311 -- 2,311 ------- ------ ------- Total current deferred tax assets........... $ 4,060 $2,438 $ 6,498 ======= ====== ======= Non current deferred tax assets: Net operating loss carryforward................ $ 2,231 $ -- $ 2,231 Future period compensation deductions.......... 1,395 -- 1,395 Tax credit carryforwards....................... 3,574 -- 3,574 Fixed assets................................... 205 -- 205 Other.......................................... 508 -- 508 ------- ------ ------- Total non current deferred tax assets....... 7,913 -- 7,913 Valuation allowances........................... (4,153) -- (4,153) ------- ------ ------- Net non current deferred tax assets..... $ 3,760 $ -- $ 3,760 ======= ====== =======
As of December 31, 2001, the Company has research and development credit carryforwards of approximately $5.1 million for federal tax purposes expiring in varying amounts between 2017 and 2021. As of December 31, 2001 the Company has federal and state net operating loss carryovers of $16.8 million and $7.4 million, respectively. The federal net operating loss carryovers will expire in 2019. The state net operating loss carryovers will expire in varying amounts between 2002 and 2004. Management believes that the Company's ability to use their deferred tax assets is limited based on the expectation that they will not be able to fully utilize the net operating losses from the purchase of Wacos in December 1999 and the research and development credits generated by Company's research and development center in New Jersey. The Company has created a valuation allowance against these deferred tax assets. 75 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) UTSC and HUTS were granted tax holidays, which started to phase out in 1999. The net impact of these tax holidays was to increase net income by approximately $6.7 million, $4.5 million, and $4.5 million for the years ended December 31, 2001, 2000 and 1999, respectively. The difference between the Company's effective income tax rate and the federal statutory rate is reconciled below:
Year Ended December 31, --------------- 2001 2000 1999 ---- ---- ---- Federal statutory rate........................ 34 % 34 % 34 % State taxes, net of federal income tax benefit -- (1) (3) Permanent differences......................... 5 7 15 Amortization of deferred compensation......... 2 8 -- Effect of difference in foreign taxes rates... (14) (18) (31) Change in valuation allowance................. -- -- 11 Other......................................... (2) 2 (22) --- --- --- Effective rate................................ 25 % 32 % 4 % === === ===
In 2001, the audit of the Company's federal income tax returns for the years ended December 31, 1999, 1998 and 1997 were completed. No other audits of the Company's income tax returns were underway as of December 31, 2001. NOTE 16--COMMON STOCK AND STOCK INCENTIVE PLANS Stock Option Plans. The 1995 Stock Plan. On July 31, 1995, the Board of Directors adopted, and in October 1995, the Company's stockholders approved, the Company's 1995 Stock Plan. Under the 1995 plan, officers, employees and consultants were eligible to acquire shares of common stock pursuant to options or stock purchase rights. At the time of adoption, 3,705,232 shares of common stock were reserved for issuance under the 1995 plan. In 1995 and 1996, the Company's Board and stockholders added an additional 5,400,000 shares to the 1995 plan, raising the total number of authorized shares reserved under the 1995 plan to 9,105,232. As of December 31, 2001, there were 6,711,744 shares authorized for issuance under the 1995 plan and options to purchase 946,004 shares of common stock were outstanding under the 1995 plan. On January 31, 1997, the Board of Directors elected not to grant any further options under the 1995 plan. Upon the adoption of the 1997 plan, all remaining unissued shares under the 1995 plan not already subject to options or other awards ceased to be reserved for issuance under the 1995 plan. The 1997 Stock Plan. On January 31, 1997, the Board of Directors adopted, and the Company's stockholders approved, the Company's 1997 Stock Plan. Under the 1997 plan, officers, employees and consultants are eligible to receive options to purchase shares of common stock and stock purchase rights. In December 1999, the Board of Directors amended the 1997 plan, which the Company's stockholders approved in February 2000. As of December 31, 2001 the Company is authorized to issue up to 16,720,496 shares subject to options. During the term of the 1997 plan, the number of shares issuable under the plan will be increased annually on the first day of each fiscal year beginning in 2001 by an amount equal to the lesser of 6,000,000 shares or 4% of the outstanding shares of common stock on that date, or a lesser amount determined by the Board. The plan terminates in January 2007, but may be terminated earlier by the Board of Directors. As 76 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) of December 31, 2001, there were options to purchase 11,272,399 shares of common stock outstanding under the 1997 plan. The Compensation Committee administers the 1997 plan. Options granted under the 1997 plan may be incentive stock options, or ISOs, which are intended to qualify for favorable federal income tax treatment under the provisions of Section 422 of the Internal Revenue Code of 1986, as amended, or non-qualified stock options, or NSOs, which do not so qualify. The Compensation Committee selects the eligible persons to whom options will be granted and determines the grant date, amounts, exercise prices, vesting periods and other relevant terms of the options, including whether the options will be ISOs or NSOs. The exercise price of ISOs granted under the 1997 plan may not be less than 100% of the fair market value of common stock on the grant date, while the exercise price of NSOs can be determined by the Compensation Committee in its discretion. Options are generally not transferable during the life of the optionee. Options vest and become exercisable as determined by the Compensation Committee, generally over four years. Options may generally be exercised at any time after they vest and before their expiration date as determined by the Compensation Committee. However, no option may be exercised more than 10 years after the grant date. Options will generally terminate (i) 12 months after the death or permanent disability of an optionee and (ii) 90 days after termination of employment for any other reason. The aggregate fair market value of the shares of common stock represented by ISOs that become exercisable in any calendar year may not exceed $100,000. Options in excess of this limit are treated as NSOs. In the event the Company is merged with or into another corporation, or all or substantially all of the Company's assets are sold, each outstanding option will be assumed or an equivalent option or right will be substituted by the successor corporation or its parent or subsidiary. If the successor corporation refuses to assume or substitute for the option or right, the options or rights will automatically vest and become exercisable in full for a period of at least fifteen days, after which time the option will terminate. Under the 1997 plan, the Company may grant stock purchase rights to eligible participants. Any shares purchased pursuant to stock purchase rights will be subject to a restricted stock purchase agreement. Unless the Compensation Committee determines otherwise, this agreement will grant the Company a right to repurchase the stock upon the voluntary or involuntary termination of the employee for any reason, including death or disability. The purchase price for repurchased shares will be the original price paid and may be paid by cancellation of any indebtedness owed to the Company. The shares of stock subject to the right of repurchase lapse over time. 2001 Director Option Plan. On March 2, 2001, the Board of Directors adopted, and in May 2001, the Company's stockholders approved, the Company's 2001 Director Option Plan. Under the 2001 Director Option Plan, those directors who are not employees of the Company ("Outside Directors") are eligible to receive options to purchase shares of common stocks. Directors Horner, Shey, Son and Toy are Outside Directors. All grants of options to Outside Directors are automatic and nondiscretionary. In July 2001, the Board of Directors amended the 2001 Director Option Plan. As of December 31, 2001 the Company is authorized to issue up to 1,200,000 shares subject to options. The Plan terminates in May 2011, but may be terminated earlier by the Board of Directors. As of December 31, 2001, there were options to purchase 320,000 shares of common stock outstanding under the 2001 Director Option Plan. The Compensation Committee administers the 2001 Director Plan. Upon approval of the 2001 Director Plan, each Outside Director was automatically granted an option to purchase eighty thousand shares of common stock (the "First Option") on the date on which such person first becomes an Outside Director (the "Anniversary Date"). A director who is an employee of the Company who ceases employment with the Company to become an Outside Director shall receive an option to purchase twenty 77 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) thousand shares of common stock (a "Subsequent Option") at the Company's first annual meeting of stockholders following such conversion to an Outside Director and at each subsequent annual stockholder meeting thereafter, provided he or she is serving as an Outside Director on each such date. As such time as each Outside Director's First Option is fully vested, each Outside Director shall be automatically granted a Subsequent Option on the Anniversary Date of each year provided he or she is then an Outside Director. Under the terms of the 2001 Director Plan, the exercise price of each option granted is the market value of the common stock on the date of grant. Such options have terms of 10 years, but terminate earlier if the individual ceases to serve as a director. The First Option grants vest as follows: 25% of shares subject to the First Option vest on each anniversary of its date of grant. The Subsequent Option grants vest as follows: 100% of the shares subject to the Subsequent Option vest on the first anniversary of its date of grant. ACD 1996 and 1997 Stock Plan. On August 27, 2001, the Board of Directors approved the assumption of the outstanding vested stock options issued under the ACD 1996 and 1997 Stock Plans upon the consummation of the merger. A total of 868,701 fully vested shares issued under the ACD 1996 and 1997 Stock Plans were converted to 46,105 UTStarcom stock options at the date of merger on November 19, 2001. A summary of activity under the Plans follows:
Weighted Shares Average Available Number of Exercise for Grant Shares Price ---------- ---------- -------- Options Outstanding, December 31, 1998 2,297,096 9,654,622 $ 1.72 Options Authorized in 1999............ 3,209,556 -- $ -- Options Granted....................... (6,055,310) 6,055,310 $ 5.65 Options Exercised..................... -- (555,911) $ 0.95 Options Forfeited or Expired.......... 720,901 (748,307) $ 3.54 ---------- ---------- Options Outstanding, December 31, 1999 172,243 14,405,714 $ 3.25 Options Authorized in 2000............ 4,404,823 -- $ -- Options Granted....................... (4,848,697) 4,848,697 $15.74 Options Exercised..................... -- (3,651,687) $ 1.25 Options Forfeited or Expired.......... 426,666 (428,000) $12.52 ---------- ---------- Options Outstanding, December 31, 2000 155,035 15,174,724 $ 7.54 Options Authorized in 2001............ 5,062,760 -- $ -- Options Granted....................... (3,326,957) 3,326,957 $19.77 Options Exercised..................... -- (5,363,601) $ 3.48 Options Forfeited or Expired.......... 559,663 (559,663) $13.79 ---------- ---------- Options Outstanding, December 31, 2001 2,450,501 12,578,417 $12.22 ========== ==========
78 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) The following table summarizes information with respect to stock options outstanding and exercisable as of December 31, 2001:
Options Outstanding Options Exercisable ----------------------------------- --------------------- Weighted Weighted Average Exercisable Weighted Outstanding at Average Remaining at Average December 31, Exercise Contractual December 31, Exercise Range of Exercise Price 2001 Price Life 2001 Price - ----------------------- -------------- -------- ----------- ------------ -------- (in years) $ 0.06-$ 0.06..... 146,724 $ 0.06 6.6 140,165 $ 0.06 $ 0.25-$ 0.25..... 127,712 $ 0.25 7.2 80,544 $ 0.25 $ 0.85-$ 0.94..... 931,004 $ 0.86 3.8 931,004 $ 0.86 $ 1.71-$ 2.50..... 486,990 $ 2.33 5.0 479,793 $ 2.33 $ 3.39-$ 4.71..... 2,100,583 $ 4.30 7.4 1,075,109 $ 4.30 $ 5.65-$ 5.65..... 10,097 $ 5.65 6.4 10,097 $ 5.65 $ 9.38-$13.61..... 3,365,044 $11.34 8.4 1,098,142 $11.09 $14.38-$21.31..... 3,632,515 $16.94 9.1 599,869 $16.80 $21.85-$30.13..... 1,752,748 $23.92 9.3 219,858 $25.29 $36.50-$47.50..... 25,000 $43.10 8.3 10,209 $43.23 ------------- ---------- --------- $ 0.06-$47.50..... 12,578,417 $12.22 8.0 4,644,790 $ 7.51 ========== =========
The Company has elected to account for employee stock-based compensation under APB 25 and has provided the following information as required by SFAS 123, "Accounting for Stock-Based Compensation." SFAS 123 requires the disclosure of proforma net income and earnings per share had the Company adopted the fair value method. The following assumptions were used to calculate the fair value of the options granted:
2001 2000 1999 ----- ------ ---- Expected remaining term in years........ 3.00 3.00 2.41 Weighted average risk-free interest rate 4.04% 5.86% 6.10% Expected dividend rate.................. 0.00% 0.00% 0.00% Volatility.............................. 86.07% 100.00% 0.00%
The weighted average fair value per share of those options granted in 2001, 2000 and 1999 was $12.22, $7.54 and $3.25, respectively. The Company was not public in 1999, therefore a zero volatility rate was used. 79 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Using the above method and assumptions, the Company's net income (loss) applicable to common stock and earnings (loss) per share, on a pro forma basis, would have been (in thousands):
Earnings (loss) Net per share Income -------------- (Loss) Basic Diluted -------- ------ ------- Year ended: December 31, 1999: Actual........................................ $(18,514) $(2.13) $(2.13) ======== ====== ====== Pro forma..................................... $(21,395) $(2.47) $(2.47) ======== ====== ====== December 31, 2000: Actual........................................ $ 27,013 $ 0.34 $ 0.27 ======== ====== ====== Pro forma..................................... $ 22,976 $ 0.29 $ 0.23 ======== ====== ====== December 31, 2001: Actual........................................ $ 56,954 $ 0.56 $ 0.52 ======== ====== ====== Pro forma..................................... $ 39,944 $ 0.39 $ 0.37 ======== ====== ======
2000 Employee Stock Purchase Plan. In February 2000, the Company's stockholders approved the 2000 Employee Stock Purchase Plan. The purchase plan is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code. The Company has reserved 2,000,000 shares of common stock for sale under the stock purchase plan. The number of shares reserved for sale under the plan will be increased annually on the first day of each fiscal year beginning in 2001 by an amount equal to the lesser of 4,000,000 shares or 2% of the outstanding shares of the Company's common stock on that date, or a lesser amount determined by the Board of Directors. The stock purchase plan will be administered by the Board or a committee appointed by the Board. The stock purchase plan is implemented by offering periods, the duration of which may not exceed 24 months. Offering periods may contain interim purchase periods. Shares purchased under the stock purchase plan will be held in separate accounts for each participant. The first offering period began in March 2000 and shall end on the last trading day on or before April 30, 2002. Employees will be eligible to participate in the stock purchase plan if they are employed by the Company for more than 20 hours per week and more than five months in a calendar year. The stock purchase plan permits eligible employees to purchase the Company's common stock through payroll deductions, which may not exceed 15% of the employee's total compensation. Stock may be purchased under the plan at a price equal to 85% of the fair market value of the Company's stock on either the date of purchase or the first day of the offering period, whichever is lower. However, the Board of Directors may in its discretion provide that the price at which shares of common stock are purchased under the plan shall be 85% of the fair market value of the Company's shares on the date of purchase. Participants may not purchase shares of common stock having a value greater than $25,000 during any calendar year. Participants may increase or decrease their payroll deductions at any time during an offering period, subject to limits imposed by the Board of Directors. If a participant withdraws from the stock purchase plan, any contributions that have not been used to purchase shares shall be refunded. A participant who has withdrawn may not participate in the stock purchase plan again until the next offering period. In the event of retirement or 80 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) cessation of employment for any reason, any contributions that have not yet been used to purchase shares will be refunded to the participant, or to the participant's designated beneficiary in the case of death, and a certificate will be issued for the full shares in the participant's account. The Board of Directors may terminate or amend the stock purchase plan, subject to stockholder approval in some circumstances. Unless terminated earlier by the Board, the stock purchase plan will have a term of 10 years. Total shares purchased under the plan were 118,223 and 73,811 in 2001 and 2000, respectively. At December 31, 2001 there were 3,716,294 shares available for purchase under the plan. NOTE 17--DEFERRED STOCK COMPENSATION In connection with the grant of certain stock options and restricted common stock to employees, non-employees and members of the Board of Directors and in connection with the acquisition of ACD (see Note 7), the Company recorded deferred stock compensation of $5.0 million, $0.3 million and $23.3 million for the years ended December 31, 2001, 2000 and 1999, respectively, representing the difference between the deemed fair value of common stock for accounting purposes and the option exercise price of these 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 related options. At December 31, 2001 approximately $6.0 million remained to be amortized over the corresponding vesting period of each respective option, generally four years. NOTE 18--401(K) PLAN On January 1, 2000, the Company adopted the UTStarcom, Inc. 401(k) Savings Plan (the "401(k) Plan") a cash-or-deferred arrangement which covers the Company's eligible employees who have attained the age of 21. The 401(k) Plan is intended to qualify under Sections 401(a), 401(m) and 401(k) of the Internal Revenue Code of 1986, as amended (the "Code"), and the 401(k) Plan trust is intended to qualify under Section 501(a) of the Code. All contributions to the 401(k) Plan by eligible employees or by the Company, and the investment earnings thereon, are not taxable to such employees until withdrawn, and any contributions the Company may make are expected to be deductible by the Company. The Company's eligible employees may elect to reduce their current eligible compensation by one percent (1%) up to twenty-five percent (25%), subject to the maximum statutorily prescribed annual limit of $11,000 for participants under age 50 and $12,000 for participants age 50 and over, and to have such salary reductions contributed on their behalf to the 401(k) Plan. The 401(k) Plan permits, but does not require, the Company to make matching contributions on behalf of all eligible employees who make salary reduction contributions to the 401(k) Plan. Commencing with the plan year beginning January 1, 2001, the Company has elected to begin making matching contributions on behalf of qualified employees who participate in the 401(k) Plan. The Company will contribute $0.50 for each dollar contributed by qualified employees to the 401(k) Plan, to a maximum of $3,000 per plan year. The Company's matching contributions are subject to a vesting schedule based upon longevity of employee service with the Company. Matching contributions were $0.4 million for the year ended December 31, 2001. 81 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 19--COMMITMENTS AND CONTINGENCIES Leases: The Company leases certain facilities under non-cancelable operating leases, which expire at various dates through 2006. The minimum future lease payments under the leases at December 31, 2001 are as follows:
December 31, 2001 ------------ Year ending: 2002.................................................... $ 4,514 2003.................................................... 3,476 2004.................................................... 1,973 2005.................................................... 77 2006.................................................... 32 ------- Total minimum lease payments............................ $10,072 =======
Rent expense for the years ended December 31, 2001, 2000 and 1999 was $3.8 million, $2.2 million, and $1.8 million, respectively. Litigation: On October 31, 2001, a complaint captioned Lacek v. UTStarcom, Inc., et. al., Civil Action No. 01-CV-9604, was filed in United States District Court for the Southern District of New York against the Company, some of our directors and officers and various underwriters for our IPO. Plaintiffs 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. 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. 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. The Company believes that it has meritorious defenses to this lawsuit and will defend this lawsuit vigorously. NOTE 20--OPERATING RISKS Financial Risks: Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of cash, cash equivalents, short-term investments and accounts receivable. The Company places its temporary cash and short-term investments with several financial institutions. Approximately $128.0 million and $44.3 million of the Company's cash was on deposit in foreign accounts at December 31, 2001 and 2000, respectively. The Company invests excess cash in highly liquid investments with original maturities of twelve months or less, such as certificates of deposit, government sponsored entities notes, commercial paper, floating rate corporate bonds, fixed income corporate bonds, and money market funds, which the Company believes have limited exposure to risk. Concentration of Credit Risk and Major Customers: The Company's first and second largest customers accounted for 6.6% and 5.9% of the Company's sales, respectively, in 2001 and 9.0% and 5.0% of accounts receivable, respectively, as of December 31, 2001. The 82 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Company's first and second largest customers accounted for 12.1% and 6.0% of the Company's net sales, respectively, in 2000 and 7.0% and 0.2% of the accounts receivable, respectively, as of December 31, 2000. The Company's first and second largest customers accounted for 30.2% and 10.7% of the Company's net sales, respectively, in 1999 and 39.0% and 6.0% of the accounts receivable, respectively, as of December 31, 1999. Approximately 90%, 90% and 93% of the Company's net sales during 2001, 2000 and 1999, respectively, were to entities affiliated with the government of China. Accounts receivable balances from these China government affiliated entities or state owned enterprises were $192.8 million and $153.8 million, respectively, as of December 31, 2001 and 2000. The Company extends credit to its customers generally without requiring collateral. The Company monitors its exposure for credit losses and maintains allowances for doubtful accounts. Country Risks: Approximately 90% of the Company's sales for the year ended December 31, 2001 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. 83 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 21--SEGMENT REPORTING 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, income from operations, 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. No customer accounted for 10% or more of consolidated revenues during the year ended December 31, 2001. Revenues from Hangzhou PTB accounted for 12.1% of consolidated revenues during the year ended December 31, 2000. Revenues from Xian Telecommunications Bureau and Kunming Telecommunications Bureau accounted for 30.2% and 10.7%, respectively, of consolidated revenues during the year ended December 31, 1999. Geographical area and product sales data are as follows (in thousands):
Year Ended December 31, 2001 -------------------------------------- Telecommunications Subscriber Equipment Handsets Total ------------------ ---------- -------- Net Sales: China................... $378,934 $186,946 $565,880 Other................... 60,004 956 60,960 -------- -------- -------- Total Net Sales..... $438,938 $187,902 $626,840 ======== ======== ======== Year Ended December 31, 2000 -------------------------------------- Telecommunications Subscriber Equipment Handsets Total ------------------ ---------- -------- Net Sales: China................... $257,474 $106,572 $364,046 Other................... 4,600 -- 4,600 -------- -------- -------- Total Net Sales..... $262,074 $106,572 $368,646 ======== ======== ======== Year Ended December 31, 1999 -------------------------------------- Telecommunications Subscriber Equipment Handsets Total ------------------ ---------- -------- Net Sales: China................... $165,484 $ 18,094 $183,578 Other................... 3,938 -- 3,938 -------- -------- -------- Total Net Sales..... $169,422 $ 18,094 $187,516 ======== ======== ========
Long-lived assets by geography are as follows (in thousands):
December 31, --------------- 2001 2000 ------- ------- China...................................................... $41,289 $17,855 U.S........................................................ 41,645 24,382 ------- ------- Total long-lived assets................................. $82,934 $42,237 ======= =======
84 UTSTARCOM, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) NOTE 22--RELATED PARTY TRANSACTIONS The Company entered into transactions with several companies that are stockholders or are affiliated with one of the Company's stockholders as follows: During 2001, the Company entered into a engineering services agreement with Matsushita Communication Industrial Co., Ltd., a stockholder of the Company. The Company recognized revenue of $1.0 million in connection with this agreement during 2001. There were no amounts included in accounts receivable or deferred revenue in respect of this agreement at December 31, 2001. In addition, the Company purchases telecommunications equipment from this Company. These purchases accounted for 21.7% and 28.4% of the Company's cost of sales in 2001 and 2000, respectively, and there were no amounts outstanding at December 31, 2001 and 2000. During 2001, the Company entered into an engineering services agreement with Mitsubishi Electric Corporation, a stockholder of the Company. During 2001, the Company recognized revenue of $1.3 million in connection with this agreement. Included in deferred revenue in respect of this agreement at December 31, 2001 was $0.7 million. There were no amounts included in accounts receivable in respect of this agreement at December 31, 2001. During 2001, the Company recognized revenue of $13.9 million with respect to sales of telecommunications equipment to an affiliate of one of the Company's stockholders. Included in accounts receivable at December 31, 2001 is $13.5 million related to this agreement. There were no amounts included in deferred revenue in respect of this agreement. During 2001, the Company entered into a professional services agreement with VoDaTech, Inc., a company whose owners are Bill Huang, the Company's Senior Vice President and Chief Technology Officer, and his wife. The Company paid VoDaTech $104,000 during 2001 for services rendered under the agreement. NOTE 23--SUBSEQUENT EVENTS In July 1997, the Company, as part of its business operations in China, acquired a 88% interest in UTStarcom (Hangzhou) Communication Co., Ltd. On January 21, 2002, the Company entered into an agreement to acquire the remaining 12% ownership in the joint venture company for a total consideration of $14.5 million payable in cash. The cash consideration will be paid in 2002. NOTE 24--QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Quarterly financial data for the periods indicated are as follows:
Quarters Ended -------------------------------------------------------------------------- Dec. 31, Sept. 30, June 30, March 31, Dec. 31, Sept. 30, June 30, March 31, 2001 2001 2001 2001 2000 2000 2000 2000 -------- --------- -------- --------- -------- --------- -------- --------- (In thousands, except per share amounts) Revenues..................... $197,128 $170,484 $140,047 $119,181 $126,997 $107,386 $75,676 $58,587 Gross profit................. $ 68,952 $ 64,276 $ 49,907 $ 41,413 $ 43,014 $ 37,292 $27,262 $20,613 Net income (loss)............ $ 16,535 $ 18,797 $ 12,260 $ 9,362 $ 13,887 $ 12,355 $ 5,020 $(3,269) Net income (loss) per share:* Basic.................... $ 0.15 $ 0.18 $ 0.13 $ 0.10 $ 0.15 $ 0.13 $ 0.05 $ (0.09) Diluted.................. $ 0.14 $ 0.17 $ 0.12 $ 0.09 $ 0.13 $ 0.12 $ 0.05 $ (0.09)
- -------- * Net income (loss) per share is computed independently for each of the quarters presented and, therefore, the sum of the quarterly net income (loss) per share may not equal the annual net income (loss) per share. 85 ITEM 9--CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10--DIRECTORS AND EXECUTIVE OFFICERS OF UTSTARCOM, INC. The information required by this section is incorporated by reference from the information in the section entitled "Election of Directors" in the Proxy Statement. The required information concerning our executive officers is contained in the section entitled "Executive Officers" in Part I of this Form 10-K. Item 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is contained in the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement and is incorporated herein by reference. ITEM 11--EXECUTIVE COMPENSATION The information required by this section is incorporated by reference from the information in the sections entitled "Election of Directors--Directors' Compensation," "Executive Compensation" and "Stock Price Performance Graph" in the Proxy Statement. ITEM 12--SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this section is incorporated by reference from the information in the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13--CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this section is incorporated by reference from the information in the section entitled "Certain Relationships and Related Transactions" in the Proxy Statement. PART IV ITEM 14--EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements--See Index to Consolidated Financial Statements and Financial Statement Schedules at page of this Form 10-K. (2) Financial Statement Schedule--See Index to Consolidated Financial Statements and Financial Statement Schedules at page of this Form 10-K. 86 (3) Exhibits
Exhibit Number Description ------ ----------- 3.1(1) Thirteenth Amended and Restated Certificate of Incorporation of UTStarcom, Inc. 3.2(1) Amended and Restated Bylaws of UTStarcom, Inc. 4.1 See exhibits 3.1 and 3.2 for provisions of the Certificate of Incorporation and Bylaws defining the rights of holders of Common Stock. 4.2(1) Specimen Common Stock Certificate. 4.3(1) Third Amended and Restated Registration Rights Agreement dated December 14, 1999. 10.1(1) Form of Indemnification Agreement. 10.2(1) 1992 Omnibus Equity Incentive Plan and form of related agreement. 10.3(1) 1995 Stock Plan and forms of related agreements. 10.4(1) 1997 Stock Plan, as amended, and forms of related agreements. 10.5(1) 2000 Employee Stock Purchase Plan and forms of related agreements. 10.6(1) Common Stock Purchase Warrant dated February 5, 1998 between UTStarcom, Inc. and Lintech Limited. 10.7(1) Common Stock Purchase Warrant dated September 20, 1999 between UTStarcom, Inc. and Talent Group International, Ltd. 10.8(1) Employment and Non-Competition Agreement dated October 6, 1995 between UTStarcom, Inc. and Hong Lu. 10.9(1) Employment and Non-Competition Agreement dated October 6, 1995 between UTStarcom, Inc. and Ying Wu. 10.10(1)* Product Manufacture & License Agreement dated May 13, 1997 between UTStarcom, Inc. and Tollgrade Communications, Inc. 10.11(1)* Sales Agreement dated February 12, 1999 between UTStarcom (China) Ltd. and BaoDing Telecommunication Bureau, Hebei Province. 10.12(1)* Sales Contract dated August 23, 1999 between UTStarcom (China) Ltd. and Xian Telecommunication Bureau. 10.13(1)* Technical License and Assistance Agreement dated November 2, 1999 between UTStarcom, Inc. and Mitsubishi Electric Corporation. 10.13(a)(1)* Amendment No. 1 to Technical License and Assistance Agreement dated February 21, 2000 between UTStarcom, Inc. and Mitsubishi Electric Corporation. 10.14(1)* Technical Assistance Agreement dated October 1, 1999 between Matsushita Communication Industrial Co. Ltd. and UTStarcom, Inc. 10.14(a)(1) Addendum dated February 18, 2000 to the Technical Assistance Agreement dated October 1, 1999 between Matsushita Communication Industrial Co. Ltd. and UTStarcom, Inc. 10.15(1)* Joint Product Development and Marketing Memorandum and Understanding dated September 2, 1999 between UTStarcom, Inc. and Matsushita Communication Industrial Co., Ltd. 10.16(1)* Joint Patent Filing Agreement dated December 1, 1998 between UTStarcom, Inc. and Matsushita Communication Industrial Co., Ltd. 10.17(1)* Loan Agreement dated June 15, 1998 between UTStarcom, Inc. and SOFTBANK Corp.
87
Exhibit Number Description ------ ----------- 10.18(a)(1)*+ Loan Agreement dated March 9, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(b)(1)* Loan Agreement dated June 7, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(c)(1)* Loan Agreement dated June 29, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(d)(1)* Loan Agreement dated July 7, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(e)(1)* Loan Agreement dated July 14, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(f)(1)* Loan Agreement dated July 21, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(g)(1)* Loan Agreement dated August 5, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(h)(1)* Loan Agreement dated August 17, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(i)(1)* Loan Agreement dated September 2, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.18(j)(1)* Loan Agreement dated September 17, 1999 between Bank of China and UTStarcom Hangzhou Telecommunications Co., Ltd. 10.19(1)* Joint Venture Agreement dated July 31, 1997 between UTStarcom, Inc. and Zhejiang Telecommunication Equipment Factory. 10.20(1)* Joint Venture Agreement dated December 8, 1995 between UTStarcom, Inc. and Chinese Guangdong Nanfeng Telecommunication Group Co. Ltd. 10.20(a)(1)* Amendment Agreement to the Contract and Articles of Association of Guangdong UTStarcom Communications Co. Ltd. dated December 11, 1997. 10.21(1)* Joint Venture Agreement dated September 12, 1997 between UTStarcom, Inc. and Zhejiang Nantian Post and Telecommunication Development Group Co. Ltd. 10.22(1) Lease dated December 23, 1997 between UTStarcom, Inc. and Tech Center Partners. 10.23(1) Lease Agreement dated April 1995, as amended, between UTStarcom, Inc. and Metro Park Associates. 10.24(1) Lease Agreements dated December 31, 1997 and May 14, 1998 between Guangdong UTStarcom Telecom Co., Ltd. and Guangdong Southern Telecom Group Huizhou Company. 10.25(1) Lease Contract dated December 15, 1996 between UTStarcom (Hangzhou) Telecommunications Co., Ltd. and Yile Village, Gudang Township. 10.26(1)* Purchase Agreement for P.R. China Market dated April 1, 1999 between UTStarcom Inc., Matsushita Electric Industrial Co., Ltd. and Matsushita Communication Industrial Co., Ltd. 10.27(1) Information Service Project Contract dated June 1, 1998 between UTStarcom (China) Ltd. and China Jitong Communication Co. Ltd. 10.28(1) Payment Agent Contract dated June 11, 1998 among UTStarcom, UTStarcom (China) Ltd, Softbank Corporation and Jitong Communication Co., Ltd.
88
Exhibit Number Description ------ ----------- 10.29(1) Agreement on Termination of Contract dated August 30, 1999 among UTStarcom, Inc., UTStarcom (China) Ltd., Softbank Corporation and Jitong Communication Co., Ltd. 10.30(1) Exchange Agreement dated October 15, 1997 between UTStarcom, Inc. and certain investors. 10.31(1) Exchange Agreement dated October 15, 1997 between UTStarcom, Inc. and certain investors. 10.32(1) Employment and Non-Competition Agreement dated October 6, 1995 between UTStarcom, Inc. and Bill Huang. 10.33(1) Lease contract on Housing and Vacant Land at Yunshan Post and Telecommunication Industrial Village dated January 3, 2000 between Guangdong UTStarcom Telecom Co., Ltd. and Guangdong Nanfang Communication Group, Huizhou Co. 10.34(1) Loan Agreement dated October 8, 1996 between UTStarcom (China) Co., Inc. and Bill X. Huang. 10.35(1) Promissory Note Secured by Deed of Trust dated February 13, 1999 issued to UTStarcom, Inc. by Bill X. Huang and Minnie Huang. 10.36(1)* Supply Agreement dated February 18, 2000 between UTStarcom, Inc. and Matsushita Electric Industrial Co., Ltd. 10.37(2)* Manufacturing License Agreement between Himachal Futuristic Communications Ltd. and UTStarcom, Inc., undated. 10.38(2)* Sales Agreement between Japan Radio Company and UTStarcom, dated March 16, 2000. 10.39(2)* Technical Collaboration Agreement between Sharp Corporation and UTStarcom, Inc., dated March 31, 2000. 10.40(2)* Parts Supply Agreement between Sharp Corporation and UTStarcom, Inc., undated. 10.41(3)* Joint Venture Agreement between SOFTBANK Corporation and UTStarcom, Inc., dated May 29, 2000. 10.42(3)* Land Use Right Assignment Agreement between the Administration Committee of Hangzhou Hi-Tech Industry Development Zone of Zhejiang Province of the People's Republic of China and UTStarcom, Inc., dated May 18, 2000. 10.43(3)* Supply Agreement between Matsushita Electric Industrial Co., Ltd., Matsushita Communications Industrial Co., Ltd., and UTStarcom, Inc., dated April 1, 2000. 10.44(4)* OEM Agreement between UTStarcom, Inc. and Zaffire, Inc., dated August 10, 2000. 10.45(4)* Development Agreement between UTStarcom, Inc. and Matsushita Communication Industrial Co., Ltd., dated September 26, 2000. 10.46(4)* OEM Agreement between UTStarcom, Inc. and Interwave Communications International, Ltd., dated July 14, 2000. 10.47(4)* OEM Agreement between UTStarcom, Inc. and Foundry Networks, Inc., dated August 24, 2000. 10.48(4)* Loan Contract between UTSC Co., Ltd. and Bank of China Beijing Branch, dated August 29, 2000. 10.49(9)* Sales Contract between UTStarcom (China), Ltd. and Zhejiang Telecom Company (Shaoxing Branch), dated November 18, 2000. 10.50(9)* Sales Contract between UTStarcom (China), Ltd. and He Nan Telecom Company, dated October 28, 2000.
89
Exhibit Number Description ------ ----------- 10.51(9)* Sales Contract between UTStarcom (China), Ltd., Xian Equipment Import/Export Company, Ltd., and Shaanxi China Telecom Group, Ltd., dated September 29, 2000 (received by UTStarcom, Inc. on October 9, 2000). 10.52(9)* Technical Assistance Agreement between UTStarcom, Inc. and Matsushita Communication Industrial Co. Ltd., dated December 1, 2000. 10.53(9)* Definitive Agreement for Collaboration between UTStarcom, Inc. and Mitsubishi Electric Corporation, dated October 22, 2000. 10.54(9)* Software License Agreement between UTStarcom, Inc. and DDI Corporation, Inc. dated October 4, 2000. 10.55(9)* Strategic Alliance, Purchase and License Agreement between UTStarcom, Inc. and Telecommunication D'Haiti S.A.M., dated December 5, 2000. 10.56(5)* Assignment Agreement between UTStarcom, Inc. and Stable Gain International Limited dated July 24, 2000. 10.57(5)* Amendment No.1 to July 24, 2000 Assignment Agreement between UTStarcom, Inc. and Stable Gain International Limited, dated March 2, 2001. 10.58(5)* Loan Agreement between China Merchant Bank and UTStarcom (China) Co., Ltd., dated March 14, 2001. 10.59(5)* Technical Service Agreement between UTStarcom (China) Co., Ltd. and Hainan Xinhuangpu Investment Co., Ltd., dated August 18, 2000. 10.60(5)* Assets Transfer Agreement between Hainan Xinhuangpu Investment Co., Ltd. and UTStarcom (China) Co., Ltd., dated August 18, 2000. 10.61(5)* Equity Transferring Agreement between Zhe Jiang Nantian Telecommunication Development Group Share Company and UTStarcom, Inc., dated February 5, 2001. 10.62(5)* Sales Contract between Zhejiang Telecom Co. and UTStarcom (China) Co., Ltd., dated March 23, 2001. 10.63(5)* Manufacturing License Agreement between Himachal Futuristic Communications Ltd. and UTStarcom, Inc., dated March 6, 2001. 10.64(7) 2001 Director Option Plan. 10.65(7)* Strategic Alliance, Purchase and License Agreement between UTStarcom, Inc. and Telecommunications D'Haiti S.A.M. dated as of April 12, 2001. 10.66(6) 2001 Director Option Plan, as amended on July 10, 2001. 10.67(8)* Purchase Contract between UTStarcom Inc. and BB Technologies Corporation, dated October 9, 2001. 10.68 Comprehensive Credit-Extension Agreement between UTStarcom (China) Ltd. and China Everbright Bank, Chaoyang Branch, Beijing, dated November 30, 2001. 10.69 Equity Transfer Agreement between UTStarcom, Inc. and Guangdong Nanfang Communications Group Co. Ltd., dated December 18, 2001. 10.70 Equity Transfer Agreement between UTStarcom, Inc. and Zhejiang Provincial Telecom. Instruments Factory and UTStarcom (Hangzhou) Communications Co., Ltd., dated January 21, 2002. 10.71 Lease Agreement between UTStarcom, Inc. and Legend Tech., dated September 12, 2001.
90
Exhibit Number Description ------ ----------- 21.1 Subsidiaries of UTStarcom, Inc. 23.1 Consent of PricewaterhouseCoopers LLP. 23.2 Consent of Willamette Management Associates. 24.1 Power of Attorney (included on signature page).
- -------- * Portions of the exhibit have been omitted pursuant to an order granted by the Securities and Exchange Commission for confidential treatment. (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (No. 333-93069), which became effective March 2, 2000. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2000. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2000. (4) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000. (5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. (6) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001. (7) Incorporated by reference to the Registrant's Registration Statement of Form S-3, which became effective July 18, 2001. (8) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 2001. (9) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000. (b) Reports on Form 8-K: 1. A Current Report on Form 8-K was filed on July 12, 2001 to report our earnings release for the second quarter of fiscal year 2001. (c) Exhibits See Item 14(a)(3) above. 91 INDEPENDENT ACCOUNTANTS REPORT ON FINANCIAL STATEMENT SCHEDULES To the Board of Directors and Stockholders of UTStarcom, Inc.: Our audits of the consolidated financial statements referred to in our report dated January 14, 2002 also included an audit of the financial statement schedules in this Annual Report on Form 10-K. In our opinion, these financial statement schedules present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /S/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP San Francisco, California January 14, 2002 92 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on the 11th day of February, 2002. UTSTARCOM, INC. (Registrant) By /s/ Michael J. Sophie ----------------------------- Michael J. Sophie Vice President of Finance, Chief Financial Officer and Assistant Secretary 93 SCHEDULE I UTSTARCOM, INC. (UNCONSOLIDATED) REGISTRANT BALANCE SHEETS (in thousands, except share and per share data)
December 31, ------------------ 2001 2000 -------- -------- ASSETS Current assets: Cash and cash equivalents...................................................... $198,285 $104,805 Short-term investments......................................................... 86,176 83,858 Accounts receivable............................................................ 114,595 105,571 Receivable from related parties................................................ 1,670 406 Inventories, net............................................................... 14,278 18,223 Other current assets........................................................... 18,994 4,889 -------- -------- Total current assets.............................................................. 433,998 317,752 Property, plant and equipment, net................................................ 21,919 6,604 Investment in affiliated companies................................................ 223,200 110,332 Goodwill and intangible assets, net............................................... 37,728 18,888 Other long-term assets............................................................ 8,653 5,768 -------- -------- Total assets................................................................... $725,498 $459,344 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................................... $ 11,354 $ 18,794 Short-term debt................................................................ -- 7 Income taxes payable........................................................... 7,458 3,999 Deferred revenue............................................................... 8,874 11,457 Other.......................................................................... 15,925 12,768 -------- -------- Total current liabilities......................................................... 43,611 47,025 -------- -------- Stockholders' equity: Preferred stock: $.00125 par value; authorized: 5,000,000 shares; issued and outstanding: none at December 31, 2001 and 2000.............................. -- -- Common stock: $.00125 par value; authorized: 250,000,000 shares; issued and outstanding: 109,302,816 at December 31, 2001 and 95,032,657 at December 31, 2000......................................................................... 138 120 Additional paid-in capital........................................................ 638,697 426,665 Deferred stock compensation....................................................... (6,045) (6,491) Retained earnings (accumulated deficit)........................................... 49,146 (7,808) Notes receivable from stockholders................................................ (381) (314) Accumulated other comprehensive income............................................ 332 147 -------- -------- Total stockholders' equity..................................................... 681,887 412,319 -------- -------- Total liabilities and stockholders' equity................................. $725,498 $459,344 ======== ========
The accompanying notes are an integral part of these financial statements. 94 SCHEDULE I UTSTARCOM, INC. (UNCONSOLIDATED) CONDENSED INFORMATION AS TO THE RESULTS OF OPERATIONS OF THE REGISTRANT (in thousands, except share and per share data)
Years Ended December 31, ---------------------------- 2001 2000 1999 -------- -------- -------- Net sales................................................................. $351,373 $267,384 $109,091 Cost of sales (includes stock compensation expense of $41, $90, and $12).. 294,995 228,624 95,866 -------- -------- -------- Gross profit.............................................................. 56,378 38,760 13,225 Operating expenses: Selling, general and administrative expenses (includes stock compensation expense of $2,499, $4,676, $4,256)...................... 25,199 14,814 8,249 Research and development expenses (includes stock compensation expense of $2,660, $6,795, $1,285)................................... 56,937 40,957 12,966 Amortization of intangible assets...................................... 7,440 4,808 188 In-process research and development costs.............................. 4,720 -- 3,992 -------- -------- -------- Total operating expenses........................................... 94,296 60,579 25,395 -------- -------- -------- Operating income.......................................................... (37,918) (21,819) (12,170) Interest income........................................................... 7,832 12,426 3,839 Interest expense.......................................................... (644) (154) (1,693) Other income (expense).................................................... (1,737) (139) 360 Equity in net income (loss) of affiliated companies....................... 99,506 47,399 21,954 -------- -------- -------- Income before income taxes and cumulative effect of a change of accounting principle............................................................... 67,039 37,713 12,290 Income tax expense (benefit).............................................. 10,085 9,720 (829) -------- -------- -------- Income from continuing operations......................................... 56,954 27,993 13,119 Loss from discontinued operations......................................... -- -- (1,656) -------- -------- -------- Net income (loss) before cumulative effect of a change of accounting principle............................................................... 56,954 27,993 11,463 Cumulative effect on prior years of the application of SAB 101, "Revenue Recognition in Financial Statements".................................... -- (980) -- -------- -------- -------- Net income................................................................ 56,954 27,013 11,463 Beneficial conversion feature of Series F convertible preferred stock..... -- -- (29,977) -------- -------- -------- Net income (loss) applicable to common stockholders....................... $ 56,954 $ 27,013 $(18,514) ======== ======== ========
The accompanying notes are an integral part of these financial statements. 95 SCHEDULE I UTSTARCOM, INC. (UNCONSOLIDATED) CONDENSED INFORMATION AS TO THE CASH FLOWS OF THE REGISTRANT (In thousands)
Years Ended December 31, ----------------------------- 2001 2000 1999 -------- --------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................................................... $ 56,954 $ 27,013 $ 11,463 Adjustments to reconcile net income (loss) to net cash used in operating activities: Loss from discontinued operations............................................... -- -- 1,656 Gain or change in ownership interest in subsidiary.............................. (277) -- -- Depreciation and amortization................................................... 15,218 7,308 1,258 Non-qualified stock option exercise tax benefits................................ 15,311 7,628 -- Write-off of in-process research and development costs.......................... 4,720 -- 3,992 Impairment of long-term investments............................................. 3,376 -- -- Net loss on sale of assets...................................................... 527 698 -- Cumulative effect of change in accounting principle............................. -- 980 -- Stock compensation expense...................................................... 5,201 11,560 5,553 Equity in net loss of affiliated companies...................................... (97,816) (47,399) (21,954) Changes in operating assets and liabilities: Accounts receivable and receivable from related parties...................... (10,288) (61,089) 3,647 Inventories.................................................................. 3,945 (6,744) (10,062) Other current and non-current assets......................................... (19,060) 2,497 (1,578) Accounts payable and payable to related parties.............................. (7,440) 14,363 (24,359) Income taxes payable......................................................... 3,459 (4,364) 1,079 Other current liabilities.................................................... 2,956 (1,987) 11,276 Deferred revenue............................................................. (2,583) 10,957 500 -------- --------- -------- Net cash used in operating activities..................................... (25,797) (38,579) (17,529) -------- --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment.......................................... (19,853) (6,119) (1,422) Investment in affiliates, net of cash acquired...................................... (18,135) (8,945) 108 Proceeds from disposal of property.................................................. -- 75 652 Purchase of intangible assets....................................................... (1,078) -- -- Purchase of short-term investments.................................................. (89,625) (124,096) -- Sales of short-term investments..................................................... 87,516 40,290 -- -------- --------- -------- Net cash used in investing activities............................................... (41,175) (98,795) (662) -------- --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of stock, net of expenses.................................................. 160,550 198,213 55,480 Proceeds (payments) from borrowing, net............................................. (5) (8) (7) Proceeds from shareholder notes..................................................... (67) 245 -- -------- --------- -------- Net cash provided by financing activities........................................... 160,478 198,450 55,473 -------- --------- -------- Effects of exchange rates on cash................................................... (26) -- -- -------- --------- -------- Net increase in cash and cash equivalents........................................... 93,480 61,076 37,282 Cash and cash equivalents at beginning of period.................................... 104,805 43,729 6,447 -------- --------- -------- Cash and cash equivalents at end of period.......................................... $198,285 $ 104,805 $ 43,729 ======== ========= ========
The accompanying notes are an integral part of these financial statements. 96 SCHEDULE I UTSTARCOM, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS NOTE 1. BASIS OF PRESENTATION UTStarcom, Inc., a Delaware corporation, is the parent company of all UTStarcom, Inc. subsidiaries. The accompanying condensed financial statements reflect the financial position, results of operations and cash flows of UTStarcom, Inc. on a separate basis. All subsidiaries of UTStarcom, Inc. are reflected as investments accounted for using the equity method. Accordingly, intercompany transactions have not been eliminated. No cash dividends were paid to UTStarcom, Inc. by its subsidiaries during the three years ended December 31, 2001. For accounting policies and other information, see the Notes to Consolidated Financial Statements included elsewhere herein. SCHEDULE II UTSTARCOM, INC. Valuation and Qualifying Accounts and Reserves For the Years Ended December 31, 2001, 2000 and 1999
Additions Balance at charged to Balance at beginning of costs and end of Description the period expenses Deductions the period ----------- ------------ ---------- ---------- ---------- Year ended December 31, 2001 Allowance for doubtful accounts. $12,835 $ 6,218 $ -- $19,053 Provision for obsolete inventory $ 9,201 $11,143 $ -- $20,344 Accrued product warranty costs.. $ 3,133 $ 6,792 $3,654 $ 6,271 Year ended December 31, 2000 Allowance for doubtful accounts. $ 6,789 $ 6,448 $ 402 $12,835 Provision for obsolete inventory $ 6,415 $ 2,786 $ -- $ 9,201 Accrued product warranty costs.. $ 1,236 $ 4,279 $2,382 $ 3,133 Year ended December 31, 1999 Allowance for doubtful accounts. $ 3,957 $ 6,006 $3,174 $ 6,789 Provision for obsolete inventory $ 2,445 $ 5,695 $1,725 $ 6,415 Accrued product warranty costs.. $ 997 $ 481 $ 242 $ 1,236
98 EX-10.68 3 dex1068.txt COMPREHENSIVE CREDIT-EXTENSION AGREEMENT EXHIBIT 10.68 Comprehensive Credit-extension Agreement [Translation] Credit Giver: UTSTARCOM (CHINA) LTD. (hereinafter referred to Party A) Address: Tel.: 65542030 Fax: 65542058 Creditor: China Everbright Bank, Chaoyang Branch, Beijing (hereinafter referred to Party B) Address: Tel.: Fax: WHEREAS, In light of "Act on Commercial Bank of People's Republic of China", through equal negotiation, both parties reach the Agreement as follows and agree it is binding on them both: Chapter One: Definition and Interpretation Article One: The following terms set forth in the Agreement has the meaning as such, except otherwise defined by the text of the Agreement: Comprehensive credit extension: one or more kind(s) of conditional promise - ------------------------------ mortgaged on credit extended by Party B to Party A. Specific transaction: specific credit extension transaction as loan extension, - -------------------- bank's acceptance bill and trade financing provided by Party B in accordance with Party B's comprehensive credit-extension to Party A. Maximum credit extension margin: maximum balance of principals of the debts in - ------------------------------- all items of specific transactions, which Party A may use on application to Party B during the term of comprehensive credit extension agreed on in this Agreement and is determined on Party B's comprehensive credit extension to Party A. Specific credit extension margin: maximum balance of principal of the debt in - -------------------------------- one item of specific transaction, which Party A may use on application to Party B during the term of comprehensive credit extension agreed on in this Agreement and is determined within maximum credit extension margin. Used credit extension margin: summation of balance of principal of the debt in - ---------------------------- one item of specific transaction, which Party A hasn't repaid during the term of comprehensive credit extension agreed on in this Agreement and is determined within specific credit extension margin. Maximum stand-by credit-extension margin: balance between maximum credit - ---------------------------------------- extension margin and all used credit extension margins. Stand-by credit extension margin: balance between maximum credit extension - -------------------------------- margin regarding one specific transaction and used credit extension margin regarding one specific transactions. Contract regarding specific transactions: contract or agreement concluded by - ---------------------------------------- Party A and Party B concerning usage of specific credit extension margin. Chapter Two: Maximum Credit Margin and Specific Credit Margin Article Two: Maximum credit extension margin (if counted in both home currency and foreign currency, foreign currency shall be accounted into home currency at the base rate of exchange on the concluding date of the Agreement) is RMB Three --------- Hundred Million Yuan - -------------------- Article Three: Within maximum credit extension margin and specific credit margin regarding specific transaction is as such: 1. Common loan: RMB 50,000,000 Among which, home currency loan as: RMB 50,000,000 Foreign currency loan as: None ------ 2. Others(Name to be expressed): Discount of commercial invoice: RMB 10,000,000 Comprehensive factoring: RMB 10,000,000 Chapter Three Term of Credit Extension Article Four: Validity term of maximum credit extension margin is: from September 30 of 2001 to September 30 of 2002. Chapter Four: Usage of Maximum Credit Margin and Specific Credit Margin Article Five: During the term of credit extension agreed on in the Agreement and within the maximum credit margin and specific credit margin, Party A may apply to Party B in writing for usage of specific credit extension on one lump sum or by items on different occasions and this written application shall carry on name, usage period and sum of specific transaction. Party B shall determine name, usage period and sum of specific transaction upon Party A's written application and credit record, Party B's policy concerning unsecured loan and conditions of the Agreement. Article Six: Summation of credit margin already used by Party A shall not exceed the maximum credit margin. During the term of credit extension, Party A may use the specific credit margin on roll-over, that is, once the debt under any specific transaction is paid up, the specific credit margin previously used on this specific transaction can be re-used on new specific transaction of the same kind. Party A shall apply for using specific credit margin within the term of credit extension and stand-by credit margin shall be automatically cancelled on expiration of the term of credit extension. Article Seven: Party A and Party B shall conclude contracts of specific transaction regarding specific transaction and contracts of specific transaction shall prevail if this Agreement conflicts with contracts of specific transaction. Article Eight: Usage period of any specific transaction shall not be later than the last day of the term of credit extension and shall not exceed one year. Chapter Five: Rate Article Nine: Interest rate, exchange rate or any rate waiting to be determined in each specific transaction under this Comprehensive Credit-extension Agreement shall be stipulated by both parties when concluding contracts of specific transaction. Contract of each specific transaction signed by both parties shall predominate. Chapter Six: Adjustment of Maximum Credit Margin and Specific Credit Margin Article Ten: Party B may adjust maximum credit margin and term of credit extension and terminate the comprehensive credit extension to Party A in the event of the following: 1. The State's monetary policies undergo a material change; 2. There is occurrence or threatening occurrence of grave financial risks; 3. The market relevant to Party A's transaction undergoes a material change; 4. Party A is being or to be exposed to grave transactional difficulties or risks; 5. Party A undergoes material system changes such as separation, amalgamation or dismissal; 6. Party A uses the fund under credit extension in the manner contradicting with the provision concerned; 7. Party A has such acts as property transfer, flight of capital and debt evasion; 8. Party A breaks the promises agreed on in this Agreement; 9. The guarantor in this Agreement undergoes severe lack of capital or transactional difficulties to such extent as to substantially affect his guaranty ability; 10. The estate under the mortgage or the pledge is destroyed or lost to the extent of threatening Party B's credit; 11. The occurrence of any other event or situation, at Party B's sole analysis or judgment, has already caused or is immediate to cause the deterioration of Party A's ability to pay debts or damage to Party B's interest. Article Eleven: In spite of the foregoing, if Party A makes a written request for adjusting each specific credit margin after the conclusion of this Agreement, Party A shall obtain Party B's permission in writing. Party A's written request and Party B's response letter are both taken as the amendment to Article Three of this Agreement and have equal legal effect to this Agreement. Chapter Seven Security Article Twelve: To ensure the prompt repayment of the debt under this Agreement, the following means of security are adopted: 1. Surety: UTStarcom (Hangzhou) Communication Co., Ltd.; which signed the Maximum Margin Guarantee Contract with the contract no. as "CEB Chao Max Surety" Article Thirteen: Notwithstanding the means of security agreed on in this Agreement as the foregoing, when conducting specific transaction, Party B has the authority to request Party A to provide other security if Party B thinks necessary and Party A shall not refuse affording other security on the ground that it is settled on security in this Agreement. Chapter Eight: Party B's Undertaking Article Fourteen: Party B shall without any unreasonable delay take up and examine and approve Party A's application on the ground that Party A applies for usage of specific credit margin in terms of this Agreement. Article Fifteen: Party B shall not take the liberty to adjust maximum credit margin and term of credit extension to the extent of being unfavorable to Party A, unless otherwise set forth in this Agreement. Chapter Nine: Party A's Undertaking Article Sixteen: Party A shall repay all the debts under the contract of specific transaction on schedule and pay all the expenses due on schedule. Article Seventeen: Party A shall use the capital within the specific credit margin in conformity with law, this Agreement and contracts of specific transaction, subject to Party B's examination at any time. Article Eighteen: During the term of credit extension, Party A shall provide Party B true financial statements and afford to Party B actual material about its main banks of deposit in China, accounts, balance held on deposits and credits and other transactional data. Article Nineteen: Party A shall open an account of settlement and average balance of settlement of each day at this account of settlement shall not be less than 5% of the summation of used credit margins. Article Twenty: During the term of credit extension, Party A shall not tender guarantee for the Third Party without prior notice to Party B and it shall not affect its ability to repay debts to Party B on schedule. Article Twenty-one: During the term of credit extension, Party A shall be liable to make the following notices: 1. Party A shall notify Party B and provide it relevant data within 15 days after change or modification in event of change of legal representatives (principals) or address or business place, alteration of the registered capital or fundamental change of shares or investment; 2. During the term of credit extension, Party A shall notify Party B immediately in event of involvement of major action, arbitration or other legal process, or fundamental change of operation or financial situation to the extent of affecting the realization of Party B's right of credit. 3. During the term of credit extension, Party A shall give two week's notice to Party B and repay all the debts incurred by Party B or fix repayment liability in event that Party A conducts such capital-reconstructing activities as annex, purchase or separation, or such activities affecting management right as contracts or lease of any kind, or any activities changing corporate structure or mode of business, or such activities terminating business as petition for declaring bankruptcy or dissolution. Article Twenty-two: Party A's breach of any provision of this Agreement or contracts of specific transaction constitutes a breach to this Agreement, of which in the event Party B may recall any financing funds under the credit margin and terminate this Agreement immediately. Chapter Ten Effectiveness of This Agreement Article Twenty-three: This Agreement establishes as of the date when both Parties' authorized representatives (principals) or their agents sign and seal this Agreement and comes into effect when the Contract of Security in this Agreement comes into effect or when both Parties' authorized representatives (principles) or their agents sign and seal this Agreement in case of no Contract of Security agreed on. Chapter Eleven Settlement of Disputes Article Twenty-four: Both Parties shall settle through friendly negotiation any disputes arising out of or relating with the performance of this Agreement. If negotiation fails, either party may file an action at the court at the site of which Party B is located. Chapter Twelve Entire Agreement Article Twenty-five: Any contract of specific transaction (If the signing date of any contract of specific transaction is within the term of comprehensive credit extension or it is proved to be concluded according to this Agreement) concluded between Party A and Party B is made a part of and subject to this Agreement, together form a single integrated Agreement. Article Twenty-six: In the event that Party A does not perform obligation stipulated in any specific transaction subject to this Agreement, Party A will be treated as breach of this Agreement, and Party B can terminate this Agreement and revoke in advance all undue credit rights. Article Twenty-seven: Any term and conditions which are not stipulated in this Agreement can be otherwise set forth in writing as an appendix of this Agreement, and such appendix is the effective part of, and have the same enforcement with this Agreement. Chapter Thirteen Miscellaneous Article Twenty-eight: This Agreement has two originals with same effectiveness and each party has one. Article Twenty-nine: This Agreement is signed in Beijing as of Nov. 30/th/, 2001. Party A(stamp) Party B(Stamp) Legal representative: Legal representative: (or entrusted agent): (or entrusted agent): Translation Certification ------------------------- I hereby certify that the foregoing represents a fair and accurate English translation of the original Chinese document. Dated: February 5, 2002 By: /s/ Michael J. Sophie ---------------------------------------- Michael J. Sophie Chief Financial Officer EX-10.69 4 dex1069.txt EQUITY TRANSFER AGREEMENT, DEC. 18, 2001 Exhibit 10.69 Equity Transfer Agreement [Translation] Transferor: Guangdong Nanfang Communications Group Co. Ltd (hereinafter Party A) Domicile: No.138 North Guangzhou Avenue Guangzhou City Legal Representative: Chen Guohan Title: Chairman of Board of Directors Nationality: China Transferee: UTStarcom Inc. (hereinafter Party B) Domicile: 1275 Harbor Bay Parkway, suite 100 Alameda, CA95402, U.S.A. Legal Representative: Hong Liang Lu Title: Chairman of Board of Directors Nationality: U.S.A. Party A and Party B incorporated a Chinese-Foreign equity joint venture, Guangdong UTStarcom Communications Co. Ltd. (hereinafter referred to as Company) in 1995. Party A and Party B, in accordance with the Law of the P.R.China on Chinese-Foreign equity Joint Ventures and the Several Provisions on the Share Right Variation of Investors of Foreign-Invested Enterprises, under the principles of Equality and Free Will, Consultation and Consensus, Honesty and Good Faith and Compensation of Equal Value, conclude this equity transfer agreement: [_] The Amount of Equity to be transferred: 1. Prior to the transfer, Party A contributes US$ 1,960,000.00 amounting to 49% of the Company's registered capital; Party B contributes US$ 2,040,000.00 amounting to 51% of the Company's registered capital. 2. In light of the operation situation of the Company, Party A agrees to transfer to Party B all the equity of the Company held by Party A in accordance with this Agreement; Party B agrees to buy the said equity. Party B shall own 100% of the equity of the Company after the realization of the transfer. 3. Neither the total investment amount nor the registered capital shall be changed. [_] Price of the Transferred Equity and the Payment Thereof 1. Upon friendly consultation between Party A and Party B, Party A agrees to transfer 49% of the equity of the Company held by Party A at the price of 30,111,200.00 Yuan. 2. Party B agrees to pay Party A the price of transferred equity in two times after the this Agreement goes into effect: Before December 31/st/, 2001, 50% of the Price of transferred equity shall be paid, i.e. 15,000,000.00 Yuan. Before January 31, 2002, the balance of 50% of the Price of transferred equity shall be paid, i.e., 15,111,200.00 Yuan. [_]. The Rights and Obligations of Both Parties After the Transfer: 1. The Company shall be run solely by Party B. Party B enjoys the shareholder's rights and bears the shareholder's obligations, while Party A will no longer participate in the running of the Company, nor enjoy the shareholder's rights. 2. The Company's all property, creditor's rights and debts shall be undertaken by Party B, thus they have nothing to do with Party A. 3. All the contracts entered into in the name of the Company shall continue to be effective; Party B shall make no rescission of these contracts for any reasons unless Party B may rescind the contracts upon the agreement thereon of both parties concerned. 4. Party A shall cooperate with Party B to complete all the transfer procedures; where special circumstances make it impossible to transfer, Party A shall promptly refund all the price of transfer to Party B. [_] Default Both Party A and Party B shall perform this agreement after it goes into effect; where either party breaches the agreement, the defaulting party shall bear the corresponding liabilities for breach of contract. [_]. Guarantee 1. Party A guarantees that the equity transferred to Party B in accordance with the stipulations hereof are held legally by Party A in the Company and that Party A has completely effective right to dispose of the said equity and that no third party shall make claims thereof to Party B. 2. Party A guarantees that the approval has been obtained from the competent authority and valid authorization has been acquired according to the relevant provisions of laws and regulations. 3. Party B guarantees that the necessary authorization has been obtained for the conclusion hereof. 4. Party B guarantees to pay Party A the price of the transferred equity according hereto. [_]. Dispute Settlement Party A and Party B shall by friendly consultation resolve the disputes concerning the validity, performance, default, rescission, indemnity and so on hereof. Where the disputes fail to be resolved within ninety days after the disputes occur, both Parties agree to submit the disputes to the arbitration of Guangzhou City Arbitration Committee and the arbitration shall be conducted in Guangzhou in accordance with the arbitration procedures of the said Committee. The arbitral awards shall be final and binding upon both Parties. During the arbitration, the other clauses hereof shall continue to be performed except the disputed parts hereof. [_]. Application of Law This equity transfer agreement shall be governed by the laws and regulations of the P.R.China. [_]. This Agreement shall be executed only after it is signed and sealed by the representatives authorized by both Parties; it shall be valid after it is ratified by the original ratifying authority. This Agreement has six copies of originals; Party A and Party B shall hold one copy respectively and the other copies shall be presented to the departments concerned for approval or records. All these copies shall be equally effective at law. Transferor: Transferee: Guangdong South Communications Group Co. Utstarcom.Inc. Representative: Representative: Date: December 18, 2001 Date: December 18, 2001 Place of Signature: Guangzhou City, China. Translation Certification ------------------------- I hereby certify that the foregoing represents a fair and accurate English translation of the original Chinese document. Dated: February 5, 2002 By: /s/ Michael J. Sophie --------------------------- Michael J. Sophie Chief Financial Officer EX-10.70 5 dex1070.txt EQUITY TRANSFER AGREEMENT, JANUARY 21, 2002 EXHIBIT 10.70 Equity Transfer Agreement [Translation] Party A: Zhejiang Provincial Telecom. Instruments Factory Domicile: No.118 Moganshan Road, Hangzhou City Name of the Legal Representative: Huang Zhaoxing Title: Director Nationality: China Party B: UTStarcom Inc. Domicile: Harbour Bay Parkway, suite 100 Alameda, CA94502, USA Name of the Legal Representative: Hong Liang Lu Title: CEO Nationality: U.S.A. Party C: UTStarcom(Hangzhou) Communication Co., Ltd. Domicile: Building No.3 Yile Industrial Zone, No.129 Wenyi Road, Hangzhou City Name of the Legal Representative: Wu Ying Title: Chairman of Board of Directors Nationality: U.S.A. WHEREAS: - -------- 1. Party A and Party B are effectively existing company juridical persons which have been registered and incorporated in accordance with the currently effective laws and regulations of China; Party B is an effectively existing company juridical person which has been registered and incorporated in accordance with the currently effective laws and regulations of DELAWARE ,U.S.A. 2. Party A and Party B incorporated the Sino-American equity joint venture, UTStarcom(Hangzhou) Communication Co., Ltd. (hereinafter referred to as Party C) in Hangzhou in 1993. Until the very day of the conclusion hereof, the registered capital of this company is US$12,440,000.00, of which Party A contributes US$1,492,800.00 amounting to 12% of the registered capital of this company; Party B contributes US$10,947,200.00 amounting to 88% of the registered capital of this company. 3. The respective competent organs of Party A, Party B and Party C agree on the equity transfer and the corresponding guarantee issues hereunder. Hereby Party A and Party B, in accordance with the Law of the P.R.China on Chinese-Foreign Equity Joint Ventures and the Several Provisions on the Share Right Variation of Investors of Foreign-Invested Enterprises, under the principles of Equality and Free Will, Consultation and Consensus, Honesty and Good Faith and Compensation of Equal Value, conclude this equity transfer agreement I. Transfer of Equity: 1. Party A contributes US$1,492,800.00 amounting to 12% of the registered capital of Party C; Party B contributes US$10,947,200.00 amounting to 88% of the registered capital of Party C. 2. Prior to the transfer of Party A's equity( i.e. prior to the completion of the administrative registration), the rights and obligations of Party C shall be enjoyed and borne by Party A. After the transfer of equity from Party A, 100% of Party C's equity shall be owned by Party B and all the rights and obligations of Party C shall be enjoyed and borne by Party B. Party A agrees to transfer to Party B all equity of Party C held by Party A, i.e. 12% of the total amount of Party C's equity and Party B agrees to accept the said equity. 3. Neither the total investment amount nor registered capital shall be changed prior to and during the transfer. II. Price of Equity transfer and the Payment Thereof: 1. The Price: upon friendly consultation between Party A and Party B, Party A agrees to transfer 12% of the equity of Party C held by Party A at the price of RMB(Yen)120,000,000.00 with October 31/st/, 2001 as the datum date; Party B agrees to buy such equity held by Party A at the above mentioned price. Note: the transfer price of RMB(Yen)120,000,000.00 has already included Party A's ownership interest in Party C by October 31/st/, 2001. 2. Payment: 1) Within seven days of the conclusion hereof, Party B pays Party A RMB(Yen)60,000,000.00, which shall be put into the account designated by Party A. 2) Within seven days as of the ratification hereof by the competent authority, Party B pays Party A 30,000,000.00 Yuan, which is 50% of the balance after the first sum of equity transfer price is deducted. Party B shall pay this amount to Party A by the method designated by Party A. 3) Within ten days after the completion of the administrative registration of equity transfer with competent authority, Party B pays the equity transfer price of 30,000,000.00 Yuan to Party A only one time. Party B shall pay this amount to Party A by the method designated by Party A. 3. Party C provides warranty for Party B's payment of the price. Provide that Party B failed to perform its obligations hereunder, Party C should bear the warrantor's responsibility of joint and several payment. III. Rights and obligations of Both Parties in the Equity Transfer: 1. Within one month of the conclusion hereof, both Parties shall provide the corresponding documents and Party C shall handle the specific issues of ratification application and registration with competent authority. 2. Party A, Party B and Party C shall pay their respective taxes and fees corresponding thereto according to the laws and regulations concerned. IV. Rights and Obligations of Both Parties After the Completion of the Equity transfer 1. Party C shall be run solely by Party B. Party B enjoys the shareholder's rights and bears the shareholder's obligations, while Party A will no longer participate in the running of the company, nor enjoy the rights or bear the obligations. 2. After such transfer, Party C's all property , creditor's rights and debts shall be undertaken by Party B, thus they have nothing to do with Party A. V. Default Both Party A and Party B shall perform this agreement after it goes into effect; where either party breaches the agreement, the defaulting party shall bear the corresponding liabilities; where the default imposes losses upon the other party, the defaulting party shall indemnify the losses. Where Party B fails to pay Party A the price of equity transfer within the time stipulated herein, Party B agrees to increase the price to RMB130,000,000.00 Yuan, which is treated as the default damages. VI. Guarantee 1. Party A guarantees that the equity transferred to Party B in accordance with the stipulations hereof are held legally by Party A in Party C and that Party A has completely effective right to dispose of the said equity. 2. Party B guarantees to pay Party A the price of equity transfer in accordance with the stipulations hereof. 3. Party A's transfer of the equity has been approved by the competent authorities, the Provincial Telecom Industrial Group Co. Ltd. and the Provincial Telecom Co. Ltd. 4. Party C guarantees that its guarantee issue herein has been approved by its competent departments. VII. Dispute Settlement Party A and Party B shall by friendly consultation resolve the disputes concerning the validity, performance, default, rescission, indemnity and so on hereof. Where the disputes fail to be resolved within sixty days after the disputes occur, both Parties agree to submit the disputes to the arbitration of Hangzhou City Arbitration Committee and the arbitration shall be conducted in Hangzhou in accordance with the arbitration procedures of the said Committee. The arbitral awards shall be final and binding upon both Parties. During the arbitration, the other clauses hereof shall continue to be performed except the disputed parts hereof. VIII. Application of Law This Equity Transfer Agreement shall be governed by the laws and regulations of P.R.China. IX. Supplementary Provisions 1. Only upon the formation of a written agreement thereon after the approval of Party A, Party B and Party C, can this Agreement be modified, amended or rescinded. 2. This Agreement shall be executed only after it is signed and sealed by the representatives authorized by Party A, Party B and Party C and after the first sum of 60,000,000.00 Yuan is paid to the account designated by Party A; this Agreement shall go into effect upon the approval of the competent authority. 3. This Agreement shall have nine copies of originals; Party A, Party B and Party C shall hold one copy respectively and the other copies shall be presented to the competent authorities for approval or records. All the copies have equal legal effect. Party A: Zhejiang Province Telecom. Instruments Factory Party B: UTStarcom Inc. Representative: Representative: Date: January 21, 2002 Date: January 21, 2002
Party C: UTStarcom (Hangzhou) Co., Ltd. Representative: Date: Place of signature: Translation Certification ------------------------- I hereby certify that the foregoing represents a fair and accurate English translation of the original Chinese document. Dated: February 5, 2002 By: /s/ Michael J. Sophie ---------------------------------------- Michael J. Sophie Chief Financial Officer EX-10.71 6 dex1071.txt LEASE AGREEMENT DATED SEPTEMBER 10, 2001 EXHIBIT 10.71 Document number: 2006793 LEASE AGREEMENT Produced by Land Development Agency in Sheng Zhen 1 LEASE AGREEMENT Landlord: LEGEND TECH. ----------- Address: Hi-Tech Industrial Zone, Nan Shen District, Shenzhen "Lease Permit" number: G14875 Tenant: UTSTARCOM --------- Address: 4th Floor, Wearnes Technology Building, Science & Industry Park, Nantou SZ 51806 Pursuant to "Lease Regulation of Sheng Zhen Economic District" and its relevant executive rules, this Lease Agreement is made and entered into by and between LEGEND TECH, hereinafter referred to as "Landlord", and UTSTARCOM, hereinafter referred to as "Tenant". Lease Agreement is as follows: 1. Landlord hereby leases Legend Research and Development Center located in NanShen, Sheng Zhen, hereinafter referred to as "the Premises", to Tenant. The Premises hereby leased to Tenant are nine thousand nine hundred and ninety six square feet. 2. The term of the lease is three years. The lease term commences on September 10, 2001 and will be expire on September 9, 2004. 3. Landlord leases the Premises to Tenant for purposes of general office, research and development. Landlord warrants compliance with relevant national safety standards. However, Tenant shall obtain Landlord's consent in the event of using the Premises for purposes described otherwise. Tenant shall obtain all licenses and permits necessary for changing its use of the Premises. 4. Landlord warrants compliance with all governmental laws, ordinances 2 and regulations applicable to permitted use of the Premises described in section 3 of the Lease Agreement. Tenant warrants compliance with all governmental laws, ordinances and regulations concerning Tenant's use of the Premises. 5. The monthly rent of the Premises is calculated by square feet. The second floor with a total of five thousand four hundred and fifty square feet is calculated monthly at sixty three RMP per square foot. The third floor with a total of four thousand five hundred and forty six square feet is calculated monthly at seventy RMP per square foot. The total amount of monthly rent of the Premises is six hundred sixty one thousand five hundred and seventy RMP. The rental payment is due and payable to Landlord by Tenant on or before the tenth of each month. 6. Landlord shall deliver possession of the Premises to Tenant on or before September 10, 2001. In the event Landlord fails to deliver possession on time, Tenant may require extension of the lease term upon written confirmation by both parties. 7. During the lease term, Landlord agrees to pay real property taxes, assessment of lands for rentals and rental management fees; Tenant agrees to pay utilities and management fees of the Premises. 8. Landlord shall advances the expenses payable by Tenant for the first month of the lease term. Tenant shall reimburse Landlord of the payment within 10 days after one month using the Premises. Thereafter, all payments shall be made in advance by Tenant. The amount of advanced payment is based on the actual expenses in the previous month. Landlord shall provide vouchers to Tenant in accounting all payments. Landlord is entitled to demand payment if Tenant fails to make one month advanced payment. Except as otherwise provided, Landlord is entitled to stop Tenant's use of the Premises in the event Tenant fails to make such advanced payment. 9. Security Deposit is allowed in this Lease Agreement. Landlord may charge Tenant two-month rental, which is one million three hundred twenty three thousand one hundred and forty RMP as security deposit. Landlord shall provide Tenant with vouchers upon reception of such deposit. Landlord and Tenant shall comply with all provisions in the Lease Agreement or shall be held liable in accordance with laws in the event of breach. 10. Landlord warrants compliances with all laws, ordinances and regulations concerning safety of the Premises and facilities within. Tenant shall use the Premises and all facilities properly to avoid damage. Upon expiration or termination of the Lease Agreement, Tenant shall vacate and yield up possession of the Premises to Landlord and warrant good condition of the Premises and facilities, except as ordinary wear and tear. All payments due and payable by Tenant shall be made at the same time. 11. During Tenant's use of the Premises, Tenant shall give prompt notice of defects or need for repairs to Landlord in the event such condition demands; Landlord shall commence repair within three days after reception of Tenant's notice. If Tenant is 3 unable to give notice to Landlord or Landlord fails to repair, Tenant may initiate repair on behalf of Landlord in the witness of the agreement registered agency. Landlord is responsible for the cost of repair, including such repair by Tenant. 12. If the damage or malfunction of the Premises or facilities is caused by Tenant's improper or unreasonable use of the Premises or facilities, Tenant shall be liable for timely repair or the cost of repair. If Tenant fails to make repairs, Landlord may initiate repairs on behalf of Tenant in the witness of the agreement registered agency. Tenant is responsible for the cost of such repairs. 13. During the lease term, Tenant's consent is required in the event Landlord determines to make any alterations, additions or improvements to the Premises. The approval of Government authority is also required. Landlord and Tenant shall make other written agreement with respect of the event described above. During the lease term, Tenant may make alterations, additions or improvements to the Premises subject to consents by Landlord and Government authority. Landlord and Tenant shall make other written agreement with respect to the event described above. 14. Without Landlord's consent, Tenant shall not have the right to assign, transfer or sublet all or part of the Premises to a third party. Upon Landlord's consent, Tenant shall register the assignment or sublease under the governing agency. However, the expiration date of the assignment or sublease shall not be later than the expiration date of this Lease Agreement. Tenant warrants that the Premises shall not be assigned, transferred, or sublet by assignee, transferee or sublessee. 15. During the lease term, Landlord shall notify Tenant one month earlier in the event of assigning or transferring all or part of the Premises. Tenant is entitled the first right of refusal under the same terms. If the Premises are assigned or transferred to a third party, Landlord shall assure that assignee or transferee assume the obligations of this Lease Agreement. 16. During the lease term, the Lease Agreement is terminated upon occurrence of the following events: (1) The obligations of the Lease Agreement cannot be fulfilled as a result of causes beyond reasonable control; (2) If the Premises should be taken for any public use by the government or by right of eminent domain; (3) The invalidation or expiration of Landlord's "rental permit for the Premises". If the Lease Agreement is terminated due to occurrence of section 16(3) and result in Tenant's loss, Tenant is entitled to recover the loss from Landlord. 4 17. Landlord may terminate the lease upon occurrence of the following events. Tenant shall indemnify Landlord's loss resulted from termination of the Lease Agreement. (1) Tenant fails to pay rental in excess of one month; (2) The amount of overdue payments is in excess of ten thousand RMP; (3) Tenant changes the use of the Premises unilaterally without Consents from Landlord and Government authority; (4) Tenant fails to make repairs or pay the cost of repairs in violation of section 12 of this Lease Agreement, which causes severe damage to the Premises or facilities within; (5) Tenant makes alterations, additions or improvements to the Premises without obtaining written consents from Landlord and Government authority; (6) Tenant assigns, transfers or subleases the Premises to a third party without Landlord's written consent. In the event of terminating the Lease Agreement upon occurrence of the events described above, Landlord shall give written notice to Tenant to vacate and return possession of the Premises. The remaining balance of advanced payments must return to Tenant. However, Landlord is not obliged to return the security deposit. 18. Tenant may terminate the lease upon occurrence of the following events. Landlord shall indemnify Tenant's loss resulted from termination of the Lease Agreement. (1) Landlord fails to deliver possession of the Premises in excess of one month; (2) Tenant cannot use the Premises as permitted as a result of Landlord's failure to comply with section 4 of this Lease Agreement; (3) Tenant cannot use the Premises as permitted as a result of Landlord's failure to repair or pay the cost of repairs pursuant to section 11 of this Lease Agreement; (4) Landlord makes alternations, additions or improvements to the Premises without consents of Tenant and Government authority. In the event of terminating the Lease Agreement upon occurrence of the 5 events described above, Tenant shall give written notice to Landlord of vacating and yielding up possession of the Premises. Tenant is entitled recovery of doubled security deposit and a penalty of six hundred thousand RMP and remaining balance of advanced payments made by Tenant. 19. Tenant shall make request to Landlord with respect to extension of the lease term no later than three months before the expiration date of the lease; Landlord shall provide Tenant the first right of refusal under the same term if the Premises are continued to be leased. Landlord and Tenant shall make new lease agreement if agreed to continue the lease and register the new agreement under governing agency. 20. Within five days after the termination or expiration of the lease, Tenant shall vacate and yield up immediate possession of the Premises to Landlord. Landlord may file suit against Tenant in People's court in the event Tenant fails to vacate and yield up possession of the Premises. 21. In the event Tenant fails to pay any installment of rent when such installment is due, Tenant is liable for a late charge in an amount equal to point three percent of such installment multiplied by days overdue. 22. In the event Tenant assigns, transfers or sublets all or part of the Premises unilaterally, Tenant is liable for a penalty in an amount of monthly seventy RMP per square feet assigned, transferred, or subleased. 23. In the event Landlord or Tenant fails to fulfill obligations incurred under this Lease Agreement that results in losses, the non-breaching party is entitled recovery of actual losses and foreseeable profits. 24. The Supplement Agreement entered into by Landlord and Tenant attached hereto is incorporated herein by reference into and made a part of this Lease Agreement. Landlord and Tenant may make supplement agreement for situations not covered in this Lease Agreement and such supplement shall register under governing agency. The supplement agreement is as the same effect as this Lease Agreement. 25. In the event disputes arising from the Lease Agreement, Landlord and Tenant shall resort to mediation; Petition for arbitration in Sheng Zhen arbitration committee may be filed in the event mediation is not successful. 26. The Lease Agreement in Chinese controls. 27. This Lease Agreement is executed in five counterparts. Landlord retains one copy, Tenant retains two copies and the agreement registered agency retains two copies. 28. The Lease Agreement is effective upon due execution. 6 Landlord (seal and signature): Representative: Telephone number: Bank Account: Authorized Agent (seal and signature): Tenant (seal and signature): Representative: Telephone number: Bank Account: Authorized Agent (seal and signature): Date: August 31, 2001. Registrant (seal and signature): Date: September 12, 2001. Agreement Registered Agency: Date: September 12, 2001. (seal and signature) 7 Supplement Agreement Landlord: LEGEND TECH Tel no: 6983988 Tenant: UTSTARCOM Tel no: 6635333 Pursuant to "Lease Regulation of Sheng Zhen Economic District" and its relevant executive rules, Landlord and Tenant hereby enter into this Supplement Agreement to be incorporated into and made a part of the Lease Agreement attached hereto (Lease Agreement number: 2006793) with respect to situations not covered in the Lease Agreement. 1. Premises. Landlord hereby agrees to lease the Premises located in Legend Research and Development Center at South First Avenue in South High Technology Area in Sheng Zhen, China, hereinafter referred to as "the Premises", to Tenant. The rental area in second and third floors of the Premises is nine thousand nine hundred and ninety six square feet (based on the computation by governing agency, including common area shared by the Premises.) 2. Rent and Others. Rent: The second floor with a total of five thousand four hundred and fifty square feet is calculated monthly at sixty three RMP per square feet. The monthly rent for second floor is three hundred forty three thousand three hundred and fifty RMP; the third floor with a total of four thousand five hundred and forty six square feet is calculated monthly at seventy RMP per square feet. The monthly rent for third floor is three hundred eighteen thousand two hundred and twenty RMP. The total amount of monthly rent is six hundred sixty one thousand five hundred and seventy RMP. The rent for the Premises is locked for two years. Rent adjustment in the third year shall be negotiated by Landlord and Tenant. (Rent includes real property taxes, assessment of lands for rentals and rental management fees.) Parking: Landlord shall provide Tenant with thirty three designated parking spaces, ten of which shall be ground parking while the other twenty three parking spaces may be underground. Trade Fixtures: Landlord hereby agrees to lease the Premises to Tenant free of rent for three months for the purpose of trade fixtures installing. However, Tenant agrees to pay management fees of the Premises and utilities used on or from the Premises (including proportionate utilities of common area not separately metered to Tenant.) Landlord shall deliver possession of the Premises to Tenant no later than three days after execution of the Lease Agreement. If Landlord fails to deliver possession of the Premises on time, the lease term can be extended upon negotiations by Landlord and Tenant. The calculation of rent commences on December 10, 2001. 8 Others: (1) In consideration of the obligation of Tenant to pay usage fee as herein provided, Landlord hereby agrees to provide the side of South Avenue of the Premises for installment of Tenant's signs. (Landlord and Tenant's signs of the companies shall be installed in the same manner and format on the Premises.) The annual usage fee is eighty thousand RMP. The calculation of usage fee commences upon the date of use by Tenant. The usage fee can be made in two installments. (Forty thousand RMP is due and payable no later than three days after usage for half a year, the remaining forty thousand RMP is due and payable by the end of the year of usage.) (2) Landlord hereby agrees to allow Tenant to place a test antenna on the top of the Premises free of charge. The height of the antenna shall not be in excess of five feet. Tenant shall comply with all laws or regulations with respect of placing the test antenna. The exact location of placing the test antenna shall be negotiated and confirmed by Landlord and Tenant. 3. Security Deposit. Tenant hereby agrees to pay Landlord a security deposit in the amount of two-months rent before taking possession of the Premises. (One million three hundred twenty three thousand one hundred and forty RMP.) The security deposit shall be returned by Landlord free of interest to Tenant at such time after termination or expiration of the lease that all of Tenant's obligations under this lease have been fulfilled. 4. Monthly Utilities. The utility of the Premises is metered in accordance with relevant regulations by Sheng Zhen city. Tenant shall pay all water, gas and other utilities used on or from the Premises; Tenant shall also pay the proportionate utilities of common areas not separately metered to Tenant pursuant to "Proportion Rules of Research and Development Center utilities". 5. Term and Termination of the Lease. (1) The term of the lease is three years. The term commences on September 10, 2001 and will expire on September 9, 2004. Tenant shall make written request to Landlord with respect to extension of the lease term no later than three months before the expiration date of the lease. Upon Landlord's consent, Tenant may continue to lease the Premises. (2) During the lease term, Landlord shall give notice to Tenant no later than three months before assigning or transferring all or part of the Premises. Landlord shall provide Tenant the first right of refusal under the same term if the Premises are to be assigned or transferred. If the Premises are assigned or transferred to a third party, Landlord shall assure that the assignee or transferee assumed obligations of this Lease Agreement. 9 (3) During the lease term, Tenant would not be entitled recovery of the security deposit if failing to give written notice to Landlord no later than three month before termination of the lease. 6. Management of the Premises. The Premises are managed by Sheng Zhen Mid Sea Management Company, hereinafter referred to as "Management Company". Tenant shall enter into contract with Management Company concerning the Premises immediately after execution of this Lease Agreement. The detailed content and service items are described in resident's covenant. The management fee of the Premises is ten dollars and eighty three cents RMP per month. Adjustment of management fee of the Premises upon expiration of this Lease Agreement shall not be made without consent of the association committee of the Premises. 7. Payment. (1) The monthly rent is due and payable by Tenant on or before the tenth of every month. The rent payment shall be made to a Landlord's designated account, or directly to Landlord's treasury department. Landlord is not obliged to give written notice of rent payment to Tenant. In the event Tenant fails to pay any installment of rent when such installment is due, Tenant is liable for a late charge in an amount equal to point three percent of such installment multiplied by days overdue. (2) Landlord shall provide Tenant with receipt upon reception of the security deposit; Landlord shall also provide Tenant with formal rental vouchers upon reception of rent payment made by Tenant. 8. Purposes and Regulations. (1) The Premises shall be used for the purposes of general office, research and development purposes. (The Premises are currently vacant for rental.) (2) Landlord warrants the lawfulness of permitted use described above. Landlord also warrants the Premises are in conformity with national safety standards. (Tenant shall obtain approval from Government authority as to installment of trade fixtures or alterations to the Premises. Extinguishers in the Premises shall be furnished by Tenant.) (3) Landlord warrants compliance with all governmental laws, ordinances and regulations applicable to permitted use of the Premises. (4) Tenant warrants compliance with all governmental laws, ordinances and regulations during the use of the Premises. 10 (5) Tenant shall not erect unauthorized buildings around common areas of the Premises. Landlord is entitled to demand possession of the Premises if otherwise. Tenant is liable for all losses resulted therein. 9. Possession Delivery and Maintenance. (1) Landlord warrants the Premises and facilities are in conformity with all applicable governmental laws, ordinances and regulations. Tenant shall use the Premises and facilities properly to avoid unreasonable damage. Upon termination or expiration of the lease, Tenant shall vacate and yield up possession of the Premises to Landlord and warrant good condition of the Premises and facilities, except ordinary wear and tear. All expenses due and payable by Tenant shall be made at the same time. (2) During Tenant's use of the Premises, Tenant shall give prompt notice of defects or needs to repair to Landlord in the event such condition demands; Landlord shall commence repair within three days after reception of notice from Tenant. If Landlord fails to repair, Tenant may initiate repairs on behalf of Landlord in the witness of the agreement registered agency. Landlord is responsible for the cost of repairs in both given situations. (3) If the damage or malfunction of the Premises or facilities is caused by Tenant's improper or unreasonable use of the Premises or facilities, Tenant shall be liable for timely repair or the cost of repair. If Tenant fails to repair, Landlord may initiate repair on behalf of Tenant in the witness of the agreement registered agency. Tenant is responsible for the cost of such repair. (4) During the lease term, Tenant shall give written notice to Landlord and obtain consent from Government authority no later than thirty days before making alterations, additions, improvements or trade fixtures installments to the Premises. In the event of emergencies, such as typhoon, earthquake, fire or burglary, etc., Management Company and Landlord have the right to enter the Premises for emergency without giving notice to Tenant. (5) During the lease term, upon obtaining consents from Landlord and Government authority, Tenant may make alterations, additions, improvements or trade fixture installments to the Premises. 10. Remedies for Breach of this Agreement. (1) Upon occurrence of the following events, Landlord has the right to stop furnishing water, gas and other utility services. Tenant is liable for losses resulted therein. a. Tenant fails to pay rental in excess of one month; b. The amount of overdue payment by Tenant is in excess of ten thousand RMP; 11 c. Tenant changes the use of the Premises unilaterally without obtaining consents from Landlord and Government authority; d. Tenant assigns, transfers or sublets all or part of the Premises to third party without Landlord's consent; e. Tenant fails to make repair or pay the cost of repair in violation of section 9(3) of this Supplement Agreement, which causes severe damage to the Premises or facilities within; f. Tenant makes alterations, additions, improvements or trade fixture installments to the Premises without consents from Landlord and Government authority in violation of section 9(5) of the Supplement Agreement. Upon occurrence of the events described above, Landlord is entitled to terminate the lease unilaterally and repossess the Premises after giving written notice to Tenant. The remaining balance of advanced payments made by Tenant shall be returned to Tenant. However, Landlord is not obliged to return the safety deposit. (2) Upon occurrence of the following events, Tenant has the right to terminate the lease. Landlord is liable for losses resulted therein. a. Landlord fails to deliver possession of the Premises in excess of one month; b. Tenant is not able to use the Premises as permitted due to Landlord's violation of section 8(3) of the Supplement Agreement; c. Tenant is not able to use the Premises due to Landlord's failure to make repairs or pay the cost of repair without causes in violation of section 9(2) of the Supplement Agreement; d. Landlord shall not make alterations, additions or improvements to the Premises without obtaining consents from Tenant and Government authority. Upon occurrence of the events described above, Tenant is entitled to terminate the lease unilaterally and vacate the Premises after giving written notice to Landlord. Tenant is entitled to recovery of doubled security deposit, a penalty in an amount of six hundred thousand RMP by Landlord and the remaining balance of advanced payments made by Tenant. 11. Vacation of the Premises. (1) Tenant shall give written notice to Landlord no later than three 12 months before vacating of the Premises if such is earlier than the expiration date of the lease. Upon inspection of the Premises by Landlord, the security deposit shall be returned to Tenant free of interest if Tenant fulfills all obligations incurred in this Agreement. (2) Upon expiration, termination of the lease or earlier vacating of the Premises, Tenant shall not remove or damage the annexed fixtures to the Premises, including but not limited to doors, windows, walls, ceilings, lights, air holes and electricity facilities; However, Tenant shall remove fixtures that are deemed unnecessary to keep or as garbage by both parties. In the event Tenant removes trade fixtures such as air conditioning at Tenant's own expenses, Tenant shall restore the Premises to their original condition. Tenant shall complete removal and vacation of the Premises within five days. 12. The Lease Agreement is terminated automatically upon occurrence of the following events during the lease term: (1) The obligations of the Lease Agreement cannot be fulfilled as a result of causes beyond reasonable control; (2) If the Premises should be taken for any public use by the government or by right of eminent domain; (3) The invalidation or expiration of Landlord's "rental permit for the Premises". Tenant is entitled to recovery of the losses resulted from termination of the Lease Agreement due to section 12(3). 13. Dispute Resolution. (1) Landlord and Tenant may make any supplement agreement with respect to situations not covered in this Agreement during the lease term. In the event disputes arise from the Lease Agreement, Landlord and Tenant shall resort to mediation; Petition for arbitration in Sheng Zhen arbitration committee may be filed in the event mediation is not successful. (2) The Lease Agreement is hereby agreed and entered into by Landlord and Tenant. This Lease Agreement is effective upon due execution by both parties. The Agreement is executed in five counterparts. Both parties retain two copies and the agreement registered agency retains one copy of the Agreement. 14. Miscellaneous. (1) Landlord shall execute formal "Lease Agreement" of Sheng Zhen 13 Land Development Agency with Tenant on or before February 10, 2001. Tenant may request recovery of losses from Landlord in the event of failure to execute the formal Lease Agreement. "Lease Agreement" is in the same effect as this Supplement Agreement. In the event of conflict between "Lease Agreement" (agreement number:2006793) and this Supplement Agreement, Supplement Agreement controls. (2) Correspondence between Landlord and Tenant in Chinese controls. (3) Chinese interpretation of this Agreement controls. (4) The Agreement is hereby agreed and entered into by Landlord and Tenant. The Supplement Agreement is effective upon due execution by both parties. The Supplement Agreement is executed in five counterparts. Both parties retain two copies and the agreement registered agency retains one copy of the Agreement. Landlord: /s/ LEGEND TECH Tenant: /s/ UTSTARCOM, Inc. --------------- ------------------- Bank: Bank: Account number: Account number: Representative: Representative: Date: Date: Registrant: Agreement Registered Agency: Date: Executed in Legend Research and Development Center in Sheng Zhen, China. 14 Translation Certification ------------------------- I hereby certify that the foregoing represents a fair and accurate English translation of the original Chinese document. Dated: February 8, 2002 By: /s/ Michael J. Sophie ---------------------------------------- Michael J. Sophie Chief Financial Officer 15 EX-21.1 7 dex211.txt SUBSIDIARIES OF UTSTARCOM, INC. Exhibit 21.1 UTSTARCOM SUBSIDIARIES
Place of Incorporation Name or Organization - ---- ---------------------- UTStarcom China Co., Ltd. (UTSC)........................... China UTStarcom (Hangzhou) Communications Co., Ltd. (HUTS)....... China Advanced Communication Devices Corporation (ACD)........... California
1 EX-23.1 8 dex231.txt CONSENT OF PRICEWATERHOUSECOOPERS Exhibit 23.1 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-82458) and the Registration Statements on Form S-8 (Nos. 333-44548 and 333-60150) of UTStarcom, Inc. of our report dated January 14, 2002 relating to the consolidated financial statements, which appears in this Annual Report on Form 10-K/A. We also consent to the incorporation by reference of our report dated January 14, 2002 relating to the financial statement schedules, which appears in this Annual Report on Form 10-K/A. PricewaterhouseCoopers LLP San Francisco, California February 11, 2002 EX-23.2 9 dex232.txt CONSENT OF WILLAMETTE MANAGEMENT ASSOCIATES Exhibit 23.2 CONSENT OF INDEPENDENT APPRAISER We hereby consent to the use in this Form 10-K of UTStarcom, Inc. ("UTStarcom") and any amendments thereto, of all summary information contained therein relating to our independent appraisal of Wacos, Inc. ("Wacos") in connection with the acquisition of Wacos by UTStarcom in December 1999 and of all summary information contained therein relating to our independent appraisal of Advanced Communication Devices Corporation ("ACD") in connection with the acquisition of ACD by UTStarcom in November 2001. We also consent to the references to our firm in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Notes to Consolidated Financial Statements" contained in this Form 10-K. WILLAMETTE MANAGEMENT ASSOCIATES /s/ STEVEN D. GARBER -------------------------------------- Date: February 6, 2002 -----END PRIVACY-ENHANCED MESSAGE-----